Mr Sydney Armstrong
ECN 1100 Introduction to Microeconomics
Lecture Note (5)
Consumer Behaviour
Evidence indicated that consumers can fulfill specific wants with succeeding units of a commodity but
that each added unit provides less utility than the last unit purchased. A product has utility if it can
satisfy a want: Utility is want-satisfying power. The utility of a good or service is the satisfaction or
pleasure one gets from consuming it. Three characteristics of the concept must be emphasized:



“Utility” and “usefulness” are not synonymous. Paintings by Picasso may offer great utility to art
connoisseurs but are useless functionally (other than for hiding a crack on a wall).
Implied in the first characteristic is the fact that utility is subjective. The utility of a specific
product may vary widely from person to person. A “jack-up” truck may have great to someone
who drives off-road but little utility to someone too old to climb into the rig. Eyeglasses have
tremendous utility to someone who has poor eyesight but no utility at all to persons like Mr.
Armstrong with 20/20 vision.
Because utility is subjective, it is difficult to quantify. But for illustration purposes we assume
that people can measure satisfaction with units called utils.
Total Utility and Marginal Utility
It is important for us to distinguish between total utility and marginal utility. Total utility is the
total amount of satisfaction or pleasure a person derives from consuming some specific
quantity. Marginal utility is the extra satisfaction a consumer realizes from an additional unit of
that product. Alternatively, we can say that marginal utility is the change in total utility that
results from the consumption of 1 more unit of a product. Mu = ΔTU/ΔQ
Hot Dogs
Consumed
0
1
2
3
4
5
6
7
Total
Utility, Utils
0
10
18
24
28
30
30
28
Marginal
Utility, Utils
10
8
6
4
2
0
-2
This information can be used to construct two graphs which are shown below.
Total Utility
35
30
25
20
Total Utility
15
10
5
0
1
2
3
4
5
6
7
8
Marginal Utility
12
10
8
6
4
Marginal Utility
2
0
-2
1
2
3
4
5
6
7
8
-4
Starting at the origin (from the graph or table), we observe that each of the first 5 units
increases total utility (TU) but by a diminishing amount. Total utility reaches a maximum with
the addition of the sixth unit and then decline. So in the graph and table above we find that
marginal utility (MU) remains positive but diminishes through the first 5 units (while total utility
increases but at a decreasing rate). Marginal utility is zero for the sixth unit (because that unit
doesn’t changes total utility). Marginal utility then becomes negative with the seventh unit and
beyond (because total utility is falling).
The table and graphs above tell us that each successive hot dog yield less extra utility, meaning
fewer utils, than the preceding one as the consumer’s wants for hot dog comes closer and
closer to fulfillment. The principle that marginal utility declines as the consumer acquire
additional units of a given product is known as the law of diminishing marginal utility. It is
important to note that diminishing marginal utility always steps in after the first unit.
Consumer Choice and Budget Constraint
In addition to explaining the law of demand, the idea of diminishing marginal utility explains
how consumers allocate their money incomes among the many goods and services available for
purchase.
The typical consumer’s situation has the following dimensions.




Rational behavior – The consumer is a rational person, who tries to use his or her
money income to derive the greatest amount of satisfaction, or utility from it.
Consumers want to get the most for their money or, technically, to maximize their
utility. They engage in rational behavior.
Preferences – Each consumer has clear cut preferences for certain of the goods and
services that are available in the market. We assume that buyers also have a good idea
of how much marginal utility they will get from successive units of the various products
they might purchase.
Budget constraint – At any point in time the consumer has fixed/ limited amount of
money income. Since each consumer supplies a finite amount of human and property
resources to society, he or she earns only limited income. Thus, every consumer faces
what economists called a budget constraint (budget limitation), even those who earn
millions of dollars a year. Of course, budget constraints are more severe for consumers
with average incomes than for those with extraordinarily high incomes.
Prices – Goods are scares relative to the demand for them, so every good carries a price
tag. We assume that the price tags are not affected by the amount of specific goods
each person buys.
Utility-Maximizing Rule
Of all the different combinations of goods and services a consumer can obtain within his or her
budget, which specific combination will yield the maximum utility or satisfaction? To maximize
satisfaction, the consumer should allocate his or her money income so that the last dollar spent
on each product yield the same amount of extra (marginal) utility. We call this the utility
maximizing rule. When the consumer has balanced his or her margins using the rule, there is no
incentive to alter the expenditure pattern. The consumer is in equilibrium and would be worse
off if there were any alteration in the bundle of goods purchased, providing there is no
change in taste, income, products or prices.
Utility Maximizing Rule:
MU of product A/ price of A = MU of product B/ Price of B…MU of product Z/ Price of Z
Assume that John’s income is $10
Product A: Product B:
Price = $ 1 Price = $ 2
Unit of the Marginal
Marginal
product
utility (A) Utility (B)
First (1)
10
24
Second (2) 8
20
Third (3)
7
18
Fourth (4)
6
16
Fifth (5)
5
12
Sixth (6)
4
6
Seventh (7) 3
4
Base on the table above which combination of product A and product B will maximize the
consumer utility?
Unit of the
product
First (1)
Second (2)
Third (3)
Fourth (4)
Fifth (5)
Sixth (6)
Seventh (7)
Assume that John’s income is $10
Product A: Price = $ 1
Product B: Price = $ 2
Marginal
Marginal Utility Marginal
Marginal Utility
utility (A) per Dollar
Utility (B) per Dollar
(MU/price) (A)
(MU/price) (B)
10
10
24
12
8
8
20
10
7
7
18
9
6
6
16
8
5
5
12
6
4
4
6
3
3
3
4
2
From the table above, the utility maximizing combination of goods attainable by John is 2 units
of A and 4 units of B Note that the marginal utility per dollar for both products is equal to 8. By
summing the marginal utility information from column 2 and column 4, we find that John is
obtaining 18 (10+8 =18) utils of satisfaction from 2 units of product A and 78 (24+20+18+16=78)
utils of satisfaction form the 4 units of B. His 10 dollars optimally spent (1*2 + 2*4 = 10),
yielding 96 utils of satisfaction (18+78 =96).
Note that there are two situations where the marginal utility per dollar for each product is
equal at 10 and 6. Why these outcomes are inferior to the one above?
First, when the marginal utility per dollar is equal to 10 for both products the first thing to note
is that John is not spending all of his income, because at this point he is purchasing only 1 unit
of product A with 2 units of product b which gives us 1*1 +2*2= 5. In this case he is only
spending 5 dollars of his income. Apart from this his total utility is 54 utils that is 10 utils from
the 1 unit of product A and 44 (24+20= 44) utils from the 2 units of product B which is less than
96 when compare to the combination above.
Second, when the marginal utility per dollar for both products is equal to 6 the combination of
product A and B at this point will produce a greater level of satisfaction than the previously
discussed combinations, but given John’s income of $10 this combination is unattainable. This is
so because when the marginal utility per dollar for both products is 6 he would be purchasing 4
units of product A with 5 units of product B which gives us 1*4 + 2*5= 14. In essence to get this
combination he would need an income of 14 dollars which he doesn’t have. What is total utility
at this point?
What needs to happen in the following case to put the consumer into equilibrium when:
MU of product A/ price A < MU of product B/ price B
MU of product A/ price A > MU of product B/ Price B
Indifference Curve Analysis
A more advance explanation of consumer behavior and equilibrium is based on:


Budget lines
Indifference curves
The Budget Line:
What is attainable
A budget line (or, more technically, the budget constraint) is a schedule or curve that shows the
various combinations of two products a consumer can purchase with a specific money income.
If the price of product A is $ 1.50 and the price for product B is $ 1, a consumer can purchase all
the combinations of A and B shown in the table below with the consumer money income being
$12. At one extreme, the consumer might spend all of his or her income on 8 units of A and
have nothing left to spend on B according to the table. Or, by giving up 2 units of A and thereby
“freeing up” $3, the consumer could have 6 units of A and 3 units of B. And so on to the other
extreme, at which the consumer could buy 12 units of B at $1 each, spending his or her entire
money income on B with nothing left to spend on A.
The Budget Line: whole-Unit Combination
of A and B Attainable with an Income of
$12
Units of A
Units of B
Total
(Price= $1.50) (Price= $1) Expenditure
8
0
$ 12 (= 12+0)
6
3
$12 (= 9+3)
4
6
$12 (=6+6)
2
9
$12 (=3+9)
0
12
$12 (=0+12)
This information can be represented graphically as shown below, however the graph is not
restricted to whole units of A and B as in the table. Every point on the graph represents a
possible combination of A and B, including fractional quantities.
Product A
Budget Line
9
8
7
6
5
4
3
2
1
0
0
2
4
6
8
10
12
14
Product B
The slope of the budget line measures the ration of the price of B to the price A; more precisely,
the absolute value of the slope is PB/PA = $1/$1.50 = 2/3 or 0.67. This is the mathematical way
of saying that the consumer must forego 2 units of A (measured on the vertical axis) to buy 3
units of B (measured on the horizontal axis). In moving down the budget line, 2 units of A (at
$1.50 each) must be given up to obtain 3 more units of B (at $1 each). This yields a slope of 2/3.
The Budget line has two other significant characteristics:


Income changes – The location of the budget lines varies with money income. An
increase in money income shifts the budget line to the right; a decrease in money
income shifts the curve to the left. To verify this recalculate the table above, assuming
that income is (a) $24 and (b) $6 and plot the new budget lines.
Price changes – A change in product price also shifts the budget line. A decline in the
price of both products- equivalent of an increase in real income- shifts the curve to the
right. Conversely, an increase in the prices of A and B shifts the curve to the left. Note
what happens if the price of B changes while the price of A and income remain the
same. If the price of B drops, the lower end of the budget line fans outward to the right.
The opposite will happen if the price of B increases in this case the lower end of the
budget line fans inwards to the left. In both instances the line remains “anchored” at 8
units on the vertical axis because the price of A has not changed.
Income increase
Income Decrease
QA
QA
QB
QB
Price A and B Decreases
Price A and B Increases
QA
QA
QB
Price of B Decreases
QB
Price of B increases
QA
QA
QB
QB
Price of A Decreases
Price of A Increases
QA
QA
QB
QB
Indifference Curves
What is preferred
Budget lines reflect “objective” market data, specifically what income and prices. They reveal
combinations of product A and product B that can be purchased, given current money income
and prices.
Indifference curves, on the other hand reflect “subjective” information about consumer
preferences for A and B. An indifference curve shows all the combination of two products A and
B that will yield the same level of satisfaction or total utility to a consumer. The table and graph
below presents a hypothetical indifference curve for product A and B. The consumer’s
subjective preferences are such that he or she will realize the same total utility from each
combination of A and B shown in the table or on the curve. So the consumer will be indifferent
(will not care) as to which combination is actually obtained.
An Indifference Schedule (Whole Units)
Combination Units of A
Units of B
I
12
2
K
6
4
L
4
6
M
3
8
Product A
Indifference Curve
14
12
10
8
6
4
2
0
0
2
4
6
8
10
Product B
Indifference curves have several important characteristics:


Indifference curves are Downwards sloping – An indifference curve slopes downward
because more of one product means less of the other if total utility is to remain
unchanged. Suppose the consumer moves from one combination of A and B to another,
say from J to K in the table and graph above. In so doing, the consumer obtains more of
product B, increasing his or her total utility. But because total utility is the same
everywhere on the curve, the consumer must give up some of product A, to reduce total
utility by a precisely offsetting amount. Thus more of b necessitates less of A and the
quantity of A and B are inversely related. A curve that reflects inversely related variables
is downwards-sloping.
Indifference Curves are Convex to the Origin – A downward-sloping curve can be
concave (bowed outwards) or convex (bowed inwards) to the origin. A concave curve
has an increasing slope (steeper) slope as one move down the curve, while a convex
curve has a diminishing (flatter) slope as one move down the curve. Note that the
indifference curve is convex to the origin. Its slope diminishes or become flatter as we
move from J to K to L, and so on down the curve. The slope of the indifference curve at
each point is called the Marginal Rate of Substitution (MRS). The MRS shows the rate at
which the consumer is willing to substitute one good foe another (in this case B for A) to
remain equally satisfy. The diminishing slope of the indifference curve means that the
willingness to substitute B for A diminishes as one move down the curve. MRS = Δ Y/ΔX

Indifference Curves Never Intersect – Indifference curves identify a given level of
satisfaction. Higher indifference curve mean higher level of satisfaction, lower
indifference curves means lower levels of satisfaction. So when indifference curves
intersect it would be difficult to identify on which curve the consumer is having a
greater level of satisfaction.
Indifference Map
The single indifference curve as the one above reflects some constant (but unspecified) level of
total utility or satisfaction. It is possible and useful to sketch a whole series of indifference
curves or an indifference map, as shown below. Each curve reflects a different level of total
utility. Specifically, each curve to the right of our curve (labeled I) reflects combinations of A
and B that yield more utility than I. Each curve to the left of I reflects less total utility than I. As
we move out from the origin, each successive indifference curve represents a higher level of
utility.
Quantity of A
I
Quantity of B
Special Indifference Curves
Perfect Substitutes
Quantity of A
Perfect Complements
Quantity of A
Quantity of B
Quantity of B
Equilibrium at Tangency
Since the axes for the budget line and indifference map are the same we can superimpose a
budget line on the consumer’s indifference map as shown below. By definition, a budget line
indicates all the combinations of A and B that the consumer can attain with his or her money
income, given the price of A and B. Of these attainable combinations, the consumer will prefer
the combination that yields the greatest satisfaction or utility. Specifically, the utilitymaximizing combination will be the combination lying on the highest attainable indifference
curve. It is called the consumer’s equilibrium position.
Quantity of A
Y
W
QA1
I3
X
I2
2
QB1
Z
I
I
I
I
Quantity of B
In the graph above the consumer’s equilibrium position is at point X, where the budget line is
tangent to I. Why not point Y? Because Y is on a lower indifference curve I2. By moving down
the budget line (by shifting dollars from purchases of A to purchases of B) the consumer can
attain an indifference curve farther from the origin and thereby increase the total utility derived
from the same income. Why not Z? For the same reason: Point Z is on a lower indifference
curve I2. By moving up the budget line (by reallocating dollars from B to A) the consumer can
get to higher indifference curve I and increase total utility.
How about W on the indifference I3? While it is true that W would yield a greater total utility
than X, point W is beyond (outside) the budget line and hence is not attainable by the
consumer. Point X represents the optimal attainable combination of product A and B. Note
that, according to the definition of tangency, the slope of the highest attainable indifference
curve equals the slope of the budget line. Because the slope of the indifference curve reflects
the MRS (marginal rate of substitution) and the slope of the budget line is P B/PA, the
consumer’s optimal or equilibrium position is the point where
MRS = PB
.
PA
The Derivation of the Demand Curve
The budget line determining the above equilibrium position assumes that money income is $12
and that PA = $1.5 and PB = $1. Let’s see what happens to the equilibrium position when we
increase PB to $1.5 and hold both money income and the price of A constant.
The result is shown in the graph below. The budget line fans to the left, yielding a new
equilibrium point X1 where it is tangent to the lower indifference curve I2. At X1 the consumer
buys QB2 units of B and QA2 units of A. our interest is in B, and we now have sufficient
information to locate two points on the demand curve for product B. We know that at
equilibrium point X the price of B is $1 and the quantity purchased is QB1 units; at equilibrium
point X1 the price of B is $1.5 and QB2 are purchased.
By simple manipulation of the price of B in an indifference curve-budget line context, we have
obtained a downward-sloping demand curve for B. We have thus again derived the law of
demand assuming “other things equal,” since only the price of B was changed.
Quantity of A
QA2
X1
X
I3
QA1
QB2
I
I2 I
I
2
Quantity
of B
I
QB1
Price of B
1.5
1
D
QB2
QB1
Quantity of B
The notes came from McConnell &Brue, Economics, 15th edition, 2002.
You are required to supplement this with additional reading.