Chapter 3: Consumer Behavior and Utility
Maximization
Objectives of chapter 3:
• A closer look at the law of demand
• Theory of consumer behavior
• Utility maximization and demand curve
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Introduction
– When we go the market, we buy things, such as food,
hygiene product, electronics, etc.
– Anyway, when we check the bucket of 2 people, we will
see that the things they bought are very different.
Ravy bought apple while Chenda bought orange. Why?
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A closer look at the law of demand
• Income effects: is the impact that a change in price of a
product has on a consumer’s real income, and
consequently on the quantity demanded of that goods.
• Substitution effects: is the impact that a change in a
product’s price has on its relative expensiveness, and
consequently on the quantity demanded.
• The Law of Diminishing Marginal Utility:
– Utility of a goods or service is a satisfaction or pleasure
someone gets from consuming it.
– Utility is different from usefulness.
– Utility is subjective. A thinks that a pen has more utility than B
does. As it is subjective, it is difficult to quantify.
– For study purpose, we mark utility unit as utils. 4 utils> 3 utils.
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Utility
• Total utility: total amount of satisfaction or pleasure a
person get from consuming a certain amount of goods or
services.
– Reading a book give pleasure to Riya, which can be quantified as
20 utils. Reading three books give pleasure to Riya as 50 utils.
• Marginal utility: the amount of satisfaction or pleasure a
person get from consuming 1 more unit of the product.
– Reading the first book give pleasure to Riya 20 utils. Reading the
second book give pleasure to Riya 17 utils. Reading the thrid book
give pleasure to Riya 13 utils.
– Marginal Utility (MU) = Change of total utility (TU)/Change in
quantity of product consumed (Q)
– MU = ∆TU/∆Q
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The law of diminishing marginal utility
(a)
• The more the product a person consume, the less
desirable the person is for that product.
– The first plate of rice provides great utility for the eater. The
second plate also provides utility for the eater but less than the
previous plate. The third plate provides even less utility than the
second plate.
• When marginal utility decreases and still remain positive,
the total utility increases. However, when marginal utility
decreases below zero level (negative), the total utility
starts falling down.
– The 10th plate of rice will provide negative utility for the eater.
(the case of Chouchuok in Preah Vesanda story)
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The law of diminishing marginal utility
(b)
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The law of diminishing marginal utility
(c)
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The law of diminishing marginal utility
and the demand curve
• If successive units of a good provide smaller and smaller
amount of marginal utility, then the consumer will buy
additional units of a product only if its price falls.
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Theory of consumer behavior
• Rational behavior: a rational person try to use her/his
money income to get the greatest amount of
satisfaction, or utility. We can say that a rational person
maximize her/his utility.
• Preference: each consumer has a clear cut preference
for certain goods and services available in the market.
• Budget constraint: at a point of time, consumer has
limited income.
• Prices: consumers price-takers, that is their individual
buying behavior will not affect the market price of any
given product.
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Utility maximizing rule
• To maximize satisfaction, the consumer should allocate
her or his money income so that the last dollar spent on
each product yields the same amount of marginal utility.
• Or we can say that the utility is maximized at a
combination of two goods at which:
• Marginal Utility Product A get from a dollar spent on A =
Marginal Utility Product B get from a dollar spent on B
• MU_A/Price_A = MU_B/Price_B
• Inferior options: other combinations of A and B that do
not meet the above condition.
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Utility maximization and the demand
curve
• When the price of a product X falls, the quantity
demanded of the product X will increase.
• Before the price of the product X falls, we can get a
combination of the product X with other products, which
makes the utility of the consumer maximized. This
combination will give the quantity demanded of the
product X at that given price.
• When the price of the product X falls, we will have a new
combination of the product X with other products, which
makes the utility of the consumer maximized. This
combination will give a greater quantity demanded of the
product X at that lower price.
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Utility maximization and the demand
curve
• When the price of a product X falls, the quantity
demanded of the product X will increase.
• Before the price of the product X falls, we can get a
combination of the product X with other products, which
makes the utility of the consumer maximized. This
combination will give the quantity demanded of the
product X at that given price.
• When the price of the product X falls, we will have a new
combination of the product X with other products, which
makes the utility of the consumer maximized. This
combination will give a greater quantity demanded of the
product X at that lower price.
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