CHAPTER IV

CONSUMER BEHAVIOR AND

UTILITY MAXIMIZATION
LEARNING OBJECTIVES

After reading this chapter, you will learn about:

1. Goods and services
2. Consumer tastes and preferences
3. Maslow’s hierarchy of needs
4. The economics of satisfaction
5. Consumer surplus

We, as consumers are unique in many ways. We have different needs, wants and
demands. We differ in likes and dislikes, standards, reactions, lifestyles, traditions, etc.
However, due to said uniqueness our behavior as consumers is hard to identify and
measure. From an economic standpoint, our objective as consumers is to maximize our
satisfaction given our limited budget (or income). With this in mind, economics seeks to
explain why consumers behave differently and in a particular manner.
In this chapter, you will learn how we, as consumers, behave in order to
maximize satisfaction from the goods and services that we consume given our limited
income.

CONSUMER

Who is the consumer? A consumer is one who demands goods and services.
Without consumption (households), there is no need for production (firms). The
consumer is king in a capitalist or free-market economy. Producers, for their own
interest, have to satisfy the needs and wants of consumers in order to earn profits. In
this perspective, all of us are consumer; as we live our daily lives, we demand goods
and services the moment we wake up in the morning until we retire to our beds at
night.
Since we are the ultimate purchasers of goods and services, we have the power to
determine what is produced; this is referred to as consumer sovereignty. In general
terms, if we as consumers demand more of goods, then more of it will be supplied or
vice versa. The producers simply obey the wishes and desires of consumers. This
therefore implies that producers are ‘passive agents’ (Pass and Lowes 1993) in the price
system, simply responding to what consumers want. However, in certain kinds of
markets (notably oligopoly and monopoly), producers are so powerful vis-à-vis

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consumers that it is they who effectively determine the range of choice available to us
consumers. This said, our freedom to satisfy our human wants is not completely
unlimited. The government restricts consumer sovereignty for the good of society and
its individual consumers. For example, the government prohibits the use of dangerous
drugs and substances and regulates the use of products that are health hazards, like
alcoholic beverages and cigarettes. It also regulates products that are destructive to the
environment.

GOODS AND SERVICES

Goods refer to anything that provides satisfaction for the needs, wants, and
desires of the consumers. They can be any tangible economic products (like cars,
books, clothes, etc.) that contribute directly (final goods) or indirectly (intermediate
goods) to the satisfaction of human needs and wants. Services, on the other hand,
are any intangible economics activities (such as hairdressing, catering,
insurance, banking, telecommunications, etc.), that likewise contribute
directly or indirectly to the satisfaction of human wants.
Tangible goods can be classified according to, but not limited to, the following:

CONSUMER GOODS
These are the goods that yield satisfaction directly to any consumer .
These goods are primarily sold for consumption, and not to be used for further
processing or as input/raw materials needed in producing another good. Usually, these
are the goods that are easily accessible to consumers (e.g. soft drinks, bread, crackers,
cellular phone loads).

ESSENTIAL OR NECESSITY GOODS VS. LUXURY GOODS

Essential or necessity goods are goods that satisfy the basic needs of
man. In other words, these are goods that are necessary to our daily existence. These
are goods that we cannot live without such as food, water, shelter, clothing, electricity,
medicines, etc.
Conversely, luxury goods are those that men may do without, but are used to
contribute to his comfort and well- being. Examples of luxury good/s are private jet,
yacht, luxury cars, perfumes, jewelry, etc.

ECONOMIC AND FREE GOOD

An economic good is that which is both useful and scarce. It has value
attached to it and a price has to be paid for it’s used. If a good is so abundant that
there is enough of it to satisfy everyone’s needs without anybody paying for it, that
good is free.
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Water from our faucet is an economic good, because we are not utilizing it for free, we
have to pay its distributor. The air that we breathe and the sunlight coming from the
sun are examples of free goods.

CONSUMER TASTES AND PREFERENCES

Consumers have various tastes and preferences. Generally, tastes and preferences are
determined by age, income, education, gender, occupation, customs and traditions, as
well as culture. Preferences are the choices made by consumers as to which products or
services to consume. The strength of our preferences will determine which product to
buy, given our limited disposable income and thus, the demand of products. As well as
which product to buy, we consumers also express our preferences for the particular
brand of a product we purchase. Even in the choice of food, clothing, and shelter, for
instance, we differ in our choices and preferences. Some prefers bread to rice, others
like fish and vegetables instead of meat. In fact, we can recognize that no two
consumers have exactly the same likes and dislikes. Some individuals have simple
tastes and few preferences; other are sophisticated and extravagant in their
preferences and tastes.
Before we leave this discussion, it is also important to understand what a brand
is. Simply defined, a brand is the name, term, or symbol given to a product by a
supplier in order to distinguish his offering from that of similar products supplied by
competitors. Brand names are used as focal point of product differentiation between
suppliers. Examples of brand names include Coca Cola for the soft drink products;
Guess, Levi’s, and Lacoste for RTW products, etc. Now, can you identify other brands
that you usually buy or consume?

MASLOW’S HIERARCHY OF NEEDS

Maslow’s hierarchy of needs identifies the basic priorities of every consumer. Maslow
saw human needs in the form of a hierarchy, ascending from the lowest to the highest.
He concluded that when one set of needs is satisfied, this kind of needs ceases. The
basic human needs placed by Maslow in an ascending order of importance (like a
pyramid) are: (a) physiological needs, (b) security/ safety needs, (c) social needs, (d)
esteem needs, and (e) self-actualization needs.

PHYSIOLOGICAL NEEDS
These are the basic needs for sustaining human life itself, such as food, water,
warmth, shelter, sex, and sleep. According to Maslow, until these needs are satisfied to
the degree necessary to maintain life, other higher needs will not stimulate people.

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 SAFETY NEEDS
These are the needs to be free of physical danger, stimulated by the fear of losing
one’s work, property, food, or shelter.

SOCIAL NEEDS
These needs covers the value of the sense of belonging, love, care, acceptance (of
self and by others), and understanding of family, relatives and friends.

ESTEEM NEEDS
These needs explain the importance of self-esteem, recognition, individual status,
and society’s general acceptance of an individual. This kind of need produces
satisfaction in the form of power, prestige, status, and self-confidence.

SELF-ACTUALIZATION NEEDS
These needs explain the worth of a person’s self-development, growth, realization,
and achievement. According to Maslow, this is the highest need in the hierarchy. It is
the desire to become what is capable of becoming-to maximize one’s potential and to
accomplish something.

THE ECONOMICS OF SATISFACTION

You might be wondering by now how economics can explain the behavior of consumers
in order to attain a maximum level of satisfaction of the goods and services that they
generally consume. In this section, we try to explain how consumers attain maximum
satisfaction level on the many goods and services available to them for consumption.
However, we have to remember at this point that satisfaction is a relative term. We
differ in the ways we are satisfied, as well as in the degree of our satisfaction. As we
have said earlier, no two consumers have the same likes and dislikes. This section will
discuss some of the theories that economist have devised to explain how consumers
are able to attain maximum level of satisfaction when consuming a particular good or
service.

UTILITY THEORY
Utility in economics, refers to the satisfaction or pleasure that an
individual or consumer gets from the consumption of a good or service that
he purchases. For purposes of economic analysis, utility is also measured by how
much a consumers are willing to pay for a good/service.
Table 4.1 presents a hypothetical demand schedule for siopao. You will notice in
the table that the amount of money that you are willing to buy for an additional unit of
siopao declines. What is the reason for this? As you might have experienced, the more
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siopao you eat, the more you become satiated so that you are not willing to spend
more for the next siopao that you wish to consume. In other words, the satisfaction or
utility that you derived in the consumption of siopao declines as you consume more and
more of it.
The hypothetical examples illustrate what the utility theory is all about. It simply
tries to explain how our satisfaction or utility as consumers decline when we try to
consume more and more of the same good at a particular point in time.
Two important concept need to be explained before we totally understand the
utility theory. These are: the marginal utility and total utility concepts

Marginal utility is defined as the additional satisfaction that an individual derives

from consuming an extra unit of a good or service . Marginal means ‘additional’ or
‘extra’. In economics, we use marginal analysis in the examination of the effects of
adding one extra unit to, or taking away one unit from, some economic variable. For
this purpose, we are interested in the incremental or additional unity derived from an
additional consumption of a commodity. Thus, the marginal utility of a commodity is the
increase in total utility or satisfaction derived from the consumption of an additional or
extra unit of such commodity; it is the loss of utility of satisfaction if one less unit is
consumed.

Table 4.1Hypothetical Demand Schedule for Siopao

Price (P) Quantity Demanded (QD)

15.00 1
12.75 2
10.50 3
8.25 4

This table shows that as you continue to buy siopao, your willingness to pay
for it continuously declines because your satisfaction from the good declines as
you consumes more of it.

Total utility, on the other hand, is the total satisfaction that a consumer derives
from the consumption of a given quantity of a good or service in a particular time
period. Our total utility usually increases as we consume more and more of a good or
services, but generally the increase is at slower or declining rate. These implies that

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each extra units consumed add less marginal utility than the previous as we become
satiated with the good or services we are consuming.
Let us illustrate this using the hypothetical utility schedule presented in Table
4.2. Assume that at the end of our class, you were to hurry that you went directly to
the criteria. In the criteria, you brought and consume one siopao for your merienda. In
this case, your total marginal utilities are 40 utils. Assume further that you consumed
another siopao because you were very hungry after the class. Your total utility now
increases to 90 utils since the marginal utility increased by 50 utils. Let us now assume
that you consumed five siopao. Take note in that table that your total utilty for the fifth
unit is 350 utils. However, marginal utility is always more important, yet marginal utility
has declined to 80 utils. Why is his so? This is because of the Law of Diminishing
Marginal Utility.

This Law states that as a consumer gets more satisfaction in the long
run, he experiences a decline in his satisfaction for the goods and services.
This means that consumption of more successive units of the same increases total
utility, but at a decreasing rate because marginal utility diminishes. In other words, as
we consume more and more of a good or service, we like it less and less, and as we
consume increasing amounts of a good or service, we derive diminishing utility, or
satisfaction, from each additional unit consumed.

Table 4.2 Hypothetical Schedule for Siopao

Unit Purchased Total Utility Marginal Utility

1 40 40
2 90 50
3 170 80
4 270 100
5 350 80

The table shows the various units purchased, the total utility for each unit
purchased, and the corresponding marginal utility. The derivation of marginal
utility is shown below.

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MATHEMATICAL DERIVATION OF MARGINAL UTILITY
How do we derive marginal utility? Marginal utility is simply the change in total
utility divided by the change in quantity. Thus,

MU=∆ TU
∆Q

Expanding our equation, we can solve for marginal utility using the following equation:

MU= TU2 -TU1

Q2 - Q1

Where:
TU2= the new total utility
TU1= the original utility
Q2= the new quantity consumed
Q1= the original quantity consumed
Applying the formula, we can derive the marginal utility for the total utility
presented in Table 4.2. Thus, if we want to determine the marginal utility from the
consumption of two pieces of siopao to three pieces, we can simply apply the
formulated presented above.
MU=170-90
3-2
MU=80

You may try the other combination of quantity and total utility and solve for the
marginal utility.

GRAPHICAL ILLUSTRATION OF TOTAL UTILITY AND MARGINAL UTILITY

Figure 4.1 and 4.2 are graphical presentations of the total and marginal utility concepts.
As we discussed earlier, when we consume more and more of a good or service, our
total utility increases but at decreasing rate. This illustrated in Figure 4.1 where we
have a convex utility curve. We can see from the curve, as indicated by the dashed
lines, that the initial consumption of 1 unit of Q to 2 units of Q has a larger angle than
the following consumption (from 2 units to 3 units). We can therefore imply that the
consumption from 1 unit of Q to 2 units of Q has a total utility of 10 utils or an
incremental increase of 5 utils, while for the next consumption it only increased to 11
utils, or any an additional 1 util.

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Until when do we stop consuming the same good? As consumers, we have our own
unique way of maximizing our utility or satisfaction. we are given the opportunity to
maximize our satisfaction by continuously consuming more units of a certain good until
our satisfaction falls down zero. when our marginal utility hits zero, we can say that we
have already reached the peak of our satisfaction for that good/ service. Beyond this
point ( negative MU), we will have already exceeded our satisfaction such that we can
stop consuming the same good.

CONSUMER SURPLUS

We have already encountered the term surplus in our discussion of price equilibrium in
the previous chapter. We have to remember that the term surplus is used in economics
for several related quantities. For this section, our interest is to understand what
consumer surplus is.

In general, consumer surplus is a measure of the welfare we gain from the

consumption of goods and services; it’s a measure of the benefits that we derive from
the exchange of goods. in specific terms, consumer surplus is the difference between
the total amount that we are willing and able to pay for a good or service, and the total
amount that we actually pay for that good or service.

Let us illustrate this through an example. suppose you are interested in buying a
new pair of maong pants. With a budget of Php3,000.00, you head to the mall to look
for the pants. Upon visiting a boutique, you find out that the pants that you like most
only cost Php2,500.00, so you bought the pants immediately. What is your consumer
surplus?

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 Take note in our example that you are willing to pay Php3,000.00 for the pants.
However, when you bought the pants your actual cost was only Php2,500.00, so
therefore you have a consumer surplus of Php500.00. Why? Because consumer surplus
is simply the difference between what you pay ( for the pants and all other goods or
services that you buy) and what you would have been willing to pay for them.

We can also illustrate our example of the consumer surplus using a graph. Since
the consumer surplus is the difference between what you pay and the price you would
have been willing to pay, then the consumer surplus in figure 4.3 is the area between
Php 2,500.00 (the actual price) and Php 3,000.00 (the price that you are willing to pay
for the pants).

Could you think of other examples based on your own experience how you are
able to apply the concept of consumer surplus.

CHAPTER SUMMARY

 A consumer is one who demands goods and services.

 Goods refer to anything that provides satisfaction to the needs, wants, and
desires of the consumer.
 Services are any intangible economic activities ( such as hairdressing, catering,
insurance, banking, telecommunications, etc.), that likewise contribute directly or
indirectly to the satisfaction of human wants.
 Consumer goods are goods that yield satisfaction directly to any consumer.
 Essential or necessity goods are goods that satisfy the basic needs of man.

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 Luxury goods are those which men may do without, but which are used to
contribute to his comfort and well -being.
 Tastes and preferences are determined by age, income, education, gender,
occupation, customs and traditions as well as culture.
 Maslow’s hierarchy of needs identifies the basic priorities of every consumer:
(a) physiological needs; (b) security, or safety needs; (c) social needs; (d)
esteem needs; and (e) self-actualization needs.
 Utility, in economics, refers to the satisfaction or pleasure that an individual or
consumer gets from the consumption of a good or service that he or she
purchases.
 Marginal utility is defined as the additional satisfaction that an individual
derives from consuming an extra unit of a good or service.
 Total utility is the total satisfaction that a consumer derives from the
consumption of a given quantity of a good or service in a particular time or
period.
 Law of Diminishing Marginal Utility states that as a consumer gets more
satisfaction in the long run, he experiences a decline in his satisfaction for goods
and services.
 Consumer surplus is a measure of the welfare we gain from the consumption
of goods and services, or a measure of the benefits that we derive from the
exchange of goods.

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