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    CH 3 Consumer Behavior

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    - Total utility increases as marginal utility is positive, is maximum when marginal utility is zero, and starts declining when marginal utility becomes negative. - The law of diminishing marginal utility states that as consumption of a good increases, the marginal utility from additional units decreases. - Ordinal utility theory assumes utility can only be ranked, not measured. Indifference curves show combinations of goods providing equal utility. The marginal rate of substitution is the rate at which one good can be substituted for another on an indifference curve. - A consumer achieves equilibrium where their highest attainable indifference curve is tangent to their budget constraint, maximizing utility subject to their budget.

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    CH 3 Consumer Behavior

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    37 views23 pages
    - Total utility increases as marginal utility is positive, is maximum when marginal utility is zero, and starts declining when marginal utility becomes negative. - The law of diminishing marginal utility states that as consumption of a good increases, the marginal utility from additional units decreases. - Ordinal utility theory assumes utility can only be ranked, not measured. Indifference curves show combinations of goods providing equal utility. The marginal rate of substitution is the rate at which one good can be substituted for another on an indifference curve. - A consumer achieves equilibrium where their highest attainable indifference curve is tangent to their budget constraint, maximizing utility subject to their budget.

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    Ch 3 Consumer Behavior

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    - Total utility increases as marginal utility is positive, is maximum when marginal utility is zero, and starts declining when marginal utility becomes negative. - The law of diminishing marginal utility states that as consumption of a good increases, the marginal utility from additional units decreases. - Ordinal utility theory assumes utility can only be ranked, not measured. Indifference curves show combinations of goods providing equal utility. The marginal rate of substitution is the rate at which one good can be substituted for another on an indifference curve. - A consumer achieves equilibrium where their highest attainable indifference curve is tangent to their budget constraint, maximizing utility subject to their budget.

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    37 views23 pages

    CH 3 Consumer Behavior

    Uploaded by

    future tube
    - Total utility increases as marginal utility is positive, is maximum when marginal utility is zero, and starts declining when marginal utility becomes negative. - The law of diminishing marginal utility states that as consumption of a good increases, the marginal utility from additional units decreases. - Ordinal utility theory assumes utility can only be ranked, not measured. Indifference curves show combinations of goods providing equal utility. The marginal rate of substitution is the rate at which one good can be substituted for another on an indifference curve. - A consumer achieves equilibrium where their highest attainable indifference curve is tangent to their budget constraint, maximizing utility subject to their budget.

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    of 23

    CHAPTER THREE

    THEORY OF CONSUMER BEHAVIOR


    1
    THE CONCEPT OF UTILITY

    • The satisfaction which a consumer gets by having or consuming a


    goods and services is called utility.
    • The same commodity gives different utilities to different
    consumers.
    • Even for the same consumer, utility varies from unit to unit, from
    time to time and from place to place.
    2
    Total utility

    • The total utility refers to the sum total of satisfaction which a


    consumer receives by consuming the various units of the
    commodity.
    • The more units of the commodity he/she consumes the greater
    will be his/her total utility or satisfaction from it, up to a certain
    point and then starts to decline.
    3
    Marginal utility

    • The marginal utility of a commodity is defined as the


    change in total utility resulting from one unit change in
    the consumption of a good.

    TU
    MU 
    Q
    4
    Relationship between TU and MU
    • The relationship between total utility and marginal utility can be easily
    discussed with the help of the following table.

    Units of oranges consumed Marginal utility (utils) Total utility (utils)


    0 - 0
    1 10 10
    2 8 18
    3 5 23
    4 2 25
    5 1 26
    6 0 26
    7 -3 23 5
    6
    Summary of relationship between total utility
    (TU) and marginal utility (MU)

    • TU increases as long as marginal utility is positive.


    • TU is Maximum when MU is zero.
    • TU starts declining when MU becomes negative.
    7
    Cardinal utility theory
    • It is an economic theory which operates under the
    assumption that utility from different units of good or
    between different goods is measurable Quantitatively.

    Assumptions of a cardinal utility theory


    • Rationality
    • Cardinal utility
    • Diminishing marginal utility 8
    The law of diminishing marginal utility
    (LDMU)
    • According to the law for any individual consumer the value that
    he/she attaches to successive units of a particular commodity will
    diminish steadily as his/her total consumption of that commodity
    increase, the consumption of all other goods being held constant.

    • In other words, As the amount of commodity consumed increases, the


    utility derived by the consumer from the additional units, that’s
    marginal utility, goes on decreasing.
    9
    THE ORDINAL UTILITY THEORY

    • It is theory which operates under the assumption that utility from


    different units of a good or between different goods need only be
    rank able and not measurable.

    • If a consumer gets more utility from bundle A than from bundle


    B, it means that the consumer will rank bundle A above bundle B.
    his/her need is not known by “how much” A is preferred to B.
    10
    Assumptions of ordinal utility theory
    • Rationality
    • Complete ordering
    • Consistency
    • Transitivity
    • Non-satiation
    • Diminishing marginal rate of substitution
    11
    INDIFFERENCE SET, CURVE AND MAP

    Indifference set
    • An indifference set refers to a table which shows various
    combinations of two goods which give equal level of satisfaction
    (utility) to the consumer.
    • Since each of these combinations gives equal satisfaction, the
    consumer is indifferent among them.

    12
    Indifference Set
    Combinations Good X (units) Good Y (units)
    A 1 10
    B 2 7
    C 3 5
    D 4 4

    13
    Indifference curve Indifference map

    14
    Properties of indifference curve
    • Indifference curve is downward sloping
    • Indifference curve is convex to the origin
    • Two indifference curves never cross each other

    15
    Marginal rate of substitution (MRS)

    • The marginal rate of substitution of X for Y (MRSx,y) is defined as


    the number of units of good Y that must be given up in exchange
    for an extra unit of good X so that the consumer maintains the
    same level of satisfaction.
    • In other words, it shows the rate at which one good is substituted
    for another good, while remaining on the same indifference
    curve.

    16
    Combination Good X Good Y MRSx,y
    A 1 12  -
    B 2 8 4
    C 3 5 3
    D 4 3 2
    E 5 2 1

    17
    The budget line or Iso-expenditure line

    • Budget line is a graph that shows various combinations of two


    commodities which can be purchased within a given budget at a
    given prices of the two commodities.
    • Any combination of the two commodities on or within the
    budget line is attainable, whereas any combination above the
    budget line is not attainable (because of the budget constraint).

    18
    • Let a consumer have Y = birr 2,000, Px = birr 50 and Py = birr40.
    • Find
    • Qx? And
    • Qy?
    Solution

    Qx=Y/Px Qy=Y/Py
    Qx= 2000/50 Qy= 2000/40
    Qx= 40 Qy= 50

    19
    The Budget Line

    20
    Consumer’s equilibrium
    • A consumer shall be in equilibrium where he/she can maximize
    his/her utility, subject to his/her budget constraint.
    • In other words, where the highest attainable indifference curve
    and the budget line are tangent to each other the consumer will
    attain equilibrium.
    • The equilibrium combination of the goods X and Y gives him/her
    maximum satisfaction because that relates to the highest
    indifference curve the consumer can reach within his/her
    available budget. 21
    Consumer’s Equilibrium

    22
    23

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