consumer-2

Pham Thi Hanh Nhan – SEM - HUST
Lesson 5.
Consumer Behavour
Background to Demand
Principles of Microeconomics - PTHN - SEM - HUST29/01/2015 Slide -- 1

Contents
1. Principle of analysis
2. Consumer Preferences (Consumer Utility)
3. Constrained Optimization
4. Consumer Choices
5. Demand
6. Factors effecting demand
7. Summary/exercises
29/01/2015 Principles of Microeconomics - PTHN - SEM - HUST Slide -- 2

Principles of Microeconomics - PTHN - SEM - HUST Slide -- 3
a. “Rational” Consumer Objectives
1. In the Neoclassical economics, the goal of
consumer behavior is utility maximization [or
maximization of Net benefits]:
rational consumer: a person who weighs up the
costs and benefits to him/her of each
additional unit of a good purchased
2. Consumer choice among various alternatives is
subject to constraints:
· income or budget
· prices of goods purchased
· preferences
29/01/2015

b. Models of Consumer Behavior
1. Marginal Utility approach
· cardinal measure of utility
· problem of related goods
2. Indifference approach
· ordinal utility
· related goods
· observable behavior

2. Consumer Preferences (Consumer Utility)
Utility Approach to Consumer Behavior
1. Need for cardinal measure of utility
2. Analysis is useful for explaining
behavior
3. Total and Marginal utility
4. “law of diminishing Marginal Utility”
5. Equi-marginal rule and utility
maximization

2.1 Need for cardinal measure of utility
Definition of consumer utility?
· Util = an imaginary unit of satisfaction from
consumption of a good
· Total utility (TU) is total satisfaction a
consumer gets from the consumption of all the
units of a good consumed within a given time
period.
· Marginal utility (MU) is the extra satisfaction
gained from consuming one extra unit of a good
within a given time period

Total utility [TU] is defined as the amount of utility (utils) an
individual derives from consuming a given quantity of a good
during a specific period of time. TU = f(Q, preferences, . .)
1 2 3 4 5 6 7 Q/ut
20
40
60
100
80
120
Utility
Q
1
2
4
8
5
6
7
3
TU
30
55
75
90
100
105
105
100
.
.
......TU
TU

Nature of Total Utility
· When more and more units of a good are consumed
in a specific time period, the utility derived tends
to increase at a decreasing rate.
· Eventually, some maximum utility is derived and
additional units cause total utility to diminish.
· As an example, think of eating “free” hot cakes.
· It is possible for total utility to initially increase
at an increasing rate.

Marginal Utility
· Marginal utility [MU] is the change in total utility
associated with a 1 unit change in consumption.
· As total utility increases at a decreasing rate,
MU declines.
· As total utility declines, MU is negative
· When TU is a maximum, MU is 0 [This is
sometimes called the “Satiation point” or the point
of “absolute diminishing utility.”

Marginal Utility [MU] is the change in total utility [DTU]
caused by a one unit change in quantity [DQ] ;
MU = DTU
DQ
Utility
Q
1
2
4
8
5
6
7
3
TU
30
55
75
90
100
105
105
100
MU
DQ=1 DTU=30
The first unit consumed increases TU by 30.
.
Remember that the MU is associated with the
midpoint between the units as each additional
unit is added.
30
DQ=1 DTU=25
.25
DQ
The 2cd unit increases TU by 25.
25
DQ=1 DTU=20
.
20
.
15
10
.
5
0
-5
1 2 3 4 5 6 7 Q/ut
10
20
30
MU
. ..
MU

1 2 3 4 5 6 7 Q/ut
20
40
60
100
80
120 TU
TU
1 2 3 4 5 6 7 Q/ut
10
20
30
MU
The MU is the slope of TU or the
rate of change in TU associated
with a one unit change in quantity.
[Using calculus, MU is the change in TU
as change in quantity approaches 0.]
The first unit consumed, DQ
increases TU by 30, DTU.
DQ
.
.
.
. . . . .
DTU
For the first unit:
DTU
DQ
MU = =
1
30
The slope of TU is = 30,
DQ
DTU
. The second unit changes TU [ DTU] by
25, The slope of TU between the 1 and
second unit is 25.
.
between the 2cd and 3rd
units DTU = 20 or the
slope of TU is 20.
. . . . . .
MU
MU is the slope of the TU.
Where MU = 0, TU is a maximum.
max TU

Consumer Preferences
· Both MU and TU are determined by the “preferences” or
utility function of the individual and the quantity consumed.
· Utility cannot be measured directly but individual choices
reveal information about the individual’s preferences
· Surrogate variables [age, gender, ethnic background,
religion, etc.] may be correlated with preferences.
· There is a tendency for TU to increase at a decreasing rate
[MU declines] as more of a good is consumed in a given time
period: i.e. “diminishing marginal utility”

Diminishing Marginal Utility
· Initially, it may be possible for TU to increase at
an increasing rate. In which case MU will increase
[MU is the slope of TU which is increasing].
· Eventually, as more and more of a good are
consumed in a given time period, TU continues to
increase but at a decreasing rate; MU decreases.
· This is called the point of “diminishing marginal
utility.”

Consumer Choices
· If there were no costs associated with choices,
the individual will consume a good until MU = 0 [this
maximizes TU or the total benefits, TB]
· Typically, individuals are constrained by a budget
[or income] and the prices they pay for the goods
they consume.
· Net benefits are maximized where MB = MC; as
long as the MU or MB of the next unit of good purchased exceeds
the Price or MC, it will increase net benefits

Society and Individual
· The individual will purchase more of a good so long
as their perceived or anticipated MB exceeds the
price they must pay for the good: Buy so long as
MB > P, optimum where, P = MB
· From a social perspective that good should only be
produced and sold if the price is greater than or
equal to the MC: Sell so long as P > MC, optimum
where P = MC
· Social optimum when MB = P = MC

Constrained Optimization
· Individual choices then become a function of the
price of the good, income [budget], prices of
related goods and preferences.
· QX = f (PX , Y, PY, Preferences, . . . )
· Where:
· PX = price of good X
· Y = income
· PY = prices of related goods
· “preferences” is the individual’s utility function

Utility and Demand
· Individual choice is influenced by:
· QX = f (PX , Y, PY, Preferences, . . . )
· These are the same variables in the
demand function
· The forces that shape the demand
function can be analyzed with utility
analysis

Qy
Qx
B > PxQx + PyQy
The budget constraint can be expressed:
The amount of good Y that can be purchased
is the budget divided by the price of good Y, B
Py
B
Py
For an B = $80,
and Py = $5
80
5
= 16 =
The amount of good X
that can be purchased
is,
B
Px
B
Px
For an B = $80,
and PX = $3
80
3
= 26.7 =
Connecting the two intercepts
identifies all combinations of
goods X &Y that can be
purchased for a budget of $80,
Py = $5, and PX = $3.
Any combination
inside area 0AC
can be purchased
for less than $80.
0
A
C

Good X
Utility X
Qx
1
2
4
8
5
6
7
3
TUx
30
55
75
90
100
105
105
100
20
15
10
5
0
-5
30
25
MUx
Good Y
Utility Y
Qy
1
2
4
8
5
6
7
3
TUy
60
90
110
120
128
128
120
100
60
30
20
10
8
0
- 8
- 20
MUy
Consider an individual’s utility preference for 2 goods, X & Y;
If the two goods were “free,”
[ or no budget constraint],
the individual would consume
each good until the MU of
that good was 0, 7 units
of good X and 6 of Y.
Once the goods have a price
and there is a budget
constraint, the individual
will try to maximize the
utility from each additional
dollar spent.

Utility X
Qx
1
2
4
8
5
6
7
3
TUx
30
55
75
90
100
105
105
100
20
15
10
5
0
-5
30
25
MUx
For PX = $3, the
MUX per dollar
spent on good
X is;
Given the budget constraint, Individuals will attempt to
gain the maximum utility for each additional dollar spent,
“the marginal dollar.”
MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
For PY = $5, the
MUY per dollar
spent on good
Y is;
Utility Y
Qy
1
2
4
8
5
6
7
3
TUy
60
90
110
120
128
128
120
100
60
30
20
10
8
0
- 8
- 20
MUy
MUY
PY
12
6
4
2
1.6
0

Utility X
Qx
1
2
4
8
5
6
7
3
TUx
30
55
75
90
100
105
105
100
20
15
10
5
0
-5
30
25
MUx
MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
Utility Y
Qy
1
2
4
8
5
6
7
3
TUy
60
90
110
120
128
128
120
100
60
30
20
10
8
0
- 8
- 20
MUy
MUY
PY
12
6
4
2
1.6
0
Now the preferences of the individuals and the relative prices
of the two goods are displayed in the tables.
If the objective is
to maximize utility
given prices,
preferences, and
budget, spend each
additional $ on the
good that yields
the greater utility
for that
expenditure.

MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
MUY
PY
12
6
4
2
1.6
0
Given the preferences of the individual and the relative
prices of the goods [PX = $3, PY = $5], the MU’s for
each dollar spent are:
To maximize TU given a budget of $30,the first
expenditure would logically be for good Y since
the MUY for each dollar is 12.
 $5The second expenditure is for good X,
[MUX $ is greater than MUY $]$3
The third & fourth expenditures are for
good X since the MU per dollar spent is
greater for X than Y.
$3
$3
The fifth expenditure is for is for good Y.
 $5
Continue to maximize the MU per $ spent.
$3
 $5
$3
AT THIS POINT YOU HAVE SPENT THE BUDGET OF $30.
MUX
PX
>MUY
PY
, BUY X ! MUX
PX
<MUY
PY
, BUY Y !

MUX
PX
>MUY
PY
says that the marginal utility of an additional
dollar spent on good X is greater than that of
a dollar spent on good Y.
MUX
PX
<MUY
PY
indicates that the MU per dollar spent on good
Y exceeds that of a dollar spent on good X.
If the amount spent on the two goods is equal to the budget
then
MUX
PX
>MUY
PY
suggests that the individual should buy
less of Y in order to buy more of X.
MUX
PX
<MUY
PY
says to purchase less X to pay for additional
amounts of Y.
=MUX
PX
MUY
PY
is an equilibrium condition!

PX X + PY Y = B
=MUX
PX
MUY
PY
subject to the constraint:
insures the individual has maximized their total utility and
has not spent more on the two goods than their budget.
This model can be expanded to include as many goods as
necessary:
=MUX
PX
MUY
PY
= = . . . =MUZ
PZ
MUN
PN
subject to;
PX X + PY Y + Pz Z + . . . + PN N = B
From this information a demand for the goods can be
constructed.

Utility X
Qx
1
2
4
8
5
6
7
3
TUx
30
55
75
90
100
105
105
100
20
15
10
5
0
-5
30
25
MUx
MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
Utility Y
Qy
1
2
4
8
5
6
7
3
TUy
60
90
110
120
128
128
120
100
60
30
20
10
8
0
- 8
- 20
MUy
MUY
PY
12
6
4
2
1.6
0
Given the preference functions for goods X and Y,
and the prices of the two goods: PX = $3, PY = $5.
the MU of derived
from each dollar
of expenditure
can be calculated.
If the individual is
maximizing utility,
their choices,
constrained by
their preferences,
the prices and
their budget can
be shown:

MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
MUY
PY
12
6
4
2
1.6
0
prices [PX = $3, PY = $5] and
budget [$30], the individual’s choices were:
 $5$3
$3
$3
 $5
$3
 $5
$3
Given preferences,
Five units of X and 3 units of Y were purchased
These choices can be shown in the context of
a demand model:
1 2 3 4 5 6 7 QX/ut
PX
1
2
3
4
5
At PX = $3,
given budget,
Py and preferences,
5 units of X are purchased.
PX =
5
This point lies on the
demand for good X.
.

MUY
PY
12
6
4
2
1.6
0
1 2 3 4 5 6 7 QX/ut
PX
1
2
3
4
5
.
Given the individual’s preferences, the price of Y [PY]
and the budget [B = $30], the individual purchased
5 units of X when the price of X [PX ] was $3.
MUX
PX
10.
8.33
6.67
5.00
3.33
1.67
0
[$3]
Raise the price of X [PX ] to $5 and the MUX per
$ spent is reduced.
MUX
PX
6
5
4
3
2
1
0
[$5]
MUX
PX
6
5
4
3
2
1
0
[$5] Choices about spending the $30 are now:
 $5
 $5
$5
$5
 $5$5
The $30 is now spent.
=
MUX
PX
MUY
PY
At PX = $5,
ceteris paribus,
3 units of X are
purchased.
. DemandThat
portion
of demand
between $3 and $5
is mapped!

Demand
· By continuing to change the price of good X
[and holding all other variables, PY , budget or
income and preferences constant,] the rest of
the demand for good X can be mapped.
· All price and quantity combinations on the
demand for X are equilibrium points for
the consumer [They are maximizing utility;
holding all other variables, PY , budget or income
and preferences constant]

1 2 3 4 5 6 7 QX/ut
PX
1
2
3
4
5
By changing the price of the good [in this case, good X] and
holding all other variables [PY , budget or income and
preferences] constant, the demand for the good can be
mapped.
The demand function
is a schedule of the
quantities that
individuals are willing
and able to buy at a
schedule of prices
during a specific
period of time,
ceteris paribus.

1 2 3 4 5 6 7 QX/ut
PX
1
2
3
4
5
The demand function has a negative slope because of the
income and substitution effects.
Income effect: As the price of a good that you buy increases
and money income is held constant, your real income decreases
and you can not afford
to buy as much as you
could before.
Substitution effect: As
the price of one good rises
relative to the prices of
other goods, you will tend
to substitute the good
that is relatively cheaper
for the good that is
relatively more expensive.

Income effects
· As the price of a good that you buy
increases, you will have less real income.
· This is the basis of price indices that
measure changes in real income as prices
rise or fall.
· The consumer price index is one of the
indices that is used [currently there is a
debate about how it is calculated].

Substitution Effects
· As the price of a good increases
[decreases] while the prices of other
goods is constant, it becomes
relatively more [less] expensive.
· Individuals would substitute relatively
less expensive goods for relatively
more expensive ones even if their
real income were constant.

1 2 3 4 5 6 7 QX/ut
PX
1
2
3
4
5
6
7
Notice that someone is willing and able to pay $6.80 for the
first unit.
6.80
If the market price [established by S and D]
were $3, the buyer would purchase at $3 even though they
were willing to pay
$6.80 for the first unit.
They receive utility
that they did not have
to pay for [6.80-3.00].
This is called consumer
surplus.
At market equilibrium,
.Consumer surplus will be
the area above the market
price and below the demand
function.
consumer
surplus
CONSUMER SURPLUS

Demand
· Demand functions can be derived from utility
[cardinal measures] or indifference functions
[ordinal measures]
· Normally, demand functions show and inverse
relationship between price and quantity
· a change in price “causes” a change in “quantity
demanded”
· a change in any other variable [income, prices of
related goods, population, preferences, . . .] will
“cause a change in demand” or shift of demand

consumer-2

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