CHAPTER 4

THEORY ON CONSUMERS BEHAVIOR

Content

Theory on consumers utility

The principle of diminishing marginal utility

Consumers surplus

Consumers preferences

Budget constraint

Utility maximizing choice

I. Theory on consumers utility

1. Some definitions
1.1. Utility (U)
-

The benefit or satisfaction that a person gets

from the consumption of a good or service
An abstract concept
Unit free
Subjectivity (depends on consumers
perception)

I. Theory on consumers utility

1. Some definitions
1.2. Total utility (TU)
-

The total benefit or satisfaction that a person

gets from the consumption of goods and
services
Depends on the persons level of consumption
more consumption generally gives more total
utility

I. Theory on consumers utility

1. Some definitions
1.3. Marginal utility (MU)
-

The change in total utility resulting from a one-unit

increase in the quantity of a good consumed

I. Theory on consumers utility

2. The principle of diminishing marginal
utility
- In a certain time period, continuous consumption
will tend to the increase in total utility but a
decrease in marginal utility

* Application

I. Theory on consumers utility

3. Consumers surplus (CS)
- The difference between P
the market price and the
price buyer is willing to
pay

CS

P*

- The area below demand

curve and above the
market price line

II. Theory on consumers choice

1. Consumers preferences
- Some assumptions:
+ Preferences do not depend on goods price or income
+ People can sort all the possible combinations of goods
they might consume into 3 groups: preferred, not
preferred and indifferent
+ Consumers prefer more to less
+ Consumers preference is transitivity

II. Theory on consumers choice

1. Consumers preferences
A

II. Theory on consumers choice

1. Consumers
preferences

Movie

Indifference curve:
shows the various
combinations of consumption
quantities that lead to the
same level of well-being or
happiness

Better
A

C
I2

B
I1

Food

II. Theory on consumers choice

1. Consumers preferences

Indifference curves characteristics

Downward sloping, the closer to the right

hand-side, the higher utility consumer can gain
Never intersect
X.MUx + Y.MUy = 0
-MUx / MUy = Y / X
-MUx / MUy : the slope of Indifference curve =
The marginal rate of substitution (MRS)

II. Theory on consumers choice

1. Consumers preferences

MRS:

A
B
C
D

II. Theory on consumers choice

MRS reveals consumers preference toward good
and service
Y

II. Theory on consumers choice

*Special indifference curve
Perfect substitute goods

II. Theory on consumers choice

*Special indifference
curve
Perfect Complement goods

II. Theory on consumers choice

2. Budget constraint
- Budget line (BL): shows the various combinations of

consumption that consumer can get from the available

income
Movie
I=PX.QX+PY.QY
(Y)
C
=> QY= I/PY (PX/PY).QX
A
=> PX/PY : the slope of budget
constraint or price line
B
Area C: can not afford
D
Area D: Inefficient
Food
(X)

II. Theory on consumers choice

2. Budget constraint
- I, PX= const, PY changes

PY decreases:
PY increases:

BL1

II. Theory on consumers choice

2. Budget constraint
- I, PY= const, PX changes

PX decreases:
PX increases:

BL1
X

II. Theory on consumers choice

2. Budget constraint
- PX, PY= const, I changes

I increases:
I decreases:

BL1
X

II. Theory on consumers choice

3. Optimal consumption combination
Y

C
D
I3

B
I2
I1
X

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II. Theory on consumers choice

3. Utility maximizing choice
- At point C, the indifference curve slope is equal to
the budget lines slope

- In case of many goods and services:

Chapter 4: Review
A consumer decides to spend his income of
200$ on X and Y.
a. PX = 4$, PY = 2$. Draw this consumers budget line
b. Due to the decrease in quantity supplied, Ys price goes
up to 4$. Draw new budget line
c. There is a promotion from the seller. Buying 20 units of Y
at price of 2$, consumer will get 10 units more free of
charge. This is applied on the first 20 units of Y only.
The following units are still applied the price of 2$
(except the bonus). Draw new budget line

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