DEMAND AND CONSUMER BEHAVIOR Dela Cruz, Gerielle Marie A.

OUTLINE
I. Demand and Consumer Behavior
A. Choice and Utility Theory
a. Marginal Utility and the Law of Diminishing Marginal Utility

b. Numerical Example
B. Derivation of Demand Curves
a. The Equimarginal Principle
b. Why Demand Curve Slope Downward
c. Leisure and Optimal Allocation of Time
d. Analytical Developments in Utility Theory
OUTLINE
C. Alternative Approach
a. Substitution Effect
b. Income Effect
D. From Individual to Market Demand
a. Demand Shifts
b. Substitutes and Complements
c. Empirical Estimates of Price and Income Elasticities
OUTLINE
E. The Economics of Addiction
F. Paradox of Value
G. Consumer Surplus
a. Applications of Consumer Surplus
OUTLINE
II. Appendix
A. The Indifference Curve
a. Law of Substitution
b. The Indifference Map
B. Budget line or Budget Constraint
C. The Equilibrium Position of Tangency
D. Changes in Income and Price
a. Income Change
b. Single Price Change
E. Deriving the Demand Curve
CHOICE AND UTILITY THEORY
 Utility
Denotes satisfaction
Refers to how consumers rank different goods and
services
 Theory of Demand
Consumer choose the bundle of consumption goods that
they most prefer.
MARGINAL UTILITY AND THE LAW OF
DIMINISHING MARGINAL UTILITY
 Marginal Utility – increment to your utility
 Law of Diminishing Marginal Utility
 States that the amount of extra or marginal utility declines as a person
consumes more and more of a good

The Law of Diminishing Marginal Utility states that, as the

amount of a good consumed increases, the marginal utility
of that good tends to decline.
MARGINAL UTILITY AND THE LAW OF
DIMINISHING MARGINAL UTILITY

Marginal
Utility
Consumed
Goods
NUMERICAL EXAMPLE

CON
UTILITY SUMP
TION
RELATIONSHIP OF TOTAL AND MARGINAL UTILITY

The total utility is the sum of all the

marginal utilities that were added from
the beginning.
EQUIMARGINAL PRINCIPLE

The fundamental condition of maximum satisfaction or

utility is the equimarginal principle. It states that a
consumer will achieve maximum satisfaction or utility
when the marginal utility of the last dollar spent on a
good is exactly the same as the marginal utility of the
last dollar spent on any other good.
EQUIMARGINAL PRINCIPLE
 Marginal Utility of Income
Common marginal utility per dollar of all commodities is consumer
equilibrium
WHY DEMAND CURVES SLOPE DOWNWARD
 If there is an increase in the price of good and the marginal utility per
dollar is constant…
MU of good1 to price will be below the MU per dollar of all the other
goods.
(1) Lowering the consumption of good1
(2) raising the MU of good1
(3) Reduce the level of consumption of good1
WHY DEMAND CURVES SLOPE DOWNWARD
CONSU-
MERS
DESIRE
FOR DEMAND CURVE
PRICE OF CONSUM SLOPE
GOOD -PTION DOWNWARD
LEISURE AND THE OPTIMAL ALLOCATION OF TIME

The principle of consumer choice suggest that

you will make the best use of your time when
you equalize the marginal utilities of the last
minute spent on each activity.
ANALYTICAL DEVELOPMENTS IN UTILITY THEORY
 Ordinal utility
 consumers need to determine only their preference ranking of bundle of
commodities.
Ordinal variables (dimensionless) are ones that we can rank in order, but for
which there is no measure of quantitative difference between the situations
ALTERNATIVE APPROACH: SUBSTITUTION EFFECT
AND INCOME EFFECT
 this approach explains the factors that tend to make the responsiveness of
quantity demanded to price the price elasticity of demand large or small.
 indifference analysis asks about the substitution effect and the income effect
of a change in price
SUBSTITUTION EFFECT
 when the price of good rises, consumers will tend to substitute
other goods for the more expensive good in order to satisfy their
desires more inexpensively
INCOME EFFECT
 Real income- the actual quantity of goods that your money income can buy
 income effect- the change in the quantity demanded that arises because a price
change lowers consumers real income
 income elasticity- the percentage change in quantity demanded divided by the
percentage change in income, holding other things, such as prices constant
FROM INDIVIDUAL TO MARKET DEMAND

The demand curve for a good for the entire

market is obtained by summing up the
quantities demanded by all the consumers.
FROM INDIVIDUAL TO MARKET DEMAND
DEMAND SHIFTS
 demand curve shows how the quantity of good
demanded responds to a change in its own price.
SUBSTITUTES AND COMPLEMENTS
 substitutes- there is an increase in price of one good and it demands for the other
 complements- there is an increase in price of one good and decrease the demand
for the other
 independent- there is a price change in the other but there is no effect on the
demand of the other
EMPIRICAL ESTIMATES OF PRICE AND INCOME
ELASTICITIES
THE ECONOMICS OF ADDICTION
 addiction – a pattern of compulsive and uncontrolled use of a
substance
Prohibition can be interpreted as a sharp upward shift in the
supply curve
THE PARADOX OF VALUE

Nothing is more useful than water but it will

scarce purchase anything. A diamond, on the
contrary, has scarce any value in use; but a very
great quantity of other goods may frequently
be had exchange for it.
CONSUMER SURPLUS
 the gap between the total utility of a good and its total market value
 measures the extra value that the consumer receive above that what they
pay for a commodity.
Application of Consumer Surplus
 cost benefit analysis which attempts to determine the costs and benefit of a
government program.
APPENDIX
THE INDIFFERENCE CURVE

The curve contour

linking up the four
points
LAW OF SUBSTITUTION
 the curve is drawn in the way to illustrate the property that seems most often to
hold true in reality and which we call the law of substitution:

The scarcer the good, the greater its relative

substitution value; its marginal utility rises relative to
the marginal utility of the good that has become
plentiful
THE INDIFFERENCE MAP
BUDGET LINE OR BUDGET CONSTRAINT

Line NM is the budget

line or budget
constraint
THE EQUILIBRIUM POSITION OF TANGENCY
 consumers’ equilibrium is attained at the point
where the budget line is tangent to the highest
indifference curve
INCOME CHANGE
SINGLE PRICE CHANGE
 higher food price has definitely reduced food
consumption, but clothing consumption may move in
either direction.
REFERENCE
Samuelson, P. A., & Samuelson, W. (1980). Economics. New York: McGraw-Hill.