Demand and the

Consumer
Marginal Utility Theory
• Utility and consumer satisfaction
• Total and marginal utility
– diminishing marginal utility
• The optimum level of consumption
– consumer surplus
• marginal consumer surplus
• total consumer surplus
• consumer surplus and the marginal utility
curve
 Tina’s marginal utility from petrol
120

110

100
MU, P (pence per litre)

90

80

70

60

50

40
0 250 500 750 1000
Q (litres per annum)
 Tina’s marginal utility from petrol
120

110
a
100
MU, P (pence per litre)

Consumer b
90
surplus c
80 MU

70

60

50

40
0 250 500 750 1000
Q (litres per annum)
Marginal Utility Theory
• Utility and consumer satisfaction
• Total and marginal utility
– diminishing marginal utility
• The optimum level of consumption
– consumer surplus
• marginal consumer surplus
• total consumer surplus
• consumer surplus and the marginal utility
curve
– rational consumer behaviour
Marginal Utility Theory
• Utility and consumer satisfaction
• Total and marginal utility
– diminishing marginal utility
• The optimum level of consumption
– consumer surplus
• marginal consumer surplus
• total consumer surplus
• consumer surplus and the marginal utility
curve
– rational consumer behaviour
• maximising consumer surplus: P = MU
 Consumer surplus
MU, P

P1

MU

O Q1 Q
 Consumer surplus
MU, P

P1

Total
consumer MU
expenditure

O Q1 Q
 Consumer surplus
MU, P

Total
consumer
surplus
P1

Total
consumer MU
expenditure

O Q1 Q
Marginal Utility Theory
• Marginal utility and the demand curve
– an individual’s demand curve
 Deriving an individual person’s demand curve
MU, P

Consumption at Q1

P1
a where P1 = MU

MU = D

O Q1 Q
 Deriving an individual person’s demand curve
MU, P

Consumption at Q2

P1
a where P2 = MU

b
P2

MU = D

O Q1 Q2 Q
 Deriving an individual person’s demand curve
MU, P

Consumption at Q3

P1
a where P3 = MU

b
P2

P3
c

MU = D

O Q1 Q2 Q3 Q
Marginal Utility Theory
• Marginal utility and the demand curve
– an individual’s demand curve
– the market demand curve
Marginal Utility Theory
• Marginal utility and the demand curve
– an individual’s demand curve
– the market demand curve
• the shape of the demand curve
Marginal Utility Theory
• Marginal utility and the demand curve
– an individual’s demand curve
– the market demand curve
• the shape of the demand curve
• shifts in the demand curve
Marginal Utility Theory
• Marginal utility and the demand curve
– an individual’s demand curve
– the market demand curve
• the shape of the demand curve
• shifts in the demand curve

• Limitations of the one-commodity

version
Marginal Utility Theory
• Marginal utility and the demand curve
– an individual’s demand curve
– the market demand curve
• the shape of the demand curve
• shifts in the demand curve

• Limitations of the one-commodity

version
– marginal utility affected by consumption
of other goods
Marginal Utility Theory
• Marginal utility and the demand curve
– an individual’s demand curve
– the market demand curve
• the shape of the demand curve
• shifts in the demand curve

• Limitations of the one-commodity

version
– marginal utility affected by consumption
of other goods
– marginal utility of money not constant
Risk, Uncertainty and Insurance
• Demand under conditions of risk and
uncertainty
– the problem of imperfect information
• Attitudes towards risk and
uncertainty
– defining risk and uncertainty
– types of odds
– risk attitudes
• risk neutral
• risk loving
• risk averse
Risk, Uncertainty and Insurance

• Diminishing marginal utility of income

and attitudes towards risk taking
– most people are risk averse

– diminishing marginal utility of incomes

 Total utility of income

TU
Total utility

a
U1

0 5000 10 000 15 000

Income (£)
 Total utility of income

TU
b
U2
Total utility

a
U1

0 5000 10 000 15 000

Income (£)
 Total utility of income

c TU
U3
b
U2
Total utility

a
U1

0 5000 10 000 15 000

Income (£)
 Total utility of income

c TU
U3
b
U2
d
U4
Total utility

a
U1

0 5000 8000 10 000 15 000

Income (£)
Risk, Uncertainty and Insurance
• Insurance: a way of removing risks

– how insurers spread risks

• the law of large numbers

• importance of the independence of risks

– problems for insurers

• adverse selection

• moral hazard
The Characteristics Approach
• Consumer choice between products
– importance of products' characteristics
• Identifying & plotting characteristics
– plotting a product's mix of
characteristics
The characteristics of two brands of breakfast cereal
Healthbran
Quantity of fibre

Tastyflakes

f1 h1
t1
f3

O s1 s3
Quantity of sugar
The Characteristics Approach
• Consumer choice between products
– importance of products' characteristics
• Identifying & plotting characteristics
– plotting a product's mix of
characteristics
– changes in a product's characteristics
The characteristics of two brands of breakfast cereal
Healthbran
Quantity of fibre

Tastyflakes

f1 h1
t1
f3

O s1 s3
Quantity of sugar
The Characteristics Approach
• Consumer choice between products
– importance of products' characteristics
• Identifying & plotting characteristics
– plotting a product's mix of
characteristics
– changes in a product's characteristics
• The budget constraint
The Characteristics Approach
• Consumer choice between products
– importance of products' characteristics
• Identifying & plotting characteristics
– plotting a product's mix of
characteristics
– changes in a product's characteristics
• The budget constraint
– affects how much of each characteristic
can be purchased
The characteristics of two brands of breakfast cereal
Healthbran
Quantity of fibre

Tastyflakes

f1 h1
t1
f3

O s1 s3
Quantity of sugar
The Characteristics Approach
• Consumer choice between products
– importance of products' characteristics
• Identifying & plotting characteristics
– plotting a product's mix of
characteristics
– changes in a product's characteristics
• The budget constraint
– affects how much of each characteristic
can be purchased
• effects of a change in the budget
The characteristics of two brands of breakfast cereal
Healthbran

f2 h2
Quantity of fibre

Tastyflakes

f1 h1
t1
f3

O s1 s2 s3
Quantity of sugar
The Characteristics Approach
• Consumer choice between products
– importance of products' characteristics
• Identifying & plotting characteristics
– plotting a product's mix of
characteristics
– changes in a product's characteristics
• The budget constraint
– affects how much of each characteristic
can be purchased
• effects of a change in the budget
• effects of change in a product's price
The characteristics of two brands of breakfast cereal
Healthbran

f2 h2
Quantity of fibre

Tastyflakes

f1 h1
t1
f3

O s1 s2 s3
Quantity of sugar
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
 The efficiency frontier
Healthbran

Assume a given budget and that this

is the maximum amount of Healthbran
that can be afforded for this budget
(assuming no Tastyflakes are purchased)
Quantity of fibre

a Tastyflakes
f1

c The efficiency frontier

f3
b
f2 Alternatively, for the same budget,
assume that this amount of
Tastyflakes could be purchased
(assuming no Healthbran is purchased)

O s1 s3 s2
Quantity of sugar
 The efficiency frontier: four brands
Healthbran
Oatybix

a
Quantity of fibre

b
Tastyflakes

Sweetreats
d

O
Quantity of sugar
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
 Consuming a mixture of two products
Healthbran
Quantity of fibre

a Tastyflakes

c
fall

d b
fh

ft e

O sh st sall
Quantity of sugar
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
– cases of shifts in the frontier
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption
– indifference curves
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption
– indifference curves
• plotting indifference curves
Quantity of characteristic A Choosing between brands

I5
I4
I3
I2
I1

Quantity of characteristic B
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption
– indifference curves
• plotting indifference curves
• the shape of the curves
Quantity of characteristic A Choosing between brands

I5
I4
I3
I2
I1

Quantity of characteristic B
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption
– indifference curves
• plotting indifference curves
• the shape of the curves
– the optimum consumption point
The Characteristics Approach
• The efficiency frontier
– shows the different combinations of
characteristics that can be purchased
• interpreting a point on the frontier
– cases of shifts in the frontier
• The optimum level of consumption
– indifference curves
• plotting indifference curves
• the shape of the curves
– the optimum consumption point
• the tangency point
 Choosing between brands
Brand 1
Brand 2 Quantities of any one of
three brands that can be
purchased for a given
Quantity of characteristic A

budget at current prices.

Brand 2 is chosen
a
Brand 3

c I5
I4
I3
I2
I1

Quantity of characteristic B
 Choosing a mixture of brands
Brand 1
Quantity of characteristic A

a Brand 2

e I5
I4
c I3
I2
I1

Quantity of characteristic B
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
 Choosing between brands
Brand 1
Brand 2
Fall in price
of brand 1.
Quantity of characteristic A

d
Brand 1 is now chosen

a
Brand 3

c I5
I4
I3
I2
I1

Quantity of characteristic B
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
– changes in income
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
– changes in income
• parallel movement of efficiency frontier
 Choosing a mixture of brands
Brand 1
Quantity of characteristic A

Rise in income
a Brand 2

e I5
I4
c I3
I2
I1

Quantity of characteristic B
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
– changes in income
• parallel movement of efficiency frontier
– changes in a product's characteristics
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
– changes in income
• parallel movement of efficiency frontier
– changes in a product's characteristics
• change in slope of product's ray
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
– changes in income
• parallel movement of efficiency frontier
– changes in a product's characteristics
• change in slope of product's ray
• movement along new ray
 A change in the characteristics of Brand 1
Brand 1 (before) Brand 1 is
Brand 1 (after) now chosen
Quantity of characteristic A

Characteristics
c
a of Brand 1 change
Brand 2

b
I2
I1
Brand 2
is chosen

Quantity of characteristic B
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
– changes in income
• parallel movement of efficiency frontier
– changes in a product's characteristics
• change in slope of product's ray
• movement along new ray
– changes in tastes
The Characteristics Approach
• Response to various changes
– changes in a product's price
• movement along the product's ray
• relationship to cross-price elasticity of
demand
– changes in income
• parallel movement of efficiency frontier
– changes in a product's characteristics
• change in slope of product's ray
• movement along new ray
– changes in tastes
• shift in indifference curves
The Characteristics Approach
• Usefulness of characteristics
approach
– helps understand the nature of
consumer choice
– helps firms in understanding the effects
of making changes
• to consumer perceptions
– through changing product specifications
– by promoting various characteristics through
advertising
• repositioning its product
 Options open to the firm producing Brand 1
Brand 1
Effect of Brand 2
lowering prices,
Quantity of characteristic A

e
or advertising
d
Brand 3

a b

c
I5
I4
I3
I2
I1

Quantity of characteristic B
The Characteristics Approach
• Usefulness of characteristics
approach
– helps understand the nature of
consumer choice
– helps firms in understanding the effects
of making changes
• to consumer perceptions
– through changing product specifications
– by promoting various characteristics through
advertising
• repositioning its product
• launching a new brand
The Characteristics Approach
• Limitations of characteristics
approach
– problem in measuring characteristics
– most products have many
characteristics
• only two characteristics can be plotted
– problem in identifying indifference
curves
• hard for one individual
• more difficult for whole markets
– but can divide markets into segments
– consumer tastes change