Download Marginal Utility

Introduction to Economics
Eco 101
Lecture# 4
Consumer behavior
Cardinal Approach
The Theory of Consumer
Behavior
The principle assumption upon which the
theory of consumer behavior is built is: a
consumer attempts to allocate his/her limited
money income among available goods and services
so as to maximize his/her utility (satisfaction).
Theories of Consumer Choice
• The Marginal utility Analysis or Cardinal Approach
– Utility is measurable in a cardinal sense
• The Indifference Curve Analysis or Ordinal Approach
– Utility is measurable in an ordinal sense
Utility
• Utility is want satisfying power
• The utility of a good and service is the satisfaction or
pleasure one gets from consuming it
• It is a subjective satisfaction derived from
consumption, it means it can vary from person to
person. e.g. eyeglasses can have greater utility for a
person having poor eyesight ,while no utility for a
person having clear vision.
Total and Marginal Utility
• Total Utility (TU) is the satisfaction that a consumer
receives from all units of a product consumed within
a given time period
• Marginal Utility (MU) - the change in total utility
when consumption of a good changes by one unit.
• MU = DTU / D Q consumed of a good
Law of Diminishing MU
• The law of diminishing marginal utility states that the more of
a product the consumer has, the less will be its marginal utility.
• If a person started using some product eventually, a point is
reached where the marginal utility obtained by consuming
additional units of a good starts to decline.
• Example
• If you are really hungry, you get a lot of satisfaction from
first slice of pizza.
• If you keep eating pizza, the satisfaction from the 8th slice
would be much less than that of the first slice.
Relationship between Total
Utility and Marginal Utility
Total Utility
4
5
6
7
10
18
24
]
]
]
28
]
30
]
30
]
28
]
10
8
TR
Total Utility
1
2
3
30
(2)
(3)
Total Marginal
Utility, Utility,
20
10
0
6
1
4
2
0
-2
2
3
4
Units Consumed
5
6
7
Marginal Utility
Marginal Utility
(1)
Quantity
consumed
10
8
6
4
2
0
-2
MU
1
2
3
4
Units Consumed
5
6
7
The Marginal Utility Curves
• As people have different MU
tastes and preferences so
the marginal utility curves
are also different.
• First, Marginal utility
may fall sharply as the
consumption rises. this
means the consumer want
is fully satisfied for a few
units of a product .As the
previous example of pizza
is showing the instant
satisfaction
Q
The Marginal Utility Curves
• Second, marginal utility
may fall gently as
consumption rises. The
consumer want is slowly
filled up as consumption
rises
• For example you are buying
6 shirts in a year. But if you
are offered another 6 shirts
you will not possibly refuse.
thus MU will fall slowly
MU
Q
The Marginal Utility Curves
• Third, the marginal
utility can be always
negative. If you dislike
chicken or never touch
it, the MU will remain
in negative zone for any
quantity of
consumption.
MU
Q
Equilibrium conditions in cardinal
approach
• In case of a single commodity  (x)
MUx = Px will be the consumer equilibrium
• If MUx > Px – Consumer can increase his
welfare by purchasing more units of x
• If MUx < Px---- Consumer can increase his
total satisfaction by cutting down the quantity
of x and keeping more of his income unspent.
Law of equi-marginal utility/ Utility maximizing
Rule
• The marginal utility analysis explains how a rational consumer
will allocate a given amount of income among different good
to achieve the maximum level of satisfaction
• The law of marginal utility requires that a consumer Allocate
Money Income in such way that Last Dollar Spent on
Each Product Yields the Same Marginal Utility
• In case of more commodities the equilibrium
condition of consumer is equality of ratios of the
Marginal utilities of the individual commodities to
their prices
• MUx/Px= MUy/Py=…..=MUn/Pn
Consumer Equilibrium In Multiple Good
Case
• In case of more commodities the equilibrium
condition of consumer is equality of ratios of the
Marginal utilities of the individual commodities to
their prices
• MUx/Px= MUy/Py=…..=MUn/Pn
Numerical Example
Units of
Product
X
1
2
3
4
5
MU
Product
X
Units of
Product
Y
16
12
10
8
6
1
2
3
4
5
MU
Product
Y
14
10
6
4
2
Utility-Maximizing Combination of Products X and Y Obtainable
with an Income of $5 is the 3 units of x and 2 units of y. As the
marginal utilities of last item of both products are equal and total
utility is also maximum 62 units.
If consumer chooses any other combination the utility will not
be maximized according to law of equi marginal utility as if he
purchase 4 units of X and 1 Unit of Y .the utility is 14+46 is 60
which is less than maximum combination and the utility of last
units is also not same.
Graphical Representation
MU
16
14
Maximum
satisfaction
combination
Disequilibrium
condition
6
4
MUX
2
MUY
5
Y
4
3
2
1
1
2
Units of
Products
3 4
5
X
Consumer Equilibrium with Income
Constraint Analysis
• If a consumer has to purchase various goods in given money
income , he will spend his income in such a way that the
marginal utility of last unit of each product should be same.
• This equilibrium condition is defined as
• MUx/Px= MUy/Py=…..=MUn/Pn in law of equi marginal
utility
• But we can write this equilibrium condition in another way
including the income constraint as XPX+YPY=I
• X= quantity of X, Y=quantity of Y I= income
PX=price of X PY= price of Y
• If we suppose Px = 2, PY=1,
I=8
• If consumer purchases 2
units of X and 4 units of Y
income constraint function
will be
XPx+Ypy = I
2(2)+4(1) =8
8 =8
In consumer equilibrium
condition
MUx/Px =MUy/Py
16/2 =4/1
8=4
Qx
MU Qy
x
MUy
1
20
1
7
2
16
2
6
3
12
3
5
4
8
4
4
5
4
5
3
• This analysis shows the selected combination can not satisfy
consumer equilibrium condition as it was failed to satisfy both
equations
• Suppose consumer choose another combination such as 3 units
of X and 2 units of y
• The income constraint function will be
XPx+YPy = I
3(2)+2(1) =8
8 =8
• Consumer equilibrium condition will be
MUx/Px =MUy/Py
12/2 =6/1
6 =6
• This analysis shows this is the equilibrium combination having
maximum level of satisfaction within the income constraint.
Derivation of an Individual Demand
curve from Utility Approach
• Based on the law of DMU
• MU curve a line with –ve slope
• Geometrically The MUx= slope of the total
utility as Mu= DU/DQ
• Demand curve of good x is identical to the
positive segment of the MU curve.
Graphical Representation
MUX
Px
P1
MU1
P2
MU2
Q1
Q2
Qx
Q1
Q2
Qx
Critique of the Cardinal Approach
• The satisfaction derived from various commodities
can not be measured objectively as utility is a state of
mind
• Consumer purchases are mostly based on fashion,
habits or customs instead of utility analysis
• No careful calculation exists in real life about the cost
and benefit analysis