Presentation on theme: "Introduction to Economics Eco 101"— Presentation transcript:
1 Introduction to Economics Eco 101 Lecture# 4Consumer behaviorCardinal Approach
2 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).
3 Theories of Consumer Choice The Marginal utility Analysis or Cardinal ApproachUtility is measurable in a cardinal senseThe Indifference Curve Analysis or Ordinal ApproachUtility is measurable in an ordinal sense
4 Utility Utility is want satisfying power The utility of a good and service is the satisfaction or pleasure one gets from consuming itIt 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.
5 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 periodMarginal Utility (MU) - the change in total utility when consumption of a good changes by one unit.MU = DTU / D Q consumed of a good9
6 Law of Diminishing MU Example 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.ExampleIf 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.
7 Relationship between Total Utility and Marginal Utility 1020308642-21357Total UtilityMarginal Utility(1)Quantity consumed(2)TotalUtility,(3)MarginalUtility,TR12345671018242830]108642-2Units ConsumedMarginal UtilityMUUnits Consumed7
8 The Marginal Utility Curves As people have different 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 satisfactionMUQ
9 The Marginal Utility Curves Second, marginal utility may fall gently as consumption rises. The consumer want is slowly filled up as consumption risesFor 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 slowlyMUQ
10 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.MUQ
11 Equilibrium conditions in cardinal approach In case of a single commodity (x)MUx = Px will be the consumer equilibriumIf MUx > Px – Consumer can increase his welfare by purchasing more units of xIf MUx < Px---- Consumer can increase his total satisfaction by cutting down the quantity of x and keeping more of his income unspent.11
12 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 satisfactionThe 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 UtilityIn case of more commodities the equilibrium condition of consumer is equality of ratios of the Marginal utilities of the individual commodities to their pricesMUx/Px= MUy/Py=…..=MUn/Pn
13 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 pricesMUx/Px= MUy/Py=…..=MUn/Pn
14 Numerical ExampleMUProductXUnits ofProductYMUProductYUnits ofProductX1234514106421612108612345Utility-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 is 60 which is less than maximum combination and the utility of last units is also not same.
16 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 asMUx/Px= MUy/Py=…..=MUn/Pn in law of equi marginal utilityBut we can write this equilibrium condition in another way including the income constraint as XPX+YPY=IX= quantity of X, Y=quantity of Y I= income PX=price of X PY= price of Y
17 Qx MUx Qy MUy 1 20 7 2 16 6 3 12 5 4 8 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 beXPx+Ypy = I2(2)+4(1) =88 =8In consumer equilibrium conditionMUx/Px =MUy/Py16/2 =4/18 = 4
18 This analysis shows the selected combination can not satisfy consumer equilibrium condition as it was failed to satisfy both equationsSuppose consumer choose another combination such as 3 units of X and 2 units of yThe income constraint function will beXPx+YPy = I3(2)+2(1) =88 =8Consumer equilibrium condition will beMUx/Px =MUy/Py12/2 =6/16 =6This analysis shows this is the equilibrium combination having maximum level of satisfaction within the income constraint.
19 Derivation of an Individual Demand curve from Utility Approach Based on the law of DMUMU curve a line with –ve slopeGeometrically The MUx= slope of the total utility as Mu= DU/DQDemand curve of good x is identical to the positive segment of the MU curve.
21 Critique of the Cardinal Approach The satisfaction derived from various commodities can not be measured objectively as utility is a state of mindConsumer purchases are mostly based on fashion, habits or customs instead of utility analysisNo careful calculation exists in real life about the cost and benefit analysis