1. Consumer Behaviour and Utility Maximization
Petros Kosmas, PhD
Lecturer, Varna Free University
Lecturer, CASA College
Lecture 7

2. Down-Sloping Demand Curve
Income effect
- The impact the change in the price of a product has on a consumer’s real income.
Substitution effect
- The impact the change in a product’s price has on its relative expensiveness.
Diminishing Marginal Utility

3. Law of Diminishing Marginal Utility
As a buyer consumes more units of a product, each additional unit provides less additional utility.
Terminology
- Utility: the ability to satisfy a want
- subjective (utility varies from person to person)
- Utils: Imaginary unit of measure of satisfaction

4. Utility
Total utility
- The total amount of satisfaction a person derives from consuming some specific quantity of a product.
Marginal utility
- The additional satisfaction a consumer realizes from an additional unit of that product.

5. Hamburgers consumed
Total utility
(utils)
Marginal
Utility (utils) - 1 10 2 18 8 3 24 6 4 28 5 30 7 -2

6. Hamburgers consumed
Total utility
(utils)
Marginal
Utility (utils) - 1 10 2 18 8 3 24 6 4 28 5 30 7 -2

7. TU

8. Hamburgers consumed
Total utility
(utils)
Marginal
Utility (utils) - 1 10 2 18 8 3 24 6 4 28 5 30 7 -2

9. MU

13. Law of Diminishing Marginal Utility
Relation to Demand – As marginal utility diminishes, buyers will buy additional units only if the price falls. (Downward sloping demand curve)
Relation to Elasticity – The amount by which marginal utility declines helps determine the product’s price elasticity of demand.

14. Law of Diminishing Marginal Utility
Relation to Elasticity
Marginal Utility Decline
Demand Elasticity
Rapid
Inelastic
Slow
Elastic

15. Theory of Consumer Behavior
Rational behavior – Consumers will use their money to derive the greatest amount of utility (Total Utility).
Preferences – Each consumer has clear-cut preferences for certain goods, and knows how much marginal utility each successive unit will give them.

16. Theory of Consumer Behavior
Budget Restraint – At any point in time, the consumer has a fixed amount of money income.
Prices – Every good and service carries a price tag. The individual consumer cannot affect the product’s price.
*Therefore: The consumer must choose the combination of goods and services that provides the greatest amount of utility within the budget restraint.

17. Utility Maximizing Rule
To maximize satisfaction the consumer allocates his money income so that the last dollar spent on each product yields the same amount of marginal utility.

18. Example Income = $10 1st 10 24 2nd 8 20 3rd 7 18 4th 6 16 5th 5 12 6th
Unit of product
Product A=$1
Product B=$2 MU
1st 10 24
2nd 8 20
3rd 7 18
4th 6 16
5th 5 12
6th 4
7th 3

19. Example Income = $10 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

20. Income = $10 - $2 = $8 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

21. Income = $8 - $3 = $5 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

22. Income = $5 - $2 = $3 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

23. Income = $3 - $3 = $0 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

24. Example Income = $10 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2
2 of A + 4 of B: Total Utility = = 96 utils

25. Possible Combinations
Total Utility
Total Price 5 90
$10 2 4 96 3 93 6 84 8 1 69 10 46

26. Maximum Utility A ($1) B($2) Total Utility Total Price 5 90 $10 2 4 965 90
$10 2 4 96 3 93 6 84 8 1 10

27. Using the marginal utility data from the previous example, determine the utility-maximizing combination of goods A and B with a money income of $14.

28. Income = $14 - $10 = $4 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

29. Income = $4 - $1 = $3 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

30. Income = $3 - $3 = $0 1st 10 24 12 2nd 8 20 3rd 7 18 9 4th 6 16 5th 5
Unit of product
Product A=$1
Product B=$2 MU
MU/price
1st 10 24 12
2nd 8 20
3rd 7 18 9
4th 6 16
5th 5
6th 4 3
7th 2

31. Algebraic Restatement
Maximum consumer satisfaction 
Last dollar spent on product A yields the same amount of marginal utility as the last dollar spent on product B, C,…X
In other words, the marginal utility per dollar spent on A = the marginal utility per dollar spent on B, C,…X

32. Algebraic Restatement

33. From the Original Example

34. Inferior Options
A ($1)
B($2)
Total Price 5
$10 2 4 3 6 8 1 10

35. Inferior Options

36. Deriving the Demand Schedule (Product B, Income = $10)
Price Per unit of B
Quantity Demanded $2 4 $1 ?

37. Income = $10 1st 10 24 2nd 8 20 3rd 7 18 4th 6 16 5th 5 12 6th 4 7th 3
Unit of product
Product A=$1
Product B=$1 MU
MU/price
1st 10 24
2nd 8 20
3rd 7 18
4th 6 16
5th 5 12
6th 4
7th 3

38. Income = $10 1st 10 24 2nd 8 20 3rd 7 18 4th 6 16 5th 5 12 6th 4 7th 3
Unit of product
Product A=$1
Product B=$1 MU
MU/price
1st 10 24
2nd 8 20
3rd 7 18
4th 6 16
5th 5 12
6th 4
7th 3

39. Deriving the Demand Schedule (Product B, Income = $10)
Price Per unit of B
Quantity Demanded $2 4 $1 6

40. The Demand Curve P DB $2 $1 Q 4 6