First Semester S.Y.

2020-2021

ECON 1011
MODULE IN

PRINCIPLES OF
ECONOMICS WITH AGRARIAN
REFORM AND TAXATION
Week 6

CONSUMER CHOICE AND UTILITY

MAXIMIZATION

To the students:

This module is for educational purposes only. No part of this module may be reproduced,
used in any form or by any means - graphic, electronic or mechanical, including
photocopying, recording and uploading through internet. The teacher-writer makes no
claim to the originality. The concepts, principles and illustrations were diligently compiled
from various articles, researches and textbook as cited in the reference section of this
module. Thank you.

Topics
Consumer Goods and Services
Maslow’s Hierarchy of Needs Consumer Theory
Cardinal Utility Analysis Utility
Total Utility Marginal Utility
Ordinal Utility Analysis Consumer Surplus

Learning Outcomes
• Describe how consumer’s choice are measured or represented
• Understand how the consumer maximizes satisfaction
• Discuss the different approach in analyzing consumer satisfaction

KLEVEN JAKE A. VILLAMOR, MBA

Instructor
ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

INTRODUCTION

We, as a consumers are unique in many ways. We have different needs, wants
and demands. We differ in likes and dislikes, standards, lifestyles, tradition, etc.
However our behavior as a consumer is hard to identify and measure. From an
economic stand point, our objective as consumers is to maximize our satisfaction
given our limited budget. With this in mind, economics seeks to explain why
consumer behave differently an in particular manner.

CONSUMER

A consumer is one who demands goods and services. Without consumption,

there is no need for production. The consumer is the king in a capitalist or free-
market economy. Their needs must be satisfied by the producers in order for the
producers to earn a profit. In this perspective all of us are consumers because as we
live we demand goods and services.

Consumers are people or organizations that purchase products or services. The

term also refers to hiring goods and services. They are humans or other economic
entities that use a good or service. Furthermore, they do not sell on that item that
they bought.

They are the end users in the distribution chain of goods and services. In fact,
sometimes the consumer might not be the buyer.

For example, young children are the end users of toys, but their parents buy
them. Therefore, in the market for toys, the buyer and consumer are often different
people.

GOODS AND SERVICES

We desire to have all the things to satisfy our present and future wants. Thus,
our desire is for all those things that satisfy our wants. All these things are either
material goods or services. If something is not wanted by anybody it will not be
called a good or service.

Goods are material things wanted by human beings. They can be seen or
touched. Services are non-material things. These cannot be seen or touched only
their effects are felt. When we are hungry, we take food. When we fall sick, we take
medicines. When we study, we use book, notebook, pen, paper etc. All these are
examples of goods which satisfy some of our wants. All the things which satisfy
human wants are good.

However, wants for haircut, washing of cloths, mending of shoes, stitching of

cloths, studying in a school or a college etc. are not satisfied by goods. These are
satisfied by the services performed by a barber, washer man, cobbler, tailor and
teacher etc. So some of our wants are satisfied by goods and some by services.
Hence, all the human wants can be satisfied by goods and services.

Classification of Goods and Services:

(i) Free Goods and Economic goods:

The goods which have unlimited supply and are provided as free gift of nature.
The goods which are not man-made and do not have to pay anything to get them.
These goods are known as ‘Free Goods’. For example, air, sea, water, sunlight, sand
in the desert etc. On the other hand, goods like vegetables, grains, minerals, fruits,

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

fishes etc. which are neither man-made nor unlimited supply of nature are known
as ‘Economic Goods’ All these goods are sold and purchased in the market only.

(ii) Free Services and Economic Services:

Services which cannot be bought in the market and which are only rendered out
of love, affection etc. are known as ‘Free Services’. For example, all services given by
the parents to their children are free services. However, all the services that can be
bought in the market are ‘Economic Services’. Services rendered by doctors,
teachers, lawyers, barbers, cobblers etc. are the example of economic services.

(iii) Consumer Goods and Capital Goods:

The goods which are directly used by the consumer for the purposes of
consumption are known as ‘Consumer Goods’ The example of consumer goods are
bread, biscuit, butter, jam, rice, fish, egg, shoes, shirts, fan, book, pen, cooking gas
etc. On the other hand, all the goods which are not directly used to satisfy
consumption but which are used in further production are called ‘Producer Goods’
or ‘Capital Goods’. The examples are seeds, fertilizers, tools, machines, raw
materials etc.

(iv) Consumer Services and Producer Services:

When services are used directly by consumers to satisfy their wants, they are
called consumer services. When services are used by producers to produce other
goods and services, they are called producer services. When the tailor stitches our
shirt, it is a consumer service However when the tailor stitches a shirt for a ready
made garments shop, the service rendered by him is a producer service.

(v) Single Use and Durable Use Goods:

Goods (both consumer goods and producer goods) which are only used or
consumed for single time or only once are known as single use goods. Bread, milk,
fruits, vegetables etc. are the example of single use consumer goods. On the other
hand, seeds, fertilizers, raw materials etc. are the example of single use producer
goods.

Some goods (both consumer goods and producer goods) can be used for a
considerable period, that is, they can be used again and again. They are called
durable use goods. For example, table, chair, cloths, shoes etc. are the durable use
consumer goods. On the other hand, tube wells, tractors, pump-sets etc. are the
example of durable use producer goods.

(vi) Private Goods and Public Goods:

On the basics of ownership goods can be classified into two groups. All the
goods which are owned by private bodies are called private goods. For example, a
car, a house, a motorbike, a mobile phone, books, a television set etc. are the private
goods.

There are large number of goods which are collectively owned by the society, the
public or the government. These are called public or government goods. For
example, roads, bridges, hospitals, government schools etc. are the public goods or
the social goods or the government goods.

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

MASLOW’S HIERARCHY OF NEEDS

Abraham Maslow developed the Hierarchy of Needs model in 1940-50s USA, and

the Hierarchy of Needs theory remains valid today for understanding human
motivation, management training, and personal development. 

Maslow's Hierarchy of Needs states that we must satisfy each need, in turn, starting
with the first, which deals with the most obvious needs for survival itself:

 Only when the lower order needs of physical and emotional well-being are
satisfied are we concerned with the higher-order needs of influence and
personal development. 
 Conversely, if the things that satisfy our lower order needs are swept away,
we are no longer concerned about the maintenance of our higher-order
needs.

Maslow's original Hierarchy of Needs model was developed between 1943-1954, and
first widely published in Motivation and Personality in 1954. At this time the
Hierarchy of Needs model comprised five needs. This original version remains for
most people the definitive Hierarchy of Needs

CONSUMER THEORY

You are constantly making economic decisions. At the highest level of

generality, we are all very much alike

Come up against the same constraints

Too little income or wealth
Too little time to enjoy it all

The theory of individual decision making is called “consumer theory”

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

Part I. The Budget Constraint

Virtually all individuals must face two facts of economic life

 Have to pay prices for the goods and services they buy
 Have limited funds to spend

A consumer’s budget constraint identifies which combinations of goods and services

the consumer can afford with a limited budget

Mathematical expression:
Px * X + Py * Y = m
Where m is budget,
Px and Py are prices for good
X and Y are goods

Graphical representation of a budget constraint: budget line

The price of one good relative to the price of another

Interpretation on the vertical / horizontal intercepts

The slope of the budget line indicates the spending trade-off between one good
and another

Amount of one good, that must be sacrificed in order to buy more of another
good
If PY is the price of the good on the vertical axis, then the slope of the budget line is
–PX / PY

Max’s entertainment budget:

m = $150
Max is making choice to go to a local
rock concert (Good X) or see a movie (Good Y):
A movie ticket (Px) = $10
A concert ticket (Py) = $30

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

Changes in the Budget Line

 Changes in income
Increase in income will shift the budget line upward (and rightward)
A decrease in income will shift the budget line downward (and leftward)
Changes in income do not affect the budget line’s slope

 Changes in price
In each case, one of the budget line’s intercepts will change, as well as its
slope
When the price of a good changes, the budget line rotates
Both its slope and one of its intercepts will change

Part II. Preferences

How can we possibly speak systematically about people’s preferences?

People are different. Despite differences in preferences, we can find some important
common denominators. something true for a wide variety of people.

Assumptions on Preferences
(1) Rationality

People have preferences. We assume that you can look at two alternatives
and state either that you prefer one to the other or entirely indifferent between
the
Preferences are logically consistent, or transitive. Rational preference: choices can be
made and they are logically consistent. Rationality is a matter of how you make your
choices, and not what choices you make. What matters is that you make logically
consistent choices

(2) More Is Better

We generally feel that more is better
The model of consumer choice in this chapter is designed for preferences that satisfy
the “more is better” condition
It would have to be modified to take account of exceptions
The consumer will always choose a point on the budget line
Rather than a point below it

Consumer Choice: Two Theories

Theories of consumer decision making
 Marginal utility
 Indifference curve

Both assume that preferences are rational

Both assume that consumer would be better off with more of any good
Both theories come to same general conclusions about consumer behavior
However, to arrive at those conclusions each theory takes a different road

Part III. Consumer Decisions: UTILITY

A consumer usually decides his demand for a commodity on the basis of utility (or
satisfaction) that he derives from it. What is utility? Utility of a commodity is its
want-satisfying capacity. The more the need of a commodity or the stronger the
desire to have it, the greater is the utility derived from the commodity.

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

Utility - a quantitative measure of pleasure or satisfaction obtained from consuming

goods and services

Assume that consumers as striving to maximize their utility

any decision maker tries to make the best out of any situation
Anything that makes the consumer better off is assumed to raise his utility
Anything that makes the consumer worse off will decrease his utility

CARDINAL UTILITY ANALYSIS

Cardinal utility analysis assumes that level of utility can be expressed in
numbers. For example, we can measure the utility derived from a shirt and say, this
shirt gives me 50 units of utility. Before discussing further, it will be useful to have a
look at two important measures of utility

Measures of Utility

Total Utility:
Total utility of a fixed quantity of a commodity (TU) is the total satisfaction
derived from consuming the given amount of some commodity x. More of
commodity x provides more satisfaction to the consumer. TU depends on the
quantity of the commodity consumed. Therefore, TUn refers to total utility
derived from consuming n units of a commodity x.

Marginal Utility
Marginal Utility: Marginal utility (MU) is the change in total utility due to
consumption of one additional unit of a commodity. For example, suppose 4
bananas give us 28 units of total utility and 5 bananas give us 30 units of total
utility. Clearly, consumption of the 5th banana has caused total utility to
increase by 2 units (30 units minus 28 units). Therefore, marginal utility of the
5th banana is 2 units.

MU = ΔTU
ΔQ

MU = TU2 - TU1
Q2-Q1

Where: MU = Marginal Utility

TU2 = the new utility
TU1 = the original utility
Q2 = the new quantity consumed
Q1 = the original quantity consumed

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

LAW OF DIMINISHING MARGINAL UTILITY

Law of Diminishing Marginal Utility as defined by Alfred Marshall (1842-1924)

states that marginal utility from consuming each additional unit of a commodity
declines as its consumption increases, while keeping consumption of other
commodities constant. MU becomes zero at a level when TU remains constant.

What Happens When Things Change:

Changes In Income - A rise in income—with no change in price—leads to a new
quantity demanded for each good

Whether a particular good is normal (quantity demanded increases) or

inferior (quantity demanded decreases) depends on the individual’s preferences

Changes In Price - A drop in the price of concerts rotates the budget line rightward,
pivoting around its vertical intercept

The consumer will select the combination of movies and concerts on his
budget line that makes him as well off as possible.

ORDINAL UTILITY ANALYSIS

Cardinal utility analysis is simple to understand, but suffers from a major
drawback in the form of quantification of utility in numbers. In real life, we never
express utility in the form of numbers. At the most, we can rank various alternative
combinations in terms of having more or less utility. In other words, the consumer
does not measure utility in numbers, though she often ranks various consumption
bundles. This forms the starting point of this topic – Ordinal Utility Analysis.

A consumer’s preferences over the set of available bundles can often be

represented diagrammatically. We have already seen that the bundles available to
the consumer can be plotted as points in a two dimensional diagram. The points
representing bundles which give the consumer equal utility can generally be joined
to obtain a curve like the one in Figure 2.3. The consumer is said to be indifferent
on the different bundles because each point of the bundles give the consumer equal
utility. Such a curve joining all points representing bundles among which the
consumer is indifferent is called an indifference curve. All the points such as A, B, C
and D lying on an indifference curve provide the consumer with the same level of
satisfaction. It is clear that when a consumer gets one more banana, he has to
forego some mangoes, so that her total utility level remains the same and she
remains on the same indifference curve. Therefore, indifference curve slopes
downward. The amount of mangoes that the consumer has to forego, in order to get
an additional banana, her total utility level being the same, is called marginal rate of
substitution (MRS). In other words, MRS is simply the rate at which the consumer
will substitute bananas for mangoes, so that her total utility remains constant. So,
MRS Y X =| ∆ ∆ | / 3

Features of Indifference Curve

1. Indifference curve slopes downwards from left to right
2. .Higher indifference curve gives greater level of utility
3. .Two indifference curves never intersect each other:

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

CONSUMER SURPLUS
Consumer surplus = total willingness to pay for a good - the total
amount consumers actually do pay.

Consumer enjoys consumer surplus if he pays the same amount of

money for each unit of good he buys.

It is a measure of the net benefits received by the consumer.

CS occurs when people are able to buy a good for less than they would be willing to
pay. They enjoy more utility than they had to pay for.

Application of Consumer Surplus

This concept has more public policy relevance.

• Since it is a measure of the net benefits received by the consumer, government can
estimate the loss or increase in consumer welfare due to any policy change.

SUMMARY

 A consumer is one who demands goods and services.

 Goods are material things wanted by human beings
 Services are non-material things.
 Classification of Goods and Services are Free Goods and Economic goods, Free
Services and Economic Services, Consumer goods and capital goods, Consumer
and Producer services, single use and durable use goods and private and public
goods.
 Abraham Maslow developed the Hierarchy of Needs
 Maslow's Hierarchy of Needs states that we must satisfy each need, in turn,
starting with the first, which deals with the most obvious needs for survival
itself
 A consumer’s budget constraint identifies which combinations of goods and
services the consumer can afford with a limited budget
 Utility a quantitative measure of pleasure or satisfaction obtained from
consuming goods and services
 Marginal utility of a thing to anyone diminishes with every increase in the
amount of it that he / she already has

References:

Samuelson, Paul A. ECONOMICS McGraw Hill, New York, 2011

Viray, Marcelino, et al. PRINCIPLES OF ECONOMICS

(w/ TAR) National Book Store, Mandaluyong City, 2010
BIBLICAL INTEGRATION
Lucas, Marilou P. et al. BASIC ECONOMICS WITH
TAXATION AND LAND REFORM Revised Edition.
Bulacan, Philippines. Trinitas Publishing, Inc., 2009 Genesis 2:15

Medina, Roberto G. PRINCIPLES OF ECONOMICS

Rex Printing Company, Inc. Quezon City, 2003
The LORD God took the man and put
him in the garden of Eden to work it and
keep it.

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ECON 1011 Principles of Economics with Agrarian Reform and Taxation
Consumer Choice and Utility Maximization

Exercise 4: CONSUMER

Name: ____________________________________________ Score: _________

Section/Schedule: __________________________________ Date: __________

I. Below is a table of quantities and total utilities associated with three

different consumer goods. Based on their total utilities, which good obeys
the law of diminishing marginal utility? (25 points)

Quantity Total Utility (Tea) Total Utility Total Utility (Soda)

(Coffee)
1 10 50 100
2 20 150 180
3 30 300 240
4 40 500 280
5 50 800 300

Answer: ______________________

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