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    BMGT 21 - Lesson 4

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    Caryl Ribo Tabing
    Microeconomics

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    BMGT 21 - Lesson 4

    Uploaded by

    Caryl Ribo Tabing
    4 views16 pages
    Microeconomics

    Original Title

    Bmgt 21- Lesson 4

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    © © All Rights Reserved

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    PDF, TXT or read online from Scribd

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    Microeconomics

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    4 views16 pages

    BMGT 21 - Lesson 4

    Uploaded by

    Caryl Ribo Tabing
    Microeconomics

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 16

    LESSON 4 - BASIC MICROECONOMICS

    Consumer Behavior

    Objectives:

    ● Understand how consumers make decisions to


    maximize satisfaction.

    ● Analyze the concept of utility and its role in consumer


    choices and its consumption.

    ● Explore indifference curves and how they interact with


    budget constraints in decision-making.

    I. Utility Theory: Total and Marginal Utility

    A. Utility

    Defined Utility refers to the satisfaction or benefit a


    consumer derives from consuming goods or services. In
    consumer behavior, we assume that individuals are
    rational and will make choices that maximize their utility.
    Types of Utility:

    ● Total Utility (TU): This is the total satisfaction


    received from consuming a certain quantity of a good
    or service. It increases as more units of the good are
    consumed, but at a decreasing rate (explained further
    by the law of diminishing marginal utility).

    ● Marginal Utility (MU): This is the additional


    satisfaction gained from consuming one more unit of
    a good or service. It’s calculated as the change in
    total utility when the quantity of a good consumed
    changes by one unit.

    Mathematical Representation:

    Total Utility (TU) = Σ Marginal Utility (MU)

    Marginal Utility (MU) = Δ Total Utility / Δ Quantity

    Illustration: Imagine a consumer eating slices of pizza:

    The first slice provides immense satisfaction (high


    marginal utility).
    The second slice adds satisfaction but not as much as the
    first (lower marginal utility).

    By the third slice, the additional satisfaction starts to


    decrease even more.

    ● Let's break down and compute the total utility and


    marginal utility using the mathematical representation
    provided.

    Scenario: A Consumer Eating Pizza

    Assume a consumer eats 3 slices of pizza, and we


    measure their Total Utility (TU) and Marginal Utility (MU)
    as they consume each slice. We'll compute the Marginal
    Utility (MU) for each slice based on the change in Total
    Utility (TU) as they consume more slices.

    Step-by-Step Calculation:

    Slice 1:

    Total Utility (TU1): 20 units (the satisfaction from the first


    slice)
    Marginal Utility (MU1): Since this is the first slice, the
    marginal utility equals the total utility of this slice, i.e.,
    MU1 = TU1 = 20 units.

    Slice 2:

    Total Utility (TU2): 35 units (satisfaction after the second


    slice)

    Marginal Utility (MU2): The marginal utility for the second


    slice is calculated by the change in total utility:

    MU2 = ΔTU / ΔQuantity = (TU2 - TU1) / (Q2 - Q1)

    MU2 = (35 - 20) / (2 - 1) = 15 units

    Slice 3:

    Total Utility (TU3): 45 units (satisfaction after the third


    slice)

    Marginal Utility (MU3): Again, calculate the marginal utility


    based on the change in total utility:

    MU3 = (TU3 - TU2) / (Q3 - Q2)

    MU3 = (45 - 35) / (3 - 2) = 10 units


    Summary of Results:

    Interpretation:

    After consuming the first slice of pizza, the consumer's


    total utility is 20, and the marginal utility is also 20.

    The second slice increases total utility to 35, but the


    additional satisfaction (marginal utility) decreases to 15.

    By the third slice, total utility rises to 45, but the marginal
    utility further drops to 10, illustrating the Law of
    Diminishing Marginal Utility.
    B. Utility Maximization

    Consumers aim to maximize their total utility given their


    income and the prices of goods. They continue to
    consume a good until the marginal utility of consuming
    one more unit equals the price paid for that good.

    The Utility Maximization Condition:


    MUx / Px = MUy / Py

    Where:

    MUx and MUy are the marginal utilities of goods X and Y

    Px and Py are the prices of goods X and Y


    Consumers will allocate their budget in such a way that
    the marginal utility per peso spent on each good is
    equalized.
    Conclusion:
    To maximize utility, the consumer should continue
    adjusting their consumption until the marginal utility per
    peso spent on both goods is equalized. In the scenario,
    the consumer should consume more pizza and less soda
    to approach the equilibrium.

    II. Law of Diminishing Marginal Utility

    The Law of Diminishing Marginal Utility states that as a


    person consumes more units of a good, the additional
    satisfaction (marginal utility) obtained from each
    successive unit decreases. In simpler terms, the more you
    have of something, the less pleasure or benefit you derive
    from consuming additional units of it.

    Example:

    The first glass of water after a hot day gives immense


    satisfaction.

    The second glass still provides satisfaction but less than


    the first.
    By the third or fourth glass, the satisfaction drops
    significantly, and eventually, drinking more water could
    even become undesirable.

    Economic Implications:

    The law of diminishing marginal utility helps explain the


    downward-sloping demand curve. As consumers purchase
    more of a good, the marginal benefit decreases, and they
    will only continue buying additional units if the price falls.

    Consumer Decision Making: This principle drives how


    consumers spread their income across different goods.
    Once the marginal utility of a good decreases, they seek
    to buy other goods that provide higher marginal utility
    relative to their price.

    III. Indifference Curves and Budget Constraints

    A. Indifference Curves

    Indifference curves represent combinations of two goods


    that provide a consumer with the same level of
    satisfaction. The consumer is "indifferent" between any of
    the combinations on a single curve because they all yield
    the same utility.
    Properties of Indifference Curves:

    1. Downward Sloping: Indifference curves slope


    downwards, showing that if you consume more of one
    good, you must consume less of another to maintain the
    same level of utility.

    2. Convex to the Origin: They are bowed inward, reflecting


    a diminishing marginal rate of substitution (MRS). As you
    consume more of one good, you are willing to give up less
    of the other good to maintain the same utility.

    3. Do Not Cross: Each indifference curve represents a


    different level of utility, and curves cannot cross because it
    would imply two different utility levels at the same point.

    4. Higher Curves Represent Higher Utility: The farther


    from the origin, the higher the level of utility.
    Marginal Rate of Substitution (MRS):

    MRS is the rate at which a consumer is willing to trade one


    good for another while staying on the same indifference
    curve (maintaining the same utility). As the consumer
    moves along the curve, the MRS typically diminishes due
    to the principle of diminishing marginal utility.

    B. Budget Constraints

    The budget constraint represents all combinations of two


    goods that a consumer can afford, given their income and
    the prices of the goods. It’s a straight line showing the
    trade-off between the two goods within the consumer’s
    budget.

    Equation of Budget Line: Income = (Px × Qx) + (Py × Qy)


    Where:
    Px and Py are the prices of goods X and Y
    Qx and Qy are the quantities of goods X and Y
    Income is the consumer's total spending limit
    C. Consumer Equilibrium

    The point of consumer equilibrium occurs where the


    highest possible indifference curve is tangent to the
    budget line. At this point:

    The slope of the indifference curve (MRS) equals the


    slope of the budget line (the ratio of prices, Px/Py).

    The consumer has allocated their income in such a way


    that utility is maximized given their budget.

    Summary:

    In this lesson, we examined how consumers make choices


    to maximize satisfaction under the constraints of their
    income and prices of goods. The theory of utility helps
    explain why consumers derive different levels of
    satisfaction from consuming goods, and the law of
    diminishing marginal utility shows that satisfaction
    decreases as consumption increases. Indifference curves,
    paired with budget constraints, illustrate how consumers
    make trade-offs between goods to maximize their overall
    utility.

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