LESSON IV

CONSUMER BEHAVIOR

TOPICS
1. The Concept of Utility
2. What is Utility?
3. Consumer Equilibrium
4. Indifference Analysis
5. Substitution
6. Budget Line

LEARNING OUTCOMES
At the end of the lesson, students should be able to:
1. Calculate total utility
2. Propose decisions that maximize utility
3. Explain marginal utility and the significance of diminishing marginal utility
4. Explain how income, prices, and preferences affect consumer choices
5. Contrast the substitution effect and the income effect
6. Utilize concepts of demand to analyze consumer choices

TOPIC 1: THE CONCEPT OF UTILITY

In the attempt to satisfy wants, consumers make choices as frequent as wants are felt.
Should a person wake up early or late? Should he eat rice and eggs or rice and fish for breakfast?
Play billiards or meet a friend? Call a plumber or do the fixing himself? These are examples of
choices that a consumer makes and they are important considerations in the study of consumer
behavior. But how useful is knowledge of consumer behavior? The answer lies on how
important are profits to the firms. It is very crucial for firms to synchronize their efforts to
match the purchasing behavior of consumers. If they are not able to do so, losses and
bankruptcy are highly probable. In acquiring a working knowledge of consumer behavior,
understanding the concepts of utility are important preliminary items. As an individual has
wants, it is normal for him to desire to satisfy those wants. In this regard, he already has a set of
preferences for goods and services and if not, he is on his way to preparing one. So, how then is
the consumer able to establish a set of preferences for goods and services? The concept of utility
is very useful in providing answers to the above-cited question.

TOPIC 2: WHAT IS UTILITY?

 Utility may be defined as the power of goods and services to satisfy wants. It refers to
“the pleasure or satisfaction associated with having, using, consuming, or benefiting from
goods or services.” The quality of the product or service is primarily responsible for its power
to satisfy wants. Examples of the causes and sources of utility are security, pride, power,
pleasure, comfort, ease of use, etc. However, a good that may satisfy a person may not
necessarily satisfy another. For example, a nice looking toy may satisfy a boy but not an adult
person. The toy, in short, has utility to the boy but not to the adult. Also, a product or service
may satisfy two different persons but the level of satisfaction will also be different. A piece of
ripe banana, for example, may be fully satisfying for Pedro but only partially satisfying for Juan.
A thing that possesses a want-gratifying quality may not possess utility if it is not capable of
being used. For example, shrimps in the river are also useful in the sense that they can satisfy our
want for food, but they have no utility until they are caught. The utility of a certain good varies
from person to person. A book, for example, may have utility to a person but not to one who
cannot read. Listening to Mozart music may have utility to a Mozart fan but not to one who is
not.

Measuring Utility

In this regard, economists have proposed two ways of measuring utility: (1) the
cardinal utility approach, and (2) the ordinal utility approach. The cardinal utility approach
refers to the measurement of utility by assigning numerical values, referred to as utils, such as
1 util, 12 utils, 140 utils or -35 utils. The ordinal utility approach measures utility in terms of
ranks, such as those indicating levels from most satisfying to least satisfying to least satisfying,
best to worst, and highest to lowest.

The Utility Function

Utility is the technical term for satisfaction. There is a functional relationship between
utility and consumption as the need for the latter arises. This functional relationship assumes two
(2) forms and and is quantitatively defined as follows:
TU (Total Utility) = Function Q (Consumption)

MU = Δ (TU)
ΔQ (Satisfaction from an additional unit of
consumption)
Where: Δ = change Δ TU = change in Total Utility ΔQ = change in quantity

The satisfaction of human wants is the purpose of using products and services.
Individual persons obtain satisfaction at increasing levels as they consume the product or
service increases as more units are consumed. This increase in utility is called marginal utility.
In more precise terms, marginal utility refers to “the satisfaction an individual receives from
consuming one additional unit of good or service.”
Table 6
SCHEDULE OF TOTAL MARGINAL UTILITY
FOR FRANCISCO LUNA
----------------------------------------------------------------------------------------------------------------
Guavas Consumed Total Utility Marginal Utility
(in pieces) (in utils) (in utils)
----------------------------------------------------------------------------------------------------------------
1 50 50
2 80 30 (or 80-50)
3 100 20 (or100-80)
4 110 10 (or110-100)
5 90 -20 (or 90-110)
6 20 -70 (or 20-90)
-----------------------------------------------------------------------------------------------------------------
Table 6 illustrates the concept of marginal utility applied to Maria Sunga’s consumption
of guavas. The total utility derived by Maria in consuming a piece of guava is 50 utils. Her total
utility for consuming the second guava is 80 utils. The second guava generated a marginal utility
of 30 utils. The fourth guava gave Maria a total utility of 110 utils but with a marginal utility of
only 10 utils. This indicates full satisfaction of Maria’s need for guavas at that particular time.
For more information visit this website: Utility Theory and Marginal Utility Calculation:
https://www.youtube.com/watch?v=pblYFRVL-OI
Total utility declined at the fifth and sixth guavas as Maria felt satisfied. The total
utility and marginal curves are depicted in Figures 14 and 15. It is important to take note that
marginal utility decreases as more pieces of guavas are consumed. This is an illustration of the
law of diminishing marginal utility. Specifically, the law states that “the amount of extra or
marginal utility declines as a person consumes more and more of a good.”

Figure 14
TOTAL UTILITY CURVE

Figure 15
MARGINAL UTILITY CURVE

TOPIC 3: CONSUMER EQUILIBRIUM

Consumers are expected to behave in a rational manner, i.e., they make decisions on the
basis of choosing which alternative would be most advantageous to them. Decision-making,
however, will be simple if the consumer wants only a single good at a given time. This is not
realistic, however, because consumers find it necessary to buy a variety of goods. This will
make his decision-making a little complicated as he has to determine which goods to buy and
at what quantity. To complicate matters, the consumer is faced with the following realities:
1. the varying prices of goods competing for his attention, and
2. the limited income or purchasing power he has.
The consumer cannot buy everything he wants because of his limited income. Rather, he
is forced to compromise and decide what and how much of each of the many items he can
afford and will best suit his needs. The most preferred combination of goods to buy is referred
to as consumer equilibrium.

Utility Maximization
It is expected that the rational consumer will attempt to choose an option that will offer
him maximized utility. Let us assume that Maria Sunga is determining what combination of two
goods, ice cream and chocolate bar, must she purchase for her to obtain maximum satisfaction
with her limited fund of one hundred pesos. Maria is confronted with the price of ice cream at
₱20 per cone and ₱15 for a bar of chocolate, regardless of how many are bought. From Maria’s
point of view, the utility of the two items in various quantities are shown in Table 7.

Table 7
THE UTILITY OF TWO GOODS
-----------------------------------------------------------------------------------------------------------------
Amount of Utility
(in utils)
Quantity From Ice Cream From Chocolate Bar
Consumed Total Marginal Total Marginal
-----------------------------------------------------------------------------------------------------------------
0 0 0 0 0
1 14 14 9 9
2 22 8 17 8
3 24 2 24 7
4 24 0 27 3
5 21 -3 29 2
6 10 -11 30 1
-------------------------------------------------------------------------------------------------------------------

The utility of the first cone of ice cream is 14 utils from Maria’s point of view. Total
utility (TU) goes up as more cones of ice cream are consumed until it reaches the highest TU
point at 3 cones. The TU at the fifth and sixth cones decline as Maria’s need is fully satisfied.
The marginal utility (MU) for ice cream is highest with the first cone and declines with the
second and third cones. The MUs decline further with the fifth and sixth cones registering
negative figures. The highest TU for chocolate bars but the lowest MU is also derived from 6
bars. With the budget constraint of ₱100, only six combinations of ice cream and chocolate bars
are possible. Shown in Table 8 are the various combinations. The maximum utility that Maria
can derive from spending her ₱100 is with Combination 2, i.e., 2 conefuls of ice cream and 4
bars of chocolate.

Table 8
SCHEDULE OF COMBINATIONS FOR MARIA SUNGA’S UTILITY MAXIMIZATION
----------------------------------------------------------------------------------------------------------------
Combination Quantity Total Total
Ice Cream + Choco Bars Price Utils
-----------------------------------------------------------------------------------------------------------------
1 1 5 P95 43
2 2 4 100 49
3 3 2 90 41
4 4 1 95 33
5 5 0 100 21
6 0 6 90 30
-----------------------------------------------------------------------------------------------------------------

ACTIVITY 4.1 PROBLEM

1. Below is Simon’s utility schedule for consuming fried chicken and spring rolls
Fried chicken Cheese Bread
Units Total Marginal Total Marginal
Consumed Utility Utility Utility Utility
1 100 100 50 50
2 150 50 75 25
3 170 20 80 5
4 180 10 80 0
5 180 0 78 -2
Graph :
1. The Total and Marginal Utility Curves for fried chicken.
2. The Total and Marginal Utility Curves for spring rolls.
 2. Complete Simon’s utility schedule from consuming mango:
Q TU MU
1 90 ____
2 190 100

29

3 ___ 80
4 ___ 70
5 400 ____

6 440 ____

7 ___ 0
8 ___ -2

3. Plot Simon’s TU and MU in a graph.

TOPIC 4: INDIFFERENCE ANALYSIS

Another technique used in analysis of consumer demand is based on the notion of

ordinal utility. This means that when the consumer is faced with a set of alternative “bundles”
of goods, he is able to rank them all in order of preference. When confronted by any two
bundles, for instance, he is able to say whether he prefers one to the other or whether he is
indifferent between them (which means he regards them as equally desirable or equivalent).
Table 9 shows a sample indifference schedule drawn for Maria. The schedule indicates
that Maria will derive equal satisfaction from all combinations listed. Maria is indifferent to all
the various combinations. This means she does not care whether she is given 12 pieces of mango
plus 2 pieces of guava or 10 pieces of mango plus 4 pieces of guava, etc.
Table 9
INDIFFERENCE SCHEDULE
-------------------------------------------------------------------------------------------------------------------
Combination Mangoes Guavas
(in pieces) (in pieces)
-------------------------------------------------------------------------------------------------------------------
1 12 2
2 10 4
3 8 6
4 6 8
5 4 10
6 2 12
------------------------------------------------------------------------------------------------------------------
The Indifference Curve
Figure 16
INDIFFERENCE CURVE

When the indifference schedule is plotted on a graph, the line joining all points is
referred to as the indifference curve. All points in the curve indicate their respective
combinations of goods and services which yield equal levels of satisfaction. A sample
indifference curve is shown in figure 16.

For more information visit this website: Indifference Curves:

https://www.youtube.com/watch?v=iOmDo5jLFw8

TOPIC 5: SUBSTITUTION

Most often, consumers use substitute goods to satisfy their wants. Commodities which
can be used or consumed in place of other goods are referred to as substitute goods. The
substitution option is exercised by the consumer when there are available goods and services
which yield the same level of satisfaction but at lower costs. A consumer, for instance, may
prefer to consume mangoes. If he is confronted by the high price of mangoes and other fruits, he
will consider looking for a substitute. If he finds bananas as the only lower-priced fruit, he may
decide to consider it as a substitute for mangoes. As a result of his action, however, the demand
for bananas will increase. If rise in the price of a good causes an increase in the demand for
another, these two goods qualify as substitutes. When two or more substitutes are available, the
consumers will generally choose the lowest-priced commodity.

Types of Substitutes

Substitutes may be classified as: 1) close substitutes, and 2) weak substitutes

A close substitutes provides an almost or equal level of satisfaction as that of the
substituted good or service. For example, pineapple may be considered a close substitute for
mangoes. A weak substitute provides a lower level of satisfaction than the substituted good or
service. An example of a weak substitute for mangoes is rice cake when used as dessert during
meals.

TOPIC 6: THE BUDGET LINE

The budget line is a useful tool in determining the combinations of goods and services
that will satisfy the consumer with a limited income or budget to spare. Figure 17 shows the
budget line for two goods under consideration by Maria and which is specified in Table 7. Any
point on the budget line (point A, B, C, D, E, or F) gives a combination of ice cream and
chocolate bars that can be bought and that exhausts the entire budget of Maria, given the prices
of ice cream and chocolate bars. Any point below the budget line is feasible but Maria will not
be exhausting her entire budget. Any point above the budget line cannot be covered by
Maria’s income. Considering the above-cited statements, the budget line may be defined as “the
line on a diagram that shows the various combinations of commodities that can be bought
with a given income at a given set prices.”

Figure 17
THE BUDGET LINE FOR TWO GOODS
 ACTIVITY 4.2 SELF CHECK QUESTIONS

For more information visit this website:

Budget Lines & Indifference Curves: https://www.youtube.com/watch?v=4RLEf70CDnw

Budget Constraints: https://www.youtube.com/watch?v=sNRZE0kwNGI

ACTIVITY 4.3 PROBLEM

1. Explain all the reasons why a decrease in a product's price would lead to an increase in
purchases.
2. As a college student you work at a part-time job, but your parents also send you a monthly
“allowance.” Suppose one month your parents forgot to send the allowance. Show graphically
how your budget constraint is affected. Assuming you only buy normal goods, what would
happen to your purchases of goods?

ACTIVITY 4.4 PROBLEM

A. The Equi-marginal Principle of Utility Maximation

Formula: MU of good (A) = MU of good (B)

Price of good (A) Price of good (B)

Price of fried chicken = Php100.00 Price of cheesebread = Php50.00

Q MU MU/P Q MU MU/P
(chicken) (cheesebread)
0 0 0 0 0 0
1 100 1 1 50
2 50 0.5 2 25
3 20 0.2 3 5
4 10 0.1 4 0
5 0 0 5 -2

Utility Maximizing Combination

Optimum Bundles Budget
MU/P = 1 1 fried chicken and 1 cheese bread Php150.00
MU/P = 0.5 2 fried chicken and 2 cheese bread Php300.00
 MU/P =0.1 4 fried chicken and 3cheese bread Php550.00

B. Derivation of Demand

Suppose that a 50% discount on fried chicken is offered in the store. A new
MU/P schedule for fried chicken will be calculated as
New price (fried chicken)=P 50.00 Price (cheese bread) = P 50.00
Q MU (C) MU/P (C) Q MU (CB) MU/P (CB )
0 0 0 0 0 0
1 100 1 50 1.00
2 50 2 25 0.50
3 20 3 5 0.10
4 10 4 0 0.00
5 0 5 -2 -0.04

C. Arvin Cruz demand for fried chicken

Price QD

P100 ____
50 ____
D. Compute the following:

1. Find the bundle of soda and chicharon that will maximize Ana’s utility given the following:
a. Price of soda is P 1.00
b. Price of chicharon is P 4.00 per plate
c. His budget is P 20.00

SODA CHICHARON
Q TU MU MU/P Q TU MU MU/P
1 40 1 100
2 70 2 160
3 95 3 200
4 115 4 230
5 133 5 250
6 150 6 265
7 165 7 275
8 175 8 280
9 183 9 284
10 190 10 287
OPTIMUM BUNDLES BUDGET

2. What is the marginal utility per peso spent on each good? What is the total utility derived from
the combination of goods that fits her budget?

ACTIVITY 4.5 KEY TERMS

Direction: Briefly define the following

Utility Indifference Schedule
Total Utility Indifference Curve
Marginal Utility Substitutes
Consumer Equilibrium Budget Line

ACTIVITY 4.6 TEST YOUR UNDERSTANDING

Direction: Answer the following questions:

1. What is the meaning of the term utility?

2. How is utility measured? Why is measuring utility an important exercise?
3. Distinguish total utility from marginal utility.
4. In what way may the income of the consumer affect his buying behavior?
5. Sometimes a consumer does not choose an option that maximizes utility. Why?
6. What is an indifference analysis?
7. What is an indifference curve?
8. What is a substitute?
9. When is substitution exercised?
10. What is the purpose of the budget line?