THEORY OF CONSUMER BEHAVIOUR
WEEK THREE
THEORY OF CONSUMER BEHAVIOUR
CONTENT
- Definition of Utility
- Cardinal school of thought/Assumption
- Concept of Total, Average and Marginal Utility
- The law of Diminishing Marginal Utility.
THEORY OF CONSUMER BEHAVIOUR
The theory of consumer behaviour is also known as the theory of household behaviour. It is primarily concerned with how the consumer or household tries to satisfy his/her wants by dividing his/her limited amount of income between the various commodities that give him equal amount of satisfaction.
WHAT IS UTILITY?
Utility can be defined as the amount of satisfaction that is derived by a consumer from the consumption of a given commodity.
Hence, when a consumer derives satisfaction from the consumption of a commodity, it can be said that the commodity or service possesses utility.
Utility therefore, is relative to a consumer, depending on the time, place, form, etc.
A commodity that can satisfy a consumer’s want at a particular point in time and place may not satisfy another’s want.
- Utility is how much something helps or satisfies us.
- It’s like a measure of usefulness or satisfaction.
- When you use a thing like a game or food, you feel happy because of it. That’s utility.
- We decide what to get or use based on how much utility it gives us.
- The more helpful or satisfying something is, the more utility it has.
EVALUATION
- Define utility.
- What is consumer behaviour?
- Mention four relative factors that determine utility.
- Is the utility derived from certain commodity always constant or fixed?
There are basically two schools of thought in the analysis of utility and they are as follows:
- Cardinal school of thought
- Ordinal school of thought.
CARDINAL SCHOOL OF THOUGHT:
This approach emphasizes that utility is measurable. That is, after consuming a given quantity of a commodity the consumer can simply evaluate his satisfaction through the use of figures which range from zero to infinity.
ASSUMPTIONS OF CARDINAL APPROACH
- Utility is measurable
- The consumer is rational
- There is diminishing marginal utility
- Total utility (TU) depends on the quantity consumed.
- Money income of the consumer is held constant
- Utility is measurable: It assumes that you can measure the satisfaction or happiness people get from consuming goods and services.
- Marginal utility: It assumes that the additional satisfaction (marginal utility) from consuming one more unit of a good decreases as you consume more of that good. In other words, the more you have of something, the less extra satisfaction each additional unit provides.
- Rational behavior: It assumes that individuals are rational decision-makers who seek to maximize their overall utility when making choices.
ORDINAL SCHOOL OF THOUGHT:
The ordinal school of thought in economics is based on a different set of assumptions compared to the cardinal school. Here are the key assumptions of the ordinal school:
- Preference ranking: It assumes that individuals can rank their preferences for different goods and services. In other words, people can say what they like more, less, or equally, but it doesn’t require measuring the exact amount of satisfaction.
- Indifference curves: The ordinal approach uses indifference curves to represent different combinations of goods that provide the same level of satisfaction. This means that within a particular curve, the individual is indifferent to the choices because they provide the same level of satisfaction.
- Transitivity of preferences: It assumes that people’s preferences are transitive, meaning if someone prefers option A to option B and option B to option C, they also prefer option A to option C.
The ordinal school doesn’t attempt to measure the exact level of utility but focuses on the relative ranking of preferences. This approach is often considered more realistic and flexible in modeling consumer choices
CONCEPT OF TOTAL, AVERAGE AND MARGINAL UTILITY
- Total Utility (TU):
- Total Utility is the total satisfaction or happiness that a person gets from consuming a certain quantity of a good or service.
- It represents the overall benefit or pleasure derived from all units of a product consumed.
- As you consume more of a good, the total utility generally increases, but it may increase at a diminishing rate.
- Average Utility (AU):
- Average Utility is the per-unit satisfaction obtained from consuming a good or service.
- It is calculated by dividing the Total Utility by the number of units consumed.
- AU = Total Utility / Quantity Consumed.
- Average Utility helps us understand how much satisfaction, on average, each unit of a product provides.
- Marginal Utility (MU):
- Marginal Utility is the additional satisfaction gained from consuming one more unit of a good or service.
- It helps us make decisions about how much of a product to consume.
- Marginal Utility tends to decrease as you consume more of a good due to the law of diminishing marginal utility, which means each additional unit provides less extra satisfaction.
- When MU equals zero, it signifies that you are maximizing your satisfaction because the extra unit provides no additional benefit.
These concepts are essential in understanding consumer choices and how people allocate their resources to maximize their utility or satisfaction.
TOTAL UTILITY:
This is the total amount of satisfaction a consumer derives from the consumption of a particular commodity at a point in time. Consumers’ utility increases as the quantity consumed increases but not at equal rate because consumer has a saturation point in the consumption of particular commodity at a given time.
y
Units of
Utility
TU
X
Qty of goods
AVERAGE UTILITY: This derived by dividing total utility by the units of the commodity consumed. That is, it is the satisfaction which a consumer derives per unit of a commodity consumed. AU = TU/Q
MARGINAL UTILITY: This means the additional satisfaction a consumer derives from the consumption of additional unit of a particular commodity. It is then the change in the total utility as a result of the consumption of additional unit of a commodity. MU = ∆TU/∆Q
UTILITY SCHEDULE
| Quantity of Goods consumed | Total Utility | Average Utility | Marginal Utility |
| 1 | 4 | 4 | – |
| 2 | 7 | 3.5 | 3 |
| 3 | 9 | 3 | 2 |
| 4 | 10 | 2.5 | 1 |
| 5 | 10 | 2.0 | 0 |
RELATIONSHIP BETWEEN TOTAL UTILITY AND MARGINAL UTILITY
- The MU begins to fall right after the first unit of the commodity has been consumed and continues to diminish until it reaches zero level on x – axis and below.
- At the point where the MU reaches zero level on the x – axis, TU reaches its maximum point.
- When the MU cuts the x – axis, TU begins to fall from its peak.
- When the MU descends below the x – axis and becomes negative, the TU curve begins to slope downward
TOTAL AND MARGINAL UTILITY CURVE
Total and Marginal Utility curves are graphical representations used in economics to illustrate the concepts of Total Utility (TU) and Marginal Utility (MU) as related to the consumption of goods and services.
- Total Utility (TU) Curve:
- The Total Utility Curve shows how the total satisfaction or utility changes as the quantity of a good or service consumed increases.
- On the TU curve, the x-axis represents the quantity of the good consumed, and the y-axis represents the total utility or satisfaction.
- As you consume more of a good, the TU curve typically rises, indicating that your total satisfaction is increasing.
- However, the slope of the curve becomes less steep as you consume more, reflecting the law of diminishing marginal utility.
- Marginal Utility (MU) Curve:
- The Marginal Utility Curve shows how the additional satisfaction (MU) changes when consuming one more unit of a good.
- On the MU curve, the x-axis represents the quantity consumed, and the y-axis represents the marginal utility.
- The MU curve usually slopes downward from left to right, demonstrating that as you consume more of a good, the additional satisfaction from each extra unit diminishes.
- When the MU curve intersects the x-axis (MU = 0), it indicates the point at which you maximize your total utility.
These curves are essential tools for economists and consumers to understand how individuals make choices about consumption. They show how the level of satisfaction changes as more of a good is consumed and help in decision-making about resource allocation.
EVALUATION
- Total Utility measures the __________ satisfaction from consuming a good.
a) Overall
b) Individual
c) Future
d) NegativeAverage Utility is calculated by dividing Total Utility by the __________ consumed.
a) Price
b) Quantity
c) Income
d) TimeMarginal Utility represents the __________ satisfaction from consuming one more unit of a product.
a) Extra
b) Initial
c) Total
d) Average - Marginal Utility tends to decrease as you consume more due to the law of __________ Marginal Utility. a) Constant b) Increasing c) Diminishing d) Negative
- Utility is a measure of how much satisfaction or __________ something provides. a) Money b) Happiness c) Labor d) Confusion
- In economics, people are assumed to make rational choices to maximize their __________ Utility. a) Total b) Marginal c) Average d) Indifference
- Indifference curves are used in the ________ school of thought to represent preferences. a) Cardinal b) Ordinal c) Rational d) Logical
- Average Utility is calculated as Total Utility divided by the __________ consumed. a) Price b) Quantity c) Income d) Time
- Marginal Utility measures the change in __________ when consuming one more unit. a) Satisfaction b) Price c) Quantity d) Income
- The law of __________ Marginal Utility states that as you consume more, the additional satisfaction decreases. a) Constant b) Increasing c) Diminishing d) Negative
- People are assumed to have ________ preferences when ranking their likes and dislikes. a) Random b) Inconsistent c) Transitive d) Emotional
- Utility helps people decide what goods and services to consume based on their __________. a) Price b) Color c) Brand d) Satisfaction
- Indifference curves show combinations of goods that provide the same level of __________. a) Scarcity b) Happiness c) Income d) Preferences
- The ordinal approach focuses on ranking preferences rather than measuring exact levels of __________. a) Satisfaction b) Money c) Price d) Quantity
- Marginal Utility equals zero when you are maximizing your __________ from consumption. a) Happiness b) Income c) Total Utility d) Debt
1 Calculate the missing value from the table below.
| Quantity of goods consumed | Total utility | Marginal utility |
| 1 | 10 | – |
| 2 | 16 | A |
| 3 | B | 4 |
| 4 | 20 | C |
THE LAW OF DIMINISHING MARGINAL UTILITY
The law of diminishing marginal utility states that, other things being equal, the marginal utility of a commodity to an individual decreases with extra unit of that commodity he consumes. In other words, the law states that if a consumer goes on consuming successive equal increments in the quantity of a commodity, then the increase in total utility resulting will become smaller and smaller, that is, satisfaction per extra unit will start falling. For instance, a beer drinker may derive maximum satisfaction in the first three bottles, after which decrease in satisfaction may set in as more and more bottles of beer are consumed until he may be unable to consume anymore.
UTILITY MAXIMIZATION
Utility maximization is also known as equilibrium of the consumer. A point where a consumer derives maximum satisfaction when his marginal utility equates the price of the commodity consumed. That is, the additional utility derived from the consumption of additional commodity is equal to price of the commodity.
In the case of one commodity, a consumer will maximize his satisfaction in the consumption of a particular commodity when the MU of that commodity equals the price of that commodity, eg MUx = Px
In the case of two or more commodities, a consumer is said to be in equilibrium or maximizes his utility when the ratio of MU of the last unit of the commodities consumed should be equal to the ratio of the price. Alternatively, a consumer’s utility is maximized when the MU per amount spent on a product is equal to the MU per amount spent on any other product, as stated below:
MUx MUy MUz
Px = Py = Pz.
where MUx = MU of commodity X
Px = Price of commodity X
MUy = MU of commodity Y
Py = Price of commodity Y
MUz = MU of commodity Z
Pz = Price of commodity Z
- The MU curve typically slopes __________ from left to right as you consume more of a good. a) Upward b) Downward c) Sideways d) Circular
- The law of __________ Marginal Utility suggests that the additional satisfaction from each extra unit diminishes. a) Constant b) Increasing c) Diminishing d) Negative
- When the MU curve intersects the x-axis, it indicates the point at which you maximize your __________. a) Income b) Total Utility c) Scarcity d) Debt
- Total and Marginal Utility curves are important tools for understanding how individuals make choices about __________. a) Travel b) Consumption c) Production d) Entertainment
- The Total Utility Curve helps visualize how total satisfaction or utility changes as the quantity of a __________ increases. a) Problem b) Good or service c) Bill d) Friend
- The MU curve shows how the additional __________ changes when you consume more of a good. a) Income b) Satisfaction c) Debt d) Scarcity
- The TU curve rises as you consume more, but it becomes __________ steep over time. a) More b) Less c) Constantly d) Unexpectedly
- The MU curve slopes downward to indicate that additional satisfaction from each extra unit __________. a) Increases b) Stays the same c) Diminishes d) Reverses
- Total and Marginal Utility curves help in making decisions about __________ allocation and maximizing satisfaction. a) Resource b) Money c) Time d) Happiness
- The Total Utility (TU) Curve illustrates how total __________ changes with the quantity of a good consumed. a) Happiness b) Satisfaction c) Money d) Scarcity
- On the TU curve, the x-axis represents the quantity of the good consumed, and the y-axis represents the __________. a) Price b) Total Utility c) Marginal Utility d) Income
- As you consume more of a good, the TU curve typically __________, indicating increased satisfaction. a) Rises b) Flattens c) Dips d) Disappears
- The slope of the TU curve becomes less steep as you consume more, reflecting the law of __________ Marginal Utility. a) Constant b) Increasing c) Diminishing d) Negative
- The Marginal Utility (MU) Curve shows how the additional satisfaction (MU) changes when consuming __________ unit(s) of a good. a) One more b) Fewer c) All available d) No additional
- On the MU curve, the x-axis represents the quantity __________, and the y-axis represents the marginal utility. a) Spent b) Consumed c) Saved d) Lost
CONSUMER SURPLUS
Consumer surplus is define as the difference between the amount a consumer budgeted to pay for a commodity based on the anticipated level of satisfaction, and the amount he actually paid to have it. When he consumed the first unit, he was willing to pay as much as #50, but the commodity’s price was #30. Thus, he saved #20.Therefore any amount above the market price of #30 represents the consumer’s surplus.
EVALUATION
- Define consumer surplus.
- State the law of diminishing marginal utility.
- Use the tale below to answer the following questions:
PLATE OF RICE CONSUMED TU MU
0 0 0
1 100 100
2 160 ?
3 ? 40
4 ? 10
5 230 ?
6 230 ?
7 200 ?
3(a). Complete the above utility schedule
(b). Draw the MU curve
(c)i At what quantity does MU equal TU?
ii What happens to the values of TU as quantity consumed increases?
iii What is the value of MU when TU is maximized?
Iv What happens to MU as the quantity consume increases?
GENERAL EVALUATION QUESTIONS
- Why is scarcity a fundamental problem?
- Define marginal utility
- Define labour.
- Differentiate between implicit cost and explicit cost.
- Explain the concept of marginal utility
- What is mobility of labour?
- List four advantages of the mean
- Explain consumer behaviour.
- Why is scarcity a fundamental problem?
- Scarcity is a fundamental problem because resources are limited, but human wants and needs are virtually unlimited. It forces individuals, businesses, and societies to make choices about how to allocate these limited resources efficiently.
- Define Marginal Utility:
- Marginal Utility is the additional satisfaction or benefit a person gets from consuming one more unit of a good or service. It’s a measure of how the consumption of an extra unit affects overall happiness or satisfaction.
- Define Labour:
- Labour refers to the physical and mental effort that individuals contribute to produce goods and services. It includes tasks, work, and services performed by people as a factor of production.
- Differentiate between Implicit Cost and Explicit Cost:
- Implicit Cost: These are opportunity costs that arise from using resources for a particular purpose instead of the next best alternative. They are not monetary expenses but represent the value of what could have been done with those resources.
- Explicit Cost: Explicit costs are the actual monetary expenses incurred in a business, such as wages, rent, utility bills, and other tangible expenditures.
- Explain the Concept of Marginal Utility:
- The concept of Marginal Utility is about how the satisfaction or happiness gained from consuming one more unit of a good changes. It helps individuals and businesses make decisions about how much to consume based on whether the additional benefit (MU) is worth the cost.
- What is Mobility of Labour?
- Mobility of labor refers to the ability of workers to move from one job or location to another in search of better employment opportunities. It can be geographical mobility (relocating for a job) or occupational mobility (changing careers).
- List Four Advantages of the Mean:
- The mean is a measure of central tendency. Four advantages include: a) It considers all values in the data. b) It’s sensitive to extreme values (outliers). c) It’s mathematically well-defined and easy to calculate. d) It provides a single, summarized value for the data.
- Explain Consumer Behavior:
- Consumer behavior refers to the actions, choices, and decision-making processes that individuals go through when purchasing goods and services. It involves how consumers select products, make buying decisions, and allocate their resources to meet their needs and desires. It’s influenced by factors like preferences, income, prices, and psychological factors
WEEKEND ASSIGNMENT
- Which one of these assumptions do economists always make about consumers? ___(a) That they are all wage earners (b) That they make rational decisions in the market (c) That they cannot spend more than their incomes (d) That they can measure utility derived from consumption
- The aim of the consumer in allocating his income is ____(a) to maximize his marginal utility (b) to buy goods he wants most whatever the price. (c) to maximize his total utility (d) to buy those goods which fallen in price.
- ……………………takes place when the ratio MU of a commodity consumed is equal to the ratio of its price (a) consumer surplus (b) law of diminishing marginal utility (c) consumer behaviour (d) utility maximization
- Total utility (TU) attains its peak when the Marginal utility (MU) is ….. (a) zero on x- axis (b) above x- axis (c) close to x – axis (d) under x- axis
- The difference between the amount of money a consumer planned to pay for a commodity and the actual amount of money he paid is………. (a) commodity price (b) consumer surplus (c) marginal cost (d) producer surplus
THEORY
- With the use of table, explain the concept of diminishing marginal utility
- Explain how utility is maximized.
- Explain the concept of marginal utility returns
Concept of Diminishing Marginal Utility:
Suppose we have a table representing the consumption of a specific good, in this case, ice cream:
| Units Consumed | Total Utility (TU) | Marginal Utility (MU) |
|---|---|---|
| 1 | 10 | 10 |
| 2 | 18 | 8 |
| 3 | 24 | 6 |
| 4 | 28 | 4 |
| 5 | 30 | 2 |
| 6 | 30 | 0 |
In this table, as you consume more units of ice cream, the Total Utility (TU) initially increases. However, the Marginal Utility (MU) decreases. It’s clear that with each additional unit of ice cream, the extra satisfaction (MU) you gain is less than the previous one. This demonstrates the law of diminishing marginal utility: as consumption increases, the additional utility decreases.
How Utility Is Maximized:
Utility is maximized when the Marginal Utility (MU) equals zero. In the table above, you can see that utility is maximized when 6 units of ice cream are consumed. At this point, the additional satisfaction (MU) is zero, indicating that consuming more would provide no extra benefit. Therefore, to maximize utility, individuals should consume until MU equals zero.
Concept of Marginal Utility Returns:
Marginal utility returns refer to how the additional satisfaction (MU) changes as you consume more units of a good. Initially, MU is usually high, indicating that each additional unit provides significant extra satisfaction. However, as consumption continues, MU begins to decrease, and in some cases, it can become zero or even negative, signifying dissatisfaction. This concept helps individuals make rational decisions about consumption to maximize their overall satisfaction and allocate resources efficiently.
