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Consumer Behavior Analysis

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Law of Diminishing

Marginal Utility

As the quantity consumed of a

good increases, the utility fromeach additional unit diminishes.

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Total utility [TU] is the amount of utility an individual derives fromconsuming a given quantity of a good. TU = f (Q, preferences, . . .)

1 2 3 4 5 6 7 Q/t

20

40

60

100

80

120

Utility

Q

12

4

8

56

7

3

TU

3055

75

90

100105

105

100

.

. ......TU

TU

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Marginal utility [MU] is derived from

consumption of each additional unit of a

commodity.

As total utility increases at a decreasing rate,

MU declines.

As total utility declines, MU is negative.

When TU is a maximum, MU is 0. Saturation point

Marginal Utility

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Marginal Utility [MU] is the change in total utility [TU]caused by a one unit change in quantity [Q] ;

MU = TU

Q

Utility

Q

12

4

8

567

3

TU

3055

75

90

100

105

105

100

MU(Q=1

(TU=30

The first unit consumed increases TU by 30.

.30(Q=1 (TU=25

.25

(Q

The 2nd unit increases TU by 25.

25(Q=1

(TU=20 .20 .15

10

.

5

0

-5

1 2 3 4 5 6 7 Q/t

10

20

30

MU

. ..MU

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The individual purchases more of a

good so long as their expected MU

exceeds the price they must pay for thegood:

Buy so long as MU > Price;

Dont buy ifMU < Price. The maximum utility occurs where

MU = Price.

Individual Choice

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Utility X

Qx

12

4

8

56

7

3

TUx

3055

75

90

100105

105

100

20

15

10

5

0

-5

3025

MUx

Utility Y

Qy

12

4

8

56

7

3

TUy

6090

110

120

128128

120

100

6030

20

10

80

- 8

- 20

MUy

Consider an individuals utility preference for 2 goods, X & Y;

Once the goods have a priceand there is a budgetconstraint, the individualwill try to maximize the

utility from each additionalUnit of money spent.

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Utility X

Qx

12

4

8

56

7

3

TUx

3055

75

90

100105

105

100

20

15

10

5

0

-5

3025

MUx For PX = Rs 3,

Given the budget constraint, individuals will attempt togain the maximum utility for each additional unit of money spent,

the marginal rupee.

MUXPX

10.8.33

6.67

5.00

3.331.67

0

For PY = Rs 5,

Utility Y

Qy

12

4

8

56

7

3

TUy

6090

110

120

128128

120

100

6030

20

10

80

- 8

- 20

MUy

MUYPY

126

4

2

1.60

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Law of Equi-Marginal Utility

MUx = Px Utility maximization

If MUx > Px consumer will spend more onx

If MUx < Px consumer will spend less on x

With given Budget Constrain consumer

will try to distribute his income in all hisrequirements in a way that his utility ismaximum from all the given products.

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Continue to maximize the MUper re. spent until the budgetof Rs 25 has been spent.

, BUY X !

MUXPX

MUYPY

Constrained Optimization

if

if

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Law of Equi-Marginal Utility

MUx/Px = MUy/Py

is an equilibrium condition

for individual choice.