Consumer Behavior and

Utility Maximization
Chathuranga Adhikari
B.com (Sp)(Hons), M.com (Reading)
Learning Objectives
• Explain the utility and its connection to consumer behavior
• Understand Total Utility and Marginal Utility
• Calculate the total utility of a collection of goods and services- Utility
Maximization
• Explain Individual demand and market demand curves
• Explain Income and substitution effects
Introduction to the Theory of Consumer
Behavior
How rational consumers decide on the optimal
combination of goods to consume with their limited
budget in order to maximize their total utility at any
given time.
Utility
• Utility = Satisfaction/Happiness/Pleasure one gets from consuming a
good.
• Utility ≠ Usefulness
• Utility is subjective
• Utility is difficult to quantify (Utils)
• Utility is difficult to quantify, as it differs between people and situations
• Measured in “utils” (a personal measure)
Two Types of Approach
❖Cardinal Approach
• The cardinal utility theory says that utility is measurable and by
placing a number of alternatives the utility can be added.
• The index used to measure utility is called utils.
❖Ordinal Approach
• The ordinal utility theory says that utility is not measurable but it can
be compared.
• The ordinal approach uses the ranking of alternatives as first, second,
third, and so on.
 Utility: A Tool to Analyze Purchase
Decisions
• The Purpose of Utility Analysis
• The purpose of utility analysis = analyze how people behave rather than how they think

• Theory of consumer choice = each consumer spends his or her income in a way that
yields the greatest satisfaction

• Utility = amount of satisfaction

 Utility: A Tool to Analyze Purchase
Decisions
• Total versus Marginal Utility
• Total utility = total benefit to a consumer from all the units of a good purchased

• Marginal utility = extra benefit from the last unit of a good purchased. Also, the
change in the total utility from the purchase of 1 more unit of the good.

•  number of goods purchased   total utility but a  marginal utility

 Explanation of the Law:
• Suppose a person is thirsty and the price of water is zero. He takes one
glass of water which gives him great satisfaction. We can say the first glass
of water has great utility for him.
• He then takes a second glass of water. The utility of the second glass of
water is less than that of the first glass of water. The utility declines
because the edge of his thirst has been blunted to a great extent.
• If he drinks a third glass of water, the utility of the third glass will be less
than that of the second, and so on. The utility goes on diminishing with the
consumption of every successive glass of water till it drops down to zero.
• It is the position of the consumer’s equilibrium or maximum satisfaction.
 Explanation of the Law:
• If the consumer is forced further to take a glass of water, it leads to
disutility causing the total utility to decline. The marginal utility will
become negative. A rational consumer will stop taking water at the point
at which marginal utility becomes negative even if the good is free.
• In short, when a good is free, a consumer increases consumption of a
good so long its additional units provide him positive marginal utility.
TOTAL AND MARGINAL UTILITY
Total Marginal
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
1 10 10

0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
10
1 10 10

0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
10
1 10 10

8
2 18
0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
4
2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
0 4
6 30 2
0
-2
1 2 3 4 5 6 7
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal TU
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils
20
0 0
10
1 10 10

8
2 18
6
3 24 0 1 2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
0 4
6 30 2
-2 0
7 28 -2
1 2 3 4 5 6 7
MU
Units consumed per meal
 TOTAL AND MARGINAL UTILITY
Total Marginal TU
Yogurts Utility, Utility, 30

Total Utility (utils)

consumed Utils Utils

0 0
20
Observe
10 Diminishing
1 10 10

8
2 18 Marginal
6
3 24 0 1
Utility
2 3 4 5 6 7

4
4 28
Units consumed per meal

Marginal Utility (utils)

10
2 8
5 30 6
0 4
6 30 2
-2 0
7 28 -2
1 2 3 4 5 6 7
MU
Units consumed per meal
Law of Diminishing Marginal Utility
• Law of diminishing marginal utility: Added satisfaction declines as a
consumer acquires additional units of a product.
• e.g. Your desire for a car may be very strong? What about for a second car?
A third?

• Additional units of a good/service are worth less and less to a consumer

in money terms.
Consider this:

• Newspaper vending machines normally allow one to take

multiple papers; publishers allow this because they believe
that people rarely take more than one paper because the
marginal utility of the second paper is often zero, and it has
little “shelf life.”
Theory of consumer behavior uses the law of diminishing marginal
utility to explain how consumers allocate their income.
Consumer Choice and the Budget Constraint

• Budget Constraint - Consumers’ incomes are limited because their

individual resources are limited.

• Goods and services have prices and are scarce relative to the demand
for them. Consumers must choose among alternative goods with their
limited money incomes.
 Consumer Choice & Budget Constraints

• Rational Behavior - we want the most from our money spent.

• Preferences – how much marginal utility will we get from more of a product?
• Budget Constraint – Everyone has one!
• Prices – Choose the “combination” of goods that most please you.
• It is the marginal utility per dollar spent that is equalized; that is,
consumers compare the extra utility of each product with its cost.

• As long as one good provides more utility per dollar than another, the
consumer will buy more of that good; as more of the first product is
bought, its marginal utility diminishes until the amount of utility per
dollar just equals that of the other product.
 Marginal Utility and Demand
• From Diminishing Marginal Utility to Downward-Sloping Demand Curves

• Law of diminishing marginal utility  negative slope of demand curves

•  price   quantity demanded   marginal utility

• Restores equality between price and marginal utility

 Marginal Utility and Demand
• From Diminishing Marginal Utility to Downward-Sloping Demand
Curves

• If successive units of a good yield smaller and smaller amounts of

extra utility, then the consumer will buy additional units of the good
only if its price falls.
Consumer Optimum for one product
The Consumer will maximize his/her total satisfaction derived from
the consumption of a particular product when the marginal utility
from the consumption of that product equals zero.
Consumer’s Equilibrium Symbolically as
follows

• At consumer’s equilibrium:
• MU=P
• re-write this as
Consumer Optimum for One Product
— if money is not sufficient, consumer will consume as long as marginal utility
is greater than price.
— Hence the general conditions for consumer’s equilibrium or optimum
purchasing rules are:

MU=P Equilibrium condition 1

M =PQ Equilibrium condition 2

— Where M denotes the amount of money he has.

— ( MU P, if there is not enough money to satisfy equilibrium condition 1)
Derivation of Demand Curve

Glasses MU Price
1 8 8
2 6 6
3 4 4
4 2 2
5 0 0
Derivation of Demand Curve

Price
MU=P

P=4

MU

0 3 Quantity
 Consumer Surplus
• The difference between what a
consumer is willing to pay for an
addition unit of a good and the
market price that he/she actually
pays is referred to as “consumer
surplus”.
• The area between the demand
curve and the price (line)
measures the total consumer
surplus
Optimum Purchasing Rule
• Purchase buns and socks until the

• When two or more goods are purchased, it is called,

Equi - Proportional Utility Rule
Consumer Choice and Budget
Constraints
For simplicity, assume the following for the typical consumer:
•Rational Behavior – want to maximize total utility
•Clear-cut Preferences
•Budget Constraint (limited income)
•Every good has a price tag
• So, consumers must compromise!
Utility Maximizing Rule
The consumer’s money income should be
allocated so that the last dollar spent on
each product yields the same amount of
extra (marginal) utility.

illustrated...
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12

How should the $10

income be allocated?
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12

Examine the two

marginal utilities
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12

Examine the two

marginal utilities
…per dollar
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12

Decision: Buy 1
Product B for $2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6 6 16 8
Fifth 5 5 12 6
Sixth 4 4 6 3
Seventh 3 3 4 2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth What
6 next?
6 16 8
Fifth 5 5 12 6
Sixth 4 4 6 3
Seventh 3 3 4 2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth What
6 next?
6 16 8
Fifth 5 5 12 6
Buy one of each
Sixth 4 4 6 3
Seventh 3 3 4 2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6 6 16 8
Fifth 5
and then...
5 12 6
Sixth 4 ($54left)6 3
Seventh 3 3 4 2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6 6 16 8
third
Fifth 5 unit
5 12 of 6
Sixth 4product
4 6B 3
Seventh 3 3 4 2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6
$3 left... 6 16 8
Fifth 5 5 12 6
Sixth 4 4 6 3
Seventh 3 3 4 2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third 7 7 18 9
Fourth 6
$3 left... 6 16 8
Fifth 5 5 12 6
Buy
Sixth 4 both! 4 6 3
Seventh 3 3 4 2
 UTILITY MAXIMIZING COMBINATION
Product A: Product B:
$ 10 income Price = $1 Price = $2
Marginal Marginal
Marginal utility per Marginal utility per
Unit of utility, dollar utility, dollar
product utils (MU/price) utils (MU/price)

First 10 10 24 12
Second 8 8 20 10
Third
Income is 7 gone...7 18 9
Fourth
the last dollar 6spent on6 16 8
each good gave the same
Fifth 5 5 12 6
utility (8) per dollar
Sixth 4 4 6 3
Seventh 3 3 4 2
Two-Good Practice Problem
Given TU, and an income/budget constraint of Rs26
find the Utility-Maximizing Combination of A and B

Product A: Product B:
Price = Rs 5 Price = Rs 3

Unit TU Unit TU

1 22 1 10
2 32 2 16
3 40 3 20
4 46 4 22
5 48 5 20
Sunil has Rs. 40 to spend on either product “A” or product “B” and wants to
maximize his utility. Suppose that the price of both products is Rs. 5. The following
table shows the total utility associated with the consumption of product A and
product B in various amounts.

Quantity Total Utility Total Utility

(Product A) (Product B)
1 140 180
2 260 340
3 360 460
4 440 520
5 500 540
Utility maximization and the demand curve
• When the price of product X falls, the quantity demanded of product X
will increase.
• Before the price of product X falls, we can get a combination of product X
with other products, maximizing the utility of the consumer. This
combination will give the quantity demanded of the product X at that given
price.
• When the price of product X falls, we will have a new combination of
product X with other products, maximizing the utility of the consumer.
This combination will give a more significant quantity demanded of
product X at that lower price.

50
Income and Substitution Effects
• Income effect
The impact that a price change has on a
consumer’s real income/ purchasing power
• Substitution effect
The impact that a change in a product’s price has
on its relative expensiveness
Thank you