BE 313

MANAGERIAL ECONOMICS

Prepared by: PEARL LETTEE D. MAUNES, MBA

Google chat/email address: [email protected]
 WEEK 4-5
Big Picture in Focus:
Unit Learning A
Rationalize consumer behavior and utility
maximization.
Essential Knowledge

The Economics of Satisfaction

To give you a clearer view of how economics can explain consumers'

behavior to attain maximum level of satisfaction on the goods and
services they consume, we will discuss some theories that support this
concept.
Essential Knowledge

Utility Theory
From an economic standpoint, utility refers to the satisfaction that a
consumer gets from using the goods or services. This is measured by
how much a consumer is willing to pay for a good/service.
Essential Knowledge
Hypothetical Demand Schedule for Siopao
Price (P) Quantity The table shows the hypothetical demand schedule for
Demanded (Qd) siopao. You will notice that the amount of money that you
are willing to buy for an additional unit of siopao declines.
15.00 1 This is because the more siopao you eat, the more you
become satisfied so that you are not willing to spend more
12.75 2 for the next siopao. In other words, our satisfaction from the
goods decreases as we consume more and more of it. This
10.50 3 is what Utility Theory is all about. It simply explains how our
satisfaction or utility as consumers decline when we try to
8.25 4 consume more of the same good at a particular point in time.
Essential Knowledge

Marginal Utility
Marginal means “additional” or “extra”. As mentioned earlier, utility
means ‘satisfaction’. Thus, marginal utility means additional
satisfaction derived from consuming an extra unit of a good or
service. Thus, the marginal utility of a commodity is the increase in
total utility or satisfaction derived from the consumption of an
additional or extra unit of such commodity; it is the loss of utility or
satisfaction if one unit less is consumed.
Essential Knowledge

Total Utility
This is defined as the total satisfaction that a consumer derives from
consuming a given quantity of a good or service in a given time. Total
utility increases as we consume more and more of a good or service,
but the increase is at a declining rate. This indicates that each extra
unit consumed adds less marginal utility (additional satisfaction)
than the previous unit as we become satisfied with the good or
service we are consuming.
Essential Knowledge
Hypothetical Utility Schedule for Siopao
The table illustrates the total utility. Assume that you are
too hungry at the end of our class so that you went out to
Unit Total Utility Marginal buy food. You bought and ate one siopao for your
Purchased Utility snacks. In this case, your total and marginal utility are 40
1 40 40 units (see table above). Assume further that you ate
2 90 50 another siopao because you are too hungry. So on your
3 170 80 2nd consumption, your total utility now increases to 90,
4 270 90 and your marginal utility increases by 50. Let us now
assume that you have eaten 5 siopao. If you look at the
5 350 80
table, in your 5th consumption (unit purchased), your
total utility is 350; however, your marginal utility declined
to 80. This is because of the Law of Diminishing of
Marginal Utility.
Essential Knowledge
Law of Diminishing of Marginal Utility
This law states that “as a consumer gets more satisfaction in the long-
run, he experiences a decline in his satisfaction for goods and
services”. This means that consumption of more successive units of
the same good increases total utility, but at a declining rate because
marginal utility (additional satisfaction) diminishes or decreases.
Simply put, as we consume more and more of a good or service, we
like it less and less. Our satisfaction declines from each additional unit
consumed.
Essential Knowledge
Mathematical Derivation of Marginal Utility
Applying the formula, we can derive the marginal utility for the total utility
∆*+ presented in the Hypothetical Utility Schedule for Siopao.
𝑀𝑈 = ∆, Unit Purchased Total Utility Marginal Utility
1 40 40
TU2 – TU1 2 90 50
MU =
Q2 – Q1 3 170 80
4 270 90
5 350 80
Where:
TU2 = the new total utility MU=TU2 – TU1 \ Q2 – Q1
TU1 = the original utility MU=40–0 \ 1 –0
Q2 = the new quantity MU=40 \ 1
Q2 = the original quantity
MU=40
Essential Knowledge
At 1 unit purchased, the original TU and Q are assumed as zero as there are no previous numbers.
Hence,

TU2 = 40
TU1 = 0
Q2 = 1
Q2 = 0

At 2 unit purchased, TU2 = 90; TU1 = 40; Q2 = 2; and Q1 = 1. Do the same up to the 5th unit
purchased to check if you can get the marginal utility given in the table above.

Until when do we stop consuming the same good?

Or when do we know that we have reached our
maximum satisfaction? We can say that we have already
reached our maximum satisfaction IF our marginal
utility falls to zero. Beyond this point, i.e., marginal
utility is already negative; we have already exceeded our
satisfaction so that we stop consuming the same good.