INTRODUCTION TO AGRICULTURAL
ECONOMICS
AEDM 111
Lecture 4: THEORY OF
CONSUMER BEHAVIOUR -
UTILITY
Prepared by
Dr. M Christian
UNIT OUTCOME
After studying this chapter, you will be able to:
• Define utility, marginal and total utility
• Explain the law of diminishing marginal utility
• Explain how the equilibrium price and quantities are determined.
• Outline the properties of the Indifference Curves
2
Theory of Consumer Behaviour
The principle assumption upon which the Theory of
consumer behavior and demand is built is:
A consumer attempts to allocated his/her limited
money income among available goods and services
so as to maximize his or her utility (satisfaction)
FEATURES OF UTILITY
UTILITY IS SUBJECTIVE: It is subjective because it
deals with the mental satisfaction of a man.
UTILITY IS RELATIVE: Utility of a commodity never
remains the same. E.g. Cooler has utility in the
summer but not during winter.
UTILITY IS NOT ESSENTIALLY USEFUL:A
commodity having utility need not be useful. Liquor
and cigarette are not useful, but to satisfy the want
of an addict then they gave utility for him.
UTILITY IS INDEPENDENT OF MORALITY: Utility
has nothing to do with morality.
Utility Theory
Economists assume that the more
pleasure a product gives, the higher
price buyers are willing to pay.
Students who like butter are willing to
pay more for buttered popcorn than
non-buttered popcorn because it offers
more total utility.
4-5 LO-1
Ordinal ranking gives information about the
order in which a consumer ranks baskets
E.g. a consumer may prefer A to B, but we
cannot know how much more she likes A to B
Cardinal ranking gives information about the
intensity of a consumer’s preferences.
We can measure the strength of a consumer’s
preference for A over B.
6
Total Utility
Utility is the pleasure or satisfaction
obtained from a good or service.
Total utility is the amount of
satisfaction obtained from entire
consumption of a product.
4-7 LO-1
Marginal Utility
Marginal utility is the change in total
utility obtained by consuming one
additional (marginal) unit of a good or
service. Change in TU/Change in Q
Average Utility total utility divide by Q
4-8 LO-1
RELATION BETWEEN TOTAL
UTILITY AND MARGINAL UTILITY
LAW OF DIMINISHING MARGINAL
UTILITY: It states that as a consumer
consumes more and more of a commodity the
marginal utility of the commodity goes on
declining becomes zero and finally becomes
negative.
Total utility is increasing at increasing rate
so long as marginal utility is positive.
Total utility becomes maximum when
marginal utility is zero.
Total utility starts declining when marginal
utility is negative.
EXAMPLE
UNTIS TOTAL UTILITY MARGINAL
UTILITY
1 8 8
2 14 6
3 18 4
4 20 2
5 20 0
6 18 -2
TU is maximum
Y
Saturation point
TU
0
X
Y
MU
MU +ve
MU = 0
0 X
MU (–)ve
INDIFFERENCE CURVE (IC)
Locus of two commodities x and y that will
grve consumers the same level of satisfaction
Preferences: What the Consumer Wants
Indifference curve: Slices of Bread
shows consumption
bundles that give the
consumer the same
level of satisfaction B
A, B, and all other
bundles on I1 make A
the consumer equally I1
happy – he is
indifferent between
them. Quantity
of Fish
14
Four Properties of Indifference Curves
Slices of
1. Indifference curves Bread
are downward-
sloping.
If the quantity of
B
fish is reduced,
the slices of bread
A
must be increased to
I1
keep consumer
equally happy.
Quantity
of Fish
15
Four Properties of Indifference Curves
Slices of
2. Higher indifference Bread
curves are preferred
to lower ones.
The consumer prefers
every bundle on I2 C
D
(like C) A I2
to every bundle on I1
I1
He prefers
(like A). every
bundle on I1 (like A) I0
to every bundle on I0 Quantity
of Fish
(like D). 16
Four Properties of Indifference Curves
Slices of Benni’s indifference
3. Indifference curves Bread curves
cannot cross.
Suppose they did.
Benni should prefer
B to C, since B has B
more of both goods.
Yet, Benni is indifferent C A
between B and C: I1 I4
He likes C as much as A
(both are on I4).
He likes A as much as B Quantity
of Fish
(both are on I1). 17
Four Properties of Indifference Curves
Slices of
4. Indifference curves bread
are convex to the
origin.
A
Consumeris willing to
give up more slices of 6
bread for a fish if he
1
has few fish (A) than if
B
he has many (B). 2
1 I1
Quantity
of Fish
18
The Budget Constraint
Ifan individual only consumes 2
goods or services (x and y), their
consumption is affected by 3
exogenous variables:
The price of x
The price of y
Income
19
Assume only two goods available: x and y
Price of x = Px
Price of y = Py Income = I
Total expenditure on basket (x,y):
Pxx + Pyy
The Basket is Affordable if total
expenditure does not exceed total
Income:
Px+Py≤I
x y 20
The set of baskets that are affordable is the
consumer’s BUDGET SET
The BUDGET CONSTRAINT defines the set of
baskets that the consumer may purchase given
the income available: Pxx+Pyy=I
The graphable BUDGET LINE is the set of baskets
that are just affordable: y=I/Py-(Px/Py)x
21
Two goods available: x and y
I = R10
Px = R1
Py = R2
Budget line: 1x + 2y = 10 …BL1
Or… y = 5 – x/2
22
Y
I/PY= 5 A y=5-1/2x; 10=2y+x
•
-PX/PY = -1/2
•
I/PX = 10 X
23
Y
Point A: one only consumes y
Point B: one only consumes x.
Point D: consumes a mixture
Point C: consumes a mixture while not
spending the entire budget
Point E: unobtainable unless prices or
I/PY= 5 A income change
•
D E
• •
• C
B
•
I/PX = 10 X
24
Shifts in the Budget Constraint
The budget line will change if any
of its components change:
Income (shift of the budget line)
Prices of x and/or y (rotation of
the budget line)
25
Shift of a budget line – Income Increase
Y
If Income increases, people have more
money to spend on both goods
The budget line will shift out
6
5
y = 6 - x/2; 12=2y+x
y=5-1/2x; 10=2y+x
10 12 X
26
Rotation of a Budget Line
Y If the price of Y rises, the budget line
gets flatter and the vertical intercept
shifts down (as seen here)
I = R10 If the price of Y falls, the budget line
PX = R1 gets steeper and the vertical intercept
PY = R3 shifts up
5
y=5-1/2x; 10=2y+x
3.33
y = 3.33 - x/3
10 27
X
Thank you for listening, ANY QUESTIONS?
