Chapter 4: Marginal Utility and Consumer Behavior lower than 10.

Consumers’ satisfaction that consumers

derived from consuming goods is utility. If we measure
One of the questions that economists are interested in is
utility, we can assign unit of value for each good that we
how people decide to spend their money is how people
consume, and it is called "util." Utility is subjective as we
decide to spend there is a field of economics known as
can observe in the example involving Mario and Luigi.
consumer theory. This study of how people decide to
There are two theories in explaining consumer behavior:
allocate their income to spending on goods has a few key
the utility approach and the indifference approach.
assumptions that lead to some important conclusions
about how a consumer decides to allocate their income Mario’s Total Utility and Marginal Utility
to spending on goods and services.
Derived from Consuming Ice Cream (Utils)
Consumers’ satisfaction that consumers derived from
consuming goods is utility. If we measure utility, we can
assign unit of value for each good that we consume, and Number
it is called "util." of Ice Total Utility Marginal Utility
Cream
Marginal Utility and Total Utility Cones
Marginal Utility 0 0 0
1 20 20
Marginal utility is the additional utility derived from 2 35 15
consuming an additional unit of a good per unit of time. 3 40 5
Total Utility 4 41 1
5 41 0
Total utility is the total number of satisfactions derived 6 36 -5
from consuming a specific quantity of a good.

Marginal utility (MU) can be computed as,

1. MU = (20 - 0) / (1-0)

= 20/1

where, MU = 20

TUf = Final Total Utility at Final Quantity 2. MU = (35 - 20) / (2-1)

(Qf) = 15/1
TUi = Initial Total Utility at Initial
Quantity (Qi) MU = 15
Qf = Final Quantity
Qi = Initial Quantity

Example:

Mario and Luigi were eating a chocolate flavored ice

cream. Luigi asked Mario, "how much do you like ice
cream?" Mario replied, "Very much." "How about you Total Utility Marginal Utility
Mario?" asked Luigi. "Not that much." If we are going to
ask Mario and Luigi to rank the satisfaction that they
derived from eating the ice cream from 1 to 10, Mario
might rank it 10. However, Luigi might just rank it much
Law of Diminishing Marginal Utility
It states that in a given period of time the satisfaction
derived from an additional unit of goods decreases as the
amount increases.
Interpersonal Utility Comparison
This are moral opinions (what society should be) or, if it
is one of the parties involved who makes the comparison,
self-interested claims.
Interpersonal comparisons of utility are known to be
scientifically impossible in economics.
A qualitative idea such as utility can be difficult to
measure, but economists try to quantify the concept in
two different ways:
Cardinal Approach
In this approach, one believes that it is measurable. One
can express his or her satisfaction in cardinal numbers
i.e., the quantitative numbers such as 1, 2, 3, and so on.
Limitation of Cardinal Approach
•In the real world, one cannot always measure utility.
• One cannot add different types of
satisfaction from different goods.
• For measuring it, it is assumed that utility of
consumption of one good is independent of
that of another.
• It does not analyze the effect of a change in
the price.
Ordinal Approach
In this approach, one believes that it is comparable. One
can express his or her satisfaction in ranking. One can
compare commodities and give them certain ranks like
first, second, tenth, etc.
The Water Diamond Paradox
The water diamond paradox is the contradiction that,
although water is on the whole more useful, in terms of
survival, than diamonds, diamonds command a higher
price in the market.
The law of diminishing marginal utility is not absolute,
there are several exceptions. This means that it does not
apply to the following circumstances or situations.
However, these exceptions are seemingly real.
1. Rarity. There are people whose hobby is
collecting coins, stamps, movies, candies and other
items. It appears that their level of satisfaction-that is,
their marginal utility increases as an additional unit of
their collection increases.
2. Avaricious. To the type of person who wants
more and more wealth, the law of diminishing return
does not apply. As the resolve to accumulate increases,
the more such people add wealth. Their desire to
accumulate money appears to have no limit or bounds.
3. Good Movies or Songs. There are people who
cannot get over a good movie, book or song. They tend
to watch the movie several times and memorize the lines
of the characters. There are songs that they sing and
listen to; some even request for these songs on radio.
Thus, it appears that each time they listen to the song,
their marginal utility increases.
4. Gluttons. Gluttons hop from one meal to
another, devouring foods and savoring sumptuous
delicacies. They are insatiable. Each bite and morsel of
food increases appetite to take more. Gluttons are
immune from the law of diminishing marginal utility.
The Law of Demand Revisited
The law of diminishing marginal utility states that the
satisfaction that consumers derive from an additional
unit decreases as the number of additional unit
increases. The law of demand states that the quantity
demand increases as the price of goods decreases.
Therefore, since consumers level of satisfaction
decreases from each additional unit of goods, they are
only willing to purchase additional units if the price
decreases. The price that the consumer is willing to pay
for the good is its marginal utility.
Utility schedule for shirts and candies for Mario:
 curves for a market are the sum of the individual demand
curves for every member of that market.

Marginal utility price ratios (MU/P) of the two goods:

Properties of the Indifference Curve
Higher Indifference

- has a great level of satisfaction. The higher

indifference curve means a greater combination of
goods. Higher indifference curve exhibits higher
level of satisfaction for consumers.

Indifference Curves

- are always downward sloping. This shows

the rate consumers are willing to substitute goods.
It does not intersect.

The following sequence of shirt and candies will be:

Mario has Php30 and he has three remaining choices.

The fifth candy and the fourth shirt have both the same
util of 0.4. Mario is indifferent between the two good.
Suppose Mario buys the fourth shirt and, lastly, the fifth
candy, to spend the entire Php90. Therefore, the
quantity demands for shirt are four units, and for candies
units. This illustrates the equi-marginal principle which
states that consumers can only maximize their Budget Constraint
satisfaction if the marginal utility peso ratio on all good
purchased are equal. The formula is: MU/P (Shirt) = - Total amount of items you can afford within a
MU/P (Candies) MU/P (any other good). current budget. This illustrates the range of choices
available within a budget. People wants to consume
Market Demand
more goods and services in quality or quantity,
This describes a demand for a given product and who consuming more goods and services increases people is
wants to purchase it. This is the demand customers, or level of satisfaction. People’s ability to consume quantity
the market for your product at any time. The demand of goods is link to their income and spending.
Example:

Ana has an income of Php75 which she can spend

money on paper and coffee. The paper’s price is Php15,
and the coffee’s price is Php5. The table below will show
the possible combination of paper and coffee Ana can
buy from her Php75.

Possible Combinations of Paper and Coffee for Ana

Budget Php75 Paper Coffee

Combinations Php15/Unit Php5/Unit
Quantity Quantity
A 5 0
B 4 3
C 3 6
D 2 9
E 0 15

Indifference Curve

- An Indifference curve shows the different

combinations of commodity x and commodity y which
can give equal satisfaction for the consumer. The higher
the indifference curve, the higher the amount of
satisfaction for the customer. The lower the indifference
curve, the lower the level of satisfaction for the
consumer.