THEORY OF CONSUMER

CHOICE
BC 204. BASIC MICROECOnoMICS
 • “A consumer is an individual or a household
composed of one or more individuals. The
consumer is the basic economic unit that
determines which commodities are purchased
and in what quantities.” (Salvatore, 2008, p.57).

• The goal of the consumer is to maximize

The satisfaction.
consumer • Consumer preferences show “indications of
how a consumer would rank (compare the
desirability of) any two possible baskets,
assuming the baskets were available to the
consumer at no cost” (Besanko and Braeutigam,
2010, p.75).
 • Satisfaction is nominal.
• Utility is the measurement of satisfaction. It is
the property of a good that satisfies human
wants (Salvatore, 2008, p.58).
Utility as a
measure of • Utility is an abstract measure of the satisfaction
or happiness a consumer receives from a bundle
happiness of goods. (Mankiw, 2009, p.465).
• Notion of opportunity cost
• Utility is measured in utils.
• Cardinal and Ordinal Utility
•

• Salvatore (2008) discussed the cardinal and ordinal

characteristics of utility. A consumer can rank his
satisfaction or utility derived from each product in a
basket of goods. For example, a person can say that
she is happier when watching a movie for one hour
than reading books in one hour.

• Cardinal utility means that an individual can attach

specific values or numbers of utils from consuming
each quantity of a good or basket of goods.
Total utility is the
total amount of the
satisfaction or
pleasure a person
derives from
consuming a
certain quantity of
good.
 • Marginal utility is the extra, or additional
satisfaction one derives as one
consumes an additional unit of the
product. It is the change in total utility
resulting from the consumption of one
more unit of a good. Marginal utility is
Marginal high on the first consumption of the good
Utility and gets smaller as one consumes
more. Marginal utility is mathematically
expressed as,

• 𝑀𝑈𝑋 = ∆𝑇𝑈𝑋 /∆𝑄𝑋

 • The Law of diminishing
Law of marginal utility states that “each
additional unit of a good
diminishing eventually gives less and less
marginal extra utility” (Salvatore, 2008, p.
60). As one consumes more of
utility the good, the extra unit of the
good provides less utility.
(Mankiw, 2009,p. 465).
Consumer Equilibrium

• Consumer satisfaction is maximized when the last peso of the person's income is
spent on each product yielding the same utility amount. The marginal utility for both goods
should be equal.
•
𝑀𝑈𝑥 𝑀𝑈𝑦
•
𝑃𝑥
= 𝑃𝑦
Consumer
Equilibrium thru
Indifference
Curve and
Budget Line

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Indifference curve

shows bundles of goods that make the consumer equally happy (Salvatore
2008).

G. Mankiw defines it as a curve which “shows consumption bundles that

give the consumer the same level of satisfaction"(Mankiw, 2009, p 195).

It shows the various combinations of two goods that give the consumer
equal utility or satisfaction.
Properties of Indifference Curves
I. Higher indifference curves are
preferred to lower ones.

II. Indifference curves do not

cross

IV. Indifference curves are bowed

inward or convex to the origin.
 • The budget constraint depicts the
consumption “bundles” that a
consumer can afford. People
consume less of what they desire
Budget because their spending is
Constraint constrained or limited by their
income.

• 𝐼 = 𝑃𝑋 𝑄𝑋 + 𝑃𝑦 𝑄𝑌
https://edition.cnn.com/cnn-underscored/money/how-to-make-
a-budget
CONSUMER EQUILIBRIUM
INCOME AND SUBSTITUTION EFFECTS

• The income effect is

defined as the
“change in
consumption that
results when a price
change moves the
consumer to a
higher or lower
indifference curve”
(Mankiw, 2009,
183).
SUBSTITUTION EFFECT
• In the event of a price
change, consumers shift
their consumption from
one combination of goods
to another. “Individuals
react to higher prices by
looking for relatively
lower-priced substitutes.
Or, conversely, they will
react to lower prices of a
good by substituting it for
a relatively higher-priced
good” (Reynolds 2011).
 • List 5 changes in consumer behavior that you have
observed during the time of pandemic brought by COVID-
19. Give 1 example of a change that exhibit income effect
and 1 example that exhibit substitution effect. Explain.
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