CONSUMER AND DEMAND

THEORY: UTILITY APPROACH

GROUP 1
FACTORS AFFECTING CONSUMER DEMAND
1. Price of the Commodity- there exist an inverse
relationship between price and quantity demanded. When the
price of a good or service increase, it will result to a decrease
in the demand for that good and vice versa.

2. Income of the Consumers- the greater the income of the

consumer, the greater will be their demand for goods.
Normal good refers to goods whose consumption goes
up as the income rises.(e.g. branded clothes, chicken, pork)
Inferior good is a good whose consumption goes down
as the income rises.(e.g. ukay-ukay clothes, canned
sardines
3. Consumer's Price Expectation- when consumers expect higher prices in
the future, they will buy more goods to avoid higher prices. (e.g. change in
the price of gasoline)
4. Number of Consumer in the Market- the greater the number of
consumers of a good, the greater the demand for it.
5. Taste and Preferences- a good for which a consumer's taste and
preferences the greater, its demand would be large and its demand curve will
lie at a higher level.
6. Climatic Condition- demand for various goods depends upon the
changes in climate and weather condition.
7. Price of the Related Goods- when the demand for a substitute decrease,
the demand for that good will also decrease.
Substitute good is a good that can be an alternative for a certain
product. The demand for this good has a direct relationship to the price of a
certain product.
Complementary goods are goods that “go together”. The demand for
these goods have inverse relationship to the price of a certain product.
8. Promotion and Advertisement- successfull advertisement
can increase the demand for a product. Commercials, using a
celebrity and print ads are some of the ways used to promote
a product.
9. Government Policy- economic policy adopted by the
government influences the demand for commodity. (e.g.
government banning the use of cigarettes in public places and
increasing its price)
10. Satisfaction of the Consumers- products that satisfies
consumer's expectation will result to the increase in consumer
demand.
Concept of Utility
 Utility definition

It is a measure of satisfaction an individual gets from the

consumption of the commodities. In other words, it is a
measurement of usefulness that a consumer obtains from
any good. A utility is a measure of how much one enjoys
a movie, favourite food, or other goods. It varies with the
amount of desire.
.
The satisfaction of a consumer is the basis of the utility function. It
measures how much one enjoys when he or she buys something. A
utility is a measure of how much one enjoys a movie, favorite food,
or other goods. It varies with the amount of desire. One can
conclude the following conclusions

 A Utility of a good differs from one consumer to another.

 It keeps on changing for the same consumer due to change in the

amount of desires.

 It should not be equated with its usefulness.

 Characteristic of Utility
 It is dependent upon human wants.
 It is immeasurable.

 A utility is subjective.

 It depends on knowledge.

 Utility depends upon use.

 It is subjective.

 It depends on ownership.
Measurement of Utility
 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.
It tells the preference of a customer in cardinal
measurement. It is measured in utils.
 Limitation of Cardinal Approach

01 02

In the real world, one One cannot add

cannot always measure
utility.
03
For measuring it, it is
assumed that utility of
consumption of one
good is independent of
that of another.
different types of
satisfaction from different
goods.
04
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. It shows
the order of preference. An ordinal approach is a
qualitative approach to measuring a utility.
 Limitation of Ordinal Approach

 It assumes that there are only two goods or two

baskets of goods. It is not always true.
 Assigning a numerical value to a concept of utility
is not easy.
 The consumer’s choice is expected to be either
transitive or consistent. It is always not possible.
 Types of Economic Utility

 Form: It refers to the specific product or service that a

company offers.
 Place: It refers to the convenience and readiness of the
services available at a place to the customer
 Time: It refers to the ease of availability of products or
services at the time when a customer needs.
 Possession: It refers to the benefit a customer derives from
the ownership of a company’s product.
 UTILITY FUNCTION

• In economics, utility function is an important concept that

measures preferences over a set of goods and services.
Utility is measured in units called utils, which represent the
welfare or satisfaction of a consumer from consuming a
certain number of goods. Satisfaction, happiness or welfare
is a highly abstract concept, economists measure utility in
terms of revealed preferences by observing consumer
choices and creating an ordering of consumption baskets
from least desired to the most preferred.
To postulate the utility function, economists make assumptions
about the human preferences for different goods. For
example, in certain situations, tea and coffee can be
considered perfect substitutes for each other, and the
appropriate utility function must reflect such preferences with a
utility form of u(c, t) = c + t, where "u" denotes the utility
function and "c" and "t" denote coffee and tea. A consumer
who consumes one pound of coffee and no tea derives a utility
of 1 util. Utility function is widely used in the rational choice
theory to analyze human behavior.
 Utility Function
• Utility function is a representation to define individual preferences
for goods and services, beyond the explicit monetary value of those
good or services.
• Utility is the measure of value an individual gets from some good
or services.
• Utility is wants or pleasure satisfying characteristic of a good or
services
• Utility analysis is the investigation of how consumers reach
decision to achive utility maximization.
• Utility is measured in units of measurement called UTILS.
Example:
• Certain situation tea and coffee can be considered perfect
substitutes for each other, and the appropriate utility function
must reflect such preferences with a utility from of
“u”(c,t)=c+t,where “u ” denotes the utility function and “c” and
“t” denote coffee and tea
• A consumer who consume one pound of coffee and no tea
derives a utility of 1 util.
• Utility Function is widely use in the rational choice theory to
analyze human behavior.
 TOTAL AND MARGINAL UTILITY
Total utility is the aggregate level of satisfaction or fulfillment that a
consumer receives through the consumption of a specific good or
service.

Total utility is the aggregate sum of satisfaction or benefit that an

individual gains from consuming a given amount of goods or services
in an economy. The amount of a person's total utility thus corresponds
to the person's level of consumption. Usually, the more that a person
consumes, the larger his or her total utility will be.
𝑇𝑈 = 𝑀𝑈1 + 𝑀𝑈2
Marginal utility is the additional bit of satisfaction, or
amount of utility, gained from each extra unit of consumption.
Marginal utility is an important economic concept because
economists use it to determine how much of an item a
consumer will buy. Positive marginal utility is when the
consumption of an additional item increases the total utility.
Negative marginal utility is when the consumption of an
additional item decreases the total utility.

∆𝑇𝑈
𝑀𝑈 =
∆𝑄
Example: the pleasure of eating the first cookie is much greater
than the pleasure received from eating the tenth or eleventh
cookie in a sitting.

Moving on from cookies, let us now consider a chocolate

bar. Say that after eating one chocolate bar your sweet tooth has
been completely satisfied. Your marginal utility (and total utility)
after eating one chocolate bar will be quite high. But if you eat
more chocolate bars, the pleasure of each additional chocolate
bar will be less than the pleasure you received from eating the
one before - probably because you are starting to feel full or you
have had too many sweets for one day. In fact, if you were to eat
5 or more chocolates, you may begin to experience pain and not
pleasure.
Chocolate Bars Marginal Total
Eaten Chocolate Chocolate
Utility Utility
0 0 0
1 70 70
2 10 80
3 5 85
4 3 88

This table shows that total utility will increase at a much slower
rate as marginal utility diminishes with each additional bar.
Notice how the first chocolate bar gives a total utility of 70 but
the next three chocolate bars together increase total utility by
only 18 additional units.
 THE LAW OF DIMINISHING MARGINAL UTILITY

• Alfred Marshall - During the course of consumption, as

more and more units of a commodity are used, every
successive unit gives utility with a diminishing rate,
provided other things remaining the same; although the
total utility increases.
• Utility - is the capacity of a commodity through which
human wants are satisfied.
• Utils - is considered as the measurable 'unit' of utility.
• Marginal utility - is derived as the change in utility as an
additional unit is consumed.
Example:

Assume that a Anna consumes 6 apples one

after another. The first apple gives him 20 utils.
When she consumes the second and third apple,
the marginal utility for each additional apple will
be lesser.
• This is because with an increase in the consumption of apples, his
desire to consume more apples falls.
 Schedule for Law of Deminishing
Marginal Utility:

Unit of Consumption Marginal Utility Total Utility

1 20 20

2 15 35

3 10 45

4 05 50

5 00 50

6 -0.5 45
Diagram:
Saturation Point - the point where the desire to
consume the same product anymore becomes zero.
Disutility - if you still consume the product after the
saturation point, the total utility starts to fall.
Example:

Consuming one candy bar may satisfy a person's

sweet tooth. If a second candy bar is consumed, the
satisfaction of eating that second bar will be less
than the satisfaction gained from eating the first.
 EQUI-MARGINAL PRINCIPLE

• The Law of Equi-Marginal Utility is an extension to the

law of diminishing marginal utility. The principle of equi-
marginal utility explains the behavior of a consumer in
distributing his limited income among various goods and
services.

This law states that how a consumer allocates his

money income between various goods so as to obtain
maximum satisfaction.
 Example:

MUa/Pa=MUb/Pub
MU-marginal utility
P-price
a&b-respective goods
 Product A price is $5
Quantity Total Utility Marginal Utility
MUa/Pa
1 100 100/5 = 20
2 170 70/5 = 14
3 220 50/5 = 10
4 250 30/5 = 6
5 260 10/5 = 2
 Product B price is $10
Quantity Total Utility Marginal Utility
MUb/Pb
1 180 180/10 = 18
2 330 150/10 = 15
3 420 90/10 = 9
4 480 60/10 = 6
5 510 30/10 = 3
Maximizing utility with a budget of $60

Quantity MUa/Pa MUb/Pb

1 20 18
2 14 15
3 10 9
4 6 6
5 2 3
• To check your work:
• 4 units of A @ $5=$20
• 4 units of B @ $10=$40
• Total of =$60
UTILITY MAXIMIZATION
THE UTILITY MAXIMATION RULE:
If any good provides more
If MUa/Pa is greater than
’happiness per $’ than
A consumer should buy goods to the point where the
MUb/Pb, then more of
another, you should buy
Good A should be
more of that good and less
last dollar spent on every good provided the same
consumed.
of the other
marginal utility as the last dollar spent on every other
good.

𝑀𝑈 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝐴 𝑀𝑈 𝑜𝑓 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝐵
=
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐴 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝐵
Assume you have $16 to spend on dessert. Determine
each of the following:

• The total utility you’d enjoy Ice cream and cake at each
level of consumption.

• The optimal combination of ice cream and cake you

would buy to maximize your total utility.

• The amount of total utility you’d enjoy at the level of

consumption.
Assume you have $16 to spend on dessert. Determine
each of the following:

• The total utility you’d enjoy Ice cream and cake at each
level of consumption.

• The optimal combination of ice cream and cake you

would buy to maximize your total utility.

• The amount of total utility you’d enjoy at the level of

consumption.
Assume you have $16 to spend on dessert. Determine
each of the following:

• The total utility you’d enjoy Ice cream and cake at each
level of consumption.

• The optimal combination of ice cream and cake you

would buy to maximize your total utility.

• The amount of total utility you’d enjoy at the level of

consumption.
Assume you have $16 to spend on dessert. Determine
each of the following:

• The total utility you’d enjoy Ice cream and cake at each
level of consumption.

• The optimal combination of ice cream and cake you

would buy to maximize your total utility.

• The amount of total utility you’d enjoy at the level of

consumption.
7+24=31 utils