Theory of Consumer

Behavior: Utility
maximization
Course Title: Managerial
Economics
Course Code: ECO-611
Class: B.S 7th (2017-21)
Teacher: Amna Bari
GCWUF
1
 Utility Theory
Utility
– The want-satisfying power of a good or
service

Utility Analysis
– The analysis of consumer decision making based on
utility maximization

 Util
– A representative unit by which utility is measured

2
 Utility Theory
Marginal Utility
– The change in total utility due to a one-unit
change in the quantity of a good or service
consumed

Change in total utility

Marginal Utility =

Change in number of units

consumed

commodity.
Total Utility 3
 Total and Marginal Utility
of Downloading and Listening to Digital
Music Albums

4
 Total and Total utility is

maximized...

Marginal Utility
of Downloading
and Listening
to Digital
…where marginal
utility equals zero.

Music
Albums
5
 Graphical
Analysis
Observations

– Marginal utility falls as more is consumed.

– Marginal utility equals zero when total utility is
at its maximum.

6
 Diminishing Marginal Utility

Law of Diminishing Marginal Utility

– The principle that as more of any good or

service is consumed, its extra benefit declines
– Increases in total utility from consumption of a
good or service become smaller and smaller
as more is consumed during a given time
period.

7
Optimizing Consumption Choices

Consumer Optimum

– A choice of a set of goods and services that

maximizes the level of satisfaction for each
consumer, subject to limited income

8
Total and Marginal Utility from Consuming
Music Album Downloads and Sandwiches on
an Income of $26

9
Total and Marginal Utility from Consuming
Music Album Downloads and Sandwiches on
an Income of $26

10
(1) (2) (3) (4) (5) (6) (7) (8)
Time (TU) (MU) (MU per $ Time (TU) (MU) (MU per
Period Music Spent) Period Sandwich $ Spent)
Album Price=$5 Price=$3
0 0 ---- ----- 0 0

1 50 50 10 1 25 25 8.3

2 95 45 9 2 47 22 7.3

3 135 40 8 3 65 18 6.0

4 171 36.5 7.3 4 80 15 5.0

5 200 28.5 5.7 5 89 9 3.0

11
Total and Marginal Utility from Consuming
Music Album Downloads and Sandwiches on
an Income of $26

12
 Optimizing Consumption
Choices
A consumer’s money income should be
allocated so that the last dollar spent on
each good purchased yields the same
amount of marginal utility (when all
income is spent), because this rule yields
the largest possible total utility.

13
 Optimizing Consumption
Choices
Law of Equi-marginal Utility

– The rule of equal marginal utilities per dollar

spent
• A consumer maximizes personal satisfaction when
allocating money income in such a way that the last
dollars spent on good A, good B, good C, and so
on, yield equal amounts of marginal utility.

14
 Optimizing Consumption
Choices
A little math
– The rule of equal marginal utilities per dollar
spent

MU of good A MU of good B MU of
good Z Price of good A = Price of good B = ... = Price
of good Z

15
(1) (2) (3) (4) (5) (6) (7) (8)
Time (TU) (MU) (MU per $ Time (TU) (MU) (MU per
Period Music Spent) Period Sandwich $ Spent)
Album Price=$5 Price=$3
0 0 ---- ----- 0 0

1 50 50 10 1 25 25 8.3

2 95 45 9 2 47 22 7.3

3 135 40 8 3 65 18 6.0

4 171 36.5 7.3 4 80 15 5.0

5 200 28.5 5.7 5 89 9 3.0

16
How a Price Change
Affects Consumer
Optimum
Income = $26
MUd
Qd = 4 36.5
Pd = 5 = 7.3

MUs
Qs = 2 22
Ps = 3 = 7.3

17
How a Price Change
Affects
Consumer Optimum
Assume Price of Music Falls to $4

MUd
Qd = 36.5
4 Pd = 4 = 9.125

MUs
Qs = 22
Ps = 3 = 7.3
2

18
How a Price Change
Affects Consumer
Optimum
Assume Price of Music Falls to $4

MUd MUs
Now >
Pd Ps

Result Buy more downloads

and MUd falls

19
Digital Music Download Prices
and Marginal Utility

20
 How a Price Change
Affects
Consumer Optimum
Consumption decisions are summarized in
the law of demand
– The amount purchased is inversely related to
price.

A consumer’s response to a price change

– At higher consumption rate, marginal
utility falls.

21
References
 Hirschey, M. and J.L. Pappas; Fundamentals of Managerial
Economics, Dryden Press, (latest ed).
 Hirschey, M. Managerial Economics, (latest edition) U.S.A.
Thomson South-Western.
 Salvatore, D. Managerial Economics, McGraw Hill, (latest ed).
Thanks!
Any questions?