Chapter 3 Consumer Behavior and Utility Maximization Objectives

Chapter 3: Consumer Behavior and Utility Maximization Objectives of chapter 3: • A closer look at the law of demand • Theory of consumer behavior • Utility maximization and demand curve Chapter 3 by TITH Seyla 1

Introduction – When we go the market, we buy things, such as food, hygiene product, electronics, etc. – Anyway, when we check the bucket of 2 people, we will see that the things they bought are very different. Ravy bought apple while Chenda bought orange. Why? Chapter 3 by TITH Seyla 2

A closer look at the law of demand • Income effects: is the impact that a change in price of a product has on a consumer’s real income, and consequently on the quantity demanded of that goods. • Substitution effects: is the impact that a change in a product’s price has on its relative expensiveness, and consequently on the quantity demanded. • The Law of Diminishing Marginal Utility: – Utility of a goods or service is a satisfaction or pleasure someone gets from consuming it. – Utility is different from usefulness. – Utility is subjective. A thinks that a pen has more utility than B does. As it is subjective, it is difficult to quantify. – For study purpose, we mark utility unit as utils. 4 utils> 3 utils. Chapter 3 by TITH Seyla 3

Utility • Total utility: total amount of satisfaction or pleasure a person get from consuming a certain amount of goods or services. – Reading a book give pleasure to Riya, which can be quantified as 20 utils. Reading three books give pleasure to Riya as 50 utils. • Marginal utility: the amount of satisfaction or pleasure a person get from consuming 1 more unit of the product. – Reading the first book give pleasure to Riya 20 utils. Reading the second book give pleasure to Riya 17 utils. Reading the thrid book give pleasure to Riya 13 utils. – Marginal Utility (MU) = Change of total utility (TU)/Change in quantity of product consumed (Q) – MU = ∆TU/∆Q Chapter 3 by TITH Seyla 4

The law of diminishing marginal utility (a) • The more the product a person consume, the less desirable the person is for that product. – The first plate of rice provides great utility for the eater. The second plate also provides utility for the eater but less than the previous plate. The third plate provides even less utility than the second plate. • When marginal utility decreases and still remain positive, the total utility increases. However, when marginal utility decreases below zero level (negative), the total utility starts falling down. – The 10 th plate of rice will provide negative utility for the eater. (the case of Chouchuok in Preah Vesanda story) Chapter 3 by TITH Seyla 5

The law of diminishing marginal utility (b) Chapter 3 by TITH Seyla 6

The law of diminishing marginal utility (c) Chapter 3 by TITH Seyla 7

The law of diminishing marginal utility and the demand curve • If successive units of a good provide smaller and smaller amount of marginal utility, then the consumer will buy additional units of a product only if its price falls. Chapter 3 by TITH Seyla 8

Theory of consumer behavior • Rational behavior: a rational person try to use her/his money income to get the greatest amount of satisfaction, or utility. We can say that a rational person maximize her/his utility. • Preference: each consumer has a clear cut preference for certain goods and services available in the market. • Budget constraint: at a point of time, consumer has limited income. • Prices: consumers price-takers, that is their individual buying behavior will not affect the market price of any given product. Chapter 3 by TITH Seyla 9

Utility maximizing rule • To maximize satisfaction, the consumer should allocate her or his money income so that the last dollar spent on each product yields the same amount of marginal utility. • Or we can say that the utility is maximized at a combination of two goods at which: • Marginal Utility Product A get from a dollar spent on A = Marginal Utility Product B get from a dollar spent on B • MU_A/Price_A = MU_B/Price_B • Inferior options: other combinations of A and B that do not meet the above condition. Chapter 3 by TITH Seyla 10

Utility maximization and the demand curve • When the price of a product X falls, the quantity demanded of the product X will increase. • Before the price of the product X falls, we can get a combination of the product X with other products, which makes the utility of the consumer maximized. This combination will give the quantity demanded of the product X at that given price. • When the price of the product X falls, we will have a new combination of the product X with other products, which makes the utility of the consumer maximized. This combination will give a greater quantity demanded of the product X at that lower price. Chapter 3 by TITH Seyla 11

Utility maximization and the demand curve • When the price of a product X falls, the quantity demanded of the product X will increase. • Before the price of the product X falls, we can get a combination of the product X with other products, which makes the utility of the consumer maximized. This combination will give the quantity demanded of the product X at that given price. • When the price of the product X falls, we will have a new combination of the product X with other products, which makes the utility of the consumer maximized. This combination will give a greater quantity demanded of the product X at that lower price. Chapter 3 by TITH Seyla 12