BAMICECO Study Guide – Module 4

Consumer Behavior and Utility Maximization

Dr. Frederick A. Halcon
Faculty
Consumer
One who demands and consumes goods and services

Ultimate purchasers of goods and services

Goods vs Services
Goods

Refer to anything that provides satisfaction to the needs, wants, and desires of the consumer

Tangible economic products that contribute directly or indirectly to the satisfaction of human needs
and wants

Services

Any intangible economic activity

Consumer goods
Goods that yield satisfaction directly to any consumer are not to be used for further processing or as
an input or raw material needed in producing another good

Essential (necessities) vs Luxury goods

Essential goods or necessities

Goods that satisfy the basic needs of man and are necessary in our daily existence as human beings

Luxury goods

Those which humans may do without but which are used to contribute to his comfort and well being

Economic vs free good

Economic Good

That which is both useful and scarce which has a value attached to it and a price has to be paid for its
use
Free Good

A good that is abundant that there is enough of it to satisfy everyone’s needs without anybody paying
for it

Tastes and Preferences

Both are determined by age, income, education, gender, occupation, customs and traditions as well as
culture

Preferences are the choices made by consumers to which products or services to consume.

Brand – the name or symbol given to a product by a supplier in order to distinguish his offering fr om
that of similar products by competitors

The Economics of Satisfaction & Utility

GOAL: Consumers maximize their satisfaction level given their budget constraint.

Utility theory

Utility refers to the satisfaction or pleasure that an individual consumer gets from the consumption of
a good or service that he/she purchases.

Utility

The total satisfaction derived from the consumption of goods and services

A scientific construct that economists use to understand how rational consumers divide their limited
resources among commodities that provide them satisfaction

Unit of measurement: “utils”

Cardinal vs. Ordinal Utility

Cardinal utility theory states that the utility (satisfaction) gained from a particular good or service can
be measured in the same way as distance, temperature and time can.

Ordinal utility theory states that while the utility of a particular good and service cannot be
measured using an objective scale; a consumer is capable of ranking different alternatives available.
Goods are often considered in “bundles” or “baskets”.
Total utility

The total satisfaction that a consumer derives from the consumption of a given good or service in
particular time period.

Marginal utility

Defined as the additional satisfaction that an individual derives from consuming an extra unit of a good
or service

“Marginal” means additional

The Law of Diminishing Marginal Utility

States that as a person increases consumption of a product - while keeping consumption of other
products constant - there is a decline in the marginal utility that person derives from consuming each
additional unit of that product

Indifference Curve
Indifference Curve

A graph that shows combinations of goods among which a consumer is indifferent

Marginal Rate of Substitution (MRS)

The rate at which a person will give up one good to get more of another good

The slope of the indifference curve

Essential Properties of Indifference Curves

Higher indifference curves are better.

Indifference curves do not intersect.

Indifference curves are downward sloping to the right.

Indifference curves are convex to the point of origin.

 Budget Line
Budget Line / Consumption Possibility Line

Shows the various combinations of two products that can be purchased by the consumer with his
income, given the prices of the two products

m = p1x1 + p2x2

Where: m – income

P1 – price of good 1

P2 - price of good 2

Sample Problem: Do as indicated.

You have an income of $40 to spend on two commodities. Commodity 1 costs $10 per unit, and 
commodity 2 costs $5 per unit. 

(a)  Write down your budget equation.  

(b) If you spent all your income on commodity 1, how many units can you buy?  

(c)  If you spent all of your income on commodity 2, how many units can you buy? 

(d) Draw your budget line and shade your budget set.

(e) Suppose your income increased to $80 and the prices remain the same, draw your new
budget line and budget set. Observe what happens.

(f) Suppose that the price of commodity 1 rises to $20 a piece, while the price of commodity
two falls to $2 per unit. Your income remains the same at $40. Draw your new budget line and
budget set. Observe what happens.

Maximizing Satisfaction or Utility

Utility is maximized when the indifference curve is tangent to the budget line.
Consumer equilibrium point (CEP) answers the question “How many units of goods X and Y should a
consumer buy given his/her income and the prices of the goods?”

Sample Problem: Do as indicated.

1.) A consumer enjoys only two goods: X and Y daily. He has a daily budget of Php 40. If the price per
unit of good X is Php4 and the price of good Y is Php4. If his utility function is described by the
equation U(X, Y) = XY =25, how many units of X and Y must he purchase to maximize his utility?

2.) Liza consumes only two goods everyday: apples and bananas. Both apples and bananas cost $1
each. She has an income of $20 everyday. If her utility function is described by U(A,B) = AB = 100,
where A and B are the quantity of apples and bananas she consumes daily. How many of each fruit
must she consume to maximize her utility?

3.) The utility derived by a consumer from eating shawarmas is given by the function U(s) = 360s – 9s2,
where s is the number of shawarmas he consumes in a month and U is in utils.

·Find the number of shawarmas he must consume in a month that will maximize his utility.

·What is his maximum utility?

·Find the marginal utility of the 10th shawarma.

·How much is the utility he derives from eating the 10th shawarma?

·Find the marginal utility of the 30th shawarma.

·How much is the utility he derives from consuming the 30th shawarma?

·Sketch the utility curve.