Last Updated 22 Jul 2020

# Theory of Consumer Behavior

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### Theory of Consumer Behavior

Useful for understanding the demand side of the market. Utility - the amount of satisfaction derived from the consumption of a commodity …. measurement units?  Cardinal utility - assumes that we can assign values for utility, (Jevons, Walras, and Marshall). E. g. , derive 100 utils from eating a slice of pizza ordinal utility approach - does not assign values, instead works with a ranking of preferences. Pareto, Hicks, Slutsky). Total utility and marginal utility. Total utility (TU) - the overall level of satisfaction derived from consuming a good or service Marginal utility (MU) additional satisfaction that an individual derives from consuming an additional unit of a good or service? As more and more of a good are consumed, the process of consumption will (at some point) yield smaller and smaller additions to utility Total Utility Curve TU.

So far, we have assumed that any amount of goods and services are always available for consumption. In reality, consumers face constraints (income and prices): Limited consumer's income or budget. Goods can be obtained at a price? Some simplifying assumptions. Consumer’s objective: to maximize his/her utility subject to income constraint 2 goods (X, Y) Prices Px, Py is fixed Consumer’s income (I) is given Consumer Equilibrium. Marginal utility per peso. Additional utility derived from spending the next peso on the good MU MU per peso = P.

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### Consumer Equilibrium

Optimizing condition:

MU X MU Y = PX PY ? If MU X MU Y > PX PY .

Spend more on good X and less of Y .

Suppose: X = fishball Y = siomai ?

Assume: PX = 2 PY = 10 .

Combination A:  X = 3 and Y = 4 .

TU = TUX + TUY = 45 + 178 = 223 .

Combination B: X = 5 and Y = 5 TU = TUX + TUY = 54 + 198 = 252 .

Presence of 2 potential equilibrium positions suggests that we need to consider income. To do so let us examine how much each consumer spends for each combination. Expenditure per combination.

Total expenditure = PX X + PY Y Combination A: 3(2) + 4(10) = 46 .

Combination B: 5(2) + 5(10) = 60 .

Scenarios: If consumer’s income = 46, then the optimum is given by combination A. .…Combination B is not affordable. If the consumer’s income = 60, then the optimum is given by Combination B…. Combination A is affordable but it yields a lower level of utility.

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