ECO-101 Micro Economic Lecture 1

1. Microeconomics
Consumer behavior and
Utility Maximization

2. Objectives
 Elaborate Demand and consumer behavior.
 Define and differentiate between choice and
utility.
 Discuss Marginal utility and the law of diminishing
marginal utility.
 Discuss Substitution and Income effects.

3. What does consumer want?
People choose those goods
and services they value
most highly.

4. Consumer Choice and Budget
Restraint
 Rational Behavior
 Preferences
 Budget Restraint
 Prices

5. Utility
It means Satisfaction
It refers to how consumers rank
different goods and services.
How rational consumers divide
limited resources.

7.  Preferences
 A household’s preferences determine the benefits or
satisfaction a person receives consuming a good or
service.
 The benefit or satisfaction from consuming a good or
service is called utility.
 Total Utility
 Total utility is the total benefit a person gets from the
consumption of goods. Generally, more consumption
gives more utility.
Maximizing Utility

8.  Table 8.1 provides an
example of total utility
schedule.
 Total utility from a good
increases as the
quantity of the good
increases.
 For example, as the
number of movies seen
in a month increases,
total utility from movies
increases.
Maximizing Utility

9.  Marginal Utility
 Marginal utility is the change in total utility that results
from a one-unit increase in the quantity of a good
consumed.
 As the quantity consumed of a good increases, the
marginal utility from consuming it decreases.
 We call this decrease in marginal utility as the quantity
of the good consumed increases the principle of
diminishing marginal utility.
Maximizing Utility

10. Law of Diminishing Marginal
Returns.
 All other things remaining constant, if only one input is increased
a point will be reached where each additional input produces
less output than the previous input.
 Law of Diminishing Returns: After a certain point, when
additional units of a variable input are added to a fixed input, the
marginal product of each additional variable input is less than the
previous input.
 Diminishing returns always apply in the short run, and in the
short run every firm will face diminishing returns. This means that
every firm finds it progressively more difficult to increase its
output as it approaches capacity production.

11. Activity:
# of Workers Total Product
(TP)
Marginal
Product
(MP)
Average Product
(AP)
1 1000 1000 1000
2 3000 2000 1500
3 5500 2500 1833
4 6500 1000 1625
5 7100 600 1420
6 7500 400 1250
7 7200 -300 1029
8 6800 -400 850

13. The Production Function, Total Product
and Marginal Product

15. Activity: A Closer Look.
Variable Inputs Total Product
(TP
Marginal
Product(MP)
Average Product(
AP)
0 0 0 0
1 10 10 10
2 25 15 12.5
3 37 12 12.3
4 47 10 11.75
5 55 8 11
6 60 5 10
7 63 3 9
8 63 0 7.9
9 62 -1 6.9

16. Activity
 Complete the following
table.
 Give diagrammatical
representation as well.
Units
consumed
Total
Utilit
y
Marginal
Utility
0 0 -
1 8 8
2 10
3 25
4 30
5 3
6 34

17.  Table 8.1 provides an
example of marginal
utility schedule.
 Marginal utility from a
good decreases as the
quantity of the good
increases.
 For example, as the
number of movies seen
in a month increases,
marginal utility from
movies decreases.
Maximizing Utility

18.  Figure 8.1(a) shows a
total utility curve for
soda.
 Total utility increases
with the consumption of
a soda increases.
Maximizing Utility

19.  Figure 8.1(b) illustrates
diminishing marginal
utility.
 As the quantity of soda
increases, the marginal
utility from soda
diminishes.
Maximizing Utility

20.  The key assumption of marginal utility theory is that the
household chooses the consumption possibility that
maximizes total utility.
 The Utility-Maximizing Choice
 We can find the utility-maximizing choice by looking at
the total utility that arises from each affordable
combination.
 The utility-maximizing combination is called a
consumer equilibrium.
Maximizing Utility

21.  Choosing at the Margin
 A consumer’s total utility is maximized by following the
rule:
 Spend all available income.
 Equalize the marginal utility per dollar for all
goods.
 The marginal utility per dollar is the marginal utility
from a good divided by its price.
Maximizing Utility

22. The Utility-Maximizing Rule:
Call the marginal utility of movies MUM .
Call the marginal utility of soda MUS .
Call the price of movies PM .
Call the price of soda PS .
The marginal utility per dollar from seeing movies is
MUM/PM .
The marginal utility per dollar from soda is MUS/PS.
Maximizing Utility

23.  You are choosing between two goods, X and Y and
your marginal utility from each is as shown below. If
your income is $9 and the prices of X and Y are $2
and $1,what quantities of each you will purchase in
maximizing utility? Specify the amount of total utility
you will realize.
Units of
X
MUx Units of Y MUy
1 10 1 8
2 8 2 7
3 6 3 6
4 4 4 5
5 3 5 4
6 2 6 3

24. Substitution Effect
 If the price of coffee goes up while other
prices do not change, the coffee has
become relatively more expensive. when
coffee has becomes more expensive
beverages, less coffee or more tea or cola
will be bought.
 When price of good rises, consumers will
tend to substitute other goods.

25. Income Effect
 When price of any good rises it tends to
decrease real income and causes income
effect.
 Real income means the actual amount of
goods and services that your money
income can buy.

26. Answer now!
 Explain the meaning of utility. What
is difference between total utility
and marginal utility? Explain law of
diminishing marginal utility and give
a numerical example.
 How would you explain theory of
Consumer Behavior?
 How are consumer choices being
made?

33. Assignment
Budget Line

34. 1.Margaret Anne may consume CDs and DVDs. Let
the following indifference map represent her
preferences and let the following consumption
bundles have the following contents:
 Consumption bundle a: 30 CDs and 1 DVD.
 Consumption bundle b: 20 CDs and 1 DVD.
 Consumption bundle c: 10 CDs and 3 DVDs.
 Consumption bundle d: 8 CDs and 1 DVD.
 Consumption bundle e: 7 CDs and 2 DVDs.
2-34

35.  Rank the five consumption bundles in
the order of Margaret Anne’s
preferences.
 Define marginal rate of substitution.
 What is the marginal rate of substitution
between consumption bundles b and
c?
2-35

36. 2. Suppose that hamburgers cost $2.00 each,
tacos cost $1.00 each, and Susan and Bob
each have $20.00 to spend. Further, assume
Susan and Bob’s preferences can be
represented by indifference curves convex to
the origin. When they maximize utility, Susan
consumes both hamburgers and tacos but Bob
only consumes hamburgers. Draw a diagram
depicting the above information. Label Susan’s
indifference curve US and Bob’s indifference
curve UB. Also, label Susan’s utility
maximizing consumption bundle, “s” and Bob’s2-36

37. 3. Bill Clinton really likes
hamburgers relative to salad.
Oprah Winfrey really likes salad
relative to hamburgers. Draw an
indifference curve for Bill and one
for Oprah on the same graph that
represent the above information
about their preferences. If they
intersect each other, have we
violated an axiom?2-37

38. 4. Carol has $50.00. Lemons cost $0.10 each and carrots
cost $0.20 each.
 What is the slope of the budget constraint?
 What is the opportunity cost in terms of lemons of
consuming 1 more carrot?
 Suppose that Carol’s income increases to $100.00, the
price of lemons increases to $0.20 and the price of carrots
increases to $0.40. Draw Carol’s new budget constraint.
 Now, assume only Carol’s income changes – from $50 to
$100. Draw the new budget constraint
 Assume only the price of lemons changes – from $0.10 to
$0.20 each. Draw the new budget constraint.
 What will happen to the slope of the budget constraint if the
price of carrots increases?
2-38

39. Thank You!