Consumer Behaviour: Utility, Demand, and Surplus (Microeconomics Chapter 6 Study Notes)

Consumer Behaviour

Introduction

This chapter explores how consumers make choices to maximize their satisfaction, or utility, given their budget constraints. It covers the concepts of utility, the effects of price changes, and the measurement of consumer surplus.

Marginal Utility and Consumer Choice

Utility: Definition and Types

• Utility is the satisfaction a consumer receives from consuming a good or service.

• Total utility is the overall satisfaction obtained from consuming a certain quantity of a product.

• Marginal utility is the additional satisfaction gained from consuming one more unit of a product.

Example: Drinking water when thirsty provides high utility at first, but as more water is consumed, the additional satisfaction (marginal utility) from each extra glass decreases.

Diminishing Marginal Utility

• The law of diminishing marginal utility states that as a consumer consumes more units of a particular product, the marginal utility from each additional unit decreases.

• This principle explains why consumers are willing to pay less for additional units of the same product.

Example: The first bottle of juice provides high satisfaction, but by the tenth bottle, the extra satisfaction is minimal.

Utility Schedules & Graphs

Utility schedules and graphs illustrate how total and marginal utility change as consumption increases.

Number of Bottles of Juice (per day)	Alison's Total Utility ("utils")	Alison's Marginal Utility ("utils")
1	20	20
2	38	18
3	53	15
4	65	12
5	75	10
6	83	8
7	89	6
8	94	5
9	98	4
10	99	1

Graphs typically show total utility rising at a decreasing rate and marginal utility declining as quantity increases.

Maximizing Utility

The Consumer’s Maximizing Decision

Consumers aim to maximize their total utility given their income and the prices of goods. The optimal allocation occurs when the marginal utility per dollar spent is equal across all products.

• Utility-maximizing rule: Allocate spending so that the marginal utility per dollar is equal for all goods.

Formula:

$\frac{MU_X}{P_X} = \frac{MU_Y}{P_Y}$

Where $MU_X$ and $MU_Y$ are the marginal utilities of goods X and Y, and $P_X$ and $P_Y$ are their prices.

Example: If Alison gets more utility per dollar from juice than from burritos, she should buy more juice and fewer burritos until the marginal utility per dollar is equalized.

Rationality and Framing in Consumer Behaviour

• Economists assume consumers are rational and seek to maximize utility.

• However, real-world choices can be influenced by how options are presented (framing).

• Policy "nudges" can guide choices without restricting freedom.

Additional info: Behavioral economics studies these deviations from rationality.

Income and Substitution Effects of Price Changes

Substitution Effect

• The substitution effect is the change in quantity demanded due to a change in a product’s relative price, holding real income constant.

• When the price of a good falls, consumers substitute it for other goods, increasing its quantity demanded.

Income Effect

• The income effect is the change in quantity demanded resulting from a change in real income, holding relative prices constant.

• If the price of a normal good falls, consumers feel richer and buy more of it.

Combined Effect: Both effects generally cause the demand curve for normal goods to slope downward.

Giffen Goods

• Giffen goods are inferior goods for which the income effect outweighs the substitution effect, resulting in an upward-sloping demand curve.

• Characteristics:

  • Inferior good (demand increases as income falls)

  • Large proportion of household expenditure

Additional info: Giffen goods are rare in practice.

Conspicuous Consumption Goods

• Goods bought for "snob appeal" may seem to violate utility maximization, but market demand curves are still generally downward sloping.

Consumer Surplus

Definition and Measurement

• Consumer surplus is the difference between the total value consumers place on a good and the amount they actually pay.

• It represents the "profit" or extra benefit consumers receive from market transactions.

Graphical Representation: Consumer surplus is the area under the demand curve and above the price line, up to the quantity purchased.

Consumer Surplus Table

Unit	Maximum Price Willing to Pay	Market Price	Consumer Surplus (per unit)
1	$10	$5	$5
2	$9	$5	$4
3	$8	$5	$3
...	...	...	...

Additional info: The total consumer surplus is the sum of surplus for all units purchased.

Paradox of Value

Explanation

• The paradox of value asks why essential goods like water have low prices, while non-essential goods like diamonds have high prices.

• Resolution: Price is determined by both demand and supply. Water is abundant (high supply), so its price and marginal value are low, but total value is high. Diamonds are scarce (low supply), so their price and marginal value are high, but total value is low.

Summary Table:

Good	Marginal Value	Total Value	Price
Water	Low	High	Low
Diamonds	High	Low	High

Additional info: Marginal analysis explains market prices better than total value alone.