Students ScoreBooster Video Tutorials on JAMB (UTME), WAEC (SSCE, GCE), NECO, and NABTEB EXAMS Economics www.scoreboosterproject.com www.scoreboosterproject.com
THEORY OF CONSUMER BEHAVIOUR (I) (JAMB (UTME)) Presented by Mutalib Anifowose BSc. (Accounting), MSc. (Accounting & Finance) ACCA, ACA, ACS, ACTI. www.scoreboosterproject.com
The utility concepts- total utility, average utility, cardinal utility, ordinal utility marginal utility and the calculation of utility schedules. value in use and value in exchange indifference curve and budget line www.scoreboosterproject.com
What is utility? The utility concepts Utility is NOT usefulness! Utility means only that you think enough of something to buy it. Utility is measured by how much you are willing to pay for something. Utility is a measure of happiness or satisfaction. Economists use the term utility to describe the amount of usefulness or satisfaction that someone gets from the use of a product The principle assumption upon which the theory of consumer behavior and demand is built is: a consumer attempts to allocate his/her limited money income among available goods and services so as to maximize his/her utility (satisfaction). www.scoreboosterproject.com
The utility concepts Utility is NOT usefulness! Utility means only that you think enough of something to buy it. Utility is measured by how much you are willing to pay for something. Utility is a measure of happiness or satisfaction. Economists use the term utility to describe the amount of usefulness or satisfaction that someone gets from the use of a product The principle assumption upon which the theory of consumer behavior and demand is built is: a consumer attempts to allocate his/her limited money income among available goods and services so as to maximize his/her utility (satisfaction). www.scoreboosterproject.com
Utility Maximization A consumer maximizes the total utility or satisfaction obtained from spending his income and is in equilibrium when the marginal utility of the last dollar spent on each commodity is the same. Marginal utility The extra usefulness or satisfaction a person gets from acquiring or using one more unit of a product is an important extension of this concept because it explains so much about demand. www.scoreboosterproject.com
Theories of Consumer Choice Utility Concepts: The Cardinal Utility Theory (TUC) Utility is measurable in a cardinal sense cardinal utility - assumes that we can assign values for utility. E.g., derive 100 utils from eating a slice of pizza The Ordinal Utility Theory (TUO) Utility is measurable in an ordinal sense ordinal utility approach - does not assign values, instead works with a ranking of preferences.
The Cardinal Approach Nineteenth century economists, such as Jevons, Menger and Walras, assumed that utility was measurable in a cardinal sense, which means that the difference between two measurement is itself numerically significant. U X = f (X), U Y = f Y,.. Utility is maximized when: MU X / MU Y = P X / P Y
The Cardinal Approach 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. Formula : MU = Change in total utility Change in quantity = TU Q
The Cardinal Approach Law of Diminishing Marginal Utility (Return) = As more and more of a good are consumed, the process of consumption will (at some point) yield smaller and smaller additions to utility When the total utility maximum, marginal utility = 0 When the total utility begins to decrease, the marginal utility = negative (-ve)
EXAMPLE Number Purchased Total Utility Marginal Utility 0 0 0 1 4 4 2 7 3 3 8 1 4 8 0 5 7-1
The Cardinal Approach TU, in general, increases with Q At some point, TU can start falling with Q (see Q = 5) If TU is increasing, MU > 0 From Q = 1 onwards, MU is declining principle of diminishing marginal utility As more and more of a good are consumed, the process of consumption will (at some point) yield smaller and smaller additions to utility
Numerical Illustration Q x TU X MU X MUx Px Q Y TU Y MU Y MUy Py 1 30 30 15 1 50 50 5 2 39 9 4.5 2 105 55 5.5 3 45 6 3 3 148 43 4.3 4 50 5 2.5 4 178 30 3 5 54 4 2 5 198 20 2 6 56 2 1 6 213 15 1.5
UTME 2015 MCQ 43 Bags of rice TU MU 1 30-2 80 50 3 120 40 4 K 30 5 170 Z 6 180 10 UTME 2015MCQ1 From the table above, determine the value of K. A. 200 B.150 C.90 D.140 UTME 2015 MCQ 43 From the table above, determine the value of Z. A. 40 B.30 C.10 D.20 www.scoreboosterproject.com
June 2010 Q1 The table below represents a traveler s consumption of bottles of Coca-Cola. Study the table carefully and answer the questions that follow (a) complete the missing figures D, E, F, G and H. (b) Draw the demand curve for the traveler s consumption of Coca-Cola (c) Explain the law of diminishing marginal utility as the basis for the slope of the traveler s demand curve No. of bottles Total Utility Marginal Utility 1 15 15 2 29 F 3 42 13 4 D 12 5 65 G 6 75 H 7 E 0 www.scoreboosterproject.com
The Ordinal Approach Economists believe that utility is measurable in an ordinal sense--the utility derived from consuming a good, such as X, is a function of the quantities of X and Y consumed by a consumer. U = f ( X, Y )
Ordinal Utility Theory (TUO) Can be measured in qualitative, not quantitative, but only lists the main options (indifference curves & budget line). Rational human beings will choose to maximize the utility by selecting the highest utility Difference consumers, difference utilities.
INDIFFERENCE CURVE (IC) Curve where the points represent a combination of items when the consumer at indifference situation (satisfaction). Axes: both axes refer to the quantity of goods For the combination that produces a higher level of satisfaction, the curves shift to the right (IC 2 ) from the first curve (IC 1 ) In contrast, the curves shift to the left (IC- 1 )
INDIFFERENCE CURVE goods Y A S B T C D IC 2 IC 1 IC -1 O 4 7 11 goods X
PROPERTIES OF INDIFFERENCE CURVE Downward sloping from left to right: This shows an increase in quantity of certain good. Convex to the origin: the marginal rate of substitution (MRS) decreased MRS = quantity of goods Y willing to substitute to obtain one unit of goods X & this substitution is to maintain its position at the same level of satisfaction Do not cross (intersect): consumer preferences transitive Eg : Quantities X and Y for the combination of A> a combination of B; utility A> B * When cross = C, so the utility A = C & B = C; utility A = B = C. This is not transitive as above * Different ICs show different level of satisfaction. Far from the origin, the higher the satisfaction.
IC curves can not intersect Good Y C A B IC1 IC2 Good X
Budget line (BL) Line showing all combinations of items can be purchased for a particular level of income (M) ; M =PxQx + PyQy The slope depends on the prices of goods X and Y, the slope = Px/Py Slope -ve: to use more goods X, Y should reduce & vice versa In the X-axis, when the quantity Y = 0, all M used to purchase X; M = PxQx Qx =M/Px At the Y axis, when the quantity X = 0, all M used to purchase Y; M = PyQy Qy =M/Py
FACTORS SHIFT THE BUDGET LINE Changes in prices of goods X Y Px Px X
EFFECTS OF PRICE CHANGES ON THE BUDGET LINE When price of good X increases, the quantity of good X is reduced (by maintaining the quantity of Y) & vice versa. Points on the X axis shifted to the left (a small quantity of X) When the price of Y increases, the quantity Y is reduced (by maintaining the quantity of X) & vice versa Point on Y axis move to the bottom (small quantity in Y)
FACTORS SHIFT THE BUDGET LINE Changes in the price of goods Y Y Py Py X
FACTORS SHIFT THE BUDGET LINE Changes in income Y I I X
UTME 2012 MCQ 11 Comparison of interpersonal utility is impossible because A. Utility is measured in utiles B. Marginal utility is not observable C. Utility is subjectively D. Individual income differ UTME 2012 MCQ 12 When the slope of the total utility curve is declining, the marginal utility of a consumer will be increasing if he A. Stops consuming more of the commodity B. Reduces the quantity consumed C. Increases the quantity consumed D. Consumes more of another commodity UTME 2011 MCQ 15 Ranking is the method used in measuring A. Marginal utility B. Ordinal utility C. Cardinal utility D. Total utility www.scoreboosterproject.com
UTME 2010 MCQ 12 One of the assumption of ordinal utility explain theory is that A. Choice is not consistent B. Utility can be ranked C. Total utility is a function of price D. Satisfaction is measureable UTME 2010 MCQ 13 The law of diminishing marginal utility explains why A. The slope of a normal demand curve is negative B. An abnormal demand curve slopes upwards C. The slope of a normal demand curve is positive D. The consumption of inferior goods increases with income JUNE 2010 MCQ 11 At the highest level of total utility, marginal utility is A. Negative B. positive and falling C. positive and rising D. zero JUNE 2010 MCQ 12 The law of diminishing marginal utility states that, the more a commodity is consumed the A. Higher the satisfaction derived from an additional unit B. Higher the price to be paid C. Lower the quantity supplied D. Lower the rate of increase in the total utility derived www.scoreboosterproject.com
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Next video will be on more Diminishing marginal utility and the law of demand. relationship between total utility, average utility and marginal utility. Consumer equilibrium using the indifference curve and marginal analyses. Effects of shift in the budget line and the indifference curve. The effects of changes in price on consumer equilibrium. The relationship between marginal utility and the demand curve Questions and Solutions www.scoreboosterproject.com
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