economy
Principles of Microeconomics
(ECO2103)
Diploma in Business Administration
Mehdi Tasaloti
mehdi.tasaloti@newinti.edu.my
Faculty of Business,
Communication & Law (FOBCAL)
INTI International University
August 2014 Session
Faculty of Business, Communications and Law
INTI International University
1
Class syllabus for Long semester
Week
1-3
4-6
Topic
Economics Concepts, Issues & tools
Price Theory ( Demand & Supply) / Individual assignment/ Test 1
7&8
Applications of Price Theory ( Elasticity)/
Group assignment
9
Theory of Consumer behavior
10
Market Failure & Externalities
11&12 Theory of Firm: Production and Costs / Test 2
13 & 14 Market Structures
Faculty of Business, Communications and Law
INTI International University
2
Topic 4:
Theory of Consumer Behavior
Faculty of Business, Communications and Law
INTI International University
3
Introduction o The CONSUMER is essential to the market. Understanding how the consumer makes his/her purchasing decisions is key. o Individual consumption decisions are made with the goal of maximizing total satisfaction from consuming various goods and services
Faculty of Business, Communications and Law
INTI International University
4
What is Utility?
Why do you buy the goods and services you do? It must be because they provide you with satisfy. You feel better off because you have purchased them. Economists call this satisfaction utility.
Benefits that consumers obtain from goods & services they consume is utility.
Utility = Satisfaction/Happiness/Pleasure one gets from consuming a good.
Utility is difficult to quantify, as it differs between people and situations Measured in “utils”
Faculty of Business, Communications and Law
INTI International University
5
Total Utility (TU)
If we could measure utility, total utility would be the number of units of utility that a consumer gains from consuming a given quantity of a good, service, or activity during a particular time period. The higher a consumer’s total utility, the greater that consumer’s level of satisfaction.
Marginal Utility (MU)
The amount by which total utility rises with consumption of an additional unit of a good, service, or activity, all other things unchanged, is marginal utility.
Faculty of Business, Communications and Law
INTI International University
6
• Total Utility (TU)
Total amount of satisfaction or pleasure a person derives from consuming a given quantity of that product
• Marginal Utility (MU)
The extra satisfaction a consumer derives from one additional unit of that product.
In other words, the change in Total Utility that results from the consumption of one more unit
MU = ΔTU/ΔQ
Faculty of Business, Communications and Law
INTI International University
7
(1)
Tacos
Consumed
Per Meal
0
1
2
3
4
5
6
7
(2)
(3)
Total Marginal
Utility, Utility,
Utils
Utils
0
]
10
]
18
]
24
]
28
]
30
]
30
]
28
10
8
Total Utility (Utils)
Total Utility
30
TU
20
10
0
6
0
-2
Faculty of Business, Communications and Law
LO1
INTI International University
Marginal Utility (Utils)
2
2
3
4
5
6
7
1
4
1
2
3
4
5
6
7 MU
10
8
6
4
2
0
-2
8
6-8
Law of diminishing Marginal Utility
Suppose that you are really thirsty and you decide to consume a soft drink. Consuming the drink increases your utility, probably by a lot.
Suppose now you have another. That second drink probably increases your utility by less than the first. A third would increase your utility by still less. This tendency of marginal utility to decline beyond some level of consumption during a period is called the law of diminishing marginal utility
Faculty of Business, Communications and Law
INTI International University
9
Law of diminishing Marginal Utility
The principle that as more of any good or service is consumed, its extra benefit declines
Increases in total utility from consumption of a good or service become smaller and smaller as more is consumed during a given time period. Faculty of Business, Communications and Law
INTI International University
10
The Budget Line
Consumer’s choices are limited by the budget available. Total spending for goods and services can fall short of the budget constraint but may not exceed it. Suppose a college student, Rocky, wants to go in for Music classes and Karate classes. A day spent pursuing either activity costs $50. Suppose he has $250 available to spend on these two activities each semester.
Faculty of Business, Communications and Law
INTI International University
11
A change in consumer income and the budget line
If consumer income increases then the consumer will be able to purchase higher combinations of goods. Hence an increase in consumer income will result in a shift in the budget line. This is illustrated in Figure . Note that the prices of the two goods have remained the same, therefore, the increase in income will result in a parallel shift in the budget line.
Faculty of Business, Communications and Law
INTI International University
12
A change in the price of a good and the budget line
If income is held constant, and the price of one of the goods changes then the slope of the curve will change. In other words, the curve will pivot. This is illustrated in Figure below.
Faculty of Business, Communications and Law
INTI International University
13
Optimizing Consumption Choices
Or
Utility Maximization
A consumer’s money income should be allocated so that the last dollar spent on each good purchased yields the same amount of marginal utility
(when all income is spent), because this rule yields the largest possible total utility.
Faculty of Business, Communications and Law
INTI International University
14
Optimizing Consumption Choices Or
Utility Maximization
The rule of equal marginal utilities per dollar spent:
A consumer maximizes personal satisfaction when allocating money income in such a way that the last dollars spent on good A, good B, good C, and so on, yield equal amounts of marginal utility.
MU of good A
MU of good Z
MU of good B
=
= ... =
Price of good A
Price of good Z
Price of good B
Faculty of Business, Communications and Law
INTI International University
Mehdi Taslaoti
15
Optimizing Consumption Choices Or
Utility Maximization
• Consumer allocates income so that the marginal utility per dollar spent on each good is the same for all commodities purchased MU X MUY
=
PX
PY
Faculty of Business, Communications and Law
INTI International University
16
End of Topic 4
Faculty of Business, Communications and Law
INTI International University
17
(ECO2103)
Diploma in Business Administration
Mehdi Tasaloti
mehdi.tasaloti@newinti.edu.my
Faculty of Business,
Communication & Law (FOBCAL)
INTI International University
August 2014 Session
Faculty of Business, Communications and Law
INTI International University
1
Class syllabus for Long semester
Week
1-3
4-6
Topic
Economics Concepts, Issues & tools
Price Theory ( Demand & Supply) / Individual assignment/ Test 1
7&8
Applications of Price Theory ( Elasticity)/
Group assignment
9
Theory of Consumer behavior
10
Market Failure & Externalities
11&12 Theory of Firm: Production and Costs / Test 2
13 & 14 Market Structures
Faculty of Business, Communications and Law
INTI International University
2
Topic 4:
Theory of Consumer Behavior
Faculty of Business, Communications and Law
INTI International University
3
Introduction o The CONSUMER is essential to the market. Understanding how the consumer makes his/her purchasing decisions is key. o Individual consumption decisions are made with the goal of maximizing total satisfaction from consuming various goods and services
Faculty of Business, Communications and Law
INTI International University
4
What is Utility?
Why do you buy the goods and services you do? It must be because they provide you with satisfy. You feel better off because you have purchased them. Economists call this satisfaction utility.
Benefits that consumers obtain from goods & services they consume is utility.
Utility = Satisfaction/Happiness/Pleasure one gets from consuming a good.
Utility is difficult to quantify, as it differs between people and situations Measured in “utils”
Faculty of Business, Communications and Law
INTI International University
5
Total Utility (TU)
If we could measure utility, total utility would be the number of units of utility that a consumer gains from consuming a given quantity of a good, service, or activity during a particular time period. The higher a consumer’s total utility, the greater that consumer’s level of satisfaction.
Marginal Utility (MU)
The amount by which total utility rises with consumption of an additional unit of a good, service, or activity, all other things unchanged, is marginal utility.
Faculty of Business, Communications and Law
INTI International University
6
• Total Utility (TU)
Total amount of satisfaction or pleasure a person derives from consuming a given quantity of that product
• Marginal Utility (MU)
The extra satisfaction a consumer derives from one additional unit of that product.
In other words, the change in Total Utility that results from the consumption of one more unit
MU = ΔTU/ΔQ
Faculty of Business, Communications and Law
INTI International University
7
(1)
Tacos
Consumed
Per Meal
0
1
2
3
4
5
6
7
(2)
(3)
Total Marginal
Utility, Utility,
Utils
Utils
0
]
10
]
18
]
24
]
28
]
30
]
30
]
28
10
8
Total Utility (Utils)
Total Utility
30
TU
20
10
0
6
0
-2
Faculty of Business, Communications and Law
LO1
INTI International University
Marginal Utility (Utils)
2
2
3
4
5
6
7
1
4
1
2
3
4
5
6
7 MU
10
8
6
4
2
0
-2
8
6-8
Law of diminishing Marginal Utility
Suppose that you are really thirsty and you decide to consume a soft drink. Consuming the drink increases your utility, probably by a lot.
Suppose now you have another. That second drink probably increases your utility by less than the first. A third would increase your utility by still less. This tendency of marginal utility to decline beyond some level of consumption during a period is called the law of diminishing marginal utility
Faculty of Business, Communications and Law
INTI International University
9
Law of diminishing Marginal Utility
The principle that as more of any good or service is consumed, its extra benefit declines
Increases in total utility from consumption of a good or service become smaller and smaller as more is consumed during a given time period. Faculty of Business, Communications and Law
INTI International University
10
The Budget Line
Consumer’s choices are limited by the budget available. Total spending for goods and services can fall short of the budget constraint but may not exceed it. Suppose a college student, Rocky, wants to go in for Music classes and Karate classes. A day spent pursuing either activity costs $50. Suppose he has $250 available to spend on these two activities each semester.
Faculty of Business, Communications and Law
INTI International University
11
A change in consumer income and the budget line
If consumer income increases then the consumer will be able to purchase higher combinations of goods. Hence an increase in consumer income will result in a shift in the budget line. This is illustrated in Figure . Note that the prices of the two goods have remained the same, therefore, the increase in income will result in a parallel shift in the budget line.
Faculty of Business, Communications and Law
INTI International University
12
A change in the price of a good and the budget line
If income is held constant, and the price of one of the goods changes then the slope of the curve will change. In other words, the curve will pivot. This is illustrated in Figure below.
Faculty of Business, Communications and Law
INTI International University
13
Optimizing Consumption Choices
Or
Utility Maximization
A consumer’s money income should be allocated so that the last dollar spent on each good purchased yields the same amount of marginal utility
(when all income is spent), because this rule yields the largest possible total utility.
Faculty of Business, Communications and Law
INTI International University
14
Optimizing Consumption Choices Or
Utility Maximization
The rule of equal marginal utilities per dollar spent:
A consumer maximizes personal satisfaction when allocating money income in such a way that the last dollars spent on good A, good B, good C, and so on, yield equal amounts of marginal utility.
MU of good A
MU of good Z
MU of good B
=
= ... =
Price of good A
Price of good Z
Price of good B
Faculty of Business, Communications and Law
INTI International University
Mehdi Taslaoti
15
Optimizing Consumption Choices Or
Utility Maximization
• Consumer allocates income so that the marginal utility per dollar spent on each good is the same for all commodities purchased MU X MUY
=
PX
PY
Faculty of Business, Communications and Law
INTI International University
16
End of Topic 4
Faculty of Business, Communications and Law
INTI International University
17