Microeconomics Lec5

Federal Urdu University Islamabad
Faculty of Management Sciences

(Department of Business Administration)
Lecture # 5
Course Title: ‘Principles of Micro Economics’
Course Instructor: Ms. Maryam Bibi
Utility
• Utility is a term in economics that refers to the
total satisfaction received from consuming a
good or service.
Marginal Utility
Marginal utility is the utility gained by consuming an

additional unit of a service or good.
Law of Diminishing Marginal
Utility
The law of diminishing marginal utility states that the

additional utility gained from an increase in consumption
decreases with each subsequent increase in the level of
consumption.

Explanation
Table: Food Consumed Total Utility Marginal Utility
1 Plate 10 -
2 Plate 18 8
3 Plate 24 6
4 Plate 28 4
5 Plate 30 2
6 Plate 30 0 MU=0,TU=Max
7 Plate 28 -2
Diagram
TU
Q
MU
Diagram shows that in the beginning TU increases at a
decreasing rate and MU falls but it is still positive. Hence
TU is at its maximum point. when TU fall, MU becomes
negative this situation shows that consumer is no more
desirous for additional units of goods.
MU=
Theory of Consumer Behaviour
There are two major approaches to consumer behaviour.

1. Cardinal utility approach
2. Ordinal utility approach
Cardinal Utility Approach
According to some economists, utility is modeled as a
quantifiable or cardinal property of the economic goods that
a person consumes. To help with this quantitative
measurement of satisfaction, economists assume a unit
known as a “util” to represent the amount of psychological
satisfaction for a specific good.
For example, an individual judges that a piece of pizza
will yield 10 utils and that a bowl of pasta will yield 12
utils.
Ordinal Utility Approach
The ordinal utility concept states that the satisfaction a

consumer obtains after consuming various commodity
cannot be measured in numbers, but can be arranged in
order of preference. Pasta>Pizza> Burger
Indifference Curve
An indifference curve is a graph showing combination of two
goods that give the consumer equal satisfaction and utility.
each point on an indifference curve indicates that a
consumer is indifferent between the two and all points give
him the same utility.
Indifference curve is always convex to the origin because as
you consume more of one good you will consume less of the
other. . Good X
IC1
Good Y
Marginal Rate of
Substitution/Slope of IC
• Rate of exchange between two commodities x and y is called MRS.
• It refers to the amount of one good that is substitutable for another.
• MRS is slope of indifference curve.
• When indifference curve is convex then it means that you consume more of
one good you will consume less of the other here MRS decreases as law of
diminishing marginal substitution sets in.
• If slope of IC(MRS) is constant then it means that individual is willing to give
up the same amount of good y for each additional units of good x.
• Concave indifference curve represents that individual is willing to give up
more and more units of good y for each additional unit of x. i.e MRS increases.
MRSxy=
Types of Indifference Curve
Indifference curve for perfect Substitutes:
If two goods x and y are perfect substitutes,
the indifference curve is a straight line with negative slope,
because the MRSxy is constant. In this case, the consumer
does not distinguish between these two goods and regards
them as the same commodity, such as two brands of tea.
GoodY
Good X
Indifference curve for Complimentary goods:
The indifference curve of perfect complementary goods is
‘L’ shaped.
Example: ‘Left shoe’ and ‘Right shoe’ can be considered as
perfect complimentary goods. This is because the utility of
Left shoe would be zero without a Right shoe and vice
versa.
Table
Combination Left Shoe Right Shoe
A 1 1
B 1 2
C 1 3
D 1 4
E 1 5
Explanation
• From combination ‘A’ to combination ‘E’ the quantity
of Left shoe is constant and the quantity of Right
shoe is increasing.
• Combination ‘B’ till E the extra right shoe would be of
no use because its importance would be zero unless
coupled with another left shoe.
Right Shoe
Left shoe
Similarly, we can have another set of combinations for
Left and Right shoe by changing the scenario.
Combination Right Shoe Left Shoe

A 1 1
Right Shoe
B 1 2
C 1 3
D 1 4
E 1 5 Left Shoe
So combining all the above cases, the final graph
is given below. (L shaped)
Right Shoe
Left Shoe
Indifference curve for normal goods:
• Here we have downward sloping indifference curve.
• Indifference curves are not intersecting each other.
• Indifference curves are convex to the origin
• Higher indifference curve gives higher utility.
X
Y
The Budget Line
A budget line shows the combinations of two

products that a consumer can afford to buy with
a given income using all of their available
budget.
Equation of Budget Line
Px.Qx+Py.Qy = M
Where,
Px is the price of goods X;
Qx is the quantity of goods X;
Py is the price of goods Y;
Qy is the quantity of goods Y;
M is the income of the consumer.
Combination Book($10 per Pencil($ 5 per Budget Allocation
book) pencil)
A 0 10 10*0+5*10
=$50INCOME
B 1 8 10*1+5*8=50
C 2 6 10*2+5*6=50
D 3 4 10*3+5*4=50
E 4 2 10*4+5*2 =50
F 5 0 10*5+5*0=50
Graph of Budget Line
Prices are constant throughout a budget line

BOOK
0
pencil
Properties of Budget Line
Negative Slope: It slopes downward showing an
inverse relationship between the buying of the
two goods.
Real Income Line: It functions on the principle of
income and the spending capacity of a consumer.
Tangent to Indifference Curve: The indifference
curve touches the budget line at a point, and this
point is known as the consumer’s equilibrium
Revealed Preference Theory
• Revealed preference, a theory offered by

American economist Paul Anthony Samuelson
in 1938, states that consumer behavior, if their
income and the item's price are held constant,
is the best indicator of their preferences.
• Revealed preference theory works on the
assumption that consumers are rational.
• Three primary axioms of revealed preference
are WARP, SARP, and GARP.
Weak Axiom of Revealed Preference (WARP)
This axiom states that given incomes and prices,

if one product or service is purchased instead of
another, then, as consumers, we will always
make the same choice. The weak axiom also
states that if we buy one particular product,
then we will never buy a different product or
brand unless it is cheaper, offers increased
convenience, or is of better quality.
Strong Axiom of Revealed Preference (SARP)
The strong axiom essentially generalizes the

weak axiom to cover multiple goods and rules
out certain inconsistent chains of choices. In a
two-dimensional world that is a world with only
two goods between which consumers choose,
the weak and strong axioms can be shown to be
equivalent.
Generalized Axiom of Revealed Preference (GARP)
This axiom covers the case when, for a given

level of income and or price, we get the same
level of benefit from more than one
consumption bundle. “If x is revealed preferred
to y, directly or indirectly, then it can not be that
y is strictly directly preferred to x.”

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Federal Urdu University Islamabad

Faculty of Management Sciences

Marginal utility is the utility gained by consuming an

The law of diminishing marginal utility states that the

There are two major approaches to consumer behaviour.

The ordinal utility concept states that the satisfaction a

Combination Right Shoe Left Shoe

A budget line shows the combinations of two

Prices are constant throughout a budget line

• Revealed preference, a theory offered by

This axiom states that given incomes and prices,

The strong axiom essentially generalizes the

This axiom covers the case when, for a given

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