Econ 221 Chapter 7. Utility Maximization
Econ 221 Chapter 7. Utility Maximization
Econ 221 Chapter 7. Utility Maximization
consumption of their preferred set of commodities. This guides them all through their
will result to higher utility. At all times consumers aim at reaching the optimal level of
satisfaction and hence will keep on purchasing certain set of commodities so as to reach
this plateau.
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buying behavior is determined by such sets of needs and the influences that create these (monthly/weekly); where he buys it (from retail or supermarket); how often he buys it
needs as well as the stages consumer go through to satisfy them (needs). (frequency of buying, say every fortnight) and how much he buys it (100 gram/200
gram). It must also be noted that the behavior is likely to show variation from individual
Stages of the Buying Process
to individual, from product to product and from an individual of one region to individual
To understand buying behavior, it is necessary to look at the buying process as a of another region. Thus, analyzing the consumer behavior is a prerequisite though the
set of stages consumers go through. Consumer behavior can be divided into three very process is highly complicated. At the same time, a firm’s ability to establish and maintain
distinct stages. These stages are as follows: a satisfying exchange relationship depends on the level of understanding of buying
behavior. Consumer behavior field explores the decision process and acts of people
Stage 1: pre-purchase stage involved in buying and using products.
Stage 2: purchase stage What is Consumer Behavior in Marketing?
Stage 3: post-purchase stage In marketing, understanding consumer behavior has become very important for
businesses. Consumer behavior refers to the study which analyzes how consumers make
Scope of Consumer Behavior Field decisions about their wants, needs, buying or act with respect to a product, service or
organization. It is very critical to understand the behavior of consumers to analyze the
The field of consumer behavior tries to find out the answers to the following behavior of potential consumers towards a new product or service. It is also very useful
questions: for companies to identify opportunities which have not yet been met.
What are the products people buy? An example in the aspect of consumer behavior is the change in eating habits which
drastically increased the demand for gluten-free products. Businesses which have
Why they buy them? identified this market gap have produced gluten-free products and have tapped this
market aspect as well.
How they buy them?
When they buy them? On the other side, those companies which failed in monitoring consumer behavior could
not manage to fill this void in the marketplace and were left behind. Understanding the
Where they buy them? behavior of consumers allows pro-active companies to increase their market share
through anticipating the shift within the consumer choice.
How often they buy them?
How is the decision process of the consumer? Factor affecting Consumer Behavior
Understanding how consumer behavior impacts marketing renders it vital to understand
For instance, if you intend to produce a new variety of tooth paste, you should those factors which affect consumer behavior and which include:
analyze the nature of individual consumption behavior as to why consumer uses tooth
paste (to whiten teeth/prevent tooth decay); which brand of toothpaste he buys (say
Close-up or Aromatic); why he buys it (because he believes that it will whiten his teeth
better than competing brands); how he buys it (cash/credit); when he buys it
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Cultural Factors Personal Factors
Consumer behavior is influenced by cultural factors like social class, buyer’s culture, and Personal factors impact buying decisions and include age, economic situation and
subculture. There are three types of cultural factors include social class, culture, and occupation. In considering personal factors, buying behavior is also influenced by habits,
subculture. Culture can be different by region, different groups and even countries. opinions and interests along with other personal issues.
Cultural shifts are always important for marketers whether marketing new products or Human Life Cycle Stages is another example, here marketers target markets based on
existing products with new features and attributes. For examples nowadays cultural shift the human life cycle. They will target teenagers with bright colors, loud music and fast
towards health and fitness has created a huge demand for exercise equipment, low food. A young couple will prefer to buy a retirement plan and secure their future.
calories and organic food and other fitness services. This cultural shift greatly influenced Occupation and Economic Circumstances. A person occupation affects the consumer
the consumer behavior throughout the world i.e. America, England and Europe and many decision while buying goods and services. For example, if you are a blue-color worker
parts of the world. People go to Gym and love organic and healthy food. you will prefer to buy more work-related clothes. On the other hand, if you are an office
Culture is the combination of subcultures. If you are a Muslim, Hindu or Christian, worker you will tend to buy smart clothes. Different types of companies specialize in
your buying behavior will be influenced by different subcultures. It will affect your making products based on occupational group. For example, a software house will
choice and preferences like your food, clothing, career goals and recreational activities. develop different software for accountants, lawyers, retailers and engineers.
Another cultural factor is the social class that can affect the consumer buying behavior Marketers closely observe buyer personal income, saving and interest rate. Their
in different parts of the world. For example, in the western world, both the lower class marketing mix decisions are based on economic indicators. For example, The price of
and upper might show the same buying behavior. But in other countries like India upper Nikon D-5 professional camera is over $6000, you can only purchase this camera if you
class have a tendency to buy luxury cars, gadgets, and personal care products. But people enough disposable income, savings or borrowing power.
from the lower class are unable to spend money on these purchases.
Social Factors Lifestyle means how a person lives in a society. For example, you are living in a posh
Social factors greatly influence the purchasing behavior of consumers. Social influencers area and people have expensive watches, branded clothes and luxury cars. You have to
are diverse and include family, school or work communities, social interaction or any maintain your status and image.
group with which an individual interacts. It also includes an individual’s social class Psychological Factors
which comprises of education level, living conditions, and income. Psychological factors that impact buying decision includes perception, motivation and
beliefs and attitudes. Every consumer will respond to marketing message based upon
Social Reference. For example, Last month I was eagerly needed a laptop. I went to a their attitudes and perceptions.
nearby market and purchased a MacBook Pro laptop. What factors affect my buying
decision and why I purchased MacBook Pro. It was because my closest friend already Motivation. People have different needs at a time. Some needs are biological i.e. hunger,
having the same brand and he is quite satisfied with this product. thirst and some are psychological i.e. recognition, self-esteem and belonging. When a
Family. Family plays an important role in the decision-making process. For example, if need reaches a certain level of intensity it becomes a motive. According to Philip Kotler,
you are a married person, you will always prefer those products that would benefit both a motive is a need that has the power to direct the person to seek satisfaction.
husband and wife. Maslow’s Hierarchy of Needs also known as Maslow’s theory of motivation was
Social Role and Status. Let us understand social role and status and how it affect developed by Abraham Maslow in 1943. This Maslow’s theory is based on human
consumer behavior. For example, you are a Chief Financial Officer in a leading motivation. It is shaped like a pyramid and have a bottom to top approach. According to
organization, you are someone’s son, husband and father. your role can also affect the this hierarchy, there are five levels of human needs.
buying tendency of many people. Physiological needs consist of basic human needs like water, food and
sleep.
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Safety needs consist physical safety of humans like personal, emotional, Point-of-sale: This requires obtaining statistics from stores or corporate
financial security headquarters. Companies should focus upon a particular type of product
Social Belonging and needs consist of love, friendship needs and determine whether the product is purchased more than often in a
Self-Esteem are those needs looking for self-respect, recognition and certain time period in comparison to other time periods. This paves way
social-status for researching the reasons why a particular brand was selected over the
Self-actualization is the need for personal growth, development and other.
realization.
Freud Theory of Motivation. This theory tells us that the unconscious psychological
forces such as emotions and desires shape an individual behavior. These are three factors The concept of utility maximization was developed by the utilitarian philosophers Jeremy
are Id, superego and ego. Bentham and John Stuart Mill. It was incorporated into economics by English
Consumer Behavior Models economist Alfred Marshall. An assumption in classical economics is that the cost of a
Through observation and research, there have been developed several models which product that a consumer is willing to pay is an approximation of the maximum utility that
further explains the buying behavior of consumers and which includes black box, they receive from the purchased good.
personal variables as well as complex models.
Understanding Utility Maximization
Black-box model: This model is based upon external stimulus-response
which means that a point triggers the consumer’s mind to make a The combination of goods or services that maximize utility is determined by comparing
purchasing decision which is influenced by different factors like the marginal utility of two choices and finding the alternative with the highest total utility
sampling, marketing message, promotions, product availability and price. within the budget limit. The decision is influenced by the option that produces a higher
Personal variables: When a consumer is influenced by personal-variable level of satisfaction. This explains how companies and individuals develop consumption
model, decisions are based upon internal factors. Internal factors may habits.
include belief systems, goals, goals, traditions, personal opinions or any
other similar internal motivator. The consumer may consider purchasing more of one item and less of another. Through
Complex model: Complex model includes both external and internal maximizing utility, the consumer will buy an item that produces the greatest marginal
variables. utility with the least amount of spending.
How to Study Consumer Behavior
Several factors affect the consumer behavior and there are some methods that are used to
For example, if product ‘A’ comes with twice more marginal utility than product ‘B,’ that
study consumer behavior. These methods include:
means product ‘A’ is providing more marginal utility per dollar than ‘B.’ As a result, the
consumer may decide to buy more of product ‘A.’
Surveys: Surveys can be conducted on the phone, internet or in-person.
Surveys should avoid the open-ended question and should include The utility-maximizing rule is expressed as follows:
multiple-choice questions so that answers are given easily.
Focus groups: This involves hosting a group of different type of
customers to discuss over a product type and to understand the reasons
why customers will buy certain brands. This should include open-ended
questions and allow participants to try a new brand and write down their
views about it.
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gained from a particular unit of consumption. An allocated constant unit for utils is set
since there is no actual figure for utility satisfaction.
TU = U1 + MU2 + MU3…
Where:
Total Utility Maximization
TU is Total Utility
Total utility refers to the total amount of satisfaction that a person obtains by consuming U is Utility
a specific quantity of units of a product at a given time. The greater the consumer’s total MU is Marginal Utility
utility, the higher the measure of satisfaction acquired.
Total utility is used to determine a consumer’s decision based on utility maximization in
the economic setting. A company’s management should make production changes by The total utility is equivalent to the number of utils realized from each unit of
analyzing the marginal utility increase or decrease. consumption. However, the theory assumes that every additional unit of consumption
generates less marginal utility, which is the law of diminishing marginal utility.
Consumers try to maximize their utility with every item consumed based on rational
choice theory. Their decisions are geared toward acquiring the most affordable items with
the highest level of satisfaction.
Marginal Utility Maximization
Generally, consumer behavior is based on maximizing total utility by acquiring units that
enable them to gain maximum utility for the amount they spend. This is partially due to
the budget constraints and the desire to achieve as much satisfaction as possible from the Marginal utility refers to the additional satisfaction that a consumer achieves from
consumption of a product. utilizing one additional item. For example, if the utility of consuming the first cake is ten
utils and eight utils for the second cake, the marginal utility of consuming the second
cake is eight utils. If two utils are assigned to the utility of the third cake, then the
marginal utility of consuming the third cake is two utils.
Calculating Total Utility Maximization
Generally, a customer will consume a product up until the marginal utility is equal to
zero. That is, if the cake provides more satisfaction than the cost, then the consumer will
Each unit of a product or service has its utility, while every additional unit of continue buying it.
consumption has its marginal utility. The total utility equation assigns base values called
utils. Economists examine utils over a broad range and determine the level of satisfaction
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The objective of marginal utility is to determine the quantity of a product that the
consumer is willing to buy. Individuals and companies make decisions regarding their The total utility of the two apples is 35 utils. When the consumer consumes the third
utility. If a certain item comes with marginal utility, the consumer will continue to
purchase more of that good. apple, the total utility becomes 45 utils. Thus, marginal utility of the third apple is 10 utils
However, if the utility of that product declines with the consumption of each subsequent (45-35). In other words, marginal utility of a commodity is the loss in utility if one unit
additional unit, then the consumer will stop when marginal utility reaches zero or
becomes negative. less is consumed. Algebraically, the marginal utility (MU) of n units of a commodity is
the total utility (TU) of n units minus the total utility of n-1. Thus MU of nth unit=TU of
Total Utility vs. Marginal Utility!
n unit—TU- of (n-1).
Every commodity possesses utility for the consumer. When the consumer buys apples he
receives them in units, 1, 2, 3, 4 etc., as shown in Table 1. To begin with, 2 apples have The relation between total and marginal utility is explained with the help of Table 1.
more utility than 1; 3 more utility than 2, and 4 more than 3. The units of apples which
Table 1: Relation between TU and MU:
the consumer chooses are in a descending order of their utilities.
In his estimation, the first apple is the best out of the lot available to him and
thus gives him the highest satisfaction, measured as 20 utils. The second apple will
naturally be the second best with lesser amount of utility than the first, and has 15 utils.
So long as total utility is increasing, marginal utility is decreasing up to the 4th unit.
Total utility is the sum total of utilities obtained by the consumer from different units of a
When total utility is maximum at the 5th unit, marginal utility is zero. It is the point of
commodity. In our illustration, the total utility of two apples is 35= (20+ 15) utils, of
satiety for the consumer. When total utility is decreasing, marginal utility is negative (the
three apples 45= (20+15+10) utils, and of four apples 50= (20+l 5+10+5) utils. Marginal
6th and the 7th units). These units give disutility or dissatisfaction, so it is no use having
utility is the addition made to total utility by having an additional unit of the commodity.
them.
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This relationship is shown in Figure 1.
To draw the curves of total utility and marginal utility, we take total utility from column
(2) of Table 1 and obtain rectangles. By connecting the tops of these rectangles with a
What is the Law of Diminishing Marginal Utility?
smooth line, we get the TU curve that peaks at point Q and then slowly declines. To draw
The Law of Diminishing Marginal Utility states that the additional utility gained from an
the MU curve, we take marginal utility from column (3) of the table. The MU curve is increase in consumption decreases with each subsequent increase in the level of
consumption. Marginal Utility is the change in total utility due to a one-unit change in
represented by the increment in total utility shown as the shaded blocks in the figure. the level of consumption. The Law of Diminishing Marginal Utility states the marginal
utility gradually decreases with the level of consumption, utility being defined as
satisfaction or benefit.
The Marginal Utility gained from the x th unit of consumption is equal to the difference
between the total utility gained from x units of consumption and the total utility gained
from x–1 units of consumption.
When the tops of these blocks are joined by a smooth line, we obtain the MU curve. So The Law of Diminishing Marginal Utility is best understood through an analogy.
Consider the following example:
long as the TU curve is rising, the MU curve is falling. When the former reaches the
John is extremely hungry and goes to a restaurant that offers a buffet. He loads up his
highest point Q, the latter touches the X-axis at point С where the MU is zero. When the
plate with food and starts eating. The amount of satisfaction gained by John from a plate
of food is directly proportional to John’s hunger level. Therefore, the first plate of food
TU curve starts falling from Q onwards, the MU becomes negative from С onwards.
will give John more satisfaction (utility) than the second plate of food, which in turn will
give John more satisfaction than the third plate of food.
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The situation above occurs because each plate of food reduces John’s hunger level. The Mathematical Interpretation of the Law of Diminishing Marginal Utility
reduction in hunger level results in less satisfaction from the plate of food being
consumed. Each plate of food fills John up and thus lessens the amount of satisfaction he The law of diminishing marginal utility states the utility function is upward sloping and
will get from the plates of food that follow. Mathematically, it can be represented by the concave. The neoclassical microeconomic theory assumes that all commodities are
following table: infinitely divisible. This allows economists and mathematicians to assume continuous
utility functions and use calculus to analyze marginal changes.
The example above implicitly makes use of the assumption of continuity. For instance,
one can read off the graph that 3.5 plates of food give the consumer 27.5 units of utility.
If we assume a continuous utility function, then the marginal utility from the x th unit of
consumption is simply the slope (or derivative) of the total utility function at x units.
Multiple Choice
Instructions: Fill the blank with the letter of your answer before the number.
___ 2. When the price of a product falls for a normal good, the:
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d. substitution effect will encourage consumers to purchase more of the product and What is Consumer Behavior? - Definition, Factors, Models & Examples
the income effect will encourage them to purchase less. (marketingtutor.net)
3. George consumes only two goods, pizza and compact discs. Both are normal Unit-01.pdf (ebookbou.edu.bd)
goods for George. Suppose the price of pizza decreases. George's consumption of
compact discs will: Total Utility vs. Marginal Utility (explained with diagram) (yourarticlelibrary.com)
References: