Lesson 3

THEORY OF CONSUMER BEHAVIOR

UTILITY – is the term for satisfaction in economics. It is the objective of every consumer.
UTILITY THEORY – assumes that satisfaction is measurable in units called utils. It supposes that people
while purchasing or consuming goods and services are subconsciously estimating the satisfaction they
derived out of the said consumption.
- Each of the consumers may have their own scale to measure utility. A person has the liberty to
make his own scale in measuring his own satisfaction.
MARGINAL UTILITY – is the additional satisfaction derives from consuming an extra piece.
TOTAL UTILITY – is the sum of all the marginal utility he gets from consuming successive amount of the
said food.
Ex. Utility schedule of Jason for chicken nuggets and shanghai rolls.

Units consumed 1 2 3 4 5
Total utility 100 150 170 180 180 (utils)
Marginal utility 100 50 20 10 0 (utils)
Total utility 50 75 80 80 78 (utils)
Marginal utility 50 25 5 0 -2 (utils)

In concrete terms, total utility will continue to increase so long as the marginal utility is positive. At the
point of satisfaction, where the marginal utility is equal to zero, total utility remains the same. When the
consumer begins to feel disutility or dissatisfaction, total utility declines. Beyond this point, any
additional consumption will lead to lesser and lesser total utility.

THE LAW OF DIMINISHING MARGINAL UTILITY

Explain why people don’t consume more than what can satisfy them. It suggests that a person’s
additional satisfaction or his marginal utility declines as he consumes more and more of a particular
commodity during some specified period of time.
- However, any addiction, obsession to a good or service or set completion cases are exception to
the law.

THE EQUI-MARGINAL PRINCIPLE

Aside from taste and preferences that the utility schedule already reflects, prices of the goods or service
as well as the consumer’s budget for that commodity serve as important elements that are involved in
the process of making a rational choice.
- Consumer balance their selection of goods and services in order to achieve equilibrium.

INDIFFERENCE CURVE – approach stressed the ordinal ranking of preference among the goods and
services consumers buy.
- Shows a set of consumption choices, each of which yields the same amount of utility.
CHARACTERISTICS OF THE INDIFFERENCE CURVE:
1. It is normally negatively sloped. A downward sloping indifference curve suggests that the consumer is
indifferent between two combinations of goods, where one combination may contain more units of X,
but fewer units of Y and the other containing fewer units of X but more units of Y.
2. It is convex to the point of origin due to the influence of the Law of Diminishing Marginal Utility. The
more of a commodity a consumer has the less valuable an additional unit becomes, therefore, marginal
utility declines. A person who has 4 sandwiches and only 1 drink might be willing to trade 2 sandwiches
for an additional drink.
3. Indifference curves are non-intersecting. Rational consumers are consistent with their preferences.
If a consumer prefer A to B and B to C, then he also prefers A to C.

MARGINAL RATE OF SUBSTITUTION (MRS)

MRS = change in food consumption

Change in clothing consumption

Indifference schedule
Food consumption 56 46 37 29 22 16 11 8 5 3 2
Clothing consumption 1 2 3 4 5 6 7 8 9 10
Marginal rate of substitution - (10)

BUDGET LINE – contains infinite points of combinations in the consumption of tow commodity items
that the same budget can buy at constant prices.
CONSUMER’S SURPLUS – the peso value that the consumer is willing to pay for a certain volume of a
commodity item is less than the peso value of the benefit from its consumption.
PARADOX OF VALUE
The paradox of value answers on How is it that water, which is very useful, that life is impossible
without it, has such a low price; whereas diamond which are not quite necessary have such high price.
The answer lies on the equilibrium theory of supply and demand as well as the theory of diminishing
marginal utility.
Lesson 4 given by the individual member to the
Production Input- involved utilizing inputs to association.
produce a desired product. Business syndicate- is organized by several
Production Function- contains the functional corporations to carry out a particularly large
relationship between output and a basic factor project.
in the form of land, labor or capital, assuming Real Assets- are machineries, buildings,
the other factors of fixed size. materials and supplies.
Productivity- is ratio of output to input or the Monetary Assets- is in the form of money and
average product yield of the inputs. near money part of which the firm transforms
Profit- can be attained by organizing the into real assets through purchases or
business according to the owners objectives acquisition.
and resources. Inventories- The utilized resources are simply
- Is the positive net effect or the positive transformed into these unsold goods which
difference between revenue and cost. become part of the firm’s stock of assets.
- with the revenue earned, the firm can Imputed Cost-is the value imputed or assigned
recover what it foregoes in the process to any cost item that is not recorded in the
of production and the excess issimply books.
the profit created. Opportunity Cost- this is the best opportunity
Loss- the negative difference between revenue that an entrepreneur foregoes among the other
and cost. alternate endeavor.
Modified Profit or Loss- is simply the
FORMS OF BUSINESS ORGANIZATION. comparative gain in shifting from one
Sole Proprietorship- is an enterprise owned by alternative to the other.
a single individual who alone benefits from the
profits or suffers the losses.
TWO BASIC COMPONENTS OF TOTAL COST
Partnership – is the agreement of two or more
persons who bind themselves to contribute 1. Fixed cost
money, property, or business know-hot to a 2. Variable cost
common fund with the intention of dividing
profits or losses among themselves.
Corporation- is an artificial being created by Total Cost= TFC + AFC
operation of law having the right of succession Average Fixed Cost = TFC/Q
and the powers, attributes, and properties
expressly authorized by law or incidents to its Average Variable Cost= TVC/Q
existence.
Average Total Cost= AFC + AVC
Cooperative Association- is a non-profit
enterprise, owned and democratically Marginal Cost= CHANGE IN TC/ CHANGE IN Q
controlled on a mutual basis by the members
who participate in the savings generated by the Total Revenue x Q
cooperative in proportion to the patronage
Lesson 6 Why Monopolies Arise
THE FIRM'S SHORT-RUN DECISION TO SHUT • The fundamental cause of monopoly is
DOWN barriers to entry.
A SHUTDOWN refers to a short-run decision not
to produce anything during a specific period of Barriers to entry have three sources:
time because of current market conditions. 1. Ownership of a key resource.
EXIT refers to a long-run decision to leave the - This tends to be rare. De Beers is an
market. The firm considers its sunk costs when example
deciding to exit, but ignores them when 2. The government gives a single firm the
deciding whether to shut down. exclusive right to produce some good.
SUNK COSTS are costs that have already been - Patents, Copyrights and Government
committed and cannot be recovered. Licensing.
3. Costs of production make a single producer
The Firm’s Short-Run Decision to Shut Down more efficient than a large number of
The firm shuts down if the revenue it producers.
gets from producing is less than the variable - Natural Monopolies
cost of production.

Shut down if TR < VC MONOPOLY VERSUS COMPETITION

Shut down if TR/Q < VC/Q Monopoly
Shut down if P < AVC • Is the sole producer
• Has a downward-sloping demand curve
THE FIRM'S LONG-RUN DECISION TO EXIT OR • Is a price maker
ENTER A MARKET • Reduces price to increase sales
In the long-run, the firm exits if the Competitive Firm
revenue it would get from producing is less than • Is one of many producers
its total cost. • Has a horizontal demand curve
Exit if TR < TC • Is a price taker
Exit if TR/Q < TC/Q • Sells as much or as little at same price
Exit if P < ATC
- Total Revenue
A firm will enter the industry if such an P x Q = TR
action would be profitable. - Average Revenue
Enter if TR > TC TR/Q = AR = P
Enter if TR/Q > TC/Q - Marginal Revenue
Enter if P > ATC TR/Q = MR

MONOPOLY
• While a competitive firm is a price
taker, a monopoly firm is a price maker.
Lesson 7 PRICE DISCRIMINATION is the practice of selling
A MONOPOLY'S TOTAL, AVERAGE, AND the same good at different prices to different
MARGINAL REVENUE customers, even though the costs for producing
for the two customers are the same. In order to
A Monopoly’s Marginal Revenue do this, the firm must have market power.
- When a monopoly increases the
amount it sells, it has two effects on total TWO IMPORTANT EFFECTS OF PRICE
revenue (P x Q). DISCRIMINATION:
1. The output effect—more output is sold, so Q 1. It can increase the monopolist’s profits.
is higher. 2. It can reduce deadweight loss.
2. The price effect—price falls, so P is lower.
But in order to price discriminate, the firm must
1. Be able to separate the customers on the
COMPARING MONOPOLY AND COMPETITION basis of willingness to pay.
- For a competitive firm, price equals 2. Prevent the customers from reselling the
marginal cost. product.
P = MR = MC
- For a monopoly firm, price exceeds OUTPUT AND PRICE UNDER PURE
marginal cost. COMPETITION
P > MR = MC - The price of the product in a pure
competition cannot be influenced by any seller
A MONOPOLY'S PROFIT or buyer. Because the quantity held by any
individual seller is only a small fraction of the
Profit equals total revenue minus total costs. total quantity produced, changing his price will
- Profit = TR – TC not be a cause for retaliation from competitors.
- Profit = (TR/Q - TC/Q) x Q
- Profit = (P - ATC) x Q PRICE AND OUTPUT DETERMINATION UNDER
MONOPOLY
• The monopolist will receive economic - Since the monopolist is the sole seller in
profits as long as price is greater than average the market, his demand curve is also the
total cost. industry’s demand curve. When he raises his
prices, the quantity he disposes will be reduced.
PUBLIC POLICY TOWARD MONOPOLIES When he lowers his price, the reverse happens.
Government responds to the problem of
monopoly in one of four ways. FIXING THE MONOPOLY PRICE – monopolist
• Making monopolized industries more faces three possible cost situations.
competitive. 1. Constant costs – indicate that the per unit
• Regulating the behavior of monopolies. cost of the monopolist remains unchanged even
• Turning some private monopolies into if the quantity sold is increased or decreased.
public enterprises. 2. Increasing costs – means that the cost of
• Doing nothing at all. production increases as quantity produced is
increased.
3. Decreasing costs – the monopolist’s cost of NATURAL MONOPOLY – is when a single firm
production decreases as the quantity produced can supply goods or services to an entire
is increased. market at a smaller cost than could two or more
firms.
PRICE AND OUTPUT DETERMINATION UNDER
OLIGOPOLY Monopoly is a situation in which the market is
1. If he cuts his price, competitors will retaliate dominated by one seller or producer. By law a
and he will not gain anything, but short-term monopoly occurs if a firm has a market share of
profits from his initial move. His long run profits 25%.
(and that of his competitors) will be reduced.
2. If he raises his price, his customers will move PROBLEMS OF MONOPOLY
to his competitors. His sales volume and • Consumers may pay higher prices due to the
consequently, his sales revenue will decline. lack of competition
• Consumers may have less choice
PRICE DETERMINATION UNDER • Firms may not be very efficient with their
MONOPOLISTIC COMPETITION resources because there is no need to reduce
Strives to differentiate its products from costs
that of its competitors. If it is successful in • Less innovation (new products)
maintaining a sizable group of loyal customers,
it will attempt to maximize profits, observing BENEFITS OF MONOPOLY
the law of supply and demand. • The firm should make higher profits
• The firm may use these to invest in new
MONOPOLY products or improve existing products.
** while competitive firm is a price taker a
monopoly is a price maker EXTERNALITIES OF ENTRY INCLUDES:
- It is a sole seller of its product. 1. Product variety externalities
- Its product does not have close 2. Business stealing externalities.
substitutes
- The fundamental cause of monopoly is PRODUCT VARIETY EXTERNALITIES
barriers to entry. - Because consumers gets some
consumer surplus from the introduction of a
BARRIERS TO ENTRY HAVE THREE SOURCES: new product, entry of a new firm convey a
1. Ownership of a key resource. positive externalities on consumers.
2. The government gives a single firm the
exclusive right to produce some goods. BUSINESS STEALING EXTERNALITIES
3. Cost of production make a single - Because other firms lose customers and
producer more efficient than a large number of profits from the entry of a new competitor,
producers. entry of a new firm impose a negative
externalities on existing firms.
LESSON 8 DEPRECIATION – refers to the reduction in
APPROACHES TO ESTIMATING NATIONAL value of an asset through wear and tear.
INCOME: NET NATIONAL PRODUCT – this refers to the
1. Industrial origin approach (also referred GNP less the part of the output needed to
to as value added approach) replace the capital goods worn out in producing
2. Product approach (also expenditure the output.
approach) DIRECT TAXES – these are taxes such as sales,
3. Income approach excise, and business property taxes, license fees
and tariffs which firms treat as costs of
INDUSTRIAL ORIGIN APPROACH – measures producing a product or service and pass on (full
national income by determining the sum of the or partial) to buyers by charging them high
market value of the total production of all the prices.
major industries comprising the economy. SUBSIDIES – this is the payment of funds,
goods, or services by a government, business,
MAJOR INDUSTRIES CONSIST OF THE or household for which it receives no good or
FOLLOWING: service in return.
a. Agriculture, fisheries and forestry DISPOSABLE INCOME – part of the national
b. Industrial sector income that is available to households for
c. Service sector consumption or saving.
- Is estimated by deducting from GNP all
PRODUCT APPROACH – it involves calculating taxes, business saving, and depreciation; then
the sum of all expenditures on final goods. adding government and other transfer
payments and government interest payments.
PRIVATE (OR PERSONAL) CONSUMPTION
EXPENDITURES – refers to the spending by CONSUMPTION AND SAVINGS
households on the following types of goods. CONSUMPTION – is the total expenditure in an
1. Durable consumer goods. economy of goods and services by individuals or
2. Nondurable consumer goods such as candies, a nation during a given period.
newspapers, toilet papers, soft drinks, and ball - Refers to direct satisfaction of human wants.
pen. - Includes not only the use of consumer goods
3. Services such as those provided by teachers, and services but also the use of raw materials
architects, interior decorators, and electrician. and other inputs in the production process.
INCOME APPROACH – the owners of these CONSUMPTION FUNCTION – refers to the
resources receive earnings in the form of rent, relationship between total consumption
wages and salaries, interest and dividends and expenditure in the economy, and total
profit. consumer’s income.
GROSS DOMESTIC INVESTMENT – these are
expenditures for newly produced capital goods CONSUMPTION PATTERNS
like machinery, equipment, tools, buildings, and When there is a change in income,
additional inventory. there is also a change in consumption behavior.
An income increases, the consumption of lower
priority goods is felt but only after basic 1. To provide for old age.
necessities are sufficiently covered. With lower 2. To provide for children’s education.
income, expenditures for necessities like food 3. To accumulate funds for acquisition of capital
predominate. When there is an increase in goods.
income, expenditures on certain goods like 4. To accumulate wealth.
automobiles and transportation begin to
appear. Further increases in income give way to
spending in medical care, education, recreation
and others.
CONSUMPTION MAY BE CATEGORIZED INTO TOTAL SAVINGS IS COMPOSED OF THE
THE FOLLOWING: FOLLOWING:
1. Durable goods 1. Personal savings – those made by individual
A. Motor vehicles households for the purpose of future
B. Household equipment consumption.
C. Others 2. Business savings – consist of depreciation
2. Nondurable goods allowances and retained earnings. Depreciation
A. Food allowances are used to replace wornout and
B. Clothing and apparel obsolete plant and equipment.
C. Energy 3. Government savings – is achieved when any
D. Others government units runs a budget surplus. Means
3. Services that the government unit spend less than its
A. Housing income.
B. Medical care 4. Foreign savings – when foreign investments
C. Recreation in our country are bigger than our country’s
D. Education investments abroad, we have an investment
E. Others surplus.

SAVING- when the consumer decides not to SAVING FUNCTION – refers to the relationship
spend all or part of his income, he is exercising between savings and income.
his option of saving. The amount that he - Shows the amount of saving that
decides not to spend is regarded as savings. households or a nation will undertake at each
- Is simply a postponement of level of income.
consumption.

REASONS WHY PEOPLE SAVE:

LESSON 9
SAVING FUNCTION – refers to the relationship between savings and income.
- Shows the amount of saving that households or a nation will undertake at each level of income.

AVERAGE PROPENSITY TO CONSUME (APC) – refers to the proportion of income devoted to

consumption
- If APC for the entire economy is to be determined, the total value of expenditure on
consumption of goods and services is divided by the value of national income

THE FORMULA FOR APC = CE/DI

CE = Consumption expenditures
DI = disposable income

INCOME AND APC

DI CE APC
1000 1,500 1.5
1,500 1,800 1.2
2,000 2,200 1.1
2,500 2,500 1.0
3,000 2,800 0.93
3,500 3,100 0.885
4,000 3,300 0.825

AVERAGE PROPENSITY TO SAVE (APS) – is the proportion of income (of an individual or the whole
economy) which is not spent on consumption of goods and services.

THE FORMULA FOR APS = S/DI

S = Savings
DI = Disposable income

INCOME AND APS

DI S APS
1,000 -500 -0.5
1,500 -300 -0.2
2,000 -200 -0.1
2,500 0 0
3,000 200 0.066
3,500 400 0.11
4,000 700 0.175
MARGINAL PROPENSITY TO CONSUME (MPC) – refers to the proportion of a small increase in income
which will be devoted to increased consumption expenditure.

FORMULA FOR MPC

Change in consumption/change in disposable income

Ex. IF disposable income increased to P1,500 billion from P1,000 billion and consumption to P1,800
billion from P1,500 billion, MPC is calculated as follows:

MPC = P1,800 billion – P1,500 billion

1,500 billion – P1,000 billion
= 300/500
=0.60

MPC AND INCOME

DISPOSABLE CONSUMPTION CHANGE IN CHANGE IN MPC

INCOME EXPENDITURES INCOME CONSUMPTION
1,000 1,500
1,500 1,800 500 300 .60
2,000 2,200 500 400 .80
2,500 2,500 500 300 .60
3,000 2,800 500 300 .60
3,500 3,100 500 300 .60
4,000 3,300 500 200 .40

MARGINAL PROPENSITY TO SAVE (MPS)- is the proportion of an increase in income that is saved.

THOSE WHO RECEIVE ADDITIONAL INCOMES HAVE 3 OPTIONS DEPENDING ON CERTAIN FACTORS.
1. To spend the entire amount of consumption.
2. To save the entire amount.
3. To spend a part for consumption and to save the remaining amount.
FORMULA FOR MPS
Change in savings/change in disposable income
Ex. IF disposable income increased from P1,000 billion to 1,500 billion and dissavings decreased from
P500 billion to P300 billion. MPS is calculated as

MPS = (-300 billion) – (-500 billion)

1,500 billion – P1,000 billion
= 200/500
=0.40

MPS AND INCOME

DISPOSABLE SAVINGS CHANGE IN CHANGE IN MPS

INCOME INCOME SAVINGS (CS/CDI)
1,000 -500
1,500 -300 500 200 0.40
2,000 -200 500 100 0.20
2,500 0 500 200 0.40
3,000 200 500 200 0.40
3,500 400 500 200 0.40
4,000 700 500 300 0.60
Lesson 10 PRICE LEVEL
DETERMINANTS OF THE LEVEL OF The prices of goods and services
CONSUMPTION sometimes move upward and sometimes
1. Distribution of national income downward. Where there is an increase in the
2. Rate of interest price level, consumption tends to decrease, and
3. The desire to hold cash when there is a decrease, consumption tends to
4. Price levels increase.
5. Population
6. Income POPULATION
7. Taxes When everything is equal, a bigger
8. Attitudes and values number of people will consume more than a
smaller number of people. When a country’s
DISTRIBUTION OF NATIONAL INCOME population is increasing, it is expected that
When a large portion of the national consumption will also increase.
income goes to a small segment of the entire
population, there is an uneven distribution of INCOME
purchasing power. The consumption needs of Income is regarded as a major factor in
that privileged segment are limited and these consumption. People with higher incomes tend
affect the total consumption for the economy. to consume more than those with lower
The small income of the less privileged incomes.
segments of society severely limits their
consumption. On the contrary, total TAXES
consumption will tend to be larger if national Taxes reduce the money available for
income is evenly distributed. consumption. Less taxes means more money for
consumption and more taxes means less money
RATE OF INTEREST for consumption.
When interest rates are high, people
are motivated to save more and thus, to ATTITUDES AND VALUES
consume less. However, when interest rates are People’s attitudes and values differ.
lower than the earning capacity of some assets, These reflect on their consumption
these assets are acquired thereby reducing expenditures. Ex. Some people consider
savings. grooming as very important and must take
precedence over other concerns.
DESIRE TO HOLD CASH
Some persons anticipate future needs
that will require some amounts of cash.
Because of this, they will hold on to whatever
cash they have; and if this is not enough, save a
part of their current incomes.