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BBEK1103
Principle of Microeconomics
Table of Contents
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BBEK1103 Principle Of Microeconomics
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BBEK1103 Principle Of Microeconomics
constraint income. The higher the price willing to be paid, the high the level of satisfaction. For
example, eating a KFC Snack Plate will give 8 util, while KFC 6 piece Nugget will give 6 util.
The KFC Snack Plate gives 2 extra unit of utility compared to KFC 6 piece Nugget. Therefore,
the consumer will buy the KFC Snack Plate even if the price is higher. The most convenient way
to measure utility is by money. Thus utility can be measured quantitatively in monetary units or
cardinal units.
Marginal Utility (MU) can be defined as the increased in the total utility when consumption
increases by 1 unit. Marginal utility (MU) is the addition to the total utility derived from the
consumption of one additional unit. For example, when a consumer consumes one KFC Snack
Plate, he gets total utility equal to 8 utils. By consuming second KFC Snack Plate, total utility
becomes 15 utils. Therefore the marginal utility of the second KFC Snack Plate is 7 utils i.e 15-8.
The marginal utility can be calculated by using the formula below:
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BBEK1103 Principle Of Microeconomics
The Table 1.0 below shows the relationship between Total Utility and Marginal Utility based on
the consumption of KFC Snack Plate when the consumer is hungry.
26 24 25 25
24 22
22
19
20
18
Total Utility, (TU)
15
16
14
12
10 8
8
6
4
2
0
0 1 2 3 4 5 6 7
Quantity, (Q)
Figure 1.0.1
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BBEK1103 Principle Of Microeconomics
Figure 1.0.1 is the illustration of the total utility derived from Table 1.0. In this figure, we can
observed that as the quantity increases, the total utility also increases until the total utility reaches
constant. This is because when marginal utility is zero, total utility is the maximum. Total utility
generally remains positive and marginal utility can be positive, zero or even negative. The Figure
1.0.2 below is the illustration of the marginal utility derived from Table 1.0. In this figure below,
we can observe that the marginal utility decreases as the quantity increases. When marginal
utility is positive, total utility rises. When marginal utility is negative, total utility falls.
9
8
8
7
7
Marginal Utility, (MU)
5
4
4
3
3
2
2
1
1
0
0
0 1 2 3 4 5 6 7 8
Quantity, (Q)
Figure 1.0.2
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BBEK1103 Principle Of Microeconomics
consumer do not want any more KFC Snack Plate. This is because when the saturation point is
reached, the marginal utility of a commodity becomes zero. Thus, as the quantity of the
consumption of KFC Snack Plate increases, the marginal utility decreases. The second point
states that the different commodities are not a perfect substitutes for each other. This means that
when a consumer eat more and more units of KFC Snack Plate, the intensity of his particular
desire for the KFC Snack Plate diminishes.
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BBEK1103 Principle Of Microeconomics
Indifference Curve
The Indifference Curve was invented by Francis Ysidro Edgeworth. The indifference curve can
be defined as the locus point of all the combination of two products that produces the same level
of satisfaction or utility to the consumer. When choice involves only two products, which is KFC
Snack Plate and KFC 6 piece Nugget, an indifference curve will show various combination of
KFCs Snack Plate and 6 piece Nugget that can give the equal satisfaction or utility to the
consumer.
Various Combinations
Utility
Combinations Unit of KFCs Snack Plate Unit of KFCs 6 piece Nugget
A. 7 1 40u
B. 3 2 40u
C. 2 4 40u
Table 2.0
8
Combo A (1,7)
7
6
KFC's Snack Plate
4
Combo B (2,3)
3
Combo C (4,2)
2
0
0 1 2 3 4 5
KFC's 6 piece Nugget
Figure 2.1
The Table 2.0 above shows various combination of the products that will yield the same amount
of utility. The point mark on Figure 2.1 graph shows the equivalent amount of utility.
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BBEK1103 Principle Of Microeconomics
When you have various group of combinations that will yield to various amount of utility, if you
connect them and build a set of indifference curve on the same graph, you have already formed
an indifference map. It consist of a series or group of curves showing various level of satisfaction
or utility of the consumers. The higher the indifference curve is from the original position, then
the higher the utility is. For example, the curve KFC3 in Figure 2.2 gives a higher level of
satisfaction compared to curve KFC1 and KFC2. The same as curve KFC2, the lower the curve
from the original position, the lower the utility.
KFCs Snack Plate
KFC3
KFC1
KFC2
Figure 2.0
(a) Assumptions
There are a few assumptions that will be used to ensure an accurate consumer analysis:
(i) Every combination of product KFCs Snack Plate and KFCs 6 piece Nugget must
be on the same in indifference curve.
(ii) An indifference curve has a negative gradient because you must obtain more of
product KFCs 6 piece Nugget if you give up a part of KFCs Snack Plate to
ensure satisfaction remains unchanged.
(iii) A higher indifference curve is preferred as it represents more consumption.
(iv) The indifference curve can never intersect as each curve on the indifference map
represents different combinations with different level of satisfaction.
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BBEK1103 Principle Of Microeconomics
Example:
Gradient at Combo B
= 6
73
= 21
=-4
Thus, the gradient of the indifference curve has a -4 gradient which is referred to as
marginal rate of substitution of KFCs Snack Plate and KFCs 6 piece Nugget [MRSXY =
-( /) ]. This gradient indicates the rate where the consumer is willing to give up
KFCs Snack Plate to obtain an additional unit of KFCs 6 piece Nugget with the utility
remaining unchanged.
Budget Line
The Budget Line can be defined by a curve that shows the combinations of two products that can
be purchased by consumer using a certain amount of income and based on the market price of
the product.
For example, lets assume the income of consumer is Income (I) = 80,
The Price of KFCs Snack Plate (Y) = RM 10
The Price of KFCs 6 piece Nugget(X) = RM 5
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BBEK1103 Principle Of Microeconomics
Various Combinations
Income, (I)
Combinations Unit of KFCs Snack Plate, (Y) Unit of KFCs 6 piece Nugget, (X)
A 8 0 80
B 6 4 80
C 4 8 80
D 2 12 80
E 0 16 80
Table 3.0
Budget Line Y = Px x X + Py x Y
9
Combo A
8
7
Combo B
6
KFC'S Snack Plate
5
Combo C
4
3
Combo D
2
1
Combo E
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
KFC's 12 piece Nugget
Figure 3.1
The slope of the budget line indicates how many unit of KFCs Snack Plate the consumer
must give up to buy one more unit of KFCs 6 piece Nugget. For example, the slope at Combo B
on the budget line is /.
I = Px x X + Py x Y
Slope of Budget Line = = 6 =
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If the consumer spends all his money on KFCs Snack Plate, he will obtain 8 units of it;
and if the consumer spends all money on KFCs 6 piece Nugget, he will obtain 16 units of it. The
consumer can use any combination as long the combination satisfy the rule I = PxX + PyY, that is
income (I) is equivalent to the total expenditure (PxX + PyY).
16
8
KFCs Snack Plate
16 32
KFCs 6 piece Nugget
Figure 3.2
Lets assume that the price of one product changes, but the income of the consumer and
price of other product is held constant. For instance, there is a fall in the price of KFCs
Snack Plate, the consumer will purchase more of that particular product than before. A
price change can cause the budget line to rotate. This is because the equation is changed.
From, I = PxX + PyY
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BBEK1103 Principle Of Microeconomics
Y=
Since Px/Py is the gradient of the budget line, if either one of the price changes, the
gradient of the curve will also change.
A
8 8
A
A A
16 X 16 X
Figure 3.3
Lets assume that initially, the price of KFCs 6 piece Nugget is RM 5 and price of KFCs Snack
Plate is RM 10, and income is RM 80, the budget line AA line in Figure 3.3(a). When the price
of KFCs Snack Plate drops to RM 5, the slope becomes steeper (AA). This indicates that more
KFCs Snack Plate can be bought with the available income. In Figure 3.3(b) shows that when
the price is increased to RM 20, the slope becomes shallow (AA). This indicates that less
KFCs Snack Plate can be bought with the available income. There are no changes in the X-axis
of both as the price of KFCs 6 piece Nugget remained unchanged.
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BBEK1103 Principle Of Microeconomics
Consumer Equilibrium
Consumer Equilibrium under Cardinal Utility
A consumer equilibrium is achieved when a consumer reaches his maximum satisfaction level
when the last unit of money spent on each product that yields the same utility. In Cardinal
Utility, there are consumption equilibrium for one good and consumer equilibrium for two goods
or more.
(a) Consumption Equilibrium for one good
One way to gain maximum satisfaction from a limited income is by measuring util in
monetary value. The marginal utility becomes the sum of money in which the consumer
is willing to pay to obtain extra one unit of a product. For example, if the consumer is
willing to pay RM 2 for an additional unit of KFC Snack Plate, then the KFC Snack Plate
has MU = RM 2. Since, it only involves consumption of one product, the consumer will
maximize satisfaction when marginal utility from the consumption of the good is
equivalent to the price (MU = P) because marginal utility indicates the willingness to pay.
Along the demand curve, marginal utility is equivalent to price (MU= P), where the
consumer are at an optimum condition.
Quantity of KFC
Total Utility Marginal Utility Price (RM)
Snack Plate
1 5 5 10
2 11 6 10
3 16 5 10
4 20 4 10
5 23 3 10
6 20 -3 10
Table 4.0
The table above shows total utility, marginal utility and the price for KFC Snack Plate.
From the table above, the consumer has achieved equilibrium at the third unit. This is
because the marginal utility is equivalent to the price.
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BBEK1103 Principle Of Microeconomics
When the consumer obtain particular product free-of-charge, there are no budget
constraint and the consumer will not be restricted by the willingness to pay. Therefore,
the consumer will use the product until maximum total utility is reached which is in the
fifth unit according to the table. If the consumer purchase the sixth unit, he/she will feel
uncomfortable due to excessive consumption.
The above equation indicates that a consumer reaches equilibrium when MU derived
from each Ringgit spent on two products is equal.
The above equation indicates that a consumer is in equilibrium when MU ratio of any
two products equals to the price ratio.
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BBEK1103 Principle Of Microeconomics
C
B
KFC3
KFC1
KFC2
Figure 4.1
Figure 4.1 illustrates the 3 levels of satisfaction represented by 3 indifference curve. According
to the figure, the line that intersect the indifference map is called the budget line. Therefore,
consumers may not choose curve like KFC3 due to budget constraints.
The consumer can choose combination A and C but that point is not optimal as it is a downward
movement along the budget line that may still increase the satisfaction. When point B is
achieved, the consumer has reach equilibrium because after that point the total utility will
decrease. Point B is the equilibrium point where the indifference curve is tangent with the budget
line. Hence, both will have the equal gradient.
=
substitution of KFC Snack Plate and KFC 6 piece Nugget is the amount of ringgit that we are
willing to exchange for one additional unit of KFC 6 piece Nugget. Therefore, in order to
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BBEK1103 Principle Of Microeconomics
maximize the utility, the consumer has to choose the combination of products where the
marginal rate of substitution is equivalent to the relative price.
Summary
In conclusion, we can see how the Cardinal and Ordinal utility theory has influence the
consumer to behave according to the Law of Demand. There are many difference between
Cardinal and Ordinal. The consumer rational thinking, choice and priority is important in
the economy world as there are many business owners compete to win the consumers heart
to buy their products. In the analysis of both theories, we can conclude and see how the
consumer achieve maximum satisfaction from a constrained income. In the ordinal theory,
we could see how the budget line changes when there is a change in the price of goods and
how the consumer chooses and prioritize their needs. As a rational consumer, the consumer
will choose the products which will let the consumer gain more satisfaction from the
consumption of products within their budget because the consumer wants satisfaction from
every single Ringgit and wants the money that he/she spent to be valuable.
(3500 words)
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BBEK1103 Principle Of Microeconomics
Bibiliography
Ahmad Samidi, M., Abdullah, N., Ali, J., & Mohd Mohaideen, Z. (2013). Utility
Analysis. In BBEK1103 Principles of Microeconomics/Microeconomics I (2nd ed.). Seri
Kembangan, Selangor: Meteor Doc. Sdn. Bhd.
Chand, S. (2013, September 19). The Concept of Utility: Its Meaning, Total Utility and
Marginal Utility | Economics. Retrieved November 10, 2015, from
http://www.yourarticlelibrary.com/economics/the-concept-of-utility-its-meaning-total-
utility-and-marginal-utility-economics/8866/
Dwivedi, D. (1985). Theory of Consumer Demand. In Principles of economics (2 ed.).
New Delhi, Delhi: Vani Educational Books.
Dwivedi, D. (2011). Cardinal Utility approach to demand analysis. In Microeconomics I
For University of Delhi. Delhi: Pearson.
Rittenberg, L., & Tregarthen, T. (n.d.). Principles of Microeconomics, v. 1.0. Retrieved
November 12, 2015, from
http://catalog.flatworldknowledge.com/bookhub/21?e=rittenberg-ch07_s02
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