Chapter 5

CONSUMER THEORY

MUV Approach

Value of a good

1. Use value

2. Exchange value

The value of a good

The maximum amount of another good which a person is willing to forgo to obtain it.

Exchange value of a good

The market value of the good.

Different person have different values of a good, depending on:

his wealth and income

prices of other good

how informed the person is, e.g.: his education and experience

Basic assumption of the approach

1. Each individual choose many goods2. For each individual, some good are scare

each has to choose.3. Economic goods are substitutes.4. People have difference tastes and

preference. not all individuals choose the same goods

5. Individuals are consistent.6. Postulate of diminishing MUV

1. Total Use Value (TUV)TUV of good x is measured by the maximum amount of other good that a person is willingly to sacrifice in order to obtain the total unit of good x.

2. Marginal Use Value (MUV)MUV of good x is measured by the maximum amount of another good that a person is willingly to pay for an extra unit of good x.

3. Average use value (AUV)Average use value is the total use value divided by the number of units of a good.

Key Terms

8

The MUV schedule for Sam towards Hamburger

1st 2nd 3rd 4th

MUV $6 $4 $2 $0

TUV $6

AUV $6

Diminishing MUV

$10 $12 $12

$5 $3$4

9

Findings1. The greater the amount of a

good one has, the greater its TUV to the person is.

2. The slope of the TUV schedule

diminishes, reflecting the postulate of diminishing marginal value.

3. TUV is the sum of MUV

4. The value of TUV is maximized when MUV equal to zero.

Q

TUV

0

TUV

a) An TUV schedule

TUV Q = MUV

10

Findings - continue1. Area under the MUV

curve is the TUV of the good.

2. The larger the amount of a good one has , the smaller of other goods one willingly to pay to an additional unit is.

3. The AUV of an unit of good is greater than its MUV

4. The slope of MUV is twice the slope of AUV

Q

TUV

0MUV AUV

b) An AUV schedule

TUV

11

The slope of MUV is twice the slope of AUV

For a straight line MUV curve,TUV is equal to:

MUV = Area DOC

MUV AUV

P

QO

A B

C

D

E

Area DOC = Area ABCDHence, ADE = EBC

AE = EBSlope of MUV= AD AESlope of AUV = AD = AD = 1 MUV AB 2AE 2

As TUV=AUV X Q TUV = Area ABCO

Demand Curve = MUV?An individual Demand shows the relationship between P and Qd, assuming other things being constant.

One can look at an individual demand curve as “the max. price that would be paid for an extra unit of a goods at different amounts.”

Based on this view, we can derive a demand curve of an individual for his or her MUV schedules.

The Demand curve is just the same as MUV

P

Q

75

3 4

Law of Diminishing Use Value

As more of a good a person owns, the amount of its total use value to him but the marginal use value to him .More X TUV

MUVAn individual’s MUV of any goods depends on the amount he has already had.

Consumer equilibrium is at P = D = MUV

Q

P

0

D = MUV

*

Consumer equilibrium

If P > MUV

Qd until P = MUV

If P < MUV

Qd until P = MUV

If p = MUV

consumer equilibrium is attained.

5

10

15

Paradox of Value The things which have the greatest value in use frequently have little or no value in exchange and those which have the greatest value in exchange frequently are have little value in use.

Example Water Vs Diamond. Why?

Form a group and try to explain it by using the concept of TUV & MUV

Consumer Surplus

The concept of consumer surplus was first introduced by Alfred Marshall in 1890. It is defined as the excess of Total Value (or Total Use Value) over the market expenditure (or Total Exchange Value).

Consumer Surplus = TUV – TEV

where TUV = the amount willingly paid.

Where TEV = the amount actually paid.

Since TUV = ΣMUV and TEV = P X Q, the above formula can be rewritten as:

Consumer Surplus = ΣMUV – P X Q

Consumer surplus is the extra amount the consumer is willing to pay over and above what he actually pays, given the quantity demanded.

Total Consumer surplus

Price Quantity Total Exchange

Value

Total Use Value

Total consumer Surplus

$10 1 $10 $10 $0

9 2 18 19 1

8 3 24 27 3

7 4 28 34 6

6 5 30 40 10

5 6 30 45 15

4 7 28 49 21

3 8 24 52 28

2 9 18 54 36

1 10 10 55 45

Demand & Consumer SurplusAt a price of $8, the amount purchased is 3 units.Total Exchange Value is $24(area ODBC). Total Use Value is OABC. Hence the consumer gains a surplus of ADB which is equal to $3.

Q

P

0

D = MUV

8

3

A

B

C

D

20

Paradox of value

P P

MUV=D MUV=DQQ

Even the exchange value or P for water is lower than Diamond,the consumer gains a much larger surplus from water rather than it is from diamond.

21

How to extra the consumer surplus?

Selling in package

You can only choose to buy the entire units or

none of them

$30 for the entire 6 units

All-or-nothing Demand

It shows the maximum amount a consumer is willing to pay for an extra unit of a good. Given that the consumer has to take all of the units at that price or have none of them.

All-or-nothing D is the same as AUV curve

Q

P

0

D = MUV

All-or-nothing demandAUV1 =

P1

P2

Q1

Q2

From the diagram:

If price is at P1

Normally the consumer will buy Q1 of the good.

Under all-or-nothing arrangement:

the consumer has to buy Q2,

Hence, the TUV of the good to the

consumer = AUV1 x Q2

= total exchange value P1 x Q2no consumer surplus Hence, the 2 shaded triangles

are exactly the same.

24

What’s the other way to extra

consumer surplus?

Charges an entrance fee which is equal to

Consumer surplus