consumer behavior
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Chapter 7. Consumer Behavior. Chapter Objectives. Total utility and marginal utility Law of diminishing marginal utility Marginal utility-to-price ratios Deriving the demand curve Income and substitution effects Appendix: the indifference curve model. 7- 2. Utility. - PowerPoint PPT PresentationTRANSCRIPT
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Consumer Behavior
Chapter 7
Chapter Objectives
• Total utility and marginal utility• Law of diminishing marginal utility• Marginal utility-to-price ratios • Deriving the demand curve • Income and substitution effects • Appendix: the indifference curve
model
7-2
Utility
• Diminishing marginal utility (again)
• Satisfaction obtained from consumption
• Three characteristics–Differs from usefulness–Subjective–Difficult to quantify
7-3
Utility
• Total utility–Total satisfaction from a specific
quantity• Marginal utility
–Extra satisfaction from an additional unit
• Law of diminishing marginal utility –Explains downward sloping
demand7-4
Utility Graphically
0
10
20
30
1086420
-2
1 2 3 4 5 6 7
1 2 3 4 5 6 7
To
tal U
tilit
y (U
tils
)M
arg
inal
Uti
lity
(Uti
ls)
(1)Tacos
ConsumedPer Meal
(2)Total
Utility,Utils
(3)MarginalUtility,Utils
0
1
2
3
4
5
6
7
0
10
18
24
28
30
30
28
]]]]]]]
10
8
6
4
2
0
-2
TU
MU
Total Utility
Marginal Utility
Units Consumed Per Meal
Units Consumed Per Meal
7-5
Theory of Consumer Behavior
• Key dimensions of the consumer problem–Rational behavior–Preferences –Budget constraint–Prices
7-6
Theory of Consumer Behavior
• Find utility maximizing combination of goods
• Utility maximizing rule–Allocate income–Last dollar spent on each
good yields same marginal utility
–Marginal utility per dollar
7-7
Numerical ExampleCombinations of apples and oranges obtainable with an income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Apple (product A)
Price = $1
(3)Orange (product B)
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Compare marginal utilitiesThen compare per dollar - MU/PriceChoose the highestCheck budget - proceed to next item
7-8
Numerical ExampleCombinations of apples and oranges obtainable with an income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Apple (product A)
Price = $1
(3)Orange (product B)
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Again, compare per dollar - MU/PriceChoose the highestBuy one of each – budget has $5 leftProceed to next item
7-9
Numerical ExampleCombinations of apples and oranges obtainable with an income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Apple (product A)
Price = $1
(3)Orange (product B)
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Again, compare per dollar - MU/PriceBuy one more orange – budget has $3 leftProceed to next item
7-10
Numerical ExampleCombinations of apples and oranges obtainable with an income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Apple (product A)
Price = $1
(3)Orange (product B)
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Again, compare per dollar - MU/PriceBuy one of each – budget exhausted
7-11
Numerical ExampleCombinations of apples and oranges obtainable with an income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Apple (product A)
Price = $1
(3)Orange (product B)
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Final result – at these prices, purchase 2 apples and 4 oranges
7-12
Algebraic Generalization
MU of product A
price of A
MU of product B
price of B=
8 Utils
$1
16 Utils
$2=
Optimum Achieved – Money income is allocated so that the last dollar spent on
each product yields the same extra or marginal utility
7-13
Pri
ce
of
Pro
du
ct
B
0
1
2
4 6
Quantity Demanded of B
Deriving the Demand Curve
$2
1
4
6
Price Per Unit of B
QuantityDemanded
DBIncome Effects
Substitution Effects7-14
Applications and Extensions
• New products increase utility
–iPods
• The diamond-water paradox
• The value of time
• Medical care purchases
• Cash and noncash gifts
7-15
Behavioral Economics
• Human instinct for variety• Consume more when there
is more variety–M&Ms
• Time inconsistency–Final exams–Retirement savings
7-16
Key Terms
• Law of diminishing marginal utility• Utility• Total utility• Marginal utility• Rational behavior• Budget constraint• Utility maximizing rule• Income effect• Substitution effect
7-17
Next Chapter Preview…
The Costs ofProduction
7-18
The Budget Line
–Income changes–Price changes
2 4 6 8 10 12
Qu
anti
ty o
f A
6
8
10
12
4
2
0
Quantity of B
Units of A(Price = $1.50)
Units of B(Price = $1)
TotalExpenditure
8
6
4
2
0
0
3
6
9
12
$12
12
12
12
12(Attainable)
(Unattainable)
Income = $12PA = $1.50
Income = $12PB = $1
7-19
Indifference CurvesWhat is preferred
– Downsloping and convex– Marginal rate of substitution
2 4 6 8 10 12
Qu
anti
ty o
f A
6
8
10
12
4
2
0
Quantity of B
Combination Units of A Units of B
j
k
l
m
12
6
4
3
2
4
6
8
j
k
lm
I
7-20
Indifference Curve Analysis• The indifference map• Equilibrium position at tangency
2 4 6 8 10 12
Qu
anti
ty o
f A
6
8
10
12
4
2
0
Quantity of B
I1
I2
I3
I4
X
WPreferred – But RequiresMore Income
MRS = PB
PA
7-21
Demand Curve Derived
Pri
ce o
f B
$1.50
1.00
.50
2 4 6 8 10 12Quantity of B
X
2 4 6 8 10 12
Qu
anti
ty o
f A
6
8
10
12
4
2
0
Quantity of B
I2
I3
DB
At $1 price for B, 6 units of B are purchased
Record the results
As price of B increases to $1.50, only 3 units of B are bought
Record the results
Connect the points tocreate the demand curve for B 7-22
Appendix Key Terms
• Budget Line
• Indifference curve
• Marginal rate of substitution (MRS)
• Indifference map
• Equilibrium position
7-23
Next Chapter Preview…
The Costs ofProduction
7-24