copyright 2011the mcgraw-hill companies 5-1 law of diminishing marginal utility theory of consumer...
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Copyright 2011The McGraw-Hill Companies5-1
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
5Consumer Behavior and Utility Maximization
Copyright 2011The McGraw-Hill Companies5-2
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Chapter Objectives• Total Utility, Marginal Utility, and the
Law of Diminishing Marginal Utility• How Rational Consumers Compare
Marginal Utility-to-Price Ratios for Products in Purchasing Combinations to Maximize Total Utility
• How to Derive the Demand Curve by Observing Behavior
• How the Utility-Maximization Model Highlights Income and Substitution Effects of a Price Change
• Budget Lines, Indifference Curves, Utility Maximization, and Demand Derivation in the Indifference Curve Model of Consumer Behavior
Copyright 2011The McGraw-Hill Companies5-3
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Law of Diminishing Marginal Utility
• Terminology–Utility–Total Utility–Marginal Utility
• Marginal Utility and Demand
Graphically…
5.1
5.1
Copyright 2011The McGraw-Hill Companies5-4
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Law of Diminishing Marginal Utility
0
10
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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
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]]]]]]]
10
8
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2
0
-2
TR
MU
Total Utility
Marginal Utility
Units Consumed Per Meal
Units Consumed Per Meal
Copyright 2011The McGraw-Hill Companies5-5
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Theory of Consumer Behavior• Consumer Choice and
Budget Constraint–Rational Behavior–Preferences–Budget Constraint–Prices
• Utility Maximizing Rule–Allocate Money Income so
that Last Dollar Spent on Each Product Yields the Same Marginal Utility
Copyright 2011The McGraw-Hill Companies5-6
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = R1
(3)Product B:Price = R2
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
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8
6
3
2
Compare Marginal UtilitiesThen Compare Per Dollar - MU/PriceChoose the HighestCheck Budget - Proceed to Next Item
Copyright 2011The McGraw-Hill Companies5-7
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = R1
(3)Product B:Price = R2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
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5
4
3
12
10
9
8
6
3
2
Again, Compare Per Dollar - MU/PriceChoose the HighestBuy One of Each – Budget Has R5 LeftProceed to Next Item
Copyright 2011The McGraw-Hill Companies5-8
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = R1
(3)Product B:Price = R2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
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12
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5
4
3
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3
2
Again, Compare Per Dollar - MU/PriceBuy One More B – Budget Has R3 LeftProceed to Next Item
Copyright 2011The McGraw-Hill Companies5-9
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = R1
(3)Product B:Price = R2
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
Copyright 2011The McGraw-Hill Companies5-10
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = R1
(3)Product B:Price = R2
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 of Item A and 4 of B 5.1
Copyright 2011The McGraw-Hill Companies5-11
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Theory of Consumer BehaviorAlgebraic Restatement:
MU of Product A
Price of A
MU of Product B
Price of B=
8 Utils
R1
16 Utils
R2=
Optimum Achieved - Money Income is Allocated so that the Last Dollar Spent on Each Product Yields the
Same Extra or Marginal Utility
Copyright 2011The McGraw-Hill Companies5-12
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Pri
ce
of
Pro
du
ct
B
0
1
2
4 6
Quantity Demanded of B
Deriving the Demand CurveSame Numeric Example:
R2
1
4
6
Price Per Unit of B
QuantityDemanded
DBIncome Effects
Substitution Effects5.2
Copyright 2011The McGraw-Hill Companies5-13
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Applications and Extensions
• DVDs and DVD Players
• The Diamond-Water
Paradox
• The Value of Time
5.3
Copyright 2011The McGraw-Hill Companies5-14
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Indifference Curve Analysis• Budget Line (Constraint)
–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 = R1.50)
Units of B(Price = R1)
TotalExpenditure
8
6
4
2
0
0
3
6
9
12
R12
12
12
12
12(Attainable)
(Unattainable)
Income = R12PA = R1.50
Income = R12PB = R1
Appendix
Copyright 2011The McGraw-Hill Companies5-15
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Indifference Curve Analysis• What is Preferred
– Down sloping– Convex to Origin– Marginal Rate of Substitution
(MRS)
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
Appendix
5.4
Copyright 2011The McGraw-Hill Companies5-16
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
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
Appendix
Copyright 2011The McGraw-Hill Companies5-17
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Derivation of the Demand Curve• Measurement of Utility
Pri
ce o
f B
R1.50
1.00
.50
1 2 3 4 5 6 7 8 9 101112Quantity of B
Marginal Utilityof A
Marginal Utilityof B
Price of A Price 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 R1 Price for B, 6 Units are PurchasedRecord the ResultsAs Price of B Increases to R1.50,Only 3 Units of B are BoughtRecord the ResultsConnect the Points toCreate the Demand Curve
Appendix
Copyright 2011The McGraw-Hill Companies5-18
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Criminal Behavior
• Economic Analysis Offers Insights Into Property Crimes Such as Robbery, Burglary, and Auto Theft
• Theory of a Rational Consumer• Buy Versus Steal Decision• Compare Marginal Utility of
Item Versus Costs – Guilt, Fines, or Prison Time
• Crime May Be Reduced by “Increasing” the “Price of Crime”
Last
Word
Copyright 2011The McGraw-Hill Companies5-19
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
Key Terms• law of diminishing marginal utility• utility• total utility• marginal utility• rational behavior• budget constraint• utility-maximizing rule• income effect• substitution effect• budget line• indifference curve• marginal rate of substitution (MRS)• equilibrium position
Copyright 2011The McGraw-Hill Companies5-20
Law of Diminishing Marginal UtilityTheory of Consumer BehaviorDeriving the Demand CurveApplications and ExtensionsBudgetLinesIndifferenceCurvesEquilibriumLast Word
Key Terms
End Show
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The Costs ofProduction