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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.

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Consumer behavior

Chapter 7

Consumer Behavior


Chapter objectives

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

Utility

  • Diminishing marginal utility (again)

  • Satisfaction obtained from consumption

  • Three characteristics

    • Differs from usefulness

    • Subjective

    • Difficult to quantify

7-3


Utility1

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 demand

7-4


Utility graphically

Utility Graphically

30

20

Total Utility (Utils)

]

]

]

]

]

]

]

10

0

1

1

2

2

3

3

4

4

5

5

6

6

7

7

10

8

6

Marginal Utility (Utils)

4

2

0

-2

Total Utility

(1)

Tacos

Consumed

Per Meal

(2)

Total

Utility,

Utils

(3)

Marginal

Utility,

Utils

TU

0

10

18

24

28

30

30

28

0

1

2

3

4

5

6

7

10

8

6

4

2

0

-2

Units Consumed Per Meal

Marginal Utility

MU

Units Consumed Per Meal

7-5


Theory of consumer behavior

Theory of Consumer Behavior

  • Key dimensions of the consumer problem

    • Rational behavior

    • Preferences

    • Budget constraint

    • Prices

7-6


Theory of consumer behavior1

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 example

Numerical Example

(2)

Apple (product A)

Price = $1

(3)

Orange (product B)

Price = $2

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(a)

Marginal

Utility,

Utils

(a)

Marginal

Utility,

Utils

First

Second

Third

Fourth

Fifth

Sixth

Seventh

10

8

7

6

5

4

3

10

8

7

6

5

4

3

24

20

18

16

12

6

4

12

10

9

8

6

3

2

Combinations of apples and oranges obtainable with an income of $10

(1)

Unit of

Product

Compare marginal utilities

Then compare per dollar - MU/Price

Choose the highest

Check budget - proceed to next item

7-8


Numerical example1

Numerical Example

(3)

Orange (product B)

Price = $2

(2)

Apple (product A)

Price = $1

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(a)

Marginal

Utility,

Utils

(a)

Marginal

Utility,

Utils

First

Second

Third

Fourth

Fifth

Sixth

Seventh

10

8

7

6

5

4

3

10

8

7

6

5

4

3

24

20

18

16

12

6

4

12

10

9

8

6

3

2

Combinations of apples and oranges obtainable with an income of $10

(1)

Unit of

Product

Again, compare per dollar - MU/Price

Choose the highest

Buy one of each – budget has $5 left

Proceed to next item

7-9


Numerical example2

Numerical Example

(3)

Orange (product B)

Price = $2

(2)

Apple (product A)

Price = $1

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(a)

Marginal

Utility,

Utils

(a)

Marginal

Utility,

Utils

First

Second

Third

Fourth

Fifth

Sixth

Seventh

10

8

7

6

5

4

3

10

8

7

6

5

4

3

24

20

18

16

12

6

4

12

10

9

8

6

3

2

Combinations of apples and oranges obtainable with an income of $10

(1)

Unit of

Product

Again, compare per dollar - MU/Price

Buy one more orange – budget has $3 left

Proceed to next item

7-10


Numerical example3

Numerical Example

(3)

Orange (product B)

Price = $2

(2)

Apple (product A)

Price = $1

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(a)

Marginal

Utility,

Utils

(a)

Marginal

Utility,

Utils

First

Second

Third

Fourth

Fifth

Sixth

Seventh

10

8

7

6

5

4

3

10

8

7

6

5

4

3

24

20

18

16

12

6

4

12

10

9

8

6

3

2

Combinations of apples and oranges obtainable with an income of $10

(1)

Unit of

Product

Again, compare per dollar - MU/Price

Buy one of each – budget exhausted

7-11


Numerical example4

Numerical Example

(2)

Apple (product A)

Price = $1

(3)

Orange (product B)

Price = $2

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(b)

Marginal

Utility

Per Dollar

(MU/Price)

(a)

Marginal

Utility,

Utils

(a)

Marginal

Utility,

Utils

First

Second

Third

Fourth

Fifth

Sixth

Seventh

10

8

7

6

5

4

3

10

8

7

6

5

4

3

24

20

18

16

12

6

4

12

10

9

8

6

3

2

Combinations of apples and oranges obtainable with an income of $10

(1)

Unit of

Product

Final result – at these prices, purchase 2 apples and 4 oranges

7-12


Algebraic generalization

Algebraic Generalization

MU of product B

MU of product A

price of B

price of A

16 Utils

8 Utils

$1

$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


Deriving the demand curve

Deriving the Demand Curve

2

Quantity

Demanded

Price Per

Unit of B

Price of Product B

1

0

4

6

Quantity Demanded of B

4

$2

6

1

Income Effects

Substitution Effects

DB

7-14


Applications and extensions

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

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

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

Next Chapter Preview…

The Costs of

Production

7-18


The budget line

The Budget Line

12

Total

Expenditure

Units of B

(Price = $1)

Units of A

(Price = $1.50)

10

8

Quantity of A

6

4

2

0

2

4

6

8

10

12

Income = $12

Quantity of B

PA= $1.50

Income = $12

PB= $1

  • Income changes

  • Price changes

0

3

6

9

12

8

6

4

2

0

(Unattainable)

$12

12

12

12

12

(Attainable)

7-19


Indifference curves

Indifference Curves

12

10

Combination

Units of A

Units of B

8

Quantity of A

6

4

2

0

2

4

6

8

10

12

Quantity of B

What is preferred

  • Downsloping and convex

  • Marginal rate of substitution

j

j

k

l

m

12

6

4

3

2

4

6

8

k

l

m

I

7-20


Indifference curve analysis

Indifference Curve Analysis

MRS =

12

10

8

Quantity of A

6

4

PB

2

PA

0

2

4

6

8

10

12

Quantity of B

  • The indifference map

  • Equilibrium position at tangency

Preferred –

But Requires

More Income

W

X

I4

I3

I2

I1

7-21


Demand curve derived

Demand Curve Derived

12

10

8

Quantity of A

6

X

4

2

I3

I2

0

2

4

6

8

10

12

Quantity of B

$1.50

1.00

.50

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 to

create the demand curve for B

Price of B

DB

2

4

6

8

10

12

Quantity of B

7-22


Appendix key terms

Appendix Key Terms

  • Budget Line

  • Indifference curve

  • Marginal rate of substitution (MRS)

  • Indifference map

  • Equilibrium position

7-23


Next chapter preview1

Next Chapter Preview…

The Costs of

Production

7-24


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