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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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slide1

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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