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Consumer Behavior

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

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  1. Chapter 7 Consumer Behavior

  2. 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

  3. Utility • Diminishing marginal utility (again) • Satisfaction obtained from consumption • Three characteristics • Differs from usefulness • Subjective • Difficult to quantify 7-3

  4. 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

  5. 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

  6. Theory of Consumer Behavior • Key dimensions of the consumer problem • Rational behavior • Preferences • Budget constraint • Prices 7-6

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. Behavioral Economics • Human instinct for variety • Consume more when there is more variety • M&Ms • Time inconsistency • Final exams • Retirement savings 7-16

  17. 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

  18. Next Chapter Preview… The Costs of Production 7-18

  19. 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

  20. 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

  21. 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

  22. 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

  23. Appendix Key Terms • Budget Line • Indifference curve • Marginal rate of substitution (MRS) • Indifference map • Equilibrium position 7-23

  24. Next Chapter Preview… The Costs of Production 7-24

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