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Consumer Behavior and Utility Maximization

19. Consumer Behavior and Utility Maximization. Click to Link to Appendix 19: Indifference Curve Analysis. Chapter Objectives. Total Utility, Marginal Utility, and the Law of Diminishing Marginal Utility

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Consumer Behavior and Utility Maximization

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  1. 19 Consumer Behavior and Utility Maximization Click to Link to Appendix 19: Indifference Curve Analysis

  2. 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

  3. G 19.1 O 19.1 Law of Diminishing Marginal Utility • Terminology • Utility • Total Utility • Marginal Utility • Marginal Utility and Demand Graphically…

  4. 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 Law of Diminishing Marginal Utility Total Utility (1) Tacos Consumed Per Meal (2) Total Utility, Utils (3) Marginal Utility, Utils TR 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

  5. 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

  6. (3) Product B: Price = $2 (2) 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 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B 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. (3) Product B: Price = $2 (2) 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 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B 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

  8. (3) Product B: Price = $2 (2) 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 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Again, Compare Per Dollar - MU/Price Buy One More B – Budget Has $3 Left Proceed to Next Item

  9. (3) Product B: Price = $2 (2) 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 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Again, Compare Per Dollar - MU/Price Buy One of Each – Budget Exhausted

  10. (3) Product B: Price = $2 (2) Product A: Price = $1 (b) Marginal Utility Per Dollar (MU/Price) (b) Marginal Utility Per Dollar (MU/Price) W 19.1 (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 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Final Result – At These Prices, Purchase 2 of Item A and4 of B

  11. MU of Product B MU of Product A Price of B Price of A 16 Utils 8 Utils $1 $2 Theory of Consumer Behavior Algebraic Restatement: = = Optimum Achieved - Money Income is Allocated so that the Last Dollar Spent on Each Product Yields the Same Extra or Marginal Utility

  12. O 19.2 2 Quantity Demanded Price Per Unit of B Price of Product B 1 0 4 6 Quantity Demanded of B Deriving the Demand Curve Same Numeric Example: 4 $2 6 1 Income Effects Substitution Effects DB

  13. O 19.3 Applications and Extensions • DVDs and DVD Players • The Diamond-Water Paradox • The Value of Time • Medical Care Purchases • Cash and Noncash Gifts

  14. Criminal Behavior Last Word • 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”

  15. law of diminishing marginal utility utility total utility marginal utility rational behavior budget constraint utility-maximizing rule income effect substitution effect Key Terms

  16. Next Chapter Preview… The Costs of Production Chapter 20! Click to Link to Appendix 19: Indifference Curve Analysis

  17. 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 Return to Chapter 19 Indifference Curve Analysis • Budget Line (Constraint) • Income Changes • Price Changes Appendix 0 3 6 9 12 8 6 4 2 0 (Unattainable) $12 12 12 12 12 Indifference Curve Analysis Demand Curve Appendix Terms (Attainable)

  18. O 19.4 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 Return to Chapter 19 Indifference Curve Analysis • What is Preferred • Downsloping • Convex to Origin • Marginal Rate of Substitution (MRS) Appendix j j k l m 12 6 4 3 2 4 6 8 k l m Indifference Curve Analysis Demand Curve Appendix Terms I

  19. MRS = 12 10 8 Quantity of A 6 4 PB 2 PA 0 2 4 6 8 10 12 Quantity of B Return to Chapter 19 Indifference Curve Analysis • The Indifference Map • Equilibrium Position at Tangency Appendix Preferred – But Requires More Income W X Indifference Curve Analysis Demand Curve Appendix Terms I4 I3 I2 I1

  20. 12 Marginal Utility of B Marginal Utility of A 10 = 8 Price of B Price of A Quantity of A 6 X 4 2 I3 I2 0 2 4 6 8 10 12 Quantity of B $1.50 Price of B 1.00 .50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of B Return to Chapter 19 Derivation of the Demand Curve • Measurement of Utility Appendix At $1 Price for B, 6 Units 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 Indifference Curve Analysis Demand Curve Appendix Terms DB

  21. Return to Chapter 19 Appendix Key Terms • budget line • indifference curve • marginal rate of substitution (MRS) • indifference map • equilibrium position Appendix Indifference Curve Analysis Demand Curve Appendix Terms

  22. Return to Chapter 19 Next Chapter Preview… The Costs of Production Chapter 20! Indifference Curve Analysis Demand Curve Appendix Terms

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