Consumer Behavior, Utility
Maximization, Indifference Curves
Income Effect

Impact Δ price of product has on
real income/purchasing power
(real vs. nominal) and therefore on
quantity demanded


Inflation/deflation
Objective measure: true regardless
of changes in other goods
Substitution Effect


Impact Δ price product on relative
expensiveness and therefore QD
Subjective measure: inoperative if
everything else gets more
expensive too
Law of Diminishing Marginal Utility




Utility: want-satisfying power
1) not usefulness; 2) subjective; 3)
but quantifiable: utils
Total utility vs. marginal utility
Helps explain demand curve (have
to cut prices to sell more as MU
diminishes) and elasticity (how
quickly MU diminishes: fast=
inelastic, slower = elastic)
Theory of Consumer Behavior




1) Rational: maximize total utility
2) Preferences: good idea of
marginal utility
3) Budget restraint: finite resources
+ therefore income
4) Prices: product prices not
affected by amount individual buys
(unlike Bootie Beer stocks)
Utility-Maximizing Rule

“The consumer should allocate
his/her money income so that the
last dollar spent on each product
yields the same amount of marginal
utility” “balance the margins”
equilibrium, ceteris paribus
Units
A: price =$1;B: price =$2; Income $10
A: MU
A: MU/$ B: MU
B: MU/$
1
10
10
24
12
2
8
8
20
10
3
7
7
18
9
4
6
6
16
8
5
5
5
12
6
Algebra

MU A/$A = MUB/$B
Indifference Curves



Budget line: a schedule or curve that
shows various combinations of two
products a consumer can purchase with
a specific money income
Income Δ Δ curve (up right; down
left)
Price Δ: if both Δ shift; if one slope Δ
Unattainable
Attainable
(inefficient)
Attainable
(efficient)
Indifference Curve

IC: Shows all combinations of two products A
and B which will yield the same total
satisfaction/utility to a consumer



Gets same utility from any combination, so indifferent
to which combination
Downsloping: more of one means less of the
other
Convex to origin: diminishing slope as move
down marginal rate of substitution:
willingness to substitute B for A diminishes as
move down curve: as amount of B increase, MU
of B decreases while as quantity A decreases
MU of A increases (and vice versa)
Indifference Map
Perfect Substitutes
Perfect Complements (l+r shoes)
Equilibrium position: intersection
budget line and highest indifference
curve
Difference Marginal Utility Theory and
Indifference Curve Theory



MUT requires consumer knows MU
ICT requires only that knows that
different combination generates
more or less satisfaction but not
how much more/less
Nevertheless, at equilibrium Pb/Pa=
MUb/MUa so both give same result
Deriving a Demand Curve from the
Indifference Curve