The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
8
C HAPTE R
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
Next
Slide
Consumer Behavior and
Utility Maximization
End
Show
8-1
Copyright McGraw-Hill/Irwin, 2005
THE LAW OF DEMAND
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8-2
Next
Slide
A Closer Look…
The Income Effect
A lower price frees income
for additional purchases and vice versa
The Substitution Effect
A lower price relative to other
goods attracts new buyers and vice versa
Copyright McGraw-Hill/Irwin, 2005
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8-3
Next
Slide
LAW OF DIMINISHING
MARGINAL UTILITY
• Utility Defined
• Subjective Nature
• Difficult to Quantify
Total Utility
Marginal Utility
graphically examined...
Copyright McGraw-Hill/Irwin, 2005
TOTAL AND MARGINAL UTILITY
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
0
1
0
10
30
Total Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
Utility Maximization
and the Demand
Curve
10
0
Marginal Utility (utils)
Applications and
Extensions
Key Terms
Previous
Slide
20
Next
Slide
End
Show
1
Copyright McGraw-Hill/Irwin, 2005
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
1
8-4
2
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
0
1
0
10
10
30
Total Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
Utility Maximization
and the Demand
Curve
10
0
Marginal Utility (utils)
Applications and
Extensions
Key Terms
Previous
Slide
20
Next
Slide
End
Show
1
Copyright McGraw-Hill/Irwin, 2005
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
1
8-5
2
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
0
1
2
0
10
18
20
10
0
Marginal Utility (utils)
Applications and
Extensions
Key Terms
Previous
Slide
10
8
30
Total Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
Next
Slide
End
Show
1
Copyright McGraw-Hill/Irwin, 2005
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
1
8-6
2
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
0
1
2
3
0
10
18
24
Key Terms
Previous
Slide
Next
Slide
End
Show
20
10
0
Marginal Utility (utils)
Applications and
Extensions
10
8
6
30
Total Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
1
Copyright McGraw-Hill/Irwin, 2005
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
1
8-7
2
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
0
1
2
3
4
0
10
18
24
28
Key Terms
Previous
Slide
Next
Slide
End
Show
10
8
6
4
Total Utility (utils)
Law of Diminishing
Marginal Utility
30
20
10
0
Marginal Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
1
Copyright McGraw-Hill/Irwin, 2005
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
1
8-8
2
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
0
1
2
3
4
5
0
10
18
24
28
30
Next
Slide
End
Show
10
8
6
4
2
Total Utility (utils)
Law of Diminishing
Marginal Utility
30
20
10
0
Marginal Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
1
Copyright McGraw-Hill/Irwin, 2005
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
1
8-9
2
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 10
Next
Slide
0
1
2
3
4
5
6
0
10
18
24
28
30
30
10
8
6
4
2
0
Total Utility (utils)
Law of Diminishing
Marginal Utility
30
20
10
0
Marginal Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
1
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
1
Copyright McGraw-Hill/Irwin, 2005
2
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 11
Next
Slide
0
1
2
3
4
5
6
7
0
10
18
24
28
30
30
28
Copyright McGraw-Hill/Irwin, 2005
10
8
6
4
2
0
-2
30
Total Utility (utils)
Law of Diminishing
Marginal Utility
TU
20
10
0
Marginal Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
1
2
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
MU
1
2
3
4
5
6
7
Units consumed per meal
TOTAL AND MARGINAL UTILITY
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 12
Next
Slide
0
1
2
3
4
5
6
7
0
10
18
24
28
30
30
28
Copyright McGraw-Hill/Irwin, 2005
10
8
6
4
2
0
-2
30
Total Utility (utils)
Law of Diminishing
Marginal Utility
TU
20
10
0
Marginal Utility (utils)
The Law of Demand
Tacos
Total Marginal
consumed Utility, Utility,
per meal Utils
Utils
Observe
Diminishing
Marginal
Utility
1
2
3
4
5
6
7
Units consumed per meal
10
8
6
4
2
0
-2
MU
1
2
3
4
5
6
7
Units consumed per meal
THEORY OF CONSUMER BEHAVIOR
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 13
Next
Slide
Consumer Choice and
Budget Constraint
• Rational Behavior
• Clear-Cut Preferences
• Subject to a Budget
Constraint
• Responds to Price
Changes
Copyright McGraw-Hill/Irwin, 2005
THEORY OF CONSUMER BEHAVIOR
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 14
Next
Slide
Utility Maximizing Rule
The consumer’s money
income should be allocated
so that the last dollar spent
on each product yields the
same amount of extra
(marginal) utility.
illustrated...
Copyright McGraw-Hill/Irwin, 2005
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Unit of
product
First
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
10
10
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 15
Next
Slide
How should the $10
income be allocated?
Copyright McGraw-Hill/Irwin, 2005
12
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Unit of
product
First
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
10
10
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
12
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 16
Next
Slide
Examine the two
marginal utilities
Copyright McGraw-Hill/Irwin, 2005
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Unit of
product
First
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
10
10
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
12
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 17
Next
Slide
Examine the two
marginal utilities
…per dollar
Copyright McGraw-Hill/Irwin, 2005
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Unit of
product
First
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
10
10
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
12
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 18
Next
Slide
Decision: Buy 1
Product B for $2
Copyright McGraw-Hill/Irwin, 2005
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 19
Next
Slide
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
10
24
Second 8
8
20
Third
7
7
18
Fourth What
6
6
16
next?
Fifth
5
5
12
Sixth
4
4
6
Seventh 3
3
4
Copyright McGraw-Hill/Irwin, 2005
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 20
Next
Slide
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
10
24
12
Second 8
8
20
10
Third
7
7
18
9
Fourth What
6
6
16
8
next?
Fifth
5
5
12
6
Buy one of each
Sixth
4
4
6
3
Seventh 3
3
4
2
Copyright McGraw-Hill/Irwin, 2005
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 21
Next
Slide
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
10
24
Second 8
8
20
Third
7
7
18
Fourth 6
6
16
and
then...
Fifth
5
5
12
($5
left)
Sixth
4
4
6
Seventh 3
3
4
Copyright McGraw-Hill/Irwin, 2005
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 22
Next
Slide
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
10
Second 8
8
Third
7
7
Fourth 6
6
third
unit
Fifth
5
5
Sixth product
4
4
Seventh 3
3
Copyright McGraw-Hill/Irwin, 2005
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
of12
B 6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 23
Next
Slide
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
Second 8
Third
7
Fourth
6
$3 left...
Fifth
5
Sixth
4
Seventh 3
Copyright McGraw-Hill/Irwin, 2005
10
8
7
6
5
4
3
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 24
Next
Slide
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
10
Second 8
8
Third
7
7
Fourth
6
6
$3 left...
Fifth
5
5
Buy
both!
Sixth
4
4
Seventh 3
3
Copyright McGraw-Hill/Irwin, 2005
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
$ 10 income
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Unit of
product
Product A:
Price = $1
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
First
10
10
Second 8
8
Third
7
7
Income is gone...
the
last dollar 6
spent on
Fourth
6
each good gave the same
Fifth
5
5
utility (8) per dollar
Sixth
4
4
Seventh 3
3
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 25
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
Product B:
Price = $2
Marginal
Marginal utility per
utility,
dollar
utils
(MU/price)
24
20
18
16
12
6
4
12
10
9
8
6
3
2
UTILITY MAXIMIZING COMBINATION
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Algebraic Restatement of the
Utility Maximization Rule
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
MU of product A
Price of A
=
MU of product B
Price of B
Applications and
Extensions
Key Terms
8 Utils
Previous
Slide
End
Show
8 - 26
Next
Slide
$1
Copyright McGraw-Hill/Irwin, 2005
=
16 Utils
$2
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
UTILITY MAXIMIZATION AND
THE DEMAND CURVE
Deriving the Demand Schedule
and Curve
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 27
Given from the previous example schedule:
• Preferences or Tastes
• Money Income
• Prices of Other Goods
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
UTILITY MAXIMIZATION AND
THE DEMAND CURVE
Deriving the Demand Schedule
and Curve
Create a demand schedule from the
purchase decisions as the price of
the product is varied ...
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 28
Next
Slide
Price per unit of B
$2
1
Quantity Demanded
4
6
Graphically…
Copyright McGraw-Hill/Irwin, 2005
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 29
Price per unit of Good B
The Law of Demand
UTILITY MAXIMIZATION AND
THE DEMAND CURVE
Deriving the Demand Schedule
and Curve
$2
1
DB
Next
Slide
0
4
6
Quantity Demanded of Good B
Copyright McGraw-Hill/Irwin, 2005
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 30
Income
and
$2
Substitution Effects
Revisited
1
Price per unit of Good B
The Law of Demand
UTILITY MAXIMIZATION AND
THE DEMAND CURVE
Deriving the Demand Schedule
and Curve
DB
Next
Slide
0
4
6
Quantity Demanded of Good B
Copyright McGraw-Hill/Irwin, 2005
APPLICATIONS AND EXTENSIONS
The Law of Demand
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 31
DVDs and DVD Players
The Diamond-Water
Paradox
The Value of Time
Medical Care Purchases
Cash and Noncash Gifts
Next
Slide
Copyright McGraw-Hill/Irwin, 2005
income effect
substitution effect
utility
total utility
marginal utility
law of diminishing marginal utility
rational behavior
budget constraint
utility-maximizing rule
Copyright McGraw-Hill/Irwin, 2005
BACK
END
The Law of Demand
Law of Diminishing
Marginal Utility
Next…
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Previous
Slide
End
Show
8 - 33
Next
Slide
Indifference Curve Analysis
Copyright McGraw-Hill/Irwin, 2005