Chapter 7
Consumer
Behavior
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
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
• Diminishing marginal utility
(again)
• Satisfaction obtained from
consumption
• Three characteristics
–Differs from usefulness
–Subjective
–Difficult to quantify
7-3
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
(1)
(2)
(3)
Tacos
Total Marginal
Consumed Utility, Utility,
Per Meal Utils
Utils
2
3
4
5
6
7
0
10
18
24
]
]
]
]
28
]
30
]
30
]
28
10
8
4
2
0
-2
30
TU
20
10
0
6
Marginal Utility (Utils)
0
1
Total Utility (Utils)
Total Utility
1
2
3
4
5
6
Units Consumed Per Meal
7
Marginal Utility
10
8
6
4
2
0
-2
MU
1
2
3
4
5
6
Units Consumed Per Meal
7
7-5
Theory of Consumer Behavior
• Key dimensions of the consumer
problem
–Rational behavior
–Preferences
–Budget constraint
–Prices
7-6
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
Combinations of apples and oranges obtainable
with an income of $10
(1)
Unit of
Product
(2)
Apple (product A)
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
Orange (product B)
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
First
10
10
24
Second
8
8
20
Third
7
7
18
Compare
marginal
utilities
Fourth
6
6
16
Then
- MU/Price
Fifth compare
5 per dollar
5
12
Choose
the highest
Sixth
4
4
6
Check
to next4 item
Seventh budget
3 - proceed
3
12
10
9
8
6
3
2
7-8
Numerical Example
Combinations of apples and oranges obtainable
with an income of $10
(1)
Unit of
Product
(2)
Apple (product A)
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
First
10
10
Second
8
8
Third
7
7
Again,
compare
per dollar
Fourth
6
6
Choose
the highest
Fifth
5
5
Buy
– budget
Sixth one of each
4
4
Proceed
to next
item3
Seventh
3
(3)
Orange (product B)
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
24
12
20
10
18
9
- MU/Price
16
8
12
6
has $5
6 left
3
4
2
7-9
Numerical Example
Combinations of apples and oranges obtainable
with an income of $10
(1)
Unit of
Product
(2)
Apple (product A)
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
Orange (product B)
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Fourth
6
6
16
8
Again,
compare
per dollar
- MU/Price
Fifth
5
5
12
6
Buy
Sixth one more
4 orange
4 – budget
6 has $3 3left
Proceed
to next
item3
Seventh
3
4
2 7-10
Numerical Example
Combinations of apples and oranges obtainable
with an income of $10
(1)
Unit of
Product
(2)
Apple (product A)
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
Orange (product B)
Price = $2
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar
(MU/Price)
First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Fourth
6
6
16
8
Fifth
5
5
12
6
Again,
compare
per dollar
- MU/Price
Sixth
4
4
6
3
Buy
one of each
– budget
exhausted
Seventh
3
3
4
2
7-11
Numerical Example
Combinations of apples and oranges obtainable
with an income of $10
(2)
Apple (product A)
Price = $1
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(3)
Orange (product B)
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
First
10
10
24
12
Second
8
8
20
10
Third
7
7
18
9
Fourth
6
6
16
8
Fifth
5
12
6
Final
result5 – at these
prices,
Sixth
4
4
6
3
purchase
23 apples3 and 4 oranges
Seventh
4
2
7-12
Algebraic Generalization
MU of product A
price of A
8 Utils
$1
=
=
MU of product B
price of B
16 Utils
$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
Price Per Quantity
Unit of B Demanded
$2
4
1
6
Price of Product B
2
1
Income Effects
DB
0
Substitution Effects
4
6
Quantity Demanded of B
7-14
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
• Human instinct for variety
• Consume more when there
is more variety
–M&Ms
• Time inconsistency
–Final exams
–Retirement savings
7-16
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…
The Costs of
Production
7-18
The Budget Line
–Income changes
–Price changes
12
Total
(Price = $1.50)
(Price = $1)
Expenditure
8
6
4
2
0
0
3
6
9
12
$12
12
12
12
12
10
Quantity of A
Units of A Units of B
Income = $12
PA = $1.50
8
(Unattainable)
6
Income = $12
PB = $1
4
2
0
(Attainable)
2
4
6
8
10
12
Quantity of B
7-19
Indifference Curves
What is preferred
– Downsloping and convex
– Marginal rate of substitution
12
j
12
2
k
6
4
l
4
6
m
3
8
10
Quantity of A
Combination Units of A Units of B
j
8
k
6
l
4
m
2
0
I
2
4
6
8
10
12
Quantity of B
7-20
Indifference Curve Analysis
• The indifference map
• Equilibrium position at tangency
12
10
Quantity of A
MRS =
8
6
W
X
4
PB
PA
Preferred –
But Requires
More Income
I4
2
0
I3
I1
2
4
6
8
Quantity of B
10
I2
12
7-21
Demand Curve Derived
12
At $1 price for B,
6 units of B are
purchased
Quantity of A
10
8
6
X
4
Record the results
2
I2
Price of B
0
2
4
6
8
10
Quantity of B
12
$1.50
I3
As price of B increases
to $1.50, only 3 units of
B are bought
Record the results
1.00
.50
DB
2
4
6
8
10
Quantity of B
12
Connect the points to
create the demand
curve for B
7-22
Appendix Key Terms
•
•
•
•
•
Budget Line
Indifference curve
Marginal rate of substitution (MRS)
Indifference map
Equilibrium position
7-23
Next Chapter Preview…
The Costs of
Production
7-24