Download Chapter 7

Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
19
Consumer
Behavior and
Utility
Maximization
Click to Link to Appendix 7: Indifference Curve Analysis
7-1
Copyright 2008 The McGraw-Hill Companies
Chapter Objectives
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-2
• 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
Copyright 2008 The McGraw-Hill Companies
Law of Diminishing Marginal
Utility
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
• Terminology
–Utility
–Total Utility
–Marginal Utility
• Marginal Utility and
Demand
Graphically…
Key Terms
End Show
7-3
O 7.1
Copyright 2008 The McGraw-Hill Companies
G 7.1
Law of Diminishing Marginal
Utility
(1)
(2)
(3)
Tacos
Total Marginal
Consumed Utility, Utility,
Per Meal Utils
Utils
0
1
2
3
4
5
6
7
0
10
18
24
]
]
]
]
28
]
30
]
30
]
28
10
8
4
2
0
-2
Key Terms
30
TR
20
10
0
6
Marginal Utility (Utils)
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Total Utility (Utils)
Total Utility
1
3
4
5
6
10
8
6
4
2
0
-2
MU
2
3
4
5
6
Units Consumed Per Meal
7-4
Copyright 2008 The McGraw-Hill Companies
7
Marginal Utility
1
End Show
2
Units Consumed Per Meal
7
Theory of Consumer Behavior
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-5
• 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
Copyright 2008 The McGraw-Hill Companies
Theory of Consumer Behavior
Numerical Example:
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-6
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
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
Compare
Marginal
Utilities
Fourth
6
6
16
8
Then
Compare
Per 5Dollar - MU/Price
Fifth
5
12
6
Choose
the4Highest4
Sixth
6
3
Check
- Proceed
to Next
Item2
Seventh Budget
3
3
4
Copyright 2008 The McGraw-Hill Companies
Theory of Consumer Behavior
Numerical Example:
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-7
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
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
Again,
Compare
Per6 Dollar -16
MU/Price8
Fourth
6
Choose
the5Highest5
Fifth
12
6
Buy
Has
Sixth One of 4Each – Budget
4
6 $5 Left
3
Proceed
to 3Next Item
Seventh
3
4
2
Copyright 2008 The McGraw-Hill Companies
Theory of Consumer Behavior
Numerical Example:
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-8
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
Product B:
Price = $2
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
First
10
10
Second
8
8
Third
7
7
Fourth
6
6
Again,
Compare
Per5 Dollar
Fifth
5
Buy
B – 4Budget
Sixth One More
4
Proceed
to 3Next Item
Seventh
3
Copyright 2008 The McGraw-Hill Companies
24
12
20
10
18
9
16
8
-12
MU/Price6
Has
6 $3 Left
3
4
2
Theory of Consumer Behavior
Numerical Example:
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-9
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
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
5
12
6
Again,
Compare
Per4 Dollar - MU/Price
Sixth
4
6
3
Buy
One of 3Each – 3Budget Exhausted
Seventh
4
2
Copyright 2008 The McGraw-Hill Companies
Theory of Consumer Behavior
Numerical Example:
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-10
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(1)
Unit of
Product
(2)
Product A:
Price = $1
(b)
Marginal
(a)
Marginal
Utility
Utility,
Per Dollar
Utils
(MU/Price)
(3)
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
Result
– At 5These Prices,
Sixth
4
4
6
3
Purchase
2 of Item
Seventh
3
3 A and 44 of B 2W 7.1
Copyright 2008 The McGraw-Hill Companies
Theory of Consumer Behavior
Algebraic Restatement:
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
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
Key Terms
End Show
7-11
Copyright 2008 The McGraw-Hill Companies
Deriving the Demand Curve
Same Numeric Example:
2
Price Per Quantity
Unit of B Demanded
$2
4
1
6
Price of Product B
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
1
Income Effects
Key Terms
DB
0
Substitution Effects
End Show
7-12
Copyright 2008 The McGraw-Hill Companies
4
6
Quantity Demanded of B O 7.2
Applications and Extensions
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
• DVDs and DVD Players
• The Diamond-Water
Paradox
O 7.3
• The Value of Time
• Medical Care Purchases
• Cash and Noncash Gifts
Key Terms
End Show
7-13
Copyright 2008 The McGraw-Hill Companies
Criminal Behavior
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-14
• 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”
Copyright 2008 The McGraw-Hill Companies
Key Terms
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Key Terms
End Show
7-15
• law of diminishing marginal
utility
• utility
• total utility
• marginal utility
• rational behavior
• budget constraint
• utility-maximizing rule
• income effect
• substitution effect
Copyright 2008 The McGraw-Hill Companies
Next Chapter Preview…
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
The Costs of
Production
Key Terms
End Show
Click to Link to Appendix 7: Indifference Curve Analysis
7-16
Copyright 2008 The McGraw-Hill Companies
Indifference Curve Analysis
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Indifference
Curve Analysis
Demand Curve
Appendix Terms
• Budget Line (Constraint)
–Income Changes
–Price Changes
12
Total
Units of A Units of B
(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
Appendix
8
(Unattainable)
6
Income = $12
PB = $1
4
2
0
Key Terms
Income = $12
PA = $1.50
(Attainable)
2
4
6
8
10
12
Quantity of B
End Show
Return to Chapter 7
7-17
Copyright 2008 The McGraw-Hill Companies
Indifference Curve Analysis
• What is Preferred
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Indifference
Curve Analysis
Demand Curve
Appendix Terms
– Downsloping
– Convex to Origin
– Marginal Rate of Substitution
(MRS)
12
j
Combination Units of A Units of B
j
12
2
k
6
4
l
4
6
m
3
8
10
Quantity of A
Appendix
8
l
4
m
2
0
Key Terms
k
6
I
2
4
6
8
10
12
Quantity of B
End Show
O 7.4
Return to Chapter 7
7-18
Copyright 2008 The McGraw-Hill Companies
Indifference Curve Analysis
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
12
10
MRS =
Quantity of A
Appendix
• The Indifference Map
• Equilibrium Position at Tangency
8
6
W
X
4
Indifference
Curve Analysis
Demand Curve
Appendix Terms
2
Key Terms
0
PB
PA
Preferred –
But Requires
More Income
I4
I3
I1
2
End Show
4
6
8
Quantity of B
10
I2
12
Return to Chapter 7
7-19
Copyright 2008 The McGraw-Hill Companies
Derivation of the Demand Curve
Indifference
Curve Analysis
Demand Curve
Appendix Terms
12
Quantity of A
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
10
Marginal Utility
of A
8
Price of A
6
X
4
2
I2
0
Price of B
Appendix
• Measurement of Utility
2
4
6
8
10
Quantity of B
12
$1.50
1.00
.50
Key Terms
DB
End Show
1 2 3 4 5 6 7 8 9 1011 12
Quantity of B
7-20
Copyright 2008 The McGraw-Hill Companies
I3
=
Marginal Utility
of B
Price of B
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
Return to Chapter 7
Appendix Key Terms
Appendix
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
Indifference
Curve Analysis
Demand Curve
Appendix Terms
• budget line
• indifference curve
• marginal rate of
substitution (MRS)
• indifference map
• equilibrium position
Key Terms
End Show
Return to Chapter 7
7-21
Copyright 2008 The McGraw-Hill Companies
Next Chapter Preview…
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Last Word
Appendix
The Costs of
Production
Indifference
Curve Analysis
Demand Curve
Appendix Terms
Key Terms
End Show
Return to Chapter 7
7-22
Copyright 2008 The McGraw-Hill Companies