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Chapter 11: Income
Inequality and Poverty
Pages 252-254
Consumer Behavior
and Utility
Maximization
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
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Law of Diminishing Marginal
Utility
 Terminology
O 19.1
 Utility
 Total
Utility
 Marginal Utility
G 19.1
 Marginal
Utility and
Demand
Graphically…
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Law of Diminishing Marginal
Utility
0
1
2
3
4
5
6
7
0
]
10
18 ]
24 ]
28 ]
30 ]
30
]
28
]
10
8
6
4
2
0
-2
30
TR
20
10
0
Marginal Utility (Utils)
(1)
(2)
(3)
Tacos
Total Marginal
Consumed Utility, Utility,
Per Meal Utils
Utils
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
7
Units Consumed Per Meal
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
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
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(2)
Product A:
Price = $1
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(3)
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
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
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(3)
Product B:
Price = $2
(2)
Product A:
Price = $1
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(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
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
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(3)
Product B:
Price = $2
(2)
Product A:
Price = $1
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(a)
Marginal
Utility,
Utils
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
McGraw-Hill/Irwin
(b)
Marginal
Utility
Per Dollar
(MU/Price)
24
12
20
10
18
9
16
8
-12
MU/Price6
Has
6 $3 Left
3
4
2
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(3)
Product B:
Price = $2
(2)
Product A:
Price = $1
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(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
Per4 Dollar - MU/Price
Sixth
4
6
3
Buy
One of 3Each – 3Budget Exhausted
Seventh
4
2
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A and B Obtainable with an Income of $10
(2)
Product A:
Price = $1
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
First
10
Second
8
Third
7
Fourth
6
Fifth
5
Final
Result
Sixth
4
Seventh
3
(b)
Marginal
Utility
Per Dollar
(MU/Price)
10
8
7
6
At 5These
4
3
(3)
Product B:
Price = $2
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar
(MU/Price)
24
12
20
10
18
9
16
8
12
6
Prices,
6
3
4
2W 19.1
–
Purchase 2 of Item A and 4 of B
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer Behavior
Algebraic Restatement:
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
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Deriving the Demand Curve
Same Numeric Example:
Price Per
Unit of B
Quantity
Demanded
$2
4
1
6
Price of Product B
2
1
Income Effects
DB
0
Substitution Effects
McGraw-Hill/Irwin
4
6
Quantity Demanded of BO 19.2
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Applications and Extensions
 DVDs
and DVD Players
 The
Diamond-Water
Paradox
 The
Value of Time
 Medical
 Cash
McGraw-Hill/Irwin
O 19.3
Care Purchases
and Noncash Gifts
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Criminal Behavior
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”

McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Key Terms









law of diminishing marginal utility
utility
total utility
marginal utility
rational behavior
budget constraint
utility-maximizing rule
income effect
substitution effect
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Next Chapter Preview…
Public
Goods and
Market
Failure
McGraw-Hill/Irwin
Copyright  2007 by The McGraw-Hill Companies, Inc. All rights reserved.