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Consumer Behavior and Utility Maximization

21. C H A P T E R. Consumer Behavior and Utility Maximization. LAW OF DIMINISHING MARGINAL UTILITY. Utility Defined Subjective Nature Difficult to Quantify. Total Utility. Marginal Utility. graphically examined. Observe Diminishing Marginal Utility. TOTAL AND MARGINAL UTILITY. TU.

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Consumer Behavior and Utility Maximization

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  1. 21 C H A P T E R Consumer Behavior andUtility Maximization

  2. LAW OF DIMINISHINGMARGINAL UTILITY • Utility Defined • Subjective Nature • Difficult to Quantify Total Utility Marginal Utility graphically examined...

  3. Observe Diminishing Marginal Utility TOTAL AND MARGINAL UTILITY TU Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 30 20 10 0 1 2 3 4 5 6 7 0 10 18 24 28 30 30 28 Total Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 Marginal Utility (utils) MU 1 2 3 4 5 6 7 Units consumed per meal

  4. THEORY OF CONSUMER BEHAVIOR A Typical Consumer... • Exhibits Rational Behavior • Has Clear-Cut Preferences • Subject to a Budget Constraint • Responds to Price Changes

  5. THEORY OF CONSUMER BEHAVIOR 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...

  6. $ 10 income Income is gone... the last dollar spent on each good gave the same utility (8) per dollar UTILITY MAXIMIZING COMBINATION Product B: Price = $2 Product A: Price = $1 Marginal utility per dollar (MU/price) Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility, utils Unit of product 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 Sixth 4 4 6 3 Seventh 3 3 4 2

  7. MU of product B MU of product A Price of A Price of B UTILITY MAXIMIZING COMBINATION Algebraic Restatement of the Utility Maximization Rule =

  8. UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Given from the previous example schedule: • Preferences or Tastes • Money Income • Prices of Other Goods

  9. 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 ... Quantity Demanded Price per unit of B $2 4 1 6 Graphically…

  10. UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve $2 Price per unit of Good B 1 DB 0 4 6 Quantity Demanded of Good B

  11. Substitution Effects and Income Effects Revisited UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve $2 Price per unit of Good B 1 DB 0 4 6 Quantity Demanded of Good B

  12. APPLICATIONS AND EXTENSIONS The Compact Disc Takeover The Diamond-Water Paradox The Value of Time Medical Care Purchases Cash and Noncash Gifts Chapter Conclusions

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