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Chapter 11: Income Inequality and Poverty Pages 252 -254 Consumer Behavior and Utility Maximization Chapter 11: Income Inequality and Poverty Pages 252 -254 Consumer Behavior and Utility Maximization

Chapter Objectives l l l Total Utility, Marginal Utility, and the Law of Diminishing Chapter Objectives l l l 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 Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Law of Diminishing Marginal Utility l Terminology O 19. 1 l Utility l Total Law of Diminishing Marginal Utility l Terminology O 19. 1 l Utility l Total Utility l Marginal Demand Utility and G 19. 1 Graphically… Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Law of Diminishing Marginal Utility 0 1 2 3 4 5 6 7 Mc. Law of Diminishing Marginal Utility 0 1 2 3 4 5 6 7 Mc. Graw-Hill/Irwin 0 10 ] 18 ] 24 ] 28 ] 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, Per Meal 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 Units Consumed Per Meal 7 Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Theory of Consumer Behavior l Consumer Choice and Budget Constraint Rational Behavior l Preferences Theory of Consumer Behavior l Consumer Choice and Budget Constraint Rational Behavior l Preferences l Budget Constraint l Prices l l Utility l Maximizing Rule Allocate Money Income so that Last Dollar Spent on Each Product Yields the Same Marginal Utility Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable 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 Compare Marginal Utilities Fourth 6 6 24 20 18 16 (b) Marginal Utility Per Dollar (MU/Price) 12 10 9 8 Then Compare Per Dollar - MU/Price 6 Fifth 5 5 12 Choose the 4 Highest Sixth 4 6 3 Check Budget - Proceed to Next Item 2 Seventh 3 3 4 Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable 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 First Second Third Again, Fourth (a) Marginal Utility, Utils 10 8 7 Compare 6 (b) Marginal Utility Per Dollar (MU/Price) 10 8 7 Per 6 (a) Marginal Utility, Utils Dollar (b) Marginal Utility Per Dollar (MU/Price) 24 12 20 10 18 9 - MU/Price 16 8 Choose the 5 Highest Fifth 5 12 6 Buy One of 4 Each – Budget Has $5 Left Sixth 4 6 3 Proceed to 3 Next Item Seventh 3 4 2 Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable 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) First Second Third Fourth 10 8 7 6 24 20 18 16 12 10 9 8 Again, Compare Per Dollar -12 MU/Price Fifth 5 5 6 Buy One More B – Budget Has $3 Left Sixth 4 4 6 3 Proceed to 3 Next Item Seventh 3 4 2 Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable 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) First Second Third Fourth 10 8 7 6 24 20 18 16 12 10 9 8 Fifth 5 5 12 6 Again, Compare Per Dollar - MU/Price Sixth 4 4 6 3 Buy One of 3 Each – 3 Budget Exhausted Seventh 4 2 Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable 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) First Second Third Fourth 10 8 7 6 24 20 18 16 12 10 9 8 Fifth 5 12 Final Result – At 5 These Prices, 6 Sixth 4 4 6 3 Purchase 3 of Item A and 44 of B 2 W 19. 1 2 Seventh 3 Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Theory of Consumer Behavior Algebraic Restatement: MU of Product A Price of A 8 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 Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Deriving the Demand Curve Same Numeric Example: Price Per Unit of B Quantity Demanded 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 Mc. Graw-Hill/Irwin 4 6 Quantity Demanded of BO 19. 2 Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Applications and Extensions l DVDs and DVD Players l The Diamond-Water Paradox l The Applications and Extensions l DVDs and DVD Players l The Diamond-Water Paradox l The Value of Time l Medical l Cash Mc. Graw-Hill/Irwin O 19. 3 Care Purchases and Noncash Gifts Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Criminal Behavior ast L d or W l Economic Analysis Offers Insights Into Property Criminal Behavior ast L d or W l Economic Analysis Offers Insights Into Property Crimes Such as Robbery, Burglary, and Auto Theft l Theory of a Rational Consumer l Buy Versus Steal Decision l Compare Marginal Utility of Item Versus Costs – Guilt, Fines, or Prison Time l Crime May Be Reduced by “Increasing” the “Price of Crime” Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Key Terms l l l l law of diminishing marginal utility total utility marginal Key Terms l l l l law of diminishing marginal utility total utility marginal utility rational behavior budget constraint utility-maximizing rule income effect substitution effect Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Next Chapter Preview… Public Goods and Market Failure Mc. Graw-Hill/Irwin Copyright 2007 by The Next Chapter Preview… Public Goods and Market Failure Mc. Graw-Hill/Irwin Copyright 2007 by The Mc. Graw-Hill Companies, Inc. All rights reserved.