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The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior 21 CHAPTER Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 1 Next Slide Consumer Behavior and Utility Maximization Copyright Mc. Graw-Hill/Irwin, 2002

THE LAW OF DEMAND The Law of Demand Law of Diminishing Marginal Utility Total THE LAW OF DEMAND The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 2 Next Slide A Closer Look… The Income Effect A lower price frees income for additional purchases and vice versa The Substitution Effect A lower price relative to other goods attracts new buyers and vice versa Copyright Mc. Graw-Hill/Irwin, 2002

The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 3 Next Slide LAW OF DIMINISHING MARGINAL UTILITY • Utility Defined • Subjective Nature • Difficult to Quantify Total Utility Marginal Utility graphically examined. . . Copyright Mc. Graw-Hill/Irwin, 2002

TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination 0 10 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils Utility Maximization and the Demand Curve Marginal Utility (utils) Key Terms End Show 21 - 4 10 0 Applications and Extensions Previous Slide 20 Next Slide 1 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 1 Copyright Mc. Graw-Hill/Irwin, 2002 2 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination 0 10 10 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils Utility Maximization and the Demand Curve Marginal Utility (utils) Key Terms End Show 21 - 5 10 0 Applications and Extensions Previous Slide 20 Next Slide 1 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 1 Copyright Mc. Graw-Hill/Irwin, 2002 2 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve 0 1 2 0 10 18 10 8 Marginal Utility (utils) Key Terms End Show 21 - 6 20 10 0 Applications and Extensions Previous Slide 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils Next Slide 1 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 1 Copyright Mc. Graw-Hill/Irwin, 2002 2 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve 0 1 2 3 0 10 18 24 10 8 6 Key Terms Previous Slide End Show 21 - 7 Next Slide 20 10 0 Marginal Utility (utils) Applications and Extensions 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils 1 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 1 Copyright Mc. Graw-Hill/Irwin, 2002 2 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions 0 1 2 3 4 0 10 18 24 28 10 8 6 4 Key Terms Previous Slide End Show 21 - 8 Next Slide Total Utility (utils) Law of Diminishing Marginal Utility 30 20 10 0 Marginal Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils 1 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 1 Copyright Mc. Graw-Hill/Irwin, 2002 2 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 9 0 1 2 3 4 5 0 10 18 24 28 30 10 8 6 4 2 Next Slide Total Utility (utils) Law of Diminishing Marginal Utility 30 20 10 0 Marginal Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils 1 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 1 Copyright Mc. Graw-Hill/Irwin, 2002 2 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 10 Next Slide 0 1 2 3 4 5 6 0 10 18 24 28 30 30 10 8 6 4 2 0 Total Utility (utils) Law of Diminishing Marginal Utility 30 20 10 0 Marginal Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils 1 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 1 Copyright Mc. Graw-Hill/Irwin, 2002 2 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 11 Next Slide 0 1 2 3 4 5 6 7 0 10 18 24 28 30 30 28 10 8 6 4 2 0 -2 Copyright Mc. Graw-Hill/Irwin, 2002 30 Total Utility (utils) Law of Diminishing Marginal Utility TU 20 10 0 Marginal Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils 1 2 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 MU 1 2 3 4 5 6 7 Units consumed per meal

TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 12 Next Slide 0 1 2 3 4 5 6 7 0 10 18 24 28 30 30 28 10 8 6 4 2 0 -2 Copyright Mc. Graw-Hill/Irwin, 2002 30 Total Utility (utils) Law of Diminishing Marginal Utility TU Observe Diminishing Marginal Utility 20 10 0 Marginal Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, per meal Utils 1 2 3 4 5 6 7 Units consumed per meal 10 8 6 4 2 0 -2 MU 1 2 3 4 5 6 7 Units consumed per meal

THEORY OF CONSUMER BEHAVIOR The Law of Demand Law of Diminishing Marginal Utility Total THEORY OF CONSUMER BEHAVIOR The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 13 A Typical Consumer. . . • Exhibits Rational Behavior • Has Clear-Cut Preferences • Subject to a Budget Constraint • Responds to Price Changes Next Slide Copyright Mc. Graw-Hill/Irwin, 2002

THEORY OF CONSUMER BEHAVIOR The Law of Demand Law of Diminishing Marginal Utility Total THEORY OF CONSUMER BEHAVIOR The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 14 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. . . Next Slide Copyright Mc. Graw-Hill/Irwin, 2002

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Unit of product First Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) 10 10 Marginal utility, utils 24 Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 15 Next Slide How should the $10 Income be allocated? Copyright Mc. Graw-Hill/Irwin, 2002 12

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 16 Next Slide Unit of product First Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) 10 10 Marginal utility, utils 24 12 Examine the two marginal utilities Copyright Mc. Graw-Hill/Irwin, 2002

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 17 Next Slide Unit of product First Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) 10 10 Marginal utility, utils 24 12 Examine the two marginal utilities …per dollar Copyright Mc. Graw-Hill/Irwin, 2002

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 18 Next Slide Unit of product First Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) 10 10 Marginal utility, utils 24 12 Decision: Buy 1 Product B for $2 Copyright Mc. Graw-Hill/Irwin, 2002

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 19 Next Slide Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) Marginal utility, utils First 10 10 24 Second 8 8 20 Third 7 7 18 Fourth What next? 6 6 16 Fifth 5 5 12 Sixth 4 4 6 Seventh 3 3 4 Copyright Mc. Graw-Hill/Irwin, 2002 12 10 9 8 6 3 2

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 20 Next Slide Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) Marginal utility, utils First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth What next? 6 6 16 8 Fifth 5 5 12 6 Buy one of each Sixth 4 4 6 3 Seventh 3 3 4 2 Copyright Mc. Graw-Hill/Irwin, 2002

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 21 Next Slide Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) Marginal utility, utils First 10 10 24 Second 8 8 20 Third 7 7 18 Fourth 6 6 16 and then. . . 12 Fifth 5 5 ($5 left) 6 Sixth 4 4 Seventh 3 3 4 Copyright Mc. Graw-Hill/Irwin, 2002 12 10 9 8 6 3 2

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 22 Next Slide Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) Marginal utility, utils First 10 10 24 Second 8 8 20 Third 7 7 18 Fourth 6 6 16 third unit of Fifth 5 5 12 product B 6 Sixth 4 4 Seventh 3 3 4 Copyright Mc. Graw-Hill/Irwin, 2002 12 10 9 8 6 3 2

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 23 Next Slide Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) First 10 Second 8 Third 7 Fourth left. . . $3 6 Fifth 5 Sixth 4 Seventh 3 Copyright Mc. Graw-Hill/Irwin, 2002 10 8 7 6 5 4 3 Marginal utility, utils 24 20 18 16 12 6 4 12 10 9 8 6 3 2

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 24 Next Slide Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) First 10 10 Second 8 8 Third 7 7 Fourth left. . . 6 $3 6 Fifth 5 5 Buy both! 4 Sixth 4 Seventh 3 3 Copyright Mc. Graw-Hill/Irwin, 2002 Marginal utility, utils 24 20 18 16 12 6 4 12 10 9 8 6 3 2

UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal UTILITY MAXIMIZING COMBINATION $ 10 income The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility per dollar utility, (MU/price) utils Marginal utility per dollar (MU/price) First 10 10 Second 8 8 Third is gone. . . 7 7 Income the last dollar 6 Fourth spent on 6 each good gave the same Fifth 5 5 utility (8) per dollar Sixth 4 4 Seventh 3 3 Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 25 Next Slide Copyright Mc. Graw-Hill/Irwin, 2002 Marginal utility, utils 24 20 18 16 12 6 4 12 10 9 8 6 3 2

UTILITY MAXIMIZING COMBINATION The Law of Demand Law of Diminishing Marginal Utility Total and UTILITY MAXIMIZING COMBINATION The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Algebraic Restatement of the Utility Maximization Rule Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions MU of product A Price of A Key Terms Previous Slide End Show 21 - 26 Next Slide Copyright Mc. Graw-Hill/Irwin, 2002 = MU of product B Price of B

The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 27 Next Slide 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 Copyright Mc. Graw-Hill/Irwin, 2002

The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 28 Next Slide 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. . . Price per unit of B $2 1 Quantity Demanded 4 6 Graphically… Copyright Mc. Graw-Hill/Irwin, 2002

Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 29 Next Slide Price per unit of Good B The Law of Demand UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve $2 1 DB 0 Copyright Mc. Graw-Hill/Irwin, 2002 4 6 Quantity Demanded of Good B

Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 30 Next Slide $2 Substitution Effects and Income Effects Revisited 1 Price per unit of Good B The Law of Demand UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve DB 0 Copyright Mc. Graw-Hill/Irwin, 2002 4 6 Quantity Demanded of Good B

APPLICATIONS AND EXTENSIONS The Law of Demand Law of Diminishing Marginal Utility Total and APPLICATIONS AND EXTENSIONS The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 31 Next Slide The Compact Disc Takeover The Diamond-Water Paradox The Value of Time Medical Care Purchases Cash and Noncash Gifts Chapter Conclusions Copyright Mc. Graw-Hill/Irwin, 2002

income effect substitution effect utility total utility marginal utility law of diminishing marginal utility income effect substitution effect utility total utility marginal utility law of diminishing marginal utility rational behavior budget constraint utility-maximizing rule Copyright Mc. Graw-Hill/Irwin 2002 BACK END

The Law of Demand Law of Diminishing Marginal Utility Next… Total and Marginal Utility The Law of Demand Law of Diminishing Marginal Utility Next… Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - 33 Next Slide Indifference Curve Analysis Copyright Mc. Graw-Hill/Irwin, 2002