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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 - PowerPoint PPT Presentation
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Chapter 11: Income Inequality and Poverty
Pages 252-254Consumer Behavior
and Utility Maximization
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
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 UtilityTerminology
UtilityTotal UtilityMarginal Utility
Marginal Utility and Demand
Graphically…
O 19.1
G 19.1
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Law of Diminishing Marginal Utility
0
10
20
30
1086420
-2
1 2 3 4 5 6 7
1 2 3 4 5 6 7
To
tal U
tilit
y (U
tils
)M
arg
inal
Uti
lity
(Uti
ls)
(1)Tacos
ConsumedPer Meal
(2)Total
Utility,Utils
(3)MarginalUtility,Utils
0
1
2
3
4
5
6
7
0
10
18
24
28
30
30
28
]]]]]]]
10
8
6
4
2
0
-2
TR
MU
Total Utility
Marginal Utility
Units Consumed Per Meal
Units Consumed Per Meal
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer BehaviorConsumer Choice and
Budget ConstraintRational BehaviorPreferencesBudget ConstraintPrices
Utility Maximizing RuleAllocate 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 BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)Product B:Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
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5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Compare Marginal UtilitiesThen Compare Per Dollar - MU/PriceChoose the HighestCheck Budget - Proceed to Next Item
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)Product B:Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
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6
5
4
3
12
10
9
8
6
3
2
Again, Compare Per Dollar - MU/PriceChoose the HighestBuy One of Each – Budget Has $5 LeftProceed to Next Item
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)Product B:Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Again, Compare Per Dollar - MU/PriceBuy One More B – Budget Has $3 LeftProceed to Next Item
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)Product B:Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Again, Compare Per Dollar - MU/PriceBuy One of Each – Budget Exhausted
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(1)Unit of
Product
(a)MarginalUtility,Utils
(a)MarginalUtility,Utils
(b)Marginal
UtilityPer Dollar(MU/Price)
(b)Marginal
UtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)Product B:Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2
Final Result – At These Prices, Purchase 2 of Item A and 4 of B W 19.1
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Theory of Consumer BehaviorAlgebraic Restatement:
MU of Product A
Price of A
MU of Product B
Price of B=
8 Utils
$1
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.
Pri
ce
of
Pro
du
ct
B
0
1
2
4 6
Quantity Demanded of B
Deriving the Demand CurveSame Numeric Example:
$2
1
4
6
Price Per Unit of B
QuantityDemanded
DBIncome Effects
Substitution EffectsO 19.2
McGraw-Hill/Irwin 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 Care Purchases
Cash and Noncash Gifts
O 19.3
McGraw-Hill/Irwin Copyright 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Criminal BehaviorEconomic Analysis Offers
Insights Into Property Crimes Such as Robbery, Burglary, and Auto Theft
Theory of a Rational ConsumerBuy Versus Steal DecisionCompare Marginal Utility of Item
Versus Costs – Guilt, Fines, or Prison Time
Crime May Be Reduced by “Increasing” the “Price of Crime”
Last
Word
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.
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