Chap 21

Consumer Behavior &

Utility MaximizationBy: Anabel Gonzalez

& Amanda Reina

A Closer Look at the Law of Demand

Income Effect: Lower the price of a product, the more a consumer can buy of that product

Substitution Effect: Impact that a change in a product’s price has on its relative expensiveness and consequently on the quantity demanded.

Law of Diminishing Marginal Utility

Although consumer wants in general may be insatiable, wants for particular commodities can be satisfied.

Utility: Want-satisfying power Not equal to Usefulness Vary widely from person to person Subjective and difficult to quantify (assume people can

measure satisfaction with units called utils, units of utility)

Total Utility and Marginal Utility

Total Utility (TU): total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service.

Marginal Utility (MU): extra satisfaction a consumer gets from an additional unit of that same product.

Marginal Utility, Demand and Elasticity

Consumer will rather spend additional dollars on products that provide more (or equal) utility, nor less.

If MU of extra units drops off so rapidly demand is inelastic.

If MU of extra units drops off modestly demand is elastic.

Theory of Consumer Behavior

How do consumers distribute their money incomes among the many goods and services available for purchase? The consumer will choose the goods and

services that they find most satisfying/useful.

Consumer Choice & Budget Constraint

A typical consumer: Rational Behavior Preferences Budget constraint Prices

Consumer Choice &Budget Constraint

Rational Behavior: Consumer tries to derive the greatest amount of

satisfaction, or utility. “The most for their money”

Preferences: Clear inclination for certain goods and services

available in the market.

Consumer Choice &Budget Constraint

Budget constraint: Consumers have a fixed income

Prices: Goods are scarce in relation to the demand for

them; therefore, every good carries a price tag Consumer has limited number of dollars, so they

can only buy a limited amount of goods.

Utility-Maximizing Rule To maximize satisfaction, the consumer

should distribute his/her money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility.

$1$5

Algebraic Restatement MU of product A MU product B

Price of A = Price of B

2 Utils 10 Utils

$1 = $2•The last dollar spent on A provides only 2 utils of satisfaction, while on B it provides 5 utils of satisfaction.

•Consumer can increase satisfaction by buying more of product B and less of product A.

Utility Maximization & the Demand Curve

Price per Unit of B

Quantity Demanded

$2 4

$1 6

Quantity demanded of B

Pric

e pe

r un

it of

B

$1

$2

4 6

Product price and quantity demanded are inversely related!

P($)