Consumer behavior

MicroeconomicsConsumer behavior and Utility Maximization

ObjectivesElaborate Demand and consumer behavior.Define and differentiate between choice and utility. Discuss Marginal utility and the law of diminishing marginal utility. Discuss Substitution and Income effects.

What does consumer want?

People choose those goods and services they value most highly.

Consumer Choice and Budget RestraintRational BehaviorPreferencesBudget RestraintPrices

Utility

It means SatisfactionIt refers to how consumers rank different goods and services.How rational consumers divide limited resources.

PreferencesA households preferences determine the benefits or satisfaction a person receives consuming a good or service. The benefit or satisfaction from consuming a good or service is called utility.Total UtilityTotal utility is the total benefit a person gets from the consumption of goods. Generally, more consumption gives more utility. Maximizing Utility

Table 8.1 provides an example of total utility schedule.Total utility from a good increases as the quantity of the good increases.For example, as the number of movies seen in a month increases, total utility from movies increases.Maximizing Utility

Marginal UtilityMarginal utility is the change in total utility that results from a one-unit increase in the quantity of a good consumed. As the quantity consumed of a good increases, the marginal utility from consuming it decreases. We call this decrease in marginal utility as the quantity of the good consumed increases the principle of diminishing marginal utility. Maximizing Utility

Law of Diminishing Marginal Returns.All other things remaining constant, if only one input is increased a point will be reached where each additional input produces less output than the previous input.Law of Diminishing Returns: After a certain point, when additional units of a variable input are added to a fixed input, the marginal product of each additional variable input is less than the previous input.Diminishing returns always apply in the short run, and in the short run every firm will face diminishing returns. This means that every firm finds it progressively more difficult to increase its output as it approaches capacity production.

Activity:# of WorkersTotal Product(TP)Marginal Product(MP)Average Product(AP)110001000100023000200015003550025001833465001000162557100600142067500400125077200-300102986800-400850

The Production Function, Total Product and Marginal Product

Activity: A Closer Look.Variable InputsTotal Product(TPMarginal Product(MP)Average Product( AP)000011010102251512.53371212.34471011.755558116605107633986307.9962-16.9

Activity

Complete the following table.Give diagrammatical representation as well.

Units consumedTotalUtilityMarginalUtility00-18821032543053634

Table 8.1 provides an example of marginal utility schedule.Marginal utility from a good decreases as the quantity of the good increases.For example, as the number of movies seen in a month increases, marginal utility from movies decreases.Maximizing Utility

Figure 8.1(a) shows a total utility curve for soda.Total utility increases with the consumption of a soda increases.

Maximizing Utility

Figure 8.1(b) illustrates diminishing marginal utility.As the quantity of soda increases, the marginal utility from soda diminishes.Maximizing Utility

The key assumption of marginal utility theory is that the household chooses the consumption possibility that maximizes total utility. The Utility-Maximizing ChoiceWe can find the utility-maximizing choice by looking at the total utility that arises from each affordable combination.The utility-maximizing combination is called a consumer equilibrium. Maximizing Utility

Choosing at the MarginA consumers total utility is maximized by following the rule: Spend all available income. Equalize the marginal utility per dollar for all goods.The marginal utility per dollar is the marginal utility from a good divided by its price.

Maximizing Utility

The Utility-Maximizing Rule: Call the marginal utility of movies MUM .Call the marginal utility of soda MUS .Call the price of movies PM .Call the price of soda PS .The marginal utility per dollar from seeing movies is MUM/PM .The marginal utility per dollar from soda is MUS/PS.Maximizing Utility

You are choosing between two goods, X and Y and your marginal utility from each is as shown below. If your income is $9 and the prices of X and Y are $2 and $1,what quantities of each you will purchase in maximizing utility? Specify the amount of total utility you will realize.Units of XMUxUnits of YMUy1101828273636444553546263

Substitution Effect

If the price of coffee goes up while other prices do not change, the coffee has become relatively more expensive. when coffee has becomes more expensive beverages, less coffee or more tea or cola will be bought.When price of good rises, consumers will tend to substitute other goods.

Income Effect

When price of any good rises it tends to decrease real income and causes income effect.Real income means the actual amount of goods and services that your money income can buy.

Answer now!Explain the meaning of utility. What is difference between total utility and marginal utility? Explain law of diminishing marginal utility and give a numerical example.How would you explain theory of Consumer Behavior?How are consumer choices being made?

AssignmentBudget Line

1.Margaret Anne may consume CDs and DVDs. Let the following indifference map represent her preferences and let the following consumption bundles have the following contents:Consumption bundle a: 30 CDs and 1 DVD.Consumption bundle b: 20 CDs and 1 DVD.Consumption bundle c: 10 CDs and 3 DVDs.Consumption bundle d: 8 CDs and 1 DVD.Consumption bundle e: 7 CDs and 2 DVDs.2-34

Rank the five consumption bundles in the order of Margaret Annes preferences. Define marginal rate of substitution.What is the marginal rate of substitution between consumption bundles b and c?2-35

2. Suppose that hamburgers cost $2.00 each, tacos cost $1.00 each, and Susan and Bob each have $20.00 to spend. Further, assume Susan and Bobs preferences can be represented by indifference curves convex to the origin. When they maximize utility, Susan consumes both hamburgers and tacos but Bob only consumes hamburgers. Draw a diagram depicting the above information. Label Susans indifference curve US and Bobs indifference curve UB. Also, label Susans utility maximizing consumption bundle, s and Bobs utility maximizing consumption bundle, b.2-36

3. Bill Clinton really likes hamburgers relative to salad. Oprah Winfrey really likes salad relative to hamburgers. Draw an indifference curve for Bill and one for Oprah on the same graph that represent the above information about their preferences. If they intersect each other, have we violated an axiom?2-37

4. Carol has $50.00. Lemons cost $0.10 each and carrots cost $0.20 each. What is the slope of the budget constraint?What is the opportunity cost in terms of lemons of consuming 1 more carrot?Suppose that Carols income increases to $100.00, the price of lemons increases to $0.20 and the price of carrots increases to $0.40. Draw Carols new budget constraint.Now, assume only Carols income changes from $50 to $100. Draw the new budget constraintAssume only the price of lemons changes from $0.10 to $0.20 each. Draw the new budget constraint.What will happen to the slope of the budget constraint if the price of carrots increases? 2-38

Thank You!