1. 7 Consumer Behavior and Utility Maximization
Click to Link to Appendix 7: Indifference Curve Analysis

2. 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

3. Law of Diminishing Marginal Utility
Terminology
Utility
Total Utility
Marginal Utility
Marginal Utility and Demand
Graphically…
O 7.1
G 7.1

4. Law of Diminishing Marginal Utility
Total Utility 10 20 30 8 6 4 2 -2 1 3 5 7
Total Utility (Utils)
Marginal Utility (Utils)
(1)
Tacos
Consumed
Per Meal
(2)
Total
Utility,
Utils
(3)
Marginal
Utility,
Utils TR 1 2 3 4 5 6 7 10 18 24 28 30 ] 10 8 6 4 2 -2
Units Consumed Per Meal
Marginal Utility MU
Units Consumed Per Meal

5. Theory of Consumer Behavior
Consumer Choice and Budget Constraint
Rational Behavior
Preferences
Budget Constraint
Prices
Utility Maximizing Rule
Allocate Money Income so that Last Dollar Spent on Each Product Yields the Same Marginal Utility

6. Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(2)
Product A:
Price = $1
(3)
Product B:
Price = $2
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(a)
Marginal
Utility,
Utils
(1)
Unit of
Product
First
Second
Third
Fourth
Fifth
Sixth
Seventh 10 8 7 6 5 4 3 24 20 18 16 12 10 8 7 6 5 4 3 12 9 2
Compare Marginal Utilities
Then Compare Per Dollar - MU/Price
Choose the Highest
Check Budget - Proceed to Next Item

7. Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(2)
Product A:
Price = $1
(3)
Product B:
Price = $2
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(a)
Marginal
Utility,
Utils
(1)
Unit of
Product
First
Second
Third
Fourth
Fifth
Sixth
Seventh 10 8 7 6 5 4 3 24 20 18 16 12 10 8 7 6 5 4 3 12 9 2
Again, Compare Per Dollar - MU/Price
Choose the Highest
Buy One of Each – Budget Has $5 Left
Proceed to Next Item

8. Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(2)
Product A:
Price = $1
(3)
Product B:
Price = $2
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(a)
Marginal
Utility,
Utils
(1)
Unit of
Product
First
Second
Third
Fourth
Fifth
Sixth
Seventh 10 8 7 6 5 4 3 24 20 18 16 12 10 8 7 6 5 4 3 12 9 2
Again, Compare Per Dollar - MU/Price
Buy One More B – Budget Has $3 Left
Proceed to Next Item

9. Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(2)
Product A:
Price = $1
(3)
Product B:
Price = $2
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(a)
Marginal
Utility,
Utils
(1)
Unit of
Product
First
Second
Third
Fourth
Fifth
Sixth
Seventh 10 8 7 6 5 4 3 24 20 18 16 12 10 8 7 6 5 4 3 12 9 2
Again, Compare Per Dollar - MU/Price
Buy One of Each – Budget Exhausted

10. Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10
(2)
Product A:
Price = $1
(3)
Product B:
Price = $2
(b)
Marginal
Utility
Per Dollar
(MU/Price)
(a)
Marginal
Utility,
Utils
(1)
Unit of
Product
First
Second
Third
Fourth
Fifth
Sixth
Seventh 10 8 7 6 5 4 3 24 20 18 16 12 10 8 7 6 5 4 3 12 9 2
Final Result – At These Prices, Purchase 2 of Item A and 4 of B
W 7.1

11. Theory of Consumer Behavior
Algebraic 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

12. Deriving the Demand Curve
Same Numeric Example:
Price of Product B 1 2 4 6
Quantity Demanded of B
Price Per
Unit of B
Quantity
Demanded $2 4 1 6
Income Effects
Substitution Effects DB
O 7.2

13. Applications and Extensions
DVDs and DVD Players
The Diamond-Water Paradox
The Value of Time
Medical Care Purchases
Cash and Noncash Gifts
O 7.3

14. Criminal Behavior
Last
Word
Economic Analysis Offers Insights Into Property Crimes Such as Robbery, Burglary, and Auto Theft
Theory of a Rational Consumer
Buy Versus Steal Decision
Compare Marginal Utility of Item Versus Costs – Guilt, Fines, or Prison Time
Crime May Be Reduced by “Increasing” the “Price of Crime”

15. Key Terms law of diminishing marginal utility utility total utility
rational behavior
budget constraint
utility-maximizing rule
income effect
substitution effect

16. The Costs of Production Next Chapter Preview… Chapter 8
Click to Link to Appendix 7: Indifference Curve Analysis

17. Indifference Curve Analysis
Budget Line (Constraint)
Income Changes
Price Changes
Appendix 2 4 6 8 10 12
Quantity of A
Quantity of B
Income = $12
PA = $1.50
Units of A
(Price = $1.50)
Units of B
(Price = $1)
Total
Expenditure 8 6 4 2 3 6 9 12
$12 12
(Unattainable)
Income = $12
PB = $1
Indifference Curve Analysis
Demand Curve
Appendix Terms
(Attainable)
Return to Chapter 7

18. Indifference Curve Analysis
What is Preferred
Downsloping
Convex to Origin
Marginal Rate of Substitution (MRS)
Appendix 2 4 6 8 10 12
Quantity of A
Quantity of B j
Combination
Units of A
Units of B j k l m 12 6 4 3 2 4 6 8 k l m
Indifference Curve Analysis
Demand Curve
Appendix Terms I
O 7.4
Return to Chapter 7

19. Indifference Curve Analysis
The Indifference Map
Equilibrium Position at Tangency
Appendix 2 4 6 8 10 12
Quantity of A
Quantity of B
MRS = PB PA
Preferred –
But Requires
More Income W X
Indifference Curve Analysis
Demand Curve
Appendix Terms I4 I3 I2 I1
Return to Chapter 7

20. Derivation of the Demand Curve
Measurement of Utility
Appendix X 2 4 6 8 10 12
Quantity of A
Quantity of B I2 I3
Marginal Utility
of A
of B
Price of A
Price of B =
At $1 Price for B,
6 Units are Purchased
Record the Results
As Price of B Increases to $1.50,
Only 3 Units of B are Bought
Connect the Points to
Create the Demand Curve
Price of B
$1.50
1.00
.50 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of B
Indifference Curve Analysis
Demand Curve
Appendix Terms DB
Return to Chapter 7

21. marginal rate of substitution (MRS) indifference map
Appendix Key Terms
budget line
indifference curve
marginal rate of substitution (MRS)
indifference map
equilibrium position
Appendix
Indifference Curve Analysis
Demand Curve
Appendix Terms
Return to Chapter 7

22. The Costs of Production Next Chapter Preview… Chapter 8
Indifference Curve Analysis
Demand Curve
Appendix Terms
Return to Chapter 7