Consumer Behavior and Utility Maximization Chapter 19 AP Economics

Law of Diminishing Marginal Utility Added satisfaction declines as a consumer acquires additional units of a given product Consumer wants in general are insatiable, but wants for particular items can be satisfied Durable goods such as an automobile

Utility A product has utility if it can satisfy a want: Utility has a wanting satisfying power Satisfaction or pleasure one gets from consuming it Utility and usefulness are not synonymous Utility is subjective—a specific product may vary widely from person to person Utility is difficult to quantify

Total Utility and Marginal Utility Total amount of satisfaction or pleasure a person derives from consuming some specific quantity Marginal utility The extra satisfaction a consumer realizes from an additional unit of that product Change in total utility that results from the consumption of 1 more unit of a product

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 TU 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

Theory of Consumer Behavior Explains how consumers allocate their money incomes among the many goods and services available for purchase

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

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

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

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

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

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

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

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

Indifference Curve Analysis Budget Line (Constraint) Income Changes Price Changes 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 (Attainable) Return to Chapter 19

Indifference Curve Analysis What is Preferred Downsloping Convex to Origin Marginal Rate of Substitution (MRS) 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 I Return to Chapter 19

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

Derivation of the Demand Curve Measurement of Utility 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 DB Return to Chapter 19