Consumer Behavior ·The goal of consumer behavior is utility maximization ·Consumer choice among various alternatives is subject to constraints: ·income or budget ·prices of goods purchased ·preferences

Models of Consumer Behavior ·Marginal Utility approach ·cardinal measure of utility ·Indifference approach ·ordinal utility

Cardinal Utility Approach to Consumer Behavior ·Total and Marginal utility ·Law of diminishing Marginal Utility ·Equimarginal rule and utility maximization

Total utility [TU] is defined as the amount of satisfaction an individual derives from consuming a given quantity of a good during a specific period of time Q/ut Utility Q TU TU TU

Nature of Total Utility ·When more and more units of a good are consumed in a specific time period, the utility derived tends to increase at a decreasing rate ·Eventually, some maximum utility is derived and additional units cause total utility to diminish. As an example, think of eating “free” muffins..or paani puri.. ·It is possible for total utility to initially increase at an increasing rate..

Marginal Utility [MU] is the change in total utility [  TU] caused by a one unit change in quantity consumed[  Q] ; MU =  TU QQ Utility Q TU MU  Q=1  TU=30 The first unit consumed increases TU by  Q=1  TU= QQ The 2cd unit increases TU by  Q=1  TU= Q/ut MU...

Q/ut TU 331 Utility Q TU MU 30  TU= MU

Marginal Utility ·Marginal utility [MU] is the change in total utility associated with a 1 unit change in consumption. ·Relation between TU and MU: ·As total utility increases at a decreasing rate, MU declines. ·When TU is a maximum, MU is 0 [This is sometimes called the “Satiation point” or the point of “absolute diminishing utility.” ·As total utility declines, MU is negative

Diminishing Marginal Utility ·Initially, it may be possible for TU to increase at an increasing rate. In which case MU will increase [MU is the slope of TU which is increasing]. ·Eventually, as more and more of a good are consumed in a given time period, TU continues to increase but at a decreasing rate; MU decreases.

QyQy QxQx B > P x Q x + P y Q y The budget constraint can be expressed: The amount of good Y that can be purchased is the budget divided by the price of good Y, B PyPy B PyPy For an B = $80, and P y = $ = 16 = The amount of good X that can be purchased is, B PxPx B PxPx For an B = $80, and P X = $ = 26.7 = Connecting the two intercepts identifies all combinations of goods X &Y that can be purchased for a budget of $80, P y = $5, and P X = $3. Any combination inside area 0AC can be purchased for less than $80. 0 A C

Good X Utility X QxQx TU x MU x Good Y Utility Y QyQy TU y MU y Consider an individual’s utility preference for 2 goods, X & Y; If the two goods were “free,” [ or no budget constraint], the individual would consume each good until the MU of that good was 0, 7 units of good X and 6 of Y. Once the goods have a price and there is a budget constraint, the individual will try to maximize the utility from each additional dollar spent.

Utility X QxQx TU x MU x For P X = $3, the MU X per dollar spent on good X is; Given the budget constraint, Individuals will attempt to gain the maximum utility for each additional dollar spent, “the marginal dollar.” MU X PXPX For P Y = $5, the MU Y per dollar spent on good Y is; Utility Y QyQy TU y MU y MU Y PYPY

Utility X QxQx TU x MU x MU X PXPX Utility Y QyQy TU y MU y MU Y PYPY Now the preferences of the individuals and the relative prices of the two goods are displayed in the tables. If the objective is to maximize utility given prices, preferences, and budget, spend each additional $ on the good that yields the greater utility for that expenditure.

MU X PXPX MU Y PYPY Given the preferences of the individual and the relative prices of the goods [P X = $3, P Y = $5], the MU’s for each dollar spent are: To maximize TU given a budget of $30,the first expenditure would logically be for good Y since the MU Y for each dollar is 12.  $5 The second expenditure is for good X, [MU X $ is greater than MU Y $]  $3 The third & fourth expenditures are for good X since the MU per dollar spent is greater for X than Y.  $3  The fifth expenditure is for is for good Y.  $5 Continue to maximize the MU per $ spent.  $3  $5  $3 AT THIS POINT YOU HAVE SPENT THE BUDGET OF $30. MU X PXPX > MU Y PYPY, BUY X ! MU X PXPX < MU Y PYPY, BUY Y !

MU X PXPX > MU Y PYPY says that the marginal utility of an additional dollar spent on good X is greater than that of a dollar spent on good Y. MU X PXPX < MU Y PYPY indicates that the MU per dollar spent on good Y exceeds that of a dollar spent on good X. If the amount spent on the two goods is equal to the budget then MU X PXPX > MU Y PYPY suggests that the individual should buy less of Y in order to buy more of X. MU X PXPX < MU Y PYPY says to purchase less X to pay for additional amounts of Y. = MU X PXPX MU Y PYPY is an equilibrium condition!