1. Theory of Consumer Behavior
Chapter 3

2. Topics of Discussion Utility Theory Total Utility Marginal Utility
Meet Carl Consumer
Law of Diminishing Marginal Utility
Indifference Curves
Concept of Isoutility
Marginal Rate of Substitution
The Budget Constraint

3. Utility Function Total utility = Qhamburgers x Qpizza
A utility function is an algebraic expression
that allows us to rank consumption bundles
or combinations of goods.
Total utility = Qhamburgers x Qpizza
Pages 39-40

4. Utility Function Total utility = Qhamburgers x Qpizza
A utility function is an algebraic expression
that allows us to rank consumption bundles
or combinations of goods.
Total utility = Qhamburgers x Qpizza
This approach assumes that utility is
cardinally measurable in the same sense
that a ruler measures distance.
Pages 39-40

5. Quantity of hamburgers
Ranking Total Utility
Bundle
Quantity of hamburgers
Quantity of pizza
Total Utility A
2.5
10.0 25 B
3.0
7.0 21 C
4.0
6.25
Rank A and C over B
Indifferent between A and C

6. Marginal Utility Marginal utility is the change in utility
derived from an increase in consumption
of a particular good.
MUhamburgers =  utility ÷  hamburgers
Page 40

7. Marginal Utility Marginal utility is the change in utility
derived from an increase in consumption
of a particular good.
MUhamburgers =  utility ÷  hamburgers
This value will fall (rise) as consumption
increases (decreases).
Page 40

8. Marginal utility goes
to zero at the peak of
the total utility curve
Page 42

9. “Law of Diminishing Marginal Utility” --
Marginal utility decreases as more of a good is consumed over a given time period.

10. Indifference Curves Cardinal measurement of utility is both
unreasonable and unnecessary. We can
instead use an ordinal measurement of utility,
which means all we need to know is that one
bundle is preferred over another.
Page 43

11. Indifference Curves Cardinal measurement of utility is both
unreasonable and unnecessary. We can
instead use an ordinal measurement of utility,
which means all we need to know is that one
bundle is preferred over another.
Modern consumption theory is based upon the notion of isoutility curves, where “iso” is
the Greek for “equal”. The consumer is
assumed to be indifferent among different
combinations of goods along a isoutility curve.
Page 43

12. Increasing
utility
Page 43

13. The two indifference
curves here can be
thought of as providing
200 and 700 utils of
utility.
Page 43

14. The two indifference
curves here can be
thought of as providing
200 and 700 utils of
utility.
One would normally
expect a number of
additional isoutility
or indifference curves.
Page 43

15. Slope of Indifference Curve
The slope of an indifference curve is known
as the marginal rate of substitution (MRS).
The marginal rate of substitution of hamburgers
for tacos is given by:
MRS =  tacos ÷ hamburgers
Page 43

16. Slope of Indifference Curve
The slope of an indifference curve is known
as the marginal rate of substitution (MRS).
The marginal rate of substitution of hamburgers
for tacos is given by:
MRS =  tacos ÷ hamburgers
The MRS reflects the number of tacos a consumer
is willing to give up for an additional hamburger.
Pages 43-44

17. The MRS between points M and Q is equal to:
-2.0 = -2 ÷ 1.0
Page 43

18. This means the consumer is will to give up 2 tacos in exchange for an additional hamburger!
Page 43

19. IMPORTANT POINT
Along the SAME indifference curve, the decrease in taco consumption from point M to point Q times the accompanying increase in the MU of tacos MUST be identical to the increase in consumption of hamburgers from point M to point Q times the accompanying decrease in the MU of hamburgers.

20. Δtacos MUhamburgers =
Δhamburgers MUtacos
(3.4)

21. Concept of Budget Constraint
Weekly budget for fast food:
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS  BUDGET
where PHAMBURGERS and PTACOS represent the current price of hamburgers and tacos while QHAMBURGERS and QTACOS represent the quantities you plan to consume during the week.
Page 45

22. Concept of Budget Constraint
Weekly budget for fast food:
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS  BUDGET
where PHAMBURGERS and PTACOS represent the current price of hamburgers and tacos while QHAMBURGERS and QTACOS repre- sent the quantities you plan to consume during the week.
The budget constraint limits the amount that you can be spent on these items. A graph depicting this constraint is referred to as the budget line. The slope of this line is given by:
Slope of budget line = - (PHAMBURGERS ÷ PTACOS)
Page 45

23. Example of a Budget Constraint
Tacos
($0.50 each)
Hamburgers
($1.25 each)
Expenditure 10
$5.00 5 2 4
Each of these combinations
represent a point on the
budget line….
Page 46

24. Original budget line
Change in income or both prices
Line BA is the original budget line. It says that Carl can afford either 10 tacos or two hamburgers a week with his $5 weekly budget.
Change in taco price
Change in hamburger price
Page 46

25. The original budget line would shift in to line FG
Change in income or both prices
The original budget line
would shift in to line FG
if Carl’s available income
fell in half (or both prices
doubled). It would shift
out to line ED if Carl’s
income doubled (or both
prices fell in half).
Change in taco price
Change in hamburger price
Page 46

26. The budget line would shift out to line AE if the price of
Original budget line
Change in income or both prices
The budget line would shift
out to line AE if the price of
tacos fell in half or shift in
to line AF if taco prices fell
in half. Note the price of
hamburgers did not change!
Change in taco price
Change in hamburger price
Page 46

27. Finally, the budget line would shift out to line BD if the price
Original budget line
Change in income or both prices
Finally, the budget line would
shift out to line BD if the price
of hamburgers fell in half, or
in to line line BG if the price
of hamburgers doubled.
Change in taco price
Change in hamburger price
Page 46

28. Engel’s Law:
The more wealthy a consumer becomes, the percentage of income spent for food decreases.
1857

30. Chapter 4 unites the concepts of indifference curves with a budget constraint to determine consumer equilibrium….