1. Consumer Behavior and Utility Maximization
Chapter 19 AP Economics

2. 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

3. 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

4. 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

5. 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

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

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
Compare Marginal Utilities
Then Compare Per Dollar - MU/Price
Choose the Highest
Check Budget - 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
Choose the Highest
Buy One of Each – Budget Has $5 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 More B – Budget Has $3 Left
Proceed to Next Item

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
Again, Compare Per Dollar - MU/Price
Buy One of Each – Budget Exhausted

11. 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

12. 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

13. 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

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

15. 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

16. 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

17. 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

18. 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