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Law of Diminishing Marginal Utility Utility is the satisfaction one gets from consuming a good or service Not the same as usefulness Subjective Difficult to quantify LO1 6-2

Law of Diminishing Marginal Utility Util is one unit of satisfaction or pleasure Total utility is the total amount of satisfaction Marginal utility is the extra satisfaction from an additional unit of the good MU = ΔTU/ΔQ LO1 6-3

Law of Diminishing Marginal Utility As consumption of a good or service increases, the marginal utility obtained from each additional unit of the good or service decreases Explains downward sloping demand LO1 6-4

Total Utility and Marginal Utility LO1 0 10 20 30 10 8 6 4 2 0 -2 1234567 1234567 Total Utility (Utils) Marginal Utility (Utils) (2) Total Utility, Utils (3) Marginal Utility, Utils 0123456701234567 0 10 18 24 28 30 28 10 8 6 4 2 0 -2 Total Utility TU (1) Tacos Consumed Per Meal MU ] ] ] ] ] ] ] 6-5

Theory of Consumer Behavior Rational behavior Preferences Budget constraint Prices LO2 6-6

Utility Maximizing Rule Consumer allocates his or her income so that the last dollar spent on each product yields the same amount of extra (marginal) utility Algebraically MU of product A MU of product B Price of A Price of B LO2 = 6-7

Deriving the Demand Curve LO3 Price of Orange 0 \$1 \$2 46 Quantity Demanded of Oranges \$2 1 4 6 Quantity Demanded Price Per Orange DODO 6-8

Income and Substitution Effects Income effect The impact that a price change has on a consumer’s real income Substitution effect The impact that a change in a product’s price has on its relative expensiveness LO4 6-9

Prospect Theory How people actually deal with life’s ups and downs People judge things relative to the status quo People experience: Diminishing marginal utility for gains Diminishing marginal disutility for losses People are loss adverse LO5 6-10

Losses and Shrinking Packages Consumers see any price increase as a loss relative to the status quo Producers are reducing package size instead of raising prices LO5 6-11

Framing Effects and Advertising Consumers evaluate events in a particular mental frame New information alters the frame in which the consumer defines whether situations are gains or losses LO5 6-12

The Endowment Effect Market transactions may be affected by the endowment effect because: The seller has a tendency to demand a higher price The buyer has a tendency to offer a lower price LO5 6-13

The Budget Line: What is Attainable Combinations of two products a consumer can purchase with their money income Slope is the ratio of the price of B to the price of A Location varies with income changes Location varies with price of products LO6 6App-15

24681012 Quantity of A 6 8 10 12 4 2 0 Quantity of B The Budget Line LO6 Units of B (Price = \$1) Units of A (Price = \$1.50) Total Expenditure 8642086420 0 3 6 9 12 \$12 12 (Attainable) (Unattainable) Income = \$12 P A = \$1.50 Income = \$12 P B = \$1 6App-16

Indifference Curves: What is Preferred Combinations of two products that yield the same amount of total utility The consumer is indifferent as to which combination to purchase Characteristics Downsloping Convex to the origin Reflects the MRS LO6 6App-17

Indifference Curves LO6 246 8 1012 Quantity of A 6 8 10 12 4 2 0 Quantity of B Combination Units of AUnits of B jklmjklm 12 6 4 3 24682468 j k l m I 6App-18

The Indifference Map Series of indifference curves where each curve reflects different amounts of utility Each successive curve outward reflects a higher level of utility LO6 6App-19

The Indifference Map LO6 246810 12 Quantity of A 6 8 10 12 4 2 0 Quantity of B I1I1 I2I2 I3I3 I4I4 6App-20

Equilibrium at Tangency The consumer’s equilibrium position Indifference curve is tangent to the budget line Utility is maximized MRS equals the ratio of the price of B to the price of A LO6 6App-21

Equilibrium at Tangency LO6 24681012 Quantity of A 6 8 10 12 4 2 0 Quantity of B I1I1 I2I2 I3I3 I4I4 X W Preferred – but requires more income MRS = PBPB PAPA 6App-22

Derivation of the Demand Curve LO6 Price of B \$1.50 1.00.50 24681012 Quantity of B X 24681012 Quantity of A 6 8 10 12 4 2 0 Quantity of B I2I2 I3I3 DBDB 6App-23