Law of Diminishing Marginal Utility Theory of Consumer

Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Key Terms End Show 19 Consumer Behavior and Utility Maximization Click to Link to Appendix 19: Indifference Curve Analysis 19 -1 Copyright 2008 The Mc. Graw-Hill Companies

Chapter Objectives Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Key Terms End Show 19 -2 • Total Utility, Marginal Utility, and the Law of Diminishing Marginal Utility • How Rational Consumers Compare Marginal Utility-to-Price Ratios for Products in Purchasing Combinations to Maximize Total Utility • How to Derive the Demand Curve by Observing Behavior • How the Utility-Maximization Model Highlights Income and Substitution Effects of a Price Change • Budget Lines, Indifference Curves, Utility Maximization, and Demand Derivation in the Indifference Curve Model of Consumer Behavior Copyright 2008 The Mc. Graw-Hill Companies

Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix • Terminology –Utility –Total Utility –Marginal Utility • Marginal Utility and Demand Key Terms Graphically… End Show 19 -3 O 19. 1 Copyright 2008 The Mc. Graw-Hill Companies G 19. 1

Law of Diminishing Marginal Utility (1) (2) (3) Tacos Total Marginal Consumed Utility, Per Meal Utils 0 1 2 3 4 5 6 7 0 ] 18 ] 24 ] 28 ] 30 ] 28 10 8 4 2 0 -2 Key Terms End Show 19 -4 Copyright 2008 The Mc. Graw-Hill Companies 30 TR 20 10 0 6 Marginal Utility (Utils) Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Total Utility (Utils) Total Utility 1 2 3 4 5 6 Units Consumed Per Meal 7 Marginal Utility 10 8 6 4 2 0 -2 MU 1 2 3 4 5 6 Units Consumed Per Meal 7

Theory of Consumer Behavior Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Key Terms End Show 19 -5 • Consumer Choice and Budget Constraint – Rational Behavior – Preferences – Budget Constraint – Prices • Utility Maximizing Rule – Allocate Money Income so that Last Dollar Spent on Each Product Yields the Same Marginal Utility Copyright 2008 The Mc. Graw-Hill Companies

Theory of Consumer Behavior Numerical Example: Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product (2) Product A: Price = $1 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils (3) Product B: Price = $2 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils First 10 10 Second 8 8 Third 7 7 Compare Marginal Utilities Fourth 6 6 24 20 18 16 12 10 9 8 Then Compare Per Dollar - MU/Price Fifth 5 5 12 6 Choose the 4 Highest 4 Sixth 6 3 Check - Proceed to Next Item 2 Seventh Budget 3 3 4 Key Terms End Show 19 -6 Copyright 2008 The Mc. Graw-Hill Companies

Theory of Consumer Behavior Numerical Example: Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product First Second Third Again, Fourth (2) Product A: Price = $1 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils 10 8 7 Compare 6 10 8 7 Per 6 (3) Product B: Price = $2 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils Dollar 24 12 20 10 18 9 - MU/Price 16 8 Choose the 5 Highest 5 Fifth 12 6 Buy Has Sixth One of 4 Each – Budget 4 6 $5 Left 3 Proceed to 3 Next Item Seventh 3 4 2 Key Terms End Show 19 -7 Copyright 2008 The Mc. Graw-Hill Companies

Theory of Consumer Behavior Numerical Example: Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product First Second Third Fourth (2) Product A: Price = $1 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils 10 8 7 6 (3) Product B: Price = $2 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils 24 20 18 16 12 10 9 8 Again, Compare Per 5 Dollar -12 MU/Price 6 Fifth 5 Buy One More B – Budget Has $3 Left Sixth 4 4 6 3 Proceed to 3 Next Item Seventh 3 4 2 Key Terms End Show 19 -8 Copyright 2008 The Mc. Graw-Hill Companies

Theory of Consumer Behavior Numerical Example: Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product First Second Third Fourth (2) Product A: Price = $1 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils 10 8 7 6 (3) Product B: Price = $2 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils 24 20 18 16 12 10 9 8 Fifth 5 5 12 6 Again, Compare Per 4 Dollar - MU/Price Sixth 4 6 3 Buy One of 3 Each – 3 Budget Exhausted Seventh 4 2 Key Terms End Show 19 -9 Copyright 2008 The Mc. Graw-Hill Companies

Theory of Consumer Behavior Numerical Example: Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product First Second Third Fourth (2) Product A: Price = $1 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils 10 8 7 6 (3) Product B: Price = $2 (b) Marginal (a) Utility Marginal Per Dollar Utility, (MU/Price) Utils 24 20 18 16 12 10 9 8 Fifth 5 12 6 Final Result – At 5 These Prices, Sixth 4 4 6 3 Purchase 2 of Item A and 44 of B 2 W 19. 1 Seventh 3 3 Key Terms End Show 19 -10 Copyright 2008 The Mc. Graw-Hill Companies

Theory of Consumer Behavior Algebraic Restatement: Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix MU of Product A Price of A 8 Utils $1 = = MU of Product B Price of B 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 Key Terms End Show 19 -11 Copyright 2008 The Mc. Graw-Hill Companies

Deriving the Demand Curve Same Numeric Example: 2 Price Per Quantity Unit of B Demanded $2 4 1 6 Price of Product B Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix 1 Income Effects Key Terms DB 0 Substitution Effects End Show 19 -12 Copyright 2008 The Mc. Graw-Hill Companies 4 6 Quantity Demanded of BO 19. 2

Applications and Extensions Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix • DVDs and DVD Players • The Diamond-Water Paradox O 19. 3 • The Value of Time • Medical Care Purchases Key Terms • Cash and Noncash Gifts End Show 19 -13 Copyright 2008 The Mc. Graw-Hill Companies

Criminal Behavior st Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Key Terms End Show 19 -14 La d r Wo • Economic Analysis Offers Insights Into Property Crimes Such as Robbery, Burglary, and Auto Theft • Theory of a Rational Consumer • Buy Versus Steal Decision • Compare Marginal Utility of Item Versus Costs – Guilt, Fines, or Prison Time • Crime May Be Reduced by “Increasing” the “Price of Crime” Copyright 2008 The Mc. Graw-Hill Companies

Key Terms Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Key Terms End Show 19 -15 • law of diminishing marginal utility • total utility • marginal utility • rational behavior • budget constraint • utility-maximizing rule • income effect • substitution effect Copyright 2008 The Mc. Graw-Hill Companies

Next Chapter Preview… Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix The Costs of Production Key Terms End Show Click to Link to Appendix 19: Indifference Curve Analysis 19 -16 Copyright 2008 The Mc. Graw-Hill Companies

Indifference Curve Analysis Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Indifference Curve Analysis Demand Curve Appendix Terms • Budget Line (Constraint) –Income Changes –Price Changes 12 Units of A Units of B Total (Price = $1. 50) (Price = $1) Expenditure 8 6 4 2 0 0 3 6 9 12 $12 12 12 Key Terms 10 Quantity of A Appendix Income = $12 PA = $1. 50 8 (Unattainable) 6 4 2 0 (Attainable) 2 4 6 Income = $12 PB = $1 8 Quantity of B 10 12 End Show 19 -17 Return to Chapter 19 Copyright 2008 The Mc. Graw-Hill Companies

Indifference Curve Analysis Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Indifference Curve Analysis Demand Curve Appendix Terms – Downsloping – Convex to Origin – Marginal Rate of Substitution (MRS) 12 j Combination Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 8 k 6 l 4 m 2 0 Key Terms End Show 10 Quantity of A Appendix • What is Preferred I 2 4 6 8 Quantity of B 10 12 O 19. 4 19 -18 Return to Chapter 19 Copyright 2008 The Mc. Graw-Hill Companies

Indifference Curve Analysis Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix 12 10 MRS = Quantity of A Appendix • The Indifference Map • Equilibrium Position at Tangency 8 6 W X 4 Indifference Curve Analysis Demand Curve Appendix Terms 2 Key Terms 0 Preferred – But Requires More Income I 4 I 3 I 1 2 End Show 19 -19 PB PA 4 6 8 Quantity of B 10 I 2 12 Return to Chapter 19 Copyright 2008 The Mc. Graw-Hill Companies

Derivation of the Demand Curve Indifference Curve Analysis Demand Curve Appendix Terms 12 Quantity of A Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix 10 Marginal Utility of A 8 Price of A 6 X 4 2 I 2 0 Price of B Appendix • Measurement of Utility 2 4 6 8 10 Quantity of B $1. 50 1. 00. 50 Key Terms End Show 12 DB 1 2 3 4 5 6 7 8 9 101112 Quantity of B 19 -20 Copyright 2008 The Mc. Graw-Hill Companies I 3 = Marginal Utility of B 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 Record the Results Connect the Points to Create the Demand Curve Return to Chapter 19

Appendix Key Terms Appendix Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix Indifference Curve Analysis Demand Curve Appendix Terms • budget line • indifference curve • marginal rate of substitution (MRS) • indifference map • equilibrium position Key Terms End Show 19 -21 Return to Chapter 19 Copyright 2008 The Mc. Graw-Hill Companies

Next Chapter Preview… Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Last Word Appendix The Costs of Production Indifference Curve Analysis Demand Curve Appendix Terms Key Terms End Show 19 -22 Return to Chapter 19 Copyright 2008 The Mc. Graw-Hill Companies