Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show Consumer Behavior and Utility Maximization 21 C H A P T E R

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show THE LAW OF DEMAND A Closer Look… The Income Effect A lower price frees income for additional purchases - and vice versa The Substitution Effect A lower price relative to other goods attracts new buyers - and vice versa

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show LAW OF DIMINISHING MARGINAL UTILITY Utility Defined Subjective Nature Difficult to Quantify Total Utility Marginal Utility graphically examined...

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils) TU MU

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils Units consumed per meal Total Utility (utils) Marginal Utility (utils) TU MU Observe Diminishing Marginal Utility

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show THEORY OF CONSUMER BEHAVIOR A Typical Consumer... Exhibits Rational Behavior Has Clear-Cut Preferences Subject to a Budget Constraint Responds to Price Changes

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show THEORY OF CONSUMER BEHAVIOR Utility Maximizing Rule The consumer’s money income should be allocated so that the last dollar spent on each product yields the same amount of extra (marginal) utility illustrated...

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION How should the $10 Income be allocated?

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION Examine the two marginal utilities

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION Examine the two marginal utilities …per dollar

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION Decision: Buy 1 Product B for $2

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Second Third Fourth Fifth Sixth Seventh Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION What next?

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Second Third Fourth Fifth Sixth Seventh Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION What next? Buy one of each

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Second Third Fourth Fifth Sixth Seventh Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION and then... ($5 left)

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Second Third Fourth Fifth Sixth Seventh Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION third unit of product B

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Second Third Fourth Fifth Sixth Seventh Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION $3 left...

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Second Third Fourth Fifth Sixth Seventh Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION $3 left... Buy both!

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show First Second Third Fourth Fifth Sixth Seventh Unit of product $ 10 income Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price) UTILITY MAXIMIZING COMBINATION Income is gone... the last dollar spent on each good gave the same utility (8) per dollar

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show Algebraic Restatement of the Utility Maximization Rule MU of product A Price of A MU of product B Price of B = UTILITY MAXIMIZING COMBINATION

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Preferences or Tastes Money Income Prices of Other Goods Given from the previous example schedule:

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show UTILITY MAXIMIZATION AND THE DEMAND CURVE Create a demand schedule from the purchase decisions as the price of the product is varied... Price per unit of B Quantity Demanded $24 16 Graphically… Deriving the Demand Schedule and Curve

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Quantity Demanded of Good B Price per unit of Good B $ DBDB

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Quantity Demanded of Good B Price per unit of Good B $ DBDB Substitution Effects and Income Effects Revisited

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show APPLICATIONS AND EXTENSIONS The Compact Disc Takeover The Diamond-Water Paradox The Value of Time Medical Care Purchases Cash and Noncash Gifts Chapter Conclusions

income effect substitution effect utility total utility marginal utility law of diminishing marginal utility rational behavior budget constraint utility-maximizing rule ENDBACK Copyright McGraw-Hill/Irwin 2002

Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide Next Slide End Show Next… Indifference Curve Analysis