CONSUMER BEHAVIOR AND UTILITY MAXIMIZATION Pertemuan 17 Matakuliah: J0114-Teori Ekonomi Tahun: 2009

Bina Nusantara University 3 Law of Diminishing Marginal Utility Terminology – Utility is the benefit or satisfaction a person receives from consuming a good or a services – Total Utility is total amount of of satisfaction or pleasure a person derives from consuming some specific – Marginal Utility is the extra satisfaction aconsumer realizes from and additional unit of that product

Bina Nusantara University 4 Law of Diminishing Marginal Utility Total Utility (Utils) Marginal Utility (Utils) (1) Tacos Consumed Per Meal (2) Total Utility, Utils (3) Marginal Utility, Utils ] ] ] ] ] ] ] TR MU Total Utility Marginal Utility Units Consumed Per Meal

Bina Nusantara University 5 Theory of Consumer Behavior 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

Bina Nusantara University 6 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product (a) Marginal Utility, Utils (a) Marginal Utility, Utils (b) Marginal Utility Per Dollar (MU/Price) (b) Marginal Utility Per Dollar (MU/Price) (2) Product A: Price = $1 (3) Product B: Price = $2 First Second Third Fourth Fifth Sixth Seventh Final Result – At These Prices, Purchase 2 of Item A and 4 of B

Bina Nusantara University 7 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

Bina Nusantara University 8 Price of Product B Quantity Demanded of B Deriving the Demand Curve Same Numeric Example: $ Price Per Unit of B Quantity Demanded DBDB Income Effects Substitution Effects

Bina Nusantara University 9 Applications and Extensions DVDs and DVD Players The Diamond-Water Paradox The Value of Time Medical Care Purchases Cash and Noncash Gifts O 19.3

Bina Nusantara University 10 Indifference Curve Analysis Budget Line (Constraint) –Income Changes –Price Changes Quantity of A Quantity of B Units of A (Price = $1.50) Units of B (Price = $1) Total Expenditure $12 12 (Attainable) (Unattainable) Income = $12 P A = $1.50 Income = $12 P B = $1

Bina Nusantara University 11 Indifference Curve Analysis What is Preferred –Downsloping –Convex to Origin –Marginal Rate of Substitution (MRS) Quantity of A Quantity of B Combination Units of AUnits of B jklmjklm j k l m I

Bina Nusantara University 12 Indifference Curve Analysis The Indifference Map Equilibrium Position at Tangency Quantity of A Quantity of B I1I1 I2I2 I3I3 I4I4 X W Preferred – But Requires More Income MRS = PBPB PAPA

Bina Nusantara University 13 Derivation of the Demand Curve Measurement of Utility Price of B $ Quantity of B Marginal Utility of A Marginal Utility of B Price of A Price of B = X Quantity of A Quantity of B I2I2 I3I3 DBDB 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