1 C H A P T E R 7 1 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Consumer Choice

2 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Consumer Behavior  The theory of consumer behavior explores the decisions made by individual consumers and makes the connection between those decisions and the market demand curve.

3 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin The Marginal Principle and Individual Demand  To determine the quantity produced at a given price, the consumer considers the benefit and cost of buying the good.  Each point on the individual demand curve is the result of a rational choice by the consumer.

4 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin The Individual Demand Curve  The marginal principle can be used to show how consumers incorporate benefits and costs into their consumption decisions. Marginal PRINCIPLE Increase the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost.

5 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Total Utility and Marginal Utility  The benefit of consuming a good is called total utility, and is measured in utils, or imaginary units of satisfaction.  This benefit is “tested” by the consumer after each unit has been consumed, or on a per-unit basis, using the marginal principle.  Marginal utility is the change in total utility resulting from the consumption of one additional unit of the good.

6 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Total Utility and Marginal Utility  Total utility increases at a decreasing rate, while marginal utility decreases.

7 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Total Utility and Marginal Utility Marginal Utility and the Marginal Principle Number of burgers Marginal benefit of burgers = Marginal utility of burgers (utils) Number of tacos Marginal utility of tacos (utils) Marginal cost of burgers = 3 times the marginal utility of tacos (utils) Assumptions: Consumer’s income = $30.00 Price of a burger = $3.00 Price of a taco = $1.00

8 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin The Marginal Benefit of Consumption Marginal Benefit of Burgers Number of burgers Marginal benefit of burgers = Marginal utility of burgers (utils)

9 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Finding the Marginal Cost of Consumption  Five burgers cost $15, leaving $15 to spend on tacos, or 15 tacos.  The marginal utility of 15 tacos is one util.  Given the price of burgers and tacos, there is a tradeoff of 3 tacos per burger.  Marginal cost of a burger = marginal utility of tacos x tradeoff between burgers and tacos.  Marginal cost of fifth burger = 1 util per taco x 3 tacos per burger

10 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin The Marginal Cost of Consumption The Marginal Cost of Burgers Number of burgers Number of tacos Marginal utility of tacos (utils) Marginal cost of burgers = 3 times the marginal utility of tacos (utils)

11 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Marginal cost (utils) Marginal benefit (utils)Quantity Finding a Point on the Demand Curve  Marginal benefit equals marginal cost when 8 burgers are consumed.  The marginal principle is satisfied at point m.  A point on the demand curve: at a price of $3, the quantity of burgers demanded equals

© 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Finding a Point on the Demand Curve  The marginal principle is satisfied at point m, which demonstrates why at a price of $3, the quantity of burgers demanded equals 8 (a point on the demand curve).

13 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin The Utility-maximizing Rule  The consumer maximizes utility by picking the affordable combination of consumer goods that makes the marginal utility per dollar spent on each good equal to that of a second good: