1. Theory of Consumer Behavior
Chapter 3

2. Discussion Topics Utility theory Indifference curves
The budget constraint

3. Utility Function Total utility = Qhamburgers x Qpizza
A utility function is an algebraic expression
that allows us to rank consumption bundles
or combinations of goods.
Total utility = Qhamburgers x Qpizza
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4. Utility Function Total utility = Qhamburgers x Qpizza
A utility function is an algebraic expression
that allows us to rank consumption bundles
or combinations of goods.
Total utility = Qhamburgers x Qpizza
This approach assumes that utility is
cardinally measurable in the same sense
that a ruler measures distance.
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5. Quantity of hamburgers
Ranking Total Utility
Bundle
Quantity of hamburgers
Quantity of pizza
Total Utility A
2.5
10.0 25 B
3.0
7.0 21 C
2.0
12.5
Ranking of consumption bundles

6. Quantity of hamburgers
Ranking Total Utility
Bundle
Quantity of hamburgers
Quantity of pizza
Total Utility A
2.5
10.0 25 B
3.0
7.0 21 C
2.0
12.5
Rank A and C over B
Indifferent between A and C

7. Marginal Utility Marginal utility is the change in utility
derived from an increase in consumption
of a particular good.
MUhamburgers =  utility ÷  hamburgers
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8. Marginal Utility Marginal utility is the change in utility
derived from an increase in consumption
of a particular good.
MUhamburgers =  utility ÷  hamburgers
This value will fall (rise) as consumption
increases (decreases).
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9. Marginal utility goes
to zero at the peak of
the total utility curve
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10. Indifference Curves Cardinal measurement of utility is both
unreasonable and unnecessary. We can
instead use an ordinal measurement of utility,
which means all we need to know is that one
bundle is preferred over another.
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11. Indifference Curves Cardinal measurement of utility is both
unreasonable and unnecessary. We can
instead use an ordinal measurement of utility,
which means all we need to know is that one
bundle is preferred over another.
Modern consumption theory is based upon the notion of isoutility curves, where “iso” is
the Greek for “equal”. The consumer is
assumed to be indifferent among different
combinations of goods along a isoutility curve.
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12. Increasing
utility
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13. The two indifference
curves here can be
thought of as providing
200 and 700 utils of
utility.
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14. The two indifference
curves here can be
thought of as providing
200 and 700 utils of
utility.
One would normally
expect a number of
additional isoutility
or indifference curves.
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15. Slope of Indifference Curve
The slope of an indifference curve is known
as the marginal rate of substitution (MRS).
The marginal rate of substitution of hamburgers
for tacos is given by:
MRS =  tacos ÷ hamburgers
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16. Slope of Indifference Curve
The slope of an indifference curve is known
as the marginal rate of substitution (MRS).
The marginal rate of substitution of hamburgers
for tacos is given by:
MRS =  tacos ÷ hamburgers
The MRS reflects the number of tacos a consumer
is willing to give up for an additional hamburger.
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17. The MRS between points M and Q is equal to:
-2.0 = -2 ÷ 1.0
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18. This means the consumer is willing to give up 2 tacos in exchange for one additional hamburger!
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19. This means the consumer is willing to give up 2 tacos in exchange for one additional hamburger!
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20. Which bundle would you prefer more…bundle M or bundle Q?
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21. The answer is that this we would be indifferent because they give us the same utility. The ultimate choice will depend on the prices of these two products.
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22. What about the choice between bundle M and bundle P?
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23. We would prefer bundle P over bundle M because it gives us more utility or satisfaction. The question is whether we can afford to buy 5 tacos and 5 hamburgers!
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24. Concept of Budget Constraint
Weekly budget for fast food:
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS  BUDGET
where PHAMBURGERS and PTACOS represent the current price of hamburgers and tacos while QHAMBURGERS and QTACOS repre- sent the quantities you plan to consume during the week.
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25. Concept of Budget Constraint
Weekly budget for fast food:
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS  BUDGET
where PHAMBURGERS and PTACOS represent the current price of hamburgers and tacos while QHAMBURGERS and QTACOS repre- sent the quantities you plan to consume during the week.
The budget constraint limits the amount that you can be spent on these items. A graph depicting this constraint is referred to as the budget line. The slope of this line is given by:
Slope of budget line = - (PHAMBURGERS ÷ PTACOS)
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26. Example of a Budget Constraint
Tacos
($0.50 each)
Hamburgers
($1.25 each)
Expenditure 10
$5.00 5 2 4
Each of these combinations
represent a point on the
budget line….
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27. Original budget line
Change in income or both prices
Line BA is the original budget line. It says that Carl can afford either 10 tacos or two hamburgers a week with his $5 weekly budget.
Change in taco price
Change in hamburger price
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28. The original budget line would shift in to line FG
Change in disposable income
The original budget line
would shift in to line FG
if Carl’s available income
fell in half (or both prices
doubled). It would shift
out to line ED if Carl’s
income doubled (or both
prices fell in half).
Change in taco price
Change in hamburger price
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29. The budget line would shift out to line AE if the price of
Original budget line
Change in disposable income
The budget line would shift
out to line AE if the price of
tacos fell in half or shift in
to line AF if taco prices fell
in half. Note the price of
hamburgers did not change!
Change in taco price
Change in hamburger price
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30. Finally, the budget line would shift out to line BD if the price
Original budget line
Change in income or both prices
Finally, the budget line would
shift out to line BD if the price
of hamburgers fell in half, or
in to line line BG if the price
of hamburgers doubled.
Change in taco price
Change in hamburger price
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31. In Summary
Consumers rank preferences based upon utility or the satisfaction derived from consumption
Businesses spend millions of dollars on product research
A budget constraint limits the amount we can buy in a particular period
Price is therefore important

32. Chapter 4 unites the concepts of indifference curves with a budget constraint to determine consumer equilibrium….