2. Consumer Behavior 06 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

3. 21 - 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 Chapter Objectives 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

4. 21 - 3 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

5. 21 - 4 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...

6. 21 - 5 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 0101 0 10 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

7. 21 - 6 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 0101 0 10 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

8. 21 - 7 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 012012 0 10 18 10 8 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

9. 21 - 8 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 01230123 0 10 18 24 10 8 6 0 1 2 3 4 5 6 7 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 1 2 3 4 5 6 7

10. 21 - 9 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 0123401234 0 10 18 24 28 10 8 6 4 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

11. 21 - 10 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 012345012345 0 10 18 24 28 30 10 8 6 4 2 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

12. 21 - 11 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 01234560123456 0 10 18 24 28 30 10 8 6 4 2 0 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

13. 21 - 12 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 0123456701234567 0 10 18 24 28 30 28 10 8 6 4 2 0 -2 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 TU MU 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

14. 21 - 13 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 0123456701234567 0 10 18 24 28 30 28 10 8 6 4 2 0 -2 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 TU MU 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7 Observe Diminishing Marginal Utility

15. 21 - 14 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

16. 21 - 15 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...

17. 21 - 16 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 10 10 24 12 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?

18. 21 - 17 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 10 10 24 12 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

19. 21 - 18 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 10 10 24 12 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

20. 21 - 19 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 10 10 24 12 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

21. 21 - 20 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 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 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?

22. 21 - 21 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 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 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

23. 21 - 22 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 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 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)

24. 21 - 23 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 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 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

25. 21 - 24 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 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 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...

26. 21 - 25 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 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 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!

27. 21 - 26 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 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 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

28. 21 - 27 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

29. 21 - 28 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:

30. 21 - 29 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

31. 21 - 30 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 $2 1 0 4 6 DBDB

32. 21 - 31 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 $2 1 0 4 6 DBDB Substitution Effects and Income Effects Revisited

33. 21 - 32 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 DVDs and DVD Players The Diamond-Water Paradox The Value of Time Medical Care Purchases Cash and Noncash Gifts O 7.3

34. 21 - 33 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 Criminal Behavior 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”

35. Prospect Theory How people actually deal with life’s up and downs People judge things relative to the status quo People experience: Diminishing marginal utility for gains Diminishing marginal disutility for losses People are loss adverse LO5 6-34

36. Losses and Shrinking Packages Consumers see any price increase as a loss relative to the status quo Producers are reducing package size instead of raising prices LO5 6-35

37. Framing Effects and Advertising Consumers evaluate events in a particular mental frame New information alters the frame in which the consumer defines whether situations are gains or losses LO5 6-36

38. Anchoring and Credit Card Bills Estimates of value are influenced by recent information no matter how irrelevant Can lead to people altering valuations unconsciously LO5 6-37

39. Mental Accounting and Warranties Separate purchases into “mental accounts” rather than looking at the big picture Mental accounting exaggerates any potential loss LO5 6-38

40. The Endowment Effect Market transactions may be affected by the endowment effect because: The seller has a tendency to demand a higher price The buyer has a tendency to offer a lower price LO5 6-39

41. Nudging People Using behavioral economics to change people’s behavior Subtle manipulations are used to generate socially better outcomes Unaware of being manipulated LO5 6-40

42. 21 - 41 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 Key Terms Law of diminishing marginal utility Utility Total utility Marginal utility Rational behavior Budget constraint Utility maximizing rule Income effect Substitution effect 7-41