1. Copyright 2011The McGraw-Hill Companies 5-1 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show 5 Consumer Behavior and Utility Maximization

2. Copyright 2011The McGraw-Hill Companies 5-2 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms 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

3. Copyright 2011The McGraw-Hill Companies 5-3 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Law of Diminishing Marginal Utility Terminology –Utility –Total Utility –Marginal Utility Marginal Utility and Demand Graphically… 5.1

4. Copyright 2011The McGraw-Hill Companies 5-4 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Law of Diminishing Marginal Utility 0 10 20 30 10 8 6 4 2 0 -2 1234567 1234567 Total Utility (Utils) Marginal Utility (Utils) (1) Tacos Consumed Per Meal (2) Total Utility, Utils (3) Marginal Utility, Utils 0123456701234567 0 10 18 24 28 30 28 ] ] ] ] ] ] ] 10 8 6 4 2 0 -2 TR MU Total Utility Marginal Utility Units Consumed Per Meal

5. Copyright 2011The McGraw-Hill Companies 5-5 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show 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

6. Copyright 2011The McGraw-Hill Companies 5-6 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10 (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 = R1 (3) Product B: Price = R2 First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 24 20 18 16 12 6 4 10 8 7 6 5 4 3 12 10 9 8 6 3 2 Compare Marginal Utilities Then Compare Per Dollar - MU/Price Choose the Highest Check Budget - Proceed to Next Item

7. Copyright 2011The McGraw-Hill Companies 5-7 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10 (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 = R1 (3) Product B: Price = R2 First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 24 20 18 16 12 6 4 10 8 7 6 5 4 3 12 10 9 8 6 3 2 Again, Compare Per Dollar - MU/Price Choose the Highest Buy One of Each – Budget Has R5 Left Proceed to Next Item

8. Copyright 2011The McGraw-Hill Companies 5-8 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10 (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 = R1 (3) Product B: Price = R2 First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 24 20 18 16 12 6 4 10 8 7 6 5 4 3 12 10 9 8 6 3 2 Again, Compare Per Dollar - MU/Price Buy One More B – Budget Has R3 Left Proceed to Next Item

9. Copyright 2011The McGraw-Hill Companies 5-9 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10 (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 = R1 (3) Product B: Price = R2 First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 24 20 18 16 12 6 4 10 8 7 6 5 4 3 12 10 9 8 6 3 2 Again, Compare Per Dollar - MU/Price Buy One of Each – Budget Exhausted

10. Copyright 2011The McGraw-Hill Companies 5-10 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of R10 (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 = R1 (3) Product B: Price = R2 First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 24 20 18 16 12 6 4 10 8 7 6 5 4 3 12 10 9 8 6 3 2 Final Result – At These Prices, Purchase 2 of Item A and 4 of B 5.1

11. Copyright 2011The McGraw-Hill Companies 5-11 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Theory of Consumer Behavior Algebraic Restatement: MU of Product A Price of A MU of Product B Price of B = 8 Utils R1 16 Utils R2 = Optimum Achieved - Money Income is Allocated so that the Last Dollar Spent on Each Product Yields the Same Extra or Marginal Utility

12. Copyright 2011The McGraw-Hill Companies 5-12 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Price of Product B 0 1 2 46 Quantity Demanded of B Deriving the Demand Curve Same Numeric Example: R2 1 4 6 Price Per Unit of B Quantity Demanded DBDB Income Effects Substitution Effects 5.2

13. Copyright 2011The McGraw-Hill Companies 5-13 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Applications and Extensions DVDs and DVD Players The Diamond-Water Paradox The Value of Time 5.3

14. Copyright 2011The McGraw-Hill Companies 5-14 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Indifference Curve Analysis Budget Line (Constraint) –Income Changes –Price Changes 24681012 Quantity of A 6 8 10 12 4 2 0 Quantity of B Units of A (Price = R1.50) Units of B (Price = R1) Total Expenditure 8642086420 0 3 6 9 12 R12 12 (Attainable) (Unattainable) Income = R12 P A = R1.50 Income = R12 P B = R1 Appendix

15. Copyright 2011The McGraw-Hill Companies 5-15 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Indifference Curve Analysis What is Preferred –Down sloping –Convex to Origin –Marginal Rate of Substitution (MRS) 24681012 Quantity of A 6 8 10 12 4 2 0 Quantity of B Combination Units of AUnits of B jklmjklm 12 6 4 3 24682468 j k l m I Appendix 5.4

16. Copyright 2011The McGraw-Hill Companies 5-16 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Indifference Curve Analysis The Indifference Map Equilibrium Position at Tangency 24681012 Quantity of A 6 8 10 12 4 2 0 Quantity of B I1I1 I2I2 I3I3 I4I4 X W Preferred – But Requires More Income MRS = PBPB PAPA Appendix

17. Copyright 2011The McGraw-Hill Companies 5-17 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Derivation of the Demand Curve Measurement of Utility Price of B R1.50 1.00.50 123456789101112 Quantity of B Marginal Utility of A Marginal Utility of B Price of A Price of B = X 24681012 Quantity of A 6 8 10 12 4 2 0 Quantity of B I2I2 I3I3 DBDB At R1 Price for B, 6 Units are Purchased Record the Results As Price of B Increases to R1.50, Only 3 Units of B are Bought Record the Results Connect the Points to Create the Demand Curve Appendix

18. Copyright 2011The McGraw-Hill Companies 5-18 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms 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” Last Word

19. Copyright 2011The McGraw-Hill Companies 5-19 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms 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 budget line indifference curve marginal rate of substitution (MRS) equilibrium position

20. Copyright 2011The McGraw-Hill Companies 5-20 Law of Diminishing Marginal Utility Theory of Consumer Behavior Deriving the Demand Curve Applications and Extensions Budget Lines Indifference Curves Equilibrium Last Word Key Terms End Show Next Chapter Preview… The Costs of Production