06 Consumer Behavior McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved Chapter Objectives 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 End Show 21 - Next Slide • 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 Copyright McGraw-Hill/Irwin, 2002 THE LAW OF DEMAND A Closer Look… 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 End Show 21 - Next Slide 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 Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility LAW OF DIMINISHING MARGINAL UTILITY • Utility Defined • Subjective Nature • Difficult to Quantify Total Utility Marginal Utility graphically examine Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions Key Terms Previous Slide End Show 21 - Next Slide Copyright McGraw-Hill/Irwin, 2002 TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination 10 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, Utility, per meal Utils Utils Utility Maximization and the Demand Curve Marginal Utility (utils) Key Terms End Show 21 - 10 Applications and Extensions Previous Slide 20 Next Slide Units consumed per meal 10 -2 Copyright McGraw-Hill/Irwin, 2002 2 Units consumed per meal TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination 10 10 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, Utility, per meal Utils Utils Utility Maximization and the Demand Curve Marginal Utility (utils) Key Terms End Show 21 - 10 Applications and Extensions Previous Slide 20 Next Slide Units consumed per meal 10 -2 Copyright McGraw-Hill/Irwin, 2002 2 Units consumed per meal TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve 10 18 10 Marginal Utility (utils) Key Terms End Show 21 - 20 10 Applications and Extensions Previous Slide 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, Utility, per meal Utils Utils Next Slide Units consumed per meal 10 -2 Copyright McGraw-Hill/Irwin, 2002 2 Units consumed per meal TOTAL AND MARGINAL UTILITY Law of Diminishing Marginal Utility Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve 10 18 24 10 Key Terms Previous Slide End Show 21 - Next Slide 20 10 Marginal Utility (utils) Applications and Extensions 30 Total Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, Utility, per meal Utils Utils Units consumed per meal 10 -2 Copyright McGraw-Hill/Irwin, 2002 2 Units consumed per meal TOTAL AND MARGINAL UTILITY Total and Marginal Utility Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions 10 18 24 28 10 Key Terms Previous Slide End Show 21 - Next Slide Total Utility (utils) Law of Diminishing Marginal Utility 30 20 10 Marginal Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, Utility, per meal Utils Utils Units consumed per meal 10 -2 Copyright McGraw-Hill/Irwin, 2002 2 Units consumed per meal TOTAL AND 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 End Show 21 - 10 10 18 24 28 30 10 Next Slide Total Utility (utils) Law of Diminishing Marginal Utility 30 20 10 Marginal Utility (utils) The Law of Demand Tacos Total Marginal consumed Utility, Utility, per meal Utils Utils Units consumed per meal 10 -2 Copyright McGraw-Hill/Irwin, 2002 2 Units consumed per meal UTILITY MAXIMIZING COMBINATION The Law of Demand Law of Diminishing Marginal Utility Total and Marginal Utility Algebraic Restatement of the Utility Maximization Rule Theory of Consumer Behavior Utility Maximizing Combination Utility Maximization and the Demand Curve Applications and Extensions MU of product A Price of A Key Terms Previous Slide End Show 21 - 27 Next Slide Copyright McGraw-Hill/Irwin, 2002 = MU of product B Price of B 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 End Show 21 - 28 Next Slide UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Given from the previous example schedule: • Preferences or Tastes • Money Income • Prices of Other Goods 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 End Show 21 - 29 Next Slide UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Create a demand schedule from the purchase decisions as the price of the product is varied Price per unit of B $2 Quantity Demanded Graphically… Copyright McGraw-Hill/Irwin, 2002 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 End Show 21 - 30 Price per unit of Good B The Law of Demand UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve $2 DB Next Slide Copyright McGraw-Hill/Irwin, 2002 Quantity Demanded of Good B 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 End Show 21 - 31 $2 Substitution Effects and Income Effects Revisited Price per unit of Good B The Law of Demand UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve DB Next Slide Copyright McGraw-Hill/Irwin, 2002 Quantity Demanded of Good B Applications and Extensions 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 • DVDs and DVD Players • The Diamond-Water Paradox • The Value of Time • Medical Care Purchases Key Terms Previous Slide End Show 21 - 32 Next Slide • Cash and Noncash Gifts Copyright McGraw-Hill/Irwin, 2002 O 7.3 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 End Show 21 - 33 Next Slide 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” Copyright McGraw-Hill/Irwin, 2002 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 Losses and Shrinking Packages • Consumers see any price increase as • LO5 a loss relative to the status quo Producers are reducing package size instead of raising prices 6-35 Framing Effects and Advertising • Consumers evaluate events in a • LO5 particular mental frame New information alters the frame in which the consumer defines whether situations are gains or losses 6-36 Anchoring and Credit Card Bills • Estimates of value are influenced by • LO5 recent information no matter how irrelevant Can lead to people altering valuations unconsciously 6-37 Mental Accounting and Warranties • Separate purchases into “mental • LO5 accounts” rather than looking at the big picture Mental accounting exaggerates any potential loss 6-38 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 Nudging People • Using behavioral economics to • • LO5 change people’s behavior Subtle manipulations are used to generate socially better outcomes Unaware of being manipulated 6-40 Key Terms 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 End Show 21 - 41 Next Slide • Law of diminishing marginal utility • Utility • Total utility • Marginal utility • Rational behavior • Budget constraint • Utility maximizing rule • Income effect • Substitution effect Copyright McGraw-Hill/Irwin, 2002 7-41 ... Marginal utility, utils First 10 10 24 12 Second 8 20 10 Third 7 18 Fourth What 6 16 next? Fifth 5 12 Buy one of each Sixth 4 Seventh 3 Copyright McGraw-Hill/Irwin, 2002 UTILITY MAXIMIZING COMBINATION... MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Given from the previous example schedule: • Preferences or Tastes • Money Income • Prices of Other Goods Copyright McGraw-Hill/Irwin,... Slide UTILITY MAXIMIZATION AND THE DEMAND CURVE Deriving the Demand Schedule and Curve Create a demand schedule from the purchase decisions as the price of the product is varied Price per unit