Lecture Economics (18th edition): Chapter 7 - McConnell, Brue, Flynn''s

Chapter 7 - Consumer behavior. In this chapter, you will see how individual consumers allocate their incomes among the various goods and services available to them. Given a certain budget, how does a consumer decide which goods and services to buy? This chapter will develop a model to answer this question. This chapter will also survey some of the recent insights about consumer behavior provided by the field of behavioral economics.

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Consumer Behavior

Chapter 7

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Chapter Objectives

• Total utility and marginal utility

• Law of diminishing marginal utility

• Marginal utility-to-price ratios

• Deriving the demand curve

• Income and substitution effects

• Appendix: the indifference curve model

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Utility Graphically

0 10 20 30

10 8 6 4 2 0 -2

(3) Marginal Utility, Utils

] ] ] ] ] ] ]

10 8 6 4 2 0 -2

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Theory of Consumer Behavior

• Key dimensions of the consumer problem

–Rational behavior

–Preferences

–Budget constraint

–Prices

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Theory of Consumer Behavior

• Find utility maximizing

combination of goods

• Utility maximizing rule

–Allocate income

–Last dollar spent on each

good yields same marginal

utility

–Marginal utility per dollar

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(a) Marginal Utility, Utils

(b) Marginal Utility Per Dollar (MU/Price)

(2)

Apple (product A) Price = $1

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

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(2)

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 $5 left

Proceed to next item

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(2)

24 20 18 16 12 6 4

10 8 7 6 5 4 3

12 10 9 8 6 3 2

Buy one more orange – budget has $3 left Proceed to next item

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(2)

24 20 18 16 12 6 4

10 8 7 6 5 4 3

12 10 9 8 6 3 2

Buy one of each – budget exhausted

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(2)

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 apples and 4 oranges

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Optimum Achieved – Money income

is allocated so that the last dollar spent on each product yields the same extra or

marginal utility

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Quantity Demanded of B

Deriving the Demand Curve

$2 1

4 6

Price Per

Unit of B

Quantity Demanded

D B

Income Effects

Substitution Effects

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Applications and Extensions

• New products increase utility

–iPods

• The diamond-water paradox

• The value of time

• Medical care purchases

• Cash and noncash gifts

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Behavioral Economics

• Human instinct for variety

• Consume more when there

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Next Chapter Preview…

The Costs of

Production

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The Budget Line

4 2

$12 12 12 12 12

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Indifference Curves

What is preferred

– Downsloping and convex

– Marginal rate of substitution

4 2

0

Quantity of B

Combination Units of A Units of B

j k l m

12 6 4 3

2 4 6 8

j

k l

m

I

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Indifference Curve Analysis

• The indifference map

• Equilibrium position at tangency

W Preferred –

But Requires More Income

MRS = P PB

A

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Demand Curve Derived

Record the results

As price of B increases

to $1.50, only 3 units of

B are bought Record the results

Connect the points to create the demand curve for B

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Appendix Key Terms

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Next Chapter Preview…

The Costs of

Production

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