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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.
Chapter Consumer Behavior McGrawưHill/Irwin Copyrightâ2009byTheMcGrawưHillCompanies,Inc.Allrightsreserved 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 7-2 Utility • Diminishing marginal utility (again) • Satisfaction obtained from consumption • Three characteristics – Differs from usefulness – Subjective – Difficult to quantify 7-3 Utility • Total utility – Total satisfaction from a specific quantity • Marginal utility – Extra satisfaction from an additional unit • Law of diminishing marginal utility – Explains downward sloping demand 7-4 Utility Graphically (1) (2) (3) Tacos Total Marginal Consumed Utility, Utility, Per Meal Utils Utils 10 18 24 28 30 30 28 ] ] ] ] ] ] ] 10 -2 30 TU 20 10 Marginal Utility (Utils) Total Utility (Utils) Total Utility Units Consumed Per Meal Marginal Utility 10 -2 MU Units Consumed Per Meal 7-5 Theory of Consumer Behavior • Key dimensions of the consumer problem – Rational behavior – Preferences – Budget constraint – Prices 7-6 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 7-7 Numerical Example Combinations of apples and oranges obtainable with an income of $10 (1) Unit of Product (2) Apple (product A) Price = $1 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) (3) Orange (product B) Price = $2 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) First 10 10 24 Second 8 20 Third 7 18 Compare marginal utilities Fourth 6 16 Then compare per dollar - MU/Price Fifth 5 12 Choose the 4highest Sixth Check budget to next4 item Seventh - proceed 12 10 7-8 Numerical Example Combinations of apples and oranges obtainable with an income of $10 (1) Unit of Product (2) Apple (product A) Price = $1 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) First 10 10 Second 8 Third 7 Again, compare per dollar Fourth 6 Choose the highest Fifth 5 Buy – budget Sixth one of each 4 Proceed to next item3 Seventh (3) Orange (product B) Price = $2 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) 24 12 20 10 18 - MU/Price 16 12 has $5 left 7-9 Numerical Example Combinations of apples and oranges obtainable with an income of $10 (1) Unit of Product (2) Apple (product A) Price = $1 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) (3) Orange (product B) Price = $2 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) First 10 10 24 12 Second 8 20 10 Third 7 18 Fourth 6 16 Again, compare per dollar - MU/Price Fifth 5 12 Buy one more orange4 – budget6 has $3 3left Sixth Proceed to next item3 Seventh 7-10 Numerical Example Combinations of apples and oranges obtainable with an income of $10 (1) Unit of Product (2) Apple (product A) Price = $1 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) (3) Orange (product B) Price = $2 (a) Marginal Utility, Utils (b) Marginal Utility Per Dollar (MU/Price) First 10 10 24 12 Second 8 20 10 Third 7 18 Fourth 6 16 Fifth 5 12 Again, compare per dollar - MU/Price Sixth 4 Buy one of each – budget exhausted Seventh 3 7-11 Numerical Example Combinations of apples and oranges obtainable with an income of $10 (2) Apple (product A) Price = $1 (1) Unit of Product (a) Marginal Utility, Utils (b) Marginal Utility Per Dollar (MU/Price) First Second Third Fourth Fifth Sixth Seventh 10 10 (3) Orange (product B) Price = $2 (b) (a) Marginal Marginal Utility Utility, Per Dollar Utils (MU/Price) 24 20 18 16 12 Final result – at these prices, purchase apples and oranges 12 10 7-12 Algebraic Generalization MU of product A price of A Utils $1 = = MU of product B price of B 16 Utils $2 Optimum Achieved – Money income is allocated so that the last dollar spent on each product yields the same extra or marginal utility 7-13 Deriving the Demand Curve Price Per Quantity Unit of B Demanded $2 Price of Product B Income Effects Substitution Effects DB Quantity Demanded of B 7-14 Applications and Extensions • New products increase utility – iPods • The diamond-water paradox • The value of time • Medical care purchases • Cash and noncash gifts 7-15 Behavioral Economics • Human instinct for variety • Consume more when there is more variety – M&Ms • Time inconsistency – Final exams – Retirement savings 7-16 Key Terms • • • • • • • • • Law of diminishing marginal utility Utility Total utility Marginal utility Rational behavior Budget constraint Utility maximizing rule Income effect Substitution effect 7-17 Next Chapter Preview… The Costs of Production 7-18 The Budget Line –Income changes –Price changes 12 Total (Price = $1.50) (Price = $1) Expenditure 0 12 $12 12 12 12 12 10 Quantity of A Units of A Units of B Income = $12 PA = $1.50 (Unattainable) (Attainable) Income = $12 PB = $1 Quantity of B 10 12 7-19 Indifference Curves What is preferred – Downsloping and convex – Marginal rate of substitution 12 j 12 k l m 10 Quantity of A Combination Units of A Units of B j k l m I Quantity of B 10 12 7-20 Indifference Curve Analysis • The indifference map • Equilibrium position at tangency 12 Quantity of A 10 PB MRS = PA W X Preferred – But Requires More Income I4 I3 I1 Quantity of B 10 I2 12 7-21 Demand Curve Derived 12 At $1 price for B, units of B are purchased Quantity of A 10 X Record the results I2 Price of B 10 Quantity of B 12 $1.50 I3 As price of B increases to $1.50, only units of B are bought Record the results 1.00 50 DB 10 Quantity of B 12 Connect the points to create the demand curve for B 7-22 Appendix Key Terms • • • • • Budget Line Indifference curve Marginal rate of substitution (MRS) Indifference map Equilibrium position 7-23 Next Chapter Preview… The Costs of Production 7-24 ... constraint Utility maximizing rule Income effect Substitution effect 7- 17 Next Chapter Preview… The Costs of Production 7- 18 The Budget Line –Income changes –Price changes 12 Total (Price = $1.50)... 7- 22 Appendix Key Terms • • • • • Budget Line Indifference curve Marginal rate of substitution (MRS) Indifference map Equilibrium position 7- 23 Next Chapter Preview… The Costs of Production 7- 24... Marginal Utility 10 -2 MU Units Consumed Per Meal 7- 5 Theory of Consumer Behavior • Key dimensions of the consumer problem – Rational behavior – Preferences – Budget constraint – Prices 7- 6 Theory of