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Consumer Behavior and Utility Maximization

Consumer Behavior and Utility Maximization. Chapter 19 AP Economics. Law of Diminishing Marginal Utility. Added satisfaction declines as a consumer acquires additional units of a given product Consumer wants in general are insatiable, but wants for particular items can be satisfied

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Consumer Behavior and Utility Maximization

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  1. Consumer Behavior and Utility Maximization Chapter 19 AP Economics

  2. Law of Diminishing Marginal Utility • Added satisfaction declines as a consumer acquires additional units of a given product • Consumer wants in general are insatiable, but wants for particular items can be satisfied • Durable goods such as an automobile

  3. Utility • A product has utility if it can satisfy a want: Utility has a wanting satisfying power • Satisfaction or pleasure one gets from consuming it • Utility and usefulness are not synonymous • Utility is subjective—a specific product may vary widely from person to person • Utility is difficult to quantify

  4. Total Utility and Marginal Utility • Total utility • Total amount of satisfaction or pleasure a person derives from consuming some specific quantity • Marginal utility • The extra satisfaction a consumer realizes from an additional unit of that product • Change in total utility that results from the consumption of 1 more unit of a product

  5. 30 20 Total Utility (Utils) ] ] ] ] ] ] ] 10 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 10 8 6 Marginal Utility (Utils) 4 2 0 -2 Law of Diminishing Marginal Utility Total Utility (1) Tacos Consumed Per Meal (2) Total Utility, Utils (3) Marginal Utility, Utils TU 0 10 18 24 28 30 30 28 0 1 2 3 4 5 6 7 10 8 6 4 2 0 -2 Units Consumed Per Meal Marginal Utility MU Units Consumed Per Meal

  6. Theory of Consumer Behavior • Explains how consumers allocate their money incomes among the many goods and services available for purchase

  7. (3) Product B: Price = $2 (2) Product A: Price = $1 (b) Marginal Utility Per Dollar (MU/Price) (b) Marginal Utility Per Dollar (MU/Price) (a) Marginal Utility, Utils (a) Marginal Utility, Utils First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 10 8 7 6 5 4 3 24 20 18 16 12 6 4 12 10 9 8 6 3 2 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Compare Marginal Utilities Then Compare Per Dollar - MU/Price Choose the Highest Check Budget - Proceed to Next Item

  8. (3) Product B: Price = $2 (2) Product A: Price = $1 (b) Marginal Utility Per Dollar (MU/Price) (b) Marginal Utility Per Dollar (MU/Price) (a) Marginal Utility, Utils (a) Marginal Utility, Utils First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 10 8 7 6 5 4 3 24 20 18 16 12 6 4 12 10 9 8 6 3 2 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Again, Compare Per Dollar - MU/Price Choose the Highest Buy One of Each – Budget Has $5 Left Proceed to Next Item

  9. (3) Product B: Price = $2 (2) Product A: Price = $1 (b) Marginal Utility Per Dollar (MU/Price) (b) Marginal Utility Per Dollar (MU/Price) (a) Marginal Utility, Utils (a) Marginal Utility, Utils First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 10 8 7 6 5 4 3 24 20 18 16 12 6 4 12 10 9 8 6 3 2 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Again, Compare Per Dollar - MU/Price Buy One More B – Budget Has $3 Left Proceed to Next Item

  10. (3) Product B: Price = $2 (2) Product A: Price = $1 (b) Marginal Utility Per Dollar (MU/Price) (b) Marginal Utility Per Dollar (MU/Price) (a) Marginal Utility, Utils (a) Marginal Utility, Utils First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 10 8 7 6 5 4 3 24 20 18 16 12 6 4 12 10 9 8 6 3 2 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Again, Compare Per Dollar - MU/Price Buy One of Each – Budget Exhausted

  11. (3) Product B: Price = $2 (2) Product A: Price = $1 (b) Marginal Utility Per Dollar (MU/Price) (b) Marginal Utility Per Dollar (MU/Price) (a) Marginal Utility, Utils (a) Marginal Utility, Utils First Second Third Fourth Fifth Sixth Seventh 10 8 7 6 5 4 3 10 8 7 6 5 4 3 24 20 18 16 12 6 4 12 10 9 8 6 3 2 Theory of Consumer Behavior Numerical Example: Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10 (1) Unit of Product Final Result – At These Prices, Purchase 2 of Item A and4 of B

  12. MU of Product B MU of Product A Price of B Price of A 16 Utils 8 Utils $1 $2 Theory of Consumer Behavior Algebraic Restatement: = = Optimum Achieved - Money Income is Allocated so that the Last Dollar Spent on Each Product Yields the Same Extra or Marginal Utility

  13. 2 Quantity Demanded Price Per Unit of B Price of Product B 1 0 4 6 Quantity Demanded of B Deriving the Demand Curve Same Numeric Example: 4 $2 6 1 Income Effects Substitution Effects DB

  14. Applications and Extensions • DVDs and DVD Players • The Diamond-Water Paradox • The Value of Time • Medical Care Purchases • Cash and Noncash Gifts

  15. 12 Total Expenditure Units of B (Price = $1) Units of A (Price = $1.50) 10 8 Quantity of A 6 4 2 0 2 4 6 8 10 12 Income = $12 Quantity of B PA= $1.50 Income = $12 PB= $1 Return to Chapter 19 Indifference Curve Analysis • Budget Line (Constraint) • Income Changes • Price Changes 0 3 6 9 12 8 6 4 2 0 (Unattainable) $12 12 12 12 12 (Attainable)

  16. 12 10 Combination Units of A Units of B 8 Quantity of A 6 4 2 0 2 4 6 8 10 12 Quantity of B Return to Chapter 19 Indifference Curve Analysis • What is Preferred • Downsloping • Convex to Origin • Marginal Rate of Substitution (MRS) j j k l m 12 6 4 3 2 4 6 8 k l m I

  17. MRS = 12 10 8 Quantity of A 6 4 PB 2 PA 0 2 4 6 8 10 12 Quantity of B Return to Chapter 19 Indifference Curve Analysis • The Indifference Map • Equilibrium Position at Tangency Preferred – But Requires More Income W X I4 I3 I2 I1

  18. 12 Marginal Utility of B Marginal Utility of A 10 = 8 Price of B Price of A Quantity of A 6 X 4 2 I3 I2 0 2 4 6 8 10 12 Quantity of B $1.50 Price of B 1.00 .50 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of B Return to Chapter 19 Derivation of the Demand Curve • Measurement of Utility At $1 Price for B, 6 Units are Purchased 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 DB

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