The Theory of Consumer Behavior Rinzie Luyao Stanley Saavedra SLIDES PREPARED BY JUDITH SKUCE, GEORGIAN COLLEGE © 2005 McGraw-Hill Ryerson Ltd Microeconomics, Chapter In this Topic we will learn The two explanations for why the demand curve is downward sloping The theory of consumer choice The connection between utility maximization and the demand curve To apply marginal utility theory to real world situations What consumer surplus is and how to measure it © 2005 McGraw-Hill Ryerson Ltd Microeconomics, Chapter Theory of Consumer Behavior Topics A Closer Look at The Law of Demand Theory of Consumer Choice Utility Maximization and the Demand Curve Applications & Extensions Consumer Surplus © 2005 McGraw-Hill Ryerson Ltd Microeconomics, Chapter Income & Substitution Effects  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 © 2005 McGraw-Hill Ryerson Ltd Microeconomics, Chapter Law of Diminishing Marginal Utility gains in satisfaction decline as additional units are consumed  Terminology   utility  is want-satisfying power (units - utils) Total & Marginal Utility  total utility: total amount of satisfaction  marginal utility: extra satisfaction from consuming one more unit graphically examined © 2005 McGraw-Hill Ryerson Ltd Microeconomics, Chapter Total and Marginal Utility Total Utility 10 18 24 28 30 30 28 © 2005 McGraw-Hill Ryerson Ltd Figure Marginal Utility TU Total Utility 40 total utility Tacos consumed per meal 30 20 10 0 quantity Microeconomics, Chapter 6 Total and Marginal Utility Total Utility 10 18 24 28 30 30 28 © 2005 McGraw-Hill Ryerson Ltd Figure Marginal Utility TU Total Utility 40 total utility Tacos consumed per meal 30 20 10 0 quantity Microeconomics, Chapter Total and Marginal Utility Total Utility 10 18 24 28 30 30 28 © 2005 McGraw-Hill Ryerson Ltd Figure Marginal Utility TU Total Utility 40 total utility Tacos consumed per meal 30 20 10 0 quantity Microeconomics, Chapter Total and Marginal Utility 10 18 24 28 30 30 28 © 2005 McGraw-Hill Ryerson Ltd Figure Marginal Utility TU 10 Total Utility 40 total utility Total Utility 30 20 10 0 8 quantity Marginal Utility marginal utilitiy Tacos consumed per meal 15 10 -5 quantity Microeconomics, Chapter Total and Marginal Utility 10 18 24 28 30 30 28 © 2005 McGraw-Hill Ryerson Ltd Figure Marginal Utility TU 10 Total Utility 40 total utility Total Utility 30 20 10 0 8 quantity Marginal Utility marginal utilitiy Tacos consumed per meal 15 10 -5 quantity Microeconomics, Chapter 10 Indifference Curves Units of A Units of B j 12 k l m j 10 Quantity of A combination 12 k 2 © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 49 Indifference Curves Units of A Units of B j 12 k l m j 10 Quantity of A combination 12 k l 2 © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 50 Indifference Curves Units of A Units of B j 12 k l m j 10 Quantity of A combination 12 k l m 2 © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 51 Indifference Curves Units of A Units of B j 12 k l m j 10 Quantity of A combination 12 k l m I © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 52 Indifference Curves 12 j Indifference Indifference curves curves are are downsloping downsloping Quantity of A 10 k l m I © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 53 Indifference Curves 12 j Indifference Indifference curves curves are are convex convex to to the the origin origin Quantity of A 10 k l m I © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 54 Indifference Curves 12 j 10 Quantity of A Marginal Marginal rate rate of of substitution substitution (MRS) (MRS) is is the the slope slope of of the the indifference indifference curve curve at at any any point point MRS MRS diminishes, diminishes, so so curve curve is is convex convex k l m I © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 55 Indifference Curves 12 Quantity of A Indifference Indifference map map shows shows aa series series of of indifference indifference curves, curves, for for different different levels levels of of utility utility 10 I4 I3 I2 I1 2 © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 56 Equilibrium at Tangency 12 Quantity of A Point Point XX represents represents the the optimal optimal attainable attainable combination combination of of products productsAA&& BB 10 X I4 I3 I2 I1 2 © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 57 The Measurement of Utility     marginal utility theory assumes utility is numerically measurable indifference curve approach requires only that a consumer specify if a particular combination of products yields more or less utility than another at equilibrium, MRS=PB/PA equivalent to marginal utility approach since MU A MU B PB MU B MU B     MRS  PA PB PA MU A MU A © 2005 McGraw-Hill Ryerson Ltd Microeconomics, Chapter 58 Derivation of the Demand Curve 12 What What happens happens ifif the the price price of of BB increases increases to to $1.50? $1.50? Quantity of A 10 X I4 I3 I2 I1 2 © 2005 McGraw-Hill Ryerson Ltd Quantity of B Microeconomics, Chapter 10 12 59 Derivation of the Demand Curve 12 New New budget budget line line reflects reflects the the price price change change Quantity of A 10 PB=$1.00 X PB=$1.50 © 2005 McGraw-Hill Ryerson Ltd I4 I3 I2 I1 Quantity of B Microeconomics, Chapter 10 12 60 Derivation of the Demand Curve 12 New New equilibrium equilibrium '' point is X point is X Quantity of A 10 PB=$1.00 X' I4 I3 I2 I1 PB=$1.50 © 2005 McGraw-Hill Ryerson Ltd X Quantity of B Microeconomics, Chapter 10 12 61 Derivation of the Demand Curve 12 Recording Recording quantities quantities demanded demanded of of BB at at various various prices prices of of BB yields yields the the demand demand curve curve for for BB Quantity of A 10 X' I4 I3 I2 I1 2 © 2005 McGraw-Hill Ryerson Ltd X Quantity of B Microeconomics, Chapter 10 12 62 PB QB $1.00 $1.50 Price of B We We can can derive derive the the demand demand curve curve without without measuring measuring utility utility in in utils utils Quantity of A Figure A-5 12 10 X' I4 II23 I1 2 10 12 Quantity of B $1.50 $1.00 DB $0.50 © 2005 McGraw-Hill Ryerson Ltd X 10 12 Quantity of B Microeconomics, Chapter 63