6 Consumer Behavior and Utility Maximization 4 Key Concepts Understanding Utility Total and Marginal Utility Maximization Equalizing Marginal Utility per Dollar MUP A MUP B Individual and Market Demand Curves ID: 551387
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Slide1
AP ECONOMICS – CHAPTER 6
Consumer Behavior and
Utility MaximizationSlide2
4 Key Concepts
Understanding Utility: Total and Marginal
Utility Maximization: Equalizing Marginal Utility per Dollar (MU/P
A
= MU/P
B
)
Individual and Market Demand Curves
Income and Substitution Effects (review from unit two)Slide3
Introduction
The CONSUMER is essential to the market. Understanding how the consumer makes his/her purchasing decisions is key.Slide4
1. Understanding Utility
Utility
= Satisfaction/Happiness/Pleasure one gets from consuming a good.
Utility and usefulness are NOT synonymous in economics.
Utility is difficult to quantify, as it differs between people and situations
ie. A blanket to a person living in Arizona vs. a person living in Minnesota.
Measured in “
utils
” (a personal measure)Slide5
1. Understanding Utility
Total Utility
(TU)
Total amount of satisfaction or pleasure a person derives from consuming a given quantity of that product
Marginal Utility
(MU)
The extra satisfaction a consumer derives from one additional unit of that product.
In other words, the change in Total Utility that results from the consumption of one more unitSlide6
Law of Diminishing Marginal Utility
Explains that the more of a good a person gets, the less utility he gets from each additional unit.
Consumer wants in general are insatiable, but wants for particular items can be satisfied for a time.
Example: Durable goods such as an automobileSlide7
First is the Best
It is important to note that your marginal utility begins to fall after the very first unit you consume.
In other words, your very first taco holds great utility. While you may enjoy your second taco, it doesn’t bring as much utility as the first
At some point, your MU becomes negative. (takes away from your total satisfaction).Slide8
Law of Diminishing Marginal Utility
0
10
20
30
10
8
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4
2
0
-2
1
2
3
4
5
6
7
1
2
3
4
5
6
7
Total Utility (Utils)
Marginal Utility (Utils)
(1)
Tacos
Consumed
Per Meal
(2)
Total
Utility,
Utils
(3)
Marginal
Utility,
Utils
0
1
2
3
4
5
6
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10
18
24
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]
]
]
]
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]
10
8
6
4
2
0
-2
TU
MU
Total Utility
Marginal Utility
Units Consumed Per Meal
Units Consumed Per MealSlide9
2. Utility Maximization
Explains how consumers allocate their money incomes among the many goods and services available for purchase
You will be faced with problems that provide you with a consumer’s MU or TU derived from purchasing 2 goods. You will be expected to show how many of each a rational consumer would purchase.Slide10
Theory of Consumer Behavior
Numerical Example:
Find the Utility-Maximizing Combination of
A
and
B
, if you have an
Income of $10
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar(MU/Price)
(b)MarginalUtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)
Product B:
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
24
20
18
16
12
6
4
10
8
7
6
5
4
3
12
10
9
8
6
3
2Slide11
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A
and
B
Obtainable with an
Income of $10
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar(MU/Price)
(b)MarginalUtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)
Product B:
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
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 Slide12
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A
and
B
Obtainable with an
Income of $10
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar(MU/Price)
(b)MarginalUtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)
Product B:
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
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 Slide13
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A
and
B
Obtainable with an
Income of $10
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar(MU/Price)
(b)MarginalUtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)
Product B:
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
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
Buy One More B – Budget Has $3 Left
Proceed to Next Item Slide14
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A
and
B
Obtainable with an
Income of $10
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar(MU/Price)
(b)MarginalUtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)
Product B:
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
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
Buy One of Each – Budget ExhaustedSlide15
Theory of Consumer Behavior
Numerical Example:
Utility-Maximizing Combination of Products
A
and
B
Obtainable with an
Income of $10
(1)
Unit of
Product
(a)
Marginal
Utility,
Utils
(a)
Marginal
Utility,
Utils
(b)
Marginal
Utility
Per Dollar(MU/Price)
(b)MarginalUtilityPer Dollar(MU/Price)
(2)Product A:Price = $1
(3)
Product B:
Price = $2
First
Second
Third
Fourth
Fifth
Sixth
Seventh
10
8
7
6
5
4
3
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 of Item A
and
4 of B
Slide16
Theory of Consumer Behavior
Algebraic Restatement:
MU of Product A
Price of A
MU of Product B
Price of B
=
8 Utils
$1
16 Utils
$2
=
Optimum Achieved
-
Money Income is Allocated so that the Last Dollar Spent on Each Good Yields the Same Extra or Marginal UtilitySlide17
Two-Good Practice Problem
Given MU, and an income/budget constraint of $20…
find the Utility-Maximizing Combination of
A
and
B
(2)
Product A:
Price = $2
(3)
Product B:
Price = $5
Unit
MU
Unit
MU
1
20
1
30
2
10
2
20
3
6
3
15
4
3
4
5
5
1
5
-5Slide18
(2)
Product A:
Price = $2
(3)
Product B:
Price = $1
Unit
TU
Unit
TU
1
22
1
10
2
32
2
16
3
40
3
20
4
46
4
22
5
48
5
20
Given TU, and an income/budget constraint of $9…
find the Utility-Maximizing Combination of
A
and
B
Two-Good Practice ProblemSlide19
The Problem with Utils
Answer the following problem:
If Henry derives
5 utils
from the 1
st
candy bar,
3 utils
from the 2
nd
candy bar,
0 utils
from the 3
rd
candy bar, and -5 utils from the 4th candy bar…How many candy bars should Henry consume if each candy bar …Is absolutely free (MC = 0)Costs $2Costs $4Slide20
From ‘Utils’ to ‘Benefit’
Because Utils cannot be compared between people, and cannot be compared to dollars… economists must measure satisfaction in
Benefit
.
Benefit is the same concept as utility, but it is measured in dollars (according to the consumer’s
WILLINGNESS TO PAY
.
Total Benefit ($), Marginal Benefit ($)Slide21
Golden Rule of Consumption
A rational consumer will continue to purchase until…
MB = MC
To consume one more would mean your marginal cost is greater than your marginal benefitSlide22
Start with an individual
consumer
maybe you, maybe me, but could be anyone
Derive demand curve for that
individual
focus on marginal utility or marginal benefit
Add up demand curves for
many
such individuals to get
market
demand curve
3. Individual and Market Demand Curves Slide23
Assumption about consumer behavior
General economic principle
People
make purposeful choices
with limited resources
When applied to the behavior of consumers
People
maximize utility
subject to a budget constraintSlide24
3. Individual and Market Demand Curves
Consider all consumers in the market
Add up quantity demanded by all individuals at each price to get market demand
Add horizontally to create
market demand curveSlide25Slide26
4. Substitution and Income Effects
This topic on the AP Course Outline was already covered
in Chapter 1 through 3.
To review, just remember that
both of these effects help to explain why the demand curve slopes
downward
.Slide27
Review Questions – Utility
Which of the following factors contributes to a downward-sloping demand curve?
I. The income effect
II. The substitution effect
III. Diminishing marginal utility
A. I only
B. III only
C. I and II only
D. II and III only
E. I, II, and III Slide28
Review Questions – Utility
What is the marginal utility of the third cup of peanuts Brian consumes?
A. 3 units of utility
B. 9 units of utility
C. 12 units of utility
D. 2 units of utility
E. 14 units of utility Slide29
Review Questions – Utility
If the price of peanuts is $1 per cup and the price of jelly beans is $2 per cup, and Brian wants to maximize his utility, what should he purchase first?
A. 1 cup of peanuts because peanuts produce a lower total utility
B. 1 cup of peanuts because the price of peanuts is lower
C. 1 cup of peanuts, because the marginal utility per dollar for peanuts is lower than the marginal utility per dollar of jelly beans
D. 1 cup of jelly beans, because the marginal utility per dollar for jelly beans is higher than the marginal utility per dollar of peanuts
E. 1 cup of jelly beans, because jelly beans produce a higher total utilitySlide30
Review Questions – Utility
If TU = total utility, MU = marginal utility, and P = price, in order to maximize utility, a consumer should purchase the mix of hamburgers and hot dogs where
A. the MU of hamburgers equals the MU of hot dogs
B. the MU equals the TU of hamburgers, and the MU equals the TU of hot dogs
C. the TU of hamburgers equals the TU of hot dogs
D. the MU / P of hamburgers equals the MU / P of hot dogs
E. the TU / P of hamburgers equals the TU / P of hot dogsSlide31
Review Questions – Utility
If Matt’s total utility from consuming slices of cheese increased at a constant rate, no matter how many bratwurst Matt consumed, what would Matt’s demand curve for slices of cheese look like?
A. Vertical
B. Horizontal
C. Downward sloping
D. Upward sloping
E. First upward, but eventually downward slopingSlide32
Review Questions – Utility
Every day Molly spends her lunch money consuming apples, at $1 each, and oranges, at $2 each. At her current level of consumption, molly’s marginal utility of apples is 12 and her marginal utility of oranges is 18. If she has already spent all of her lunch money, how should Molly change her consumption decision to maximize utility?
A. She should make no changes; she is consuming the utility maximizing combination of apples and oranges.
B. She should increase her apple consumption and decrease her orange consumption until the marginal utility per dollar is equal for both.
C. She should decrease her apple consumption and increase her orange consumption until the marginal utility per dollar is equal for both.
D. She should increase her apple consumption and decrease her orange consumption until the marginal utility is equal for both.
E. She should decrease her apple consumption and increase her orange consumption until the marginal utility is equal for both. Slide33
Review Questions – Utility
If generic peanut butter is an inferior good, a decline in consumer income causes
A. the price of generic peanut butter to go down.
B. the demand for name-brand peanut butter to go up.
C. the supply of generic peanut butter to go up.
D. the demand for generic peanut butter to go up.
E. the price of bread to go down.Slide34
Key Terms
law of diminishing marginal utility
utility
total utility
marginal utility
rational behavior
budget constraint
utility-maximizing rule
income effect
substitution effectSlide35
Price of Product
B
0
1
2
4
6
Quantity Demanded of
B
Deriving the Demand Curve
Same Numeric Example:
$2
1
4
6
Price Per
Unit of B
Quantity
Demanded
D
B
Income Effects
Substitution Effects