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Consumer Behavior
06
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
21 - 2Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
Chapter Objectives• Total Utility, Marginal Utility, and the Law of
Diminishing Marginal Utility• How Rational Consumers Compare Marginal
Utility-to-Price Ratios for Products in Purchasing Combinations to Maximize Total Utility
• How to Derive the Demand Curve by Observing Behavior
• How the Utility-Maximization Model Highlights Income and Substitution Effects of a Price Change
• Budget Lines, Indifference Curves, Utility Maximization, and Demand Derivation in the Indifference Curve Model of Consumer Behavior
21 - 3Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
THE LAW OF DEMANDA Closer Look…
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
21 - 4Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
LAW OF DIMINISHINGMARGINAL UTILITY
• Utility Defined• Subjective Nature• Difficult to QuantifyTotal UtilityMarginal Utility
graphically examined...
21 - 5Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
01
010
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
21 - 6Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
01
010 10
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
21 - 7Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
012
01018
10 8
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
21 - 8Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
0123
0101824
10 8 6
0 1 2 3 4 5 6 7
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
1 2 3 4 5 6 7
21 - 9Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
01234
010182428
10 8 6 4 Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
21 - 10Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
012345
01018242830
10 8 6 4 2
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
21 - 11Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
0123456
0101824283030
10 8 6 4 2 0
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
21 - 12Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
01234567
010182428303028
10 8 6 4 2 0 -2
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
TU
MU
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
21 - 13Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
TOTAL AND MARGINAL UTILITYTacos
consumedper meal
TotalUtility,Utils
MarginalUtility,Utils
01234567
010182428303028
10 8 6 4 2 0 -2
Units consumed per meal
Units consumed per meal
30
20
10
To
tal
Uti
lity
(u
tils
)M
arg
ina
l U
tili
ty (
uti
ls)
10 8 6 4 2 0 -2
TU
MU
0 1 2 3 4 5 6 7
1 2 3 4 5 6 7
ObserveDiminishing
MarginalUtility
21 - 14Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
THEORY OF CONSUMER BEHAVIOR
A Typical Consumer...• Exhibits Rational
Behavior• Has Clear-Cut
Preferences• Subject to a Budget
Constraint• Responds to Price
Changes
21 - 15Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
THEORY OF CONSUMER BEHAVIOR
Utility Maximizing Rule
The consumer’s money income should be allocated so that the last dollar spent on each product yields the same amount of extra (marginal) utility
illustrated...
21 - 16Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
How should the $10 Income be allocated?
21 - 17Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
Examine the twomarginal utilities
21 - 18Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
Examine the twomarginal utilities
…per dollar
21 - 19Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
Decision: Buy 1Product B for $2
21 - 20Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Sixth 4 4 6 3Seventh 3 3 4 2
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
What next?
21 - 21Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Sixth 4 4 6 3Seventh 3 3 4 2
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
What next?Buy one of each
21 - 22Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Sixth 4 4 6 3Seventh 3 3 4 2
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
and then...($5 left)
21 - 23Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Sixth 4 4 6 3Seventh 3 3 4 2
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
third unit of product B
21 - 24Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Sixth 4 4 6 3Seventh 3 3 4 2
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
$3 left...
21 - 25Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Sixth 4 4 6 3Seventh 3 3 4 2
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
$3 left...Buy both!
21 - 26Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
First 10 10 24 12Second 8 8 20 10Third 7 7 18 9Fourth 6 6 16 8Fifth 5 5 12 6Sixth 4 4 6 3Seventh 3 3 4 2
Unit ofproduct
$ 10 incomeProduct A: Price = $1 Product B: Price = $2
Marginalutility,utils
Marginalutility per
dollar(MU/price)
Marginalutility,utils
Marginalutility per
dollar(MU/price)
UTILITY MAXIMIZING COMBINATION
Income is gone...the last dollar spent on
each good gave the sameutility (8) per dollar
21 - 27Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
Algebraic Restatement of theUtility Maximization Rule
MU of product A
Price of A
MU of product B
Price of B=
UTILITY MAXIMIZING COMBINATION
21 - 28Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
UTILITY MAXIMIZATION ANDTHE DEMAND CURVE
Deriving the Demand Schedule and Curve
• Preferences or Tastes• Money Income• Prices of Other Goods
Given from the previous example schedule:
21 - 29Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
UTILITY MAXIMIZATION ANDTHE DEMAND CURVE
Create a demand schedule from thepurchase decisions as the price of the product is varied ...
Price per unit of B Quantity Demanded
$2 4 1 6
Graphically…
Deriving the Demand Schedule and Curve
21 - 30Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
UTILITY MAXIMIZATION ANDTHE DEMAND CURVE
Deriving the Demand Schedule and Curve
Quantity Demanded of Good B
Pri
ce p
er u
nit
of
Goo
d B $2
1
0 4 6
DB
21 - 31Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
UTILITY MAXIMIZATION ANDTHE DEMAND CURVE
Deriving the Demand Schedule and Curve
Quantity Demanded of Good B
Pri
ce p
er u
nit
of
Goo
d B $2
1
0 4 6
DB
Substitution Effectsand Income Effects
Revisited
21 - 32Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
Applications and Extensions
• DVDs and DVD Players
• The Diamond-Water Paradox
• The Value of Time
• Medical Care Purchases
• Cash and Noncash Gifts
O 7.3
21 - 33Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
Criminal Behavior• Economic Analysis Offers Insights
Into Property Crimes Such as Robbery, Burglary, and Auto Theft
• Theory of a Rational Consumer• Buy Versus Steal Decision• Compare Marginal Utility of Item
Versus Costs – Guilt, Fines, or Prison Time
• Crime May Be Reduced by “Increasing” the “Price of Crime”
Prospect Theory
• How people actually deal with life’s up and downs
• People judge things relative to the status quo
• People experience:• Diminishing marginal utility for gains
• Diminishing marginal disutility for losses
• People are loss adverse
LO5 6-34
Losses and Shrinking Packages
• Consumers see any price increase as a loss relative to the status quo
• Producers are reducing package size instead of raising prices
LO5 6-35
Framing Effects and Advertising
• Consumers evaluate events in a particular mental frame
• New information alters the frame in which the consumer defines whether situations are gains or losses
LO5 6-36
Anchoring and Credit Card Bills
• Estimates of value are influenced by recent information no matter how irrelevant
• Can lead to people altering valuations unconsciously
LO5 6-37
Mental Accounting and Warranties
• Separate purchases into “mental accounts” rather than looking at the big picture
• Mental accounting exaggerates any potential loss
LO5 6-38
The Endowment Effect
• Market transactions may be affected by the endowment effect because:
• The seller has a tendency to demand a higher price
• The buyer has a tendency to offer a lower price
LO5 6-39
Nudging People
• Using behavioral economics to change people’s behavior
• Subtle manipulations are used to generate socially better outcomes
• Unaware of being manipulated
LO5 6-40
21 - 41Copyright McGraw-Hill/Irwin, 2002
The Law of Demand
Law of Diminishing Marginal Utility
Total and Marginal Utility
Theory of Consumer Behavior
Utility Maximizing Combination
Utility Maximization and the Demand Curve
Applications and Extensions
Key Terms
PreviousSlide
NextSlide
EndShow
Key Terms
• Law of diminishing marginal utility
• Utility• Total utility• Marginal utility• Rational behavior• Budget constraint• Utility maximizing rule• Income effect• Substitution effect
7-41