4 - 1 Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total...

4 - 1Copyright 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

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Consumer Behavior andUtility Maximization

4LECTURE


The Law of Demand







Key Terms

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LAW OF DIMINISHINGMARGINAL UTILITY

• Utility Defined• Subjective Nature• Difficult to QuantifyTotal UtilityMarginal Utility

graphically examined...


The Law of Demand







Key Terms

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TOTAL AND MARGINAL UTILITYTacos

consumedper meal

TotalUtility,Utils

MarginalUtility,Utils

01

010

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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


01

010 10



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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


012

01018

10 8



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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


0123

0101824

10 8 6

0 1 2 3 4 5 6 7



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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


01234

010182428

10 8 6 4 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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


012345

01018242830

10 8 6 4 2



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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


0123456

0101824283030

10 8 6 4 2 0



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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


01234567

010182428303028

10 8 6 4 2 0 -2



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


The Law of Demand







Key Terms

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consumedper meal

TotalUtility,Utils


01234567

010182428303028

10 8 6 4 2 0 -2



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


The Law of Demand







Key Terms

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THEORY OF CONSUMER BEHAVIOR

A Typical Consumer...• Exhibits Rational

Behavior• Has Clear-Cut

Preferences• Subject to a Budget

Constraint• Responds to Price

Changes


The Law of Demand







Key Terms

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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...


The Law of Demand







Key Terms

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First 10 10 24 12

Unit ofproduct

$ 10 incomeProduct A: Price = $1 Product B: Price = $2

Marginalutility,utils

Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)

UTILITY MAXIMIZING COMBINATION

How should the $10 Income be allocated?


The Law of Demand







Key Terms

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First 10 10 24 12

Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


Examine the twomarginal utilities


The Law of Demand







Key Terms

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First 10 10 24 12

Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


Examine the twomarginal utilities

…per dollar


The Law of Demand







Key Terms

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First 10 10 24 12

Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


Decision: Buy 1Product B for $2


The Law of Demand







Key Terms

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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



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


What next?


The Law of Demand







Key Terms

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Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


What next?Buy one of each


The Law of Demand







Key Terms

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Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


and then...($5 left)


The Law of Demand







Key Terms

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Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


third unit of product B


The Law of Demand







Key Terms

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Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


$3 left...


The Law of Demand







Key Terms

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Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


$3 left...Buy both!


The Law of Demand







Key Terms

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Unit ofproduct



Marginalutility per

dollar(MU/price)


Marginalutility per

dollar(MU/price)


Income is gone...the last dollar spent on

each good gave the sameutility (8) per dollar


The Law of Demand







Key Terms

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Algebraic Restatement of theUtility Maximization Rule

MU of product A

Price of A

MU of product B

Price of B=



The Law of Demand







Key Terms

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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


The Law of Demand







Key Terms

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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


The Law of Demand







Key Terms

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Indifference Curve Analysis

4LECTURE

APPENDIX


The Law of Demand







Key Terms

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A CONSUMER’S PRODUCTINDIFFERENCE

Qu

an

tity

of

A

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price$1.50

Units ofB Price$1.00

TotalExpenditures

8 0 $126 3 124 6 122 9 120 12 12An Indifference

ScheduleCombi-nation

Unitsof A

Unitsof B

j 12 2k 6 4l 4 6m 3 8

j

k

lm

I


The Law of Demand







Key Terms

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A CONSUMER’S BUDGET LINE



TotalExpenditures

8 0 $126 3 124 6 122 9 120 12 12

(Attainable)Q

ua

nti

ty o

f A

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

(Unattainable)


The Law of Demand







Key Terms

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TotalExpenditures

8 0 $126 3 124 6 122 9 120 12 12

(Attainable)Q

ua

nti

ty o

f A

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

(Unattainable)An Increase in incomemakes the purchase of more of either or both

items possible


The Law of Demand







Key Terms

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TotalExpenditures

8 0 $126 3 124 6 122 9 120 12 12

(Attainable)Q

ua

nti

ty o

f A

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

(Unattainable)Price changes cause

a change in the quantitydemanded of the items


The Law of Demand







Key Terms

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A CONSUMER’S EQUILIBRIUM POSITION

I1

I2

Qu

an

tity

of

A

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

I3

I4

(Attainable)

(Unattainable)



TotalExpenditures

8 0 $126 3 124 6 122 9 120 12 12An Indifference

ScheduleCombi-nation

Unitsof A

Unitsof B

j 12 2k 6 4l 4 6m 3 8


The Law of Demand







Key Terms

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What happens if the price of Bincreases to $1.50

PriceB QuantityB

$1.00 6


I3

The budget linerotates reflectingthe reduction inthe quantity of B

units which isattainable

Qu

an

tity

of

A

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12


The Law of Demand







Key Terms

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PriceB QuantityB

$1.00 1.50

63

By recording thevarious quantitiesdemanded at thevarious prices yieldsthe Demand schedule


I2

I3

The budget linerotates reflectingthe reduction inthe quantity of B

units which isattainable

Qu

an

tity

of

A

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12


The Law of Demand







Key Terms

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PriceB QuantityB

$1.00 1.50

63

By recording thevarious quantitiesdemanded at thevarious prices yieldsthe Demand schedule


Price of B

Quantity of B

$1.50

1.00

0

2 4 6 8 10 12

DB

Plotting the Points yields the Demand Curve for Product B

4 - 1 Copyright McGraw-Hill/Irwin, 2002 The Law of Demand Law of Diminishing Marginal Utility Total...

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