macroeconomic mcgrowhill micro ch 6 19e use this one

The Law of DemandShow LAW OF DIMINISHING MARGINAL UTILITY • Utility Defined • Subjective Nature • Difficult to Quantify Total Utility Marginal Utility graphically examined..... The Law o

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Consumer Behavior

06

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The Law of Demand

• Budget Lines, Indifference Curves, Utility Maximization, and Demand Derivation in the Indifference Curve Model of Consumer

Behavior

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THE LAW OF DEMAND

A 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

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LAW OF DIMINISHING MARGINAL UTILITY

• Utility Defined

• Subjective Nature

• Difficult to Quantify

Total Utility Marginal Utility

graphically examined

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TOTAL AND MARGINAL UTILITY

Tacos consumed per meal

Total Utility, Utils

Marginal Utility, Utils

0

1

0

10

Units consumed per meal

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0

1

0

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0 1

2

0 10

18

10 8

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0 1 2

3

0 10 18

24

10 8 6

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0 1 2 3

4

0 10 18 24

28

10 8 6

4 Units consumed per meal

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0 1 2 3 4

5

0 10 18 24 28

30

10 8 6 4 2

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0 1 2 3 4 5

6

0 10 18 24 28 30

30

10 8 6 4 2 0

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0 1 2 3 4 5 6

7

0 10 18 24 28 30 30

28

10 8 6 4 2 0

-2

TU

MU

0 1 2 3 4 5 6 7

1 2 3 4 5 6 7

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0 1 2 3 4 5 6 7

0 10 18 24 28 30 30

28

10 8 6 4 2 0

-2

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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

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First 10 10 24 12

Unit of product

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

Marginal utility, utils

Marginal utility per dollar (MU/price)

UTILITY MAXIMIZING COMBINATION

How should the $10 Income be allocated?

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First 10 10 24 12

Unit of product

Examine the two marginal utilities

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First 10 10 24 12

Unit of product

Examine the two marginal utilities

…per dollar

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First 10 10 24 12

Unit of product

Decision: Buy 1 Product B for $2

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First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2

Unit of product

What next?

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Unit of product

What next?

Buy one of each

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Unit of product

and then

($5 left)

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Unit of product

third unit of product B

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Unit of product

$3 left

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Unit of product

$3 left

Buy both!

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Unit of product

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Algebraic Restatement of the

Utility Maximization Rule

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UTILITY MAXIMIZATION AND

THE DEMAND CURVE

Deriving the Demand Schedule and Curve

• Preferences or Tastes

• Money Income

• Prices of Other Goods

Given from the previous example schedule:

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Create a demand schedule from the purchase decisions as the price of the product is varied

Price per unit of B Quantity Demanded

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Revisited

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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

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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”

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• Diminishing marginal utility for gains

• Diminishing marginal disutility for losses

• People are loss adverse

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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

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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

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Anchoring and Credit Card Bills

• Estimates of value are influenced by recent information no matter how

irrelevant

• Can lead to people altering valuations unconsciously

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Mental Accounting and Warranties

• Separate purchases into “mental

accounts” rather than looking at the

big picture

• Mental accounting exaggerates any

potential loss

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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

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Nudging People

• Using behavioral economics to

change people’s behavior

• Subtle manipulations are used to

generate socially better outcomes

• Unaware of being manipulated

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