CONSUMER BEHAVIOR AND UTILITY MAXIMIZATION

Pertemuan 17

Matakuliah : J0114-Teori EkonomiTahun : 2009

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Law of Diminishing Marginal Utility

Terminology– Utility is the benefit or satisfaction a person receives from consuming a good or a services– Total Utility is total amount of of satisfaction or pleasure a person derives from consuming some specific– Marginal Utility is the extra satisfaction aconsumer realizes from and additional unit of that product

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Law of Diminishing Marginal Utility

0

10

20

30

1086420

-2

1 2 3 4 5 6 7

1 2 3 4 5 6 7

To

tal

Uti

lity

(U

tils

)M

arg

ina

l U

tili

ty (

Uti

ls)

(1)Tacos

ConsumedPer Meal

(2)Total

Utility,Utils

(3)MarginalUtility,Utils

0

1

2

3

4

5

6

7

0

10

18

24

28

30

30

28

]]]]]]]

10

8

6

4

2

0

-2

TR

MU

Total Utility

Marginal Utility

Units Consumed Per Meal

Units Consumed Per Meal

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Theory of Consumer Behavior

• Consumer Choice and Budget Constraint– Rational Behavior– Preferences– Budget Constraint– Prices

• Utility Maximizing Rule– Allocate Money Income so that Last

Dollar Spent on Each Product Yields the Same Marginal Utility

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Theory of Consumer BehaviorNumerical Example:Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10

(1)Unit of

Product

(a)MarginalUtility,Utils

(a)MarginalUtility,Utils

(b)Marginal

UtilityPer Dollar(MU/Price)

(b)Marginal

UtilityPer Dollar(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

First

Second

Third

Fourth

Fifth

Sixth

Seventh

10 10 10 10

8 8 24 12

7 7 18 9 16 8

Final Result – At These Prices, Purchase 2 of Item A and 4 of B

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Theory of Consumer BehaviorAlgebraic Restatement:

MU of Product A

Price of A

MU of Product BPrice of B=

8 Utils$1

16 Utils$2

=

Optimum Achieved - Money Income is Allocated so that the Last Dollar Spent on Each Product Yields the Same Extra or Marginal Utility

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Pri

ce

of

Pro

du

ct

B

0

1

2

4 6Quantity Demanded of B

Deriving the Demand Curve

Same Numeric Example:

$2

1

4

6

Price Per Unit of B

QuantityDemanded

DB

Income Effects

Substitution Effects

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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 19.3

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Indifference Curve Analysis• Budget Line (Constraint)

– Income Changes– Price Changes

2 4 6 8 10 12

Qu

anti

ty o

f A

6

8

10

12

4

2

0

Quantity of B

Units of A(Price = $1.50)

Units of B(Price = $1)

TotalExpenditure

8

6

4

2

0

0

3

6

9

12

$12

12

12

12

12(Attainable)

(Unattainable)

Income = $12PA = $1.50

Income = $12PB = $1

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Indifference Curve Analysis• What is Preferred

– Downsloping– Convex to Origin– Marginal Rate of

Substitution (MRS)

2 4 6 8 10 12

Qu

anti

ty o

f A

6

8

10

12

4

2

0

Quantity of B

Combination Units of A Units of B

j

k

l

m

12

6

4

3

2

4

6

8

j

k

lm

I

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Indifference Curve Analysis• The Indifference Map• Equilibrium Position at Tangency

2 4 6 8 10 12

Qu

anti

ty o

f A

6

8

10

12

4

2

0

Quantity of B

I1

I2

I3

I4

X

W

Preferred – But RequiresMore Income

MRS = PB

PA

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Derivation of the Demand Curve

• Measurement of UtilityP

rice

of

B

$1.50

1.00

.50

1 2 3 4 5 6 7 8 9 101112Quantity of B

Marginal Utilityof A

Marginal Utilityof B

Price of A Price of B=X

2 4 6 8 10 12

Qu

anti

ty o

f A

6

8

10

12

4

2

0

Quantity of B

I2

I3

DB

At $1 Price for B, 6 Units are PurchasedRecord the ResultsAs Price of B Increases to $1.50,Only 3 Units of B are BoughtRecord the ResultsConnect the Points toCreate the Demand Curve