Chap 21Consumer Behavior &Utility Maximization By: Anabel Gonzalez & Amanda Reina
A Closer Look at the Law of Demand • Income Effect: Lower the price of a product, the more a consumer can buy of that product • Substitution Effect: Impact that a change in a product’s price has on its relative expensiveness and consequently on the quantity demanded.
Law of Diminishing Marginal Utility • Although consumer wants in general may be insatiable, wants for particular commodities can be satisfied. • Utility: Want-satisfying power • Not equal to Usefulness • Vary widely from person to person • Subjective and difficult to quantify (assume people can measure satisfaction with units called utils, units of utility)
Total Utility and Marginal Utility • Total Utility (TU): total amount of satisfaction or pleasure a person derives from consuming some specific quantity of a good or service. • Marginal Utility (MU): extra satisfaction a consumer gets from an additional unit of that same product.
Marginal Utility, Demand and Elasticity • Consumer will rather spend additional dollars on products that provide more (or equal) utility, nor less. • If MU of extra units drops off so rapidly demand is inelastic. • If MU of extra units drops off modestly demand is elastic.
Theory of Consumer Behavior • How do consumers distribute their money incomes among the many goods and services available for purchase? • The consumer will choose the goods and services that they find most satisfying/useful.
Consumer Choice & Budget Constraint • A typical consumer: • Rational Behavior • Preferences • Budget constraint • Prices
Consumer Choice &Budget Constraint • Rational Behavior: • Consumer tries to derive the greatest amount of satisfaction, or utility. • “The most for their money” • Preferences: • Clear inclination for certain goods and services available in the market.
Consumer Choice &Budget Constraint • Budget constraint: • Consumers have a fixed income • Prices: • Goods are scarce in relation to the demand for them; therefore, every good carries a price tag • Consumer has limited number of dollars, so they can only buy a limited amount of goods.
Utility-Maximizing Rule • To maximize satisfaction, the consumer should distribute his/her money income so that the last dollar spent on each product yields the same amount of extra (marginal) utility. $1 $5
Algebraic Restatement • MU of product A MU product B Price of A = Price of B 2 Utils 10 Utils $1 = $2 • The last dollar spent on A provides only 2 utils of satisfaction, while on B it provides 5 utils of satisfaction. • Consumer can increase satisfaction by buying more of product B and less of product A.
Utility Maximization & the Demand Curve P($) $2 Product price and quantity demanded are inversely related! Price per unit of B $1 4 6 Quantity demanded of B