1 c h a p t e r 7 1 © 2001 prentice hall business publishingeconomics: principles and tools,...

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© 2001 Prentice Hall Business Publishing© 2001 Prentice Hall Business Publishing Economics: Principles and Tools, 2/eEconomics: Principles and Tools, 2/e O’Sullivan & SheffrinO’Sullivan & Sheffrin

Consumer Choice

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Consumer Behavior

The theory of consumer behavior explores the decisions made by individual consumers and makes the connection between those decisions and the market demand curve.

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The Marginal Principle and Individual Demand

To determine the quantity produced at a given price, the consumer considers the benefit and cost of buying the good.

Each point on the individual demand curve is the result of a rational choice by the consumer.

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The Individual Demand Curve

The marginal principle can be used to show how consumers incorporate benefits and costs into their consumption decisions.

Marginal PRINCIPLEIncrease the level of an activity if its marginal benefit exceeds its marginal cost, but reduce the level if the marginal cost exceeds the marginal benefit. If possible, pick the level at which the marginal benefit equals the marginal cost.

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Total Utility and Marginal Utility

The benefit of consuming a good is called total utility, and is measured in utils, or imaginary units of satisfaction.

This benefit is “tested” by the consumer after each unit has been consumed, or on a per-unit basis, using the marginal principle.

Marginal utility is the change in total utility resulting from the consumption of one additional unit of the good.

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Total utility increases at a decreasing rate, while marginal utility decreases.

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Marginal Utility and the Marginal PrincipleNumber of burgers

Marginal benefit of burgers = Marginal utility of burgers (utils)

Number of tacos

Marginal utility of tacos (utils)

Marginal cost of burgers = 3 times the marginal utility of tacos (utils)

5 18 15 1 3

6 16 12 2 6

7 14 9 3 9

8 12 6 4 12

9 10 3 5 15

10 8 0 6 18

Assumptions:

Consumer’s income = $30.00 Price of a burger = $3.00 Price of a taco = $1.00

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The Marginal Benefit of Consumption

Marginal Benefit of Burgers

Number of burgers

Marginal benefit of burgers = Marginal utility of burgers (utils)

5 18

6 16

7 14

8 12

9 10

10 8

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Finding the Marginal Cost of Consumption

Five burgers cost $15, leaving $15 to spend on tacos, or 15 tacos.

The marginal utility of 15 tacos is one util. Given the price of burgers and tacos,

there is a tradeoff of 3 tacos per burger. Marginal cost of a burger = marginal

utility of tacos x tradeoff between burgers and tacos.

Marginal cost of fifth burger = 1 util per taco x 3 tacos per burger

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The Marginal Cost of Consumption

The Marginal Cost of Burgers

Number of burgers

Number of tacos

Marginal utility of tacos (utils)

Marginal cost of burgers = 3 times the marginal utility of tacos (utils)

5 15 1 3

6 12 2 6

7 9 3 9

8 6 4 12

9 3 5 15

10 0 6 18

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Marginal cost (utils)

Marginal benefit (utils)Quantity

Finding a Point on the Demand Curve

Marginal benefit equals marginal cost when 8 burgers are consumed.

The marginal principle is satisfied at point m.

A point on the demand curve: at a price of $3, the quantity of burgers demanded equals 8.

3 18 5

616 6

914 7

1212 8

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Finding a Point on the Demand Curve

The marginal principle is satisfied at point m, which demonstrates why at a price of $3, the quantity of burgers demanded equals 8 (a point on the demand curve).

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The Utility-maximizing Rule

The consumer maximizes utility by picking the affordable combination of consumer goods that makes the marginal utility per dollar spent on each good equal to that of a second good:

m arginal u tility of burgers

price of burgers

m arginal u tility of tacos

price of tacos

1 c h a p t e r 7 1 © 2001 prentice hall business publishingeconomics: principles and tools,...

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