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Unformatted text preview: Consumer Behavior and Utility Maximization CHAPTER SEVEN CONSUMER BEHAVIOR AND UTILITY MAXIMIZATION LECTURE NOTES I. Introduction A. Learning objectives In this chapter students will learn: 1. About total utility, marginal utility, and the law of diminishing marginal utility. 2. How rational consumers compare marginal utility-to-price ratios for products in purchasing combinations of products that maximize their utility. 3. How a demand curve can be derived by observing the outcomes of price changes in the utility-maximization model. 4. How the utility-maximization model helps highlight the income and substitution effects of a price change. 5. About budget lines, indifference curves, utility maximization, and demand derivation in the indifference curve model of consumer behavior. (Appendix) B. Americans spend trillions of dollars on goods and services each yearmore than 95 percent of their after-tax incomes, yet no two consumers spend their incomes in the same way. How can this be explained? C. Why does a consumer buy a particular bundle of goods and services rather than others? Examining these issues will help us understand consumer behavior and the law of demand. II. Law of Diminishing Marginal Utility A. Although consumer wants in general are insatiable, wants for specific commodities can be fulfilled. The more of a specific product that consumers obtain, the less they will desire more units of that product. This can be illustrated with almost any item. The text uses the automobile example, but houses, clothing, and even food items work just as well. B. Utility is a subjective notion in economics, referring to the amount of satisfaction a person gets from consumption of a certain item. C. Marginal utility refers to the extra utility a consumer gets from one additional unit of a specific product. In a short period of time, the marginal utility derived from successive units of a given product will decline. This is known as diminishing marginal utility. D. Figure 7.1 and the accompanying table illustrate the relationship between total and marginal utility. 1. Total utility increases as each additional tacos is purchased through the first five, but utility rises at a diminishing rate since each tacos adds less and less to the consumers satisfaction. 2. At some point, marginal utility becomes zero and then even negative at the seventh unit and beyond. If more than six tacos were purchased, total utility would begin to fall. This illustrates the law of diminishing marginal utility. E. Consider This Vending Machines and Marginal Utility 34 Consumer Behavior and Utility Maximization 1. Newspaper vending machines normally allow one to take multiple papers; publishers allow this because they believe that people rarely take more than one paper because the marginal utility of the second paper is often zero, and it has little shelf life. 2. Soft drink vending machines distribute one can or bottle at a time. Even if the marginal utility of the second unit of soda is low in the short run, the long shelf life would allow...
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