Consumer Behavior

Law of Diminishing Marginal Utility

 The simplest theory of consumer behavior rests squarely on the law of diminishing marginal utility . This principle,
first discussed in Chapter 3, is that added satisfaction declines as a consumer acquires additional units of a given
product.
 Although consumer wants in general may be insatiable, wants for particular items can be satisfied. In a specific span of
time over which consumers’ tastes remain unchanged, consumers can obtain as much of a particular good or service as
they can afford.
 But the more of that product they obtain, the less they want still more of it. Consider durable goods, for example. A
consumer’s desire for an automobile, when he or she has none, may be very strong. But the desire for a second car is
less intense; and for a third or fourth, weaker and weaker.
 Unless they are collectors, even the wealthiest families rarely have more than a half-dozen cars, although their
incomes would allow them to purchase a whole fleet of vehicles.
 Utility” and “usefulness
 Utility is subjective
 Utility is difficult to quantify
Total Utility and Marginal Utility
 Total utility and marginal utility are related, but different, ideas. Total utility is the total amount of satisfaction or
pleasure a person derives from consuming some specific quantity—for example, 10 units—of a good or service.
 Marginal utility is the extra satisfaction a consumer realizes from an additional unit of that product—for example,
from the eleventh unit. Alternatively, marginal utility is the change in total utility that results from the consumption of
1 more unit of a product.

 newspaper publishers and soft-drink firms use alternative vending techniques because of the
highly different rates of decline in marginal utility for their products.
 The newspaper seller uses inexpensive dispensers that open to the full stack of papers.
 The soft-drink seller uses expensive vending machines that limit the consumer to a single
can at a time. Each vending technique is optimal under the particular economic
circumstance.
Curves TU and MU are graphed from the data in the table.

(a) As more of a product is consumed, total utility increases at a diminishing rate, reaches a maximum,
and then declines.

(b) Marginal utility, by definition, reflects the changes in total utility. Thus marginal utility diminishes
with increased consumption, becomes zero when total utility is at a maximum, and is negative when
total utility declines. As shown by the shaded rectangles in (a) and (b), marginal utility is the change in
total utility associated with each additional taco. Or, alternatively, each new level of total utility is found
by adding marginal utility to the preceding level of total utility.
Marginal Utility and Demand
 The law of diminishing marginal utility explains why the demand curve for a given product slopes downward. If
successive units of a good yield smaller and smaller amounts of marginal, or extra, utility, then the consumer will buy
additional units of a product only if its price falls.

 The consumer for whom Figure 6.1 is relevant may buy two tacos at a price of $1 each. But because he or she obtains
less marginal utility from additional tacos, the consumer will choose not to buy more at that price. The consumer
would rather spend additional dollars on products that provide more utility, not less utility. Therefore, additional tacos
with less utility are not worth buying unless the price declines. (When marginal utility becomes negative, Taco Bell
would have to pay you to consume another taco!)

 Thus, diminishing marginal utility supports the idea that price must decrease in order for quantity demanded to
increase. In other words, consumers behave in ways that make demand curves downsloping.
Theory of Consumer Behavior
In addition to explaining the law of demand, the idea of diminishing marginal utility explains how consumers allocate their
money incomes among the many goods and services available for purchase.

Consumer Choice and the Budget Constraint

 Rational behavior
 Preferences
 Budget constraint
 Prices
Utility-Maximizing Rule
 Of all the different combinations of goods and services a consumer can obtain within his or her budget,
which specific combination will yield the maximum utility or satisfaction?

 To maximize satisfaction, the consumer should allocate his or her money income so that the last dollar
spent on each product yields the same amount of extra (marginal) utility. We call this the utility-
maximizing rule.

 When the consumer has “balanced his margins” using this rule, he has achieved consumer equilibrium
and has no incentive to alter his expenditure pattern. In fact, any person who has achieved consumer
equilibrium would be worse off—total utility would decline—if there were any alteration in the bundle of
goods purchased, providing there is no change in taste, income, products, or prices.
Numerical Example
 Marginal Utility per Dollar
 Decision-Making Process
 Inferior Options
 Algebraic Generalization
Utility Maximization and the Demand Curve
Once you understand the utility-maximizing rule, you can easily see why product
price and quantity demanded are inversely related. Recall that the basic
determinants of an individual’s demand for a specific product are
(1) preferences or tastes,
(2) money income, and
(3) the prices of other goods.

The utility data in Table 6.1 reflect our consumer’s preferences. We continue to
suppose that her money income is $10. And, concentrating on the construction of
an individual demand curve for oranges, we assume
that the price of apples, now representing all “other goods,” is still $1.
 The consumer represented by the data in the table maximizes utility
by purchasing 4 oranges at a price of $2.

 The decline in the price of oranges to $1 disrupts the consumer’s

initial utility-maximizing equilibrium.

 The consumer restores equilibrium by purchasing 6 rather than 4

oranges. Thus, a simple price-quantity schedule emerges, which
locates two points on a downsloping demand curve.
Income and Substitution Effects
 Recall from Chapter 3 that the income effect is the impact that a change in the price of a product has on a
consumer’s real income and consequently on the quantity demanded of that good.
 In contrast, the substitution effect is the impact that a change in a product’s price has on its relative
expensiveness and consequently on the quantity demanded. Both effects help explain why a demand curve
such as that in Figure 6.2 is downsloping.
You are choosing between two goods, X and Y, and your marginal utility from each is as shown in the
table below. If your income is $9 and the prices of X and Y are $2 and $1, respectively, what
quantities of each will you purchase to maximize utility? What total utility will you realize?
Assume that, other things remaining unchanged, the price of X falls to $1. What quantities of X
and Y will you now purchase? Using the two prices and quantities for X, derive a demand
schedule (price-quantity-demanded table) for X.
Units of X MUx Units of Y MUy

1 10 1 8
2 8 2 7
3 6 3 6
4 4 4 5
5 3 5 4
6 2 6 3
Columns 1 through 3 in the table below show the marginal utility which a particular consumer would get by
purchasing various quantities of products A, B, and C.
(1) (2) (3)
Unit of Marginal Marginal Marginal
product utility, A utility, B utility, C
First 18 39 12
Second 16 36 10
Third 14 33 9
Fourth 12 30 8
Fifth 10 27 7
Sixth 8 24 5
Seventh 6 21 3

If the prices of A, B, and C are $2, $3, and $1, respectively, and the consumer has $26 to spend on these three
products, what combination of the three products should be purchased in order to maximize utility?
Applications and Extensions
 The iPod:
 The iPod came on the market in November 2001. Less than six years later, Apple sold its 100 millionth unit.
Furthermore, those units enabled Apple to sell more than 2.5 billion songs through its online iTunes store.
 The swift ascendancy of the Pod resulted mainly from a leapfrog in technology Not only is the iPod much more
compact than the portable digital CD player that it replaced, it can hold a lot more songs.
 This example demonstrates a simple but important point: New products succeed by enhancing consumers’ total
utility.

 The diamond-water paradox:

 Before marginal analysis, economists were puzzled by the fact that some essential goods like water had
lower prices than luxuries like diamonds.
 The paradox is resolved when we look at the abundance of water relative to diamonds.
 Theory tells us that consumers should purchase any good until the ratio of its marginal utility to price is the
same as that ratio for all other goods.
 The marginal utility of an extra unit of water may be low as is its price, but the total utility derived from water
is very large.
 The total utility of all water consumed is much larger than the total utility of all diamonds purchased.
 However, society prefers an additional diamond to an additional drop of water, because of the abundant stock
of water available.
 Time also has a value, so this must be considered in decision ‑making and utility maximization. The total price of an
item must include the value of the time spent in consuming the product, i.e., the wage value of an hour of time. When
time is considered, consumer behavior appears to be much more rational.
 Highly paid doctors may not spend hours hunting for bargains because their time is more valuable than the
money to be saved from finding the best buy.
 Foreigners observe that Americans waste material goods but conserve time. This could be because our high
productivity makes our time more valuable than many of the goods we waste.
The Budget Constraint Line
A.Show various combinations of two products which can be purchased with a given money income with knowledge
of the prices of the two products. (Figure 1)
B.A decrease in money income shifts the budget constraint line inward to the left in Figure 1; an increase in money
income shifts the budget constraint line outward to the right in Fig. 1.
C.Price changes in either of the two products will rotate the budget constraint line. For example, in Figure 1, if the
price of A rises, less of A will be purchased at each of the possible combinations of A and B, so the curve will fan
downward along the vertical A‑axis. A decrease in A’s price would have the curve fanning upward along the
A‑axis.
 Indifference Curve Analysis
A.downsloping because both products yield utility to the consumer. Going down the curve means more of one
commodity is being consumed, thus increasing the consumer’s total utility. To keep total utility constant, some
amount of the other commodity must be given up to precisely offset the gain in total utility. Thus, the quantities of
the two commodities are inversely related. Any curve showing an inverse relationship is downsloping.
B.Curves are convex to the origin.
1. Technically, the slope of an indifference curve at each point measures the marginal rate of substitution (MRS) of the
combination of two goods represented by that point. The slope or MRS shows the rate at which the consumer who
possesses the combination must substitute one good for the other (say, B for A) to remain equally satisfied. The
diminishing slope of the indifference curve means that the willingness to substitute B for A diminishes as more of B
is obtained.
2. Rationale for this shape is related to diminishing marginal utility. If the consumer has a lot of A and very little of B,
B is more valuable at the margin, while A has a lower marginal utility. The consumer will then be willing to give up
a substantial amount of product A to get more units of B. However, as the consumer obtains more and more of B and
gives up more and more A, this relationship changes. The consumer will not be willing to give up much A to get
more of B. In other words, the slope of the curve diminishes, and the curve is, by definition, convex to the origin.
What is shown by the indifference map for two goods? Which indifference curve would a consumer want to be
on?
 
An indifference map shows the set of indifference curves for the consumer. Each curve is convex to the
origin and does not cross the other. Each indifference curve shows a level of utility. The farther an indifference
curve is away from the origin, the higher the level of utility. The consumer will want to be on the indifference
curve that is the one farthest from the origin.

What is shown by the indifference map for two goods? Which indifference curve would a consumer want to
be on?
 
An indifference map shows the set of indifference curves for the consumer. Each curve is convex to
the origin and does not cross the other. Each indifference curve shows a level of utility. The farther an
indifference curve is away from the origin, the higher the level of utility. The consumer will want to be on the
indifference curve that is the one farthest from the origin.
 Equilibrium at Tangency
The consumer’s utility‑maximizing combination of A and B
will occur on the highest attainable indifference curve.

This is where the budget constraint line is tangent to an

indifference curve, which is the highest attainable level of
utility.
Higher levels will be unattainable or off the budget line.

By definition, the budget line indicates all the combinations The consumer’s equilibrium position is represented by point X,
of A and B that the consumer can attain with his or her where the black budget line is tangent to indifference curve I3.
money income, given the prices of A and B. The consumer buys 4 units of A at $1.50 per unit and 6 of B at $1
per unit with a $12 money income.
Of these attainable combinations, the consumer will prefer
Points Z and Y represent attainable combinations of A and B but
the combination that yields the greatest satisfaction or
yield less total utility, as is evidenced by the fact that they are on
utility. Specifically, the utilitymaximizing combination will be lower indifference curves.
the combination lying on the highest attainable indifference
curve. It is called the consumer’s equilibrium position. Point W would entail more utility than X, but it requires a greater
income than the $12 represented by the budget line.
Using Figure 4, explain why the point of tangency of the budget line with an indifference curve is the consumer’s
equilibrium position. Explain why any point where the budget line intersects an indifference curve will not be
equilibrium. Explain: “The consumer is in equilibrium where MRS = PB/PA.”

 The tangency point places the consumer on the highest attainable indifference curve; it identifies the
combination of goods yielding the highest total utility.

 All intersection points place the consumer on a lower indifference curve. MRS is the slope of the indifference
curve; PB/PA is the slope of the budge line.

 Only at the tangency point are these two slopes equal. If MRS > PB/PA or MRS < PB/PA, adjustments in the
combination of products can be made to increase total utility (get to a higher indifference curve).
Equivalency at Equilibrium

 As indicated at the beginning of this appendix, an important difference exists between the marginal-utility theory
of consumer demand and the indifference curve theory.

 The marginal-utility theory assumes that utility is numerically measurable, that is, that the consumer can say how
much extra utility he or she derives from each extra unit of A or B. The consumer needs that information to
determine the utility-maximizing (equilibrium) position, which is defined by

 The indifference curve approach imposes a less stringent requirement on the consumer. He or she need only specify
whether a particular combination of A and B will yield more than, less than, or the same amount of utility as some
other combination of A and B will yield.

 The consumer need only say, for example, that 6 of A and 7 of B will yield more (or less) satisfaction than will 4 of
A and 9 of B. Indifference curve theory does not require that the consumer specify how much more (or less)
satisfaction will be realized.
The Derivation of the Demand Curve

(a) When the price of product B is increased from $1 to

$1.50, the equilibrium position moves from X to X',
decreasing the quantity demanded of product B from
6 to 3 units.

(b) The demand curve for product B is determined by

plotting the $1–6-unit and the $1.50–3-unit price-quantity
combinations for product B.
Assume that the data in the accompanying table indicate an indifference curve for Mr. Chen. Graph this curve, putting
A on the vertical and B on the horizontal axis. Assuming the prices of A and B are $1.50 and $1.00, respectively, and
that Mr. Chen has $24 to spend, add his budget line to your graph. What combination of A and B will Mr. Chen
purchase? Does your answer meet the MRS = PB/PA rule for equilibrium?

Units of A Units of B

16 6
12 8
8 12
4 24

As shown in the graph, Mr. Chen will purchase 8A and 12B, spendinghis
$24 8  $1.50  12  $1.00. The answer does meet the MRS  PB / PA rule. Thus,
MRS  8 / 12  PB / PA  $1.00 / $1.50  2 / 3.
i)
Explain graphically how indifference analysis can be used to derive a demand curve.
In the top graph appearing below, the initial equilibrium is at X, where the budget line is tangent to
indifference curve I2. Money income is $12; the price of A is $1.50 and the price of B is $1.00.
Dropping a perpendicular from X in the top diagram to the bottom diagram, we obtain X’, a point
on the demand curve of B. We note that at the price of $1.00, Q is 7.
We now assume that the price of B rises to $2.00, causing the budget line to fan to the left (inwards)
from its anchor on the vertical (A) axis to Q of 6 on the horizontal (B) axis. This causes the new
budget line to be tangent, at Y, to an indifference curve, I1, closer to the origin—one that gives less
utility. Dropping a perpendicular from Y in the top diagram to the bottom diagram, we obtain Y’,
the second point on the demand curve of B. We note that at the higher price of $2.00, Q is 3.

i) We can continue this procedure to obtain more points on the demand curve of B.
The graph below depicts a Bob’s budget line for 2 goods and three indifference curves depicting his preferences.
Use this graph to answer the following questions.
(a) Bob’s friend Martha argues that B represents the least pleasurable bundle for Bob. Do you agree?
(b) Bob’s friend Michael argues that Bob should choose to consume bundle D since it offers him the highest
utility. Do you agree?
(c) If you were a friend of Bob’s, which bundle would you advise him to take?

(a) Martha is right in that bundle B is one of the least pleasurable bundles depicted in the graph. However,
bundle A is also a least pleasurable bundle, as it falls on the same indifference curve as B, which is t he
lowest depicted in the graph. Even though A is on Bob’s budget line, the combination of goods is not
any more satisfying to Bob than bundle B.
(b) While bundle D does provide the highest utility for Bob of the bundles displayed, that point is not
attainable for him, given his budget constraints depicted by the budget line. Thus, choosing bundle D is
not a viable option.
(c) If I were Bob’s friend, I would advise him to choose bundle C. This point is ideal because, given his
preferences reflected in the indifference curve, bundle C represents the most pleasurable combination
Bob can attain given his budget constraints. Thus, Bob exhausts his resources in the most efficient and
pleasurable fashion for him.

60

50

40
Quantity of B

30 D
A
20
C

10
B
0
0 10 20 30 40 50
Quantity of A
 1. Utility:  2. Marginal utility can be: 
A. is synonymous with usefulness. A. positive, but not negative.
B. is want-satisfying power. B. positive or negative, but not zero.
C. is easy to quantify. C. positive, negative, or zero.
D. rarely varies from person to person. D. decreasing, but not negative

3. Mary says, "You would have to pay me $50 to attend that pro
wrestling event." For Mary, the marginal utility of the event is: 
A. zero.
B. positive, but declines rapidly.
C. negative.
D. positive, but less than the ticket price.
5. Refer to the above data. The value for Y is:
A. 25.
4. The first Pepsi yields Craig 18 units of utility and the second B. 30.
C. 40.
yields him an additional 12 units of utility. His total utility from D. 45.
three Pepsis is 38 units of utility. The marginal utility of the
third Pepsi is: 
A. 26 units of utility.
B. 6 units of utility.
C. 8 units of utility.
D. 38 units of utility.
Marginal utility:  Mrs. Arnold is spending all her money income by buying
A. is equal to total utility divided by the number of units bottles of soda and bags of pretzels in such amounts that
consumed. the marginal utility of the last bottle is 60 utils and the
B. is equal to total utility if the demand curve is linear. marginal utility of the last bag is 30 utils. The prices of
C. increases as more of a product is consumed. soda and pretzels are $.60 per bottle and $.40 per bag
D. diminishes as more of a product is consumed. respectively. It can be concluded that: 
A. the two commodities are substitute goods.
While eating at Alex's "Pizza by the Slice" restaurant, Kara B. Mrs. Arnold should spend more on pretzels and less on
experiences diminishing marginal utility. She gained 10 units of soda.
satisfaction from her first slice of pizza consumed, and would C. Mrs. Arnold should spend more on soda and less on
only receive 5 units of satisfaction from consuming a second pretzels.
slice. Based on this information we can conclude that:  D. Mrs. Arnold is buying soda and pretzels in the utility-
A. Alex may have to lower the price to convince Kara to buy a maximizing amounts.
second slice.
B. Kara will not eat a second slice, even if it is given to her at
no charge.
C. Kara will definitely want to buy a second slice of pizza.
D. even if Kara buys a second slice, she will not buy a third
slice.
Answer the next question(s) on the basis of the following two schedules which show the
amounts of additional satisfaction (marginal utility) which a consumer would get from
successive quantities of products J and K.
Refer to the above data. What level of total utility is
realized from the equilibrium combination of J and
K, if the consumer has a money income of $52 and
the prices of J and K are $8 and $4 respectively? 
A. 156 utils
B. 124 utils
C. 276 utils
D. 36 utils

Refer to the above data. If the consumer has a money income of Refer to the above data. If the consumer's money
$52 and the prices of J and K are $8 and $4 respectively, the income were cut from $52 to $28, and the prices of J
consumer will maximize her utility by purchasing:  and K remain at $8 and $4 respectively, she would
A. 2 units of J and 7 units of K. maximize her satisfaction by purchasing: 
B. 5 units of J and 5 units of K. A. 3 units of J and 3 units of K.
C. 4 units of J and 5 units of K. B. 1 unit of J and 3 units of K.
D. 6 units of J and 3 units of K. C. 4 units of J and 1 unit of K.
D. 2 units of J and 3 units of K.
Suppose that Ms. Thomson is currently exhausting her money If you receive a gift whose market price is $20, but
income by purchasing 10 units of A and 8 units of B at prices of you consider it to be worth only $10, then: 
$2 and $4 respectively. The marginal utility of the last units of A A. there is a $10 or 50 percent value gain.
and B are 16 and 24 respectively. These data suggest that Ms. B. there may or may not be a value loss.
Thomson:  C. there is a $10 or 50 percent value loss.
A. has preferences that are at odds with the principle of D. you can be relatively certain the giver was a
diminishing marginal utility. sibling or other close relative.
B. considers A and B to be complementary goods.
C. should buy less A and more B. Assume you are spending your full budget and
D. should buy less B and more A. purchasing such amounts of X and Y that the
marginal utility from the last units consumed is 40
and 20 utils respectively. Assume (a) the prices of X
Assume MUc and MUd represent the marginal utility that a consumer gets from products C and Y are $8 and $4 respectively; (b) it takes 3 hours
and D, the respective prices of which are Pc and Pd. The consumer will increase his total
utility from a specific money outlay by spending more on C and less on D if initially: to consume a unit of X and 1 hour to consume a unit
A. of Y; and (c) your time is worth $2 per hour. You 
B.
A. should substitute X for Y until the marginal utility
per hour is the same for both products.
C. B. are consuming X and Y in the optimal amounts.
D.
C. should consume less of Y and more of X.
D. should consume less of X and more of Y.