Chapter 7
Theory of Consumer Behavior
McGraw-Hill/Irwin
©2009 The McGraw-Hill Companies, All Rights Reserved
Learning Objectives
 When you have completed this chapter you will
know everything you’ll ever need to know about:
1.
2.
3.
4.
5.
6.
Marginal utility.
The law of diminishing marginal utility.
Total utility.
Maximizing utility.
The water-diamond paradox.
Consumer surplus.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-2
Utility
 What is utility?
• Utility is NOT usefulness!
• Utility means only that you think enough of something to
buy it.
• Utility is measured by how much you are willing to pay for
something.
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7-3
Hypothetical Demand Schedule for
Hamburgers
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7-4
Marginal Utility
 The additional utility derived from consuming one
more unit of a good or service.
Note: MU is the same as the price.
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7-5
Law of Diminishing Marginal Utility
 As we consume more and more of a good or
service, we like it less and less.
Price
Units Purchased
MU
$2.75
1
$2.75
2.00
2
2.00
1.00
3
1.00
.25
4
.25
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7-6
Total Utility
 The utility you derive from consuming a certain
number of units of a good or service.
To get total utility, just add up the marginal utilities of
the units purchased.
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7-7
Maximizing Utility
 How much we buy of any good or service depends
on:
• Its price.
• Our marginal utility schedule.
In real life there is usually only ONE price!
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7-8
Maximizing Utility
 We try to spend our money on what will give us the
most utility!
• As we consume more of a good or service, its utility declines!
• This means that we will keep buying more of a good or
service until our marginal utility falls to the level of the price.
At this point marginal utility is the same as the price.
Marginal Utility
Price
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
= 1
7-9
Maximizing Utility
 We try to spend our money on what will give us the
most utility!
• Remember, as we consume more of a good or service, its
utility declines!
• This means that we will keep buying more of a good or
service until our MU falls to the level of the price.
The price is $1.00. How many units would you buy?
The answer is
3.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-10
Maximizing Utility (continued)
 The MU of the last unit purchased will always
equal its price.
The answer is 3.
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7-11
Maximizing Utility
The price is $2. How many units will you buy?
The answer is 2.
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7-12
Maximizing Utility
 We try to spend our money on what will give us the
most utility!
• Remember, as we consume more of a good or service, its
utility declines!
• This means that we will keep buying more of a good or
service until our MU falls to the level of the price.
The MU of the last unit purchased will always equal its price.
The answer is 2.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-13
General Utility Formula

The MU of the last unit purchased will always equal its price:
MU = 2.75 =
Price
2.75
2.00 =
2.00
1.00
1.00 =
.25 =
.25 1
If this is true for hamburgers, it will be true for everything else.
MU1
MU2
MU3
MUn
=
=
=
Pn
P3
P2
P1
Remember, we will keep buying anything until its MU declines to the
price level.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
19-14
General Utility Formula (continued)
Price
# Purchased
MU
TU
$2.75
1
$2.75
$2.75
2.00
2
2.00
4.75
1.00
3
1.00
5.75
.25
4
.25
6.00
0
0
0
6.00
 If a good or service were free, you would keep
consuming until the MU fell to zero.
 As we consume more units, MU declines, but TU
keeps rising.
Therefore, we maximize our total utility when our MU
falls to zero.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-15
Questions for Discussion
Hamburgers
Fries
Coke
Price
QD
MU
Price QD
MU
Price QD
$ 3.00
1
$3.00
$1.50
1
$1.50
$1.50
2.00
2
2.00
1.00
2
1.00
.50
1.00
3
1.00
.50
3
.50
MU
1 $1.50
2
.50
 How many burgers, fries, and cokes would you
consume if burgers were $3, fries were $.50, and cokes
were $.50?
1 hamburger; 3 fries; 2 cokes
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7-16
Questions for Discussion
Hamburgers
Price QD MU
Fries
Price QD
$ 3.00
1
$3.00
$1.50
1
$1.50
$1.50
2.00
2
2.00
1.00
2
1.00
.50
1.00
3
1.00
.50
3
.50
MU
Coke
Price QD MU
1 $1.50
2
.50
 How many burgers, fries, and cokes would you
consume if burgers were $1, fries were $1, and cokes
were $1.50?
1st answer: 1 hamburger; 3 fries; 2 cokes
2nd answer: 3 hamburgers; 2 fries; 1 coke
This is consistent with the law of supply and demand.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-17
The Water-Diamond Paradox
 Water, which is essential to life, is cheap.
• Water is abundant.
• A great deal of water is consumed.
• Therefore, the MU of the last gallon consumed is as low
as its price, which is relatively low.
 Diamonds are not essential to life, yet they are
very expensive.
• Diamonds are scarce.
• People buy relatively few diamonds.
• Therefore, the MU of the last diamond purchased is as
high as its price, which is relatively very high.
 MU water = MU diamonds = 1
Price water
Price diamonds
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-18
Some Limitations of Utility Applications
 Utility is not inherent in a particular good or service.
• Utility is simply a measure of what a particular buyer is
willing to pay.
• Amanda may be willing to pay $100 for a pair of running
shoes while Tom is only willing to pay $60 for the same
style.
• We can’t assume a poor person would get more pleasure
out of spending $10 than a rich person.
• Even though it might sound reasonable …we cannot make
interpersonal utility comparisons.
• We can observe a person’s spending behavior and
determine their personal utility schedule.
• People’s individual schedules can change over time.
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7-19
Consumer Surplus
 Consumer surplus is the difference between what
you pay for some good or service and what you would
have been willing to pay
Price
Hamburger
Schedule
# Purchased
MU
TU
$2.75
1
$2.75
$2.75
2.00
2
2.00
4.75
1.00
3
1.00
5.75
.25
4
.25
6.00
0
5
0
The price of hamburgers is $0.25.
You would buy 4 @ .25 = $1.00.
You would have been willing to pay $6.00.
Your consumer surplus would be ($6.00 - $1.00) = $5.00.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-20
Consumer Surplus
 Consumer surplus is the difference between what you
pay for some good or service and what you would have
been willing to pay.
Hamburger
Schedule
Price
# Purchased
MU
TU
$2.75
1
$2.75
$2.75
2.00
2
2.00
4.75
1.00
3
1.00
5.75
.25
4
.25
6.00
0
5
0
Price of Hamburgers is $2.00.
You would buy 2 @ 2.00 = $4.00.
You would have been willing to pay $4.75.
Your consumer surplus would be ($4.75 - $4.00) = $0.75.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-21
Consumer Surplus
 The consumer surplus in this
graph would be represented by
the area to the left of the demand
curve (what you would have
been willing to pay) and above
the price line.
If the price of hamburger is
$0.25, you would have
purchased 4. The consumer
surplus would be the triangle
area above the price line.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
19-22
Consumer Surplus
 The consumer surplus in this graph would be represented by the
area to the left of the demand curve (what you would have been
willing to pay) and above the price line.
If the price of
hamburger is
$2.00, you
would have
purchased 2.
The consumer
surplus would
be the triangle
area above the
price line.
3.00
2.00
1.00
0.25
D
0
1
2
3
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4
5
6
19-23
Hypothetical Demand Schedule for Sessions
with a Personal Trainer
Try calculating MU and TU.
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7-24
Hypothetical Utility Schedule for Sessions with
a Personal Trainer
What is the consumer surplus for 4 sessions?
Answer: $145 – (4 x $25) = $45.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-25
Do Price Gougers Rip Us off?
 The one thing you should remember from this
chapter is that “Nobody over pays!”
 The economic rule of thumb is: Even if you pay a
very high price for a good or service you are not
getting ripped off.
• This is true even if you are buying from a price gouger.
• In economics we can’t make moral judgments.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-26
Chapter Issue: All-You-Can-Eat Buffets
 You’re at an All-You-Can-Eat pizza buffet.
• You have 4 slices.
• You can’t quite finish the 4th slice.
• How much marginal utility would you have gotten from a 5th
slice?
• Answer: Less than zero.
• How much marginal utility did you get from the 4th slice?
• Not a lot since you can’t finish it.
• The 4th slice did, however, provide you with some marginal
utility.
©2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
7-27