# Chapter 3 Theory of Consumer Behavior

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```					Theory of
Consumer
Behavior
Chapter 3
Topics of Discussion
Utility Theory
Total Utility
Marginal Utility
Meet Carl Consumer
Law of Diminishing Marginal Utility

Indifference Curves
Concept of Isoutility
Marginal Rate of Substitution

The Budget Constraint
Utility Function
A utility function is an algebraic expression
that allows us to rank consumption bundles
or combinations of goods.

Total utility = Qhamburgers x Qpizza

Pages 39-40
Utility Function
A utility function is an algebraic expression
that allows us to rank consumption bundles
or combinations of goods.

Total utility = Qhamburgers x Qpizza

This approach assumes that utility is
cardinally measurable in the same sense
that a ruler measures distance.
Pages 39-40
Ranking Total Utility
Quantity of Quantity of   Total
Bundle     hamburgers    pizza       Utility
A             2.5           10.0     25
B             3.0           7.0      21
C             4.0           6.25     25

Rank A and C over B
Indifferent between A and C
Marginal Utility
Marginal utility is the change in utility
derived from an increase in consumption
of a particular good.

MUhamburgers =  utility ÷  hamburgers

Page 40
Marginal Utility
Marginal utility is the change in utility
derived from an increase in consumption
of a particular good.

MUhamburgers =  utility ÷  hamburgers

This value will fall (rise) as consumption
increases (decreases).

Page 40
Marginal utility goes
to zero at the peak of
the total utility curve

Page 42
“Law of Diminishing Marginal
Utility” --

Marginal utility decreases as more
of a good is consumed over a given
time period.
Indifference Curves
Cardinal measurement of utility is both
unreasonable and unnecessary. We can
instead use an ordinal measurement of utility,
which means all we need to know is that one
bundle is preferred over another.

Page 43
Indifference Curves
Cardinal measurement of utility is both
unreasonable and unnecessary. We can
instead use an ordinal measurement of utility,
which means all we need to know is that one
bundle is preferred over another.
Modern consumption theory is based upon
the notion of isoutility curves, where “iso” is
the Greek for “equal”. The consumer is
assumed to be indifferent among different
combinations of goods along a isoutility curve.
Page 43
Increasing
utility

Page 43
The two indifference
curves here can be
thought of as providing
200 and 700 utils of
utility.

Page 43
The two indifference
curves here can be
thought of as providing
200 and 700 utils of
utility.

One would normally
expect a number of
or indifference curves.
Page 43
Slope of Indifference Curve
The slope of an indifference curve is known
as the marginal rate of substitution (MRS).
The marginal rate of substitution of hamburgers
for tacos is given by:
MRS =  tacos ÷ hamburgers

Page 43
Slope of Indifference Curve
The slope of an indifference curve is known
as the marginal rate of substitution (MRS).
The marginal rate of substitution of hamburgers
for tacos is given by:
MRS =  tacos ÷ hamburgers
The MRS reflects the number of tacos a consumer
is willing to give up for an additional hamburger.

Pages 43-44
The MRS between points
M and Q is equal to:
-2.0 = -2 ÷ 1.0

Page 43
This means the consumer
is will to give up 2 tacos in
exchange for an additional
hamburger!

Page 43
IMPORTANT POINT
• Along the SAME indifference curve, the
decrease in taco consumption from point M
to point Q times the accompanying increase
in the MU of tacos MUST be identical to
the increase in consumption of hamburgers
from point M to point Q times the
accompanying decrease in the MU of
hamburgers.
Δtacos            MUhamburgers
=
Δhamburgers         MUtacos

(3.4)
Concept of Budget Constraint
Weekly budget for fast food:
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS  BUDGET

where PHAMBURGERS and PTACOS represent the current
price of hamburgers and tacos while QHAMBURGERS and
QTACOS represent the quantities you plan to consume
during the week.

Page 45
Concept of Budget Constraint
Weekly budget for fast food:
PHAMBURGERS x QHAMBURGERS + PTACOS x QTACOS  BUDGET

where PHAMBURGERS and PTACOS represent the current price of
hamburgers and tacos while QHAMBURGERS and QTACOS repre-
sent the quantities you plan to consume during the week.

The budget constraint limits the amount that you can be spent
on these items. A graph depicting this constraint is referred to
as the budget line. The slope of this line is given by:

Slope of budget line = - (PHAMBURGERS ÷ PTACOS)
Page 45
Example of a Budget Constraint
Tacos         Hamburgers
(\$0.50 each)     (\$1.25 each)   Expenditure
10               0            \$5.00
5               2            \$5.00
0                  4          \$5.00

Each of these combinations
represent a point on the
budget line….                       Page 46
Original budget line       Change in income or both prices

Line BA is the original
budget line. It says that
Carl can afford either 10
tacos or two hamburgers
a week with his \$5 weekly
budget.
Change in taco price       Change in hamburger price

Page 46
Original budget line   Change in income or both prices
The original budget line
would shift in to line FG
if Carl’s available income
fell in half (or both prices
doubled). It would shift
out to line ED if Carl’s
income doubled (or both
in half).
prices fellChange in taco price   Change in hamburger price

Page 46
Original budget line       Change in income or both prices

Change in taco price        budget line would
The Change in hamburger price shift
out to line AE if the price of
tacos fell in half or shift in
to line AF if taco prices fell
in half. Note the price of
hamburgers did not change!

Page 46
Original budget line   Change in income or both prices

Finally, the budget line would
shift out to line BDinif the price
Change taco price     Change in hamburger price
of hamburgers fell in half, or
in to line line BG if the price
of hamburgers doubled.

Page 46
Engel’s Law:
The more wealthy a
consumer becomes, the
percentage of income spent
for food decreases.
1857
Chapter 4 unites the concepts
of indifference curves with a
budget constraint to determine
consumer equilibrium….

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