Law of

Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
3
Demand
Curve
Applications
and
Extensions
Budget
Lines
Indifference
Consumer Behavior
Curves
Equilibrium
Last Word
and Utility
Maximization
Copyright 2021 McGraw-Hill Education
 To ponder upon…
Law of
Diminishing
Marginal
Do we use economics everyday?
Utility
Theory of
Consumer• After how many glasses of water, is your thirst
Behavior
Deriving the satisfied?
Demand
Curve • If you drink an extra one, how does this make
Applications
and you feel?
Extensions
Budget • How do you decide if you will keep drinking
Lines
Indifference
water?
Curves
Equilibrium
Last Word

Copyright 2021 McGraw-Hill Education

 In this chapter you will learn:
Law of
Diminishing • What is total utility, marginal utility, and the law of
Marginal
Utility
diminishing marginal utility.
Theory of
Consumer
• How rational consumers compare marginal utility-
Behavior to-price ratios for products in purchasing
Deriving the
Demand combinations to maximize total utility.
Curve
Applications • How to derive the demand curve by observing
and
Extensions
behaviour.
Budget • How the utility-maximization model highlights
Lines
Indifference income and substitution effects of a price change.
Curves
Equilibrium • How we define budget lines, indifference curves,
Last Word utility maximization, and demand derivation in the
indifference curve model of consumer behaviour.

Copyright 2021 McGraw-Hill Education

 Where from now?
Law of
Diminishing
Marginal
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
CurveTermi Law of Deriving
Theory of Indifference
Applications diminishing the Budget
marginal consumer demand curves
and nology behaviour constraint analysis
utility curve
Extensions
Budget
Lines
Indifference
Curves
Equilibrium
Last Word

Copyright 2021 McGraw-Hill Education

 Terminology
Law of
Diminishing
Marginal The utility of a good or service is the
Utility
Theory of
satisfaction or pleasure one gets from
Consumer
Behavior
consuming it.
Deriving the
Demand
Curve • ≠ usefulness
Applications
and • subjective
Extensions• difficult to quantify
Budget
Lines
Indifference
Curves
Total utility (TU) is the total amount of
Equilibrium satisfaction a person derives from
Last Word
consuming some specific quantity of a
good or a service.
Copyright 2021 McGraw-Hill Education
 Terminology (cont.)
Law of
Diminishing
Marginal utility (MU)
Marginal
Utility
Theory of
• is the extra satisfaction a consumer
Consumer realizes from an additional unit of that
Behavior
Deriving the product.
Demand
Curve
Applications
and
or
Extensions
Budget • is the change of total utility that results
Lines
Indifference from the consumption of 1 more unit of a
Curves
Equilibrium product.
Last Word
ΔTU
MU =
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ΔQ
 Terminology (cont.)
Law of
Diminishing
Marginal
Utility
Theory of
Weighted Marginal utility
Consumer
Behavior
(MU/Price)
Deriving the
Demand
Curve • is the per-rand value extra satisfaction
Applications
and (weighted extra satisfaction) a
Extensions
Budget consumer realizes from an additional
Lines
Indifference
unit of that product.
Curves
Equilibrium
Last Word
MU
WMU =
Price
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 Law of diminishing MU
Law of • In brief, satisfaction declines as
Diminishing
Marginal consumer acquires additional units of a
Utility
Theory of given product.
Consumer
Behavior
Deriving the
• If successive units of a good yield
Demand
Curve
smaller and smaller amounts of MU,
Applications
and
the consumer will buy additional
Extensions
Budget
product only if price falls.
Lines
Indifference • Hence, the demand curve for a given
Curves
Equilibrium product slopes downward.
Last Word

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 Law of diminishing MU
Total Utility
Law of
Diminishing
30
Marginal

Total Utility (Utils)

(1) (2) (3)
Utility Burgers TU, MU, TU
Theory ofconsumed Utils Utils 20
Consumer per meal
Behavior
Deriving the0 0
Demand
1 10
] 10 10
Curve
Applications2 18
] 8
0
and
24
] 6 1 2 3 4 5
Units consumed per meal
6 7
Extensions 3
]
Marginal Utility (Utils)
4 Marginal Utility
Budget 4 28
Lines
Indifference5 30
] 2 10
8
Curves 6 30
] 0 6

28 ]
Equilibrium -2 4
Last Word 7 2
0
-2 MU
1 2 3 4 5 6 7
Units consumed per meal
Copyright 2021 McGraw-Hill Education
 Consumer choice and budget
constraint
Law of
Diminishing
Marginal Rational behaviour
Utility
Theory of• Consumers try to maximise their utility with the
Consumer available income.
Behavior
Deriving the
Demand Preferences
Curve
Applications
and
Extensions Budget constraint
Budget
Lines • At any point in time the consumer has a fixed, limited
Indifferenceamount of money income.
Curves
Equilibrium
Last Word Prices
• Goods are scarce relative the demand so every good
carries a price tag.
Copyright 2021 McGraw-Hill Education
 Theory of consumer behavior
Numerical example:
Utility-maximizing combination of products
Law of
A and B obtainable with an income of R10
Diminishing
Marginal
Utility (2) (3)
Theory of Product A: Product B:
Consumer Price = R1 Price = R2
Behavior
Deriving the (b) (b)
(a) MU (a)
Demand (1) MU MU MU
Curve per rand per rand
Unit of (Utils) (MU/Price) (Utils)
Applications product (MU/Price)
and
Extensions First 10 10 24 12
Budget
Lines Second 8 8 20 10
Indifference
Third 7 7 18 9
Curves
Equilibrium • Compare Marginal Utilities
Fourth 6 6 16 8
Last Word
• Then compare
Fifth 5
per-rand
5
value
12
(MU/Price)
6
• Choose the
Sixth 4 highest
4 6 3
• Check budget
Seventh 3 (R83left), proceed
4 to next
2 item
Copyright 2021 McGraw-Hill Education
 Theory of consumer behavior
Numerical example:
Utility-maximizing combination of products
Law of
Diminishing A and B obtainable with an income of R10
Marginal
Utility (2) (3)
Theory of Product A: Product B:
Consumer Price = R1 Price = R2
Behavior
(b) (b)
Deriving the (a) MU (a)
Demand (1) MU MU MU
Curve per Rand per rand
Unit of (Utils) (MU/Price) (Utils)
Applications product (MU/Price)
and
Extensions First 10 10 24 12
Budget
Lines Second 8 8 20 10
Indifference
Third 18 9
Curves
Equilibrium • Again, compare per-rand value (MU/Price)
Fourth 16 8
Last Word
• Choose
Fifth
the highest 12 6
• Sixth MU per rand, \buy one of
Same 6 each 3
• Budget
Seventh has R5 left, proceed to next
4 item2
Copyright 2021 McGraw-Hill Education
 Theory of consumer behavior
Numerical example:
Utility-maximizing combination of products
Law of
Diminishing A and B obtainable with an income of R10
Marginal
Utility (2) (3)
Theory of Product A: Product B:
Consumer Price = R1 Price = R2
Behavior
(b) (b)
Deriving the (a) MU (a)
Demand (1) MU MU MU
Curve per Rand per rand
Unit of (Utils) (MU/Price) (Utils)
Applications product (MU/Price)
and
Extensions First 10 10 24 12
Budget
Lines Second 8 8 20 10
Indifference
Curves Third 7 7 18 9
Equilibrium
Fourth 6 6 16 8
Last Word •Fifth
Again, compare
5
per-rand
5
value
12
(MU/Price)
6
•Sixth
Buy one more
4 B 4 6 3
•Seventh
Budget has3 R3 left,3 proceed to
4 next item
2
Copyright 2021 McGraw-Hill Education
 Theory of consumer behavior
Numerical example:
Utility-maximizing combination of products
Law of
Diminishing A and B obtainable with an income of R10
Marginal
Utility (2) (3)
Theory of Product A: Product B:
Consumer Price = R1 Price = R2
Behavior
(b) (b)
Deriving the (a) MU (a)
Demand (1) MU MU MU
Curve per Rand per rand
Unit of (Utils) (MU/Price) (Utils)
Applications product (MU/Price)
and
Extensions First 10 10 24 12
Budget
Lines Second 8 8 20 10
Indifference
Curves Third 7 7 18 9
Equilibrium
Last Word
Fourth 6 6 16 8
Fifth 5 5 12 6
•Sixth
Again, compare
4 per-rand
4 value
6 (MU/Price)
3
•Seventh
Buy one of3 each – 3budget exhausted
4 2
Copyright 2021 McGraw-Hill Education
 Theory of consumer behavior
Numerical example:
Utility-maximizing combination of products
Law of
Diminishing A and B obtainable with an income of R10
Marginal
Utility (2) (3)
Theory of Product A: Product B:
Consumer Price = R1 Price = R2
Behavior
(b) (b)
Deriving the (a) MU (a)
Demand (1) MU MU MU
Curve per Rand per rand
Unit of (Utils) (MU/Price) (Utils)
Applications product (MU/Price)
and
Extensions First 10 10 24 12
Budget
Lines Second 8 8 20 10
Indifference
Curves Third 7 7 18 9
Equilibrium
Last Word
Fourth 6 6 16 8
Fifth 5 5 12 6
Final
Sixth result:4 at these4 prices, purchase
6 3
2 of item A and
Seventh 3 4 of3B 4 2
Copyright 2021 McGraw-Hill Education
 Theory of consumer behavior
Algebraic restatement:
Law of
Diminishing
Marginal MU of product A MU of product B
Utility
Theory of
Consumer Price of A
= Price of B
Behavior
Deriving the
Demand
Curve
Applications 8 Utils 16 Utils
and
Extensions
R1
= R2
Budget
Lines
Indifference
Curves
Equilibrium
Optimum achieved
Last Word Money income is allocated so that the last
rand spent on each product yields the
same extra or marginal utility.
Copyright 2021 McGraw-Hill Education
 Theory of Consumer Behaviour
Derive the demand curve for B
Law of
(2) (3)
Diminishing
Product A: Product B:
Marginal
Utility Price = R1 Price = R1
Theory of (b) (b)
Consumer (1) (a) (a)
MU per rand MU per rand
Behavior Units MU (Utils) (MU/Price) MU (Utils) (MU/Price)
Deriving the
Demand
Curve First 10 10 24 24
Applications
and Second 8 8 20 20
Extensions 7 7 18 18
Budget Third
Lines Fourth 6 6 16 16
Indifference
Curves Fifth 5 5 12 12
Equilibrium
Last Word Sixth 4 4 6 6
Seventh 3 3 4 4

Final Outcome: @ this price, buy 4 of A and 6 of B

Copyright 2015 McGraw-Hill Education
 Deriving the demand curve
Law ofPrevious example shows
Diminishing
the consumer’s preferences.
Marginal
Utility
TheoryToofderive the demand curve: 2
Consumer
• Money income remains the
Behavior

Price of product B
Derivingsame
the (R10)
Demand
Curve• Concentrate on one good (B)
Applications
• Assume the price of the other
and
good (A) remains the same.
Extensions 1
Budget
Lines
Indifference Price per Quantity
Curves DB
Equilibrium unit of B demanded
Last Word
R2 4
0
4 6
1 6
Quantity demanded of B
Copyright 2021 McGraw-Hill Education
 Deriving the demand curve
Law of
Income effect
Diminishing
Marginal
Utility• The impact that a change in
Theory of 2
Consumer the price of a product has on
Behaviora consumer’s real income

Price of product B
Derivingand
the consequently on the
Demandquantity demanded of the
Curve
good.
Applications
and
Extensions 1
Budget Substitution effect
Lines
Indifference
Curves
• The impact that a change in DB
a product’s price has on its
Equilibrium
Last Wordrelative expensiveness and
consequently on the quantity
demanded. 0
4 6
Quantity demanded of B
Copyright 2021 McGraw-Hill Education
 Theory of consumer behavior
Cardinal and Ordinal Theories
Law of
Cardinal
Diminishing
Marginal
MU of product A
= MU of product B
Utility
Theory of
Price of A
Consumer
Behavior Price of B
Deriving the
Demand
Curve
Applications
and
Ordinal
Extensions
Budget
Budget Lines
Lines
Indifference
Curves
Indifference Curves
Equilibrium
Last Word

Copyright 2021 McGraw-Hill Education

 Budget line (constraint)
Law of
Diminishing
• It is a schedule or curve showing
Marginal
Utility
various combinations of two products
Theory of
Consumer a consumer can purchase with a
Behavior
Deriving the
Demand
specific money income.
Curve 12
Applications Income = R12
Units of A Units of B Total 10
and (Price = R1.50) (Price = R1) expenditure PA = R1.50
Extensions

Quantity of A
Budget 8
8 0 R12 (Unattainable)
Lines
Indifference6 3 12 6
Curves Income = R12
Equilibrium4 6 12 4
(Attainable) PB = R1
Last Word 2 9 12 2
0 12 12
0
2 4 6 8 10 12
Quantity of B
Copyright 2021 McGraw-Hill Education
 Budget line (constraint)
Law of
Diminishing
Marginal
Utility
Income changes
Theory of
Consumer
Behavior • The location of the budget line
Deriving the
Demand varies with money income.
Curve
Applications
and
Extensions

Price changes
Budget
Lines
Indifference
Curves
Equilibrium
Last Word • Change in product prices of
products shifts the budget line.
Copyright 2021 McGraw-Hill Education
 Indifference curve analysis
Law of
Diminishing
Marginal
Utility
What is preferred
Theory of
Consumer
Behavior
Deriving the • They show all the combinations of products
Demand A and B that will yield the same total
Curve
Applications satisfaction or total utility to the consumer.
and
Extensions
Budget
Lines
• The consumer, hence, will be indifferent (will
Indifference not care) as to which combinations is
Curves
Equilibrium
actually obtained.
Last Word

Copyright 2021 McGraw-Hill Education

 Indifference curve analysis
Law of Combination Units of A Units of B
Diminishing
Marginal j 12 2
Utility
Theory of k 6 4
Consumer
Behavior l 4 6 12
Deriving the j
Demand 10
Curve
m 3 8
Applications

Quantity of A
8
and
Extensions 6 k
Budget
Lines l
4 m
Indifference
Curves 2
Equilibrium I
Last Word
0
2 4 6 8 10 12
Quantity of B

Copyright 2021 McGraw-Hill Education

 Indifference curve analysis
Law of Down-sloping
Diminishing
Marginal • More of one product means less of the other if
Utility
Theory of total utility is to remain unchanged.
Consumer
Behavior
Deriving the Convex to the origin
Demand
Curve
Applications• Slope of a curve at a particular point is measured
and
Extensions by drawing a straight line tangent to that point.
Budget • Slopes decline in absolute terms as we move
Lines
Indifference down the curve.
Curves • Slopeà Marginal rate of substitution (MRS): rate
Equilibrium
Last Word at which the consumer who possesses the
combination will substitute one good for the other
to remain equally satisfied.

Copyright 2021 McGraw-Hill Education

 Indifference curve analysis
Convex to the origin- Diminishing MRS
Law of Consumer
Diminishing Unit of B is
is prepared
Marginal
Begin at valuable to give up a Sacrifice 6
Utility (high MU)
point j (lots substantial units of A to MRS=6/2=
Theory of
of A, less of while unit of amount of A get 2 B
Consumer A is less 3
B)
Behavior to get for (jàk)
valuable example 2
Deriving the (low MU)
Demand units of B.
Curve
Applications 12
j
and
Extensions 10
Budget
Quantity of A

Lines 8
Indifference
Curves 6 k
Equilibrium l
Last Word 4 m
2 I
0
2 4 6 8 10 12
Copyright 2021 McGraw-Hill Education
Quantity of B
 Indifference curve analysis
Convex to the origin- Diminishing MRS
Law of Unit of A is
Diminishing more valuable
Marginal Consumer is
(high MU) prepared to
Begin
Utility at point
while unit of B sacrifice only
kTheory
(less A,ofmore
is less MRS=2/2=1
B)
Consumer 2 units of A to
Behavior valuable (low get 2 B (kàl)
Deriving the MU)
Demand marginally.
Curve
Applications 12
j
and
Extensions 10
Budget
Quantity of A

Lines 8
Indifference
Curves 6 k
Equilibrium l
Last Word 4 m
2 I
0
2 4 6 8 10 12
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Quantity of B
 Indifference curve analysis
Convex to the origin- Diminishing MRS
Law of
Diminishing
Marginal
As the amount of B As the quantity
Utility of A decreases,
increases, the MU of
Theory of
additional units of B MRS declines
Consumer its MU
decreases.
Behavior increases.
Deriving the
Demand
Curve
Applications 12
j
and
Extensions 10
Budget
Quantity of A

Lines 8
Indifference
Curves 6 k
Equilibrium l
Last Word 4 m
2 I
0
2 4 6 8 10 12
Copyright 2021 McGraw-Hill Education
Quantity of B
 Indifference curve analysis
• Indifference map
Law of – Series of indifference curves, each showing a
Diminishing
Marginal different level of utility; never cross each other
Utility
Theory of
Consumer 12
Behavior
Deriving the
Demand 10
Curve
Applications
and 8
Quantity of A

Extensions
Budget
6
Lines
Indifference
Curves 4
Equilibrium
Last Word I4
2 I3
I2
0 I1
2 4 6 8 10 12
Copyright 2021 McGraw-Hill Education
Quantity of B
 Indifference curve analysis
Law of
• Equilibrium position at tangency (x)
Diminishing
Marginal
– Combination lying on the highest
Utility
Theory of
attainable indifference curve
Consumer 12
Behavior
Deriving the
Demand 10 PB
Curve MRS =
Applications PA
and 8
Quantity of A

Extensions
Budget Preferred –
6 W but requires
Lines
Indifference more income
Curves 4 X
Equilibrium
At X:
Last slope of
Word I4
indifference curve 2 I3
= slope of budget I2
line 0 I1
2 4 6 8 10 12
Copyright 2021 McGraw-Hill Education
Quantity of B
 Derivation of the demand curve
MU of A MU of B
Law of
Diminishing
12
=
10 Price of A Price of B
Marginal Quantity of A
Utility 8
Theory of
Consumer 6
• At R1 price for B, 6
Behavior
4
X units are purchased
Deriving the
Demand 2
Curve I3
Applications
I2 • As price of B increases
0
and 2 4 6 8
Quantity of B
10 12 to R1.50,only 3 units of B
Extensions
Budget are bought
Lines
Price of B

Indifference
Curves R1.50 • Connect the points to
Equilibrium
Last Word 1.00 create the demand curve
.50
DB
1 2 3 4 5 6 7 8 9 1011 12
Quantity of B
Copyright 2021 McGraw-Hill Education
 Derivation of the demand curve
Law of
Diminishing
Marginal Marginal Utility theory
Utility
Theory of
Consumer
• assumes that utility is numerically measurable:
Behavior the consumer can say how much extra can be
Deriving the
Demand gained by an extra unit of A or B.
Curve
Applications
(MUA/PA=MUB/PB)
and
Extensions
Budget
Indifference curve approach
Lines
Indifference • the consumer needs only to specify whether a
Curves
Equilibrium particular combination of A and B will yield
Last Word more than, less than or the same amount of U
as some other combination.

Copyright 2021 McGraw-Hill Education

 Cardinal and Ordinal Utility
• Marginal Utility
Law of
Diminishing
Marginal
• Cardinal Equation
Utility
Theory of
(MU /PA=MUB/PB) = PB/PA = MUB/MUA
Consumer
Behavior A
Deriving the
Demand
Curve
Applications
• Ordinal Equilibrium point = MRS
and
Extensions
• MRS = PB/PA Price relationship
Budget
Lines
Indifference
Curves
Equilibrium
• PB/PA = PB/PA
Last Word

Cardinal = Ordinal approach of consumer theory

Copyright 2021 McGraw-Hill Education
 Last Word
Although Economic Analysis Is Not Particularly Relevant in
Explaining Some Crimes of Passion and Violence, It Does
Law of
Provide Interesting Insights on Such Property Crimes as
Diminishing
Marginal Robbery, Burglary and the hijacking of cars
Utility
Theory of
Consumer
Behavior
Deriving the
Demand
Curve
Applications
and
Extensions
Budget
Lines
Indifference
Curves Case Study
Equilibrium
Last Word Consumer Behaviour and Utility maximization

Copyright 2021 McGraw-Hill Education

 Key terms
• law of diminishing marginal utility
Law of • utility
Diminishing
Marginal • total utility
Utility • marginal utility
Theory of
Consumer • rational behavior
Behavior • budget constraint
Deriving the
Demand • utility-maximizing rule
Curve • budget line
Applications
and • indifference curve
Extensions
Budget • marginal rate of substitution (MRS)
Lines • equilibrium position
Indifference
Curves
Equilibrium
Last Word

Copyright 2021 McGraw-Hill Education