Managerial Economics Thomas

eighth edition Maurice

Chapter 5

Theory of
Consumer Behavior
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Utility
• Benefits consumers obtain from
goods & services they consume is
utility
• A utility function shows an
individual’s perception of the utility
level attained from consuming
each conceivable bundle of goods

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Theory of Consumer Behavior

• Assume consumers have complete
information about availability, prices, &
utility levels of all goods & services
• All bundles of goods can be ranked
based on their ability to provide utility –
for any pair of bundles A & B:
• Prefer bundle A to bundle B
• Prefer bundle B to bundle A
• Indifferent between the two bundles

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Indifference Curves
• Locus of points representing different
bundles of goods, each of which yields
the same level of total utility
• Negatively sloped & convex
• Marginal rate of substitution (MRS)
• Absolute value of the slope of the
indifference curve
• Diminishes along the indifference curve as X
increases & Y decreases

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Typical Indifference Curve
(Figure 5.1)

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Indifference Map (Figure 5.3)

Quantity of Y

IV

III

II

Quantity of X

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Marginal Utility
• Addition to total utility attributable
to the addition of one unit of a
good to the current rate of
consumption, holding constant the
amounts of all other goods
consumed

MU = U X

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Marginal Rate of Substitution

• MRS shows the rate at which one
good can be substituted for another
while keeping utility constant
• Negative of the slope of the
indifference curve
• Ratio of the marginal utilities of the
goods
Y MU X
MRS  − =
X MUY
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Consumer’s Budget Line

• Shows all possible commodity
bundles that can be purchased at
given prices with a fixed money
income
M = PX X + PY Y
or
M PX
Y = − X
PY PY
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Utility Maximization
• Utility maximization subject to a
limited money income occurs at the
combination of goods for which the
indifference curve is just tangent to
the budget line

Y MU X PX
MRS = − = =
X MUY PY

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Utility Maximization
• Consumer allocates income so that
the marginal utility per dollar spent
on each good is the same for all
commodities purchased

MU X MUY
=
PX PY

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