The Law of Demand

Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
21 C HAPTE R

Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Consumer Behavior and
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Utility Maximization
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Copyright McGraw-Hill/Irwin, 2002
 THE LAW OF DEMAND
The Law of Demand
Law of Diminishing
A Closer Look…
Marginal Utility
Total and Marginal
Utility
The Income Effect
Theory of Consumer
Behavior
A lower price frees income
Utility Maximizing
Combination
for additional purchases -
Utility Maximization
and the Demand
and vice versa
Curve

The Substitution Effect

Applications and
Extensions
Key Terms

A lower price relative to other

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goods attracts new buyers -
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and vice versa
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Copyright McGraw-Hill/Irwin, 2002
 LAW OF DIMINISHING
The Law of Demand MARGINAL UTILITY
• Utility Defined
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
• Subjective Nature
• Difficult to Quantify
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
Total Utility
Marginal Utility
graphically examined...
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End
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Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility

1 10
Theory of Consumer
Behavior
10
Utility Maximizing
Combination
Utility Maximization
and the Demand
0 1 2 3 4 5 6 7
Curve
Applications and Units consumed per meal

Marginal Utility (utils)

Extensions 10
Key Terms 8
6
4
2
Previous Next 0
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-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
21 - 4
Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility
10
1 10
Theory of Consumer
Behavior
10
Utility Maximizing
Combination
Utility Maximization
and the Demand
0 1 2 3 4 5 6 7
Curve
Applications and Units consumed per meal

Marginal Utility (utils)

Extensions 10
Key Terms 8
6
4
2
Previous Next 0
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-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
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Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility
10
1 10
Theory of Consumer
Behavior
10
Utility Maximizing 8
Combination
Utility Maximization
2 18
and the Demand
0 1 2 3 4 5 6 7
Curve
Applications and Units consumed per meal

Marginal Utility (utils)

Extensions 10
Key Terms 8
6
4
2
Previous Next 0
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-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
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Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility
10
1 10
Theory of Consumer
Behavior
10
Utility Maximizing 8
Combination
2 18
Utility Maximization
6
and the Demand
Curve 3 24 0 1 2 3 4 5 6 7

Applications and Units consumed per meal

Marginal Utility (utils)

Extensions 10
Key Terms 8
6
4
2
Previous Next 0
Slide Slide
-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
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Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility
10
1 10
Theory of Consumer
Behavior
10
Utility Maximizing 8
Combination
2 18
Utility Maximization
6
and the Demand
3 24 0 1 2 3 4 5 6 7

4
Curve

4 28
Applications and Units consumed per meal

Marginal Utility (utils)

Extensions 10
Key Terms 8
6
4
2
Previous Next 0
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-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
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Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility
10
1 10
Theory of Consumer
Behavior
10
Utility Maximizing 8
Combination
2 18
Utility Maximization
6
and the Demand
3 24 0 1 2 3 4 5 6 7

4
Curve

4 28
Applications and Units consumed per meal

Marginal Utility (utils)

10
2
Extensions
8
5 30
Key Terms
6
4
2
Previous Next 0
Slide Slide
-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
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Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility
10
1 10
Theory of Consumer
Behavior
10
Utility Maximizing 8
Combination
2 18
Utility Maximization
6
and the Demand
3 24 0 1 2 3 4 5 6 7

4
Curve

4 28
Applications and Units consumed per meal

Marginal Utility (utils)

10
2
Extensions
8
5 30
Key Terms
6
0 4

Previous Next 6 30 2
0
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-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
21 - 10
Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal TU
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
20
0 0
Total and Marginal
Utility
10
1 10
Theory of Consumer
Behavior
10
Utility Maximizing 8
Combination
2 18
Utility Maximization
6
and the Demand
3 24 0 1 2 3 4 5 6 7

4
Curve

4 28
Applications and Units consumed per meal

Marginal Utility (utils)

10
2
Extensions
8
5 30
Key Terms
6
0 4
6 30 2
Previous Next
-2 0
7 28 MU
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-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
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Copyright McGraw-Hill/Irwin, 2002
 TOTAL AND MARGINAL UTILITY
Tacos Total Marginal TU
The Law of Demand consumed Utility, Utility, 30

Total Utility (utils)

Law of Diminishing per meal Utils Utils
Marginal Utility
Total and Marginal
Utility 0 0
20
Observe
10 Diminishing
1 10
Theory of Consumer
Behavior
10
Utility Maximizing 8
Combination
2 18 Marginal
Utility Maximization
6
and the Demand
3 24 0 1 2
Utility
3 4 5 6 7

4
Curve

4 28
Applications and Units consumed per meal

Marginal Utility (utils)

10
2
Extensions
8
5 30
Key Terms
6
0 4
6 30 2
Previous Next
-2 0
7 28 MU
Slide Slide
-2
End 1 2 3 4 5 6 7
Show Units consumed per meal
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Copyright McGraw-Hill/Irwin, 2002
 THEORY OF CONSUMER BEHAVIOR
The Law of Demand
A Typical Consumer...
Law of Diminishing

• Exhibits Rational
Marginal Utility
Total and Marginal
Utility
Theory of Consumer
Behavior Behavior
• Has Clear-Cut
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Preferences
Extensions
Key Terms
• Subject to a Budget
Constraint
• Responds to Price
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End
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21 - 13 Changes
Copyright McGraw-Hill/Irwin, 2002
 THEORY OF CONSUMER BEHAVIOR
The Law of Demand Utility Maximizing Rule
Law of Diminishing
Marginal Utility
Total and Marginal
Utility
The consumer’s money
Theory of Consumer
Behavior
income should be allocated so
Utility Maximizing
Combination
Utility Maximization
that the last dollar spent on
and the Demand
Curve each product yields the same
Applications and
Extensions
Key Terms
amount of extra (marginal)
utility
illustrated...
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End
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Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
How should the $10
Previous Next
Income be allocated?
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End
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Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve

Examine the two

Applications and
Extensions
Key Terms

Previous Next
marginal utilities
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End
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Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve

Examine the two

Applications and
Extensions
Key Terms

Previous Next
marginal utilities
…per dollar
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End
Show
21 - 17
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve

Decision: Buy 1
Applications and
Extensions
Key Terms

Previous Next
Product B for $2
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End
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21 - 18
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Second 8 8 20 10
Applications and
Extensions
Third 7 7 18 9
Key Terms
Fourth What
6 next?
6 16 8
Previous Next
Fifth 5 5 12 6
Slide Slide
Sixth 4 4 6 3
End
Show
21 - 19
Seventh 3 3 4 2
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Second 8 8 20 10
Applications and
Extensions
Third 7 7 18 9
Key Terms
Fourth What
6 next?
6 16 8
Fifth 5 5 12 6
Previous Next Buy one of each
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Sixth 4 4 6 3
End
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21 - 20
Seventh 3 3 4 2
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Second 8 8 20 10
Applications and
Extensions
Third 7 7 18 9
Key Terms
Fourth 6 6 16 8
Fifth
and
5
then...
5 12 6
Previous
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Next
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Sixth ($5
4 left)
4 6 3
End
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Seventh 3 3 4 2
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Second 8 8 20 10
Applications and
Extensions
Third 7 7 18 9
Key Terms
Fourth 6 6 16 8
Fifth third
5 unit
5 of12 6
Sixth product B 6
Previous Next
Slide Slide
4 4 3
End
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Seventh 3 3 4 2
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Second 8 8 20 10
Applications and
Extensions
Third 7 7 18 9
Key Terms
Fourth 6
$3 left... 6 16 8
Previous Next
Fifth 5 5 12 6
Slide Slide
Sixth 4 4 6 3
End
Show
21 - 23
Seventh 3 3 4 2
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Second 8 8 20 10
Applications and
Extensions
Third 7 7 18 9
Key Terms
Fourth 6
$3 left... 6 16 8
Fifth 5 5 12 6
Previous
Slide
Next
Slide
Buy
Sixth both!
4 4 6 3
End
Show
21 - 24
Seventh 3 3 4 2
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION
Product A: Price = $1 Product B: Price = $2
$ 10 income
The Law of Demand
Law of Diminishing Marginal Marginal
Marginal Utility Marginal utility per Marginal utility per
Total and Marginal Unit of utility, dollar utility, dollar
Utility utils (MU/price) utils (MU/price)
product
Theory of Consumer
Behavior
Utility Maximizing
Combination First 10 10 24 12
Utility Maximization
and the Demand
Curve
Second 8 8 20 10
Applications and
Extensions
Third 7
Income is gone... 7 18 9
Key Terms
Fourth
the last dollar 6
spent on 6 16 8
each good gave the same
Fifth 5 5 12 6
Previous Next utility (8) per dollar
Slide Slide
Sixth 4 4 6 3
End
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Seventh 3 3 4 2
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZING COMBINATION

The Law of Demand

Law of Diminishing
Marginal Utility
Algebraic Restatement of the
Total and Marginal
Utility Utility Maximization Rule
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
MU of product A MU of product B
Curve
Applications and
Extensions Price of A
= Price of B
Key Terms

Previous Next
Slide Slide
End
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Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZATION AND
The Law of Demand
THE DEMAND CURVE
Law of Diminishing
Marginal Utility Deriving the Demand Schedule
Total and Marginal
Utility and Curve
Theory of Consumer
Behavior
Utility Maximizing
Combination
Given from the previous example schedule:
• Preferences or Tastes
Utility Maximization
and the Demand
Curve

• Money Income
Applications and
Extensions
Key Terms

Previous Next
• Prices of Other Goods
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Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZATION AND
The Law of Demand
THE DEMAND CURVE
Law of Diminishing
Marginal Utility Deriving the Demand Schedule
Total and Marginal
Utility and Curve
Theory of Consumer
Behavior
Utility Maximizing
Create a demand schedule from the
Combination
Utility Maximization
purchase decisions as the price of
and the Demand
Curve the product is varied ...
Applications and
Extensions
Key Terms Price per unit of B Quantity Demanded
$2 4
Next
Previous
Slide Slide 1 6
End
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Graphically…
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZATION AND
The Law of Demand
THE DEMAND CURVE
Law of Diminishing Deriving the Demand Schedule
Marginal Utility
Total and Marginal
Utility
and Curve
Theory of Consumer
Behavior
Utility Maximizing Price per unit of Good B
$2
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms
1

Previous Next DB
Slide Slide
End 0
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21 - 29 Quantity Demanded of Good B
Copyright McGraw-Hill/Irwin, 2002
 UTILITY MAXIMIZATION AND
The Law of Demand
THE DEMAND CURVE
Law of Diminishing Deriving the Demand Schedule
Marginal Utility
Total and Marginal
Utility
and Curve
Theory of Consumer
Behavior
Utility Maximizing
Substitution
$2 Effects
Price per unit of Good B
Combination
Utility Maximization
and the Demand
Curve
and Income Effects
Applications and
Extensions Revisited
1
Key Terms

Previous Next DB
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End 0
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21 - 30 Quantity Demanded of Good B
Copyright McGraw-Hill/Irwin, 2002
 APPLICATIONS AND EXTENSIONS
The Law of Demand
Law of Diminishing
The Compact Disc
Marginal Utility
Total and Marginal
Utility
Takeover
Theory of Consumer
Behavior The Diamond-Water
Utility Maximizing
Combination
Utility Maximization
Paradox
and the Demand
Curve
Applications and
The Value of Time
Extensions
Key Terms Medical Care Purchases
Previous Next
Cash and Noncash Gifts
Chapter Conclusions
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Copyright McGraw-Hill/Irwin, 2002
income effect
substitution effect
utility
total utility
marginal utility
law of diminishing marginal utility
rational behavior
budget constraint
utility-maximizing rule
Copyright McGraw-Hill/Irwin 2002 BACK END
The Law of Demand
Law of Diminishing
Marginal Utility
Next…
Total and Marginal
Utility
Theory of Consumer
Behavior
Utility Maximizing
Combination
Utility Maximization
and the Demand
Curve
Applications and
Extensions
Key Terms

Previous
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Next
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Indifference Curve Analysis
End
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Copyright McGraw-Hill/Irwin, 2002