Unit 6: Consumer Choice

Lesson 6.1: Utility and Consumer Behaviour

Consumer choice theory explores how individuals allocate their income among various goods and services to maximize their satisfaction, or utility. This section introduces the concept of utility and its relationship to consumption decisions.

• Utility: Utility is the technical term economists use to describe the satisfaction or happiness a consumer gains from consuming a good or service.

• Consumer Choices: Consumers can use their income in two main ways:

  • Consumption of goods and services

  • Accumulation of savings (requires spending less than current income)

  • If consumers wish to consume more than their current income, they must either dissave (spend savings) or borrow (which requires future consumption to be less than income to repay debt).

• Factors Influencing Willingness to Purchase:

  • Natural desire for the product

  • Relative value compared to other goods

  • Available income

• Consumer's Budget: The budget available to a consumer depends on:

  • Income from work and other sources

  • Stock of savings

  • Ability to borrow

• Valuation of Goods and Services:

  • Valuation is subjective and varies between individuals.

  • Valuation is also relative, depending on the quantity and variety of goods available.

Utility and Marginal Utility

Utility increases as consumption of a good increases, but the additional satisfaction from each extra unit typically declines. This concept is central to understanding consumer behaviour.

• Total Utility: The total satisfaction received from consuming a certain quantity of a good, represented by the utility function .

• Marginal Utility (MU): The additional utility gained from consuming one more unit of a good. Mathematically, it is the slope of the utility function at a given point.

• Diminishing Marginal Utility: As more units of a good are consumed, the marginal utility of each additional unit decreases. Eventually, marginal utility may reach zero (the consumer is satiated), or even become negative if consumption exceeds the point of satisfaction.

• Graphical Representation: Utility functions are typically concave, showing diminishing marginal utility as quantity increases.

Example: Eating slices of pizza: The first slice provides high satisfaction, but each additional slice provides less extra satisfaction than the previous one.

Deciding What to Buy

Consumers aim to maximize their utility given their budget constraints. They compare the marginal utility per dollar spent across different goods to make optimal choices.

• Equi-Marginal Principle: Utility is maximized when the marginal utility per dollar spent is equal for all goods:

• Application: If the marginal utility per dollar spent on good X is higher than on good Y, the consumer should buy more of X and less of Y until equality is achieved.

Additional info:

• Budget Constraint: The consumer's budget constraint is a linear function representing all combinations of goods X and Y that can be purchased with a given income and prices. Points below the line are affordable; points above are not.

• Formula for Budget Constraint:

  • Where is income, and are prices of goods X and Y, and , are quantities.