Consumer Choice Theory Summary

Consumer Decision-Making

  • Central to microeconomics: understanding how consumers make choices

  • Consumers aim to maximize satisfaction (utility) given income and prices

Utility

  • Definition: Satisfaction or happiness from consuming goods/services

  • Cannot be measured directly, but useful for analyzing choices

Cardinal vs. Ordinal Utility

  • Cardinal Approach: Utility quantifiable in numbers (e.g., 20 utils for 1 slice of pizza; 35 for 2)

  • Ordinal Approach: Ranks preferences without numerical values (e.g., prefers coffee > tea > water)

Marginal Utility

  • Definition: Additional satisfaction from consuming one more unit of a good

  • Example: Second slice of pizza increases total utility by 15 (from 20 to 35 utils)

Law of Diminishing Marginal Utility

  • As consumption increases, additional satisfaction decreases

  • Supports downward-sloping demand curves; willingness to pay decreases as quantity increases

Marginal Utility per Dollar

  • Calculated as MU/PMU/P (where MU = marginal utility, P = price)

  • Compares satisfaction gained per dollar spent across goods

Equalization Principle

  • Utility maximized when MU<em>x/P</em>x=MU<em>y/P</em>yMU<em>x/P</em>x = MU<em>y/P</em>y across all goods

  • Consumers should shift spending towards goods providing higher utility per dollar

Example of Utility Maximization

  • Consumer budget: $10

  • Goods: Apples ($2), Bananas ($1)

  • Strategy: Select highest MU/PMU/P until budget is exhausted

  • Optimal choice resulted in 4 Bananas + 3 Apples = Total Utility = 102 utils

Conclusion

  • Consumer choice theory helps explain utility maximization under budget constraints and its impact on market demand.