Consumer choice

level of happiness or satisfaction associated with alternative choices

a term referring to the satisfaction received by a consumer from consuming a good or service

utility maximization◦ The doctrine of utilitarianism saw the maximization

of utility as a criterion for the organization of society. According to utilitarians, such as Jeremy Bentham (1748–1832) and John Stuart Mill (1806–1873), society should aim to maximize the total utility of individuals, aiming for "the greatest happiness for the greatest number of people".

Utilityfilm

total utility (TU) - the level of happiness derived from consuming the good

marginal utility (MU) - the additional utility that is received when an additional unit of a good is consumed

Total and marginal utility

Marginal utility (MU)

0 0

1 70

2 110

3 130

4 140

5 145

6 140

-

70

40

20

10

5

-5

# of bananas total utility marginal utility

law of diminishing marginal utility - marginal utility declines as more of a particular good is consumed in a given time period, ceteris paribus

even though marginal utility declines, total utility still increases as long as marginal utility is positive. Total utility will decline only if marginal utility is negative.

Law of diminishing MU (Gossen's First Law)

As noted by Adam Smith, water is essential for life and has a low market price (often a price of zero) while diamonds are not as essential yet have a very high market price.

Smith’s explanation: “value in use” vs. “value in exchange”

Diamond-water paradoxfilm, film2

MU of water and diamonds

TU of water and diamonds

value in use = total utility value in exchange is related to marginal

utility

Value in use and value in exchange

Consumer equilibrium

1.

2. All income is spent.

The first condition listed above is sometimes referred to as the "equimarginal principle."

Individuals buy an item only if they receive a net gain from the purchase (i.e., total benefit exceeds opportunity cost).

This net gain is called “consumer surplus.”

Consumer surplus

Suppose that an individual buys 10 units of a good when the price is $5

Example

Benefits and cost of first unit

• Benefit = blue + green rectangles (=$9)

• Cost = green rectangle (=$5)

• Consumer surplus = blue rectangle (=$4)

Total benefit to consumer

Total cost to consumer

Consumer surplus

Indifference curve – a graph of all of the combinations of goods that provide a given level of utility

Any two points on an indifference curve provide the same level of utility

Indifference curves

Points on and off an indifference curve

Alternative levels of utility

Budget constraintfilm film2

Optimal consumption bundle

• the point on the budget line that maximizes a consumer's total utility• the tangency of the budget line and an indifference curve

y

y

x

x

P

MU

P

MU

www.oswego.edu/~kane/eco101.htm Czarny B. Podstawy ekonomii en.wikipedia.org/wiki/Utility

Bibliography