Microeconomics: Consumer Choice Theory

Utility: The benefit consumers obtain from consuming a good or service.

In basic economic models, we assume that consumers are utility maximizing agents.

Utility maximization : consumers try to obtain the most satisfaction (or utility) as possible.

When a person consumes one extra unit of a good or service, they experience marginal utility. When the marginal utility is equal to zero, the utility from a particular good has been maximized.

The consumer increases their utility by increasing their consumption from Q1 to Q2. However, after Q2, if the consumer were to consume one more unit, they would experience negative marginal utility, decreasing their total amount of utility. Therefore, utility is maximized at Q2.

When a consumer pays for a good or service at the market clearing price, they will consume up until their marginal utility equals the price of their purchase.

Since there are multiple different goods and services in an economy, how does a consumer with a limited budget decide how much to consume from each good in order to maximize their utility? Economists use the utility maximizing rule in order to illustrated how consumers behave.

The utility maximizing rule: this rule states that a consumer's utility is maximized when the last dollar spent on each of the goods yields the same marginal utility. In other words:

$\textit{Utility is maximized when }\frac{MUx}{Px}=\frac{MUy}{Py}$

This formula is for two goods (x and y) only, but it can be extended.

Reference: Mayer,David. AP Microeconomics Crash Course. Research & Education Association (2014). p 71-73.

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