SAD - Consumer Theory Lesson

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Consumer Theory Lesson

Individuals consume goods and services because they render utility to the individual. By utility, we mean satisfaction or usefulness. The law of diminishing marginal utility helps explain why price must be lowered to induce a consumer to purchase more of a good. The following video explains marginal utility in more detail.  

Marginal Utility

View the video below to learn more. To make the video full screen, click the double arrows at the bottom right corner of the object.

Example: Total and Marginal Utility from Consuming Hamburgers

Quantity of Hamburgers Total Utility Marginal Utility (ΔTU/ΔQ)
0 0 ------
1 50 utils 50 utils
2 80 utils 30 utils
3 90 utils 10 utils
4 92 utils 2 utils
5 82 utils -10 utils

As you can see, for each of the first four hamburgers consumed, total utility increases. This is because the additional utility, or marginal utility, gained from consuming one more hamburger is positive. Notice, however, that the marginal utility (while positive) is decreasing with each additional hamburger. That means each hamburger is providing less utility than the hamburger before it. Considering that as you eat hamburgers, you become less hungry, it makes sense that the third hamburger would not be as satisfying to you as the first or second hamburgers. Technically, a consumer could continue to eat hamburgers until the marginal utility became negative and total utility would decrease, as seen with hamburger #5. Perhaps the consumer ate until he was sick to his stomach. While this could happen, in reality, we would not expect to experience this as it would not be rational to consume in such a manner.  

Marginal utility is most useful in determining the marginal benefit (which is a dollar amount) a consumer perceives an item as being worth. The two are very closely related. Since marginal utility decreases for each additional unit, the marginal benefit - or the price a consumer is willing to pay for the unit - will decrease.  

Reaching Consumer Equilibrium

As consumers, we don't just purchase one good. We purchase many different goods. The consumer's main goal is to purchase the combination of goods and services that will render the most utility. Usually, a consumer is faced with a budget constraint. That is, our income is limited. Therefore, consumers want to get the most utility possible from a given amount of income. Think of this as trying to get the most "bang for your buck".  

To keep the example simple, assume the consumer only purchases two items - Good A and Good B. The rule for reaching consumer equilibrium is to consume until the Marginal Utility per $1 from the last unit of Good A equals the Marginal Utility per $1 from the last unit of Good B. That is:

MUA/PA = MUB/PB

Consumer Equilibrium Example Jen spends her entire budget on a combination of Good X and Good Y. With her current combination of these two goods, her marginal utility from her last unit of X is +300utils, and her marginal utility from her last unit of Y is +420utils. The prices of X and Y are $3.00 and $3.50, respectively. Is she in a position of consumer equilibrium? She is in consumer equilibrium if the MUx/Px = MUy/Py So, does +300/$3.00 = +420/$3.50? NO! Good X is rendering 100utils per $1 spent on the last unit, while Good Y is rendering 120utils per $1 spent on the last unit. How should Jen change consumption to maximize her total utility?

From the example above, Jen is not in a position of consumer equilibrium. By changing her consumption of the two goods, she can increase her total utility given her budget. How should she change consumption? She should purchase more of the good that is rendering a greater amount of utility per dollar and less of the good that is providing less utility per dollar.  

Consumer Equilibrium Practice Activity

Click on the correct boxes in the table below. To see if your answer is correct click submit.

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