Consumer Choice:

Maximizing Utility
Ch. 18, R.A. Arnold, Economics 9th Ed
Utility Theory
In this chapter we study the household (or consumer)
Remember: Households consume goods (e.g. food) since it gives them
utility (satisfaction or benefit or happiness)
Assumption: The aim of households is to maximize utility i.e. They want
to obtain the highest amount of utility from their limited income (or
resource)
Utils: The unit of utility. It is used to measure utility.
E.g. If drinking tea gives you 10 utils and drinking coffee gives you 8
utils. It means you get more satisfaction (utility) from tea as compared
to coffee
Marginal Utility and Total Utility
Marginal Utility (MU): The (additional) utility obtained from one
additional (extra) unit of a good. E.g. the marginal utility of the 1st cup
of tea is 10 utils. The marginal utility of the 2nd cup is 9 utils.

Total utility from 2 cups = 10 + 9 = 19 utils

When we say households want to maximize utility we mean they want

to maximize the total utility (i.e. obtain the highest amount of utils)
Law of Diminishing Marginal Utility
The marginal utility (MU) gained by consuming equal successive units
of a good will decline as the amount consumed (Q) increases during a
given period of time.

In symbols: if Q ↑ then MU ↓ (if Q ↓ then MU ↑ ), ceteris paribus

This law explains why the first cup of tea gives us more satisfaction
than the second one. The MU1st cup = 10 and MU2nd cup = 9. What could
be MU3rd cup ? Answer: MU3rd cup < MU2nd cup
Consumer Equilibrium: Maximizing Utility
Here, we analyse how a household (consumer) maximizes utility
Constraint of household: limited (fixed) income (budget)
We are assuming that the household is consuming all of their income
on 10 apples and 10 oranges per week. The price (P) of each apple = $1
and the price (P) of each orange = $1. (What is the households total
income per week?)
Also given, MU oranges = 30 utils and MU apples = 20 utils i.e. the
utility obtained from the 10th apple is 20 utils and 10th orange is 30 utils
**According to Economic theory consumers make purchasing
decisions by comparing the marginal utility per dollar from
different goods (MU ÷ P)**
Here we can see, (MU orange ÷ P orange ) > (MU apple ÷ P
apple)
This means the household can get more marginal utility per
dollar from oranges as compared to apples. So the household
buys more oranges to increase their total utility. But since they
are consuming all of their limited income, they have to reduce
the consumption of apples, to buy more oranges.
Continued
If the household buys more oranges then we know the MU from
oranges will fall (Law of Diminishing Marginal Returns). Here when
the household buys 1 more orange, MU from orange falls to 25 utils.
And as they buy 1 less apple, MU from apples increases to 25 utils.
Now, (MU orange ÷ P orange ) = (MU apple ÷ P apple). The
household is maximizing its utility and they have no further incentive
to change their consumption (they are in equilibrium). At
equilibrium they are consuming 11 oranges and 9 apples.
Maximizing Utility and the Law of Demand
At the end of last slide, the household had reached equilibrium and it
was maximizing utility i.e.
(MU from oranges ÷ P of oranges) = (MU from apples ÷ P of apples)
Now, if the price of apple falls then,
(MU from oranges ÷ P of oranges) < (MU from apples ÷ P of apples)
So the household increases their consumption of apples (since they get
more marginal utility per dollar from apples) and reduces their
consumption of oranges.
This is consistent with the theory of demand which tells us if P of a
good (apple) falls then the quantity demanded of (apple) rises.