CHARTER III

THE THEORY OF
CONSUMER
CHOICE

CHAPTER III: THE THEORY OF CONSUMER CHOICE

Learning objectives
By the end of this chapter, students should be able to:
 Define what is meant by utility, total utility, marginal utility.
 Understand the law of diminishing marginal utility.
 Identify the optimum level of consumption.

Reading material
Chapter 21; Principles of Economics (2021), N.Gregory Mankiw; South
Western Cengage Learning, 9th edition

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 OUTLINE

1 Utility definitions

The law of diminishing

2 marginal utility

3 The consumer’s optimal choices

1. UTILITY DEFINITIONS

Utility (U) is the amount of satisfaction obtained from the consumption of a

good or service.

Total utility (TU) is the total amount of satisfaction obtained from

consumption of all goods or services.

Marginal utility (MU) is the additional satisfaction gained by the

consumption of one more unit of a good or service.

Assume that a person’s utility can be measured in utils, where a util is one unit of
satisfaction.
Therefore,
MU = ∆TU / ∆Q
𝑻𝑼 = 𝑴𝑼𝟏 + 𝑴𝑼𝟐 + … + 𝑴𝑼𝑵 4
2. The law of diminishing marginal utility

The more of any one good we consume in a given period, the less
satisfaction we get from each additional unit.

3. The consumer equilibrium with measurable utility

How much of a good should Solution: measure

people consume if they are to
maximize their utilities?
utility

Solution: to measure
utility with money => Problem: In practice,
Using Willingness to we cannot measure
pay (WTP) “utils”.
 Willingness to Pay (WTP)
A buyer’s willingness to pay for a good is the maximum amount
the buyer will pay for that good.
WTP measures how much the buyer values the good.

name WTP
Example:
Minh $250 4 buyers’ WTP for a textbook
Trang 175
Bảo 300
Khuê 125

Consumer surplus
If price of a textbook is $200, who will buy a textbook, and what
is quantity demanded?

Minh & Bảo will buy a textbook, Trang &

Khuê will not.
name WTP
Minh $250
Bảo: MU = 300; P = 200

Trang 175 CS = MU – P = 100

Bảo 300 Consumer surplus is the amount a
buyer is willing to pay minus the amount
Khuê 125
the buyer actually pays:
CS = WTP – P
 Total consumer surplus (TCS)
Bảo: MU = 300 when P = $200
CS = MU – P = $100
name WTP
Minh $250
Minh: MU = 250 when P = $20

Trang 175 CS = MU – P = $50

Bảo 300 Total market benefits = Total market

surplus
Khuê 125
= CS = CS1 + CS2 = MU1 – P + MU2 – P
= (MU1 + MU2) – (P + P)
= TU - TE

3. The consumer's optimal choice:

one commodity
When does the • As long as they gain additional consumer
consumer go surplus (CS > 0), in other words, the price they
on purchasing
additional
are willing to pay exceeds the price they are
units? charged (MU > P)

• When they gain no additional consumer

When does the surplus (CS = 0), in other words, the price they
consumer stop are willing to pay equals the price they are
purchasing charged (MU = P)
additional • Their optimum level of consumption has been
units?
reached: consumer surplus has been
maximised.
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 3. The consumer's optimal choice:
two commodities and more
(1) Numbers of (2) Total utilities (3) Marginal utility (4) Price (P) (5) Marginal utility
drinking coffee (MU) per dollar MU/P
1 12 12 $3 4
2 22 10 3 3.3
3 28 6 3 2
4 32 4 3 1.3
5 34 2 3 0.7
6 34 0 3 0

(1) Numbers of (2) Total utilities (3) Marginal utility (4) Price (P) (5) Marginal utility
watching films (MU) per dollar MU/P

1 21 21 $6 3.5
2 33 12 6 2
3 42 9 6 1.5
4 48 6 6 1
5 51 3 6 0.5
6 51 0 6 0

3. The consumer's optimal choice:

two commodities and more

The consumer goes on purchasing until the following condition holds:

𝑴𝑼𝑿 𝑴𝑼𝒀
=
𝑷𝑿 𝑷𝒀
Where
𝑀𝑈 is the marginal utility derived from the last unit of X consumed,
𝑀𝑈 is the marginal utility derived from the last unit of Y consumed,
𝑃 is the price per unit of X,
𝑃 is the price per unit of Y.
1. MU milk/MU jam > P milk/P jam. In order to increase ulitilty, you should
consume:
a. More milk and more jam
b. Less milk and more jam
c. Less milk and less jam
d. More milk and less jam

2. MU apple/P apple < MU orange/ P orange. This means that:

a. Switching consumption from apples to oranges will increases utility
b. Switching consumption from oranges to apples will increases utility
c. Apple is more expensive than orange
d. Orange is more expensive than apple

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