Consumer Choice

 The problem of scarcity leads to the problem of

making choices for our consumption of goods and
services.

 The individuals need to take decisions about making

choices regarding what to consume

 These decisions are influenced by various factors

and hence differ from one individual to another

 Individuals have perceived valuation and also tend

to compare the relative benefits
Utility and Choice
 To explain how the comparisons are made and to
understand the consumer decisions, economists
use the concept of Utility

 Utility is the use value that a consumer attaches to a

good or is the level of satisfaction or happiness
derived from consumption a good.

 The utility an individual derives from a particular

good depends on the tastes and preferences
Counting The Utility
 To understand the concept of utility more clearly and
to illustrate utility maximization, we hypothesis that
utility can be measured cardinally

 We use ‘utils’ as the measure of utility

 We may assume that these units measure the

amount of utility that an individual derives from
consumption of a good
Total and Marginal Utility

 Total utility: a measure of the total satisfaction

derived from consuming a given quantity of
some good or service

 Marginal utility is the change in total utility that

occurs due to consumption of additional unit
The Law of Diminishing Marginal
Utility
 With each additional unit of consumption of a good,
the satisfaction derived is less

 The law of diminishing marginal utility – the marginal

utility derived from consumption of a good keeps
falling with more and more units of consumption.

 The total utility:

 rises up to the point the marginal utility is positive
 reaches maximum when marginal utility is zero
 falls when the marginal utility becomes negative
Consumer’s Choice – The Trade-off

 One of the principles of economics states that

individuals face trade-offs.

 The consumers face the trade-off for choice

of goods and services.

 In order to consume more of one good or

service one has to consume the less of other.
The Budget Constraint

 Every individuals wishes to increase the quantities of goods and

services he consumes.

 The consumer income, however, is a constraint to such a desire

and hence limits the quantities one can consume.

 The budget constraint is a line that shows various combinations

of goods and services that can be bought with the given income.

 The slope of the budget constraint equals the relative price of the
two goods – the price of one good in terms of the other.
The Consumer Preference
 The budget constraint simply shows what a consumer can afford.

 The choice of a consumer depends upon the preference.

 The ranking of utility:

 A consumer usually chooses a combination best suited to him
among the various options available to him.

 However, if the consumer finds two given combinations that suits

his taste equally then he will be indifferent in choosing either of
the two.

 The consumer would ranks both combination such that the level
of satisfaction is equal for both
The Indifference Curve

 The indifference curve graphically shows us

various combinations of consumption which
makes the consumer equally satisfied and he
remains indifferent.

 The slope of the indifference curve on any

point is the marginal rate of substitution
(MRS) – the rate at which a consumer will be
willing to substitute one good for the other.
Properties of Indifference Curve

 Higher indifference curves are preferred to lower

ones.

 Indifference curves are downward sloping

 Indifference curve do not cross each other

 Indifference curves are downwards sloping and

convex to origin – diminishing MRS
Substitution and Income Effect
 The substitution effect indicates that following
a decrease in the price of a good or service,
an individual will purchase more of the now
less expensive good and less of other goods.

 The income effect of price change indicates

that an individual’s income can buy more of
all goods when the price of one good
declines, everything else held constant.