How Consumers Make Choices

Under Income Constraints

​Let's think first...

1. What is behind a consumer's demand?

2. ​How do consumers choose among various consumer goods?

3. ​What determines the value of a consumer good?

UTILITY

​In economics the satisfaction or pleasure consumers derive from the consumption of consumer goods is called “utility”.

• ​Consumers, however, cannot have every thing they wish to have. Consumers’ choices are constrained by their incomes.

• ​Within the limits of their incomes, consumers make their consumption choices by evaluating and comparing consumer goods with regard to their utilities.

Understanding the Utility Theory

A “util” is an artificial measure of a consumer's satisfaction from consuming a good.

• Economists measure total utility, or the total number of utils, a consumer receives from consuming a quantity of a good.

• Marginal utility is the additional utility a consumer receives from consuming an additional unit of a good.

What, for you, is a "rational" consumer?

​Our basic assumptions of a "rational" consumer

• ​Consumers are utility maximizers.

• Consumers prefer more of a good (thing) to less of it.

• Facing choices X and Y, a consumer would either prefer X to Y or Y to X, or would be indifferent between them.

​Our basic assumptions of a "rational" consumer

• Transitivity: If a consumer prefers X to Y and Y to Z, we conclude he/she prefers X to Z

• Diminishing Marginal Utility: As more and more of good is consumed by a consumer, ceteris paribus*, beyond a certain point the utility starts to fall​.

​*In economics, the assumption of ceteris paribus, a Latin phrase meaning "with other things the same" or "other things being equal or held constant," is important in determining causation. It helps isolate multiple independent variables affecting a dependent variable.

How to Measure Utility

Neo prefers fried chicken with rice to a burger, and a burger to a slice of pizza.

​Measuring utility by comparison (ORDINAL)

Neo derives 10 utils from having one order of fried chicken but only 2 utils from having a burger.

​Measuring utility in "utils" (CARDINAL)

​Utility and Money

Since we use money in just about all of our trade transactions, we might as well use it as our comparative measure of utility.

(Note: This way of measuring utility is not much different from measuring utility in utils)

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Discussion

A consumer could say, "I am willing to pay $4 for a burger, $2 for a slice of pizza, and $1 for a hotdog."

Obviously, the consumer values a burger more (four times as much) than a hotdog. However, he or she may still choose to buy a hotdog, even if he/she has enough money to buy a burger, or a slice of pizza, for that matter.

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Why? ​What could be the possible explanations for this behaviour?

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Source:

Dutta, S. (2006). Introductory Economics. New Delhi, India: New Age International Publishers.

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