Overview

The theory of consumer choice explains how individuals allocate their limited income to maximize utility. It integrates utility theory, budget constraints, and the effects of price changes to show how consumers make rational decisions in response to market signals.

Key Themes and Concepts

• Total and Marginal Utility:
  • Total utility: Total satisfaction from consuming goods and services.
  • Marginal utility: Additional satisfaction from consuming one more unit.
• Law of Diminishing Marginal Utility: Marginal utility decreases as more of a good is consumed, holding all else constant.
• Utility Maximization:
  • Equal marginal utility per dollar: Consumers allocate income where MU/P is equal across all goods.
  • Consumer equilibrium: Achieved when no reallocation of spending increases total utility.
• Budget Constraints: Represent the combinations of goods a consumer can afford given income and prices.
• Indifference Curves and Optimization:
  • Indifference curves: Show combinations of goods yielding equal satisfaction.
  • Budget line: Reflects all affordable combinations.
  • Optimal choice: Where an indifference curve is tangent to the budget line.
• Income and Substitution Effects: Explain changes in consumption from price changes.
  • Substitution effect: Consumers switch to cheaper goods.
  • Income effect: Lower prices increase real income, changing consumption.
• Deriving Demand Curves: Based on utility-maximizing behavior; downward-sloping because of diminishing marginal utility and substitution effects.

Quick Tip

Consumers don’t maximize total utility — they maximize utility per dollar. That’s why prices matter. Think like a consumer: if the marginal benefit per dollar of one good is higher than another, you’ll shift your spending until equality is restored. This behavior drives demand curves.