The Theory of Consumer Choice
When you walk into a store, you are confronted with thousands of goods that you might buy. Because
your financial resources are limited, however, you cannot buy everything that you want. You therefore
consider the prices of the various goods offered for sale and buy a bundle of goods that, given your
resources, best suits your needs and desires.
In this chapter, we develop a theory that describes how consumers make decisions about what to buy.
Thus far in this book, we have summarized consumers' decisions with the demand curve. As we have seen,
the demand curve for a good reflects consumers' willingness to pay for it. When the price of a good rises,
consumers are willing to pay for fewer units, so the quantity demanded falls. We now look more deeply at
the decisions that lie behind the demand curve. The theory of consumer choice presented in this chapter
provides a more complete understanding of demand, just as the theory of the competitive firm in Chapter 14
provides a more complete understanding of supply.
One of the Ten Principles of Economics discussed in Chapter 1 is that people face trade-offs. The theory
of consumer choice examines the trade-offs that people face in their role as consumers. When a consumer
buys more of one good, he can afford less of other goods. When he spends more time enjoying leisure and
less time working, he has lower income and can afford less consumption. When he spends more of his
income in the present and saves less of it, he must accept a lower level of consumption in the future. The
theory of consumer choice examines how consumers facing these trade-offs make decisions and how they
respond to changes in their environment.
After developing the basic theory of consumer choice, we apply it to three questions about household
decisions. In particular, we ask:
Do all demand curves slope downward?
How do wages affect labor supply?
How do interest rates affect household saving?
At first, these questions might seem unrelated. But as we will see, we can use the theory of consumer
choice to address each of them.
21-1 The Budget Constraint: What the Consumer Can Afford
Most people would like to increase the quantity or quality of the goods they consume–to take longer
vacations, drive fancier cars, or eat at better restaurants. People consume less than they desire because their
spending is constrained, or limited, by their income. We begin our study of consumer choice by examining
this link between income and spending.
To keep things simple, we examine the decision facing a consumer who buys only two goods: pizza and
Pepsi. Of course, real people buy thousands of different kinds of goods. Assuming there are only two goods
greatly simplifies the problem without altering the basic insights about consumer choice.
We first consider how the consumer's income constrains the amount he spends on pizza and Pepsi.