Studying consumer behavior helps people understand and predict how consumers will respond to changes in their economic environment. Economists have developed a number of concepts to model the consumer choice process. First they define the concept of utility, or economic happiness, and they identify how the consumption of goods affects consumers' utility. Then they use this concept to show how consumers implicitly make consumption choices that maximize happiness (i.e., utility) based on their ability to pay.
At A Glance
- The concept of utility is a quantitative measure of happiness or satisfaction commonly used in economic analysis.
- Utility has ordinal but not cardinal properties, meaning utility numbers can be compared but not combined.
Marginal utility measures the incremental benefit of consuming one more unit of a good.
Diminishing marginal utility, a common feature of consumption goods, occurs when marginal utility declines as the quantity of a good consumed increases.
- Consumers maximize utility when the marginal utility per dollar spent on the last unit of each of the goods is equal.
- When consumption is not optimal, consumers can increase utility by shifting consumption toward the good with a higher marginal utility per dollar spent.
- A consumer's optimal consumption can be identified by following the good with the highest marginal utility per dollar spent until all income is used up.
- The budget constraint is a graphical representation of all the ways a consumer can spend her entire income.
Indifference curves are a graphical representation of a consumer's preferences, where each curve represents combinations of goods that provide a particular level of utility.
- A consumer's optimal consumption can be found by identifying the point where the budget constraint is tangent to one of the consumer's indifference curves.