Modern Microecon, Consumer Theory Essay Example | Topics and Well Written Essays - 2000 words

Modern Microecon, Consumer Theory - Essay Example In raw economic terms, utility is a measure of consumer satisfaction, that is, how much satisfaction a consumer derives from the consumption of a good or a service. Budget constraint on the other hand represents the combination of goods or services an individual can consume or purchase in consideration to given prices with his or her limited income. Combining the two concepts forms the foundation of consumer theory. The utility theory provides a methodological framework whereby usually, all individuals, organizations and firms evaluate given options. Utility is a term used to describe the satisfaction that each of the given options provide to the one making the decision. Hence, the basis of the utility theory is that each individual will choose that option which tends to maximize utility, working on what is called the ‘maximization principle’. This principle states that the most desirable choice is the one with the highest level of satisfaction. However, while making the se decisions, the individual must also consider his income earned along with the respective prices of the goods and services in question. ... Total utility continuously rises as consumption increases. This rise becomes smaller as more units of a product are consumed, it can also decline after a certain level of consumption. On the other hand, marginal utility measures the change in consumption benefit as a result of consuming one more or one less unit of a product. In other words, marginal utility tracks the change in total utility as the number of units consumed changes. The behavior of marginal utility is such that it tends to fall continuously as consumption of a product increases. This is because the first few units consumed of a product provide a higher level of satisfaction than the later few. For example, the first drink of water is worth a lot more to a thirsty individual than his seventh one. For a consumer to be in equilibrium certain conditions need to be met. The consumers are assumed to be rational in their decision whereby they aim to maximize the utility derived from the consumption of any product. It is als o assumed that consumers have limited incomes and that the value of utility can be quantified in monetary terms. The equi-marginal principle states that a consumer will be in equilibrium if it is not possible to switch expenditure from good X in favour of good Y to achieve an increase in total utility. In other word this principle is satisfied when the marginal utility of every dollar spent on a good is equal to the price paid for that good. If a basket of goods is in question, an individual will continue to alter the mix of consumption of the products until the marginal utility of a dollar spent on each of the goods is equal. Therefore, the equilibrium principle can be expressed as MUx/Px=MUy/Py, where MU is the marginal utility and P is the price of the good. Consumer