CONSUMER CHOICE THEORY
How does a consumer allocate a scarce income among a wide variety of choices for goods and
services? Economists use consumer choice theory to help us understand consumption deci-
sions. Diminishing marginal utility means that at some point in the consumption pattern
of a good, each additional unit consumed yields less additional satisfaction or utility. Think
of the first scoop of ice cream on a summer day. The first scoop of ice cream gives you lots
of satisfaction. However, with each additional scoop, your utility will marginally decrease,
and at some point you will even stop eating ice cream. Marginal utility is the change in total
satisfaction. Also, keep in mind that when your marginal utility decreases, you would not pay
as much for each additional scoop.
Table 5.8 shows both the total and marginal utility for each scoop of ice cream. Note that
while total utility is increasing for scoops 1 to 4, marginal utility is falling, yet is positive.
Eventually at scoop 5 both total and marginal utility are decreasing. Total utility is maximized
where marginal utility is zero.
Table 5.8 Scoops of Ice Cream
Total Marginal
Quantity Utility Utility
0 0 —
1 20 20
2 35 15
3 45 10
4 50 5
5 45 –5
THE UTILITY-MAXIMIZATION RULE
While economics assumes people face scarcity through unlimited wants, but also scarce
resources (or in this case limited budgets or a budget constraint), how do they decide what
to buy? The consumer will want to get as much extra satisfaction (measured by utility) as
possible given budget constraints. The consumer will want to buy the product with the most
utility per dollar. One way to think of marginal utility is to consider it “satisfaction points”
TIP and you want the most happiness per dollar spent. The utility-maximization rule helps solve
the problem when multiple items are being considered for purchase. For example, if you are
On FRQs regarding
the utility- at a theme park and you need to decide how much money to spend on souvenirs vs. playing
maximization games, you can use the utility-maximization formula:
question like that
in Table 5.9, the
question will change MUX MUY
=
the prices and PX PY
then ask how the
consumer will change
their consumption By applying this formula, one spends money until the marginal utility of good X (souve-
pattern. When this nirs) divided by the price of good X (souvenirs) equals the marginal utility of good Y (games)
happens, just make
divided by the price of good Y (games) given your budget constraint. If marginal utility needs
another table listing
the new marginal to increase, buy less, and if it needs to decrease, buy more. When the utility formula equals
utility/new price and out, you have reached the optimal combination.
you will ace it.
80 AP MICROECONOMICS/MACROECONOMICS
SAMPLE QUESTION
Maria has $52 to spend at an amusement park, and wants to spend her limited budget on
souvenirs or playing games. Souvenirs cost $8 each and games cost $4 each. Help her find the
optimal combination of these items to maximize her utility using Table 5.9. Note the utility
numbers are total, not marginal.
Table 5.9 Total Utility: Souvenirs vs. Games
Total Total Utility Total Utility
Units (Souvenirs $8) (Games $4)
1 56 32
2 104 60
3 136 84
4 160 104
5 180 116
6 196 126
7 208 134
The utility-maximization formula MUx/Px = MUy/Py uses marginal utility, but on an AP test
question you are often only initially given total utility. To solve this problem, look at the total
utility data and make your own table of the marginal utility and the marginal utility/price
for each product (done for you in Table 5.10). Start circling the highest marginal utilities per
dollar and continue until you have spent all the income.
Table 5.10 Marginal Utility and Marginal Utility/Price
Total Marginal Utility Marginal Utility Marginal Utility Marginal Utility
Units of Souvenirs S/Price S ($8) of Games G/Price G ($4)
1 56 7 32 8
2 48 6 28 7
3 32 4 24 6
4 24 3 20 5
5 20 2.5 12 3
6 16 2 10 2.5
7 12 1.5 8 2
This gives you the correct utility-maximization combination for Maria that is: 4 souvenirs
and 5 games given the budget constraint of $52.
ELASTICITY, TAXATION, AND CONSUMER CHOICE 81
