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Theory of consumer choice

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  1. Introduction
  2. Total and marginal utility
  3. The law of diminishing marginal utility
  4. Consumer's equilibrium: cardinal utility approach
  5. Law of Equi-marginal utility
  6. Ordinal utility
  7. Indifference curve
  8. Budgetary constraint
  9. Consumer's equilibrium: the ordinal utility approach
  10. The consumer's optimal choices
  11. Change in income and consumer behaviour
  12. Change in price and consumer behavior
  13. Bibliography

The concept of ?utility' was introduced to social thoughts by Bentham in 1789 and to economic thoughts by Jevons in 1871. The neo-classical economists devised the following system to measure the utility of a commodity. A neo-classical economist, Walras, coined a term ?util', meaning ?units of utility' and used money as the measure of utility.

The law of diminishing marginal utility is central to the Cardinal utility analysis of the consumer behavior. This law states that as the quantity consumed of a commodity increases per unit of time, the utility derived by the consumer from the successive units goes on decreasing, provided the consumption of all other goods remain constant. A consumer reaches equilibrium position when he maximizes his total utility given his income and prices of commodities he consumes. Analyzing consumer's equilibrium requires answering the question ?how does a consumer allocate his money income among the various goods and services he consumes to arrive at his equilibrium??

[...] CONSUMER'S EQUILIBRIUM: THE ORDINAL UTILITY APPROACH A consumer attains his equilibrium when he maximizes his total utility, given his income and prices of goods and services he consumes. According to ordinal utility approach, two conditions must be satisfied for the consumer to be in equilibrium, these are: 1. Necessary or first order conditions 2. Supplementary or second order condition Necessary or first order conditions: The necessary conditions for utility to be maximum requires that MRSx,y must be equal to the price ratio. [...]

[...] ?utility', the utility of a commodity for a consumer equals the money which he or she is willing to pay for the commodity. For example, if a thirsty is willing to pay $ 0.97 for one can of Pepsi, his/her utility of one can of Pepsi is ?50utils'. LIMITATIONS OF THIS METHOD: 1. This method of measuring utility has been rejected by the modern economists as it was realized over time that absolute or cardinal measurement of utility is not possible The difficulties in measuring ?utility' proved insurmountable Money was not found to be a reliable measure of utility because the utility of money changes with its stock Neither economists nor psychologists nor other scientists could devise a reliable technique or instrument for measuring the feeling of satisfaction or ?utility' The modern economists have, therefore, discarded the concept of ?cardinal utility'. [...]

[...] The consumer will therefore have a tendency to move to point E from any point IC1 in order to reach the highest possible indifference curve, all other things taste, preferences and prices of goods) remaining the same. THE CONSUMER'S OPTIMAL CHOICES The consumer chooses the point on his budget constraint that lies on the highest indifference curve. At this point, called the optimum, the marginal rate of substitution equals the relative price of the two goods. Here the highest indifference curve the consumer can reach is L2, the consumer prefers point which lies on indifference curve L3, but the consumer cannot afford this bundle of Pepsi and Pizza. [...]

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