Consumer Choice Maximizing Utility and Behavioral Economic

CONSUMER CHOICE: MAXIMIZING UTILITY AND BEHAVIORAL ECONOMICS 13

ConsumerChoice: Maximizing Utility and Behavioral Economic

OUTLINE

  1. Executive Summary – This will provide a brief explanation concerning what to expect in the entire paper.

  2. Introduction – this section will provide background information concerning consumer choice theory and how consumers maximize utility.

  3. Explanations of the Consumer Choice Theory – this part will provide a brief explanation of the consumer choice theory and concepts relating to the theory.

  4. Applications – this section will discuss how the consumer choice theory is applied in real life situations.

  5. Conclusion – in this section, highlights of the main ideas and the future of the subject matter will be discussed.

  6. References – this section will provide sources that have been used in developing the paper.

ExecutiveSummary

Accordingto the preference theory, individuals are likely to maximize theirutility, where they are provided with alternatives. Arnold (2015)argues that, utility is a measure of happiness, benefit, orsatisfaction that a consumer derives from the consumption of acommodity. Consumers will have different preferences, when they areprovided with alternatives, because of the satisfaction that theyobtain from the alternatives presented (Arnold, 2015). For instance,when two consumers are presented with an alternative of choosingbetween two kinds of fruits such as an apple and a pawpaw, the twoconsumers may choose differently because of the utility they obtainfrom the fruits. For instance, one of the consumers may choose apawpaw because he believes that he would obtain maximum satisfactionby consuming a pawpaw compared to an apple. On the other hand, theother consumer would choose an apple because he believes he wouldobtain maximum satisfaction from consuming an apple. Therefore,consumer behavior is usually different, when it comes to makingchoices. However, as a rational consumer, one has to ensure that whenprovided with alternatives he goes for the best alternative thatwould maximize his utility (Foxall, 2002). The aim of this assignmentis to discuss the concept of consumer choice in the maximization ofconsumer utility. This would concentrate of economic behaviorexhibited by consumers and will offer practical application ofconsumer behavior in maximizing utility. The paper will commence withan introduction, which will offer background information on thesubject matter, explanation of the consumer behavior in economicswould follow, and then discussion on the applications of the consumerbehavior would be provided. A conclusion will be given at the end.

Introduction

Atypical consumer is usually identified by different characteristics.One such characteristic is that a typical consumer would spendhis/her income in a manner that would guarantee him/her the mostutility or satisfaction. Another characteristic is that a typicalconsumer would have an idea of commodities and services they want andthe marginal utility that they would derive from the consumption ofsucceeding units of a given product. Besides, a typical consumerwould always make her purchases depending on a given budget, which isbased on the income that he has. Also, due to the limited incomeamount, a typical consumer would tend to purchase a limited amount ofgoods (Arnold, 2015). This implies that a consumer has to makechoices because the amount he has cannot be in a position to buy allcommodities this means that the consumer must choose a combinationof goods and services that are most satisfying with the limitedamount of income.

Accordingto the utility maximization rule, consumer’s money income must beallocated in such a manner that the last dollar spent on everyproduct bought yields the same amount of marginal utility(Chakravarty, 2002). The rule provides that a consumer will maximizeher utility when she allocates her income in a manner that themarginal utility of product A divided by the price of product A wouldbe equal to the marginal utility of product B divided by the price ofproduct B where products A and B are hypothetical goods.

Utilitymaximization rule

Marginalutility of product A/ price of A = Marginal utility of Product B/price of B

Consumers’behavior and the equilibrium they attain are usually based on theindifference curve and a budget line. A budget line indicates thedifferent combinations of two products that can be bought withcertain amount of money income. Depending with the changes in priceof the products and the income available for spending in purchasingproducts, a budget line may shift rightwards or leftwards. Ahypothetical budget line is indicated in the following diagram

Assumethat the available budget for purchasing good X and good Y is $30 andX costs $2 and Y costs $1

Onthe other hand, an indifference curve indicates all combinations ofproduct A and product B that would give the same level of utility orsatisfaction to a consumer. The further an indifference curve is fromthe origin, the more the satisfaction a consumer is likely to obtainfrom choosing a combination of goods falling on the indifferencecurve. Therefore, the highest attainable indifference curve providesthe maximum utility that a consumer would obtain.

Explanationof the Consumer Behavior in Maximizing Utility

Inexplaining the behavior of consumers, it is critical to understandthe concept of utility. Utility entails the satisfaction that onereceives from consuming a certain commodity or a combination ofcommodities. On the other hand, marginal utility describes theadditional satisfaction that a consumer receives from the consumptionof one extra unit of a certain commodity. Within a short time period,the taste of a consumer is assumed not to change however, themarginal utility obtained from consuming successive units of anygiven product would decline (Arnold, 2015). The reason behind this isbecause a consumer eventually becomes filled up or saturated with thecommodity. This depicts the law of diminishing marginal utility. Thetheory of consumer behavior utilizes the law of diminishing marginalutility in explaining the behavior of consumers in allocating theirincome. According to Arnold, the law of diminishing marginal utilityis based on the foundation that for a given time period, the marginalutility obtained by consuming equal successive units of a commoditydeclines as the amount of the commodity consumed increases. Thisimplies that the number of utils gained through consuming the firstunit of a commodity is greater compared to successive units that aconsumer would consume. Although it is not possible to measure orquantify utility that a consumer obtains by consuming a certain good,it is assumed that utility is measurable in utils. A graphindicating the law of diminishing marginal utility is as shown in thefigure below.

Thelaw of diminishing marginal utility can be used in explaining why thedemand curve for a given commodity slopes downward. In casesuccessive units of a commodity yield smaller and smaller marginalutility, then the consumer would purchase additional units of thecommodity only if the price of the commodity decreases. For instance,consider a scenario where a consumer purchases oranges forconsumption. The consumer will be willing to purchase the firstorange at an indicated price, but since he obtains less marginalutility by consuming extra oranges, the consumer will not be willingto purchase more oranges at the indicated price. In this case, theconsumer would be willing to spend more in purchasing othercommodities that offer greater or equal satisfaction as orangesrather than spend more dollars in buying more oranges.

Thelaw of diminishing marginal utility can also be used in explainingconsumer behavior because it explains how consumers allocate theirresources or incomes among the different goods and services that areavailable for purchase (Ormazabal,2006).Consumer behavior must go along with his/her budget constraint.Consumers must be rational in order to maximize their totalsatisfaction. Since the consumer must use his/her income inmaximizing utility, he would purchase less of additional units of agiven commodity with the available income since as he continues toconsume more units of the commodity his/her satisfaction decreases.Therefore, the consumer would act rationally in looking for acombination of commodities and services that would provide maximumutility rather than purchasing only one commodity in large amounts.

Aconsumer needs to balance his/her margins in order to maximize herutility. When a consumer has balanced margins, there is no incentiveof altering the expenditure pattern because the consumer is inequilibrium the consumer would be worse off in case there would beany alteration in the bundle that he chooses, provided taste, price,products, or income do not change. In addition, the law ofdiminishing marginal utility is also grounded on the perspective thatin case a commodity has a variety of uses, but only a single unit ofthe commodity is available, then a consumer would use the one unit insatisfying the most urgent need. In case a second unit of thecommodity is available, the consumer would use the second unit insatisfying a less urgent need. The chief reason for a consumer usingthe first unit to satisfy most urgent need is because the consumerwould obtain less utility by attending to his less urgent needcompared to satisfying his most urgent need. Therefore, this behaviorof consumers identifies with the law of diminishing marginal utility.

Applicationsof Consumer Choice Theory

Inpractical life, consumer choice theory in the maximization of utilitycan be applied in vending machines. Soft-drink vending machine andnewspaper dispensing devices have a similarity in that they have asimilar basic operation. These two vending machines help consumers topurchase a product through inserting coins to the machines. However,there exists a significant difference between the two machines inthat the newspaper dispenser usually opens to the entire stack and isseen to trust the customers in taking only a single copy.Nevertheless, the soft-drink vending machine does not seem to trustthe customers since instead of displaying more than one can for thecustomer to pick one and leave the others, the vending machine onlyallows customers to purchase one can at a time. This puzzle can besolved through the perspective of diminishing marginal utility(Mankiw &amp Taylor, 2006). Most customers are likely to take only asingle copy from the newspaper box, despite the entire stack beingdisplayed because the marginal utility of taking a second newspaperis almost zero. Although consumers could think of taking extranewspapers in order to sell them on the streets, the revenue receivedthrough selling the newspapers on the streets would be less comparedto the time and effort used in distributing the newspapers on thestreets. On the other hand, soft-drink vending machines usuallyreleases one can per pay because the marginal utility of soft-drinkis not equal to or almost zero and consumers may take more than onesoft-drink and consume them later. Here, the choice of consumers inmaximizing their utility is evident.

Anotherapplication of consumer choice theory can be applied in daily life byconsidering the diamond-water paradox. According to diamond-waterparadox, consumers are likely to choose purchasing a commodity thathas an increasing marginal utility compared to a product having adecreasing marginal utility. For example, consider purchasing waterand diamond. Since water is usually found in abundance and has adecreasing marginal utility, it is unlikely that consumers woulddesire to purchase another cup of water after purchasing the firstone. However, when it comes to commodities of greater value such asdiamonds, consumers are likely to purchase extra units of diamondseven after purchasing the first units. This is because commoditiessuch as diamond are usually scarce (Goetz, 2013). Therefore, in reallife situation, consumers would usually consider purchasing extraunits of commodities that have an increasing marginal utility morereadily compared to extra units of commodities that have decreasingmarginal utility. Besides, this consumer behavior would also beexhibited in commodities that are scarce consumers would usuallyprefer more extra units of scarce commodities compared to items thatare in plenty.

Besides,the consumer choice theory can also be applied in daily life, whereone gives cash and non-cash gifts to another person. Giving out cashgifts is likely to yield more utility to the receiver compared tonon-cash gifts although the non-cash gift may have a similar monetaryvalue as the cash gift. The chief reason behind the receiver of thegift deriving less utility from the non-cash gift is becauseconsumers have different preferences. The person giving the non-cashgift may offer a commodity, which may not give the receiversatisfaction. Therefore, in such a case, the receiver of the giftwould consider the cash gift to give him more satisfaction comparedto the non-cash gift since he can use the cash in purchasing acommodity that would offer him maximum utility. Hence, whenconsidering a non-cash and cash gifts, consumers would tend to derivemore satisfaction in cash gift compared to non-cash gift.

Conclusion

Aconsumer is predicted to behave in a rational manner when presentedwith alternatives. A rational consumer would spend his/her income ina manner that would guarantee him/her the most utility orsatisfaction. Besides, a rational consumer would have an idea ofcommodities and services they want and the marginal utility that theywould derive from the consumption of succeeding units of a givenproduct that is, he/she knows his/her preferences. Besides, atypical consumer would always make her purchases depending on a givenbudget, which is based on the income that is available (Maki, 2010).In the future, the behavior of consumers is not expected to changesince the law of diminishing marginal utility will always hold theutility obtained from consuming a certain commodity will decrease asthe quantity consumed increases. Besides, in the future, it willstill hold that a consumer will spend based on his or her income.

References

Arnold,A.R. (2015). Microeconomics.New York: Cengage Learning.

Chakravarty,R.S. (2002). Microeconomics.New York: Allied Publishers.

Foxall,R.G. (2002). ConsumerBehavior Analysis: The Behavioral Economics of Consumption.London: Taylor &amp Francis.

Goetz,M.K. (2013). TheParadox of Value: Water rates and the law of diminishing marginalutility. AmericanWater Works Association Journal,Vol. 105 (9), 57-59.

Hands,D. W. (2009). Economics, Psychology and the History of ConsumerChoice Theory. CambridgeJournal of Economics.

Hantula,A.D. &amp Wells, K.V. (2014). ConsumerBehavior Analysis: A Rational Approach to Consumer Choice.London: Routledge.

Lipsey,R. G., &amp Chrystal, K. A. (2015). Economics.Oxford: Oxford University Press.

Maki,A. (2010). Introductionto Estimating Economic Models.London: Routledge.

Mankiw,N. G., &amp Taylor, M. P. (2006). Economics.London: Thomson.

Ormazabal,M.K. (2006). The Law of Diminishing Marginal Utility in AlfredMarshall’s Principles of Economics. TheEuropean Journal of the History of Economic Thought,Vol. 2 (1), 91-126.