Microeconomics Foundations (ECON 101) · Module 4 of 9
Consumer Choice & Utility
How a rational consumer allocates a limited budget to maximize satisfaction.
Marginal Utility & Diminishing Marginal Utility
- Utility is the satisfaction a consumer gets from consuming a good; marginal utility is the additional utility from consuming one more unit.
- The law of diminishing marginal utility states that as a consumer consumes more units of a good, the marginal utility from each additional unit tends to decrease.
Why does the first slice of pizza typically provide more satisfaction (utility) than the fifth slice?
Solution. This illustrates diminishing marginal utility — as more units of a good are consumed, each additional unit provides less additional satisfaction than the one before it, since the consumer's need or desire is progressively more satisfied.
Utility Maximization
- A consumer maximizes total utility, subject to their budget, by allocating spending so that the marginal utility per dollar spent is equal across all goods purchased.
What condition must hold for a consumer to be maximizing their utility across two goods, given their budget?
Solution. The marginal utility per dollar spent must be equal for both goods (MU of good A ÷ price of A = MU of good B ÷ price of B); if not, the consumer could increase total utility by shifting spending toward the good with the higher marginal utility per dollar.
Consumer Surplus
- Consumer surplus is the difference between what a consumer is willing to pay for a good and what they actually pay, summed across all units purchased — represented graphically as the area below the demand curve and above the market price.
How is consumer surplus represented graphically on a supply-and-demand diagram?
Solution. As the area below the demand curve and above the equilibrium price, up to the equilibrium quantity — representing the total extra value consumers received beyond what they paid.
The Demand Curve as Marginal Benefit
- The demand curve can be interpreted as the marginal benefit curve: at each quantity, it shows the maximum price a consumer is willing to pay for one more unit, reflecting that unit's marginal value to them.
Why does the demand curve slope downward, if it represents marginal benefit?
Solution. Because of diminishing marginal utility, each additional unit of a good provides less additional benefit than the one before, so consumers are only willing to pay progressively less for each additional unit — producing a downward-sloping marginal benefit (demand) curve.
Check yourself
2 of this module's 5 quiz questions. Pick your answers, then check them in the app, with an explanation for every question.
1. What does the law of diminishing marginal utility state?
2. What condition must hold for a consumer to be maximizing utility across two goods?