Consumer Expenditure and Equi-Marginal Utility

Topics: Consumer theory, Utility, Indifference curve Pages: 6 (1705 words) Published: February 24, 2013
Consumer Expenditure and Equi-marginal Utility

Consumer behaviour theory tries to explain the relationship between price changes and consumer demand. Utility is a concept used to denote the subjective satisfaction or usefulness attained from consuming goods and services. This concept helps to explain how consumers divide their limited income / resources among different choices of goods and services that help attain them satisfaction (utility) The issue however is how we are supposed to measure utility and how the value of utility derived from various choices can be quantified. Because of these issues, the consumer behaviour theory has been reformulated and utility is viewed as a way to describe preferences. It was recognised that all that mattered about utility is whether one combination of choice had a higher utility than another; by how much higher or lower didn't really matter Preferences of consumers is the fundamental description important for analyzing choice while utility is just a simple way of describing preferences Total utility

The total satisfaction or fulfilment received by a consumer through the consumption of a goods or services or a combination of both is defined as Total utility. For instance if a person consumes five units of a commodity and derives U1, U2, U3, U4, U5 utility from the successive units of a good, his total utility will be, TU = U1+ U2 +U3+ U4+ U5|

Total utility increases with an increase in consumption, but as consumption rises, total utility grows at a diminishing rate. Every unit of a good or service has a marginal utility and the total utility is a simple addition of all the marginal utilities of the units of goods or services All consumers want to achieve the maximum possible total utility for their spending and thus they look to combine different bundles of goods and services. With their limited resources, consumers make various choices in order to increase their total utility with each additional unit of consumption.

Marginal utility
As discussed above all consumers attempt to maximize their total utility from the goods and services they consume. This process of optimisation leads the consumers to consider the marginal utility of acquiring additional units of the product or service and of acquiring one product or service as opposed to another. Product characteristics and individual tastes and preferences apart from available resources (money) determine direct demand. Utility is maximised when products are bought at levels such that relative prices equal the relative marginal utility derived from consumption.  

The marginal utility of a good is the increase in total utility gained by consuming one additional unit of that good, for a given level of consumption of other goods| Law of diminishing marginal utility

We have discussed earlier that with an increase in consumption total utility increases but at a slower and slower rate. Law of diminishing marginal utility explains this concept. The law of diminishing marginal utility says that as consumption rises the marginal utility of consuming the next unit is less than the previous one. Accordingly the marginal utility of good decreases as more and more units of that good are consumed as shown in the table and figure below: Quantity of Good| Total Utility (TU)| Marginal Utility (MU)| 1| 10| 10|

2| 19| 9|
3| 27| 8|
4| 34| 7|
5| 40| 6|
Equimarginal Utility
The dollar value of a consumer’s marginal utility from consuming additional unit of a product is called the marginal benefit. It is the maximum price that a consumer will pay for an additional unit and will fall as consumption increases. When different products are available a consumer will ensure that the last dollar spent on each product gives an equal marginal utility (MU) per dollar spent. For two products A and B this can be expressed as:

MUA = marginal utility of product A;
MUB = marginal utility of product...
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