Consumer Choice

Utility analysis is a theory used to explain why consumers choose as they do. It examines the forces behind the demand curve and how the demand curve is derived. 

Utility analysis relies on six key assumptions. These are that (a) consumers are rational, (b) utility can be measured, (c) marginal utility diminishes as consumption goes up, (d) total utility increases as consumption rises, (e) incomes are limited and (f) prices are known.

Consumer rationality means that consumers seek to maximize their satisfaction.

Utility is defined to mean satisfaction, which is measured in terms of utils. Utility is subjective in nature so that when a person assigns a certain amount of utility to a unit of a product it is meaningful only in terms of its relationship to that same person's assignments of utility to other units of that product or to other ,goods and services.

Diminishing marginal utility means that during some specified time period an individual's added satisfaction diminishes as he or she consumes additional units of the same product.

The meaning of increasing total utility is that a person will continue to attain positive satisfaction from consuming additional units of the same product-at least over the range of consumption that is consistent with the assumption of rationality. Because of the assumption of diminishing marginal utility, as the person consumes additional units of the same product over a specified period of time, he or she will find that utility will increase at a decreasing rate.

A consumer will maximize total utility or satisfaction (reach "consumer equilibrium ") when his or her total purchasing power is spent so that marginal utility per dollar for each product is the same as for every other product purchased. 

An individual's consumer equilibrium position at any particular price for a product establishes a point on that individual's demand curve for that product. By joining a number of such points, an indivdual's demand curve for a product can be drawn.

Utility analysis explains that the consumer buys what he or she pleases. Some economists believe that consumer ignorance and consumer manipulation by sellers (through advertising) is so widespread that marginal-utility theory is largely irrelevant and useless in explaining consumer behavior. They reject the view that the consumer is truly "sovereign" in deciding what to buy.

Consumers in competitive markets receive consumers surplus-value received for which they do not have to pay. This happens because of diminishing marginal utility and because consumers usually pay a uniform price for all units of the same good or service-a price representing the value that they place on the last unit bought.

Consumers often pay far lower prices for goods and services that are called essential than they pay for goods and services considered relatively unimportant. This phenomenon is referred to as the "paradox of value. " The paradox is resolved when one understands that price, or "value in exchange, " is based on marginal utility whereas the importance of a product, or its "value in use," is based on total utility.