Rational choice and diminishing utility
The textbook consumer.
Rational choice theory. Assumes consumers:
- Have clear preferences.
- Have complete information about prices, qualities, alternatives.
- Choose the combination of goods that maximises utility (satisfaction) within their budget constraint.
Utility is a measure of satisfaction. Total utility is the overall satisfaction from a quantity consumed; marginal utility is the additional satisfaction from one more unit.
Law of diminishing marginal utility. The more you consume of a good in a given time, the LESS additional satisfaction each successive unit brings.
Worked example. First slice of pizza gives utility of 10. Second slice 7. Third 4. Fourth 0. Fifth -3 (you feel sick).
Diminishing MU explains the downward demand curve at the individual level: you'll only pay a lower price for each additional unit because each adds less utility.
Optimal consumption rule. Spend additional dollars where they give the highest marginal utility per dollar. In equilibrium:
That is, the LAST DOLLAR spent on each good gives the same marginal utility. (Not formally tested at SL, but underpins the theory.)
- Rational consumer: maximises utility.
- Diminishing MU explains downward demand.
- Optimal: MU/P equalised across goods.