THEORY OF

CONSUMER
BEHAVIOR
THEORY OF CONSUMER BEHAVIOR

- The study of how people decide to spend their money, given

their preferences and budget constraints. A branch of
microeconomics, consumer theory shows how individuals
make choices, given restrains, such as their income and the
prices of goods and services.
Every member of your class had entirely different goods in his or her table than you did. Precisely
WHY every individual consumes a different “basket of goods” from every other individual in a
market economy can be understood by the following:

• Every consumer behaves rationally: Consumers try to get the "most for their money" to
maximize their total utility

• Every consumer has different preferences: Consumers have clear cut preferences and can
determine how much marginal utility they get from consuming more units of a product

• Every consumer is under a budget constraint: All consumers face a budget constraint,
therefore must make decisions about what they buy based on their limited budget

• Every product has a price: Every product has a price, so consumers must weigh their
purchasing decisions based on their marginal utility from consumption and the price of the goods
they consume
Total Utility and Marginal Utility
As explained in the introduction to this unit, rational consumers wish to maximize their happiness, or
utility when buying goods and services. Otherwise, what is the point of spending money at all? Two
concepts that will help us understand HOW consumer maximize utility, therefore, are:

• Total Utility (TU): This is the total happiness of a consumer at a particular level of consumption.
Total utility will generally increase as total consumption of particular good increases, until the
consumer has “had too much” of the good, when total utility will begin to decline.

• Marginal Utility (MU): This is the increase in total utility resulting from the consumption of each
additional unit of a particular good.
∆TU
MU =
∆Q
• Since MU measures the change in TU, as long as MU is positive at a particular level of output, TU will
be increasing. But if MU becomes negative,TU will decrease.
THE LAW OF DIMINISHING MARGINAL UTILITY

Recall from earlier units that demand for a particular

good is inversely related to the good’s price. One of
the explanations for this relationship was the law of
diminishing marginal utility , which states:

THE GREATER THE LEVEL OF CONSUMPTION OF A

PARTICULAR GOOD, THE LESS UTILITY CONSUMERS DERIVE
FROM EACH ADDITIONAL UNIT OF THE GOOD.
The Utility Maximization Rule: To maximize your total utility, you
should instead consume the combination of good that maximizes your marginal utility per dollar spent, so
that:

𝑀𝑈𝑤 𝑀𝑈𝑟
= … 𝑎𝑛𝑑 𝑠𝑜 𝑜𝑛 𝑤𝑖𝑡ℎ 𝑜𝑡ℎ𝑒𝑟 𝑔𝑜𝑜𝑑𝑠
𝑃𝑤 𝑃𝑟