When consumers make choices about the quantity of goods and
services to consume, it is presumed that their objective is to maximize total
utility. In maximizing total utility, the consumer faces a number of
constraints, the most important of which are the consumer's income and the
prices of the goods and services that the consumer wishes to consume. The
consumer's effort to maximize total utility, subject to these constraints, is
referred to as the consumer's problem. The solution to the consumer's problem,
which entails decisions about how much the consumer will consume of a number of
goods and services, is referred to as consumer equilibrium.
Determination of consumer equilibrium: Consider the simple
case of a consumer who cares about consuming only two goods: good 1 and good 2.
This consumer knows the prices of goods 1 and 2 and has a fixed income or
budget that can be used to purchase quantities of goods 1 and 2. The consumer
will purchase quantities of goods 1 and 2 so as to completely exhaust the
budget for such purchases. The actual quantities purchased of each good are
determined by the condition for consumer equilibrium, which is
This condition states that the marginal utility per dollar
spent on good 1 must equal the marginal utility per dollar spent on good 2. If,
for example, the marginal utility per dollar spent on good 1 were higher than
the marginal utility per dollar spent on good 2, then it would make sense for
the consumer to purchase more of good 1 rather than purchasing any more of good
2. After purchasing more and more of good 1, the marginal utility of good 1
will eventually fall due to the law of diminishing marginal utility, so that
the marginal utility per dollar spent on good 1 will eventually equal that of
good 2. Of course, the amount purchased of goods 1 and 2 cannot be limitless
and will depend not only on the marginal utilities per dollar spent, but also
on the consumer's budget.
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