Utility Maximization and Scarcity
Economic concepts are usually concerned about the problem of scarcity of resources that are used to fulfill many unlimited needs of individuals. Many resources that are used to fulfill the needs of different people exist. However, they are randomly distributed throughout the world and across different countries without any formula. The resources are limited although they are significant in fulfilling the wants that are unlimited as depicted by consumers.
Due to the scarcity issues facing the resources, the demand is created. The resources provide the supply of all things that could be used to fulfill all needs. However, the needs of consumers reflect the demand.
Due to many consumer needs, the demand for products is usually high and consumers have to budget their purchases based on monetary resources available (that are also limited). Therefore, the supply of resources and products forms one force within a market while the demand forms the other force whose combined effects shape the activities taking place in the market (Kehoe & Prescott 2007, P. 211). All consumers of any product and services are also considered rational as they always seek to maximize their utility given their budget constraints. The forces of demand and supply are significant in our understanding of the utility of a consumed derived from consumption of a given product or service.
As indicated above, the demand of a given product is determined by the needs to be fulfilled. Goods are exchanged in the market using a given medium of exchange that is in most cases money. Due to their unlimited nature, needs create the demand curve that indicates the quantity of goods that consumers demand in a given market at given prices. The demand schedule is used to generate the demand curve that is usually sloping downwards indicating that as the price of the products in a given market keeps increasing, consumers demand less of the products.
The supply is determined by the availability of economic resources that are scarce.
Suppliers also supply products in a market given the compensation to be received in terms of price that is usually in monetary terms. Based on the compensation received, a demand schedule can be used to develop a demand curve that indicates the amount of goods that suppliers are able and willing to supply within a given market given the compensation (price) to be received back. The supply curve is usually upward sloping indicating that that supply of a given products in the market increases as the compensation (price) suppliers receive for the goods or services keep on increasing. The forces of demand and supply provide an equilibrium in which consumers and suppliers supply and consume equal amounts of goods and services in the market at a given equilibrium price.
According to Kehoe & Prescott (2007, P.
211), consumer’s utility is the satisfaction that a consumer could derive from consuming a given set of products in the market. The concept is abstract rather than concrete or any other thing that could be observed. Therefore, the amount of units assigned to the utility of consuming a given product in the market are given arbitrarily rather than measured in order to provide a given relative value. As the consumer consumes a given product, he/she gains utility (satisfaction). At the end of the consumption exercise, the consumer usually has what is called total utility, which means the total satisfaction derived from the consumption of the given product or service. Therefore, as noted by Wayne & Hoyer (2008, p, 75), the total utility of a consumer corresponds to the total satisfaction derived from the consumption of a given product or service. Another economic concept related to this is the marginal utility, which is used to denote the additional fulfillment that a consumer derives from a given extra unit-consumption of a given product. Blackwell, Miniard & Engel (2006) note that the total utility of a given product usually increases as the consumer keep on consuming the product.
However, the marginal utility usually diminishes as the number of units of a given product or service consumed at a given time increase. Therefore, the decrease in the additional pleasure derived from consuming only fulfills the law of diminishing marginal utility, which postulates that as one continuously increases the unit of a given product being consumed, the satisfaction derived from consuming an additional unit declines with time. This is because the threshold of satisfaction derived from consuming any additional unit of a product or service does not receive similar pleasure from the consumer. In summary, the total utility of the consumer would increase at a reducing pace as the consumption of the product/service increases. In order to understand the law of demand defined above, it is necessary to understand the law of diminishing utility. Consequently, the less of a given product that a consumer takes, the more satisfaction is derived and vice versa (Vance 2003, p. 106).
The maximization of utility derived from the consumption of a given product is best understood with the understanding of the consumer demand as explained above. It should be understood that all consumers are rational in their choices especially those that directly affect their satisfaction during or after the consumption process. In order to maximize utility, consumers purchase a given product bundle (combination) as compared to the purchase of more of only one single product that would meet their needs.
Therefore, instead of spending all the money on one product only, consumer usually spread their money on a number of products that have different utilities in order to maximize the outcome. For instance, a consumer could have a given level of income called m that is to be spend on two products X and Y that are sold at prices Px and Py in the market. As a rational consumer, the consumer would purchase a bundle that maximizes the utility derived from their consumption. The budget constraint of the consumer could be depicted as: PxX+PyY?m. Given that more is better, this equation must hold.
We can draw a budget line for the consumer and thereby indicate the point of maximizing the utility. The above figure indicates the budget line with Px=1, Py=5 and M= 10. The slope of the budget line is –Px/Py. The maximization of utility is derived at the tangency of the indifference and the budget line as indicated below. At that point, the consumer has chosen the bundle that best meets his/her needs.
The slope of the indifference curve indicates that rate at which the consumer could substitute the two products hence the marginal rate of substitution (MRSyx). Therefore, the MRS is equivalent to the slope of the budget line Px/Py.
List of References
Blackwell, D, Miniard W & Engel F 2006, Consumer behavior, Thompsons publishers, South Western. Kehoe, T & Prescott, E 2007, Great Depressions of the Twentieth Century, Federal Reserve Bank of Minneapolis, Minneapolis.
Vance, D 2003, Financial Analysis & Decision Making, McGraw-Hill, New York. Wayne, D & Hoyer, M 2008, Consumer behavior, Cangage Learning, South Western, U.S.