Why are people willing to spend their money on the purchase of goods and services? The answer to this question is quite simple: because their consumption is a source of pleasure and satisfaction. The needs are endless; money is not. Therefore, to explain how people make decisions about buying a product or service, it is necessary to study the rule of maximizing utility.
Background
What is a utility maximization rule? It can be briefly explained as follows: the consumer distributes his income in such a way that every last monetary unit brings him equal pleasure and satisfaction.
This economic law is based on three premises:
- Buyers seek to distribute the money they earn so that the resulting utility of the purchased products is greatest.
- Consumers are rational economic entities. This means that they are able to independently use the rule of maximizing utility by comparing different sets of products.
- Product prices are determined by the market. Consumers cannot influence them.
Utility Maximization Rule: Formula
- MU A / Price A = MU B / Price B.
This is how the formula looks in the language of algebra. The essence of the rule is as follows: every last dollar spent on the purchase of goods or services should bring the same marginal utility (MU). This means that the consumer spent his money correctly.
The utility maximization rule requires that all revenue be spent completely. Suppose a consumer has a certain amount of dollars in his pocket. The price and usefulness of each of the products is also known. Thus, the above equality holds. A rule of maximizing utility allows us to calculate how many units of goods a buyer will acquire. Behind it lies an important psychological component: people tend to buy only what they like. If the goods are not indifferent to them, then he will remain on the store counter.
Practical application
Suppose a customer makes a choice between coffee and tea. How will the general utility maximization rule work? To do this, we need to know how he evaluates satisfaction with the purchase of the first and second drink. Suppose he estimates the usefulness of coffee at 100 points, and tea at 80. At the same time, the price of the first drink is 200 rubles, the second is 100. Obviously, in this situation, the buyer will choose tea based on weighted utility. For coffee, it is 0.5 points, for tea - 0.8.
But suppose the same buyer decided to spend all his cash on the purchase of these two drinks? Will he buy only tea? This allows us to understand the rule of maximizing utility. In fact, each subsequent cup of any of the two drinks brings less pleasure than the previous one.
Utility as an object of study
This term was first coined by the English philosopher Bentham. He understood utility as a principle that helps a person determine whether the next action will bring happiness. Bentham believed that in his choice a person is guided by his tastes and preferences. Today, the usefulness of a good is determined through its ability to satisfy the needs of a particular subject. There are two main theories for studying this concept: cardinalistic (quantitative) and ordinalistic (ordinal). The first was born in the second half of the 19th century. Her apologists were such famous scientists as Jevons, Menger and Walras. They believed utility could be measured.Ordinalists, on the contrary, do not see the possibility of a quantitative assessment of this concept. Representatives of this direction are scientists such as Edgeworth, Pareto and Fisher. They believed that a qualitative assessment of utility was enough. Their theory was further developed in the works of Hicks and Allen in the 30s of the last century.
There are two types of utility. Subjective (cardinalistic, quantitative) is an indicator that can be measured. For example, a person wanted to eat an apple. The first fruit will have the greatest usefulness for him. But the fourth apple may not bring him any satisfaction. Such a comparison is characteristic of quantitative theory. Objective utility is an indicator that cannot be measured. His research is engaged in a qualitative (ordinalist) theory. An example is often given the utility of water in the sea or sand in the desert.
The law of decreasing marginal utility
As we have seen, the satisfaction from the use of each subsequent unit of goods becomes less. The law of decreasing marginal utility was first formulated by representatives of quantitative theory - Jevons, Menger and Walras. All three wrote their research independently of each other and published them almost at the same time. The term “marginal utility” itself was coined by Friedrich von Wieser. It can vary depending on the choice of the subject, his condition (for example, well-fed or hungry) and basic needs (grain as seeds for sowing or a product for making bread). The essence of the law is that with increasing consumption, the overall usefulness of the product grows more slowly. In order to make a person buy more, you need to lower the price.
However, there are some restrictions on the application of this law:
- Inhomogeneous units. You can not immediately consider apples and bananas. All units studied must be uniform.
- Changes in tastes and preferences. The law of diminishing utility does not take them into account, but if this still happened, then it will not work correctly.
- Continuity of consumption. If there is a pause in the purchase of goods, then each subsequent unit can bring the same pleasure as the previous one.
- Price changes. The law of diminishing utility does not work in the face of constant changes in market conditions.
findings
Studying consumer behavior is a complex science. It is based on the following hypotheses:
- Consumer preferences determine their choice of a set of benefits.
- People are rational subjects who know how to fully satisfy their needs.
- A person seeks to maximize the overall utility he receives.
- Good prices are set by the market.
- The choice of goods is limited to the buyer's income.
- The determination of the most successful set of benefits takes into account the effect of the law of diminishing marginal utility.
