Theory+of+Consumer+Choice+AP+MICE

People are constantly dealing with opportunity cost in their lives, due to the condition of scarcity. Therefore, people make decisions based on not only their preferences but also their income constraints. Any income constraint can be modeled by a budget line, showing the combination of goods a person can buy given a certain money income. Below is an illustrated example:

When looking at people's preferences, an indifference curve is used. If two goods are equally preferable to each other (meaning those goods generate the same utility), then an indifference curve will show the combination of goods a person prefers assuming that the two goods are equally substitutable. The tangent to the graph is the marginal rate of substitution (MRS): if one more of a good was preferred, how much would the person be willing to forgo of an equally substitutable good? Below is an example of an indifference curve:

The ideal point for the consumer is a combination which the consumer not only can afford but also is the combination which affords maximum utility. Therefore, the optimal decision for a consumer to make is when MRS equals the relative price of goods and where the relative price of goods equals the budget constraints. This is the theory of consumer choice. There is a much simpler formula to use. We shall define MU as the marginal utility of a good. One good will be called X and the other good will be called Y. We shall define P as the price of a good. The formula to show the combination which achieves maximum utility and meets the budget constraint is:

Marginal utility of x divided by the price of x equals the marginal utility of y divided by the price of y.

Out of several different combinations of two goods, the one that satisfies the above equation is the ideal combination for the consumer and also is the combination that satisfies the theory of consumer choice.

ARTICLE TO EMPHASIZE THEORY OF CONSUMER CHOICE: []

By: Steven, Vickram, Will