“Income and Choice”

 > Explanatory Article by Marios Kyriakou, MSc Economics


About the author: Marios Kyriakou has a bachelor’s degree in Economics from the University of Cyprus and a master’s degree in Economics from the University of Warwick. He is also a holder of CySEC’s Advanced Certificate in Financial Services Legal Framework and a professional in Online Trading, Forex and CFDs with more than 7 years of experience.

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<Last updated 13.04.2020>

Dear reader,

Hi! If you are interested in Economics, I’ve prepared the below to help you become familiar with theoretical models. You should take a look at this short article where I which I discuss how a consumer maximizes satisfaction/utility taking into account an available limited amount of income.  

If our income was unlimited, then things would be easy when it comes to satisfying needs. In that case the consumer would just buy the quantities of goods that are enough for the consumer to get full satisfaction and so all needs and wants would be satisfied fully.  In reality income is limited, so not all needs and wants can be satisfied.

With limited income, the consumer must choose the best combination of goods and services, the one that maximizes the total utility. A consumer faces an income budget constraint.  The consumer must find what quantity of Good A and what quantity of Good B to obtain (a combination of quantities of each good).

In our example there are only two goods. The budget constraint line represents all the possible combinations of quantities given fixed Money Income. Which combination will the consumer choose? The consumer, maximizing his total utility, will allocate his income among various goods in such a way that his marginal utility of the last cent spent on each good is equal or proportional to its price.

When utility obtain by spending 1 EUR from a good is equal to the utility obtain by spending 1 EUR on other goods, the consumer maximizes total utility (when having fixed income).

These utility curves describe the consumer preference for the goods, how he, or she, prefers to consume them together. In the example we have now also a utility/indifference curve. Combinations of quantities that give the consumer the same satisfaction/utility when consumed (That is why is called indifference curve, because the consumer is indifferent of which combination to consume, any combination provides the same utility amount)

The consumer will choose the combination that reaches the highest Utility curve he, or she, can reach, given the budget constraint which is formed by the limited income available. Why we need to know how the consumer behaves? Because we are able to explain what happens when consumer income increases or decreases. According to this classical consumer theory, a new combination will be chosen, higher quantities of the two goods will be consumed since the consumer has now higher income. Does it reflect reality? It often does, since history showed that higher salaries/wages lead to more quantities demanded and consumed by the people.


 

“I hope I am clear on this one. If not, contact us on social media and we will do our best to help you.

Thank you for reading my articles and watching my videos.”

Marios Kyriakou

References:
Ιωάννου-Σεργίου Μ., Μάτση Μ., Σάββα Ν., Σταύρου-Παπαδοπούλου Λ., Οικονομικά Α’ Λυκείου, Α΄ Έκδοση 2016. Υπηρεσία Ανάπτυξης Προγραμμάτων, Κύπρος.
Βλαδιμήρου-Παναγιώτου Β. και Κουζαλή-Σωτηρίου Ε., Οικονομικά Β’ Λυκείου, Κύπρος, Α΄ Έκδοση 2016.  Υπηρεσία Ανάπτυξης Προγραμμάτων, Κύπρος.
Βλαδιμήρου-Παναγιώτου Β. και Κουζαλή-Σωτηρίου Ε., Οικονομικά Γ’ Λυκείου, Κύπρος, Α΄ Έκδοση 2017.  Υπηρεσία Ανάπτυξης Προγραμμάτων, Κύπρος.
Besanko, David Braeutigam, Ronald R. Gibbs, Michael, 2011, Microeconomics, Hoboken: John Wiley, 4th ed,
International student version
Frank, Robert H., 2010, Microeconomics and Behavior, New York: McGraw-Hill Irwin, 8th ed.
Estrin, Saul Laidler, David E. W. Dietrich, Michael ., 2008, Microeconomics, Harlow: FT/ Prentice Hall, 5th ed.

Disclaimer: This article is intended for educational purposes only and does not replace independent professional judgement. Its purpose is to act as a complementary educational service to society, promoting personal development and social, economic and cultural progress of citizens. While this content has been prepared in good faith, no representation or warranty, express or implied, is or will be made and no responsibility or liability is or will be accepted by the creator to the accuracy or completeness of the information presented or any other written or oral information made available to any interested party and any such liability is expressly disclaimed.

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