Understand utility theory and indifference curves in economics

What is utility theory?

Utility theory is widely used in economics to explain how consumers or decision makers best make their decisions.

Even if it is not possible to measure the utility that a consumer attributes to a specific good, the theory seeks to  compare and classify the alternatives of choice of the good  .

To better explain this concept, “utility” is used, a theoretical unit used to measure the satisfaction obtained with the consumption of a chosen product or service.

In a more simplified way, the theory is represented for a choice conflict between two goods and through indifference curves.

What are indifference curves?

Indifference curves are used to show how a consumer makes his choice between different goods according to the utility he attributes to them.

Indifference represents the points where a consumer exchanges quantities of good A for good B,  and their utility does not change  , as in the following figure:

The consumer can attribute more utility to his choice. In this case, the indifference curves are further removed from the origin. This is because the choice between goods is more useful.

If the economic agent begins to prefer one good over another, the indifference curve leans more towards the good with greater preference, maintaining the same level of utility.

Some models take into account a theoretical budget constraint in which the values ​​are attributed to the assets and disposable income of the economic agent.

Example

A consumer intends to choose between units of coffee and tea in his purchase, and attributes a utility equal to 1 in the combined choice between the two products.

To maintain the level of utility, the consumer can choose between different levels of coffee or tea, as in the following table:

Coffee unitsUnits of tea
01
0.10.9
0.30.7
0.60.4 0.4
0.90.1
10

For example, the consumer can decrease from 0.9 to 0.7 units of tea and increase from 0.1 to 0.3 units of coffee, that is, 0.2 additional units of coffee, maintaining the utility of the purchase.

Decreasing marginal utility

As we see in the graph of indifference curves, as the consumer purchases a greater quantity of one good, the quantity of the other decreases proportionally.

This concept also applies to the consumer looking for a product on the market. In this theory, the  more a product has, the less useful it will be  to the user.

Due to decreasing marginal utility, the consumer is only interested in additional quantities of a product at prices lower than the price paid for the first.

This concept begins by explaining how consumers buy more than one product, as they rate it more usefully, forming the Law of Demand.