C. Theory of the Consumer

This section of the handbook presents the neoclassical theory of the consumer. This theory has three main components. First, the consumer’s preferences over commodity bundles are numerically represented by a utility function. Utility is a function of the amounts of the various commodities in a given bundle, and represents the consumer’s comparative levels of satisfaction among bundles.

Second, the consumer is constrained by the prices of the commodities and their income. The budget constraint identifies the commodity bundles that the consumer can afford, given commodity prices and their income. Third, we assume that a consumer selects the commodity bundle that maximizes their utility subject to their budget constraint.

We next examine how the consumer’s utility maximizing choice changes in response to changes in their economic environment, such as changes in a commodity’s price, changes in a consumer’s income, or changes in other prices. This type of analysis is called comparative statics.

Finally, we use this analysis to illustrate the consumer’s labor supply decision, their consumption-savings decision, and how they make decisions in the face of uncertainty.