Assume that Jane is walking around a church picnic and she hasn’t eaten all day. In an effort to quench those hunger pangs, she walks over to the snack booth to get some pizza because that’s like her totally favorite food. Upon reading the sign on the wall, she notes that pizzas are $2 per slice. If we assume money is not going to constrain her decision, an interesting economic question is to ask how many slices Jane will buy?

We begin by recognizing that economists believe individuals make decisions on the basis of marginal analysis. That is, we analyze decisions by looking at how small changes in consumption, production, etc., affect someone like Jane in terms of benefits and in terms of costs. The "trick" is to determine exactly what the benefits and costs are to Jane and how we’d measure those benefits and costs.

If we’re talking consumption, then the benefit derived from consuming a slice of pizza is something related to the satisfaction one gets from that consumption. Satisfaction isn’t very measurable though, so we need to go one step further. Another possible way to describe benefit in this situation is the value we place on consuming a particular slice of pizza. For example, we could ask Jane how much a specific slice of pizza is worth to her, or ask what she’d be willing to pay for a certain slice. In our example, let’s measure the benefit derived from eating a particular slice of pizza as what Jane is willing to pay for a particular slice.

Of course, the cost of consuming an item is much simpler. Jane must purchase pizza at a specific price, and so we can go with that price as our measure of cost. Furthermore, because the price of each slice of pizza is $2, we are really asking how many slice of pizza Jane will buy at $2 a slice.

How many slices of pizza will Jane buy? According to marginal analysis, we can show that Jane will buy slices until the marginal benefit derived from consumption is equal to the marginal cost of engaging in that consumption. Substituting in our terminology for benefits and costs, we have another answer. Jane will consume until her marginal utility (or satisfaction) is equal to the price of each slice of pizza. This point is what we call the consumer equilibrium, and represents a point of balance or rest. It is where exchange takes place.

What does that mean in more straightforward language? Click here to learn more.