Demand and Consumer Behaviour

Dr. Rama Pal

HSS, IITB

Choice and Utility Theory

Utility means satisfaction
Utility is a scientific construct that economists use to

understand how rational consumers make decisions

In the theory of demand, we assume that people

maximize their utility, which means that they choose the

bundle of consumption goods that they most prefer

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Marginal Utility
Marginal means additional or extra.
Marginal utility denotes the additional utility you get

from the consumption of an additional unit of a

commodity
Law of Diminishing Marginal Utility
It states that, as the amount of a good consumed

increases, the marginal utility of that good tends to decline

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Example: Consumption of Ice-cream

TU

MU

10

10

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Total Utility: Consumption of Ice-cream

Total Utility

10
9
8
7
6
5
4
3
2
1
0
0
5

5
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Marginal Utility: Consumption of Ice-cream

Marginal Utility

5
4
3
2
1
0
1
6

5
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Relation between TU and MU

Total utility of consuming a particular amount is

equal to the sum of the marginal utilities up to that

point
TU is maximum when MU is zero.

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Equimarginal Principle
Assumption: consumer maximizes utility
Equimarginal principle: It states that a consumer

will achieve maximum satisfaction or utility when

the marginal utility of the last rupee spent on a good
is exactly the same as the marginal utility of the last
rupee spent on any other good

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Equimarginal Principle
The common marginal utility per rupee of all

commodities in consumer equilibrium is called the

marginal utility of income. It measures the
additional utility that would be gained if the
consumer could enjoy an extra rupees worth of
consumption

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Equimarginal Principle
MU n
MU1 MU 2

...
MU ( per rupee of income)
P1
P2
Pn

Why demand curves slope downward

A higher price for a good reduces the consumers desired

consumption of that commodity

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Examples
Allocation of money
Allocation of time

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Behavioural Economics
Calculation of marginal utility
Consumers are reasonably consistent in their tastes

and actions
Irrational or inconsistent behaviour
Asymmetric information
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The Indifference Curve

The points on the indifference curve represent consumption

bundles among which the consumer is indifferent; all are

equally desirable
Y
A=(X1,Y1)
B=(X2,Y2)

X
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The Indifference Curve

Marginal rate of substitution

slope of indifference curve = Y/ X = MUX/MUY

Diminishing MRS (convexity): the more you have

of one of the goods the more you can give it up in

exchange for other good

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Diminishing Marginal MRS

Quantity
of Pepsi
14

MRS = 6
A

4
3

0
15

MRS = 1
1

Indifference
curve
7

Quantity
of Pizza
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Indifference Map
Quantity
of Pepsi
C

D
I2
A

0
16

Indifference
curve, I1
Quantity
of Pizza
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Indifference Map
Consumption bundles on IC which are farther from

the origin are preferred

More is better
Preferences over Bads
There is an IC through each bundle

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Properties of Indifference Curves

Indifference curves cannot cross
Indifference curves slope downwards and is convex

to the origin
Indifference curves cannot be thick

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The Impossibility of Intersecting ICs

Quantity
of Pepsi
C
A

0
19

Quantity
of Pizza
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IC: Perfect Substitutes

Example: Red pencil and blue pencil
Blue
Pencil

IC2
IC1

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Red Pencil
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IC: Complements
Example: Tea and sugar
Sugar

IC2
IC1

Tea
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Problem # 1
Plot the indifference curves showing preferences

over consumption good, x and work, l. Here, your

satisfaction goes up in x and down in work (i.e., you
enjoy leisure).

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