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Classical Approach To Analyse Consumer Behaviour
Classical Approach To Analyse Consumer Behaviour
Classical Approach To Analyse Consumer Behaviour
MEANING OF UTILITY: The word utility, means they want satisfying power of a commodity. Utility is the psychological feeling of satisfaction, pleasure, happiness or well being which a consumer derives from the consumption, possession or the use of a commodity. TOTAL UTILITY: It is the sum derived by a consumer from various units of goods and services he consumes. Suppose a consumer consumes four units of a commodity, X, at a time and derives utility as U1, U2, U3, and U4. His total utility (TUx) from commodity X can be measured as follows. Tux = U1 + U2 + U3 + U4 If n number of commodities he consumes then his total utility will beTUn = Ux + Uy + Uz Utility is a psychological phenomenon. It is a feeling of satisfaction, pleasure and happiness. Measurability of utility has, however, been a contentious issue. Early economists-classical economists, viz. Jeremy Bentham, Leon walrus, Carl Menger, etc. and neo-classical economist, notably Alfred Marshall- believed that utility is cardinally or quantitatively measurable like height, weight, length, and temperature and air pressure. This belief resulted in Cardinal concept. The modern economists, most notable J.R Hicks and R.G.D Allen, however, hold the view that the view that utility is not quantitatively measurably-it is not measurable in absolute terms. This approach is called ordinal approach. CARDINAL UTILITY: Cardinal utility is that utility which can be expressed in quantitative terms i.e., utility can be measured in quantitative terms. Analysis of cardinal utility is based on the law of diminishing marginal utility. ORDINAL UTILITY: Ordinal utility is that utility which cannot be expressed in quantitative terms i.e., it can be expressed in terms of preference scales. Analysis of ordinal utility is based on the law of diminishing marginal rate of substitution. TWO APPROACHES TO CONSUMER BEHAVIOUR Based on the cardinal and ordinal utility, there are two approaches to the analysis of consumer behaviour. 1). Cardinal Utility Approach 2). Ordinal utility Approach Analysis of consumer behaviour: Cardinal Utility Approach The classical and neo-classical economists assumed it to be objective or, in other words, they thought that the utility is imbibed in the commodity. This resulted in what we call the CARDINAL Managerial Economics University of Technologies, Mauritius Page 1 of 12
The cardinal utility approach to consumer analysis makes the following assumptions:RATIONALITY - it is assumed that the consumer is a rational being in the sense that he satisfies his wants in the order of their preferences, that is, he or she buys the commodity first which yields the higher utility and that least which gives the least utility. LIMITED MONEY INCOME - The consumer has a limited money income to spend on the goods and services he or she chooses to consume. Limitedness of income, along with utility maximisation objective makes the choice between goods inevitable. MAXIMIZATION OF SATISFACTION -Every rational consumer intends to maximise his/her satisfaction from his/her given money income. UTILITY IS CARDINALLY MEASURABLE - The cardinalists have assumed that the commodities that the utility is cardinally measurable and that utility of one unit of a commodity equals the money which a consumer is prepared to pay for it or 1util = 1 unit of money. DIMINISHING IN MARGINAL UTILITY - Following the law of diminishing marginal utility, it is assumed that the utility gained from the successive units of a commodity consumed decreases as a consumer consumes larger quantity of the commodity. This is an axiom of the theory of consumer behaviour. CONSTANT MARGINAL UTILITY OF MONEY -The cardinal utility approach assumes that the marginal utility of money remains constant whatever the level of a consumer's income. This assumption is necessary to keep the scale of measuring rod of utility fixed. it is important to recall in this regard that cardinalists used 'money' as the measure of utility. UTILITY IS ADDITIVE - Cardinalists assumed not only that utility is cardinally measurable bit also that utility derived from various goods and services consumed by a consumer can be added together to obtain the total utility. in other words, the consumer has a utility function which may be expressed as: U= f(X1, X2, X3 ...Xn) Where X1, X2 ...X3 denote total quantities of the various goods consumed. Given the utility function, total utility obtained from n items can be expressed as: Un = U1(X1) +U2(X2) + U3(X3) + ......+ Un(Xn) It is the utility function which the consumer aims to maximise. HYPOTHESIS OF INDEPENDENT UTILITIES: It is assumed that the utility which a consumer obtains from a good does not depend upon the quantity consumed of other goods; it depends upon the quantity purchased of that good alone. INTROSPECTIVE METHOD: Introspection is the ability of observer to reconstruct events which go in the minds of another person with the help of self observation. That is by looking into ourselves we see inside the heads of other individuals.
To attain the maximum level of satisfaction, given his resources and other conditions, a consumer should have to reach his equilibrium position. This can be explained easily with the help of Law of Diminishing Marginal Utility and Law of Equi-Marginal Utility.
K
P1
L P2 M
P3
D O
Demand (Kgs.)
Q1 Q2 Q3 demand curve for tea. When the price of tea per kilograms is OP, the consumers demand for tea is OQ kilograms. When the price falls to OP2, demand rises to OQ2 and so on. Thus, when the price is OP1, the price quantity combination is shown by the point K. Similarly, when the price is OP2, it is shown by the point L. The curve that we get by joining the points like K, L, M, etc. is called individual demand curve. It is a curve that shows how an individuals demand changes when the price changes. DD is our individual demand curve for tea.
THE LAW OF DEMAND The law of demand states that price and quantity demanded of a commodity move in opposite directions. When the price of a commodity rises, the demand for it falls. When the price falls demand rises. As the law states, there is an inverse relationship between the price and the quantity demanded. This law holds under the condition that other things remain constant. Other things include determinants of demand, like, consumers income, price of the substitutes and complements, tastes and preferences of the consumer, etc. These factors remain constant only in short run. In the long run they tend to change. The law of demand is based on the law of diminishing marginal utility. It can be explained through a demand schedule and demand curve. DEMAND SCHEDULE Managerial Economics University of Technologies, Mauritius Page 4 of 12
DEMAND SCHEDULE FOR TEA No. of cups of tea Price per cup of demanded by a tea(Rs.) consumer per day 4 3 2 1 1 2 3 4 Points representing price-quantity combination A B C D
DEMAND CURVE The law of demand can also be presented through a demand curve. A demand curve is the locus of points showing various alternative price-quantity combinations. Demand shows the quantities of a commodity which a consumer would buy at different prices per unit of time, under the assumptions of the law of demand.
DEMAND CURVE
PRICES
X QUANTITY
1. If, suppose, the utility of x commodity is 15 units and of y is 10 units, then as per measurable approach, we should get a utility of 25 units when both commodities are taken together. However, if we see the reality, then total utility can be less than or greater than the summation of their individual utilities and this will depend upon the nature and properties of the two commodities. If the commodities are substitutes, like tea and coffee the total utility of their joint use will be less Managerial Economics University of Technologies, Mauritius Page 6 of 12
MEANING OF AN INDIFFERENCE CURVE It is the focus of all such points representing pairs of quantities between which individual is indifferent, so it is termed as indifference curve. -Prof. J. K. Smith Concept of indifference curve is based upon the assumption that every consumer has a scale of preferences between two or more commodities. There are some combinations of these commodities which provide him equal satisfaction. He can choose any of these combinations. If he chooses one combination, he is indifferent to all other combinations. Such combinations can be presented on a curve also. Such a curve is called the indifference curve. The consumer is indifferent to these combinations of commodities. Thus, an indifference curve is a curve which represents various combinations of commodities which provides equal satisfaction to a consumer. Let us take an example:COMBINATION A B C D QUANTITY OF X 1 2 3 4 QUANTITY OF Y 20 15 11 8
In the above table we show five combination of two commodities X & Y. At combination A we have 1 unit of X and 20 units of Y commodity. At combination B, we have 2 units of X and 15 units of Y and Managerial Economics University of Technologies, Mauritius Page 9 of 12
INDIFFERENCE CURVE
Y
Commodity- Y
A B C D
E
O X Commodity-X
PROPERTIES OF INDIFFERENCE CURVES Properties of indifference curve reveal the consumers behaviour, his choices and preferences. They are as follows: (a). They are Convex to the Origin : Indifference curves are always convex to the origin. Left hand position of the indifference curve is normally steep and right hand position is normally flat. This is due to the diminishing marginal rate of substitution. (b). They Slopes downward to the Right: Indifference curves slopes downwards from left to right because every consumer wants to keep total satisfaction constant. He will have to give up one commodity and get it compensated for by the other. They cannot be horizontal straight lines, nor can they be upward rising lines.
Indifference map
Y
Commodity-Y
5 4 3 2 1 O Commodity-X X IC
Budget line or Price line It is the line which shows various combination of two goods which are available to the Consumer at a given income and price. The Price line or Budget line indicates that the consumer shall be somewhere on the given Price line. Price line or budget line indicates the equilibrium of consumer that he will choose which yield him maximum satisfaction. For example if the persons income is Rs. 20 and the price of X & Y are Rs. 4 & 5 respectively. In this situation he can purchase maximum 5 units of X and 4 units of Y or any combination between them. Y=Px.Qx +Py.Qy Or, 20= 4.Qx + 5.Qy Managerial Economics University of Technologies, Mauritius Page 11 of 12
Price Line
Y
Commodity-Y
Commodity-X
CONSUMER EQUILIBRIUM A consumer is said to have reached his equilibrium position when he has maximized the level of his satisfaction, given his recourses and other condition. Three things are necessary for determining consumers equilibrium in ordinal approach. Consumers Income. Price of two commodities. Indifference map of consumer. CHARACTERSTIC OF CONSUMERS EQUILIBRIUM It is on the highest attainable IC. The price line is always tangent to the IC and it never intersects the IC. The slope of IC and the slope of price line is always equal. MRSxy is equal to the Price Ratio CONCLUSION It is important to know that in spite of tremendous development in consumption theory based on ordinal utility, the classical demand theory on cardinal has retained its appeal and applicability to the analysis of market behavior. Besides, the study of classical demand theory serves as a foundation for understanding the advanced theories of consumer behavior. The study of classical theory of demand is of particular importance and contributes a great deal in managerial decisions. Managerial Economics University of Technologies, Mauritius Page 12 of 12