UNIT-2 THEORY OF CONSUMER BEHAVIOUR

 2.1 Utility
 2.2 Law of Diminishing Marginal Utility
 2.3 Law of Equi-Marginal Utility
 2.4 Shortcomings of Utility Analysis
 2.5 Indifference Curve Analysis
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2.1 Utility

 Definition: Satisfaction or pleasure derived from consuming a good or service.

 Total Utility: The overall satisfaction obtained from consuming a certain quantity of
goods or services.
 Marginal Utility: The additional satisfaction from consuming one more unit of a good
or service.
 Example: Eating an apple provides a certain level of satisfaction, which is the utility.

2.2 Law of Diminishing Marginal Utility (LDMU)

 Definition: As a consumer consumes more units of a good, the additional satisfaction

(marginal utility) from each additional unit decreases.
 Explanation: The first unit of a good consumed provides the highest utility, and each
subsequent unit provides less and less additional satisfaction.
 Graphical Representation: Typically shown with a downward-sloping marginal
utility curve.
 Example: The first slice of pizza is very enjoyable, but by the fourth or fifth slice, the
enjoyment decreases.
 Importance: Helps explain consumer demand and pricing strategies.

2.3 Law of Equi-Marginal Utility (LEMU)

 Definition: Consumers allocate their income in a way that the last unit of money
spent on each good provides the same level of marginal utility.

Plot no 38, ECIL Cross Roads, opposite to Xenia Hospital, ECIL, Secunderabad, Telangana 500062
  Explanation: For maximum utility, consumers balance their spending across
different goods so that the ratio of marginal utility to price is equal for all goods.
 Formula: MUAPA=MUBPB=…\frac{MU_A}{P_A} = \frac{MU_B}{P_B} = \ldotsPAMUA
=PBMUB=…
 Example: If the marginal utility per dollar spent on apples is higher than that on
oranges, the consumer will buy more apples until the marginal utilities equalize.
 Importance: Guides how consumers make decisions to maximize their satisfaction
given their budget constraints.

Plot no 38, ECIL Cross Roads, opposite to Xenia Hospital, ECIL, Secunderabad, Telangana 500062
2.4 Shortcomings of Utility Analysis

 Measurement Difficulty: Utility is subjective and difficult to measure quantitatively.

 Assumption of Rationality: Assumes consumers are always rational and seek to
maximize utility, which is not always realistic.
 Ignoring Other Influences: Does not consider other factors like emotions, habits,
and social influences on consumer behavior.
 Constant Marginal Utility of Money: Assumes the marginal utility of money
remains constant, which is not true in real-life situations.
2.5 Indifference Curve Analysis (ICA)

 Definition: A graphical representation of different combinations of two goods that

provide the same level of satisfaction to the consumer.
 Properties:
a. Downward Sloping: Indicates that to maintain the same utility, an increase in
the quantity of one good must be compensated by a decrease in the other.
b. Convex to Origin: Reflects diminishing marginal rate of substitution (MRS) –
the rate at which the consumer is willing to give up one good for another
decreases.
c. Non-Intersecting: No two indifference curves can cross each other, as it would
imply inconsistent preferences.
 Budget Line: Represents all possible combinations of two goods that a consumer can
purchase given their income and the prices of the goods.
 Consumer Equilibrium: Achieved where the budget line is tangent to the highest
possible indifference curve, indicating the optimal combination of goods.
 Example: A consumer might be equally satisfied with 3 apples and 2 bananas or 2
apples and 3 bananas, represented by points on the same indifference curve.
 Importance: Provides a more realistic analysis of consumer choice without needing to
measure utility directly.
2.1 Utility

 Definition: Satisfaction or pleasure derived from consuming a good or service.

 Total Utility: The overall satisfaction obtained from consuming a certain quantity of
goods or services.
 Marginal Utility: The additional satisfaction from consuming one more unit of a good
or service.
 Example: Eating an apple provides a certain level of satisfaction, which is the utility.
2.2 Law of Diminishing Marginal Utility (LDMU)

 Definition: As a consumer consumes more units of a good, the additional satisfaction

(marginal utility) from each additional unit decreases.
 Explanation: The first unit of a good consumed provides the highest utility, and each
subsequent unit provides less and less additional satisfaction.
Plot no 38, ECIL Cross Roads, opposite to Xenia Hospital, ECIL, Secunderabad, Telangana 500062
  Graphical Representation: Typically shown with a downward-sloping marginal
utility curve.
 Example: The first slice of pizza is very enjoyable, but by the fourth or fifth slice, the
enjoyment decreases.
 Importance: Helps explain consumer demand and pricing strategies.
2.3 Law of Equi-Marginal Utility (LEMU)

 Definition: Consumers allocate their income in a way that the last unit of money
spent on each good provides the same level of marginal utility.
 Explanation: For maximum utility, consumers balance their spending across
different goods so that the ratio of marginal utility to price is equal for all goods.
 Formula: MUAPA=MUBPB=…\frac{MU_A}{P_A} = \frac{MU_B}{P_B} = \ldotsPAMUA
=PBMUB=…
 Example: If the marginal utility per dollar spent on apples is higher than that on
oranges, the consumer will buy more apples until the marginal utilities equalize.
 Importance: Guides how consumers make decisions to maximize their satisfaction
given their budget constraints.
2.4 Shortcomings of Utility Analysis

 Measurement Difficulty: Utility is subjective and difficult to measure quantitatively.

 Assumption of Rationality: Assumes consumers are always rational and seek to
maximize utility, which is not always realistic.
 Ignoring Other Influences: Does not consider other factors like emotions, habits,
and social influences on consumer behavior.
 Constant Marginal Utility of Money: Assumes the marginal utility of money
remains constant, which is not true in real-life situations.
2.5 Indifference Curve Analysis (ICA)
 Definition: A graphical representation of different combinations of two goods that
provide the same level of satisfaction to the consumer.
 Properties:
a. Downward Sloping: Indicates that to maintain the same utility, an increase in
the quantity of one good must be compensated by a decrease in the other.
b. Convex to Origin: Reflects diminishing marginal rate of substitution (MRS) –
the rate at which the consumer is willing to give up one good for another
decreases.
c. Non-Intersecting: No two indifference curves can cross each other, as it would
imply inconsistent preferences.
 Budget Line: Represents all possible combinations of two goods that a consumer can
purchase given their income and the prices of the goods.
 Consumer Equilibrium: Achieved where the budget line is tangent to the highest
possible indifference curve, indicating the optimal combination of goods.

Plot no 38, ECIL Cross Roads, opposite to Xenia Hospital, ECIL, Secunderabad, Telangana 500062
  Example: A consumer might be equally satisfied with 3 apples and 2 bananas or 2
apples and 3 bananas, represented by points on the same indifference curve.
 Importance: Provides a more realistic analysis of consumer choice without needing to
measure utility directly.

Plot no 38, ECIL Cross Roads, opposite to Xenia Hospital, ECIL, Secunderabad, Telangana 500062