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Chapter 2 Theory of Consumer Behaviour
Chapter 2 Theory of Consumer Behaviour
Consumer’s Behaviour
P R ES E N T E D BY :
ANAND PANT
FACULTY OF ECONOMICS
K A T H FO R D IN T E R N A T I O N A L
C O L L EG E O F E N GI N E ER I N G
A N D M A N A GE M E N T ,
BA L K U M A R I
Introduction to Utility
QA = MU form X commodity
QB = MU from money
QD = MU form X commodity
D QC = MU from money
C E B
Px MUm
Px
MUx
O Q0 Q Q1
Consumer’s Equilibrium
Two Commodity Case
A
E E1 Px MUm
Px
Lost Utility
Gained Utility
B
MUY
MUx
O
X0 X Y Y1 Units of commodities
Criticism
IC1
IC
IC0
O
X Goods
Law of Diminishing Marginal Rate of
Substitution (MRS)
Mathematically,
Let us suppose that a consumer consumes only two goods X and Y
and they are substitutable
The utility function of the consumer is given as
U = f(X,Y) … … … (i)
Now, let use suppose that consumer substitutes X for Y such that
his total utility remains the same
When he sacrifice some units of Y goods, total utility will change as
-∆Y. MUY … … … (ii)
Similarly, when he increases some units of X goods, total utility
will change as
+∆X. MUX … … … (iii)
MRSXY Cont…
Properties of Indifference Curve
A
C
Y Goods
E
X
IC3
D IC2
IC1
O B
Y X Goods
Income Effect and Derivation of
ICC and Engel Curve
A
ICC
Y Goods
Y1 E1
E
Y
E0
Y0
IC3
IC2
IC1
O B G X Goods
X0 X X1 D
Positive Income Effect, ICC and Engel Curve
F
A
ICC
C
Y Goods
Y1 E1
Y E
Y0 E0
IC3
IC2
IC1
O B G X Goods
X0 X X1 D
Engel Curve
Y1
Income
b
Y a
Y0 c
X Goods
X0 X X1
Negative Income Effect, ICC and Engel Curve
F
Y Goods (Normal Goods)
Y0 E0 E
Y E1
Y1 ICC
IC1 IC3
IC2
O B G
X0 X D X1
E1
Y1
E2
Y0
IC1
IC2
PCC
0 X
X1 B X2 B'
Price Effect and Demand Curve
Y
A
E1
Y Goods
Y1
E2
Y0
IC1
IC2
0 B X2 B' X
Y X1 X Goods
D
P1 a
Price
P b
D
0 X1 X2 X X Goods
Price effect for Complementary Goods
A PCC
E2
Y0
E1 IC2
Y1
IC1
0 X
X1 B B'
X2
Decomposition of Price Effect into Substitution
and Income Effect Hicksian Approach
E1
E2
E3
IC2
IC1 X
0 Q1 Q3 B D Q2 B'
PE
SE IE
Decomposition of Price Effect into Substitution and Income Effect
Slutsky Approach
E1
IC1
E3 E2
IC3 IC2
0 Q1 B Q3 D Q2 B’ X
PE
SE IE
Decomposition of Price Effect into Substitution and Income Effect
For Inferior Goods
C E1
E2
IC2
E3
IC1
0 X
Q1 Q2 Q3 B D B'
PE IE
SE
Decomposition of Price Effect into Substitution and Income Effect
for Giffen Goods
E2
C IC2
E1
E3
IC1 X
0 Q2 Q1 Q3 B D B'
PE SE
IE
Criticism Of Ordinal Utility Approach
Unrealistic Assumption
Old wine in New Bottle
Law of Transitivity is wrong
Does not explain about more than two goods
Based on hypothetical experimentation of IC
All the Goods are not divisible
Unable to explain the preferences of consumers
during uncertainty
Superiority of IC Approach
More Realistic and Scientific Measurement of Utility
No Need to Assume Constant Marginal Utility of
Money
Clear Explanation of Price Effect
Free From The Assumption of Independent Utility
Clear Explanation about Giffen Goods
Similarities
F IC1
C
G E1
E3
Money
IC3
E2
IC2
0 X
Q B' D B
X Goods
Application of IC on Subsidy
A
E3
Income
D E2
G
IC2
I
H
X
O X1 X2B M B’
X goods
Income Leisure Choice
A
Income
M E1
IC
X
O L B
Leisure
o u
k Y
a n
Th