Consumer

Behaviour
 Learning Objectives

 Introduction to Consumer Behaviour

 Utility Approach
 Law of Diminishing Marginal Utility
 Law of Equi-Marginal Utility
 Indifference Curve Approach
 Marginal Rate of Substitution
 Price Line
 Consumer Equilibrium
 Income Effect
 Substitution Effect
 Consumer Surplus
 Law of Demand

Demand of a commodity
3.00
increases with a fall in its
price
2.50
Price of Ice-Cream Cone

when other things

2.00 remains constant
1.50

1.00

0.50

0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones
 What are the other things!?

1. Income of the consumer

2. Prices of Related goods
3. Tastes of consumer
4. Consumer expectations about the
future
 Assumptions of Law of Demand

 Income level should remain same

 Tastes of the buyer should not change

 Prices of other goods should remain same

 No new substitutes for the commodity

 Price raise in future should not be expected

 School of Thoughts

Law of demand can be explained with the help of

various theories of consumer behaviour

 Cardinal Utility Approach

 Alfred Marshall

 Ordinal Utility Approach (Indifference Curve

Analysis)
 J.R. Hicks and RGD Allen

 Revealed Preference Theory

 Paul A Samuelson
 Concept of utility

Utility = Value or Usefulness

Measure of Satisfaction that a consumer

receives from consuming a commodity
 The Cardinal Utility Approach

1. The cardinal measurement of utility

1. Utility – Quantifiable and measurable in terms of
money

2. Additivity of utility
1. Utility derived from consuming different
commodities can be added – it implies
independence of utilities of different goods

U = U1(X1) + U2(X2) + …. + Un(Xn)

 Constancy of marginal utility of money

 Since ‘money’ is the measuring rod – it must be
constant
 Marginal Utility and Total Utility

Marginal Utility is ‘the increase in total

utility as a result of the consumption of
an additional unit’
Glass of TU MU
water in utils in utils

0 0 -
1 7 7
2 11 4
3 13 2
4 14 1
5 14 0
6 13 -1
Diminishing Marginal utility
 16
Gopal’s utility from consuming water
14

12
Glass of TU
10 water in utils
Utility (utils)

0 0
8 1 7
2 11
6 3 13
4 14
4 5 14
6 13
2

0
0 1 2 3 4 5 6
-2

Glass of water consumed

 16
Gopal’s utility from consuming water
14 TU
12
Glass of TU
10 water in utils
Utility (utils)

0 0
8 1 7
2 11
6 3 13
4 14
4 5 14
6 13
2

0
0 1 2 3 4 5 6
-2

Glass of water consumed

 16
Gopal’s utility from consuming water
14 TU
12 Glass TU MU
of water in utils in utils
10
Utility (utils)

0 0 -
8 1 7 7
2 11 4
3 13 2
6
4 14 1
5 14 0
4 -1
6 13

0
0 1 2 3 4 5 6
-2

Glass of water consumed

 16
Gopal’s utility from consuming water
14 TU
12 Glass of TU MU
water in utils in utils
10
Utility (utils)

0 0 -
8 1 7 7
2 11 4
3 13 2
6
4 14 1
5 14 0
4 -1
6 13

0
0 1 2 3 4 5 6
-2 MU
Glass of water consumed
 16
Gopal’s utility from consuming water
14 TU
12

10
Utility (utils)

8 Point of Satiety
MU=0 but +ve
6 TU-increasing
but @declining
4 rate

0
0 1 2 3 4 5 6
-2 MU = -ve, MU
TU – declains @
Glass of water consumed
increasing rate
 Law of diminishing Marginal Utility

‘The additional benefit which a person

derives from a given increase of his
stock of a thing, diminishes with every
increase in the stock that he already
has’
- Alfred Marshall
 Deriving Demand Curve from
Law of Diminishing Marginal Utility

MU1 P1

MU2 P2

MU3 P3

Price
MU4 P4
Marginal Utility

MU5 P5

MU6 P6

0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10 11 12
Quantity of Ice-Cream Cones Quantity
Exceptions to Law of Diminishing Marginal Utility

 Alcoholics
 More alcohol-more intoxication-more
consumption 
 Money
 More money – greater desire to acquire more
 Reading
 More knowledge by reading different books-not
the same one again and again 
 Hobbies and rare collections
 More the collection – greater the desire to have
more
 Arts
 Music, arts, drama,… more the merrier !
Equi-Marginal Utility
 Law of Equi-Marginal Utility

A consumer does not spend his income

only on one good but on number of
goods.

Hence law of demand should involve

such an analysis of choice among
goods.
 Law of Equi-Marginal Utility

The law of Equi-Marginal Utility states

that ‘the consumer would distribute his
money income between the goods in
such a way that the utility from the last
rupee spent on each good is equal’

MU of commodity X MU of commodity Y

Price of X = Price of Y
 Illustration…

Units MU of MU of
X Y Let Price of X = Rs. 2
1 20 24 and Price of Y = Rs. 3
2 18 21
3 16 18
4 14 15
5 12 9 Units MU of X MU of Y
6 10 3 Price of X Price of Y
1 10 8
2 9 7
3 8 6
4 7 5
5 6 3
6 5 1
 Illustration…

Units MU of MU of
X Y Let Price of X = Rs. 2
1 20 24 and Price of Y = Rs. 3
2 18 21
3 16 18
4 14 15
5 12 9 Units MU of X MU of Y
6 10 3 Price of X Price of Y
1 10 8
2 9 7
MU of two commodities 3 8 6
are EQUAL 4 7 5
5 6 3
6 5 1
 Limitation of Cardinal Approach

 Utility is a mental concept – hence

measurement is subjective.
Indifference Curve Approach
 Indifference Curve Approach

 In Indifference Curve analysis, consumer compares

satisfaction obtained from different combination of goods.

It is difficult to assign numbers to utility, however, one can rank

(good, better, best or bad, worse, worst) the goods in the
order of utility.

‘Consumer is able to arrange various combinations of goods

and services on a scale of preference’

Consumer is able to indicate;

- Whether he prefers one commodity bundle to other
- Whether he is indifferent between two commodity bundles.
Illustration…

Combinations Level of Order of

of 2 goods Satisfaction Preference
(Apples and
Mangos)
5 apples & 15 Highest I
Mangos

4 apples & 12 Less than the II

mangos previous

3 apples & 9 Less than the

mangos III
previous
 Indifference Schedule

It is a list of different combinations of two goods

which will give equal level of satisfaction to the
consumer

Combination Apples Mangos Level of

Satisfaction
A 20 1 I
B 16 2 I
C 13 3 I
D 11 4 I
E 10 5 I
 30 Constructing an indifference curve
28
Pears Oranges Point
26
24 30 6 a
24 7 b
22 c
20 8
20 14 10 d
18 10 13 e
Pears

8 15 f
16
6 20 g
14
12
10
8
6
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 Constructing an indifference curve
30 a
28
Pears Oranges Point
26
24 30 6 a
24 7 b
22 20 8 c
20 14 10 d
18 10 13 e
Pears

8 15 f
16 g
6 20
14
12
10
8
6
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 Constructing an indifference curve
30 a
28
Pears Oranges Point
26
b 30 6 a
24
24 7 b
22 c
20 8
20 14 10 d
18 10 13 e
Pears

8 15 f
16
6 20 g
14
12
10
8
6
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 Constructing an indifference curve
30 a
28
Pears Oranges Point
26
b 30 6 a
24
24 7 b
22 20 8 c
20 c d
14 10
18 10 13 e
Pears

8 15 f
16 g
d 6 20
14
12
e
10
f
8
6
g
4
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 Indifference curve
30 a
28
26
b
24
22
20 c
18
Pears

16
d
14
12
e
10
f
8
6
g
4 IC
2
0
0 2 4 6 8 10 12 14 16 18 20 22
Oranges
 An indifference map
30
Units of good Y

20

10

I5
I4
I3
I2
0 I1
0 10 20
Units of good X
Marginal Rate of Substitution
 Marginal Rate of Substitution

The Marginal Rate of Substitution of X for

Y (MRS XY) is defined as ‘the amount of
Y that a consumer is willing to give up
in order to gain one additional unit of X
and still remain on the same
indifference curve (i.e., at the same
level of satisfaction)’

MRS XY= Y/X

 Deriving the marginal rate of substitution (MRS)
30 a
Y = 4 MRS = 4
26 b

X = 1 MRS = Y/X
Units of good Y

20

10

0
0 67 10 20
Units of good X
 Deriving the marginal rate of substitution (MRS)
30 a
Y = 4 MRS = 4
26 b

X = 1 MRS = Y/X
Units of good Y

20

MRS = 1
10
c
Y = 1 d
9
X = 1

0
0 67 10 13 14 20
Units of good X
 Properties of Indifference Curve

 Indifference curves slope downwards from

left to right

 Indifference curves are convex to origin

 Indifference curves do not intersect each

other

 Distances of indifference curves from the

point of origin determine their preferential
order
Budget Line (Price Line)
 Budget Line (Price Line)

A Budget Line shows all

A possible combination of 2
goods that the consumer
can buy at a given level of
income and prices of two
N goods

N1
Apples

M M1 B
Mangos
A budget line

Units of Units of
good X good Y

0 30
5 20
10 10
15 0

Assumptions

PX = Rs. 2
PY = Rs.1
Budget = Rs. 30
 30 a A budget line

Units of Units of Point on

good X good Y budget line

0 30 a
Units of good Y

20 5 20
10 10
15 0

10 Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30

0
0 5 10 15 20
Units of good X
 30 a A budget line

Units of Units of Point on

good X good Y budget line

0 30 a
b
Units of good Y

20 5 20 b
10 10
15 0

10 Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30

0
0 5 10 15 20
Units of good X
 30 a A budget line
Units of Units of Point on
good X good Y budget line

0 30 a
b
Units of good Y

20 5 20 b
10 10 c
15 0

10
c Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30

0
0 5 10 15 20
Units of good X
 30 a A budget line
Units of Units of Point on
good X good Y budget line

0 30 a
b
Units of good Y

20 5 20 b
10 10 c
15 0 d

10
c Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30

0 d
0 5 10 15 20
Units of good X
Consumer Equilibrium
 Consumer Equilibrium

The point of consumer equilibrium is the point

where the budget line just touches a particular
indifference curve. This is the point of maximum
satisfaction
 Finding the optimum consumption
Units of good Y

O
Units of good X
 Finding the optimum consumption
Units of good Y

I5
I4
I3
I2
I1
O
Units of good X
 Finding the optimum consumption
Units of good Y

Budget line

I5
I4
I3
I2
I1
O
Units of good X
 Finding the optimum consumption

r
s
Units of good Y

Y1 t

u I5
I4
v I3
I2
I1
O X1
Units of good X
Increased Income and Budget Line
 40
Effect of an increase
in income on the budget line

30
Units of good Y

20

Assumptions

10 PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30

0
0 5 10 15 20
Units of good X
 Effect of an increase in income on the budget line
40

Assumptions

PX = Rs. 2
30 PY = Rs. 1
Budget = Rs. 40
Units of good Y

n
20

16
m

10 Budget
= Rs. 40
Budget
= Rs. 30
0
0 5 7 10 15 20
Units of good X
Income Effect (Income Consumption Curve)
 Effect on consumption of a change in income
Units of good Y

B1 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

I2
B1 B2 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

I4
I3
I2
B1 B2 B3 B4 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

Income-consumption curve

I4
I3
I2
B1 B2 B3 B4 I1
O
Units of good X
Price Effect
 Effect on the budget line of a fall in the price of good X
30
Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
 Effect on the budget line of a fall in the price of good X
30
Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
 Effect on the budget line of a fall in the price of good X
30
Assumptions

PX = Rs. 1
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
 Effect on the budget line of a fall in the price of good X
30 a
Assumptions

PX = Rs. 1
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20

10

B1 B2

b c
0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30
Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20

10

0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30
Assumptions

PX = Rs. 2
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20

10

B1 I1
0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30
Assumptions

PX = Rs. 1
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20

10

B1 I1
0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30 a
Assumptions

PX = Rs. 1
PY = Rs. 1
Budget = Rs. 30
Units of good Y

20
k
j

10 I2

B1 I1 B2
0
0 5 10 15 20 25 30
Units of good X
 Effect of a fall in the price of good X
30 a

Price-consumption curve
Units of good Y

20
k
j

10 I2

B1 I1 B2
0
0 5 10 15 20 25 30
Units of good X
Income Effect and
Substitution Effect
of Normal Good
Units of good Y Income and substitution effects: normal good

I3

I5
B1
QX1
Units of Good X
 Income and substitution effects: normal good

Rise in the price

of good X
Units of good Y

I1

I2
B2 B1
QX3 QX1
Units of Good X
Income Effect
 Income and substitution effects: normal good

Substitution effect
of the price rise
Units of good Y

I1

B1a B1
QX 2 QX1
Substitution Units of Good X
effect
Effect of a rise in income on the
Demand for an Inferior Good
 Effect of a rise in income on the demand for an inferior good
Units of good Y
(normal good)

B1 I1
O Units of good X
(inferior good)
 Effect of a rise in income on the demand for an inferior good

b
Units of good Y
(normal good)

I2

B1 I1 B2
O Units of good X
(inferior good)
 Effect of a rise in income on the demand for an inferior good

Income-consumption curve

b
Units of good Y
(normal good)

I2

B1 I1 B2
O Units of good X
(inferior good)
Deriving a demand curve from
a price-consumption curve
Deriving a demand curve from a price-consumption curve

Expenditure on
all other goods
a

I1
B1

Units of good X
Deriving a demand curve from a price-consumption curve

Fall in the

Expenditure on
all other goods
price of X
a b

I2
I1
B1 B2

Units of good X
Deriving a demand curve from a price-consumption curve

Further falls in

Expenditure on
all other goods
the price of X
a b

I2
I1
B1 B2

Units of good X
Deriving a demand curve from a price-consumption curve

Further falls in

Expenditure on
all other goods
the price of X
a b
c d

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X
Deriving a demand curve from a price-consumption curve

Expenditure on
all other goods
a b Price-consumption
c d
curve

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X
Deriving a demand curve from a price-consumption curve

Expenditure on
all other goods
a b Price-consumption
c d
curve

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X

P1 a
Price of good X

Q1 Units of good X
Deriving a demand curve from a price-consumption curve

Expenditure on
all other goods
a b Price-consumption
c d
curve

I4
I3
I2
I1
B1 B2 B3 B4

Units of good X

P1 a
Price of good X

P2 b
P3 c
P4 d
Demand

Q1 Q2 Q 3 Q 4 Units of good X
Consumer Surplus
When a consumer buys a commodity he pay a
price to the commodity and derives
satisfaction from the commodity.

If the satisfaction he derives from the

commodity is greater than the money he
pays for it, then this excess satisfaction is
called ‘Consumer surplus’ (Ex: Newspapers,
Salt,…)

Consumer Surplus = Price Prepared to Pay –

Actual Price Paid
 Consumer surplus
MU, P

P1

MU

O Q1 Q
 Consumer surplus
MU, P

P1

Total
consumer MU
expenditure

O Q1 Q
 Consumer surplus
MU, P

Amount of Money
which consumer is
prepared to pay
Total
consumer
surplus
P1

Total
consumer MU
expenditure Actual Money
Paid

O Q1 Q