THEORY OF CONSUMER CHOICE

THEORY OF CONSUMER DEMAND

• Explains the decision making behaviour of the
consumer in demanding a particular commodity.
• Economists have offered their theories on the
basis of measurement of utility.
• Two Major Approaches Regarding measurement
Of Utility:
– Cardinal Utility Theory
– Ordinal Utility Theory / Indifference Curve Analysis
 Marshallian Cardinal Approach
• Based on the following postulates:
– Concept of Utility and its cardinals
– The law of Diminishing Marginal utility
– The law of Equi-Marginal utility

UTILITY ANALYSIS OF DEMAND

 Demand behaviour of a rational consumer has been expressed
in terms of a demand curve which graphically represents the
Law of demand.
 Usually demand curve slopes downwards to the right.
 Indicates an inverse functional relationship between price and
demand.
MORE QUANTITY IS PURCHASED AT A LOWER PRICE

Price
(Rs.)
0
Quantity
DEMAND CURVE
 RELATIONSHIP BETWEEN TOTAL UTILITY AND
MARGINAL UTILITY
QUANTITY TOTAL UTILITY MARGINAL
UTILITY
1 10 10 INITIAL UTILITY
2 18 18-10=8
3 24 24-18=6 POSITIVE
4 28 28-24=4
5 30 30-28=2
6 30 30-30=0 ZERO
7 28 28-30=-2 NEGATIVE
THE INDIFFERENCE CURVE APPROACH
DEFINITION
“An indifference schedule is a list of alternative combination in the stocks
of two goods which yield equal satisfaction to the consumer”.

BASIC ASSUMPTIONS
• When in market, a consumer does not buy a single
commodity.
• The indifference curve approach or the preference
approach to consumer behaviour assumes that the
consumer confronts and optimises the choice .
• Chooses the one which he prefers.
• A consumer starts by describing the bundle of commodities
and its relation to the preference ordering of the consumer.
• The consumer is assumed to rank, in terms of preference.
PROCESS
• Step 1
– Construct model of consumer preference
• Step 2
– Given prices and income of the consumer to be considered
• Step 3
– Apply model of consumer preference to the feasible set.
THE PRFERENCE RELATION
1. If the consumer prefers or has indifference between X and X
then the symbol would be
Xi ≥ Xii
2. If the consumer is indifferent between X and X , it implies
Xi = Xii
3. If Xi ≥ Xii the and not consumer prefers or has indifference
between X and X then the symbol would be
X≥X
PROPERTIES OF CONSUMER PREFERENCE
ORDERING
1. COMPLETENESS
Consumer should be able to rank all bundles.
eg,., A ≥ B
2. TRANSITIVITY
Consistency of consumer behaviour.
Eg., A ≥ B , C ≤ B , this implies that A is better than C.
 Consumer’s indifferent sets are non intersecting.
3. REFLEXIVITY
A given bundle is preferred to or indifferent to itself.
4. NON – SATIATION
A rational consumer is never satiated with any goods.
5. CONTINUITY
There are no gaps or breaks in the indifference sets.
 INDIFFERENCE CURVE
I.C. may be defined as the locus of all those combinations of two
goods A and B which are equally preferred by the consumer.

PROPERTIES
• It Is Downward Sloping: if the consumer has a lesser amount of
one commodity he has to compensate by having more of the
other commodity.
• Indifference Curve Reflects The Taste Of The Consumer :
therefore they must not intersect each other.
• It Is Strictly Convex : small decrease in amount of A must be
compensated by larger and larger increments of B on the same
indifference curve
• FIGURE 1
 REVEALED PREFERENCE
• Based on observed consumer behaviour in the
market.
• How a consumer reacts to change in price and
income.
• Assumes ordinal measurement of utility.
• Also regarded as “ Behavioristic-Ordinal Utility
Approach.”
• Fundamentally based on “ Axioms of Preference”
where axioms are not expressed in terms of what a
consumer prefers but what he chooses.
CHOICE REVEALS PREFERENCE
ASSUMPTIONS
THEORY OF CONSUMER CHOICE UNDER
RISK
DEMAND ESTIMATION FOR DURABLE AND
NON-DURABLE GOODS