GSEB Std XI Economics Chapter 2 Consumer Behaviour Prepared by: Jeegar Bhatt (9725452059)

Economics
Part 1
Chapter 2 Consumer Behaviour

The common behaviour of consumer while he is engaged in wealth getting and wealth using
activities – A consumer’s motive is to get maximum income when he is engaged in wealth
getting activity. Similarly when he spends his income to purchase commodities, his motive is
to get maximum satisfaction out of this purchase.

Every consumer knows his income and prices of commodities. He also know that he cannot
change his income or prices of commodities in short term so he takes decisions regarding
which goods are to be purchased and in how much quantity.

If a consumer spends too much on one commodity, he will have to purchase less of other
commodities. In order to maximise his satisfaction, a consumer tries to get equal satisfaction
from every marginal rupee spent on different commodities.

The principle of consumer behaviour explains the determination of quantity demanded with
given income and prices. Over and above it explains why quantity demanded changes with
change in price of the given commodity, income of the consumer and prices of other
commodities.

Diminishing marginal utility:

Law of diminishing marginal utility presents the common and basic tendencies of human
nature.

Utility: Want satisfying quality of any good is called utility.

Total utility is the total amount of satisfaction or pleasure a person derives from consuming
some specific quantity—for example, 10 units—of a good or service.

Marginal utility is the extra satisfaction a consumer realises from an additional unit of that
product—for example, from the eleventh unit. Alternatively, marginal utility is the change in
total utility that results from the consumption of 1 more unit of a product.

An individual's wants are unlimited in number yet each individual's want is satiable. Because
of this, the more we have a commodity, the less we want to have more of it.
This law state that as the amount consumed of a commodity increases, the utility derived by
the consumer from the additional units, i.e marginal utility goes on decreasing.

The law of diminishing marginal utility explains the downward sloping demand curve

Definition
According to Marshall, “The additional benefit a person derives from a given increase of his
stock of a thing diminishes with every increase in the stock that he already has” or we can say
that the more of a thing a person has, the less of it he wants.

Assumptions:
All the units of a commodity must be same in all respects
The unit of the good must be standard
There should be no change in taste during the process of consumption
There must be continuity in consumption
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GSEB Std XI Economics Chapter 2 Consumer Behaviour Prepared by: Jeegar Bhatt (9725452059)

There should be no change in the price of the substitute goods

Explanation:
As more and more quantity of a commodity is consumed, the intensity of desire decreases
and also the utility derived from the additional unit.

Suppose a person eats Bread. 1st unit of bread gives him maximum satisfaction. When he
will eat 2nd bread his total satisfaction would increase. But the utility added by 2nd bread
(MU) is less than the 1st bread. His Total utility and marginal utility can be put in the form of
a following schedule.

Plotting the above data on a graph gives

Relationship between Marginal Utility and Total Utility:

MU = Ux / x

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GSEB Std XI Economics Chapter 2 Consumer Behaviour Prepared by: Jeegar Bhatt (9725452059)

Where, MU = Marginal Utility, U = Utility,  = Marginal change (an increase or

decrease of one unit), x = quantity of commodity.
In a more systematic way it can be presented as:
MU = (n+1) utility – (n) utility

There is an inverse relationship between the quantity of commodity and its marginal
utility. As quantity of commodity increases, marginal utility diminishes and marginal
utility increases as quantity decreases.

Following points makes the relationship more clear.

 Here, from the MU curve we can see that MU is declining as consumer consumes
more of the commodity. Total utility increases but at a diminishing rate.
 When TU is maximum, MU is Zero.
 After that, TU starts declining and MU becomes negative.

Exceptions to the law:

 Money: Marginal utility of money can never be zero because money is useful in
satisfying our unlimited wants.
 Hobbies and Rare Things
 Liquor and Music
 Things of Display
 Behaviour of extraordinary persons like greedy, addict, miser etc.

Importance of Law of Diminishing Marginal Utility:

 The law is useful in pricing the products. It also helps in derivation of law of demand.
 It is useful in framing fiscal policy. Fiscal policy is related with taxation.
 This law also guides the producers in deciding what to produce and how much to
produce.

Shortcomings of the law:

 It is assumed that utility is quantifiable. This assumption is unrealistic because utility
cannot be measured.
 The assumption of constancy of marginal utility of money also does not hold true
because the less money you have, the less you want to spend it.
 This law gives an explanation of demand of only one commodity, but in reality a
consumer buys more than one commodity.

Indifference curve analysis:

Indifference curve analysis is better explanation of consumer behaviour about making
choices. Here we assume that a consumer purchases combination of two commodities.
Indifference curve is superior to diminishing marginal utility analysis in the sense that it uses
ordinal measure not cardinal measure.
Ordinal analysis: Where instead of calculation, comparison is used for analysis.
Cardinal analysis: This analysis depends on calculations to arrive at a conclusion.

The indifference curve indicates the various combinations of two goods which yield equal
satisfaction to the consumer. By definition: "An indifference curve shows all the various
combinations of two goods that give an equal amount of satisfaction to a consumer".

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GSEB Std XI Economics Chapter 2 Consumer Behaviour Prepared by: Jeegar Bhatt (9725452059)

Indifference curve analysis is also known as the theory of choice of the theory of
indifference.

Indifference curve schedule:

Combinatio X Y
n
A 1 64
B 2 48
C 3 36
D 4 25
E 5 15
F 6 8

Explanation:
Above diagram shows indifference curve based on indifference curve schedule. It shows six
different combinations of commodity X and commodity Y. All of the combinations give
equal amount of satisfaction so the consumer is indifferent about any of them. The
indifference curve is convex to the origin, which means that there is negative or inverse
relationship between these two goods. In order to get one extra unit of good X, the consumer
has to let go some of the units of good Y.
The rate at which the consumer is ready to substitute units of Y for one extra unit of X is
termed as Marginal Rate of Substitution (MRS). It is also termed as slope of indifference
curve. The formula for calculating MRS is:
MRSxy = MUx / MUy or x / y

Map of Indifference Curve: Map of indifference curve suggests that the higher the
indifference curve, the higher is the benefit derived by the consumer. Given a choice a
consumer is better off selecting combination of goods on higher indifference curve.

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GSEB Std XI Economics Chapter 2 Consumer Behaviour Prepared by: Jeegar Bhatt (9725452059)

Assumptions:
 A consumer is fully aware of the surrounding economic environment.
 A consumer behaves rationally. That means he tries to gain maximum satisfaction
from the commodities he purchase.
 A consumer purchases combination of two commodities.

Budget Line:
The line which represents possible combinations for which a consumer can go is a budget
line. It is a line depicting the maximum limit of purchasing power with which maximum units
of any commodity in terms of its price. The slope and position is decided by the price of the
commodity. The slope of budget line shows the ratio of prices of two commodities. This is
also known as price line or opportunity line.

Schedule of budget line:

Suppose price of x is Rs. 4 and price of y is Rs. 2. Total income, the consumer has is Rs. 20.
In this sense the schedule of budget line can be constructed in the following manner.

The assumption that a consumer spends his entire income on the purchase of two
commodities.

Combinatio X Y
n
A 0 10
B 2 6
C 4 2
D 5 0

Explanation: Y axis measures units of y, x axis measures units of x. AB line is budget line. If
consumer spends all his income on y, he could have maximum of 10 units of y. If he spends
entire income on x, he can get maximum 5 units of x. A consumer cannot get combination
which is shown by H, which is away from the budget line and which is not within his reach.
When he goes for combination shown by K, part of his income remains unspent. Therefore he
chooses any one combination of AB budget line.

Consumer’s equilibrium:
Using indifference curve and budget line we can get consumer’s equilibrium.

Assumptions:
 Rational behaviour of consumer: A consumer is aware of market situations, therefore,
he is in his endeavour to maximise satisfaction.
 Consumer’s income is given.
 A consumer purchases different units of two commodities x and y.
 Price of both the goods are given and constant.

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GSEB Std XI Economics Chapter 2 Consumer Behaviour Prepared by: Jeegar Bhatt (9725452059)

 Units of x and y are of equal nature and divisible.

 Consumer’s taste remains constant.
 In order to maximise satisfaction, a consumer chooses the best combination of x and
y.

Diagrammatic presentation:

Explanation:
Y axis measures units of y.
X axis measures units of x.
IC1, IC2, IC3, IC4 together make a map of indifference curve. AB is budget line. D, E, F, G
and H are points of alternative combinations on AB. As a consumer spends his income, he is
free to choose any one combination out of these points.

D and H are on IC1 and give equal satisfaction. Consumer does not get maximum satisfaction
even if he chooses any one of two combinations because he has an opportunity to go for
combinations on IC2 and IC3 with the same purchasing power.

Points F and G are on IC2 giving equal satisfaction. If consumer has to choose any of the two
combinations, he would not get maximum satisfaction because he has an opportunity to go
for combinations on IC3

Point J is on IC4 giving high satisfaction, but a consumer cannot afford it as it lies outside the
budget line AB.

Point E on IC3 gives maximum satisfaction because the consumer has neither opportunity nor
the purchasing power to choose any combination on IC4.

Significance of point E:
At his point both the slope of indifference curve and the slope of budget line are same. At
point E the indifference curve is convex to origin. At point E consumer has a combination of
x and y which gives him maximum satisfaction. No change is desirable from this position. He
has no motivation for any change.

Assumption of consumer’s equilibrium:

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GSEB Std XI Economics Chapter 2 Consumer Behaviour Prepared by: Jeegar Bhatt (9725452059)

 The scales of consumer’s choice of different combinations of x and y are the same as
in map of indifference curves.
 The consumer has given income to buy x and y and he spends entire income on x and
y.
 The prices of x and y are given and are constant because a consumer is able to
influence the prices by buying more or less of both commodities.
 Commodities x and y are of same nature and divisible.

Conditions of consumer’s equilibrium:

 At a point of equilibrium, both slope of indifference curve and the slope of budget line
should be equal. At this point the budget line should be tangent to indifference curve
or the marginal rule of substitution between x and y and price ratio of x and y should
be the same.
 At the point of tangency, indifference curve should be convex to origin.

The consumer’s equilibrium presents two things:

(1) Maximum satisfaction from combination chosen by the consumer and
(2) Allocation of monetary resources to buy two commodities.