UNIT-II Consumer Behavior and Demand

Analysis
• Cardinal Utility Approach: Diminishing Marginal Utility, Law of Equi-Marginal Utility.
• Ordinal Utility Approach: Indifference Curves, Marginal Rate of Substitution, Budget Line and Consumer
Equilibrium.
• Theory of Demand: Law of Demand, Movement along vs. Shift in Demand Curve, Concept of Measurement
of Elasticity of Demand, Factors Affecting
• Elasticity of Demand, Income Elasticity of Demand, Cross Elasticity of Demand, Advertising Elasticity of
Demand.
• Demand Forecasting: Need, Objectives and Methods in brief.
Consumer Behaviour
• Consumer Behaviour is the study of individual customers, organizations, or
groups’ behaviour while selecting, purchasing, using, and disposing of goods,
ideas, and services so they can meet their wants and needs. In simple terms,
consumer behaviour is the study of consumers’ actions and reactions in the
marketplace and the reason behind their actions.

• The behaviour of a person is the way they act or behave in a certain situation.
Every individual has different perspectives, opinions, views, wants, tastes and
needs

• The theory of consumer behaviour describes how consumers buy different goods
and services. Consumer behaviour also explains how a consumer allocates its
income in relation to the purchase of different commodities and how price affect
his/her decision.
Consumer Behaviour
• Is Effected by
External Factors
Internal Factors
Consumers choice
Consumer make choices assuming that
• Consumer have Rational Behaviors
• Preferences remains same
• Budget is fixed
• Prices are constant
Theories of consumer behavior

• CARDINAL THEORY-Which explains utility is objectively measurable.

Numerical calculation of Utility

• ORDINAL THEORY- Which explains consumer can rank their

preferences.
CARDINAL APPROACH (Utility Theory)
• The utility theory explains consumer behavior in relation to the
satisfaction that a consumer gets the moment he consumes a good.
• When we speak of utility, we refer to the satisfaction or benefits that
a consumer derives of his consumption.
• This theory assumes that satisfaction can be measured in numerical
utilites.
• The unit of measures of utility is called utils.
Utility for a consumer
Two types of Utility
1.Total utility: It is the total amount of satisfaction or pleasure a person
derives from consuming some specific.
2. Marginal utility : It is the extra satisfaction a consumer realizes from
an additional unit of that product. In other words, it is additional
satisfaction that an individual derives from consuming an additional
unit of a good or services
3. Average utility: The amount of utility received by a typical unit
consumed. It's calculated by dividing the total utility by the number of
units consume.
Characteristics of Utility
• Relative Concept
• Subjective Concept
• The utility is Multi-Purpose
• Ethically Neutral Concept
• Utility Depends on the Intensity of want
• The Utility is the basis of Demand
• Measurement of utility is Hypothetical
Quantity Total Utility Marginal Utilty

1 10 10 Initial utility

2 18 18-10=8

3 24 24-18=6

4 28 28-24=4 Positive

5 30 30-28=2

6 30 30-30=0 Zero

7 28 28-30=-2 Negative
Assumption of Cardinal Utility Approach
• The consumer is rational
• Consumer are aware of prices in market
• There are variety of choices of good in the market
• There are various commodities who’s prices are not affected by the
variation in supply
• Utility is measured in term of money as there is no substitutes
• Law of Diminishing marginal utility is assumed
• No change in taste of the consumer
• Utility of commodity do not depend on one another
Cardinal Approach(Utility)
• Cardinal measurement of utility is contributed by Marshall where the
consumer pays a higher price for a commodity, the utility and vice
versa
• Analysis is the oldest theory of demand which provides an
explanation of consumer’s demand for a product and derives the law
of demand which establishes an inverse relationship between price
and quantity demanded of a product.
• Two Laws of Cardinal Approach
Law of diminishing marginal utility
Equi-Marginal Utility is based on cardinal approach
Law of Diminishing MU
• It states that, other things being equal, the marginal utility of a good
diminishes as more it is consumed in a given time period .
 Law of Equi-Marginal Utility
• Law of Equi-Marginal Utility helps to explain consumer behavior in the case
of more than one good or service. There is no limit to human wants, but
the income to satisfy those wants is limited. So, the law of equi-marginal
utility explains how a consumer allots their limited income to various goods
and services to attain maximum satisfaction.

• Australian economist H. H. Gossen was the first to come up with this law.
Thus, we also call this law Gossen’s second law, the law of maximum
satisfaction, or the law of substitution. We can also call it the principle of
proportionality between prices and marginal utility (MU).
• It states that consumers should spend their money so that the last rupee
spent on each good provides equal marginal utility. This means that
consumers should distribute their income across goods in a way that
equalizes the marginal utility per rupee spent
• The law of equi-marginal utility is important because it can help businesses
maximize profitability and efficiently allocate resources. It also provides a
rational strategy to maximize utility or satisfaction.
• ASSUMPTION
1. Prices of the products don’t change.
2. The income of the consumer doesn’t change.
3. MU of the money remains constant.
4.The buyer has complete information on the utility they get from the
product or services.
5.The buyer acts rationally to maximize satisfaction.
6.The consumer is able to express or measure utility in cardinal terms.
7.Products have substitutes, and the consumer has many wants.
8.The Law of diminishing marginal utility forms the basis of this law
Assume Mr A have 7 rs .
Suppose Mr. A spends 3 on ice-creams and 4 on chocolates. In this case, the marginal
utility of the 3rd ice cream is 6, while of 4th chocolate is 2. Since the MU of ice cream is
more than the chocolate, Mr. A will continue to buy more ice-creams and fewer
chocolates.
Continued

• Now, Mr. A buys one more chocolate and one less chips, or four ice-
creams and three chocolate. Now, the MUs of both are the same at 4.
So four ice creams and three chocolates give Mr. A the maximum
satisfaction.

• We can calculate the total utility (TU) for this combination. TU for 4
ice-creams is 28 (10 + 8 + 6 + 4), while for three chocolates is 18 (8 + 6
+ 4). So, TU for the combination is 46. The total utility from no other
combination (with $7) will be more than the TU of the above
combination (four ice creams and three chocolates).
Exceptions to Law of Equi Marginal
Utility
• This law isn’t applicable in the case of knowledge. For
instance, reading more and varieties of books gives more
satisfaction to a scholar.
• Also, this law doesn’t apply to indivisible goods. This is
because consumers cannot divide the product to adjust the
utility.
• In the case of fashion and customs also, this law doesn’t
hold. This is because people generally tend to spend money
on birthdays, marriages, and deaths.
• This law won’t work if a consumer’s income is very low, as
maximizing utility isn’t possible due to low income.
• Calculating MU for durable products isn’t possible. So, this
law doesn’t work for durable goods as well.
Cont…
• If the goods of a consumer’s choice are unavailable, then this law
won’t work. It is because the consumer, in this case, will go for
the product that gives him some satisfaction than products that
hold no utility at all.
• Some consumers don’t care for maximizing utility, or they are
lazy consumers. Such buyers will continue to consume products
disregarding utility.
• This law won’t work when the products face frequent price
changes. Price changes make it harder to calculate the utility of
products.
• When there is no limit on resources, there is no need to divert
resources from one product to another. So, the law won’t hold.
Gifts of nature, such as water, are an excellent example of this
Equi-Marginal utility
• Illustration: This law can be illustrated with the help of table.
Let us assume that the consumer has a given income of Rs 11.
He wants to spend this entire income [i.e. Rs 11] on Apple and
Orange. The price of an Apple and the price of an orange is
Rs 1 each.Read more on Sarthaks.com -
https://www.sarthaks.com/913575/explain-the-law-of-equi-
marginal-utility
• If the consumer wants to attain maximum utility, he should
buy 6 units of apples and 5 units of oranges, so that she can
get [92 + 58] = 150 units. No other combination of Apple and
Orange can give higher than 150 utilities.
• Diagrammatic Illustration: In the diagram, X – axis represents
the amount of money spent and Y axis represents the
marginal utilities of Apple and Orange respectively.
• If the consumer spends Rs 6 on Apple and Rs 5 on Orange, the
marginal utilities of both are equal, i.e. AA1 = BB1 [4 = 4],
Hence, he gets maximum utility.
Criticisms
• In practice, utility cannot be measured, only be felt.
• This law cannot be applied to durable goods.
Ordinal Utility Approach: Indifference Curves, Marginal Rate of
Substitution, Budget Line and Consumer Equilibrium.
Ordinal Utility- Indifference Curves
As per Ordinal Utility, it isn’t possible to measure utility in numbers.
However, it is possible for consumers to rank their preferences. This
approach believes that utility is a psychological thing, something similar
to happiness. Also, as per this approach, utility is a subjective thing and
varies from person to person.
Indifference Curves
• An indifference curve is a graphical representation of a
combined products that gives similar kind of satisfaction
to a consumer thereby making them indifferent.
• Every point on the indifference curve shows that an
individual or a consumer is indifferent between the two
products as it gives him the same kind of utility.
The Indifference Curve
An indifference curve depicts the various combinations of two goods,
which give the same level of satisfaction or utility to the consumer. It is
also called an equal utility curve or iso-utility curve.
The table shows an indifference schedule. A, B, C, D, and E are the
different combinations of the quantities of goods x and y, which give
the same level of utility to the consumer. The consumer is indifferent
between combinations A, B, C, D, and E
Assumptions
• Consumer acts rationally to maximize their satisfaction level with a
given income level and prices of commodities.
• Consumers can tell their order of preference for the bundles of
commodities.
• The choice of a consumer is consistent and transitive. This means if a
consumer prefers A over B and B over C, then he must prefer A over C
as well. The consistency here implies that the choice of a consumer
remains constant over time. It means if a consumer prefers A over B
at one point, then he won’t prefer B over A (or even consider them as
equal) in another period.
• Consumers always prefer larger quantities of commodities over
smaller quantities.
• This approach assumes a diminishing MRS (Marginal Rate of
Substitution). MRS is the rate at which a consumer substitutes one
commodity for another in a way that the total satisfaction remains
the same.
• Consistency
• Ordinal
• Rationality
• Non Satiety
 IC Curve Analysis
ASSUMPTION:
➢Utility is assumed to be ordinal. Thus, a consumer can rank his preferences
but cannot express the utility derived from any good in quantitative terms.
He can give his scale of preferences between two goods, x and y, such that
a. He prefers x to y. b. He prefers y to x. c. He is indifferent between x and
y.
➢It is assumed that the consumer is rational. He is assumed to have complete
knowledge about the conditions prevailing in the market.
➢Given his money income and the prices of the goods x and y, the consumer
aims at maximizing his total utility.
➢The tastes and habits of the consumer remains the same.
• The marginal rate of substitution is diminishing. (The marginal rate of
substitution of good x for good y is the amount of y that the
consumer is willing to give up in order to increase his consumption of
good x by one unit, while total utility remains the same. The marginal
rate of substitution of good x for good y is assumed to decrease as the
quantity of good x with the consumer increases.)
• The preferences of the consumer are assumed to be transitive. If he is
indifferent between goods a and b and between goods b and c, then
he is indifferent between goods a and c. Similarly, if he prefers good a
to good b and good b to good c, then he prefers good a to good c.
• As far as his choice of goods and services are concerned, the
consumer is assumed to be consistent. This implies that if in one
period the consumer shows a preference for good a as compared
with good b then he will not prefer good b to good a in another
period.
• The consumer will not be reached to a situation of complete
saturation in consuming a good. Hence, he will always prefer more of
a good to less of a good.
IC
• When the table is plotted graphically, it yields a curve as in the figure.
This curve is the indifference curve, IC1 along which the combinations
A, B, C, D, and E yield the same level of utility to the consumer.
• Hence, the consumer is indifferent between these combinations of
goods x and y.
• n the second figure, a set of indifference curves represents an
indifference map.
• A higher indifference curve depicts a larger amount of satisfaction
than a lower one because it represents a
• Greater quantity of good x or y or more of both x and y.
IC Map
• In the figure, all the combinations on indifference curve IC3 represent
the same level of utility and thus are preferred equally. But all
combinations on IC3 are preferred to the combinations on IC1 and IC2
which represent a lower level of utility than IC3
• Similarly, all combinations on IC2 are preferred to the combinations
on IC1
• Which represent a lower level of utility than IC2
Characteristics of an Indifference Curve
1. An indifference curve is negatively sloped
This is because if a consumer consumes more of good x, he will have to
cut down on his consumption of good y (implying that the two goods
can be substituted for each other) if he has to remain on the same
indifference curve and his level of utility has to remain the same.
Note: If an indifference curve does not slope downwards, then it can
take any other shape.
The two combinations
of commodity cooking
oil and commodity
wheat is shown by the
points a and b on the
same indifference
curve. The consumer is
indifferent towards
points a and b as they
represent equal level
of satisfaction.
2. IC curve convex to origin: They are convex to the origin. This is
equivalent to saying that as the consumer substitutes commodity X for
commodity Y, the marginal rate of substitution diminishes of X for Y
along an indifference curve.
In this figure as the consumer moves from A to B to C to D, the
willingness to substitute good X for good Y diminishes. This means that
as the amount of good X is increased by equal amounts, that of good Y
diminishes by smaller amounts.
The marginal rate of
substitution of X for Y is the
quantity of Y good that the
consumer is willing to give
up to gain a marginal unit of
good X. The slope of IC is
negative. It is convex to the
origin. A B C D E
3. Higher IC curve higher satisfaction: