Consumer Behavior-I

• Cardinal Approach/Utility Analysis

• Marginal Utility
• Law of Diminishing Marginal Utility
• Law of Equi-Marginal Utility

• Consumer Equilibrium

CONSUMER BEHAVIOUR?

Consumer behaviour refers to the actions and decisions that consumers make when purchasing
goods or services. It is influenced by a variety of factors, including personal factors such as age,
gender, and income, as well as social factors such as culture and social class. Consumer
behaviour theories help us understand why consumers make the decisions they do, and how we
can influence those decisions through marketing and sales strategies.

Cardinal Utility Approach

Under the cardinal utility approach, we assume that the utility level can be measured and
expressed in numbers. For example, we can measure the utility of a commodity, let’s say,
chocolates, and say that a consumer gets 20 units of utility from chocolates.

The measurement of utility or satisfaction derived by a consumer after consuming goods or services in
numerical terms.
Cardinal utility is less realistic.
It is a quantitative approach.
Cardinal utility is measured in units.
Cardinal utility is measured by Marginal Utility Analysis.

What is Cardinal Utility?

The two different measures of utility under cardinal utility are:

1. Total Utility

The total utility of a commodity’s fixed quantity is the total satisfaction level derived by a
consumer from the consumption of a given commodity. The total utility of a commodity depends
on the quantity consumed by the consumer. For example, the total utility of a commodity, let’s
say, mango, is derived from consuming 10 units.
2. Marginal Utility

The marginal utility of a commodity is the change in its total utility because of the consumption
of one additional unit of the commodity. For example, suppose 5 chocolates give consumer 20
units of total utility, and 6 chocolates give him 25 units of utility. The consumption of one extra
chocolate will provide him extra utility of 5 units. Therefore, the marginal utility of the consumer
will be 5.

What Is Marginal Utility?

Marginal utility is the added satisfaction that a consumer gets from having one more unit of a
good or service. The concept of marginal utility is used by economists to determine how much of
an item consumers are willing to purchase.

Positive marginal utility occurs when the consumption of an additional item increases the total utility. On
the other hand, negative marginal utility occurs when the consumption of one more unit decreases the
overall utility.

Understanding Marginal Utility

Economists use the idea of marginal utility to gauge how satisfaction levels affect consumer
decisions. Economists have also identified a concept known as the law of diminishing marginal
utility. It describes how the first unit of consumption of a good or service carries more utility
than later units.

Marginal utility is useful in explaining how consumers make choices to get the most benefit from their
limited budgets. In general, people will continue consuming more of a good as long as the marginal utility
is greater than the marginal cost. In an efficient market, the price equals the marginal cost. That is why
people keep buying more until the marginal utility of consumption falls to the price of the good.

Types of Marginal Utility

There are multiple kinds of marginal utility. Three of the most common ones are as follows:

Positive Marginal Utility

Positive marginal utility occurs when having more of an item brings additional happiness.
Suppose you like eating a slice of cake, but a second slice would bring you some extra joy. Then,
your marginal utility from consuming cake is positive.

Zero Marginal Utility

Zero marginal utility is what happens when consuming more of an item brings no extra measure
of satisfaction. For example, you might feel fairly full after two slices of cake and wouldn't really
feel any better after having a third slice. In this case, your marginal utility from eating cake is
zero.
Negative Marginal Utility

Negative marginal utility is where you have too much of an item, so consuming more is actually
harmful. For instance, the fourth slice of cake might even make you sick after eating three pieces
of cake.
Marginal Utility vs. Total Utility

Marginal utility measures the change in satisfaction from consuming one additional unit. Total
utility, instead, measures the total amount of satisfaction of you get from all the units you
consume of a good or service. Marginal utility affects total utility. Positive marginal utility
causes total utility to increase, while negative marginal utility decreases total utility.

How to Calculate Marginal Utility

You can calculate marginal utility by dividing the change in total utility (TU) by the change in
number of units (Q):

MU = ΔTU/ΔQ.

Law of diminishing marginal utility

The law of diminishing marginal utility states that as a consumer consumes more of a
commodity, the marginal utility derived from every additional unit consumed will decrease. The
law of demand is based on the law of diminishing marginal utility. It means that a consumer is
ready to spend less money for more units of a product as the utility level for the commodity
decreases with the increase in consumption.

Assumptions for the law of diminishing marginal utility are:

 There is continuous consumption of a commodity.

 The consumer is consuming only standard units of a commodity.

 The satisfaction level is measured in numerical or quantitative terms.

 The quality of a commodity does not change.

 The consumer consuming the commodities is rational.

 The income of the consumer and the price of the commodity are fixed.
Law of Equi-Marginal Utility
Law of Equi Marginal Utility or Gossen’s Second Law, implies that a consumer will distribute his/her
income on various commodities in a manner that marginal utility derived from the last unit of money
spent on each good is equal.

This principle forms the basis of an overall optimization strategy. The idea is simple: if you are allocating
funds or resources across multiple goods or services, you should do so in a way that the last unit of money
spent on each yields the same level of satisfaction, or utility.

By adhering to the Equi-marginal principle, you can ensure the maximum utilization of available
resources, contributing both to effectiveness and efficiency.

The mathematical expression of Equi-marginal Principle:

MUa/Pa=MUo/Po
Importance of Equi-marginal Principle in Economics

The Equi-marginal Principle forms a cornerstone in the realm of economics. Here are several key
areas where this principle exerts its influence:

 Consumer Behaviour: It aids consumers in achieving maximum satisfaction with limited

resources.
 Production: Producers use this principle to decide the level of inputs for least cost
combination and maximum output.
 Public Finance: Government agencies use it to allocate budget funds to different sectors
to ensure maximum economic welfare.
 International Trade: It is used in the distribution of resources for imports and exports.

What Is an Indifference Curve?

An indifference curve is a chart showing various combinations of two goods or commodities that
consumers can choose. Points along the curve represent combinations that will leave the
consumer equally well off. A consumer is indifferent to changes in a combination as long as it
falls somewhere along the curve.

Look at this indifference curve. You may be indifferent to buying a combination of 14 hot dogs
and 20 hamburgers, a combination of 10 hot dogs and 26 hamburgers, or a combination of nine
hot dogs and 41 hamburgers if you like both hot dogs and hamburgers. Each of these three
combinations provides the same utility.
Budget line definition

The budget line, also known as the budget constraint, exhibits all the combinations of two
commodities that a customer can manage to afford at the provided market prices and within the
particular earning degree.

The budget line is a graphical delineation of all possible combinations of the two commodities
that can be bought with provided income and cost so that the price of each of these combinations
is equivalent to the monetary earnings of the customer.

Example of a Budget Line

Radha has ₹50 to buy a biscuit. She has a few options to allocate her income so that she receives
maximum utility from a limited salary.
 Budget schedule
Cream biscuit Plain biscuit
Combination Budget allocation
(@ ₹10 per packet) (@ ₹5 per packet)
A 0 10 10 × 0 + 5 × 10 = 50
B 1 8 10 × 1 + 5 × 8 = 50
C 2 6 10 × 2 + 5 × 6 = 50
D 3 4 10 × 3 + 5 × 4 = 50
E 4 2 10 × 4 + 5 × 2 = 50
F 5 0 10 × 5 + 5 × 0 = 50

To get an appropriate budget line, the budget schedule given can be outlined on a graph.

The budget set indicates that the combinations of the two commodities are placed within the
affordability margin of a consumer.

Consumer Equilibrium

A consumer is in equilibrium when he derives maximum satisfaction from the goods and is in no
position to rearrange his purchases.

Assumptions
  There is a defined indifference map showing the consumer’s scale of preferences across
different combinations of two goods X and Y.
 The consumer has a fixed money income and wants to spend it completely on the goods
X and Y.
 The prices of the goods X and Y are fixed for the consumer.
 The goods are homogenous and divisible.
 The consumer acts rationally and maximizes his satisfaction.

Consumers Equilibrium

In order to display the combination of two goods X and Y, that the consumer buys to be in
equilibrium, let’s bring his indifference curves and budget line together.

We know that,

 Indifference Map – shows the consumer’s preference scale between various combinations
of two goods
 Budget Line – depicts various combinations that he can afford to buy with his money
income and prices of both the goods.

In the following figure, we depict an indifference map with 5 indifference curves – IC1, IC2, IC3,
IC4, and IC5 along with the budget line PL for good X and good Y.
From the figure, we can see that the combinations R, S, Q, T, and H cost the same to the
consumer. In order to maximize his level of satisfaction, the consumer will try to reach the
highest indifference curve. Since we have assumed a budget constraint, he will be forced to
remain on the budget line.

So, which combination will he choose?

Let’s say that he chooses the combination R. From Fig. 1, we can see that R lies on a lower
indifference curve – IC1. He can easily afford the combinations S, Q, or T which lie on the higher
ICs. Even if he chooses the combination H, the argument is similar since H lies on the curve IC 1
too.

Next, let’s look at the combination S lying on the curve IC2. Here again, he can reach a higher
level of satisfaction within his budget by choosing the combination Q lying on IC3 – higher
indifference curve level. The argument is similar for the combination T since T lies on the curve
IC2 too.

Therefore, we are left with the combination Q.