CHAPTER 3- THEORY OF CONSUMER BEHAVIOUR

1.Explain the relationship between TU and MU.

Total utility refers to the total amount of satisfaction derived by the consumer from the
consumption of a specific quantity of a commodity.
Marginal utility refers to the additional utility derived from the consumption of an additional
unit of a commodity.
Relationship between TU and MU
The TU curve is concave from above as TU increases at a decreasing rate because of declining
MU, reaches the maximum at point M and then falls when MU becomes negative.
Satiation Point is when TU is maximum and MU is zero and want for the commodity is fully
(satiated) saturated. After this, TU declines and MU is negative. A rational consumer will not
go beyond this point of maximum TU.
This shows that
➢ Up to point M as long as the TU is increasing at a decreasing rate, MU decreases but
remains positive.
➢ At point M when TU curve reaches its maximum, MU is zero between M and N. (the
slope of TU curve at this point is zero)
➢ After point N When TU starts decreasing (the slope of TU curve becomes negative) ,MU
becomes negative.
2.Explain the law of Diminishing Marginal Utility with the help of a Utility schedule and a
diagram.

Total utility refers to the total amount of satisfaction derived by the consumer from the consumption of a
specific quantity of a commodity.
Marginal utility refers to the additional utility derived from the consumption of an additional unit of a
commodity.

Statement of the law:

The law states that as the amount consumed of a commodity increases, other things being equal, the
utility derived by the consumer from the additional units i.e marginal utility goes on decreasing.

Consumption Total utility Marginal utility

(units) (utils) (utils)
0 0 undefined
1 10 10 (10-0)
2 17 7 (17-0)
3 21 4 (21-17)
4 22 1 (22-21)
5 22 0 (22-22)
6 19 -3 (19-22)

The table clearly shows that as consumption of mangoes increases, total utility increases but at a
diminishing rate. This means that the marginal utility decreases with increase in consumption.
▪ Up to 4 units of consumption, total utility increases but at a decreasing rate. Marginal utility is falling
but remains positive.
▪ After 4 units of consumption level, total utility is maximum and neither increases nor decreases and
remains so at 5 units. Marginal utility is zero at 5 units.
▪ After 5 units of consumption, total utility starts declining and marginal utility becomes negative.
A rational consumer will not like to go beyond the point of maximum utility.
 ➢ Total utility increases as long as Marginal utility is positive. Thus, up to point M, TU
curve has a positive slope, but its slope goes on decreasing steadily as quantity consumed
is increased because of diminishing MU.
➢ When Total utility is maximum (at point M), marginal utility is zero.
➢ Total utility decreases when MU becomes negative.

Assumptions of the law

▪ All units of the commodity must be identical
▪ The unit of the good must be standardized
▪ There should be no change in taste during the process of consumption
▪ There must be continuity in consumption
▪ There should be no change in the prices of the substitute goods
▪ The utility is measurable
Explanation of the law/ basis of the law of diminishing marginal utility
▪ As more and more quantity of a commodity is consumed, the intensity of desire
decreases and therefore the utility derived from the additional unit decreases.
▪ If there are many uses of a commodity, the most urgent requirement will be fulfilled
first, followed by the next important use and so on.

3.Explain with the help of a diagram the consumer’s equilibrium through utility approach.
Equilibrium through utility approach (one commodity case)
Definition of Consumer’s equilibrium: A consumer will be in equilibrium when he/she spends
his/her given income on the purchase of different goods and services so as to maximise his/her
total utility.
Equilibrium Condition: A utility- maximizing consumer will be in equilibrium when he/she
purchases that much quantity of a commodity where Marginal Utility of the commodity is equal
to Price of the commodity.
MUx = Px
Assumptions:
(i) The consumer is rational
(ii) Utility can be measured in monetary terms and utility of each unit of money remains
constant.
(iii)The law of diminishing marginal utility operates
(iv) Consumer’s income is given and remains constant
(v) Prices of other commodities are assumed to be given
Numerical example:

Price of shirt is assumed to be Rs.600

The consumer gets marginal utility equal to Rs 700 from first shirt and as he consumes additional
units of shirt the marginal utility goes on decreasing. The consumer will be in equilibrium when
he/she purchases 3 shirts because the marginal utility of the third shirt is equal to the price of the
shirt.
Graphical explanation

At any point above E MUx > Px. When he purchases 2 shirts MU = 650, the marginal utility
derived is more than the price of the shirt, so he purchases the 2nd shirt.
At point E MUx = Px the Consumer is in equilibrium as the marginal utility derived is equal to
the price i.e when he purchases 3 shirts.
At any point below E MUx < Px, i.e When he purchases 4 shirts, MU = 500 which is less than
the price of the shirt, so he would not like to purchase the 4th shirt.
At any point above E, MU>P and the consumer can increase his satisfaction (TU) by increasing
the number of shirts purchased, till MU=P at E.
At any point below E, MU<P and the consumer can increase his satisfaction by reducing the
number of shirts purchased till MU=P at E.
Thus point E is the point of equilibrium where MUx = Px
4.Explain the Law of Equi-Marginal Utility.
Law of Equi-Marginal Utility: Consumer maximizing his/her total utility will allocate his/her
income among various commodities in such a way that the marginal utility of the last unit of
money spent on each commodity is equal.
“The consumer will spend his money income on different goods in such a way that
marginal utility of each good is proportional to its price” (Proportionality rule)
Equilibrium condition: In the case of two commodities the consumer will be in equilibrium when
he/she spends his/her income on two commodities in a such a way that the marginal utility of
each good is proportional to its price.
MUx / Px = MUy / Py = MU per unit of money
This is subject to budget or income constraint
Assumptions:
(i) Consumer is rational
(ii) Utility can be measured in monetary terms and utility of each unit of money remains
constant.
(iii)The law of diminishing marginal utility operates
(iv) Consumer’s income is given and remains constant
(v) Prices of other commodities are assumed to be given
Price of X = Rs 5, Price of Y = 10.Income = Rs 40
Units MUx MUy MUx /Px MUy / Py
1 50 80 10 (50÷5) 8
2 45 70 9 (45÷5) 7
3 40 60 8 (40÷5) 6
4 35 50 7 (35÷5) 5
5 30 40 6 (30÷5) 4
6 25 30 5 (25÷5) 3

Combination 1: 3 units of X and 1 unit of Y Combination 3: 5 units of X and 3 unit of Y

= 3 x 5 + 1 x 10 = 5 x 5 + 3 x 10
= 15 + 10 = 25 = 25 + 30 = 55

Combination 2: 4 units of X and 2 unit of Y Combination 4: 6 units of X and 4 unit of Y

= 4 x 5 + 2 x 10 = 6 x 5 + 4 x 10
= 20 + 20 = 40 = 30 + 40 = 70

Combination 1 will give the consumer lesser satisfaction because he/she is able to spend only Rs
25 while income available to spend is Rs 40.
In combination 3 and 4, he/she is required to spend Rs 55 and Rs 70 respectively, which are out
of his/her reach (unaffordable) as the budget is Rs 40.
Since combination 2 is equal to the income to be spent i.e Rs 40 ,the consumer will be in
equilibrium when he purchases 4 units of X and 2 unit of Y.

Limitations of Law of Equi-Marginal Utility

a. It is difficult for a consumer to know the marginal utilities from different commodities
because Utility cannot be measured.
b. Consumers’ decisions to purchase are often governed more by habits and customs rather
than economic considerations.
c. Many consumers are ignorant and therefore unable to arrive at equilibrium position due
to their ignorance.
d. The law cannot be applied in case of expensive and indivisible commodities, e.g. car,
refrigerator because it is not possible to equate marginal utility of a rupee spent on them.

5.Explain how a consumer attains equilibrium using the indifference curve analysis.
An indifference curve shows various combinations of two commodities which give equal amount
of satisfaction to the consumer.
Indifference map is a group or set of indifference curves each of which represents a given level
of satisfaction. IC1, IC2, IC3)
A budget line shows various combinations of two commodities which can be purchased with a
given budget at given prices of the two commodities.
Indifference curve approach explains consumer’s equilibrium with the help of indifference map
and budget line.
Assumptions
1. The consumer is rational
2. Indifference curve is measured ordinally i.e in terms of ranking or ordering
3. IIt is assumed that the consumer has not reached the point of saturation and will always
prefer more.
4. Tastes and preferences of the consumers are consistent
5. Based on diminishing MRS – lesser the amount of one commodity consumed by a household
lesser is the willingness to substitute or sacrifice that commodity to obtain an additional unit
of other commodity.
Consumer’s equilibrium condition:
➢ A utility maximizing consumer, given his/her income, tastes and preferences and prices of
goods, will attain the equilibrium when the marginal rate of substitution between two goods
is equal to the price ratio of the two goods.
➢ MRSxy = Px /Py or MRS is equal to the price ratio of two goods.
➢ Graphically, equilibrium is at E where budget line is tangent to highest indifference curve
IC2.

Point E is the tangency point i.e the highest level of utility or the highest indifference curve that
the consumer can achieve subject to the budget constraint. It is the combination of OM of
clothing and ON of food that the consumer purchases. At this point the consumer is in
equilibrium.
Point B is not the best point because it lies on a lower indifference curve IC1, and gives a lower
utility than point E
Point D provides higher utility as it lies on a higher indifference curve IC3 but is not feasible
because it is outside the budget line.
Therefore, at point E consumer is in equilibrium because at Tangency Point T, the slope of the
Budget Line is equal to the slope of the Indifference Curve IC₂.
a. Slope of Budget Line is equal to the Price Ratio between Two Goods i.e. Px/Py
b. Slope of Indifference Curve shows the marginal rate of substitution between two goods
i.e. MRS
Hence conditions for consumer’s equilibrium is met at point of tangency where MRSxy=Px/Py.
6.Discuss the properties of indifference curve.
Properties of indifference curve:

1. Indifference curve slopes downward from left to right

Downward sloping due to marginal rate of substitution OR in order to increase additional units
of one, other commodity has to be substituted. If a consumer consumes more of one commodity,
he/she must consume less of other in order to derive same level of satisfaction from different
combinations of the two commodities.
2. It is convex to origin
Showing diminishing MRS – lesser the amount of one commodity consumed by a household
lesser is the willingness to substitute or sacrifice that commodity to obtain an additional unit of
other commodity.
3. Higher indifference curve gives higher level of satisfaction –
A combination on higher indifference curve will give more satisfaction than a combination on
lower indifference curve as he consumes more amount of one commodity or the other or more
amount of both the commodities.
4. Two indifference curves never intersect.
Each indifference curve represents different level of satisfaction. Point of intersection would give
two different levels of satisfaction, which is absurd.

7.Explain the shape of MU curve and TU curve.

The TU curve is concave from above which indicates declining slope of the curve, which means
declining marginal utility. Thus, up to a point, TU curve has positive slope, but its slope goes on
decreasing steadily as quantity consumed is increased.
TU increases at a decreasing rate because of declining MU, reaches the maximum at point M and
then falls when MU becomes negative.
The MU curve is negatively sloped curve. As consumption of the commodity increases MU
decreases continuously. Thus, MU decreases, reaches a value of zero and then turns negative.

8.Differentiate between Cardinal utility analysis and Ordinal utility analysis

Cardinal Utility (CU) Ordinal Utility (OU)

CU means that, utility derived can be OU implies that, consumer compares the utility
measured in absolute amount (quantitative derived not in quantitative terms but on a “scale
terms) of preference” of combinations of goods (i.e.
which combinations give same, more or less
utility)
Cardinal implies that utility is measurable Ordinal implies consumer’s ranking of goods, in
in quantitative terms order of preference, viz. first, second, third etc..
The Law of DMU operates Based on Diminishing Marginal Rate of
Substitution
Consumer’s Equilibrium through Cardinal Consumer’s Equilibrium through Indifference
utility and equi-marginal utility Curve Analysis

9.Marginal Rate of Substitution

Marginal Rate of Substitution (MRS) is the rate at which the consumer is willing to
substitute one good for another without changing the level of satisfaction.
Marginal Rate of Substitution of X for Y (MRSxy) is the amount of Y the consumer is willing to
give up to get one additional unit of X so that the same level of satisfaction is maintained.

10.Why is Indifference Curve Analysis superior to Marginal Utility Technique?

The Indifference Curve Analysis approach is superior and it is an improvement upon the
Marginal utility technique because
1. It makes lesser assumptions and lesser restrictive assumptions
2. It provides more general explanations of the effect of change in price of a commodity on
its demand
3. It assumes less and explains more while Marginal utility analysis assumes more and
explains less
Two important facts about indifference curve:
1. Firstly, Indifference curves do not touch X-axis or Y-axis because it is assumed that
consumer consumes both commodities. In case it touches either X or Y axes, it means
that consumer consumes only one commodity
2. Secondly, Indifference curves need not be parallel to each other. The slope of the
Indifference curve depends upon the MRS between the two commodities on the X
and Y-axes
11.Budget Line
(Indifference Curve indicates what choices the consumer would like to make. Budget line shows
the choices that consumer can actually exercise with the given income (budget) and the given
prices of the two commodities)
A Budget Line shows various combinations of two commodities which can be purchased
with a given budget at given prices of the two commodities
Combinations of Clothing and Food
Budget = ₹200. Price of food = ₹20. Price of clothing= ₹40

Units of Clothing Units of Food Expenditure (₹)

5 0 5x40+0x20=200
4 2 4x40+2x20=200
3 4 3x40+4x20=200
2 6 2x40+6x20=200
1 8 1x40+8x20=200
0 10 0x40+10x20=200

If consumer spends entire ₹200 on clothing, then he/she can purchase 5 units of clothing and no
units of food. If consumer purchases 4 units of clothing, then with ₹200, he can purchase 4 units
of clothing and 2 units of food and various other combinations of clothing and food as shown in
the above Schedule. Finally, if consumer spends entire ₹200 on food then he/she can purchase 10
units of food and no units of clothing.

Assumptions:
1. Money income (Budget) of the consumer is Fixed
2. The Prices of two commodities are Given
It is called the Budget Line or Price Line because it shows the various combinations of Clothing
and Food that can be purchased with a given Budget (₹200) at given prices of Clothing (₹40) and
Food (₹20).
Units of Food are on the horizontal axis and Units of Clothing are on the vertical axis.
It is a negatively sloping line (downward sloping) because if a consumer wants to purchase more
amount of one commodity he/she has to sacrifice some amount of he other commodity.
Properties of Budget Line:
1. It is a negative, downward sloping line. Because to purchase more amount of one
commodity, consumer has to sacrifice some amount of the other commodity.
2. Slope of Budget line is equal to the price ratio of two commodities, Px/Py .
3. It is a straight line as we assume given prices of the two commodities while drawing it.

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