Consumer Behaviour

• Consumer behavior is the study of individuals,

groups, or organizations and the processes
they use to select, secure, and dispose of
products, services, experiences, or ideas to
satisfy needs and the impacts that these
processes have on the consumer and society
 I. Introduction to Utility Analysis
Meaning of Utility

 Utility means - The power of a commodity that satisfy the wants of

consumer - want satisfying power

 Introduced by Jermy Bentham

 Measurement ‘Utils’
 Subjective entity
 Utility is based on following
Assumptions
1. Cardinal Measurability
– Utility can be measured in terms of money
– Unit is utils
2. Utilities from different goods are Independent from
each other
– Individual utility for goods
– Sum of individual utility is total utility
3. Constancy of marginal utility of money
– Marginal utility of money is constant
4. Introspective Method
• We can inspect other’s mind
• Guesswork based on our own experience
 Cardinal Utility analysis and Ordinal Utility Analysis

Utility Analysis

Cardinal Utility analysis Ordinal Utility Analysis

• Alfred Marshal • J. R. Hicks & R.G.D. Allen

• can be measured •Cannot be measured but compared
• ‘Utils’
• Law of Diminishing Marginal as rank
Utility • Indifference Curve analysis
• Quantitative
. Subjective entity or Personal
•Law of Equi-marginal Utility
•Mashellian Analysis
 Total Utility(TU) and Marginal Utility(MU)

Unit of Total Marginal

•Total Utility is the sum utility derived from Mango Utility Utility
the consumption of bundle of commodity 1 10
2 20
3 29
4 37
•Marginal Utility is the rate of change of TU
5 43
from one more unit of extra consumption
6 48
7 51
8 52
MUn = TUn – TUn-1 9 52
10 50
MU =∆TU/∆Q
 Total Utility(TU) and Marginal Utility(MU)

Unit of Total Marginal

•Total Utility is the sum utility derived Mango Utility Utility
from the consumption of bundle of 1 10 10
commodity 2 20 10
3 29 9
4 37 8
5 43 6
•Marginal Utility is the rate of change
6 48 5
of TU from one more unit of extra
7 51 3
consumption 8 52 1
9 52 0
MUn = TUn – TUn-1
10 50 -2
MU =∆TU/∆Q
 2. Cardinal Utility Analysis

a) Assumptions of Cardinal Utility analysis

b) Law of Diminishing Marginal Utility

c) Law of Equal-Marginal Utility

 Assumptions of Cardinal Utility analysis

1. Rationality of consumer
2. Cardinal measurability of utility
3. Marginal Utility of Money is constant
4. Diminishing Marginal Utility
5. Utility is Additive – TU= Ux+ Uy+ Uz+…….+ Un
6. The hypothesis of Independent Utility
7. Introspective method
 Law of Diminishing Marginal Utility

• Gossen first law

•According to Alfred Marshall ‘the additional utility which a person derive
from the consumption a commodity diminishes, that is Total Utility increase
at an diminishing rate ‘
 Law of Diminishing Marginal Utility

‘the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate ‘

Unit of Total Marginal

Mango Utility Utility

1 10
2 20
MUn = TUn – TUn-1 3 29
4 37
MU =∆TU/∆Q
5 43
6 48
7 51
8 52
9 52
10 50
 Law of Diminishing Marginal Utility

‘the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate ‘

Unit of Total Marginal

Mango Utility Utility

1 10 10
2 20 10
3 29 9
4 37 8
5 43 6
6 48 5
7 51 3
8 52 1
9 52 0
10 50 -2
 Law of Diminishing Marginal Utility

‘the additional utility which a person derive from the consumption a commodity
diminishes, that is Total Utility increase at an diminishing rate ‘

Unit of Total Marginal

Mango Utility Utility

TU
1 10 10
TU
2 20 10
3 29 9
4 37 8 No of mango
5 43 6
6 48 5
7 51 3 MU
8 52 1
9 52 0
10 50 -2
No of mango
MU
 Law of Diminishing Marginal Utility

Saturation Point MU =0 or TU is maximum

TU
TU

No of mango

MU

No of mango

MU
 Application of Law of Diminishing Marginal Utility

1. Bases of law of demand- why demand curve slops downward

2. Law of equi- marginal utility is derived
3. Consumer surplus derived
4. Progressive Tax can be justified
5. Variety in Production and consumption
6. Price determination
*Limitations/Exceptions
of Law of Diminishing Marginal Utility

(i) Case of intoxicants: The more a person drinks liquor, the more s/he
likes it.
(ii) Rare collection: If there are only two diamonds in the world, the
possession of 2nd diamond will push up the marginal utility.
(iii) Application to money: It is true that more money the man has, the
greedier he is to get additional units of it. However, the truth is that the
marginal utility of money declines with richness but never falls to zero.

Conclusion
* we can say that the law of diminishing utility, like other laws of
Economics, is simply a statement of tendency. It holds good, provided
other factors remain constant.
16
 Law of Equal-Marginal Utility
Consumer’s Equilibrium under Marshellian analysis

•Gossen Second Law

•Explain how consumer is maximize his satisfaction by allocating his income with
different commodity at various prices.

• Condition for consumer equilibrium two commodity

MUx
/Px = MUy
/Py = MU m
• Condition for consumer equilibrium more commodity

MUx
/Px = MUy
/Py = ……………………. MUn/P n = MU m
 Law of Equal-Marginal Utility
Consumer’s Equilibrium under Marshellian analysis

Condition for consumer equilibrium

MUx
/Px = MUy
/Py =MUm
Apple (A) MUA MU/PA Banana (B) MUB MU/PB
1 60 20 1 60 12
2 48 16 2 55 11
3 42 14 3 50 10 Apple – 5 Rate 15 Rupees
4 36 12 4 45 9 Banana – 3 Rate 15 Rupees
5 30 10 5 40 8
6 24 8 6 35 7
7 18 6 7 20 4

Price of A = 3 Price of B =5
MU of Money = 10
Expenditure = 5x Price of A + 3 X Price B
= 5 x 3 + 3 X 5 = Rs.30
 Law of Equal-Marginal Utility
Consumer’s Equilibrium under Marshellian analysis

•Gossen Second Law

•Explain how consumer is maximize his satisfaction by allocating his income with
different commodity at various prices.

Marginal Utility

MU Apple

MU Banana

9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 9
Unit of A Unit of B
 Critical evaluation of Cardinal Utility analysis

• Utility is not Cardinally measurable

• Marginal Utility of money is not constant

• Inadequacy of methods of introspection

• Utilities are n interdependence

• Failure to explain Giffen Paradox

• Failure to distinguish income effect and substitution effect

 Ordinal Utility
• Approach by R.G.D. Allen and J.R.Hicks
• Consumer can only rank or order the utilities
obtained from a good
• Provided Indifference curve

21
 REPRESENTING PREFERENCES WITH
INDIFFERENCE CURVES
• The consumer’s preferences allow him to choose among different
bundles of Pepsi and pizza. If you offer the consumer two different
bundles, he chooses the bundle that best suits his tastes. If the two
bundles suit his tastes equally well, we say that the consumer is
indifferent between the two bundles.

• Just as we have represented the consumer’s budget constraint

graphically, we can also represent his preferences graphically. We do
this with indifference curves.

• An indifference curve shows the bundles of consumption that

make the consumer equally happy. In this case, the indifference
curves show the combinations of Pepsi and pizza with which the
consumer is equally satisfied.
Indifference curve
 Continue
• Figure 21-2 shows two of the consumer’s many indifference
curves. The consumer is indifferent among combinations A, B,
and C, because they are all on the same curve.

• Not surprisingly, if the consumer’s consumption of pizza is

reduced, say from point A to point B, consumption of Pepsi
must increase to keep him equally happy.

• If consumption of pizza is reduced again, from point B to

point C, the amount of Pepsi consumed must increase yet
again.
 Indifference Map
• A set of indifference curves represents an
indifference map
 Indifference Marginal Rate of Substitution
• The slope at any point on an indifference curve equals the rate at which the
consumer is willing to substitute one good for the other.
• This rate is called the marginal rate of substitution (MRS). In this case, the
marginal rate of substitution measures how much Pepsi the consumer
requires in order to be compensated for a one-unit reduction in pizza
consumption.

• Notice that because the indifference curves are not straight lines, the
marginal rate of substitution is not the same at all
• points on a given indifference curve.

• The rate at which a consumer is willing to trade one good for the other
depends on the amounts of the goods he is already consuming.

• That is, the rate at which a consumer is willing to trade pizza for Pepsi
depends on whether he is more hungry or more thirsty, which in turn
depends on how much pizza and Pepsi he has.
 Marginal Rate of Substitution
• Marginal Rate of Substitution (MRS) is the
rate at which the consumer is prepared to
exchange goods X and Y
Combination of Quantity of good Quantity of good MRS
goods x and y x(Qx) y(Qy)

A 1 13
B 2 9 4
C 3 6 3
D 4 4 2
E 5 3 1
 MRS formula

Y MU X
MRS   
X MUY
 Properties of Indifference Curves
• Indifference curves slope downward to the right
• Indifference curves are always convex to the
origin
• Indifference curves can never intersect each
other
• A higher indifference curve represents a higher
level of satisfaction than the lower indifference
curve
Indifference curves when Goods x and y are
substitutes

Qy

IC1
Qx
Indifference Curve when Goods x and y are
complements

Qy

IC2
B

IC1
A

Qx
 Consumer’s Equilibrium or Maximization of
Satisfaction
• "The term consumer’s equilibrium refers to the
amount of goods and services which the consumer
may buy in the market given his income and given
prices of goods in the market, that give maximum
satisfaction to consumer".

• The aim of the consumer is to get maximum

satisfaction from his money income. Given the price
line or budget line and the indifference map