Consumer Behaviour Consumer Behaviour AnalysisAnalysis

Consumer Behaviour Consumer Behaviour AnalysisAnalysis

Subhalaxmi MohapatraSubhalaxmi MohapatraDated:04.08.2011Dated:04.08.2011

KIAMSKIAMS

Index• Utility -Cardinal versus Ordinal utility• Total, average and Marginal Utility• Law of diminishing marginal utility

– Consumer equilibrium– Consumer surplus

• Indifference Curve and its properties– Budget line– Consumer equilibrium– Effect of change in income and prices

on consumer equilibrium– Price , Income and Substitution effect– Income consumption curve and Price

consumption curve

Utility• The want satisfying power of

commodity is utility.• Same commodity gives different

utility to different consumers.• Even for the same consumer, utility

varies from unit to unit, from time to time and from place to place.

• We measure utility in units called “utils”

MEASUREMENT OF UTILITY

Cardinal utility approach Ordinal utility approach

Cardinal Utility Approach

• Alfred Marshall (1890) introduced the Cardinal Utility Theory also known as Marshallian Utility Theory.

• Utility is subjective not objective

Total Utility• Meaning:

– amount of utility a person derives from the consumption of a particular product in a given period.

– The sum total of satisfaction which a consumer derives by consuming the various units of a commodity.

Marginal Utility• Defined as the change in total utility resulting from 1 unit

change in the consumption of the good. MU x = ΔTU x / Δ Qx

MU x -- Marginal utility

ΔTU x – change in total utility

Δ Qx –change in quantity of good X respectively

MU of nth Unit = TU n - TU n-1

• Another way of finding marginal utility is by differentiating total utility function:

MUx = dTU x / dQx

Total and Marginal Utility Schedules

Number of ice creams consumed at a stretch

Total utility

0

1

3

4

2

10

6

7

5

9

8

0.00

15.00

25.00

31.00

35.00

37.50

10.00

4.00

2.50

1.25

0.90

0.80

Marginal utility

39.00

40.25

41.30

42.20

43.00

15.00

6.00

1.05

1.5

2 4 6 8 10

10

20

30

40

50

Total and Marginal Utility Curves

[i]. Increasing total utility [ii]. Diminishing marginal utility

Quantity of ice creams consumed

15

10

5

Uti

lity

20

0

Uti

lity

2 4 6 8 100

The Law of Diminishing Marginal UtilityStatement

For any individual consumer the value that he attaches to successive units of a particular commodity will diminish steadily as his total consumption of that commodity increases, the consumption of all other goods being held constant. (R. G. Lipsey) The MU declines as a person consumes more of

any good. TU grows at a slower rate as the MU starts

diminishing with each additional unit consumed. The diminishing MU is a result of the fact that a

person’s enjoyment of a good decline as more and more of the good is consumed.

Assumptions1) Various units of the goods are homogeneous.2) No time gap between consumption of the different units3) Tastes, preferences and fashions remain unchanged4) Consumer is rational ( i.e has complete knowledge and maximizes utility)

If the above conditions holds good, law holds good universally.

Maximizing UtilityEquilibrium for one product: (consumption

of all other product remains constant)The consumer will adjust her purchases until the marginal utility of last unit purchased equal to the price of a unit of that product.

MU = P, Or, MU/P = 1Equilibrium for many products: (Equi

Marginal Utility)consumers allocate expenditure among products so that equal utility is derived from the last unit of money spent on each commodity.

MUx/Px = MUy/Py = -------------- =MUn/ Pn

Utility Maximizing Rule

• In general, utility maximizing consumer spread out their expenditure until the following condition holds:

(MU x / Px ) = (MU y/ Py)

• Another View:(MU x / MU y) = (Px / Py)

Consumer Surplus

 The concept of consumer surplus was pioneered by Marshall.

According to him, “the excess of the price which a consumer would be willing to pay rather than go without a thing over which he actually does pay, is the economic measure of his surplus satisfaction.”

Thus, consumer surplus can be defined as the difference between what consumers would like to pay for a product and what they actually pay.

Ordinal Utility Theory: Indifference Curve Approach

Assumptions of the Theory

Rationality

Utility is Ordinal

Consistency

Transitivity

Non-satiety

What is an Indifference Curve (Equal Utility Curve)

• A curve that shows different combinations of two goods yielding the same level of utility (satisfaction) to the consumer

• Since all points on the curve yield equal satisfaction, the consumer likes equally all the combinations, and is thus indifferent between these combinations.

Bundle Clothing Food

c

a

b

d

e

f

30

18

13

10

8

7

5

10

15

20

25

30

Bundles Conferring Equal Satisfaction

5 10 15 20 25 30

10

20

30

35Quantity of food

Quanti

t y o

f c l

ot h

ing

per

week

An Indifference Curve

25

15

35

5

a

b

c

d e fh T I

g

An Indifference Map

A set of indifference curves is called an indifference map.

The further the curve from the origin, the higher the level of satisfaction it represents.

Properties of Indifference Curve

• Indifference curve is downward sloping

• Indifference curve is convex to the origin

• ICs can do not intersect each other

• The further away from the origin an IC lies, the higher the level of satisfaction it denotes

Marginal Rate of Substitution

The marginal rate of substitution of X for Y (MRSx,y ) is defined as the number of units of good Y that must be given up in exchange for an extra unit of goodX so that the consumer maintains the same level of satisfaction.

In other words, it shows the rate at which one good is substituted for another good, while remaining on the same indifference curve. Thus,

(slope of indifference curve) = -dY / dX = MRS x,y

Budget (Iso – Expenditure) Line

• A good is demanded by the consumer if he has (i) A preference for that good, and (ii) purchasing power to buy the good.

• His preference pattern is represented by a set of ICs,

• His purchasing power depends upon his money income and market prices of the goods.

Budget (Iso – Expenditure) Line (contd.)

Let the consumer has allocated some money to be spent on goods X and Y, whose prices are Px and Py , then his purchasing power can be represented in terms of a budget equation:

Y= Px Qx + Py Qy Budget line Equation

Where Y = Income or expenditure on goods X and Y

Qx and Qy = Quantity of good X and Y respectively

Px and Py = Prices of good X and Y respectively.The budget equation gives us a budget line.

Consumer equilibrium

Income and substitution effect

Substitution Effect:when the price of any product rises,

consumers substitute the product with a low priced product.

Income effect:change in price of a product has an effect

on the purchasing power of the customer. The decrease in the price enables to buy more of the same commodity or some other. Hence, the quantity demanded increases

I2

I3

I1

E2

An Income-consumption Line

Quantity of food per week

Qu

anti

ty o

f cl

oth

ing

per

week

E3

E1

Income-consumption line

0

I2

I3

I1

E2

The Price-consumption Line

Quantity of food per week

Qu

anti

ty o

f cl

oth

ing

per

week

E3

E1

Price-consumption line

b c d

a

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