Consumer Behaviour

Study
Module 3
Some basic Questions about
consumers

 What is behind a consumer’s decision?

 How do consumers choose from among
various consumer “goods”?
 What determines the value of a consumer
good?
Theory of Consumer Behavior
The principle assumption upon which the theory of
consumer behavior and demand is built is:

consumer attempts to allocate his/her

limited money income among available
goods and services so as to maximize his/her
utility (satisfaction).
 Utility

 The value a consumer places on a unit of a good or service

depends on the satisfaction he or she expects to derive
from consuming it at the point of making a consumption
choice.
 In economics the satisfaction or pleasure consumers derive
from the consumption of consumer goods is called “utility”.
 Consumers, however, cannot have every thing they wish to.
 Consumers’ choices are constrained by income & others.
 Within the limits of their incomes, consumers make their
consumption choices by evaluating and comparing goods
with regard to their “utilities.”
Features of utility

 It is subjective
 Depends on the mental attitude & emotions
of consumers.
 Has no physical or material existence.
 Higher the price, greater the utility.
eg: buying an original movie DVD and buying a
pirated movie CD
Different Types of Utility

 Form utility
 Time utility
 Place utility
 Service utility
Utility vs. satisfaction

Utility Satisfaction
 Refers to expected  Refers to the
satisfaction in contentment realized
consumption of after consuming a
product. product.
 Related to the pre -  Related to the stage
purchasing stage after purchasing
 Measured by the price  Cannot be measured
paid for the product. by the price paid to the
product.
Theories of Consumer Choice

 The Cardinal Theory

 Utility is measurable in a cardinal sense i:e
utility can be quantifiable. (Measurable in
terms of money). Also known as Marshallian
utility analysis.
 The Ordinal Theory
 Utility is measurable in an ordinal sense
The Cardinal Approach

19th century economists assumed that utility

was measurable in a cardinal sense, which
means that the difference between two
measurement is numerically significant.
UX = f (X), UY = f (Y), …..
eg: my utility for 1 glass of coffee as 20 units
compared to 10 units of utility for a glass of
Pepsi when measured by the base of money
spent on coffee and Pepsi.
U coffee = f (20), U Pepsi = f (10), …..
No of Samosa Price per Total utility
Samosa Expenditure

1 10 10 good Increase in the

price = increase
in the utility
2 10 20 better

3 10 30 excellent

4 10 40 uncomfortable Demand / Law

of demand

5 10 50 Highly
uncomfortable
The Law of Diminishing Marginal
Utility
 According to Marshall, “ the additional benefit which a
person derives from a given increase of his stock of a
thing diminishes with every increase in the stock that
he already has”.

 Alternatively, we could say: over a given consumption

period, as more and more of a good is consumed by a
consumer, beyond a certain point, the marginal utility
of additional units begins to fall.
Assumptions of the law

 The consumer is a rational person.

 Successive units consumed are identical.
 The unit of consumption is of specific
standard. Eg: no. of biscuits
 Consumption is simultaneous without time
interval.
 Utility is measurable objectively.
 Taste & Preference do not undergo change.
 Income of the consumer remains constant.
Applications of Law of DMU

 Law of demand
 Consumer surplus
 Value paradox (the value in use & the value in
exchange are different.
Diamond has great value in exchange coz of its
limited ss, value is high as it offers greater
utility. But water has greater value in use as it is
abundantly available but no value in exchange.)
 Taxation
Criticisms to the law
 The law suffers from the criticism that utility is
subjective in nature and can not therefore be
measured objectively.
 Money gives consumer increasing marginal utility
but not constant marginal utility.
 Continuous consumption may not be possible in
practice.
 Limited physical capacity of human.
Ordinal approach to utility

 Here, it is stated that utility is subjective

and hence cannot be measured.
 But utility for different products can be
compared by assigning ranks in the order
of preference of the consumer.
Assumptions to the approach

 Consumer possess all relevant information

about the product & market.
 They aim at maximizing their total
satisfaction through rational consumption
decisions.
 They rank goals on a continuous manner.
Basic concepts
 Total utility - The total benefit or satisfaction that
a person gets from the consumption of goods and
services.
 Marginal utility - The change in total utility
resulting from a one-unit increase in the quantity
of a good consumed.
 Consumer equilibrium - A situation in which a
consumer has allocated his or her income in the
way that, given the prices of goods and services,
maximizes his or her total utility.
 Total Utility
Q (Rs) TU (Rs) MU
200
0 0
150
1 40 40
100
2 85 45
50
3 120 35
0
1 2 3 4 5 6 7 8 9 10 11 4 140 20
5 150 10
(Marginal Utility
6 157 7
50

40 7 160 3
30
8 160 0
20

10 9 155 -5
0
1 2 3 4 5 6 7 8 9 10 11 10 145 -10
-10

-20 145
Types of Marginal utility
Budget line

 As consumers, all of us has unlimited wants and

desires.
 All our desires cannot be fulfilled coz of the
reason that we have less money at our disposal.
 A consumer’s consumption is routed through his
income capabilities.
 The limited income limits us from buying
whatever we want to buy is called Budget
constraint.
 Budget line is a downward sloping line.
Eg: budget constraint
Units of Units of Exp on X Exp on Y Total exp
Product X product Y

0 8 0 8000 8000
5 7 1000 7000 8000
10 6 2000 6000 8000
15 5 3000 5000 8000
20 4 4000 4000 8000
25 3 5000 3000 8000
30 2 6000 2000 8000
35 1 7000 1000 8000
40 0 8000 0 8000
 Budget Line
Y

Income = Px .Qx + Py. Qy

I/Py

O I/Px
Indifference curves

 Budget constraint explains the limit on the

affordability of consumer.
 Consumer’s choice depends on his set of
preferences between different goods.
 An indifference curve is a line drawn in a two-
dimensional space showing different combinations
of two goods from which the consumer draws the
same amount of utility and therefore he/she is
“indifferent” about.
Indifference curve (Normal goods)
Budget Formal Casual

5000 –Combination 1000 4000

A

5000- B 1500 3500

5000- C 2000 3000

5000-D 2500 2500

5000-E 3000 2000

5000-F 3500 1500

Combination Budget Product A Product B

A 1000 800 200

B 1000 700 300

C 1000 600 400

D 1000 500 500

E 1000 400 600

 Properties of Indifference curves
 Indifference curves for two “goods” are generally
negatively sloped
 The slope of an indifference curve reflects the degree
of substitutability of two goods for one another
 Indifference curves are generally convex to the origin,
reflecting the principle of diminishing marginal returns
 Indifference curves never cross
 Indifference curves that are farther from the origin
represent higher levels of utility
 Indifference curves never intersect each other.
Types of Indifference curves

 There are two types of indifference curves:

1. Indifference curve for Normal goods
2. Perfect complements indifference curves
3. Perfect substitutes indifference curves.
Perfect Complements Indifference Curve

 Perfect complements'
indifference curves are right-
angled.
 Perfect complements refer to
goods that can't be consumed
without each other.
 For example, to drive a diesel
car, you need diesel.
Perfect Substitutes Indifference Curve

 An indifference curve for perfect

substitute goods is linear.
 Perfect substitute good demand
quantity does not change, no matter
which goods are selected over another.
 For example, consumer wanted to buy
20 of product A, but product A is not in
there, they would just buy 20 of
product B, creating a perfect
substitute.
 The slope for a perfect substitute
indifference curve, or the MRS, is
constant.
Marginal Rate of Substitution (MRS)
 The MRS can be defined as the rate at which a
consumer is willing to forgo a number of units
good X for one more of good Y at the same
utility in order to maintain the same level of
satisfaction.
 The Marginal Rate of Substitution is used to
analyze the indifference curve
 We can calculate the marginal rate of
substitution as
M.R.S. Y X = Δ X / Δ Y, (on any point on the indifference
curve)
Illustration
Consumer Equilibrium

 Consumer equilibrium can be defined as a

consumption bundle that is feasible given a
particular budget constraint and maximizes
total utility.

 It can also be defined as the point of

consumption that equates the marginal
utility of a product or service to the price of
the product or service.
Consumer equilibrium

 In ordinal study, consumer’s utility is a

function of budget constraints and
preferences .
 Hence, he obtains equilibrium at that
consumption bundle for which the
consumer’s indifference curve is tangent to
his budget line.
Consumer Equilibrium Cont.
x2

10
Consumption of pepsi

U = 25
5
U = 12.5

Budget line
1
U=1
1 2.5 5 x1
Consumption of pizza
 Here, consumer obtains equilibrium as the
budget line becomes tangent to the
indifference curve.
 But when consumer’s income increases, his
budget line also shifts to right and become
tangent to higher level of indifference curve.
 When his income decreases, his budget line
moves towards left and become tangent to
lower level indifference curve.
Consumer Surplus
 Consumer surplus is a measure of the difference
between the amount of money a person was willing
to pay to buy a quantity of good and the actual price
they paid.
 This measure is used as a tool in policy analysis.
 Consumer surplus is represented graphically as the
area underneath the demand curve above the price
paid for the goods.
Consumer Surplus
 Consumer Surplus - the difference between the
price buyers pay for a good and the maximum
amount they would have paid for the good.

 Example:
• I’m willing to pay Rs.60 for a bottle of Diet coke
• Diet coke is on sale for Rs.50 per bottle
• Consumer surplus = Rs.10
Numerical examples
 Julie has a monthly income of $200, which she
allocates between two products such as Meat
and Potato. Suppose meat costs $4 per pound
and potato costs $2 per pound, draw her budget
constraints.

Let M= Meat and P= Potato

Julie’s budget constraint B = XPx + Ypy
200 = 4M + 2P
4M = 200 – 2P
M= 200/4-2/4p
Contd..

 For M = 0
50 – 0.5P = 0
Therefore, P = 50 / 0.5
P = 100 units

If P = 0, M will be
M = 50 – 0.5(0)
M = 50 units