Lecture # 4, Economics

CONSUMER BEHAVIOUR

Consumer Behavior

The behavior of consumer in the choice of goods can be explained in different ways. We will see
different approaches to understand how a particular individual behaves to choose certain goods.
The first approach we will discuss here is the “Utility Approach”.

i. Utility Approach (Cardinal Approach)

Utility

Utility is defined as satisfaction gained from the consumption of good. A person buys a
product because it provides satisfaction. The more a person buys, the greater the total utility he
or she will receive.

A consumer is always interested in the maximization of utility because he has limited

resources to spend on consumer goods. There are different aspects of utility:

i. Initial Utility:
The utility that the first unit of consumption gives is the initial utility.
ii. Marginal Utility:
The utility we get from the last/additional unit of consumption is the marginal utility.
iii. Positive Utility:
The utility above zero is the positive utility.
iv. Zero Utility:
When the consumer has fully satisfied his want and is not interested to use more units of
the product its marginal utility would become zero.
v. Point of Satiety:
When the marginal utility of the consumer is zero, his total utility will be maximum. This
will be his point of satiety or the satisfaction of his want.
vi. Negative Utility:
 If anyone continues consuming more units of consumption even after the point of satiety,
his marginal utility would become negative.
vii. Total Utility:
The sum of utility of all the units of consumption will be total utility.
These aspects of utility are explained with the help of a table given:
In this table, we show the consumption of six bottles of coke by a consumer. His marginal and
total utilities are given in the second and third columns. When the consumer consumes first
bottle of coke he gets 8 utils which is his initial utility. By consuming 4 bottles of coke, his
marginal utility falls from 8 to 2 utils. This is his positive marginal utility. By consuming 5 th
bottle of coke, his marginal utility become zero and total utility reaches 20 utils which is the
highest level of utility. This is the point of satiety. On consuming 6th bottle his marginal utility
becomes negative and utility falls.
Law of Diminishing Marginal Utility:

We experience every day that when we use many units of a product continuously, MU of each
additional unit of consumption tends to fall. When MU becomes zero we arrive at the point of
satiety. With any more use of that product marginal utility becomes negative. By this
consumption behavior of the people; a law has been derived which is called “Law of
Diminishing Marginal Utility”.

The additional benefit which a person derives from an increase of his stock of a thing diminishes
with every increase in the stock that he already has.

This law has been based on the logic that all human wants are satisfiable. Psychologically, when
we direly need a product we look for it. When it is available and we start using it, its first unit
gives fairly a good amount of utility. Since the want is satisfied to some extent by the use of first
unit of consumption, the MU of the second unit would be less than that of the first unit and so on.
In this way, with the consumption of a few units of the product, the want would be satisfied.
According to this table, suppose that a person is hungry and starts eating apples. The first apple
gives him 20 utils as MU. Since his want is now satisfied to some extent, the second apple gives
him 15 utils which are less than the MU of the first apple. Similarly the MU of the third to sixth
apples keep on diminishing as 10, 5, 0 -5. This is exactly what the law of diminishing marginal
utility tells us.

In the third column we find the total utility is increasing but at a diminishing rate. This also
proves that each addition to the total utility falls.

In this diagram we measure units

of apples on the horizontal axis
and marginal utility (in utils) on
the vertical axis. By joining each
unit of consumption by its
respective marginal utility we
plot points A, B, C, D, E and F.
This curve slopes down from left
to right. This shows the negative
slope of the MU curve.

Assumptions of the Law:

a. Suitable Unit of
Consumption:
A consumer good should be used in suitable units. The size of the unit should neither be
too big nor too small. For example, if we are taking coke, a glass of coke would be
suitable unit of consumption due to which MU from coke might go up. If the unit of coke
is 1.5 liters bottle, in this case the thirst of consumer would be satisfied before the unit of
consumption comes to an end.
b. Nature of Product Remains the Same:
All the units of consumption should be identical. This means that the nature of the
product should remain the same. If units of consumption differ in their characteristics
 this law would not be applicable. Suppose we take a good quality apple after a bad
quality apple, in this case MU of the second apple would be more than the first apple.
Law will not prove to be true.
c. Consecutive Use of the Product:
This law will be applicable only if various units of consumption are used consecutively
i.e. one after the other. In case we use apple in the morning and the second in the evening
MU will not fall.
d. Mental Condition of the Consumer Should not Change:
The habits, tastes and liking of the consumer should not change or in other words, his
mental condition should remain the same. Suppose that after the use first unit of
consumption, he comes to know that more and more use of the product is useful for his
health. His mental condition would change and the MU from the successive units of
consumption would rise rather than falling.
e. Income of the Consumer Should Remain Constant:
For the application of the law it is necessary that income of the consumer should remain
constant. Suppose his income increases and spends more on durable consumer goods. In
this case his MU from additional unit of durable consumer good would increase rather
than falling.
Q. How an individual decides the combination of two goods to get the maximum utility?
The law of equi-marginal utility suggests that the consumer will go for the combination that
equates the marginal utility of two goods and maximizes his total utility.

To explain this, we take the example of a consumer supposing:

i. He has 5rs in his pocket.
ii. He wants to purchase both biscuits and coke.
iii. It is assumed that the price of biscuits is 1re and the price of coke is also 1re.
iv. It is further assumed that utility can be measured in terms of utils, and
v. The consumer is rational.

Units of biscuits/coke MU of biscuits MU of coke

 1 25 20
2 20 15
3 15 10
4 10 5
5 5 0
Total Utility 75 50

According to the table, we find that if the consumer spends whole of his income (5rs) on biscuits,
he gets 75 utils as total utility. If he spends his total income on coke, he gets 50 utils of TU.
Thus, he spends 3rs on biscuits and 2rs on coke because the MU of third biscuit is 15 utils and
that of second coke is also 15 utils i.e. MU1 = MU2

Moreover, we find that if the consumer spends his income on biscuits, he gets 75 utils and 50
utils from coke. By acting upon the law of equi-marginal utility, he gets 95 (60+35) utils.

3rs = 25 + 20 + 15 = 60 utils

2rs = 20 + 15 = 35 utils.

Since 95 > 75 > 50, he is able to maximize his total utility (TU).

ii. Ordinal Approach

We have already analyzed consumer’s behavior in terms of utility. Now we shall analyze
consumer’s behavior in terms of indifference curves. This analysis of consumer behavior is
known as “Ordinal approach”. By ordinal it means we rather than measuring satisfaction, we
rank it. Let us see how it is being done.

Indifference Curves
An indifference curve is the locus of points representing those combinations of goods, which
yield same level of satisfaction to the consumer, so that he is indifferent as to the particular
combination he chooses for consumption.
All the combinations shown on IC are equally attractive to the consumer because they provide
equal satisfaction to him.
Suppose that there are two goods, X and Y, which are divisible and substitutable with each other
and the consumer tells us that the following combinations of X and Y goods yield equal level of
satisfaction to him. He does not prefer any one of these combinations over the other, so that he is
indifferent as to the particular combination he consumes:

From the information given in the above table we can easily draw an IC by measuring units of X
on x-axis and units of Y on y-axis.
By showing first, second, third and fourth combinations, we get points A, B, C and D
respectively and by joining these points, we get II curve, which is called an Indifference Curve.
All points on this curve represents such combinations of X and Y which yield equal satisfaction
to the consumer and he does not prefer any of them over the other, so he is indifferent to any of
these combinations.
If the consumer prefers different combination which gives him higher satisfaction level, then
new IC will be drawn which will be higher than previous. Higher the IC, higher the level of
satisfaction.

Budget Line
The Budget Line, also called as Budget Constraint shows all the combinations of two
commodities that a consumer can afford at given market prices and within the particular income
level.
 Suppose that the consumer is willing to
spend Rs 100 on the goods X and Y and
price of good X is Rs 20 per unit and price
of good Y is Rs 10 per unit. With Rs 100
he can either buy 5 units of good X or 10
units of good Y. this information can help
us in drawing a budget line MN in
diagram.

Consumer’s Equilibrium?
When a consumer gets the maximum possible satisfaction by spending his given income on
different goods and services, he is said to be in a state of equilibrium. When a consumer is in
equilibrium, he does not wish that if he were to spend his income some other way, he would have
obtained larger amount of satisfaction.

Assuming that the consumer has allocated Rs 100 for the purchase of good X and Y, the price of
X is Rs 20 per unit and the price of Y is Rs 10 per unit, we have drawn line MN at the budget
line of consumer in diagram and the consumer’s IC are I1, I2, I3 and I4 respectively. I1 represents
the lowest level of satisfaction and I4 represents the highest level of satisfaction for the consumer.
In diagram, the budget line MN is tangent to the I3 at point E at I3 is the highest possible IC,
which can be accessed by the consumer under the given situation. Thus point E is the consumer’s
equilibrium point at which he chooses 2 units of good X and 6 units of good Y. By spending in
this way, the total of Rs 100 on these goods, the consumer can get the highest satisfaction,
because if he chooses a point either above or below at point E on his budget line MN, he will end
up spending total amount of Rs 100 but this level of satisfaction will be lower that at point E.

Thus, a consumer is in equilibrium at the point, where his budget line is tangent to the highest
possible IC. In diagram such a point is point E at which the consumer’s budget line MN becomes
the tangent to the highest possible IC I3.