Learning Objectives

1. What is Consumer Behavior?

2. Utility
3. Law of diminishing marginal utility
4. Consumer Surplus
5. Indifference Curve, indifference Map, Indifference
Schedule
6. Properties of indifference curve
7. Marginal Rate of Substitution (MRS )
8. Price line or budget line
Approaches to Consumer
Behaviour
Cardinal • Propounded by
Marshall
Utility • Known as Marshalling
Approach Approach

Ordinal • Propounded by Hicks

& Allen
Utility • Known as Indifference
Approach Curve Analysis
 Utility
• Utility is synonymous with “Pleasure”,
“Satisfaction” & a Sense of Fulfillment
of Desire.
• Utility → “WANT SATISFYING POWER”
of a Commodity.
• Utility is a Psychological
Phenomenon.
 Utility
• Utility refers to Abstract Quality whereby an
Object Serves our Purpose.
-
Jevons
• Utility is the Quality of a Good to Satisfy a
Want.
-Hibdon
• Utility is the Quality in Commodities that
makes Individuals want to buy them.
-Mrs.
 Features of Utility
• Utility is Subjective
It deals with the Mental Satisfaction of a Man.
For Example, Liquor has Utility for a Drunkard but for a
Teetotaler, it has no Utility.

• Utility is Relative
– Utilityof a Commodity never remains same. It
varies with Time, Place & Person. For example, Cooler
has utility in Summer but not during Winter.
5
 Features of Utility
• Utility is Not Essentially Useful
– A Commodity having Utility need not be Useful.
E.g., Liquor is not useful, but it Satisfies the Want
of an Addict thus have Utility for Him.
• Utility is Ethically Neutral
– Utility has nothing to do with Ethics. Use of
Liquor may not be good from the Moral Point of
View, but as these Intoxicants Satisfy wants of the
Drunkards, they have utility.
6
 Concepts of Utility
• The Utility Derived from the
Initial Utility Consumption of Ist Unit of
Commodity.

• The Aggregate of Utilities

obtained from the Consumption of
Total Utility Different Units of Commodity.
• TUn= U1+U2+U3+U4+…..+Un

• Change in Total Utility resulting

from the change in
Marginal Utility Consumption.
• MU = TUn+TUn-1
7
Types of Marginal Utility
Positive • With Consumption of an
Marginal Additional Unit of a Commodity,
Total Utility Increases.
Utility
• With Consumption of an
Zero Marginal Additional Unit of a
Commodity, Total Utility
Utility Remains Same.

Negative •merWith Consumption of an

Additional Unit of a
Marginal Commodity, Total Utility
Utility decrease 8
Marginal Utility Analysis
(MUA)
• Formulated by Alfred Marshall.
• Theory Explains How a Consumer
spends his Income on Different
Goods & Services so as to attain
Maximum Satisfaction.
• Based on Certain Assumptions.
 Assumptions to MUA

• Cardinal Measurability of Utility

–Utility is a Measureable & Quantifiable
Entity.
–Money is the Measuring Rod of Utility
i.e. The amount of Money which a
Person is prepared to Pay for a Unit of
Good rather than go without it is a
Measure of Utility Derived.
 Assumptions to MUA

• Constancy of the Marginal Utility

of Money
–MU of Money remains Constant.
–Not Realistic. But has been made in
order to Facilitate the Measurement of
Utility of Commodity in Terms of
Money.
 Assumptions to MUA

• Hypothesis of Independent Utility

–Theory Ignores Complementarity
Between Goods.
– Utility derived from
Total Whole
Collection of Goods Purchased is the
Sum Total of Separate Utilities of
the Good.
 Laws of Diminishing Marginal Utility

• The Additional Benefit which a Person

derives from a given Increase in Stock of
a thing Diminishes with Every Increase in
the Stock that he already has.
-Marshall
• As the Consumed of a
Amount
Increases, the Marginal
Good Utility of
the Good tends to Decrease.
-
 Assumptions to Law of Diminishing
Marginal Utility

Other things being equal

-Utility can be Measured in the Cardinal
Number System.
-Marginal Utility of Money remains Constant.
-Marginal Utility of Every Commodity is
Independent.
-Every Unit of the Commodity being used is of
same Quality & Size.
 Assumptions of Law of Diminishing
Marginal Utility
• There is a Continuous Consumption of
the Commodity.
• Suitable Quantity of the Commodity
Consumed.is
• There is No Change in the Income,
Tastes, Character, Fashion and Habits
of the Consumer.
•There is No Change in the Price of the
Commodity and its Substitutes.
 Explanation
Quantities of Tea
Consumed Total Utility Marginal Utility
(cups per day)
1 30 30
2 50 20
3 65 15
4 75 10
5 83 8
6 89 6
7 93 4
8 96 3
9 98 2
10 99 1
11 95
General Economics: Theory of Consumer -4 16
Behaviou-Indiffernce Curve
 Explanation
35
30
25
20
Index of

15
Utility

10
5
0
0 2 4 6 8 10 12
-5
-10 Quantity of Tea (Cups per Day)
17
Limitations of the Law

• Utility considered as Cardinally measureable

Untenable as Utility is a Subjective Concept.
• Unrealistic Assumption regarding Marginal
utility of money being constant. Money is
subject to change.
• No Empirical Verification.
• The Derivation of Law is based on assumption of
Ceteris Paribus which is unrealistic 18
 Marshallian Consumer’s
• Surplus
Marshall defined Consumer’s Surplus as “the
excess of the Price which a Consumer would be
willing to Pay rather than go without the
thing, over that which he actually does pay.”
• Consumer’s Surplus = What a Consumer is
Willing to Pay – What he Actually Pays.
Derived from the law of Diminishing Marginal
Utility.
 Assumptions to Marshallian
Consumer’s Surplus
• Perfect Competition prevails in Market

• Consumer purchases only one Commodity.

• Price Of the Commodity is Fixed.

• Marginal Utility of Money is Constant.

Marshallian Consumer’s
Surplus Utility
No. of Units Marginal Price (Rs.) Consumer’s
Surplus
1 30 20 10
2 28 20 8
3 26 20 6
4 24 20 4
5 22 20 2
6 20 20 0
7 18 20 -
 Marshallian Consumer’s
Surplus
Y X Axis – Quantity
M
Y Axis – Price
& MU MN – Marginal Utility Curve
Price & Marginal

Total Utility = area OMRQ Price Paid = area

P R OPRQ Thus,
Consumer Surplus = area PMR
Utility

MU
O X
Q N
Quantity
 Limitations of Marshallian
Consumer’s Surplus
• Consumer’s Surplus cannot be Measured
precisely because it is difficult to measure
the Marginal Utilities of different units of a
Commodity consumed by a person.
• In case of Necessaries, the Marginal
Utilities of earlier units are infinitely large. In
such cases, Consumer’s Surplus is
always Infinite.
 Limitations of Marshallian
Consumer’s Surplus
• Consumer’s Surplus derived from a Commodity
is Affected by the Availability of Substitutes.
• No Simple rule for deriving the Utility Scale
of Articles of distinction e.g. Diamonds.

• Marginal Utility of Money is assumed to be

Constant which is Unrealistic.

24
 Indifference Curve
• A Single Indifference Curve shows the different
Combinations of X and Y that yield Equal
Satisfaction to the Consumer.
-
Leftwitch

• An Indifference Curve is a Combination of Goods,

each of which yield the same level of total
utility to which the consumer is indifferent.
 Assumptions to Indifference
Curve Analysis
• Rationality of Consumer
– The Consumer is Rational & aims at maximizing
his Total Satisfaction.
• Ordinal Utility
– Utility can be expressed Ordinally i.e.
Consumer is able to tell only Order of his
Preferences.
• Non-satiety
Consumer is not Oversupplied with goods in
Questions. 26
 Assumptions to Indifference
Curve Analysis
• Transitivity of Choice
– Means that if a Consumer prefers A to B & B
to C, he must prefer A to C.
• Consistency of Choice
– Means that if a Consumer prefers A to B in
one period, he will not prefer B to A in
another period or Treat them as Equal.
• Diminishing Marginal Rate of Substitution
27
 Indifference Curve
Schedule
• An Curve Indifference Schedule refers to a
Schedule that Indicates different Combinations of
Two Commodities which yield Equal Satisfaction.
Combination of apples Apples Oranges
and oranges
A 1 + 10
B 2 + 7
C 3 + 5
D 4 + 4
28
 Indifference Curve
•Indifference Curve is a Diagrammatic
Y
IC
representation of indifference
schedule
10 A(1+
10)
• IC is an Indifference curve.
Oranges

7 B(2+ • It is a line that shows all possible

7) C(3+
5 Combinations of Two Goods
5 ) D (4 +
4 between which a person is indifferent
4) IC

0 1 2 3
Apples
29
4 5
 Indifference Map
IC3 • An Indifference
IC2
IC1 represents
Map a
Good Y

Indifference of Curves
Group
each of which
expresses a given
level of Satisfaction.
•If an Indifference curve
Shifts to Right,
Level the of
goes onSatisfaction
Increasing.
• From the Point of View
Good X
of Satisfaction
IC >IC2>IC 30
 Marginal Rate of Substitution
•(MRS)
The Rate at which an Individual must give up
“Good A” in order to obtain One More Unit of “Good
B”, while keeping their Overall Utility
(Satisfaction) Constant. The MRS is Calculated
between Two Goods placed on an Indifference
Curve, which displays a Frontier of Equal Utility for
Each Combination of “Good A” and “Good B”.

• MRS Keeps on Declining since Consumer has

more & more units of one Good, he gives up
Less Units of Other Good.

31
 Properties of Indifference Curve

• An Indifference Curve has a Negative Slope i.e.

it Slopes Downwards.
• Indifference Curves are always Convex to the
Origin.
• Two Indifference Curves never Intersect or
become Tangent to Each other.
• Higher Indifference Curve represents Higher
Satisfaction.
 Properties of Indifference Curve
• An Indifference Curve has a
Negative Slope i.e. it Slopes Downwards.
– Property Implies that
This
amount of when the Good in
Increased, the amount of
one the Other Good
Combination is is
reduced. This is Essential if the Level of
Satisfaction is to remain the same on
an Indifference Curve.
 Properties of Indifference Curve

• Indifference Curves are always Convex to

the Origin.
– This implies that the Two Commodities are
Imperfect Substitutes for each other & that
the MRS between the two Goods Decreases
as a Consumer moves along an Indifference
Curve.
 Properties of Indifference Curve

• Indifference Curves are always Convex to

the Origin.
– Two Extreme conditions also exists.
• When 2 Goods are Perfect
Substitutes,
Indifference Curve will be a Straight
Line on which MRS is Constant.
• When 2 Goods are
Complementary,
Indifference Curve will consist of 2
Straight Lines with a Right Angle bent
which is convex to the origin i.e. it will be L 35
 Properties of Indifference Curve
• Two Indifference Curves never
Intersect or become Tangent to Each
other.
– If Two Indifference Curves Intersect or are
Tangent, it would imply that an Indifference
Curve indicates Two different Levels of
Satisfaction (One Being Larger than the
Other) yield the Same Level of Satisfaction.
This will Violate the Rule of Transitivity.
36
 Properties of Indifference Curve
• Two Indifference Curves never
Intersect or become Tangent to Each
other. IC
IC
1
2
Good Y

•A

•B
•C

Good 37
 Properties of Indifference Curve

• Higher Indifference Curve represents

Higher Satisfaction
–This is because the Combinations lying in
Higher Indifference Curve Contain
More of either one or Both Goods and
More Goods are preferred to Less of
them.
 Price Line or Budget Line
• The Budget Line shows all those
Combinations of Two Goods which
the Consumer can buy Spending his
Given Money Income on two Goods
at their given Prices.
•Remember, that the Amount of a Good
that a Person can buy will depend upon
their Income and the Price of the Good.
 Price Line or Budget Line
Y
• Point outside
PRICE LINE
given Price
the Line,
M
like H, will be Beyond
the Reach of
Good Y

•H
the Consumer.
•K • Point Below
given Price
the Line,
O N X Like K, shows the
Good X
Under Spending of
the Consumer.
40
 Consumer Equilibrium
• Consumer Equilibrium will be reached
when he is deriving Maximum possible
Satisfaction from the Goods & is in no
Position to Rearrange his Purchase of Goods.
• The Indifference Map in Combination with the
Budget Line allows us to Determine the
One Combination of Goods and Services
that the Consumer most wants and is able to
Purchase. This is the Consumer Equilibrium.

41
 Consumer Equilibrium
Y • PL – Budget
P • Line
Points R, S, Q, T,
R H all lie on
Good Y

S
Budget Line But Q
is Equilibrium
N Q
Point.
IC 4
T
ICIC
2
3

IC1
H
X
O M L
Good X
42
 Consumer Equilibrium
• At the Tangency Point Q, the slopes of the
Price Line PL And Indifference Curve IC3 are
equal.
• Slope of Indifference Curve shows MRS of X for
Y (MRSxy)
• At Equilibrium Point Q,

MRSXY = MU X
MU Y PY
PX
Thank
You