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Consumer Behaviour and Consumer Equilibrium

The document discusses consumer behavior and equilibrium, explaining theories of demand including cardinal and ordinal utility approaches. It details the budget constraint, which outlines consumer choices based on income and prices, and introduces the concept of utility and indifference curves to illustrate consumer preferences. Consumer equilibrium is achieved when a consumer maximizes satisfaction by purchasing goods where the budget line is tangent to the indifference curve.

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Abhishek yadav
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8 views

Consumer Behaviour and Consumer Equilibrium

The document discusses consumer behavior and equilibrium, explaining theories of demand including cardinal and ordinal utility approaches. It details the budget constraint, which outlines consumer choices based on income and prices, and introduces the concept of utility and indifference curves to illustrate consumer preferences. Consumer equilibrium is achieved when a consumer maximizes satisfaction by purchasing goods where the budget line is tangent to the indifference curve.

Uploaded by

Abhishek yadav
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Consumer Behaviour and

Consumer Equilibrium
Introduction
• From time to time, different theories have been
advanced to explain consumer’s demand for a good
and to derive valid demand theorem.
• Cardinal utility analysis is the oldest theory of
demand for a good which provide an explanation of
consumer’s demand for a product and derived law
of demand.
• This theory was severely criticised by J.R. Hicks and
he gave Ordinal utility approach using Indifference
curve analysis.
The Budget Constraint
• The budget constraints represents the choices or possibilities
available to a consumer regarding the amount of goods he can
buy from the market for his consumption.
• In describing the budget constraints, it is assumed that the
individual consumer has no influence or control over the prices
of goods he buys.
• Price of goods are determined by the forces of demand and
supply and individual consumer takes these prices as given and
constant for him and decides about his choice of good for
consumption subject to his budget constraints.
• The two important factors that determines the consumer’s
budget constraint are: (i) income of the consumer, and (ii) the
prices of goods.
• Thus budget constraint depict the choices open to the consumer
with his given income and price of the goods.
• All the point on the budget line constraint can be
expressed as
Px.X + Py.Y= M
• Opportunity set: refers to all combinations of two
goods that a consumer can buy including the
combinations lying inside the given budget
constraint and on it, given his income and prices of
two goods. So the above equation can be written
as:
Px.X + Py.Y≤ M
• Now, it may be noted that the opportunity set
of the individual will change when income of
the individual or prices of the change.
• When individual’s income increases, his
budget constraint shift parallel to right and
vice versa.
• If price of any one of the goods increases or
decrease the budget constraint line shifts on
the respective axis right or left in case increase
or decrease in price of good X, Up or down in
case of increase or decrease in price of good Y.
Concept of Utility
• Utility is defined as a satisfaction that a consumer derives from
consuming a good or combination of goods. It is also known as
fulfilment of desire.
• The economists called as utilitarians believed that utility was a psychic
feeling, they thought it could be measured directly in cardinal terms
with some kind og psychological or imaginary units called ‘utils”.
• Ordinal Utility: cardinal utility concept was severely criticised by
economist J.R Hicks who pointed out that one could not precisely read
consumer’s mind and measure utility in cardinal terms. He proposed
ordinal utility concept. According to which a person can give only
ranking or order to the utility he derives from various goods or
combinations of goods.
• With the indifference curve, Hicks explained how a consumer’s choice
could be explained subject to his budget constraints.
Indifference Curve
• IC represents all those combination of two goods which gives
him same satisfaction.
Good Y Good X MRSxy Good X Good Y
• 1 12 2 14
2 8 4 3 10
3 5 3 4 7
4 3 2 5 5
5 2 1 6 4

• Marginal Rate of Susbtitution: The Marginal Rate of


Substitution 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. It is the slope of IC.
• M.R.S. Y X = Δ X / Δ Y
= Loss of X/ Gain of Y
• Assumptions of IC:
– Utility is ordinal.
– Consumer is rational.
– Goods consumed are substitutable.
– Availability of more goods is always better.
– A consumer will have transitivity in his choice.
Suppose a consumer prefer item ‘A’ over ‘B’. Also,
he chooses item ‘B’ over ‘C’. Then it must prefer
item ‘A’ over ‘C’.
• Properties of IC
– The difference curve has a negative slope: This property follows
from assumption I. Indifference curve being downward sloping
means that when the amount of one good in the combination is
increased, the amount of the other good is reduced. This must be so
if the level of satisfaction is to remain the same on an indifference
curve.
– Indifferent curves do not intersect.
– They are convex from below, i.e., convex to the origin: the
indifference curve is relatively flatter in its right-hand portion and
relatively steeper in its left-hand portion. This property of
indifference curves follows from assumption 3, which is that the
marginal rate of substitution of X for Y (MRSxy) diminishes as more
and more of X is substituted for Y.
– An indifference curve that lies to the right of another, yields more
utility: The last property of indifference curve is that a higher
indifference curve will represent a higher level of satisfaction than a
lower indifference curve. In other words, the combinations which lie
on a higher indifference curve will be preferred to the combinations
which lie on a lower indifference curve.
Consumer Equilibrium: maximising
Satisfaction
• A consumer is said to be in equilibrium when he is buying such a combination
of goods as leaves him with no tendency to rearrange his purchase for goods.
• Assumptions:
• The consumer has a given indifference map exhibiting his scale of preference
for various combinations of two goods, X and Y.
• He has a fixed amount of money to spend on the two goods. He has to spend
whole of his given money on the two goods.
• Prices of the goods are given and constant for him. He cannot influence the
price of the goods by buying more or less of them.
• Goods are homogenous and divisible.
• Condition of equilibrium: given budget line must be tangent to the
indifference curve, or the MRSxy must be equal to ratio of the prices of two
goods. i.e. slope IC= slope of budget constraint.
• MRSxy= Px/Py

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