CONSUMER BEHAVIOUR

Consumer Behavior
Rational Consumer-Axiom of Utility Maximization Comparison of various baskets of goods

Two basic approaches to comparison of utilitiesCardinal and Ordinal Cardinal School-Utility can be measured-either in terms of money or in terms of a unit termed as Utils. Ordinal school-Utility cannot be measured only ranked-Two approaches-Indifference curves approach and Revealed preference hypothesis

Consumer Behavior (Cardinal Utility Analysis)

1)Law of Diminishing Marginal Utility-The marginal utility of a commodity declines as the consumer acquires more of it. 2)Law of Equimarginal Utility-The utility derived from spending an additional unit of money must be the same for all commodities. Condition for equilibrium = MUx= MUyMUn Px Py Pn

Consumer Behavior (Cardinal Utility Analysis)

Critique of the Cardinal Approach 3 basic weaknesses: 1) Assumption of cardinal utility is extremely doubtful. 2) Assumption of constant utility of money is unrealistic. It cannot be used as a measuring rod . 3) Diminishing marginal utility is an axiom.

Consumer Behavior (Ordinal Utility Analysis)- Indifference Curve Analysis

Indifference Curve A curve that defines the combinations of 2 or more goods that give a consumer the same level of satisfaction. Higher ICs show higher levels of satisfaction. Give an ordinal rank rather than cardinal measure

Consumer Behavior (Ordinal Utility Analysis)- Indifference Curve Analysis

Properties No two indifference curves cross. Convex shape. Negatively sloped.

Consumer Behavior (Ordinal Utility Analysis)- Indifference Curve

Marginal Rate of Substitution The rate at which a consumer is willing to substitute one good for another and maintain the same satisfaction level. The amount of good Y the consumer is willing to give up to maintain the same satisfaction level decreases as more of good X is acquired.

Consumer Behavior (Ordinal Utility Analysis)- Indifference Curve Analysis

The Budget Constraint Opportunity Set- The set of consumption bundles that are affordable. Budget Line-The bundles of goods that exhaust a consumers income. Market Rate of Substitution- The slope of the budget line.

Consumer Behavior (Ordinal Utility Analysis)- Indifference Curve Analysis

Changes in the Budget Line Changes in Income- Increases lead to a parallel ,outward shift in the budget line and vice versa Changes in Price- A decreases in the price of good X rotates the budget line counter-clockwise

Consumer Behavior (Ordinal Utility Analysis)- Indifference Curve Analysis

Consumer Equilibrium The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction. Consumer equilibrium occurs at a point where MRS = PX / PY. Equivalently, the slope of the indifference curve equals the budget line.

Consumer Behavior (Ordinal Utility Analysis)- Revealed Preference Analysis

The consumer by choosing a collection of goods in any one budget situation, reveals his preference for that particular collection. The chosen bundle is revealed to be preferred among all other alternative bundles available under the budget constraint. The chosen basket of goods maximizes the utility of the consumer. The revealed preference for a particular collection of goods implies the maximization of the utility of the consumer.

Consumer Behavior

Consumer Surplus: The value consumers get from a good but do not have to pay for.