C ONSUMER B EHAVIOUR

T HEORIES BEING PROPOSED TO STUDY THE CONSUMER B EHAVIOUR

Cardinal Utility Approach Ordinal Utility Approach

Indifference Curve Theory

Revealed Preference Theory

C ARDINAL U TILITY

THEORY

Suggested by Alfred Marshal. Also known as Marshallian theory. Assumptions

Rationality Cardinal Utility Constancy of marginal utility of money. Equi marginal utility Diminishing marginal utility.

MUx = f(Qx)

D RAWBACK OF CARDINAL UTILITY

Since money is the measuring rod of utility, the marginal utility of money must remain constant. If the marginal utility of money changes as income increases or decreases the measuring rod may behave like an elastic ruler. Then, it becomes inappropriate to measurement.

As Prof. Tapas Majumdar observes, if money is supposed to provide the measuring rod of utility, then evidently, as with all measuring rods, its unit must be invariant; it must measure the same amount of utility in all circumstances.

O RDINAL

UTILITY THEORY

Proposed by J. R. Hicks & R.G.D. Allen in 1934.

A SSUMPTIONS

OF

O RDINAL UTILITY APPROACH

1. Consumer is rational.

2. Utility is ordinal

Consumer makes his decision after ranking/comparing his preferences, according to the satisfaction of each basket of goods. He is not needed to know precisely the amount of satisfaction.

3. Diminishing Marginal Rate of Substitution (DMRs)

A consumer will sacrifice more of the first commodity ( say x) to have first unit of the second commodity ( say y). The rate of sacrifice decrease as consumer attain more units of Y.

Choices are consistent and transitive.

If A>B then B>A : Consistency If A>B an d B>C then A>C

M ARGINAL R ATE S UBSTITUTION (MRS)

The concept of Marginal Rate Substitution (MRS) was introduced by Dr. J.R. Hicks and Prof. R.G.D. Allen to take the place of the concept of diminishing marginal utility. The slop of indifference curve is known as Marginal Rate of Substitution MRS The rate or ratio at which goods X and Y are to be exchanged is known as the marginal rate of substitution (MRS).
Commodity x ( orange) 15 11 8 6 5 Commodity Y (apple) 1 2 3 4 5 4 3 2 1 Marginal rate of substitution

I NDIFFERENCE

CURVE

The concept of Indifference curve was given by F Y Edgeworth

It is the locus of combination of two different commodities, where consumer attain equal level of satisfaction by consuming different combination of two commodities. That is consumer is indifferent to the particular combination of two commodities. Indifference curve is convex to horizon : it is because of the diminishing marginal rate of substitution.

Various Combinations: Combin ation a) b) c) d) e) Unit of Rice Unit of Wheat

Utility

16 kg of 2 kg of Wheat Rice
12 kg of 5 kg of Wheat Rice 11 kg of Rice 10 kg of Rice 9 kg of Rice 7 kg of Wheat 10 kg of Wheat 15 kg of Wheat

100u 100u 100u 100u 100u

B ASIC TOOLS OF INDIFFERENCE

CURVE APPROACH

Consumption Bundle Budget Line Indifference Curve

C ONSUMPTION

BUNDLE

A particular combination of specific quantities of goods and services is called consumption bundle. For example : Coke and Noodles in various combinations being consumed by the user as per his budget.

B UDGET

LINE

It represent the limit within which a consumer can avail consumption bundles, with his limited income to attain maximum level of satisfaction.

I LLUSTRATIONS
Coke and Noodle : Consumption Bundle
Different Combinations of

Budget Line 50/day

3 30 45 35 25 15 0 60 50 40 30 75 65 55 45

these two commodities are as such. Price of Coke : 10 and Noodles is : 15.
Coke : Vertical ( y axis)

2 20
1 10 0 0

Noodle : Horizontal (x axis)

P ROPERTIES OF INDIFFERENCE CURVE

1.

An indifference curve has a negative slope, which means if the quantity of one commodity (say x) increase the quantity of another commodity must decrease (say y). Higher the indifference curve, higher the level of satisfaction. Two indifference curves can never intersect. It they intersect, the point of their intersection would imply two different levels of satisfaction. Which is impossible. Level of satisfaction along indifference curve is constant.

2. 3.

4. 5. 6. 7.

Indifference curve is convex to horizon.

Indifference curve is straight line for substitute product. Indifference curve is L Shaped complementary products as they cant be replaced.

A PPLICATIONS OF INDIFFERENCE
CURVE ANALYSIS
To find out the trade off between leisure and income. Need for a company to pay higher wages for overtime. Evaluation of alternate Govt. Policies
1. 2.

1. 2. 3.

Effect of food subsidy. Effect of supplementary income policy.

A SSUMPTIONS OF R EVEALED P REFERENCE T HEORY

1. Rationality of Consumer : Consumer is assumed to behave rationally,

as he prefer to maximize his level of satisfaction from the utilization of given commodities.

2. Consistency :Consumer behave consistently . That is , if he

chooses bundle A in a situation in which Bundle B was also available to him, he will not choose B in any circumstances in which bundle A is also available.

i.e. if A>B then B>A

3 .Transitivity : in a particular situation :

A>B and B>C then A>C

4. The revealed Preference Axiom : the customer by choosing the collection of goods in any one budget situation , reveals his preferences for that particular collection. The chosen bundle is revealed to be perfect among other alternative bundles, available under the budget constraint.