CONSUMER BEHAVIOUR AND ANALYSIS

UTILITY : EXTENT OF OF SATISFACTION OBTAINED FROM THE

CONSUMPTION OF GOODS AND SERVICES PREFERRED
BY CONSUMERS

APPROACHES
CARDINALIST APPROACH : Utility can be measured in subjective terms
or it is quantifiable.

ORDINAL APPROACH : Utility cannot be measured but only ranked in

Order of preference.

CARDINAL APPROACH Law of Diminishing marginal

Utility
TOTAL UTILITY : Total satisfaction enjoyed from the
consumption of the good.
MARGINAL UTILITY : Rate of change in total utility per unit
charge in the quantity of the good
consumed.
Change in total Utility
1 unit change in Quantity Consumed

LAW OF DIMINISHING MARGINAL UTILITY

Marginal Utility of any good tends to decline as we consume more
Units of it over a definite period of time. The diagramatic
representation is as follows.

Law of Diminishing Marginal Utility

Total Utility
40
30
20

Total Utility

10
0
0

Pints of
Beer
0
1
2
3
4
5
6
7

TU MU
0
10
18
24
28
30
30
29

10
8
6
4
2
0
-1

Utility
Economists use the term utility to describe the satisfaction or
enjoyment derived from the consumption of a good or service. If
we assume that consumers act rationally, this means they will
choose between different goods and services so as to maximize
total satisfaction or total utility.
Consumers will take into consideration
How much satisfaction they get from buying and then consuming
an extra unit of a good or service
The price that they have to pay to make this purchase
The satisfaction derived from consuming alternative products
The prices of alternatives goods and services

Experiment 2
Consumers go shopping with Rs 2500 in hand each
Measure of satisfaction (UTILS)
Items Available
Price
Cons 1
Cons 2
Branded Jeans
Herbal cosmetics
Pizzas
Fancy Watches
Hamburgers
AJewellery

1000
200
150
500
100
500

EQUILIBRIUM CONDITION LAW OF EQUI MARGINAL

UTILITY
Going by the assumption of rationality consumer attains equilibrium
Only when he uses that bundle of goods which gives him the highest
level of satisfaction
Suppose a consumer spends his income in purchasing 3 goods
X1, X2, X3 with respective prices of P1, P2 &P3 the consumer will
allocate his income between the three goods in such a way that the
Marginal utility per Rs he spends on every good is equalised and his
total utility is maximised. Eg if here are n number of goods
MU/P1=MU/P2=MU/P3..=MUn/Pn=Mum
If MU1/P1>MU2/P2 then the rational consumer will consume more
of X1 till MUI/P1=MU2/P2

Assumptions
The principle of equi-marginal utility is based on the following assumptions:
(a) The wants of a consumer remain unchanged.
(b) He has a fixed income.Marginal utility of money is constant
(c) The prices of all goods are given and known to a consumer.
(d) He is one of the many buyers in the sense that he is powerless to alter the
market price.
(e) He can spend his income in small amounts.
(f) He acts rationally in the sense that he want maximum satisfaction
(g) Utility is measured cardinally. This means that utility, or use of a good,
can be expressed in terms of units or utils. This utility is not only comparable
but also quantifiable.

CRITICISMS OF UTILITY THEORY

Some economists claim that utility cannot be measured objectively. There are also
doubts about the assumption of rational behaviour among consumers - particularly in a
world where consumers cannot expect to have all the information available on the
products available in a market.
The importance of consumer feedback
In standard price theory, the preferences of consumers are taken as fixed - yet we
observe that consumer's behaviour in a market is often influenced by their interaction
with other consumers and this then affects demand.

A good example of this is the behaviour of consumers who attend showings of a new
film to a cinema. Their reaction to a film will often determine how many other people
choose to pay to watch the same film. Consumer feedback may be more significant than
any amount of hype and advertising before a film is released
.
Another good example is the feedback of consumers who visit a local restaurant or
feedback from people who have stayed at a particular holiday resort. Their experiences
may exert a significant influence on the preferences and choices of other consumers. It is
little wonder that many successful firms trace some of their success at their willingness
and ability to respond pro-actively to consumer feedback.

Derivation of the demand curve

Eqiulibrium condition of the consumer is given as
MU =MUmP1
If P1 falls it automatically implies that MU should fall for equilibrium
to be restored
Furthermore it is evident that MU can decrease only if Quantity
demanded increases
p1
p2

mu1
mu2
mu3

p3
q1 q2

q3

q1

q2

q3

Therefore when price of good falls consumer will buy more of the good
To equate marginal utility to lower price. Hence the inverse relationship
Between price & quantity

ILLUSTRATION
1)

ASSUME THAT UTILITY CAN BE MEASURED IN RS. FROM THE UTILITY SCHEDULE
GIVEN BELOW.FINO HOW MANY COKES THE CONSUMER WOULD CONSUME AT THE
PRICE OF RS. 9 PER COKE.
COKES
1
2
3
4
5

TOTAL UTILITY
30
45
54
59
59

MU
0
15
9
5
0

EQUILIBRIUM IS REACHED AT A LEVEL WHERE MU = P i.e. WHEN 3 COKES ARE CONSUMED

2)

A CONSUMER HAS AN INCOME OF RS. 19 FOR A WEEK. HE WOULD LIKE TO SPENO ALL
THE RS. 19 ON THREE GOODS X, Y & Z. PRICES OF X, Y & Z ARE RS. 5, RS. 3 AND RS. 1.
THE MARGINAL UTILITY SCHEDULE IS SHOWN BELOW.

UNITS

MARGINAL

UTLITIES

MuX

MuY

MuZ

Px

Py

Pz

30

18

25

15

20

15

1.33

EQUILIBRIUM IS REACHED WHEN

MU = 5 WHERE THE CONSUMER 2 UNITS OF X,

P

2 UNITS OF Y AND 3 UNITS OF 2.

ALLOCATION OF EXPENDITURE

GOOD - X
GOOD - Y
GOOD - Z
TOTAL

QTY
2
2
3

X
x
x
x

PRICE
5
3
1

= EXPENDITURE
=
10
=
6
=
3
19

4 x 5 = 20
3x3= 9
5 x 1= 5
34

A FAMILY HAS A MONTHLY BUDGET OF RS. 340 FOR CHEESE, FISH AND HEAT PREVAILING
PRICES ARE RS. 20/ KG CHEESE , RS. 40/KG FISH AND RS. 50/ KG MEAT.
UTILITY SCHEDULE IS SHOWN BELOW
CONS
CHEESE
FISH
MEAT
70
130
170
205
230
250
260

1
2
3
4
5
6
7

80
160
210
250
285
315
335

160
290
410
510
590
650
680

WHAT IS THE MAXIMUM TOTAL UTILITY THAT CAN BE ATTAINED

CONS
1
2
3
4
5
6
7
TU

170 +

CHEESE
MU
MU/ P

MU

MU / P

MU

MU / P

70
60
40
35
25
20
10

80
80
50
40
35
30
20

2. 0
2. 0
1. 25
1. 00
0. 875
0. 75
0. 5

160
130
120
100
80
60
30

3. 2
2. 60
2. 40
2. 00
1. 60
1. 20
0. 6

160

3. 5
3. 0
2. 0
1. 75
1. 21
1. 00
0. 5
+

510 = 840

FISH

MEAT

CONSUMER SURPLUS
Consumers surplus is defined as the difference between what a
Consumer is willing to pay and what we actually pays.
p
A
PP

ILLUSTRATION

p1

p2

r1 r2

q1 q2

APPLICATION

D
Consumers
N surplus

p1
p0

A
E

Producers
surplus
q1

Dead weight loss

dD
e
e
B
a
D1
q0

RATIONALE BEHIND THE THEORY

KEY QUESTION
CAN ONE ACTUALLY MEASURE UTILITY CARDINALLY ?
DOES MONEY POSSESS CONSTANT MARGINAL UTILITY ?
IS IT PRAGMATIC TO ADOPT AN OBJECTIVE VALUATION
OF A SUBJECTIVE CONCEPT ?
BIRTH OF THE INDIFFERENCE CURVE ANALYSIS IT IS

MORE REALISTIC TO RANK YOUR PREFERENCE

THAN MEASURE YOUR SATISFACTION

DEFINITION INDIFFERENCE CURVE IS THE LOCUS OF

POINTS OF PARTICULAR COMBINATION OR BUNDLES OF
GOODS WHICH YIELD THE SAME SATISFACTION TO THE
CONSUMAR SO THAT HE IS INDIFFERENT AS TO THE
PARTICULAR COMBINATION HE CONSUMES.

ASSUMPTIONS
RATIONALITY
ORDINALITY
DIMINISHING MRS
CONSISTENCY & TRANSITIVITY OF CHOICE,

A > B, THEN B />A, IF A>B, and B>C

Then A>C

A DISCUSSION ON THE CONCEPT SLOPE

SLOPE OF THE IC CURVE MARGINAL RATE OF
SUBSTITUTION BETWEEN X & Y
MRSxy AMOUNT OF Y A CONSUMER IS WILLING TO
GIVE UP FOR AN ADDITIONAL UNIT OF X
= MUx / MUy

MATHEMATICALLY IT IS THE SLOPE OF A TANGENT AT

ANY POINT ON THE IC = - dy / dx (negative)
SLOPE OF THE BUDGET LINE PRICE RATIO OF THE
TWO COMMODITIES X & Y = - Px / Py

Qy

DOWNWARD SLOPING IC CURVE

10

F
dy

MRSxy

MRS<1

2
1
0.5

G
H I

dx

IC1

6
4
2

Qx
2

10

SLOPE OF THE IC CURVE AT F =MRSxy at F(Mux/Muy)

WHERE CONSUMER IS WILLING TO SACRIFICE 2UNITS
OF Y FOT 1 UNIT OF X

BUDGET 10

A Y/Py

Y=Px.qx +Py .qy

LINE

8
SLOPE=-OA/OB= -Y/Py/Y/Px
=-Px/Py

Assume Y = Rs 10
Px = 1, Py =1 then budget
line will be as depicted

4
2
0

B
10

Y/Px

Shifts in budget line

Fall in price of x

A`

Fall in price of y

B
Y/py`
Y/py

B`
Rise in income

INDIFFERENCE MAP
Qy

Higher Indifference curves give more satisfaction

As more of both goods X and Y are consumed

IC3
IC2
IC1

Qx

Qy
Py

CONSUMER EQUILIBRIUM

IC3
IC2
IC1
Px

Qx

At point E the slope of the indifference curve is tangential to the

Slope of the budget line= MRSxy = Px/Py

Properties of indifference curves

1. Diminishing MRS
5
4
3
2
11

6
5
4
3
2
1

MRS=1

1 2 3 4 5

2. Two IC
Curves do not
intertsect

1 2 3
Qy

A
B

MRS>1

IC2
IC1

4 5 6

3. IC curve is downward
sloping
P
R

B
O

Qx

10

Some exceptionsQy
SUBSTITUTES

COMPLEMENTS

6
4
2
2 4
Qy

6 8 10

Qx

Only Y is consumed
D

Qy

Either X or Y is
consumed

D
K
Qx

Qx

Qy

Only X is consumed

Qx

INCOME EFFECT
A2
A1

A
e2
e

e1

ICC

IC3
IC2
IC1
B

B1

B2

Price effect

Pcc
IC3
IC2
IC1
x B1

B1

B2

PRICE EFFECT =INCOME EFFECT +SUBSTITUTION EFFECT

Q
A
C
e

e2
e1

IC2
IC1

x1 x2

B1

B
Price effect (xx2) = IE (x1x2) + SE (xx1)

Demand for Q1(n)

SE
rises

IE
rises

PE
rises

Demand for Q2( I)

falls

falls

falls

Demand for Q3(G)

rises

falls

falls

Giffen good = Negative income effect outweighs positive

Substitution effect

PRICE EFFECT =INCOME EFFECT +SUBSTITUTION EFFECT

SLUTSKYS MEASURE
Q
A
C
e

e2
e1

IC3
IC2
IC1

x1 x2

B1

B
Price effect (xx2) = IE (x1x2) + SE (xx1)

Derivation of the demand

curve

Pcc

OA/OB=Y/Y/px
=px

IC3
IC2
IC1
Price

p1
p2
p3

x B1

B1

B2

d1
d2

d3

D
Quantity

Mathematical Derivation of the slope of IC curve

U=f(xy)=k
Total differential of utility function is
dU= U/ y dy+ U/ x dx
= (Muy)dy +(Mux)dx
Total change in U is caused by changes in y&x approximately
Equal to change in y * Muy + change in x* Mux
Along an IC curve total differential=0
dU=(Muy)dy +(Mux)dx=0
Rearranging we get
-dy/dx=MUx/MUy = MRS x,y OR
-dx/dy=MUy/MUx = MRS y,x OR

Slope of budget line

Y= pxqx + py.qy (income constraint)
Solving for qy we get the equation of budget line as
Pyqy = - px qx + Y
qy=-Px/Py.qx+Y/py
Slope of this line qy/ qx =Px/Py

Consumer has a monthly budget of Rs 1000. The prices of X &Y good

He consumes is Rs 10 /Kg of X and 15/ltr of Y. His utility function is
His utility function is U=(XY+X+Y). Find the optimum spending on
good X&Y.
MUx/MUy=Px/Py
MUx= U/ x =Y+1
MUy= U/ y= X+1
Px=10
Py=15
Consumer maximises his utility by equating
MUx/MUy=Px/Py
Y+1/X+1=10/15
15Y+15=10X +10
10X=15Y+5

Given budget of 1000

Px.qx+Py.qy=1000
10x+15y=1000
15y+5+15y=1000
30y=995
Y=995/30
=33.17
X=50.25
Optimum spending on good
X =50.25*10= 502.50
Y=33.17*15=497.50

Demand function for product Y

We see that at equilibrium
(Y+1)/(X+1) =10/py
10x +10= Py(Y+1)
X= Py(Y+1)-10
10
Given the budget constraint of Rs 1000
Px.X+Py.Y =1000
10. Py(Y+1)-10 +Py.Y =1000
10
Py(Y+1)-10 +Py.Y = 1000
Py.y +PY+PY=1010

2Py.Y +Py = 1010

Py(2y+1) = 1010
Py =1010/2Y+1 = Demand function

GOVERNMENT POLICIES

Income

Supplementary
income

A
Z
L

Cost of
subsidy

e3
e

e2
m

I2
I1

K
O

X1 X3

X2

B`

X
food

Critique
Can a consumer order his preferences as precisely and rationally
As the theory implies?
Can the effect of advertising, of past behaviour(habit),of
Interdependence of consumer preferences be ignored?
Does this theory establish the shape of an IC curve or is it just
assumed?
CONCLUSION
Why do we study consumer behaviour indepth?
Answer lies in the fact that market demand is a summation
Of individual demand hence the examination of the behaviour of
the consumer which in turn derives the individual demand curve
Becomes important for a business manger to plan/alter production