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Consumer Behaviour Analysis Consumer Behaviour Analysis

Subhalaxmi Mohapatra Dated:04.08.2011 KIAMS

Utility -Cardinal versus Ordinal utility Total, average and Marginal Utility Law of diminishing marginal utility Consumer equilibrium Consumer surplus Indifference Curve and its properties Budget line Consumer equilibrium Effect of change in income and prices on consumer equilibrium Price , Income and Substitution effect Income consumption curve and Price consumption curve

Index

The want satisfying power of commodity is utility. Same commodity gives different utility to different consumers. Even for the same consumer, utility varies from unit to unit, from time to time and from place to place. We measure utility in units called utils

Utility

MEASUREMENT OF UTILITY

Cardinal utility approach Ordinal utility approach

Cardinal Utility Approach


Alfred Marshall (1890) introduced the Cardinal Utility Theory also known as Marshallian Utility Theory. Utility is subjective not objective

Total Utility
Meaning:

amount of utility a person derives from the consumption of a particular product in a given period. The sum total of satisfaction which a consumer derives by consuming the various units of a commodity.

Marginal Utility
Defined as the change in total utility resulting from 1 unit change in the consumption of the good. MU x = TU x / Qx MU x -- Marginal utility TU x change in total utility Qx change in quantity of good X respectively

MU of nth Unit = TU n - TU n-1


Another way of finding marginal utility is by differentiating total utility function: MUx = dTU x / dQx

Total and Marginal Utility Schedules


Number of ice creams consumed at a stretch 0 1 2 3 4 5 6 7 8 9 10 Total utility 0.00 15.00 25.00 31.00 35.00 37.50 39.00 40.25 41.30 42.20 43.00 15.00 10.00 6.00 4.00 2.50 1.5 1.25 1.05 0.90 0.80 Marginal utility

Total and Marginal Utility Curves


50 4 0
Utility

20

15
Utility

30 20 10

10 5

10

10

Quantity of ice creams consumed

[i]. Increasing total utility

[ii]. Diminishing marginal utility

The Law of Diminishing Marginal Utility


Statement For any individual consumer the value that he attaches to successive units of a particular commodity will diminish steadily as his total consumption of that commodity increases, the consumption of all other goods being held constant. (R. G. Lipsey) The MU declines as a person consumes more of any good. TU grows at a slower rate as the MU starts diminishing with each additional unit consumed. The diminishing MU is a result of the fact that a persons enjoyment of a good decline as more and more of the good is consumed.

Assumptions
1) Various units of the goods are homogeneous. 2) No time gap between consumption of the different units 3) Tastes, preferences and fashions remain unchanged 4) Consumer is rational ( i.e has complete knowledge and maximizes utility) If the above conditions holds good, law holds good universally.

Maximizing Utility
Equilibrium for one product: (consumption of all other product remains constant) The consumer will adjust her purchases until the marginal utility of last unit purchased equal to the price of a unit of that product. MU = P, Or, MU/P = 1 Equilibrium for many products: (Equi Marginal Utility) consumers allocate expenditure among products so that equal utility is derived from the last unit of money spent on each commodity. MUx/Px = MUy/Py = -------------- =MUn/ Pn

Utility Maximizing Rule


In general, utility maximizing consumer spread out their expenditure until the following condition holds: (MU x / Px ) = (MU y/ Py) Another View: (MU x / MU y) = (Px / Py)

Consumer Surplus
The concept of consumer surplus was pioneered by
Marshall. According to him, the excess of the price which a consumer would be willing to pay rather than go without a thing over which he actually does pay, is the economic measure of his surplus satisfaction. Thus, consumer surplus can be defined as the difference between what consumers would like to pay for a product and what they actually pay.

Ordinal Utility Theory: Indifference Curve Approach

Assumptions of the Theory


Rationality Utility is Ordinal Consistency Transitivity Non-satiety

What is an Indifference Curve (Equal Utility Curve)


A curve that shows different combinations of two goods yielding the same level of utility (satisfaction) to the consumer Since all points on the curve yield equal satisfaction, the consumer likes equally all the combinations, and is thus indifferent between these combinations.

Bundles Conferring Equal Satisfaction


Bundle
a b c d e f

Clothing
30 18 13 10 8 7

Food
5 10 15 20 25 30

An Indifference Curve
35
Quantity of clothing per week

30 25 20 15 10 5 5

b c

d h T

f I

10

Quantity of food

15

20

25

30

35

An Indifference Map
A set of indifference curves is called an indifference map. The further the curve from the origin, the higher the level of satisfaction it represents.

Properties of Indifference Curve


Indifference curve is downward sloping Indifference curve is convex to the origin ICs can do not intersect each other The further away from the origin an IC lies, the higher the level of satisfaction it denotes

Marginal Rate of Substitution


The marginal rate of substitution of X for Y (MRSx,y ) is defined as the number of units of good Y that must be given up in exchange for an extra unit of goodX so that the consumer maintains the same level of satisfaction. In other words, it shows the rate at which one good is substituted for another good, while remaining on the same indifference curve. Thus, (slope of indifference curve) = -dY / dX = MRS x,y

Budget (Iso Expenditure) Line


A good is demanded by the consumer if he has (i) A preference for that good, and (ii) purchasing power to buy the good. His preference pattern is represented by a set of ICs, His purchasing power depends upon his money income and market prices of the goods.

Budget (Iso Expenditure) Line (contd.)


Let the consumer has allocated some money to be spent on goods X and Y, whose prices are Px and Py , then his purchasing power can be represented in terms of a budget equation: Y= Px Qx + Py Qy Budget line Equation Where Y = Income or expenditure on goods X and Y Qx and Qy = Quantity of good X and Y respectively Px and Py = Prices of good X and Y respectively. The budget equation gives us a budget line.

Consumer equilibrium

Income and substitution effect


Substitution Effect:

when the price of any product rises, consumers substitute the product with a low priced product.
Income effect:

change in price of a product has an effect on the purchasing power of the customer. The decrease in the price enables to buy more of the same commodity or some other. Hence, the quantity demanded increases

An Income-consumption Line

Quantity of clothing per week

Income-consumption line

E3 E2 E1 I3 I2 I1 0 Quantity of food per week

The Price-consumption Line

a Price-consumption line E1 E2 E3

Quantity of clothing per week

I3 I2 I1 b c Quantity of food per week d