2. consumer behaviour

7/28/2019 2. Consumer Behaviour

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Consumer

Behaviour


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Learning Objectives

Introduction to Consumer Behaviour Utility Approach

Law of Diminishing Marginal Utility

Law of Equi-Marginal Utility

Indifference Curve Approach

Marginal Rate of Substitution

Price Line

Consumer Equilibrium Income Effect

Substitution Effect

Consumer Surplus


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Law of Demand

Quantity of Ice-Cream Cones21 3 4 5 6 7 8 9 10 1211

3.00

2.50

2.00

1.50

1.00

0.50Priceo

fIce-CreamC

one

0

Demand of a commodityincreases with a fall in its

price

when other thingsremains constant


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What are the other things!?

1. Income of the consumer

2. Prices of Related goods

3. Tastes of consumer

4. Consumer expectations about thefuture


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Assumptions of Law of Demand

Income level should remain same

Tastes of the buyer should not change

Prices of other goods should remain same

No new substitutes for the commodity

Price raise in future should not be expected


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School of Thoughts

Law of demand can be explained with the help ofvarious theories of consumer behavior

Cardinal Utility Approach

Alfred Marshall

Ordinal Utility Approach (Indifference CurveAnalysis)

J.R. Hicks and RGD Allen

Revealed Preference Theory Paul A Samuelson


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Concept of utility

Utility = Value or Usefulness

Measure of Satisfaction that a consumerreceives from consuming a commodity


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The Cardinal Utility Approach

1. The cardinal measurement of utility1. Utility Quantifiable and measurable in terms of

money

2. Additivity of utility1. Utility derived from consuming different

commodities can be added it impliesindependence of utilities of different goods

U = U1(X1) + U2(X2) + . + Un(Xn)

Constancy of marginal utility of money Since money is the measuring rod it must be

constant


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Marginal Utility and Total Utility

Marginal Utility is the increase in totalutility as a result of the consumption ofan additional unit

Glass ofwater

TUin utils

0

1

23

4

5

6

0

7

1113

14

14

13

MUin utils

-

7

4

2

1

0

-1


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Diminishing Marginal utility


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-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Glass of

water

TU

in utils

0

1

23

4

5

6

0

7

1113

14

14

13

Utility

(utils)

Glass of water consumed

Gopals utility from consuming water


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-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Utility

(utils)


TU

Glass of

water

TU

in utils

0

1

2

3

4

5

6

0

7

11

13

14

14

13



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-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Glass of

water

TU

in utils

0

1

23

4

5

6

0

7

1113

14

14

13

MU

in utils

-

7

42

1

0

-1

Utility

(utils)


TU

MU



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-2

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Utility

(utils)


TU

MU


Point of Satiety

MU=0 but +veTU-increasingbut @decliningrate

MU = -ve,TU declines @increasing rate


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Law of diminishing Marginal Utility

The additional benefit which a personderives from a given increase of his

stock of a thing, diminishes with everyincrease in the stock that he alreadyhas

- Alfred Marshall


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Deriving Demand Curve fromLaw of Diminishing Marginal Utility

Quantity of Ice-Cream Cones

21 3 4 5 6 7 8 9 10 1211

MU1

MU2

MU3

MU4

MU5

MU6MarginalUtility

0

Quantity

21 3 4 5 6 7 8 9 10 1211

P1

P2

P3

P4

P5

P6

Price

0


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Exceptions to Law of Diminishing Marginal Utility

Alcoholics More alcohol-more intoxication-more consumption

Money More money greater desire to acquire more

Reading More knowledge by reading different books-not

the same one again and again Hobbies and rare collections

More the collection greater the desire to havemore

Arts Music, arts, drama, more the merrier !


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Equi-Marginal Utility


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A consumer does not spend his incomeonly on one good but on number ofgoods.

Hence law of demand should involvesuch an analysis of choice amonggoods.


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The law of Equi-Marginal Utility statesthat the consumer would distribute hismoney income between the goods insuch a way that the utility from the last

rupee spent on each good is equal


MU of commodity X

Price of X

MU of commodity Y

Price of Y=


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Illustration

Units MU ofX MU ofY

1

2

3

4

5

6

20

18

16

14

12

10

24

21

18

15

9

3

Units MU of X

Price of X

MU of Y

Price of Y

1

23

4

5

6

10

98

7

6

5

8

76

5

3

1

Let Price of X = Rs. 2

and Price of Y = Rs. 3


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Illustration

Units MU ofX MU ofY

1

2

3

4

5

6

20

18

16

14

12

10

24

21

18

15

9

3

Units MU of X

Price of X

MU of Y

Price of Y

1

23

4

5

6

10

98

7

6

5

8

76

5

3

1

Let Price of X = Rs. 2

and Price of Y = Rs. 3

MU of two commodities

are EQUAL


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Limitation of Cardinal Approach

Utility is a mental concept hencemeasurement is subjective.


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In Indifference Curve analysis, consumer comparessatisfaction obtained from different combination of goods.

It is difficult to assign numbers to utility, however, one can rank(good, better, best or bad, worse, worst) the goods in theorder of utility.

Consumer is able to arrange various combinations of goodsand services on a scale ofpreference

Consumer is able to indicate;

- Whether he prefers one commodity bundle to other

- Whether he is indifferent between two commodity bundles.


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Illustration

Combinations

of 2 goods

(Apples andMangos)

Level ofSatisfaction

Order ofPreference

5 apples & 15Mangos

4 apples & 12

mangos

3 apples & 9mangos

Highest

Less than theprevious

Less than theprevious

I

II

III


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Indifference Schedule

It is a list of different combinations of two goodswhich will give equal level of satisfaction to theconsumer

Combination Apples Mangos Level ofSatisfaction

A

BC

D

E

20

1613

11

10

1

23

4

5

I

II

I

I


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0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

Pears

Oranges

Pears

3024

20

14

10

8

6

Oranges

67

8

10

13

15

20

Point

ab

c

d

e

f

g

Constructing an indifference curve


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a

Pears

Oranges

Pears

3024

20

14

10

8

6

Oranges

67

8

10

13

15

20

Point

ab

c

d

e

f

g


0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22



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a

b

Pears

Oranges

Pears

3024

20

14

10

8

6

Oranges

67

8

10

13

15

20

Point

ab

c

d

e

f

g


0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22



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a

b

c

d

ef

g

Pears

Oranges

Pears

3024

20

14

10

8

6

Oranges

67

8

10

13

15

20

Point

ab

c

d

e

f

g


0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

Indifference curve


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0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

0 2 4 6 8 10 12 14 16 18 20 22

a

b

c

d

ef

g

Pears

Oranges

Indifference curve

IC

An indifference map


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0

10

20

30

0 10 20

Unitso

fgoodY

Units of goodX

I1I2

I3

I4

I5

An indifference map


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The Marginal Rate of Substitution of X forY (MRS XY) is defined as the amount ofY that a consumer is willing to give upin order to gain one additional unit of X

and still remain on the sameindifference curve (i.e., at the samelevel ofsatisfaction)

MRSXY= Y/X

Deriving the marginal rate of substitution (MRS)


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0

10

20

30

0 10 206

26

7

Unitso

fgoodY

Units of goodX

a

bY= 4

X= 1

MRS= 4

MRS= Y/X




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0

10

20

30

0 10 20

a

b

Unitso

fgoodY

Units of goodX

26

6 7

d

Y= 4

X= 1

Y = 1

X= 1

MRS= 1

MRS= 4

13 14

9

c

MRS= Y/X



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Properties of Indifference Curve

Indifference curves slope downwards fromleft to right

Indifference curves are convex to origin

Indifference curves do not intersect eachother

Distances of indifference curves from thepoint of origin determine their preferentialorder


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Budget Line (Price Line)


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Mangos

M M1 B

A

N

N1

Ap

ples

Budget Line (Price Line)

A Budget Line shows allpossible combination of 2

goods that the consumer

can buy at a given level of

income and prices of two

goods


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Units of

good X

0

5

10

15

Units of

good Y

30

20

10

0

Assumptions

PX= Rs. 2

PY= Rs.1Budget = Rs. 30

A budget line


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Unitso

fgoodY

Units of goodX

a

Units of

good X

0

5

10

15

Units of

good Y

30

20

10

0

Assumptions

PX= Rs.2

PY= Rs. 1Budget = Rs. 30

Point on

budget line

a

A budget line

0

10

20

30

0 5 10 15 20


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Unitso

fgoodY

Units of goodX

a

b

Units of

good X

0

5

10

15

Units of

good Y

30

20

10

0

Point on

budget line

a

b

Assumptions

PX= Rs. 2

PY= Rs.1Budget = Rs. 30

A budget line

0

10

20

30

0 5 10 15 20


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Unitso

fgoodY

Units of goodX

a

b

c

Units of

good X

0

5

10

15

Units of

good Y

30

20

10

0

Point on

budget line

a

b

c

Assumptions

PX= Rs. 2


A budget line

0

10

20

30

0 5 10 15 20


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Unitso

fgoodY

Units of goodX

a

b

c

d

Units of

good X

0

5

10

15

Units of

good Y

30

20

10

0

Point on

budget line

a

b

c

d

Assumptions

PX= Rs.2


A budget line

0

10

20

30

0 5 10 15 20


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Consumer Equilibrium


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Consumer Equilibrium

The point of consumer equilibrium is the point

where the budget line just touches a particular

indifference curve. This is the point of maximumsatisfaction

Finding the optimum consumption


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Unitsof

goodY

Units of good X

O



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I1I2

I3

I4

I5

Unitsof

goodY

Units of good X

O




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I1I2

I3

I4I5

Unitsof

goodY

O

Units of good X

Budget line




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I1I2

I3

I4I5

Unitsof

goodY

O

Units of good X

r

v

s

u

Y1

X1

t



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Increased Income and Budget Line

Effect of an increase


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UnitsofgoodY

Units of goodX

Assumptions

PX= Rs. 2


Effect of an increase

in income on the budget line

0

10

20

30

40

0 5 10 15 20

Effect of an increase in income on the budget line


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UnitsofgoodY

Units of goodX

Assumptions

PX= Rs. 2PY= Rs. 1

Budget = Rs. 40

Budget

= Rs. 40

Budget

= Rs. 30

16

7

0

10

20

30

40

0 5 10 15 20

m

n


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Income Effect (Income Consumption Curve)

Effect on consumption of a change in income


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UnitsofgoodY

O

Units of good X

B1

p g

I1

a



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I2

UnitsofgoodY

O

Units of good X

B1 B2 I1

p g



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I2

UnitsofgoodY

O

Units of good X

B1 B2 B3 B4 I1

I3

I4

g



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I2

UnitsofgoodY

O

Units of good X

B1 B2 B3 B4 I1

I3

I4

Income-consumption curve


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Price Effect

Effect on the budget line of a fall in the price of good X


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0

10

20

30

0 5 10 15 20 25 30

UnitsofgoodY

Units of goodX

Assumptions

PX= Rs. 2PY= Rs. 1

Budget = Rs. 30



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0

10

20

30

0 5 10 15 20 25 30

UnitsofgoodY

Units of goodX

Assumptions

PX= Rs. 2PY= Rs. 1

Budget = Rs. 30



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0

10

20

30

0 5 10 15 20 25 30

UnitsofgoodY

Units of goodX

Assumptions

PX=Rs. 1PY= Rs. 1

Budget = Rs. 30



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UnitsofgoodY

Units of goodX

Assumptions

PX=Rs. 1PY= Rs. 1

Budget = Rs. 30

B1 B2

a

b0

10

20

30

0 5 10 15 20 25 30

c

Effect of a fall in the price of good X


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0

10

20

30

0 5 10 15 20 25 30

Assumptions

PX= Rs. 2PY= Rs. 1

Budget = Rs. 30

UnitsofgoodY

Units of goodX



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UnitsofgoodY

Units of goodX

Assumptions

PX= Rs. 2PY= Rs. 1

Budget = Rs. 30

B1 I10

10

20

30

0 5 10 15 20 25 30

j



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UnitsofgoodY

Units of goodX

B1 I1

j

Assumptions

PX=

Rs. 1PY= Rs. 1

Budget = Rs. 30

0

10

20

30

0 5 10 15 20 25 30

30



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UnitsofgoodY

Units of goodX

Assumptions

PX=

Rs. 1PY= Rs. 1

Budget = Rs. 30

B1 I1 B2

a

j

0

10

20

30

0 5 10 15 20 25 30

I2

k

30



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0

10

20

30

0 5 10 15 20 25 30

UnitsofgoodY

Units of goodX

B1 I1 B2

a

j

I2

Price-consumption curve

k


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Income Effect and

Substitution Effect

of Normal Good

Income and substitution effects: normal good


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Units

ofgoodY

I3

I5

B1

f

QX1

Units of GoodX



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Units

ofgoodY

I1

I2B2

h

B1

QX1

f

Rise in the priceof good X

Units of GoodX

QX3

Income Effect



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Units

ofgoodY

Substitutioneffect

B1

QX1

f

I1

QX

2

B1a

Substitution effectof the price rise

g

Units of GoodX


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Effect of a rise in income on the

Demand for an Inferior Good

Effect of a rise in income on the demand for an inferior good


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UnitsofgoodY

(norm

algood)

Units of goodX

(inferior good)

O

I1B

1

a



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UnitsofgoodY

(norm

algood)

O

I2

I1B

1

B

2

a

b

Units of goodX

(inferior good)



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UnitsofgoodY

(norm

algood)

O

Income-consumption curve

I2

I1B

1

B

2

a

b

Units of goodX

(inferior good)


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Deriving a demand curve from

a price-consumption curve

Deriving a demand curve from a price-consumption curve


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B1I1

Expenditureon

allo

thergo

ods

Units of goodX

a



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I2

B1 B2I1

Expenditureon

allo

thergo

ods

Units of goodX

a b

Fall in the

price ofX



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I2

B1 B2I1

Expenditureon

allo

thergo

ods

Units of goodX

a b

Further falls in

the price ofX



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B1 B2 B3

I3I2

I1

I4

B4

Expenditureon

allo

thergo

ods

Units of goodX

a b c d

Further falls in

the price ofX



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B1 B2 B3

I3I2

I1

I4

B4

Expenditureon

allo

thergo

ods

Units of goodX

Price-consumptioncurve

a b c d



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B1 B2 B3

I3I2

I1

I4

B4

Expenditureon

allo

thergo

ods

Units of goodX

a Price-consumptioncurve

b c d

Priceofg

oodX

Units of oodX

P1

Q1

a



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B1 B2 B3

I3I2

I1

I4

B4

Expenditureon

allo

thergo

ods

Units of goodX

a Price-consumptioncurve

b c d

Priceofg

oodX

Units of oodX

a

Demand

P1

P2

P3P4

Q1 Q2 Q3 Q4

b

cd


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Consumer Surplus


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When a consumer buys a commodity he pay aprice to the commodity and derivessatisfaction from the commodity.

If the satisfaction he derives from thecommodity is greater than the money hepays for it, then this excess satisfaction iscalled Consumer surplus (Ex: Newspapers,Salt,)

Consumer Surplus = Price Prepared to Pay Actual Price Paid

MU P

Consumer surplus


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MU

P1

Q1O

MU, P

Q

MU P

Consumer surplus


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Total

consumer

expenditureMU

P1

Q1O

MU, P

Q

MU P

Consumer surplus


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Total

consumer

expenditureMU

Total

consumer

surplusP1

MU, P

Actual MoneyPaid

Amount of Money

which consumer is

prepared to pay

2. consumer behaviour

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