Consumer Behavior
- It's concerned with the way individuals or consumers behave when faced with the problem of
scarcity. That is, it assesses how individuals try to maximise their levels of satisfaction using
limited resources that they have at their disposal.
-The theory is also the basis of explaining the law of demand, that is, why the demand curve is
downward sloping or why people buy more at a lower price than a higher price.
- Two theories namely cardinalist approach (marginal utility theory) and the ordinalist approach
(indifference curve analysis) are going to be used in explaining consumer Behavior.
Marginal utility / cardinalist Theory
Its a theory that assumes:
(a) utility can be measured using cardinal numbers.
b) The consumer is rational, that is, the consumer would want to maximise total utility, given the
level of prices and income.
Definition of terms
Utility - it is the satisfaction derived from consuming a good.
Total utility (TU) - it is the sum of the utilities derived from all units consumed.
Marginal utility (MU) - it is the additional satisfaction a consumer get from consuming an
extra unit of a good. It declines as a consumer takes successive units of
the same commodity. This is the law of diminishing marginal utility.
MU = change in total utility.
Change in quantity
The law of diminishing marginal utility
- It states that as more and more units of the same commodity are consumed, a consumer
derives less satisfaction from an additional unit of the commodity consumed than the
previous unit. eg when a person is thirsty person the first glass of cold water will
definitely gives her the highest satisfaction. As she takes the second glass, the third and
so on of the glass, they will provide her with declining satisfaction.
The table and graph below are of the utilities an individual derives from drinking Fanta at a party.
Quantity consumed Total Utility (TU) Marginal Utility
(MU)
0 0 -
1 10 10
2 16 6
3 20 4
4 22 2
5 22 0
6 20 -2
The relationship between Total Utility (TU) and Marginal Utility (MU)
.
Utility maximisation by a rational consumer
- A rational consumer who seeks to maximize utility from a limited income should consume
a commodity up to a point where marginal utility from the last dollar spent on the
commodity is equal to the price (P) of the commodity.
i.e. P = MU ( when one commodity is being consumed)
- If MU is greater than the price paid, then the consumer obtains more total satisfaction by
buying and consuming more of the commodity. As he does that MU will converge to the
commodity’s price. If MU is less than P, then the consumer will be making a ‘loss’ on the
last unity consumed, so there will be need to reduce quantity consumed until MU= P.
- When consumer is consuming more than one commodity, the consumer will maximize
utility when ratios of marginal utilities to price per good per last dollar spent on the
last unit of each of the commodities are equal.
MUx =.MUy........=MUz
Px Py Pz
- This is the theory of equi-marginal principle
Example
Assume there are two products an individual is consuming, product X costs $2.00 per
unit and product Y costs $4.00 per unit, and that the individual has an income per period
of $16.00.
Quantity Total Marginal MUx/Px Total utility Marginal MUy/Py
demanded utility of X utility of X of Y utility of Y
1 80 80 40 68 68 17
2 132 52 26 100 32 8
3 152 20 10 128 28 7
4 168 16 8 152 24 6
5 172 8 4 172 20 5
The consumer is in equilibrium when she consumes four units of X and two of product Y. Here
MU/P for both products is the same, 8 for both products, and at this point she is exhausting all
her income of $16.00 and she obtains a higher level of total utility. At the point of equilibrium,
the consumer obtains total utility of 268 utils (80+52+20+16+68+32)
Derivation of the demand curve
Marginal utility can be used in deriving a demand curve. Using information in the table, if the
price of product Y were to fall to $2.00, ceteris paribus, then there would be a new column for
MU/P and a new equilibrium would result.
The consumer would reduce consumption of product X by 1 unit and raise consumption of
product Y by 3 units, hence consuming 3 units of X and 5 units of Y. The fall in the price of
product Y by $2.00 has led to an expansion in demand by 3 units and this can be shown below.
A fall in the price of good Y from $4 to $2 results in an expansion in the quantity demanded
from 2 to 5 units per week and thus showing the demand curve is downward sloping.
