THEORY OF COSUMER BEHAVIOUR:UTILITY

Difference between Utility analysis(Cardinal utility) and Indifference Curve

Analysis(Ordinal utility).

Basis Cardinal Utility Ordinal Utility

*Concept It is an objective concept. It is a subjective concept.
*Measurement Utility is measured in ‘Utils’. Utility is ranked based on satisfaction.

Explain the relationship between total and marginal utility with the help of a diagram.
Total utility refers to the total level of satisfaction obtained by the consumer from the consumption of a commodity at
a time.
TUn =MU1+MU2+MU3……MUnth
Marginal utility refers to the net addition made to the total utility by consuming one more unity of a commodity.
MUnth=TUn-TUn-1
Relationship between TU and MU

Unit of Total Utility Marginal Utility

mangoes
0 0 0
1 6 6
2 10 4
3 12 2
4 12 0
5 10 -2
6 6 -4

In figure, units of mangoes are shown along the x-axis and TU and MU are measured along the y-axis .MU is positive and
TU is increasing till third unit. After consuming the fourth unit of mangoes, MU is zero and TU is maximum. This point is
known as point of satiety or the stage of maximum satisfaction. After consuming fifth unit of mangoes, MU is negative and
TU starts falling.
1. Total utility increases at a diminishing rate as marginal utility from each successive unit tends to diminish.
2. When total utility reaches its maximum, marginal utility is zero.
3. When total utility falls, marginal utility becomes negative.

Explain consumers equilibrium in case of a single commodity in terms of cardinal utility approach.
OR
Explain why consumers equilibrium is attained when marginal utility of a product is equal to its price.
Meaning : A consumer purchasing a single commodity will be at equilibrium ,when he is buying such a quantity of that
commodity which gives him maximum satisfaction. To determine the equilibrium point , the consumer compares the price of the
given commodity with its utility. Being a rational consumer, he will be at equilibrium when marginal utility is equal to price paid
for the commodity i.e. MUx=Px.
Statement of the law: The concept of consumer’s equilibrium states that a utility maximizing consumer will be in equilibrium
when he purchases that much quantity of a commodity where marginal utility of the commodity equals its price.

Assumptions:
i) It is assumed that the consumer is rational.
ii) Consumer’s income is given and remains constant.
iii) The law of diminishing marginal utility operates.
iv) The utility approach makes the assumption of cardinal utility.

Explanation of the law: The law can be explained with the help of a table and graph given below:

Units of shirt MU ₹ In
1 700
2 650
3 600
4 550
5 350
figure, MUx curve slopes downward indicating that
marginal utility falls with successive consumption of shirts due to operation of law of diminishing marginal utility.
Price(Px) is a horizontal and straight line as price is fixed at ₹ 600.From the given schedule and diagram it is clear that the
consumer will be at equilibrium at point ‘E’, when he consumes three units of commodity X because at point E, MUx=Px.
He will not consume four units shirt MU of ₹ 550 is less than price paid of ₹600. Similarly, he will not consume two units
of shirt as MU of ₹650 is more than price paid. So it can be concluded that a consumer in consumption of single
commodity will be at equilibrium when MU is equal to its price i.e MUx=Px.

Law of equi- marginal utility

The law says that ‘the consumer maximizing his/her total utility will allocate his income among various commodities in such
a way that marginal utility of the last rupee spent of a commodity is equal’.
MUx/Px=MUy/Py. It is also known as law of substitution, law of maximum satisfaction, and Gossen’s second law.

Indifference curve
Indifference curve is a curve showing different combination of two goods ,
each combination offering the same level of satisfaction to the consumer
so that the consumer is indifferent between all set of bundle. It is also known
as ,’Equal Satisfaction Curve’ or ‘ISO-utility Curve’

Combination Apple(A) Orange(O)

R 1 20
S 2 15
T 3 12
U 4 10
V 5 9

Properties/Characteristics of an indifference curve

1. Indifference Curve always slopes downwards from left to right :
An indifference curve is defined as a curve that gives an equal level of
satisfaction to a consumer at every possible combination. It is possible
when a consumer is willing to sacrifice some quantity of a good to gain
an additional unit of another good. If a consumer is having more of a
good without any fall in another good, the consumer will achieve a
higher satisfaction level instead of equal. This fall in units of one good to gain more of another good gives a
downward slope to the IC.

2. Indifference Curves are always convex to the point of origin : The shape of an indifference
curve is based on the Diminishing Marginal Rate of Substitution. It means that to gain a single extra
unit of a good, a consumer is willing to sacrifice more of another
good. However, there are two extreme scenarios for the shape of an
indifference curve.
a)When two goods are the perfect substitute for each other, the
shape of the indifference curve is a straight line. In this case, the
Marginal rate of substitution is constant. b)When two goods are
perfectly complementary to each other, the shape of the indifference
curve is L-shaped and is convex to the origin.

3. Higher Indifference Curves represent a higher level of

satisfaction: A higher indifference curve represents a higher level of
satisfaction, or we can say that an indifference curve to the right of
another gives more satisfaction as a consumer prefers more goods.

4. Two Indifference Curves cannot intersect each ot her: An

indifference curve consists of different combinations of two goods giving
the same satisfaction level to a consumer. It means that every point on an
indifference curve gives the same satisfaction to the consumer. Also, an
indifference map consists of different indifference curves with different
satisfaction levels in each curve. If two indifference curves intersect with
each other, it would mean that one point on each curve gives the same
level of satisfaction which contradicts the meaning of an indifference map.

5. An Indifference Curve never touches either of the axes : The

indifference curve is based on the assumption that a consumer considers
different possible combinations of two goods and wants both goods. If an
indifference curve touches either of the axes, it would mean that a consumer is
consuming the whole of one good only, which is not possible and contradicts
the assumption. Therefore, an indifference curve never touches either of the
axes.

Assumptions of an Indifference Curve Analysis

i)The first assumption of an indifference curve analysis is that utility is ordinal. It means that the utility gained from
the consumption of a good cannot be measured in cardinal numbers like 1, 2, 3, etc. It is, therefore, measured in
ordinal numbers like 1st, 2nd, 3rd, etc. With cardinal numbers, one can easily compare the different levels of
satisfaction by ranking the preferences.
ii)The consumer consuming the two goods is assumed to be rational. In other words, the basic motive of the
consumer is to maximize his/her satisfaction level through the consumption of two goods.
iii)There are only two goods purchased and consumed by a consumer. It is because a graph has only two axes,
and the representation of two goods will be easy.
iv)The consumer is fully aware and has complete knowledge about the price of both goods in the market.
v)The price of both the goods is already given.
vi)The taste, income and habits of a consumer remain the same all the time.

Indifference Map
Indifference map refers to a set or group or family of indifference curve
each one of which represents a given level of satisfaction. In an
indifference map, indifference curves are parallel and a higher indifference
curve represents higher level of satisfaction.
Marginal Rate Of Substitution
Marginal rate of substitution is the rate at which consumer is willing to substitute one good for another without
changing the level of satisfaction. In other words, it refers to the rate at which the consumer is willing to sacrifice one
good to obtain more units of the other good.
Budget Line
Budget Line is a graphical representation of all possible combinations of two goods which can be purchased with
given income and prices, such that the cost of each of these combinations is equal to the money income of the
consumer. It is also known as Price Line, Price Opportunity Line, Price-Income Line, Budget Constraint Line.
Suppose, a consumer has a budget of 20 to be spent on two commodities: apples and bananas. If apple is priced at 4
each and banana at 2 each, then the consumer can determine the various combinations(bundles), which form the
budget line.
Combinatio Apple Banana Money
n Spent=Income
E 5 0 (5*4)+(0*2)=20
F 4 2 (4*4)+(2*2)=20
G 3 4 (3*4)+(4*2)=20
H 2 6 (2*4)+(6*2)=20
I 1 8 (1*4)+(8*2)=20
J 0 10 (0*4)+(10*2)=20

It is drawn on the assumption that:

(a) Money income of consumer is fixed. (b) The prices of two commodities are given.
It is a negatively sloped line because if the consumer wants to purchase more amount of one commodity,
he has to sacrifice some amount of the other commodity because his money income is fixed.
The main properties of budget line are: i) Budget line has a negative slope, i.e, it slopes downwards
as more of one good can be bought by decreasing some units of the other good.
ii)The slope of budget line is represented by the Price Ratio.

Consumers equilibrium using indifference curve analysis/ ordinal utility approach.

OR
Why does the consumer choose a point where the indifference curve is tangent to the budget
line.
A consumer is said to be in equilibrium when he has derived maximum satisfaction and does not want
to change his consumption level. Hence, Consumer’s Equilibrium is a situation in which a consumer
has maximum satisfaction with limited income and does not tend to change his existing way of
expenditure.
The point of equilibrium or maximum satisfaction is achieved by the study of the indifference
map and budget line together. An indifference map represents every possible indifference curve that the
consumer has, which helps in ranking their preferences. The combination of goods on the higher
indifference curve gives a higher satisfaction level to the consumer. Therefore, the highest of the
indifference curves of an indifference map is preferred by a consumer.
Conditions of Consumer’s Equilibrium
Consumer’s equilibrium can be achieved with the help of indifference curve theory only after meeting the
following two conditions:
i)MRSXY = Ratio of Prices or Px/Py
ii)MRS continuously falls: Another condition for consumer’s equilibrium is that the Marginal Rate of
Substitution (MRS) at the equilibrium point must be diminishing. In simple terms, at the point of
equilibrium, the indifference curve must be convex to the origin. Also, one cannot achieve the
equilibrium point, unless the Marginal Rate of Substitution (MRS) falls.
After fulfilling both the above-mentioned conditions, a consumer is said to be in equilibrium.

In the given figure, IC1, IC2, and IC3 are three indifference
curves, and AB is the budget line. The highest indifference
curve that a consumer can reach with the budget line’s
constraint is IC2. The budget line AB is tangent to the
indifference curve IC2 at point E. This point is the point of
equilibrium, where the consumer buys OM quantity of Good X
and ON quantity of Good Y.The other points, i.e., F and G to
the left or right of point E lie on the lower indifference curve
IC1, indicating a lower level of satisfaction. Also, as the budget
line can be tangent to only one indifference curve, the
consumer maximises his level of satisfaction at point E when
he meets both conditions of the consumer’s equilibrium.