Theory of Consumer Behavior
Underlying Assumptions
Completeness It is assumed that a consumer would be able to state own preference or
indifference between two distinct baskets of goods.
Transitivity This assumption implies that an individual consumer’s preferences are always
consistent.
Non-satiation A consumer is never satiated permanently. More is always wanted; if “some”
is good, “more” of the good is better.
----Utility Analysis
Utility is the satisfaction a consumer derives out of consumption of a commodity.
these can be divided into cardinal utility analysis and ordinal. The cardinal school
believes that utility is quantifiable in units, whereas the ordinal school posits that utility
cannot be measured, rather can be only shown as higher than or less than ranks.
Cardinal Utility
According to cardinalists , utility is a cardinal concept, and we can assign number of utils to
any commodity.
Total and Marginal Utility
Total utility refers to the sum total of utility levels out of each unit of a commodity consumed
within a given period of time.
Marginal utility is the total utility of the additional unit consumed of the commodity.
MU = TU n - TU n-1
Using calculus, we may express marginal utility as: MU = ∂ T U/ ∂Q
Law of Diminishing Marginal Utility
As per the law of diminishing marginal utility, marginal utility for successive units consumed
goes on decreasing
As you consume more and more units of a commodity, total utility would go on increasing,
but only up to a certain point, beyond which, if you continue to consume any subsequent
unit, the total utility will start decreasing
(i) The Unit of Consumption must be a Standard One Too large or too small units would not
validate the law. Thus, in the above example, if Saumil was given a small bite every time,
the law would not hold good.
(ii) Consumption must be Continuous Gap between consumption of two successive units
will invalidate the law. As in our example, if every next sandwich is taken at an interval of
two hours, the utility will not diminish with successive units of consumption because the
need for hunger will remerge.
(iii) Multiple Units of the Commodity should be Consumed In other words, demand for the
commodity should be of a recurring nature. The law normally does not apply to durable
consumer goods like house, cars, etc. Let us change our example to understand this
assumption. Suppose Saumil wants to buy a luxury car. At any point of time, he will not buy
two luxury cars; he may buy a car today and will only like to replace it after substantial
number of years of use. Hence, the law of diminishing marginal utility cannot be explained
in case of durable goods.
(iv) The Tastes and Preferences of the Consumer should Remain Unchanged during the
Course of Consumption You can see that we started our example with the statement that
Saumil has strong liking for sandwiches. If after three sandwiches he is offered cold coffee
which he likes a lot, he may not continue consumption beyond the third unit. Because it is
possible that utility from the fi rst glass of cold coffee for Saumil is equal to nine; thus he
maintains his total utility at 55.
(v) The Good should be Normal and Not Addictive in Nature Many goods like cigarettes,
alcohol etc., are consumed due to addictions, in such cases it is likely that the law does not
set in. Such consumption is governed by compulsive behaviour and does not follow the
rule of rationality.
Law of Equimarginal Utility
As per the law of equimarginal utility, marginal utilities of all commodities should be equal.
Ordinal Utility
Under ordinal utility, it is the ranking of utility that is important, not its magnitude.
Indifference Curve Analysis
An indifference curve is the locus of points which show the different combinations of two
commodities a consumer is indifferent about.
Diminishing Marginal Rate of Substitution
MRS is the proportion of one good that the consumer would be willing to give up for more
of another.
MRS is expressed as the ratio between rates of change in M and N, down the indifference
curve. Thus, MRS =-dN/dM .
consumer Income
If the price per unit of M is P M and that of N is P N , and the income of the consumer is I,
then we can express the budget constraint of the consumer in the form of a budget
equation as:
PMQM+PNQN=I
R, is not attain able
S, is not desirable;
Slope of the budget line = -pm/pn
Consumer’s Equilibrium
Consumer’s equilibrium is at the point where the budget line is tangent to the highest
attainable indifference curve by the consumer, subject to budget constraint.
