1. Consumer Behavior
And
Demand Analysis

2. UTILITY
Utility is a property common to all commodities and services desired by a person
UTILITY is the want satisfying power of a commodity
It is the psychological feeling of satisfaction, pleasure, happiness or well-being which a consumer derives from the consumption, possession or the use of that commodity
Utility varies from consumer to consumer, at different times, places, seasons and under different circumstances

3. MARGINAL UTILITY (MU)
Marginal utility is the utility of last unit or the addition to total utility by the consumption of one additional unit of that commodity
Symbolically,
MUn = TUn – TUn-1
Also, MU = Δ(TU) ΔQ

4. In terms of symbols, we can write AU = TU/Q
Total Utility (TU)
Total utility presents the sum of all the utilities derived from the total number of units.
Average Utility (AU)
Average utility is obtained by dividing total utility by the number of units of the commodity.
In terms of symbols, we can write AU = TU/Q

5. Relation among MU, TU and AU
Number of units
Total Utility (TU)
Marginal Utility (MU)
Average Utility (AU) 1 10 2 18 8 9 3 24 6 4 28 7 5 30 -2 -4

6. Relation among MU, TU and AU
Total utility rises with consumption of additional units of the commodity. However, the increase in TU is not constant, but falls steadily
When the total utility reaches its maximum value, marginal utility becomes zero
This is the point of satiety, the total utility stops rising after this stage

7. DIMINISHING MARGINAL UTILITY
THE LAW OF
DIMINISHING MARGINAL UTILITY
The law states that “as the quantity consumed of a commodity increases, the utility derived from each successive unit decreases, consumption of all other commodities remaining the same.”

8. No. of Units Consumed
Total Utility
Marginal Utility 1 30 2 50 20 3 60 10 4 65 5 -5 6 45
-15

9. Why Does The MU Decrease?
The utility gained from a unit of commodity depends on the intensity of the desire for it. When a person consumes excessive units of a commodity, his need is satisfied by degrees in the process of consumption and the intensity of his need goes on decreasing. Therefore, the utility obtained from each successive unit goes on decreasing.

10. Assumptions:
The unit of the consumer good must be a standard one
The consumer’s taste or preference must remain the same during the period of consumption
There must be continuity in consumption

11. CARDINAL UTILITY APPROACH
Attributed to Alfred Marshall and his followers, is also called the Neo-classical Approach

12. Measurement of Utility
The nineteenth century economists believed that utility was measureable
The consumer was assumed to have cardinal measure of utility
Under this, it is possible to estimate the amounts of utility, which a person derives from various units of a commodity in terms of some quantifiable unit (UTILS)

13. Under this analysis, it is assumed that
One ‘util’ equals one unit of money, and
Utility of money remains constant
In reality, however, absolute or cardinal measurement of utility is not possible. Numerous factors that affect the state of consumer’s mood, which are impossible to determine and quantify. Utility is therefore immeasurable in cardinal terms.

14. ORDINAL UTILITY APPROACH
Pioneered by J.R. Hicks, a Nobel laureate and R.G.D. Allen

15. Activity
On a very hot summer day, while going back home from college, you have the following three options to choose from:
A cold bottle of Bisleri mineral water
A chilled can of Pepsi
A packet of chocolate
You are required to rank them in the order in which you would buy them

16. Ordinal Utility
It is based on the fact that it may not be possible for consumers to express the utility of a commodity in absolute terms
But it is always possible for a consumer to tell whether a commodity is more or less or equally useful as compared to another

17. When we study consumption behavior of consumers, the most important postulate is that the consumers – individuals and households – aim at utility maximization and all their decisions and actions as consumers are directed towards utility maximization

18. Analysis of Consumer Behavior: CARDINAL UTILITY APPROACH
The cardinal utility approach makes the following assumptions:
Rationality: the consumer is a rational being, i.e., he or she buys that commodity first which yields the highest utility and last which gives the least utility
Limited money income: along with utility maximization principle, makes choice inevitable
Maximization of satisfaction
Utility is cardinally measurable

19. Analysis of Consumer Behavior: CARDINAL UTILITY APPROACH (contd…)
Diminishing marginal utility
Constant marginal utility of money
Utility is additive

20. CONSUMER
EQUILIBRIUM

21. A consumer is said to be in equilibrium when he has:
Maximized his satisfaction
Spent his entire income
Attained optimum allocation of expenditure, and
Consumed optimum quantity of each commodity

22. One - Commodity Model
A consumer with certain money income consumes only one commodity ‘X’
Since both, commodity X and his money income have utility for him, he can either spend on commodity X or retain the money as an asset

23. If the marginal utility of commodity X, is greater than marginal utility of money (as an asset), a utility maximizing consumer will exchange money for commodity X
What do you know about the marginal utility of a commodity???
And marginal utility of money???

24. Therefore, the consumer will exchange his money income on commodity X so long as MUx> Px(MUm) The utility maximizing consumer reaches his equilibrium, i.e., the level of maximum satisfaction, where MUx = Px(MUm)

25. Px(MUm) E Px
MU and Price
MUx Qx
Quantity

26. Multiple-Commodity Model : The Law of Equi-marginal Utility
This law states that a rational consumer spends his income on various goods he consumes in such a manner that each rupee spent on each good yields the same MU

27. The consumer will now distribute his income between commodities X and Y, such that
MUx = Px (MUm)
And MUy = Py (MUm)
And, given these conditions, the consumer is in equilibrium where
MUx = 1 = MUy
Px(MUm) Py(Mum)
Suppose a consumer consumes only two commodities, X and Y, their prices being Px and Py

28. According to our assumption, MU of each unit of money (or each rupee) is constant at 1, the equation can be rewritten as MUx = MUy Px Py MUx = Px MUy Py

29. THE LAW OF DEMAND
The law of demand states that the demand for a commodity increases when its price decreases and falls when its price rises, other things remaining constant.

30. The Law of Demand explained
There is an inverse relationship between price and quantity demanded
This law holds under the condition that “other things remain constant”
“Other things include other determinants of demand like, consumers’ income, prices of substitute and complimentary goods, tastes and preferences of consumers, etc.

31. Price per cup of Tea (Rs.) No. of cups of tea demanded per day
Demand Schedule
Price per cup of Tea (Rs.)
No. of cups of tea demanded per day 7 1 6 2 5 3 4
Demand schedule is a series of prices and the corresponding quantities which consumers would like to buy per unit of time

32. Factors behind the Law of Demand
Substitution Effect:
When the price of a commodity falls, prices of its substitutes remaining constant, then the substitutes become relatively costlier. Or, in other words, the commodity whose price has fallen becomes relatively cheaper.
Since a utility maximizing consumer substitutes cheaper goods for costlier ones, demand for the cheaper commodity increases.

33. 2) Income Effect:
When the price of a commodity falls, then the real income of the consumer increases. Consequently, his purchasing power increases since he is required to pay less for a given quantity
Thus, the increase in real income encourages the consumer to demand more of goods and services.

34. Exceptions to the Law of Demand
Expectations regarding further prices
Status goods
Giffen goods

35. Shifts in Demand Curve
When the demand curve changes its position, the change is known as shift in the demand curve Caused by any change that alters the quantity demanded at every price

36. Shifts in the Demand Curve
Price of
Ice-Cream
Cone
Increase
in demand
Decrease
in demand
Demand
curve, D 2
Demand
curve, D 1
Demand curve, D 3
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning

37. Shifts in the Demand Curve
A shift in the demand curve, either to the left or right
Caused by any change (other than price) that alters the quantity demanded at every price
Increase and decrease in demand are associated with non price quantity relationships of demand

38. Reasons for shift in the Demand Curve
Income effect
Substitution effect
Through advertisements, again a substitution effect
Change in prices of a complimentary good
Change in fashion, technology, season, etc

39. Changes in Quantity Demanded
Price of Ice-Cream Cones
A tax that raises the price of ice-cream cones results in a movement along the demand curve. B Rs A Rs D 4 8
Quantity of Ice-Cream Cones

40. Changes in Quantity Demanded
Extension and contraction of demand are associated with the price-quantity relationship of demand
Movement is along the demand curve

41. Analysis of Consumer Behavior
ORDINAL UTILITY APPROACH
Indifference Curve Analysis

42. Assumptions of Ordinal Utility Theory
Rationality: A consumer aims at satisfaction given his income and prices of goods and services
Ordinal Utility: The consumer is only able to tell the order of his preference for different baskets of goods

43. Assumptions of Ordinal Utility Theory
3) Transitivity and consistency of choice:
Transitivity: if a consumer prefers A to B and B to C, he must prefer A to C.
Consistency: if he prefers A to B in one time period , he will not prefer B to A in another period nor will he ever treat them as equal

44. Assumptions of Ordinal Utility Theory
4) Nonsatiety: it is also assumed that the consumer has not reached the point of saturation in case of any commodity. Therefore, a consumer always prefers a larger quantity of all the goods. 5) Diminishing marginal rate of substitution: It is the rate at which the consumer is willing to substitute one commodity (X) for another commodity (Y), so that his total satisfaction remains the same. This rate is given as Dy/Dx. The ordinal utility approach assumes that Dy/Dx goes on decreasing when a consumer continues to substitute X for Y

45. INDIFFERENCE CURVE
It is a locus of points, each representing a different combination of two substitute goods, which yield the same utility or level of satisfaction to the consumer. Therefore, he is indifferent between any two combinations of goods when it comes to making a choice between them When such combinations are plotted graphically, the resulting curve is called indifference curve

46. Marginal Rate of Substitution
The MRS is the rate at which one commodity can be substituted for another, the level of satisfaction remaining the same
For example, MRS between two commodities X and Y, may be defined as the quantity of X which is required to replace one unit of Y, in the combination of two goods, so that total utility remains the same

47. The Diminishing MRS
The quantity of a commodity that a consumer is willing to sacrifice for an additional unit of another goes on decreasing when he goes on substituting one commodity for another

48. A 12 1 --- B 8 2 4:1 C 5 3 3:1 D 4 2:1 E 1:1 Combination Biscuits (Y)
Tea (X)
MRSx,y A 12 1
--- B 8 2
4:1 C 5 3
3:1 D 4
2:1 E
1:1

49. Properties of
Indifference Curve

50. 1. Indifference Curves have a Negative Slope
This implies that
The two commodities can be substituted for each other; and
If the quantity of one commodity decreases, quantity of the other commodity must increase so that the consumer stays at the same level of satisfaction

51. 2. Indifference Curves are Convex to the Origin
The convexity implies:
That the two commodities are imperfect substitutes for one another; and
That the MRS between the two goods decreases as a consumer moves along the indifference curve

52. 3. Indifference Curves can neither Intersect nor be Tangent to each other
The intersection/tangency of two indifference curves, reflects two impossible conclusions:
That two equal combinations of two goods yield two different levels of satisfaction;
That two different combinations – one being larger that the other – yield the same level of satisfaction

53. 4. Upper Indifference Curves Represent a Higher Level of Satisfaction than the Lower Ones
An indifference curve placed above and to the right of another represents a higher level of satisfaction than the lower one

54. Slope of Indifference Curve
Slope of indifference curve = ∆Y = ∆X = MRSx,y
Quantity of Y ∆Y ∆X
Quantity of X

55. BUDGET LINE
AND
SHIFTS IN BUDGET LINE

56. Budget Line
The consumer has a given income which is a constraint to his maximizing behavior
The budget constraint shows that a consumer can choose any bundle as long as it cost less or equal to the income he has, given income and prices of goods

57. Slope of Budget Line
Slope of budget line measures the amount of change in good Y required per unit change in good X along the budget line Slope of Budget Line = Px Py

58. CONSUMER’S EQUILIBRIUM or OPTIMAL CHOICE
Equilibrium is attained when the consumer reaches the highest possible indifference curve given his budget constraint Consumer’s equilibrium point must lie on the budget line and must give the most preferred combination of goods and services

59. Quantity of Y Quantity of X Consumer’s Equilibrium A E Y* IC4 IC3 IC2B X*
Quantity of X

60. Shifts in Budget Line
Change in Price
Change in Income