Consumer Behaviour

The principle assumption upon which the theory of consumer behaviour and demand is built is:

A consumer attempts to allocate his/her limited money/resources among available goods and services so as to maximize his/her utility (satisfaction).

Utility Concepts

Cardinal utility assumes that we can assign values for utility.

Example

Derive 100 utils (theoretical unit for utility) from 
eating a slice of bread

The overall level of satisfaction derived from consuming a good or service.

Additional satisfaction that an individual derives from consuming an additional unit of a good or service.

\[ \text{MU} = \frac{\text{Change in total utility}}{\text{Change in quantity}}\]

\[ \implies \frac{\Delta \text{TU}}{\Delta Q} \]

Law of Diminishing Utility (Return) states that as more and more of a good are consumed , the process of consumption will (at some point) yield smaller and smaller additions to utility.
When the total utility maximum , marginal utility = 0
When the total utility begins to decrease , the marginal utility = negative (-ve)

Example

So far , we have assumed that any amount of goods and services are always available for consumption.
In reality , consumers face constraints (income and prices).
Consumer's objective is to maximize his/her utility subject to income constraint.
Suppose there are 2 goods \(X\) and \(Y\) with fixed prices \(P_X\) and \(P_Y\). Then consumer will reach an equilibrium when the ratio of marginal utlity to the prices is equal.

\[ \frac{MU_X}{P_X} = \frac{MU_Y}{P_Y} \]

Similarly , when the ratio is higher for a good than the other , then the consumer will prefer former.

\[ \frac{MU_X}{P_X} > \frac{MU_Y}{P_Y} \]

In this case consumer will prefer \(X\) more than \(Y\).

Example

Raj wants to eat a pack of biscuits. Raj goes to a nearby corner shop and sees there are only 2 option available Parle-g and Tiger. Both of them have the same price and same weight.

In this case Raj might buy a smaller pack of both or a bigger pack of either of them as , Raj gets an equal amount of utility from both Parle-g and Tiger.

Another scenario might be that Raj likes Parle-g more than Tiger so Raj will buy Parle-g biscuit as it gives him more utility.

Utility is measurable in an ordinal sense
Ordinal utility approach - does not assign values , instead works with a ranking of preferences.
The utlity derived from consuming a good , such as \(X\) , is a function of the quantities of \(X\) and \(Y\) consumed by a consumer.

\[ U = f(X,Y)\]
The ranking of goods according to TUO is done with the help of Indifference Cruves (IC). These curves are representations of combinations of items when the consumer is in an indifferent situation , i.e. certain combinations of goods will give the consumer the same level of satisfaction.
In general consumers tend to move to higher IC curves within their budget constraint.

Example

Downward Sloping from left to right: This shows increase in quantity of certain good.
Convex to the origin: the marginal rate of substitution (MRS) decreased. MRS = Quantity of goods \(Y\) willing to substitute to obtain one unit of goods \(X\) & this substitution is to maintain its position at the same level of satisfaction.

Example

Buying 5 Cadburry DairyMilk or getting 1 Premium Dark Chocolate.
Do not cross (intersect): Consumer preferences transitive.
Different ICs show different level of satisfaction : The farther the curve from origin , the higher the satisfaction.