Micro Economics

(Consumer Behavior. Utility and Measurement of

Utility)

by

DR. MUHAMMAD SARWAR ZAHID

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Consumer Behaviour

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Who is a Consumer ?
Any individual who purchases goods
and services from the market for
his/her end-use is called a consumer.

In simple words a consumer is one who

consumes goods and services
available in the market.

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What is consumer Interest ?
Every consumer shows interest towards particular
products and services.

Consumer interest is nothing but willingness to

purchase products and services as per their

 taste

 need and of course

 pocket.
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Consumer Behavior is the study of individuals,
groups, or organizations and the processes they select, secure,
use and dispose of products, services, experiences, or ideas to
satisfy needs and the impacts that these processes have on
the consumer and society.

- It attempts to understand the decision-making processes of

buyers, both individually and in groups such as how emotions
affect buying behaviour.

- It also tries to assess influences on the consumer from groups

such as family, friends, sports, reference groups, and society in
general to buy different products

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What is Consumer Behavior ?
Consumer Behavior is a branch which deals with the various
stages a consumer goes through before purchasing products
or services for his end use.
Why do you think an individual buys a product ?
- Need
- Social Status
- Gifting Purpose
Why do you think an individual does not buy a product ?
- No requirement
- Income/Budget/Financial constraints
- Taste
When do you think consumers purchase products ?
- Festival
- Birthday
- Anniversary
- Marriage or other special occasions 6
In a layman’s language consumer behavior deals with
the buying behavior of individuals.

Consumers purchase products and services as and

when need arises.

According to one economist, whenever need arises; a

consumer searches for several information which would
help him in his purchase.

Following are the sources of information:

- Personal Sources
- Commercial Sources
- Public Sources
- Personal Experience 7
Buying decisions of consumers also depend on
the following factors:
- Messages, advertisements, promotional materials, selective
exposure.
-Not all promotional materials and advertisements excite a
consumer. A consumer does not pay attention to everything he
sees. He is interested in only what he wants to see. Such
behavior is called selective exposure.
Consumer interpretation refers to how an individual
perceives a particular message.
- A consumer would certainly buy something which appeals him
the most.
- He would remember the most relevant and meaningful
message also called as selective retention.
-He would obviously not remember something which has nothing
to do with his need.
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 Reasons for Studying Consumer
Behavior
• To stay in business for attracting and
retaining customers
• To benefit from understanding consumer
problems
• To establish competitive advantage
At the End
The study of consumer behavior explains
as:

• Why and why not a consumer buys a

product

• When a consumer buys a product ?

* How a consumer buys a product ?

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 UTILITY
• Background:
The concept of utility was introduced for
the first time by “WILLIAM STANLEY JEVONS” (1834-
1882) of great Britain.

“utility is a subjective concept on the basis of which

people demand a commodity”.
 Utility
• Definition:
Utility
may be defined as the “amount of
satisfaction derived from a commodity or service at
a particular time”.

• Meaning:
Utility may not be confused with
usefulness as it is purely subjective satisfaction
derived from the consumption of a commodity.

 Example: water has the ability to lower the thirst, pen

has ability to write.
 Characteristics of Utility

• Dependent upon human wants.

• Immeasurable.
• Utility depend upon use.
• Utility depends upon shape.
• Utility depends upon knowledge.
• Utility depends upon ownership.
 Concepts of Utility
• Initial Utility- Satisfaction Derived from very first unit
consumed of any object.

• Total Utility – Total Satisfaction derived from the

product.

• Marginal Utility- The word Marginal means “Border” or

“Edge”.
It is the addition made to the total utility by
consuming one more unit of a commodity.
• Relationship between Total Utility, and Marginal Utility.
Cardinal Approach VS
Ordinal Approach
Cardinal Utility Analysis VS Ordinal Utility Analysis

Utility Analysis

Cardinal Utility analysis Ordinal Utility Analysis

• Alfred Marshal • J. R. Hicks & R.G.D. Allen

• can be measured •Cannot be measured but
• Units are „Utils‟ compared as rank
• Law of Diminishing • Indifference Curve
Marginal Utility analysis
•Law of Equi-marginal Utility
 CARDINAL AND ORDINAL UTILITY

 Cardinal Utility: The numbers 1, 2, 3, 4 are cardinal

numbers. For example the number 2 is twice the size
of 1. In the same way, the number 4 is four times the
size of number 1.

 According to cardinal approach, utility can be

measured.

 The exponents of the utility analysis have developed two

laws which occupy a very important place in economics
theory and they are :-
 Law of Diminishing Marginal Utility
 Law of Equi-Marginal Utility
 Law of diminishing marginal utility

• “The additional benefit which a person

derives from a given increase of his
stock of a thing diminishes with every
increase in the stock that he already
has.”
 Law of diminishing marginal utility

• Statement:
“If other things do not change and a
consumer increases the use of a commodity, the
utility of every new unit of the commodity will be
less than the utility of the previous unit.”
e.g. Drinking glass of water continuesly, 1st
glass, 2nd glass ……….
 Diagram & Table Explanation

The Law of Diminishing Marginal X Units Total Marginal

Utility Utility
35
Utility

30

25
TU 1 10 -
Total/Marginal Utilities

20
2 18 8
3 24 6
15

10

5 4 28 4
5 30 2
0

-5
1 2 3 4 5 6 7 MU
X goods
6 30 0
7 28 -2
Law of Diminishing Marginal
Utility
Assumptions:
• All the units of a commodity must be
same in all respects.
• The unit of the good must be standard.
• There should be no change in taste
during the process of consumption.
• There must be continuity in
consumption.
• There should be no change in the price
of the substitute goods.
 Law of Diminishing Marginal
Utility
Exceptions:
Money
Hobbies
Rare Things
Liquor
Music
Things of Display
 The Law of Equi Marginal Utility
DEFINTION:

 The law of equi marginal utility explains as to

how a consumer distributes his limited income
among various commodities.

 Consumer will spend his income in such a way

that the last rupee spent on each of the
commodity gives him the same marginal utility.
 THE LAW OF EQUI MARGINAL UTILITY
Units Mux Muy
1 16 14

2 12 10

3 10 6

4 8 4

5 6 2
 Exceptions of law:
• Fashion
• Ignorance
• Indivisible
• Time Factor
Meaning of Ordinal Utility analysis and its
assumptions

• Ordinal means- Can be compared with each

other- 1St , 2nd , 3rd etc.
• Ordinal Utility analysis - Utility can compared
but can not be measured.
• The tool of Indifference curve approach are
used for utility analysis
 ORDINAL UTILITY

 The numbers 1st, 2nd, 3rd, and 4th, are

ordinal numbers. These ordinal numbers
are ranked.

This ranking does not explain the actual size

relation of the numbers. The second one
might or might not be twice as big as the first
one.
The Indifference Curve:
An indifference curve is the locus of infinite
combinations of two commodities which yield the
same total utility to the consumer.

The consumer should be able to say whether

Combination A is preferred to combination B
Combination B is preferred to combination A. or
Both combinations are equally preferred

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 Assumption of Ordinal Utility Analysis or
Indifference Curve approach

1. Consumer is rational :
Consumer’s Objective is maximization of utility, subject to Price and
consumption expenditure
2. Utility is ordinal:
Utility can be ranked according to the satisfaction or utility of each
basket.
3. Consistence in choice :
if the consumer prefers combinations of A of good to the combinations
B of goods, he then remains consistent in his choice.
If A > B, then never become B > A
 Conti….

4. Consumer‟s Preference is Transitive:

A is preferred over combination B is preferred over C, then combination A is
preferred over combination A is preferred over C.
If A > B and B > C, then A > C
7. A Larger bundle of goods is preferred to smaller bundle
 USES OF INDIFFERENCE CURVES
• Explaining the theory of Index Numbers: (Index
number indicates the changes in the price level,
and thus enables us to compare the standards
of living in two different periods or situations.)
• Explaining changes in tastes and preferences:
• Measurement of Consumer’s Surplus
• Determination of the rate of exchange
• Determination of the tax policy:
• Explaining the effects of subsidies:
• Explaining the effects of Rationing:
Indifference Schedule :

• Indifference schedule is a list of various

combinations of commodities which are equally
satisfactory to the consumer concerned.
 Indifference Schedule:

Combinations Apples Mangoes

A 15 1

B 11 2

C 8 3

D 6 4

E 5 5
 Indifference curve (IC) shows all possible
combinations of apples and mangoes between which a
person is indifferent. Point A shows consumption bundle
consisting of 15 apples and one mango. Moving from point
A to Point B, we are willing to give up 4 apples to get a
second mango (total utility is the same at points A and B).
16
A
14

12
B
10
Apples

C
8
D
6 E
IC
4
2

0
0 1 2 3 4 5 6
Mangoes
Since each of the alternative bundles
of goods yields the same level of
utility, the consumer is indifferent
about which combination is actually
consumed

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 Indifference Map
A graph showing a whole set of indifference curves is
called an indifference map. All points on the same curve
give equal level of satisfaction, but each point on higher
curve gives higher level of satisfaction.

25

20

15
Apples

10
IC3
5
IC2
IC1
0
0 1 2 3 4 5
Mangoes
Properties of indifference curves :

• Indifference curves are negatively sloped

Given a combination of commodity X and commodity Y, with every
increase in X, the amount in Y should fall in order that the level of
satisfaction from every combination should remain the same.

• Indifference curves are convex to the origin

Convexity illustrates the law of diminishing marginal rate of substitution.

• Indifference curves can never intersect each other

Indifference curves can never intersect each other because each
indifference curve represents a specific level of satisfaction. If two
indifference curves intersect each other, then at the point of
intersection, the consumer is experiencing two different levels of utility.
 Budget constraint line or the Price line

• A consumer would like to go to the highest indifference

curve to gain maximum satisfaction. However, in the real
world, the power of decision making is confined to the
given constraints of the consumer.
A. The constraints are :
(i) given money income,
(ii) price of commodity X,
(iii) price of commodity Y.
There may be a number of combinations of X and Y which
can be purchased by the given budget constraint. A
budget or price line is an illustration of the various
combinations of two commodities (X and Y) which can
be purchased by the given money income
 Consumer Equilibrium

• Consumer equilibrium occurs where

the slope of the indifference curve is
equal to the slope of the budget line

• Here the absolute value of the slope

of the indifference curve is the
marginal rate of substitution, and the
absolute value of the slope of the
budget line equals the price ratio
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 Summary
• The indifference curve indicates what the
consumer is willing to buy

• The budget line shows what the consumer

is able to buy

• When the indifference curve and the

budget line are combined, we find the
quantities of each good the consumer is
both willing and able to buy

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Consumer Equilibrium
A consumer seeks a market basket that generates the maximum
level of happiness. However, one’s money income and prices of
goods imposes a limit on the level of satisfaction that one may
attain. Thus, the income at the disposal of the consumer in
conjunction with prices of the commodities will determine the
budgetary constraint or the price line.

14

12

10
Apples

8
E
6 IC
4
Price Line
2

0
0 5 10 15 20
Mangoes
• Consumer equilibrium is attained when, given his budget constraint,
the consumer reaches the highest possible point on the indifference
curve. The maximum satisfaction is yielded when the consumer
reaches equilibrium at the point of tangency between an indifference
curve and the price line. At point E, the price line is tangent to the
indifference curve.

• At the equilibrium point, slope of indifference curve = slope of price

line

• slope of indifference curve = MRS

• slope of price line = PX / PY

• Thus, at point E, MRS = PX / PY

• Thus, satisfaction is maximized when the marginal rate of

substitution of X for Y is just equal to the price of X to the price of Y.
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