CHAPTER 4

CONSUMER BEHAVIOUR

PREPARED BY: GEYATHIRI GOPI

 DEFINITION OF CONSUMER
BEHAVIOUR

Consumer behaviour refers to the study of

consumer while engaged in the process of
consumption.

Extracted from the book: Principles of Economics, Oxford University

 UTILITY APPROACH

Definition
 ‘Utility’ means the satisfaction obtained from consuming
a commodity.
Two Types of Utility Approach
1. Cardinal Approach
 The cardinal utility theory says that utility is measurable and by placing
a number of alternatives so that the utility can be added.
 The index used to measure utility is called utils.

2. Ordinal Approach
 The ordinal utility theory says that utility is not measurable but it can
be compared.
 Ordinal approach uses the ranking of alternatives as first, second,
third and so on.

Extracted from the book: Principles of Economics, Oxford University

 TOTAL UTILITY AND MARGINAL
UTILITY

TOTAL UTILITY (TU)

The total satisfaction that a person gets from the
consumption of goods and service.

MARGINAL UTILITY (MU)

The additional to total utility as a result of consuming one
more units of the same good or services.

Marginal Utility (MU) = Change in Total Utility

Change in Total Quantity

MU =  TU/  Q

Extracted from the book: Principles of Economics, Oxford University

 LAW OF DIMINISHING MARGINAL
UTILITY

 Definition
The additional benefit which a person derives from a
given increase of a stock of a thing diminishes, other
things being equal, with every increase in the stock
that he already has.
OR
Law of Diminishing Marginal Utility states that as
consumption increases more and more, marginal utility
will be less and less.

Extracted from the book: Principles of Economics, Oxford University

 LAW OF DIMINISHING MARGINAL
UTILITY (CONT.)
TU increases from consumption of 1st unit of apple until the 5th unit of
apples. After the 5th unit of apples, TU will decrease.

Units of Total Marginal

Apples Utility Utility
1 20 20
2 35 15 MU will decrease
3 45 10 and become zero at
the 5th unit of apples
4 50 5 and further
5 50 0 consumption of
6 45 -5 apples will not
satisfy the consumer
7 35 -10 as the MU shows
8 20 -15 negative signs.
Extracted from the book: Fundamentals of Economics, Oxford University
TOTAL UTILITY VS MARGINAL UTILITY (CONT.)

Extracted from the book: Fundamentals of Economics, Oxford University

 LAW OF EQUI-MARGINAL UTILITY
(EMU)

 Definition
The Law of Equi-Marginal Utility (EMU) states
that other things being equal, a consumer gets
maximum satisfaction when he allocates his limited
income to purchase of different goods, where the
marginal utility derived from the last unit of money
spent on each item of expenditure tends to be equal.

 This is also known as conditions for maximum

utility or satisfaction.

Extracted from the book: Principles of Economics, Oxford University

 LAW OF EQUI-MARGINAL UTILITY
(EMU) [CONT.]
Conditions for Equilibrium
For consumer equilibrium, this condition must be fulfilled.
Condition 1: Every ringgit spent on every commodity must
yield the same marginal utility.
Marginal Utility of X = Marginal Utility of Y
Price of X Price of Y
MUx = MUy =… = MUn
Px Py Pn

Condition 2: Total expenditure of all goods must be equal to

the total budget allocated to maximize utility.
P1Q1 + P2Q2 + … + PnQn = Total budget

Extracted from the book: Principles of Economics, Oxford University

 LAW OF EQUI-MARGINAL UTILITY
(EMU) [CONT.]
Quant Product P Product Q Product R
ity
Total MU MUP/PP Total MU MUQ/PQ Total MU MUR/PR
Utilit Utility Utility
y

1 21 4.2 7 7 16 4
2 41 4 13 6 30 3.5
3 59 3.6 18 5 42 3
4 74 3 22 4 50 2
5 85 2.2 25 3 55 1.25
6 91 1.2 27 2 58 0.75
7 91 0 28 1 60 0.5

Extracted from the book: Principles of Economics, Oxford University

 LAW OF EQUI-MARGINAL UTILITY (EMU) [CONT.]

EXAMPLE: Arwin has an income of RM37 and the prices of goods

P, Q and R are RM5, RM1 and RM4 respectively.

Fulfilling condition 1, two combination of goods are obtained:

Combination 1 : 2P, 4Q and 1R
Combination 2 : 4P, 5Q and 3R

Condition 1 : Every ringgit spent on every commodity must yield the

same marginal utility.

Combination 1 : 2P, 4Q and 1R

2(5) + 4(1) + 1(4) = 18
Combination 2 : 4P, 5Q and 3R
4(5) + 5(1) + 3(4) = 37
So, 4 units of Product P, 5 units of Product Q and 3 units of Product R
will be purchased by Arwin.

Condition 2 : Total expenditure of all goods must be equal to the

total budget allocated to maximize utility.

Extracted from the book: Principles of Economics, Oxford University

ORDINAL APPROACH
 Ordinal approach provides alternatives in utility
measurement apart from cardinal utility.
 Ordinal utility is a view of utility measurement based on
the presumption that the satisfaction of wants and
needs is immeasurable and subjective.
 Preferences for goods can be ranked (first, second,
third, etc.) but not measured according to a specific
number or index.
 In this regard, consumers need only specify whether
one good is more or less preferred than another.
 How much more or less a good is preferred is not
important.

Extracted from the book: Fundamentals of Economics, Oxford University

 ORDINAL APPROACH (CONT.)

Definition of indifference curve

 An indifference curve represents all the possible
combinations of two goods which will give the same
level of satisfaction.

Assumptions
1. Scale of preferences
2. Consumers’ preferences are transitivity
3. Rationality
4. Diminishing marginal rate of substitution
5. Concept of ordinal utility

Extracted from the book: Principles of Economics, Oxford University

 ORDINAL APPROACH (CONT.)
An indifference schedule is a list of combination of two
goods that give equal satisfaction to the consumer.

Combinations Good Y Good X

A 12 2
B 6 4
C 4 6
D 3 8
E 2 12

The table above shows all the five combinations, which

will give the equal level of satisfaction.
Extracted from the book: Principles of Economics, Oxford University
 ORDINAL APPROACH (CONT.)
An indifference curve represents all those combinations of
two goods; X and Y which yield the same level of
satisfaction to a consumer.

Extracted from the book: Principles of Economics, Oxford University

ORDINAL APPROACH (CONT.)
An indifference map shows a set of indifference curve.

The higher the indifference curve from the origin, higher

will be the utility. IC3 has the higher satisfaction.
Extracted from the book: Principles of Economics, Oxford University
 ORDINAL APPROACH (CONT.)
 Marginal Rate of Technical Substitution
- Refers to the rate at which one good is substituted for another good.
Combinations Good Y
A 12
B 8
C 5
D 3
E 1
Good X Marginal Rate of
Substitution
1 -
2 4Y : 1X
3 3Y : IX
4 2Y : 1X
5 1Y : 1X

 Characteristics of Indifference Curve

1. Indifference curve slopes downward from left to right.
2. Indifference curve are convex to the origin.
3. Higher indifference curves represent higher level of satisfaction.
4. Indifference curve never intersect each other.
5. Indifference curve does not touch the Y axis or X axis.

Extracted from the book: Principles of Economics, Oxford University

ORDINAL APPROACH (CONT.)

Characteristics of Indifference Curves

(1) Indifference curves do not intersect

(2) Higher indifference curves are preferred to lower

indifference curves
(3) Indifference curves are negatively sloped

(4) Indifference curves are convex to the origin

(5) Indifference curves do not touch the Y-axis and X-axis

Extracted from the book: Principles of Economics, Oxford University

ORDINAL APPROACH (CONT.)

A budget line represents various combinations of two

goods, which can be purchased with a given amount of
money at the given price of each unit.

Extracted from the book: Principles of Economics, Oxford University

 ORDINAL APPROACH (CONT.)
Changes in budget line
1. Change in Consumer’s Income

An increase in consumer’s income will lead to a shift of the budget line

to the right, A1B1
A decrease in consumer’s income will shift the budget line to the left as
represented by A2B2
Extracted from the book: Principles of Economics, Oxford University
 ORDINAL APPROACH (CONT.)
Changes in budget line
2. Change in Price of Good X
Budget Line Budget Line

30 30

25

20 20
Good Y

AB

Good Y
15
A1B1 AB
10 10

5 A1B1
0 0
2 4 6 8 10 12 14 16 18 20 22 24
2 4 6 8 10 12 14

Good X Good X
Good X

Price of good X increase from Price of good X decrease from RM1

RM1 to RM2 and price of good Y to RM0.50 and price of good Y
constant constant
Extracted from the book: Principles of Economics, Oxford University
 ORDINAL APPROACH (CONT.)
Changes in budget line
3. Change in Price of Good Y

Budget Line Budget Line

30 30

25 25

20 20
Good Y

Good Y
15 AB 15 AB

Good
10 Y AB1 Good
10 Y AB1

5 5

0 0
2 4 6 8 10 12 14 2 4 6 8 10 12 14

Good X Good X

Price of good Y increase from Price of good Y decrease from RM0.50

RM0.50 to RM1 and price of good X to RM0.40 and price of good X constant
constant
Extracted from the book: Principles of Economics, Oxford University
ORDINAL APPROACH (CONT.)
A consumer is in equilibrium when he or she is consuming the best possible
combination of two goods with the given amount of income.
At point a, and e, the consumer will
have a lesser satisfaction at IC2
with the same amount of income

Consumer equilibrium is reached when

indifference curve tangent with budget
Line which represents best combination
of two goods with limited income
as point C.

Extracted from the book: Principles of Economics, Oxford University

ORDINAL APPROACH (CONT.)
 INCOME EFFECT
The income effect is defined as the effect on the purchases of the
consumer caused by changes in income with prices of goods
remaining constant.

 PRICE EFFECT
Price effect explains what happens to the consumers’ equilibrium
position when the price of one good changes while the price of
another good and other factors remains constant.

 SUBSTITUTION EFFECT
Substitution effect explains what happens to the consumers’
equilibrium position when the price of both good changes – price of
one rises and price of another falls while other factors remains
constant.
Extracted from the book: Principles of Economics, Oxford University