Unit 1

Grade 10 economics

Theory of consumer behaviour

Consumer behaviour theory is the study of how people make decisions when they
purchase, helping businesses and marketers capitalize on these behaviours by predicting
how and when a consumer will make a purchase.

 Consumer theory is the study of how people decide to spend their money based on
their individual preferences and budget constraints. A branch of microeconomics,
consumer theory shows how individuals make choices subject to how much
income they have available to spend and the prices of goods and services.
 It is the study of how people make purchase decisions to satisfy their needs, wants,
or desires and how their emotional, mental, and behavioral responses influence the
buying decision.
 Consumer behavior refers to the selection, purchase and consumption of goods and
services for the satisfaction of their wants. There are different processes involved in
the consumer behavior.
 Initially the consumer tries to find what commodities he would like to consume, then
he selects only those commodities that promise greater utility. After selecting the
commodities, the consumer makes an estimate of the available money which he/she
can spend.
 Lastly, the consumer analyzes the prevailing prices of commodities and takes the
decision about the commodities he/she should consume.

The theory of consumer behaviour set out with the following important
assumptions:

 The consumer has a limited income.

 The consumer is assumed to be rational. Given the consumer’s income and the
market price s of the commodities, he/she spends the income on goods and services
that give the highest possible satisfaction or utility.

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  Consumer has relevant information to make a decision, is aware of his/her income,
and is aware of the commodities available and their prices.
1.1. The concept of Utility
 Utility is a term in microeconomics that describes to the incremental
satisfaction received from consuming a good or service. Cardinal utility
attempts to assign a numeric value to the utility of an economic act, while
ordinal utility simply provides a rank ordering.
 Utility is an economic theory that measures the value, happiness, or
satisfaction that someone gets from consuming a product or service.
 From Commodity Point of View:
 Want satisfying power of a commodity.
 From Consumer’s Point of View:
 Psychological feeling of satisfaction, pleasure, happiness or well- being
which a consumer derives from the consumption of a commodity
 Total utility
 Refers the total amount of satisfaction a consumer gets from consuming or
possessing some specific quantities of a commodity (x) at particular time.
 As the consumer consumes more of a good (x) per time period, his/ her total
utility increases. However, there is a saturation point for that commodity
after which the consumer will not be capable of enjoying satisfaction from it.
Therefore, utility decreases as consumer continue consuming on the same
commodity.
 Sum of the utilities derived by consumer from the various units of goods and
services.
i.e.,

 Marginal utility
 Addition to the total utility resulting from the consumption of one additional
unit.

; Where, ∆TU change in total utility, ∆Q=change in Quantity output

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 1.2.2 Measurement of Utility-

Utility can be measured and Utility derived from the consumption of

quantified. goods or services cannot be measured
numerically but can only be ranked in
order of preferences.

Utility derived from a particular

product is independent i.e. Consumer is consistent in ranking
consumption of one product is not
dependent on utility derived from
other products.

Law of Diminishing Marginal Utility The preferences of the consumer is based

and Law of Equi-Marginal Utility on the choice of the products available.
derived from cardinal utility.

1.2.3 Law of Diminishing Marginal Utility

 The law of diminishing marginal utility says that the marginal utility from each
additional unit declines as consumption increases.
 The marginal utility can decline into negative utility, as it may become entirely
unfavorable to consume another unit of any product.
 This law applies to all kinds of consumer goods- durable and non-durable
sooner or later.

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 Assumptions of Law:
 Unit of the consumer good must be a standard one. e.g.- A cup of tea, a bottle of
water (Same Shape & Size)
 The quality of the successive units of goods should remain the same, changes in
the quality of the product may not be helpful in proving the law.
 Consumer’s taste and preference must remain the same during the point of
consumption
 Consumption of goods should be continuous, any long gap in the consumption
will alter the law.
 Mental condition of the consumer must remain normal during the period of
consumption
 The taste and preference of the consumer should remain unchanged during the
period of purchases.
1.3. The consumer Maximization Problem
In microeconomics, the utility maximization problem is the problem consumer’s
face: "How should I spend my money in order to maximize my utility?" It is a
type of optimal decision problem.
A consumer that maximizes utility reaches his/her equilibrium position when the
allocation of his /her expenditure is such that the last birr spend on each
commodity yields the same utility.
Assumptions: Economists have developed the concept of consumer equilibrium
based on the following assumptions:
 The consumer is rational. He/ she aims at the maximization of his /her utility or satisfaction;
 Cardinal measurement of utility is possible;
 If utility is measured in money, the marginal utility of money remains constant;
 The law of diminishing marginal utility operates;
 Consumer income is given and constant;
 Commodity prices given and remain constant.

I. Consumer Equilibrium: The case of one commodity

Let’s assume that the consumer consumes a single commodity, X. the

consumer can either buy X or retain his money income Y. Under these

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 conditions, the consumer is in equilibrium when the marginal utility of X is
equal to its market price (px).
Mathematically, MUx=Px
If MUx > Px , the consumer can increase his/her welfare by purchasing more
units of x, i.e., If MUx > Px, then the consumer will not be at equilibrium and
he continues to purchase the commodity as the benefit gained from the
consumption is more than the cost of the commodity.
Similarly, if MUx < Px, then also the consumer will not be at equilibrium and
he will have to reduce the consumption of the commodity in order to
increase the satisfaction level, till MU becomes equal to the price.

II. The case of more than one commodity

The Law of Diminishing Marginal Utility is applicable only in the case of either one
commodity or single use of a commodity. However, in reality, consumers consume more than
one commodity; therefore, in those cases, the Law of Equi-Marginal Utility is used as it helps
in the optimum allocation of the consumer’s income.

Law of Equi-Marginal Utility also known as the Law of Substitution, Law of Maximum
Satisfaction, and Gossen’s Second Law is based on the Law of DMU; therefore, all of its

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assumptions will apply to the Law of Equi-Marginal Utility also. The Law of Equi-Marginal
Utility, states that a consumer gets maximum satisfaction, when ratios of MU of two
commodities and their respective prices are equal and MU falls as consumption increases.
Suppose, there are two commodities x and y upon which the consumer wants to allocate his
income to attain the equilibrium position. The consumer will be at equilibrium when the MU of
commodities x and y will be equal to their respective prices .

The two necessary conditions to attain Consumer’s Equilibrium in Two Commodities Case
are:

1. Ratio of Marginal Utility to Price is the same in the case of both goods (x and y).

We already know that a consumer consuming a single commodity (say x) will be at

MUx
equilibrium when ¿MUM……………………………………….
Px
………………………………… (1)
Similarly, a consumer consuming another commodity (say y) will be at equilibrium when
MUy
=¿ MUM………………………………………………………………..…………… (2)
Py
By Equating (1) and (2), we get MUx. MUy/Px. Py=MUM

 When Px = Py then the equilibrium condition can be written as MU x = MUy.

2. MU falls as consumption increases.

Another condition required for attaining consumer’s equilibrium in two commodities cases is that the
MU of a commodity must fall as more of it is consumed by the consumer. If the MU of a commodity
does not fall with an increase in its consumption, then the consumer will continue to buy that one
commodity only, which does not happen in reality, and the consumer will never reach at the
equilibrium position.

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Finally, it can be said that a consumer consuming two commodities will be at equilibrium when he
spends his income in a way that the ratios of Marginal Utilities of two commodities and their respective
prices are equal, and as the consumption increases MU falls.

it means that the consumer is getting

more Marginal Utility from commodity x as compared to commodity y. Therefore, the consumer will
purchase more of x and less of y, resulting in a fall in MU x and increase in MU y. The consumer will
continue to purchase more of x till,

, it means that the consumer is getting more Marginal Utility

from commodity y as compared to commodity x. Therefore, the consumer will purchase more of y and
less of x, resulting in a fall in MUy and increase in MUx. The consumer will continue to purchase
more of y till

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In the above graph, MU for commodity x is represented on OY-axis, and MU from commodity y
is represented on O1Y1-axis. Besides, MUx and MUy are the Marginal Utility curves for
commodities x and y, respectively.

The above table and graph clearly show that the consumer will spend the first rupee on
commodity x, which will provide him 26 utils of utility and will spend the second rupee on

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commodity y which will provide him 22 utils of utility. In order to reach the position of
equilibrium, the consumer should buy that combination of goods x and y, when the MU of the
last rupee spent on each commodity (x and y) is the same and MU falls as consumption
increases.

Both these conditions meet at point E when the consumer purchases 4 units of commodity x and
3 units of commodity.

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