Theory of consumer behavior

- Concept of total, Average and Marginal Utility

- Law of diminishing marginal utility.
- Law of substitution
- Consumer surplus

Introduction
The concept of utility was first propounded by the economist Benham in 1789, Stanley Jevons (Austrian
economist) in 1871. The utility means wants satisfying power of a commodity.
Consumers demand good or service because it has certain properties which fulfills their desire (wants). This
want satisfying power of good is called utility. It is not related to harmful or useful good but only related to the good
that fulfills desire. For example: someone drinks tea early in the morning and someone smokes cigarette. Both the
commodity tea and cigarette fulfill consumer’s desire. So, both the commodities have utility. In other words it does
not concern harmful or useful things. In economics, it is assumed that consumer is always rational and he/she tries to
maximize utility under the income constraint.
In this theory we study about the consumers’ behaviour (how the consumers demand good and services). The
study of consumer behaviour is divided into two concepts. They are- Traditional concept and Modern concept. The
traditional concept is developed by classical economist like Alfred Marshall, A.C. Pigou etc. According to this
concept utility is measurable. In this section we concentrate about this method. Similarly, according to modern
concept, utility is not measurable because it is a psychological phenomena of the consumer. So, it differs from
person to person.
Utility is related to consumption of goods and services. We consume goods and services which satisfy our
wants. Therefore, utility is defined as the capacity of commodity to satisfy human wants. According to Marshall,
“Utility is the measure not of usefulness, not of satisfaction, but of the intensity of desire”.
Similarly, According to Prof. Hibdon, “Utility is the ability of a commodity to satisfy a want.”
Utility is subjective concept. Therefore, different person gets different level of utility from the same
commodity under same time. Utility has nothing to do with usefulness or harmfulness, morality or immorality but
simply refers to want satisfying power of human beings. For example: Alcohol is harmful for health but it satisfies
human wants.
Total and Marginal Utility
The concept total and marginal utility analysis is based on traditional concept of utility (cardinal utility
analysis). According to cardinal utility analysis, utility can be measured in number. It is based on following
assumptions.
 Consumer is rational.
 Utility is countable.
 Marginal utility of the commodity diminishes.
 Marginal utility of money is constant.
 Prices and income is given (fixed).
Total utility (TU)
The utility which a consumer obtains by consuming all units of a commodity in certain time period is known
as total utility. In other words, it is the sum of marginal utility. If a consumer consumes n units of a commodity total
utility can be written as-
TU = Ux1 + Ux2+ Ux3+ …. + Uxn
TU = ∑Ux
Where,
TU= total utility of the consumer
 Ux1= utility obtained from first unit of the commodity
Ux2= utility obtained from second unit of the commodity
Ux3= utility obtained from third unit of the commodity
…………………………………….. ……….
Uxn = utility obtained from nth unit of the commodity
∑ = sum of utility

Marginal Utility (MU)

The utility which consumer obtains by consuming extra unit of the commodity (one more commodity) is
known as marginal utility. In other words, marginal utility is the change in total utility by consuming one more unit
of the commodity.
Symbolically
MU = ∆TU/ ∆X
Where,
MU = marginal utility
∆TU = change in total utility
∆ X = change in consumption unit of x commodity
This is explained with the help of following table and diagram.
Units of a comodity Marginal utility Total utility
1 10 10
2 8 18
3 6 24
4 4 28
5 2 30
6 0 30
7 -2 28

Above table shows the relationship between consumption of commodity and marginal utility. When a
consumer consumes first unit of a commodity, he/she obtains 10 utils of utility. Again if he consumes second unit,
utility obtained from that unit is 8 utils. Similarly, if the consumer consumes successive units (more unit of a
commodity) marginal utility decreases continuously. If consumer consumes 6th unit of the commodity, he /she
obtains 0 marginal utility. This is the equilibrium point of the consumer. It is also called maximum satisfaction
point.
In the case of total utility, it increases at decreasing rate up to the consumption of 6th unit of commodity.
After then it starts to decline.
This is shown in the following figure.
 Figure (A) shows the total utility curve, which is in increasing trend at decreasing rate up to point K.
Thereafter it starts to decline because when consumer consumes more than 6 units of commodity marginal utility
becomes negative. At point K consumer obtains highest utility and it is the point of satisfaction of the consumer.
Figure (B) shows the marginal utility of the consumer which has negative slope. It indicates that when consumer
consumes more units of a commodity marginal utility obtained form that unit decreases successively. In figure (B),
marginal utility curve is positive up to the point where consumer consumes six unit of the commodity. After then it
is negative. It indicates that if consumer consumes more than six units he does not obtain utility from that
commodity. It negatively affects him. However, rational consumer does not consume more than six units.

Law of Diminishing Marginal Utility

The law of diminishing marginal utility theory was developed by a German economist Herman Henerich Gossen
in 1854. So it is also known as first law of Gossen. Later it was reformulated by Alfred Marshall. According to Marshall,
“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.” Utility is the measure not of usefulness, not of satisfaction, but of the intensity of desire”.
According to law of diminishing marginal utility, other things remaining the same; utility obtained from
every additional unit of commodity decreases. In other words if consumer consumes more and more unit of
commodity utility obtained from that commodity decreases but total utility of the consumer increases in decreasing
trends. Marginal utility of the commodity decreases due to following two reasons.
i. Human wants are unlimited, only single want is fulfilled.
ii. Goods are not perfect substitutes to each other.
According to Thomas, “The utility of additional supplies of commodity diminishes with every increase in a
variable stock of it more over, total utility increases but a at diminishing rate, until eventually any further
increments of a commodity may even have disutility.”
When consumer consumes more units of a commodity at the same time consumer reaches to the point of
satisfaction. This situation is called consumer's equilibrium point. In this situation, marginal utility obtained from
that commodity is zero. If the consumer consumes more unit of a commodity than this level, consumer obtains
negative marginal utility and total utility starts declining. This is explained with the help of following table and
graphs.
Units of a comodity Marginal utility Total utility
1 10 10
2 8 18
3 6 24
4 4 28
5 2 30
6 0 30
7 -2 28

Above table shows the relationship between consumption of commodity and marginal utility. When a
consumer consumes first unit of a commodity, he/she obtains 10 utils of utility. Again if he consumes second unit,
utility obtained from that unit is 8 utils. Similarly, if the consumer consumes successive units (more unit of a
commodity) marginal utility decreases continuously. If consumer consumes 6th unit of the commodity, he /she
obtains 0 marginal utility. This is the equilibrium point of the consumer. It is also called maximum satisfaction
point.
In the case of total utility, it increases at decreasing rate up to the consumption of 6th unit of commodity,
thereafter it starts to decline.
 Figure (A) shows the total utility curve, which is in increasing trend at decreasing rate up to point K.
Thereafter it starts to decline because when consumer consumes more than 6 units of commodity marginal utility
becomes negative. At point K consumer obtains highest utility and it is the point of satisfaction of the consumer.
Figure (B) shows the marginal utility of the consumer which has negative slope. It indicates that when consumer
consumes more units of a commodity marginal utility obtained form that unit decreases successively. In figure (B),
marginal utility curve is positive up to the point where consumer consumes six unit of the commodity. After then it
is negative. It indicates that if consumer consumes more than six units he does not obtain utility from that
commodity. It negatively affects him. However, rational consumer does not consume more than six units.
Exceptions/ Limitations of Law of Diminishing Marginal Utility
Law of diminishing marginal utility states that, when consumer consumes more and more units of same
commodity at the particular point of time, utility obtained from additional unit of the commodity decreases
continuously. But it does not hold true for all cases. This is explained below.
1. Irrational consumer
This theory assumes that all the consumers are rational. But in reality most of people are irrational because
they use their income without thinking.
2. Cardinal utility
This theory is based upon cardinal (countable) utility. According to this concepts, utility is measurable. But
utility is a psychological phenomena. So, it differs from person to person and it is not possible to measure in
exact number.
3. Indivisible commodity
This theory is applied only for divisible (homogeneous) goods. But in real life there are so many indivisible
(non-homogenous) goods. For example- Refrigerator. In the case of refrigerator this theory is not applicable
because deviding it into small pieces has no utility.
4. Marginal utility of money changes
This theory also assumes that marginal utility of money remains constant. But, in reality it changes with
change in income level.
5. Change in income, fashion and habit of the consumer
This theory is also not applied in the case of change in income, fashion, and habit of the consumer. If income
of the consumer increases, marginal utility of that commodity increases and vice-versa. Similarly, in the case
of good of new fashion marginal utility increases.
6. Does not apply in rate and curious goods
People are interested to collect those goods which are hardly available in the market like old coins, rare paintings,
diamonds, rhino horn, elephant tusk etc. Collection of such goods give more pleasure to the interested person.
Therefore, the law does not apply to the collection of rare and curious things.
7. Does not apply to the habitual goods
 The habitual goods which are not essential to sustain the human life but used to fulfill the emotion of some
consumer is defined as habitual goods. The examples of such goods are cigarette, drugs, wine, alcohol etc.
The law of diminishing marginal utility does not apply to such goods because consumer gets higher
satisfaction when he consumes more and more units of such goods.
8. Does not apply to the basic goods
The law of diminishing marginal utility fails even to basic goods. The marginal utility derived from basic
goods such as air, sunlight, cloths etc do not diminish from their additional unit of consumption.
9. Does not apply to the goods of entertainment
The law of diminishing marginal utility does not apply to the goods of entertainment like CD, VCD, DVD, TV
and computer etc.
[

Importance of Law of Diminishing Marginal Utility

The law of diminishing marginal utility is useful for human life. Its importance is explained below.
1. Basis of various laws of economics
The law of diminishing marginal utility is the basis of various laws like law of demand, law of equi-marginal
utility, concept of elasticity of demand, concept of consumer’s surplus, etc.
2. Basis of price determination
The concept of marginal utility helps to determine the price of goods and services. The rational consumer
buys goods and services at the price which is just equal to the marginal utility that would arise from the
commodity. If the utility from a commodity declines among the consumer, sellers reduce price in the same
proportion to ensure the sales. Therefore, the law of diminishing marginal utility is the guideline to business
firm to set price of the commodity.
3. Guideline to finance minister
The law of diminishing marginal utility serves as a guideline to finance minister while making the fiscal
policy of a nation. It is because the value of money and wealth to rich people goes on declining to every
addition of them. So, finance minister can impose higher tax rates on rich people. On the other hand value of
money and wealth to poor ones become higher and higher to every addition of them. So finance minister
imposes the lower tax to such people. It is known as progressive tax. Therefore higher tax rates are imposed
on the rich and lower tax rates on poor. The progressive tax depends upon the law of diminishing marginal
utility which provides guidelines to the finance minister.
4. Guideline in households expenditure
The households want to achieve maximum satisfaction from the expense made on various items of basic
needs. Suppose a households has limited budget to spend on various household needs. If he/she spends total
budget in one commodity, the utility from the particular commodity will be less and less and will have no
budget to spend on other most essential commodities. So, to get maximum satisfaction, a person has to
allocate total budget on many of basic needs which will provide equal-marginal utility.

Law of Substitution
Law of substitution is the other concept to deal with the behaviour of the consumer. The law of substitution
was also developed by H.H. Gossen in 1854. It is often known as the second law of Gossen. This law states that
consumer substitutes one commodity in the place of other commodity, which gives higher utility. The consumer
allocates his/her money income in such a way that he/she maximizes his utility. According to this law, consumer is
in equilibrium when marginal utility of money expenditure on every commodity is equal to marginal utility of that
commodity.
MUx MUy MUN
i.e. = =… = MUM
Px Py PN
Where, MUx, MUY, ... and MUN are marginal utility of commodity of X, Y and N commodity. MUM is the
 MUx
marginal utility of money. Px ,Py ,PN are the prices of the commodity X, Y, and N respectively. In other words, ,
Px
MUy MUN
, and are weighted marginal utility of the commodities X,Y and N respectively.
Py PN
According to Marshall, “If a person has a thing which he can put to several uses, he will distribute it among
these uses in such a way that it has the same marginal utility in all”.
Assumptions of Equi-Margial Utility
 Rational Consumer
It is assumed that consumer is rational and he or she tries to maximize his or her utility under income
constraint.
 Countable (cardinal) utility
This theory assumes that utility is measurable. That is, we are able to express utility in number.
 Diminishing marginal utility
The utility obtained from additional unit of commodity decreases.
 Constant marginal utility of money
Marginal utility of money remain constant. An increase or decrease in income of the consumer does not
change marginal utility of money.
 Independent utility
It means that, the utility obtained from one commodity does not affect the utility of other commodity.
This law can be explained with the help of the following table and figure.
Units MUx MUY
1 20 18
2 18 16
3 16 14
4 12 12
5 9 9
The above table shows marginal utility of two commodities X and Y. It is asumed that consumer has Rs.5
and price of each commodity is Rs.1. Now from table if consumer uses all his money income to purchase X
commodity, he gets total utility equal to (20+18+16+12+9) 75. Similarly, if consumer uses all his income to
purchase Y commodity he gets total utility equal to (18+16+14+12+9) 69. But according to this law consumer is
rational. So, initially he purchases first unit of X commodity and obtains 20 utils of utility. Then he consumes first
unit of commodity Y and obtains 18 utils of utility. He continuously purchases different units of X and Y
commodity until his money income does not finish. That is, consumer purchase 3 units of X and 2 units of Y. In this
situation, he obtains 88 utils. Law of substitution can be explain with the help of following figure.

In the above figure, we measure marginal utility along OY axis and quantity of commodity along OX axis.
Consumer is in equilibrium at point E and E 1 by consuming OY1 commodity of Y and OX2 commodity of X. If
consumer consumes more units of Y commodity and less units of X commodity consumer is in disequilibrium. This
is shown by shaded part of the figure. Shaded part EY1Y2S is smaller than the shaded part of TX1X2E1. It means
loss of utility is greater than gain of utility.
Exceptions (limitations) of Law of Substitution
Exceptions of law of substitution or equi-marginal utility are as follows.
1. Cardinal utility
According to this law utility is measured in terms of number. But utility is a psychological phenomena. So, it
differs from person to person. Thus, it is impossible to measure in exact number.
2. Ignorance of the consumer
It is assumed that all consumers are rational. But in reality all consumer are not rational. They are unable to
choose which goods give high satisfaction to them and which give low so that it is difficult to maximize utility.
3. Fashion
Most of the consumers follow the fashion. In such situation, consumer does not utilize his /her income
properly. How they gain the maximum utility? In other words fashionable goods are purchased even if price
of the commodity is high and they do not purchase out of fashionable goods even if price of the commodity
falls.
4. Indivisible goods
This law operates only when goods are divisible or goods are divided into different units. But some goods
(durable goods) can not be divided into small units. For example: refrigerator.
5. Shortage of goods
This theory is not applied in the case of shortage goods. If goods are shortage in market, how consumer
equalizes marginal utility with other commodity.
Application of Law of Substitution
The law of substitution states that how the resources can be utilized properly. It gives guideline for how to
maximize utility. So, it is useful for the following purposes.
1. Useful for consumer
Consumers always desire to maximize his/ her utility under the fixed income. So this theory suggests about
how to maximize utility or how to utilitize money.
2. Useful for producer
The goal of producer is to maximize the profit by proper utilization of available resources (factors of
production as well as raw materials). So, this theory suggests how profit is maximized or how resources can
be utilized.
3. Useful in the field of exchange
Exchange is nothing but the process of increase in utility. So, this theory is applicable in the field of
exchange.
4. Useful in the field of distribution
In economics, distribution means to give rewards for factors (land, labour, capital, organization) of
production according to their contribution in the process of production. This is based upon equi- marginal
productivity.
5. Useful in the field of public finance
Public finance means systematic arrangement of government income and expenditure for a particular year.
Government generates income through the tax and tax is levied on the basis of utility of money. It means that,
who has high income he or she pays high level of tax as compared to low level income and vice-versa.
Indifference curve approach

This approach is also called Modern approach of utility analysis. It is quite realistic and logical than the
traditional approach. Since, it believes that human satisfaction is a psychological phenomenon and cannot be
measured quantitatively in monetary terms. An indifference curve is a curve that represents the all combinations
points of two goods which gives same level of satisfaction to the consumer. In words, consumer is indifferent for all
combination points. This concept is based on following assumptions.

Assumption of indifference curve (ordinal utility) analysis.

 Rationality: it is assumed that all consumers are rational. They try to maximize their utility under money
income constant.
 Ordinal utility: The consumer cannot be able to measure the utility obtained from different combination
of commodity but he /she is able to rank the utility (compare between two combinations). If a consumer
consumes two apples, he/she obtains more/ less utility of one apple than other apple.
 Diminishing marginal rate of substitution: Marginal rate of substitution means exchange rate between
two commodities; it is decreasing ratio. In other words marginal rate of substitution X for Y represents-
consumer give up (reduces) commodity Y to add one unit of X.
 Total utility is the function of quantity consumed: According to ordinal utility, total utility depends
upon the quantity of commodity consumed by the consumer. If consumer consumes more quantities of
commodities, total utility of consumer increases.
If consumer consumed X commodity of Nth units than total utility is given by
U= f(x1, x2, x3… xn)
U=Ux1+Ux2+Ux3+ ……. +Uxn
Where, U = total utility
Ux1= Utility obtained from first commodity
Ux2= Utility obtained from second commodity
Ux3= Utility obtained from third commodity
……………………………………………….
……………………………………………….
……………………………………………….
Uxn= Utility obtained from Nth commodity
 Consistency and transitivity of choice: Consistency means behavior of the consumer is fixed (not
changed). If the consumer chooses any one period bundle A over B, other period is also chosen from the
same bundle A over B if bundle A and B both are available.
Transitivity means consumer’s choices are transitive. That is, if consumer prefers commodity A than
commodity B and Commodity B to commodity C, commodity A is preferable to commodity C.
i.e. if A>B and B>C, than A>C.

Let us explain IC with the help of suitable example.

Table
Combination (X and Y) X goods Y goods MRS
A 1 14 -
B 2 10 4
C 3 7 3
D 4 5 2
E 5 4 1

The above table shows the different combinations of X and Y commodities. In combination A the consumer
consumes 1 unit of X and 14 units of Y. In combination B the consumer consumes 2 unit of X and 10 units of
Y. In combination B, to consume one unit of X the consumer giveup 4 unit of Y. This is called marginal rate
of substitution (1:4) and it is decreasing ratio. Similarly, other combinations C, D and E shows that consumer
consumes 3, 4, 5 units of X and 7, 5, 4 units of Y commodity respectively.

14 A
Units of Y

B
10
C
D
7 E
5
4
IC
 In the above figure, along 0X axis we measure X commodity and along 0Y axis Y commodity. IC is
indifference curve which has negative slope i.e. IC moves from upwards left to downwards right.

The properties of Indifference curve

Concept of ordinal utility (indifference curve) was introduced by Pareto and it is elaborated by Hicks and
Allen. In ordinal utility analysis, consumer is able to rank utility of commodities. If consumer consumes two
apples he/ she obtains more /less utility of apple than other apple. According to ordinal utility approach,
utility is just a psychological feeling of consumer, so we are not able to count in number.
The major properties of indifference curve are as follows:
1. IC always moves from upwards left to downwards right: According to definition of IC all
combinations of IC gives the same level of satisfaction to the consumer, so IC always moves from
upwards left to downwards right. In other words, IC has negative slopes.

Y3 A

Y2 B
Units of Y

C
Y1

IC
0
X1 X2 X3
units of X

In the above figure, Unit of X commodity is measured along OX axis and Unit of Y along OY axis. A, B
and C are three combinations points that give same level of satisfaction.

2. Indifference curve is convex to origin: IC is based on diminishing marginal rate of substitution due to
this IC is convex to the origin. Diminishing marginal rate of substitution means exchange rate between
two commodities.

Y3 A

Y2 B
unit osf Y

Y1 C

IC

0 X1 X2 X3 units of X
 In the figure, combination A is made by combination of Y3 and X1 commodities of Y and X. In this case
marginal utility of Y commodity is less than the X commodity. Similarly, when units of X increases MU
of X commodity decreases, so the consumer giveup less and less commodity of Y in further combination.
3. Higher IC gives higher level of satisfaction: In higher IC, the consumer consumes more level of
commodities than the lower IC so higher IC gives higher level of satisfaction to the consumer.
units of y

B C
Y1

IC2

IC1

0 X1 X2 units of X

In above figure, the consumer consumes X1 and Y1 units of X and Y commodity and it is denoted by
combination point B. But in combination point C the consumer consumed more units of X commodity
(X2) than combination point B and same unit of commodity of Y (Y1) so consumer obtains higher utility
at point C than combination point B.
4. Indifferent curves never intersect to each other: Different ICs give different level of satisfaction to the
consumer. If ICs are intersected each other, at the intersecting point they give equal level of satisfaction
to consumer. But according to definition of IC, higher IC gives higher level of satisfaction and lower IC
gives lower level of satisfaction to the consumer. If ICs intersect they violate this norm.

Y1 B
Units of Y

IC1
IC2
0
X1 Units of X

At point B both ICs (IC1 and IC2) give the same level of satisfaction to the consumer. But in the left side
 of Point B, IC1 gives low level of satisfaction and in the right side of point B same IC gives high level of
satisfaction than IC2. So two ICs are never intersects to each other.
5. IC may not be parallel to each other: If marginal rate of substitution between two ICs is equal, they are
parallel otherwise they are not parallel.
6. IC does not touch any axis: If IC touches any axis, at the touching point consumer consume single
commodity but from definition it is combination point of two goods.

The Marginal Rate of Substitution (MRS)

Indifference curve is the locus of different combination of two goods which gives same level of utility of the
consumer. All combination of IC gives equal level of satisfaction so consumer is indifferent to choose any of
the combination.
Marginal rate of substitution means exchange rate between two commodities; it is decreasing ratio. In other
words marginal rate of substitution X for Y represents- the consumer giveup (reduces) Y commodity to add
one unit of X commodity. Because marginal utility of commodity decreases as consumer increases its stock
and marginal utility of commodity increases as its stock decreases. This is explained with the help of the
following table.
Table
Combination (XandY) Xgoods Ygoods MRS
A 1 14 -
B 2 10 1X=4Y
C 3 7 X=3Y
D 4 5 1X=2y
E 5 4 1X=1Y

The above table shows the MRS between two commodities X and Y. It is seen that to move from
combination point A to B, the consumer is ready to giveup 4 units of Y commodity to get one unit of X.
Similarly, in the combinations C, D, E, the consumer is ready to giveup 3, 2, 1 unit of Y to gain 1 unit of X.
In this way marginal rate of substitution, (MRS) decreases as we move from upward left to downward right
of indifference curve.

14 A

B
10
Units of Y

7 C
D
5 E
4
IC

0
1 2 3 4 5 units of X
In the figure, quantity X commodity is measured along X axis and quantity of Y commodity is measured
along Y axis. In all the combinations (A, B, C, D and E), consumer gets equal level of satisfaction.

Budget Line

Budget line shows the purchasing power of the consumer. It is the ability to pay of consumer for different
combination of the commodity. It is explained with the help of suitable example. Let us suppose that
consumer’s income is Rs 10 and he is going to purchase two goods say X and Y. Price of two goods is given
Rs 2 and Rs 1 for X and Y respectively. In this situation, it can be shown in following algebraic equation.
I = X. Px + Y . Py
10 = X .2 + Y . 1

If consumer does not Purchases X commodity, he/ she is able to purchase 10 unit of Y. Similarly, If consumer does
not purchase Y commodity, he/ she is able to purchase 5 units of X commodity.
Change in Budget line

Budget line of the consumer changes due to two reasons. They are- i. change in real income and ii. change in
money income
i. Change in real income
When the price of a commodity in the market changes (either increase or decrease) due to this consumer is able to
purchase more or less of commodity than the previous level. So that price line of the consumer changes
inwards and outwards than previous level.

Figure
ii. Change in money income

When the money income of the consumer changes (either increase or decrease) due to this consumer is able to
purchase more or less of commodity than the previous level. So that price line of the consumer shifts inwards
and outwards than previous level.
Figure

Consumer’s equilibrium

Consumer equilibrium refers to that situation where consumer does not ready to change his / her combination
point of two goods. It is explained with the help of indifference curve and budget line.
Indifference curve is the locus of different combination of two goods which gives same level of utility of the
consumer. All combination of IC gives equal level of satisfaction so consumer is indifferent to choose any of
the combination and budget line shows the purchasing power of the consumer. In other words it shows the
purchasing capacity of different combination. It is based on the following assumption.
Assumption of indifference curve (ordinal utility) analysis.
 Rationality: it is assumed that consumer is rational. He/ she tries to maximize his utility under money
income constant.
 Ordinal utility: The consumer cannot able to measure the utility obtained from different combination of
commodities but he /she is able to rank the utility (compare between two combinations). If a consumer
consumes two apples, he/she obtains more/ less utility of one apple than other apple.
 Diminishing marginal rate of substitution: Marginal rate of substitution means exchange rate between
two commodities; it is decreasing ratio. In other words marginal rate of substitution X for Y represents-
consumer give up (reduces) commodity Y to add one unit of X.
 Total utility is the function of quantity consumed: According to ordinal utility, total utility depends
upon the quantity of commodity consumed by the consumer. If consumer consumes more quantities of
commodities, total utility of consumer increases.
If consumer consumed X commodity of Nth units than total utility is given by
U= f(x1, x2, x3… xn)
U=Ux1+Ux2+Ux3+ ……. +Uxn
U= Sum of x1, x2, x3… xn
Where, U = total utility
Ux1= Utility obtained from first commodity
Ux2= Utility obtained from second commodity
Ux3= Utility obtained from third commodity
……………………………………………….
 ……………………………………………….
……………………………………………….
Uxn= Utility obtained from Nth commodity
 Consistency and transitivity of choice: Consistency means behavior of the consumer is fixed (not
changed). If the consumer chooses any one period bundle A over B, other period is also chosen from the
same bundle A over B if bundle A and B both are available.

Transitivity means consumer’s choices are transitive. That is, if consumer prefers commodity A than
commodity B and Commodity B to commodity C, commodity A is preferable to commodity C. i.e. if A>B
and B>C, than A>C.

Consumer is in equilibrium when he/she maximizes his /her utility. In other words the consumer is in
equilibrium, when he/she does not try to purchase other combination of goods.
Under these assumption consumer is in equilibrium when he/she fulfills the following condition. This is
shown with the help of Indifference curve and price line (budget line) of the consumer.
Necessary condition:
Price line must be tangent to indifference curve. In other words marginal rate of substitution (MRS)
between two commodities is equal to price ratio of these commodities.
i.e. MRSX,Y = PX/PY
MRSX,Y = Marginal rate of substitution between X and Y commodity
PX = Price of X commodity and PY = Price of Y commodity.

Sufficient condition:
Indifference curve must be convex at the point of tangency (IC curve touch Price line at the equilibrium
point). This is explained in the following figure.

P S
Y Commodity

E
Y1

IC3

IC2
T
IC1
0 L
X1

X Commodity
PL is the income line of the consumer so the consumer is able to purchase any combination on this line. IC 1,
IC2 and IC3 are the indifference curves of the consumer. The consumer is in equilibrium at point E where
above conditions are fulfilled. At point E budget line or income line is tangent to IC2 and it is convex to the
origin at this point. IC3 gives the consumer maximum utility than the IC2 but due to income constant the
consumer is unable to purchase in this IC. Below the budget line consumer is able to purchase any
combination of two commodities but it gives low level of utility to the consumer than point E. If the
consumer purchases commodity at point S and T in the budget line, he / she gets less utility than point E,
because points lay lower IC. So he/ she does not equilibrium at point S and T.