CONSUMER BEHAVIOR

By Anupriya Panda
 Introduction
1. Consumer Behavior: Consumer behavior is the study of how individuals, households, or groups of people make decisions
and allocate their resources to satisfy their wants and needs.
2. Consumer Preferences: Consumers have a wide range of preferences and desires. They consider factors like price,
quality, brand, convenience, and more when making purchasing decisions. These preferences are often influenced by personal
experiences, cultural norms, and social influences.
3. Budget Constraints: Consumers have limited resources, such as income and time. As a result, they must make choices
about how to allocate their resources to maximize their well-being.
4. Rational Decision-Making: Consumer behavior is often analyzed under the assumption of rational decision-making,
where consumers aim to maximize utility or satisfaction based on their preferences and budget constraints. However, real-
world decisions can be influenced by cognitive biases, emotional factors, and imperfect information.
5. Information and Search: Consumers gather information through various channels, such as online research, word-of-
mouth, and advertising, to make informed decisions. The amount of information and the effort consumers invest in searching
for it can vary widely.
6. Purchase Process: The purchase process involves several stages, including problem recognition, information search,
evaluation of alternatives, purchase decisions, and post-purchase evaluation. Understanding this process is essential for
businesses to target consumers effectively.
7. Cultural and Social Influences: Culture, family, reference groups, and social norms can shape consumer preferences and
decisions. These factors are particularly important in explaining variations in consumer behavior across different regions and
demographic groups.
 Theories of Consumer Behavior
1. Utility Theory:
❑ Utility theory is a foundational concept in economics that assumes consumers aim to maximize their overall satisfaction
or utility.
❑ It suggests that consumers make rational choices by comparing the utility or satisfaction derived from different goods or
services and choosing the option that maximizes their well-being.
❑ Utility theory introduces the concept of indifference curves, which represent combinations of goods that provide
consumers with the same level of satisfaction.

2. Marginal Utility Theory:

❑ Marginal utility theory builds on utility theory and suggests that consumers make decisions based on the marginal utility,
or additional satisfaction, they gain from consuming an extra unit of a product.
❑ It asserts that consumers will continue to allocate resources until the marginal utility per dollar spent on each product is
equal.

3. Consumer Choice Theory:

❑ Consumer choice theory combines utility theory with budget constraints to explain how consumers make choices within
their limited resources.
❑ Itintroduces concepts like budget lines, which represent the combinations of goods that a consumer can afford given their
budget, and the optimal choice that occurs at the point where the budget line is tangent to the highest attainable
indifference curve.
 Theories of Consumer Behavior Contd..

4. Theory of Revealed Preferences:

❑ The theory of revealed preferences suggests that consumer choices can reveal their underlying preferences.
❑ It argues that consumer behavior, observed through choices made under different price and income conditions, can
provide insights into their true preferences.

5. Cultural and Social Theories:

❑ Cultural and social theories emphasize the influence of culture, reference groups, and social norms on consumer
behavior.
❑ These theories recognize that individuals make choices in a broader societal context, which can significantly impact
their preferences and decisions.

6. Information Asymmetry and Signaling Theory:

❑ Information asymmetry and signaling theory focus on situations where one party has more information than the other in
economic transactions.
❑ They explore how consumers interpret signals and information provided by sellers and how this can impact their
choices.
 Marginal Utility Approach
• The marginal utility approach focuses on how consumers make decisions about allocating their resources, such as money
or time, to maximize their satisfaction or utility. This approach is rooted in the idea that consumers make choices based on
the additional satisfaction, or marginal utility, they receive from consuming one more unit of a good or service. It includes:
1. Diminishing Marginal Utility: According to this approach, as consumers consume more of a particular good or service,
the additional satisfaction they derive from each additional unit (marginal utility) tends to decrease. In other words, the more
you have of something, the less extra satisfaction you get from each additional unit.
2. Rational Choice: Consumers are assumed to be rational decision-makers who aim to maximize their overall well-being.
In this context, rationality means that consumers make choices that optimize their utility given their budget constraints.
3. Budget Constraint: Consumers have limited resources (typically represented by their budget) to spend on various goods
and services. They must allocate their resources in a way that maximizes their utility while staying within their budget.
4. Optimal Choice: To determine their optimal consumption, consumers compare the marginal utility (satisfaction) they
derive from consuming each good with its price. They continue consuming additional units of each good until the marginal
utility per dollar spent is equal across all goods. This is the point of consumer equilibrium.
5. Indifference Curves: The marginal utility approach uses the concept of indifference curves, which are graphical
representations showing combinations of goods that provide the same level of satisfaction (utility) to the consumer. The
shape of these curves reflects the diminishing marginal utility.
6. Consumer Surplus: Consumer surplus is a key concept in this approach and represents the difference between what
consumers are willing to pay for a good (based on their marginal utility) and what they actually pay. It quantifies the
additional satisfaction consumers receive from their choices.
 The Concept of Utility
• Utility is the want satisfying power of a commodity.
• It is the expected satisfaction of a consumer when he is willing to spend money on a commodity that can satisfy his wants.
• Utility is the anticipated satisfaction by the consumer, and satisfaction is the actual satisfaction derived.
• A commodity has utility for a consumer even when it is not consumed. It is a subjective entity and varies from person to
person.
• A commodity has different utility for the same person at different places or at different points in time.
• Utility is not the same thing as usefulness. Even harmful chemicals like liquor are said to have utility because people want
them.
• Two important theories of utility are:
a. Marginal Utility analysis propounded by Marshall- Cardinal Utility Theory
b. Indifference Curve Analysis propounded by Hicks and Allen- Ordinal Utility Theory

• Utility is measured in “util”, which means one util equals one unit of money.
• Marginal Utility theory (cardinal theory) lacks in measuring the utility in quantitative terms and it is the ordinal theory that
forms the basis for the Indifference curve to measure utility in quantitative terms.
• For example, if a person prefers chocolate to ice cream and ice cream to a cold drink, he can express his preference as
chocolate > ice cream > cold drink.
 Total Utility, Marginal Utility and Average Utility
1. Total Utility (TU): Total Utility represents a person's overall satisfaction or benefit from consuming a certain quantity of
a good or service. It is the sum of the marginal utilities of each unit consumed. Mathematically, expressed as:
TU = U₁ + U₂ + U₃ + ... + Uₙ, where:
- TU is the Total Utility.
- MU₁, MU₂, MU₃, ... represent the Marginal Utilities of each unit consumed (from the first unit to the nth unit).
2. Marginal Utility (MU): Marginal Utility is the additional satisfaction gained from consuming one more unit of a good or
service. It measures the change in total utility when consumption increases by one unit. Mathematically, expressed as:
MU = ΔTU / ΔQ or Mun = TUn – TUn-1, where:
- MU is the Marginal Utility.
- ΔTU is the change in Total Utility / TUn is the Total Utility of the nth unit and TUn-1 is the total utility of the previous unit
- ΔQ represents the change in the quantity consumed.
3. Average Utility (AU): Average Utility is the average level of satisfaction obtained from consuming a certain quantity of a
good or service. It is calculated by dividing the Total Utility by the quantity consumed. Mathematically, expressed as:
AU = TU / Q, where:
- AU is the Average Utility; TU is the Total Utility; Q is the quantity consumed.
 Some Examples

Units TU MU Units MU TU
1 10 10 1 10 10
2 18 8 2 8 18
3 24 6
3 7 25
4 28 4
4 6 31
5 30 2
6 30 0 5 3 34

7 28 -2 6 0 34

Units TU AU
1 6 6
2 11 5.5
3 14 4.7
4 15 3.8
5 15 3
 Law of Diminishing Marginal Utility
• The Law:
The Law of Diminishing Marginal Utility is an important concept in economics that states that as a person consumes more
units of a particular good or service while keeping the consumption of other goods constant, the additional satisfaction or
benefit (marginal utility) derived from each successive unit decreases. This makes the MU Curve a downward sloping curve.
• Assumptions:
1. Rational Behavior: Consumers are assumed to be rational, seeking to maximize their overall satisfaction or utility.
2. Holding Other Factors Constant: The law assumes that all other factors affecting a person's utility, such as income and
preferences for other goods, remain constant.
• Example:
Let's consider the consumption of apple. Initially, when you're not full, the first bite of apple provides a high level of
satisfaction, so the marginal utility is high. However, as you continue to eat, you start to get full, and each additional bite
provides less additional satisfaction. The marginal utility decreases, and at some point, you might even reach a point where
the marginal utility becomes zero or negative, indicating that further consumption may lead to discomfort or reduced overall
satisfaction.
In this example, the law of diminishing marginal utility suggests that consumers will make choices that maximize their
overall satisfaction by allocating their resources (money) in a way that balances the diminishing marginal utility of different
goods. They will continue consuming a good until the marginal utility equals the price they are willing to pay for it.
 Law of Equi- Marginal Utility
• The Law:
The Law of Equi-Marginal Utility explains that rational consumers will allocate their resources (like money) among different
goods or services in a way that the marginal utility per dollar spent is the same for each product. The consumer is in the
equilibrium position when marginal utility of money expenditure on each good is the same.
• Assumptions:
1. Rational Behavior: Consumers are assumed to be rational and aim to maximize their overall satisfaction.
2. Limited Income: Consumers have a limited budget or income to allocate among various goods.
3. Fixed Preferences: Preferences for goods are assumed to remain constant.
• Example:
Suppose you have $20 to spend on snacks, and you are considering buying two different snacks: apples and chocolate bars.
According to the Law of Equi-Marginal Utility, you should allocate your $20 in a way that ensures the marginal utility per
dollar spent is equal for both snacks. In this case, it would mean spending an equal amount on both apples and chocolate
bars. So, you might choose to spend $10 on apples and $10 on chocolate bars, as this allocation would help you maximize
your overall satisfaction given your budget and preferences, as the marginal utility per dollar spent is equal for both goods.
This principle guides consumers in making efficient choices to get the most value from their limited resources.
• Mathematically, the law expressed as:
MU of GOOD A/Price of A = MU GOOD B/Price of B
 Some numeric examples
Suppose the consumer has a budget of Rs. 50 to allocate equally on X and Y. The prices for X and Y are Rs. 5
and Rs. 4 respectively. Find out the units for each X and Y the consumer can afford within his given budget.
Units MUx MUy Mux/Px Muy/Py
1 50 36 50/5 =10 36/4=9
2 45 32 45/5=9 32/4=8
3 40 28 40/5=8 28/4=7
4 35 24 35/5=7 24/4=6
5 30 20 30/5=6 20/4=5
6 25 16 25/5=5 16/4=4
7 20 12 20/5=4 12/4=3
8 15 8 15/5=3 8/4=2

When the consumer buys 6 units of commodity X and 5 units of commodity Y, his total expenditure will be (Rs. 5*6) +
(Rs. 4*5) = Rs. 50 on both commodities. At this point of expenditure, his satisfaction is maximized and therefore he
will be in equilibrium.
 Indifference Curve Analysis
• Assumptions:
1. Rationality: Consumers are assumed to be rational decision-makers, seeking to maximize their satisfaction or utility
given their budget constraints.
2. Transitivity: If a consumer prefers bundle A to bundle B and bundle B to bundle C, then the consumer must prefer
bundle A to bundle C. In other words, preferences are consistent.
3. Completeness: Consumers are assumed to have clear and complete preferences. For any two bundles of goods, the
consumer can express a preference, either favoring one over the other or being indifferent between them.
4. Diminishing Marginal Rate of Substitution (MRS): The MRS measures the rate at which a consumer is willing to
trade one good (X) for another (Y) so that his satisfaction remains same. It is assumed that the MRS diminishes as the
consumer consumes more of one good and less of the other.
Indifference curves are graphical representations of these assumptions. Each curve shows combinations of two goods that
provide the consumer with the same level of satisfaction or utility. The key points to understand about indifference curves
are:
1. A consumer is indifferent between any two points on the same indifference curve because they provide the same level
of satisfaction. Indifference curves slope downward from left to right, reflecting the diminishing MRS. This means that
as the consumer moves to the right along the curve, they are willing to give up less of one good to get more of the other
while remaining equally satisfied.
2. Higher indifference curves represent higher levels of satisfaction. A consumer's goal is to reach the highest possible
indifference curve within their budget constraints.
 Indifference Curve
• An indifference curve is a graphical representation of the different combinations of two goods that provide a consumer with
the same level of satisfaction or utility. It shows the trade-offs a consumer is willing to make between two goods while
remaining equally satisfied. Key points about indifference curves:
1. Equally Satisfying: All points on the same indifference curve represent bundles of goods that provide the consumer with
the same level of satisfaction. The consumer is indifferent between these bundles, meaning they view them as equally
desirable.
2. Downward Sloping: Indifference curves typically slope downward from left to right, indicating that as the consumer
consumes more of one good, they are willing to give up some of it to get more of the other good while staying at the same
level of satisfaction. This reflects the concept of the diminishing marginal rate of substitution.
3. Preferences and Utility: Indifference curves are a way to represent consumer preferences. A higher indifference curve
indicates a higher level of satisfaction or utility.
4. Budget Constraints: Indifference curves are used in conjunction with budget constraints to analyze how consumers allocate
their resources to maximize utility while considering their income and the prices of goods.
5. Indifference Curve is also know as Iso-utility curve, Locus of Points and Equal Utility Curve.
6. The slope of indifference curve is known as “Marginal Rate of Substitution.”
7. The indifference curve situation arises when consumer has a large no. of goods and services and one commodity can be
substituted for another.
 Marginal Rate of Substitution
• The Marginal Rate of Substitution (MRS) measures the rate at which a consumer is willing to exchange one good for
another while remaining at the same level of satisfaction. It quantifies the trade-off between two goods in a consumer's
preferences. The formula for MRS:
MRS = -ΔY / ΔX, or MUx/MUy, where:
MRS represents the Marginal Rate of Substitution.
-ΔY is the change in the quantity of the goods being given up.
ΔX is the change in the quantity of the goods being gained.
MUx is the marginal utility of X
MUy is the marginal utility of Y
• Example: Let's consider a consumer who is initially consuming 4 units of good X and 8 units of good Y. If the consumer is
willing to give up 2 units of Y to gain 1 more unit of X while remaining equally satisfied, the MRS can be calculated as
follows:
• Ans: MRS = ΔY / ΔX = -2 units of Y / 1 unit of X = -2
In this example, the negative sign indicates that the consumer is willing to trade 2 units of Y for 1 more unit of X and still be
equally satisfied. This means the consumer values good X more than good Y at this particular point, and the MRS represents
the consumer's willingness to make that trade-off.
 Properties of Indifference Curve

1. Equi-Satisfaction: All points on the same indifference curve provide the consumer with an equal level of satisfaction or
utility. The consumer is indifferent between these points, indicating that they view them as equally desirable.
2. Downward Sloping: Indifference curves typically slope downward from left to right. This reflects the principle of
diminishing marginal rate of substitution, meaning that as a consumer consumes more of one good and less of another while
staying on the same curve, they are willing to give up less of one good to get more of the other.
3. Convex to the Origin: Indifference curves are typically convex to the origin, indicating that the consumer's preferences
exhibit diminishing marginal utility. This reflects the idea that consumers usually prefer a balanced mix of goods.
4. No Crossing: Indifference curves do not intersect or cross each other, which means that higher curves represent higher
levels of satisfaction. If two curves were to intersect, it would violate the principle of transitivity in consumer preferences.
5. Marginal Rate of Substitution (MRS): The slope of an indifference curve, known as the Marginal Rate of Substitution
(MRS), quantifies the trade-off a consumer is willing to make between two goods while remaining equally satisfied. The
MRS is steeper (in absolute value) at the top of the curve and becomes flatter as you move down the curve, reflecting the
diminishing MRS.
 Indifference Curve and Budget Line: Consumer Equilibrium
• Introduction
a. An equilibrium is a state of rest with no tendency to change. When a consumer does not intend to change their level
of consumption, or when they derive maximum satisfaction, they are said to be in equilibrium.
b. As a result, consumer equilibrium refers to a situation in which the consumer gets the most satisfaction from the
number of goods purchased, given their income and market prices.
c. Because resources are limited compared to unlimited desires, consumers must adhere to certain rules or laws to
achieve the highest level of satisfaction.
d. Monotonic Preferences: Consumer preferences are monotonic if and only if, when choosing between two bundles,
the consumer prefers the one with more of at least one good and no less of the other.
e. Indifference Map: A collection of indifference curves representing various levels of satisfaction makes up an
indifference map. Because higher indifference curves represent more quantities of both goods or the same quantity of
one good and more quantity of the other; so, higher indifference curves represent a higher level of satisfaction.
f. Budget Line: A budget line graphically represents all possible combinations of two goods that a consumer can buy
at current market prices with their entire income. Consumers spend their entire income on one or both goods,
depending on where they are on the budget line. When the price of goods, the consumer’s income, or both, changes,
a budget line shifts. Because a consumer’s income is fixed, purchasing more units of one good necessitates
purchasing fewer units of another.
g. Budget Set: A consumer’s budget set is the set of all possible combinations of two goods that they can afford based
on their income and the market prices of the two goods.
 Assumptions Related to Indifference Curve Analysis

• Given the market prices of goods, it is assumed that the consumer has a fixed amount of money to spend on two goods.
• It’s assumed that the customer hasn’t reached satiety yet. More of both commodities is always preferred by them.
• The consumer can rank their preferences based on how satisfied they are with each bundle of goods.
• The marginal rate of substitution is assumed to be decreasing.
• The consumer is a rational individual who strives to maximize their satisfaction.
 Situations for Consumer Equilibrium
• A consumer will be at equilibrium, according to the indifference curve approach, when:
• The budget line crosses the indifference curve. i.e. budget line slope = indifference curve slope Alternatively, MRSXY =
Px/PY.
• Assume that X and Y are the two goods consumed. Let’s say the consumer wants to increase their consumption of good X
rather than good Y. MRS is the rate at which a customer is willing to give up a certain amount of Y in exchange for an
additional unit of X. The market rate of exchange (MRE) is the rate a consumer must give up a certain amount of Y to
obtain an extra unit of X.
• When MRS>MRE, the consumer is willing to sacrifice more units of Y than the market allows obtaining one unit of X.
This will result in an increase in X consumption but a decrease in Y consumption. MRS begins to drop. They continue to
eat more X until their MRS equals their MRE.
• When MRS < MRE is used, it means that the consumer is willing to sacrifice fewer units of Y than the market requires
obtaining one more unit of X. They will decrease X consumption while increasing Y consumption. MRS begins to rise.
They continue to reduce their X consumption until MRS equals MRE.