LESSON 5

THEORY OF CONSUMER BEHAVIOR

OBJECTIVES

On completing the module, you should be able to:

• Define Utility
• Analyze the Utility Concept
• Discuss The cardinal approach
THE PRINCIPAL ASSUMPTION UPON WHICH THE THEORY OF
CONSUMER BEHAVIOR AND DEMAND IS BUILT IS:

• A consumer attempts to allocate his/her

limited money income among available
goods and services so as to maximize his/her
utility (satisfaction)
 UTILITY

• Amount of satisfaction derived from the consumption of

a commodity.
• It is the power of capacity of a commodity to satisfy
human wants.
• Measurement units utils
• Useful for understanding the demand side of the market.
 UTILITY CONCEPTS:

The Cardinal Utility Theory (Utility analysis approach)

• Utility is measurable in a cardinal sense
• Cardinal Utility- assumes that we can assign values for utility
(derive 100 utils from eating a slice of pizza)
 UTILITY CONCEPTS:

The Ordinal Utility Theory (Indifference curve approach)

• Utility is not measurable in an ordinal sense.
• Ordinal utility approach-does not assign values instead works with the
order of preference of consumers for the goods.
• It indicates consumer’s preference or choice for one commodity over
another.
 THE CARDINAL APPROACH

Total Utility (TU)

• The overall level of satisfied derived from consuming a good or service. It
may be defined as the sum of the utility derived from each unit consumed
of the commodity.
• If consumer consumes four units of a commodity derives U1, U2, U3, U4
utils from the successive units consumed, then, TU= U1+ U2+ U3 – U4
 THE CARDINAL APPROACH

Marginal Utility (MU)

• Additional satisfaction that an individual derives from considering an
additional unit of a good on service.
• It is the addition to TU derived from the consumption of additional unity
of a commodity.
FORMULA:
MU = Change in total utility
Change in quantity

= TU

Q
LAW OF DIMINISHING MARGINAL UTILITY AS MORE AND MORE UNITS
OF A COMMODITY ARE CONSUMED, MARGINAL UTILITY DERIVED
FROM EACH SUCCESSIVE UNIT GOES ON FALLING.

Assumption of the Law

1. The units of the good must be standard e.g a cup of tea or a bottle of
coke, not sip of tea and coke.
2. Consumers taste and preference remains unchanged.
3. There must be continuity in consumption.
4. The mental condition of consumers remains normal during consumption.
Number Purchased Total Utility Marginal Utility

0 0 0
1 4 4
2 7 3
3 8 1
4 8 0
5 7 -1
 When TU is rising, MU is falling but it is greater
than zero (+ve)

 When TU is maximum, MU is zero.

 And when TU starts declining, MU becomes
negative.
 CONSUMER EQUILIBRIUM: CARDINAL UTILITY APPROACH

 It means a situation under which consumer spends his given

income on purchase of commodity in such a way that gives him
maximum utility (satisfaction) and he feels no urge to change.
 It is a position of rest because he does not want consume less
or more than that.
 A consumer attains his equilibrium when he maximizes his TU
given his income, consumption expenditure and price of the
commodity he consumes.
ASSUMPTIONS
 Rationality- He satisfies his wants in the
order of their utility.
 Limited money income.
 Maximization of satisfaction.
 Diminishing MU
 Constant MU of money explanation from
book.
 Favorite
CONSUMER EQUILIBRIUM: A SINGLE COMMODITY CASE

 Consumer equilibrium in purchase of a single good is

attained when:
MU in terms of money=price of thee commodity
i.e., MU of a product / MU of a rupee= price of a
product.
 
 A consumer while purchasing a good will compare its price
(cost) with is expected utility (benefits).
 He will buy the good if the benefit derived in from of utility is
greater than or at least equal to its price.
 It is difficult to compare MU of good (utils) with its price (Rs.),
therefore MU of good is converted in terms of money by
dividing MU of good by MU of rupee.
 MU of one rupee is defined as the additional utility when an
additional rupee is spent on purchase of commodity.
Ex: Let MU of a Rupee is 2 utils.
 Consumer will consume 4 utils of oranges to attain equilibrium.
Units of orange MU of orange (utils) MU in terms of Price of orange
consumed money

1 10 10/2 1

2 8 4 1

3 5 2.5 1

4 2 1 1

5 1 0.5 1

6 0 0 1
 Consumer Equilibrium: In Case of Two Commodities
 A rational consumer consumes commodities in the order of their
utilities.
 He picks up the commodity which yield the highest utility and next
the one which yields second highest utility and so on…
 He switches his expenditure from one commodity to another in
accordance with their MU.
 He continues to switch till MU of each commodity per unit of money
expenditure is the same. This is called the law of equi-MU.
 MUX =MUY
PX = P Y
 Suppose consumer has Rs. 5 income to be spent on two
goods, each costing Re.1 per unit. How he will attain
equilibrium.
 Rupees spent MU of oranges MU of apples
(utils) (utils)

1 10(1) 9(2)
2 8(3) 6(4)
3 6(5) 4
4 4 2
5 2 1

 So, he will consume 3 units of oranges and 2 units of

apples to get maximum satisfaction.
THANK YOU!!!