COURSE: BBA

SUBJECT: BUSINESS
ECONOMICS
UNIT: 3

Consumer Behavior and Demand Analysis

Consumer Behaviour
 Consumer behavior is the study of individuals,
groups, or organizations and the processes they use
to select, secure, and dispose of products, services,
experiences, or ideas to satisfy needs and the
impacts that these processes have on the consumer
and society
Utility
 Utility is a measure of satisfaction, referring to the
total satisfaction received by a consumer from
consuming a good or service
 Utility represents the advantage or fulfillment a
person receives from consuming a good or service.
 Utility, then, explains how individuals and
economies aim to gain optimal satisfaction in
dealing with scarcity.
 Total Utility

 The sum total of satisfaction which a consumer receives by consuming the

various unity of the commodity.

 (The more unit of a commodity he consumes, the greater will be his total
utility)

 The overall amount of satisfaction achieved by a consumer due to

the purchase and use of a particular item or service.

 Consumers theoretically wish to obtain the maximum degree of total utility for
the amount of money that they expend on an item or service offered by
a business.
 Marginal Utility
 The concept of marginal utility grew out of attempts by economists to
explain the determination of price.

 Marginal utility can be defined as a measure of relative satisfaction gained

or lost from an increase or decrease in the consumption of that good or
service.

 An increase in an activity's overall benefit that is caused by a unit increase

in the level of that activity, all other factors remaining constant.

 Also called marginal benefit.

 Marginal utility= C hange in total utility
Change in quantity consumed
Utility is based on following
Assumptions

1. Cardinal Measurability
 Utility can be measured in terms of money
 Unit is utils
2. Utilities from different goods are Independent from
each other
 Individual utility for goods
 Sum of individual utility is total utility
3. Constancy of marginal utility of money
 Marginal utility of money is constant
4. Introspective Method
 We can inspect other’s mind
 Guesswork based on our own experience
Law of Diminishing Marginal Utility

The law of diminishing marginal utility states that

‘as a consumer consumes more and more
units of a specific commodity,
utility from the successive units
goes on diminishing’.
 Mr. H. Gossen, a German economist, was the first

to explain this Law in 1854.

 Law of Diminishing Marginal Utility

 Law based upon following assumptions

1. The units of the good, which are consumed, are
homogeneous
2. The good is consumed within a short time without any
gaps
3. The units of the good consumed are of a standard size
4. The consumer’s income does not change in the period of
observations
5. There is no change in the tastes of the consumers.
EXAMPLE…..

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DON’T TRY THIS AT HOME ;)

1 ICE CREAM =
ECSTATIC
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DON’T TRY THIS AT HOME ;)

2nd ICE CREAM = STILL

ECSTATIC
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DON’T TRY THIS AT HOME ;)

3rd ICE CREAM = VERY HAPPY

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DON’T TRY THIS AT HOME ;)

4th ICE CREAM = HAPPY

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DON’T TRY THIS AT HOME ;)

5th ICE CREAM = STILL HAPPY

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DON’T TRY THIS AT HOME ;)

6th ICE CREAM = NOT SO

HAPPY
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DON’T TRY THIS AT HOME ;)

7th ICE CREAM = UNHAPPY

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DON’T TRY THIS AT HOME ;)

8th ICE CREAM = SICK

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The following table will make the law of diminishing
marginal utility more clear.

Units Total Utility Marginal Utility

1st ice cream 20 20

2nd ice cream 32 12

3rd ice cream 40 8

4th ice cream 44 4

5th ice cream 45 1

20
th
The graph will make the law of diminishing
marginal utility more clear
50 Total utility
40
30
20 Total utility
10
0
1 2 3 4 5 6 7 8
30 Marginal utility
20

10 Marginal utility
0
1 2 3 4 5 6 7 8
-10
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-20
*Limitations/Exceptions
of Law of Diminishing Marginal Utility

(i) Case of intoxicants: The more a person drinks liquor, the more
s/he likes it.
(ii) Rare collection: If there are only two diamonds in the world,
the possession of 2nd diamond will push up the marginal
utility.
(iii) Application to money: It is true that more money the man has,
the greedier he is to get additional units of it. However, the
truth is that the marginal utility of money declines with richness
but never falls to zero.

Conclusion
* we can say that the law of diminishing utility, like other laws of
Economics, is simply a statement of tendency. It holds good,
provided other factors remain constant.
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 Law of Equi-Marginal Utility
 The law of equi marginal utility explains as to how
a consumer distributes his limited income for
buying different goods and services
 He will spend his income in such away that the
last rupee spent on each of the commodity gives
him the same marginal utility.
 Therefore, this law is known as the Law of Equi-
Marginal Utility

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 To get maximum satisfaction out of his
limited income, the consumer carefully
weighs the satisfaction obtained from each
rupee that he spends. If he thinks that a
rupee spent on one good has greater utility
than spending it on another good, he will go
on spend his money on the former till the
satisfaction derived from the last rupee
spent in the two cases equal

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* Assumptions of the Law:
1.The utility is cardinally measurable.
2. The marginal utility of money remains constant.
3. Consumer has a limited amount of income and he
spends the entire amount.
4. The wants and habits of the consumer remain
constant.
5. The consumer is rational. He tries to get maximum
satisfaction.
6. The consumer spends his income in small
quantities while purchasing the commodities.

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Explanation
We assume that:
1. The consumer has Rs.24 with
him.
2. He has to spend his income on
two goods X and Y.
3. The price of each good is Rs.2
and 3 per unit respectively

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Table…
Units MU of X(Price MU of Y(Price
is Rs.2) is Rs. 3)

1 20 24
2 18 21
3 16 18
4 14 15
5 12 9
6 10 3 27
Units MUx/Px MUy/Py

1 10 8

2 9 7

3 8 6

4 7 5

5 6 3

6 5 1

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Ordinal Utility
 Approach by R.G.D. Allen and J.R.Hicks
 Consumer can only rank or order the utilities

obtained from a good

 Provided Indifference curve

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REPRESENTING PREFERENCES WITH
INDIFFERENCE CURVES
 The consumer’s preferences allow him to choose among
different bundles of Pepsi and pizza. If you offer the
consumer two different bundles, he chooses the bundle that
best suits his tastes. If the two bundles suit his tastes
equally well, we say that the consumer is indifferent
between the two bundles.

 Just as we have represented the consumer’s budget

constraint graphically, we can also represent his
preferences graphically. We do this with indifference curves.

 An indifference curve shows the bundles of consumption

that make the consumer equally happy. In this case, the
indifference curves show the combinations of Pepsi and
pizza with which the consumer is equally satisfied.
Indifference curve
Continue
 Figure 21-2 shows two of the consumer’s many
indifference curves. The consumer is indifferent among
combinations A, B, and C, because they are all on the
same curve.

 Not surprisingly, if the consumer’s consumption of pizza

is reduced, say from point A to point B, consumption of
Pepsi must increase to keep him equally happy.

 If consumption of pizza is reduced again, from point B to

point C, the amount of Pepsi consumed must increase
yet again.
Indifference Map
 A set of indifference curves represents an
indifference map
Indifference Marginal Rate of Substitution
 The slope at any point on an indifference curve equals the rate at
which the consumer is willing to substitute one good for the other.
 This rate is called the marginal rate of substitution (MRS). In this
case, the marginal rate of substitution measures how much Pepsi
the consumer requires in order to be compensated for a one-unit
reduction in pizza consumption.

 Notice that because the indifference curves are not straight lines,
the marginal rate of substitution is not the same at all
 points on a given indifference curve.

 The rate at which a consumer is willing to trade one good for the
other depends on the amounts of the goods he is already
consuming.

 That is, the rate at which a consumer is willing to trade pizza for
Pepsi depends on whether he is more hungry or more thirsty, which
in turn depends on how much pizza and Pepsi he has.
Marginal Rate of Substitution
 Marginal Rate of Substitution (MRS) is the rate
at which the consumer is prepared to
exchange goods X and Y
Combination of Quantity of Quantity of MRS
goods x and y good x(Qx) good y(Qy)

A 1 13
B 2 9 4
C 3 6 3
D 4 4 2
E 5 3 1
MRS formula

Y MU X
MRS   
X MUY
Properties of Indifference Curves
 Indifference curves slope downward to the
right
 Indifference curves are always convex to the

origin
 Indifference curves can never intersect each

other
 A higher indifference curve represents a

higher level of satisfaction than the lower

indifference curve
Indifference curves when Goods x
and y are substitutes

Qy

IC1
Qx
Indifference Curve when Goods x and
y are complements

Qy

IC2
B

IC1
A

Qx
Consumer’s Equilibrium or
Maximization of Satisfaction
 "The term consumer’s equilibrium refers to the
amount of goods and services which the
consumer may buy in the market given his
income and given prices of goods in the market,
that give maximum satisfaction to consumer".

 The aim of the consumer is to get maximum

satisfaction from his money income. Given
the price line or budget line and the indifference
map