Theory of Consumer Theory-2

Theory of Consumer
Behaviour
TOPICS
• Utility theory
• Indifference curves
3
Introduction
• The willingness of consumers to
purchase a product or service is the
fundamental source of profit for many
business
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Introduction
• Understanding consumer behaviour,
then is the first step in making
profitable pricing, advertising,
product design and production
decisions
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Introduction
• Firms spends a great deal of time and
money trying to estimate and forecast
the demand of their products
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Introduction
• A manager’s need for practical
analysis of demand – both estimation
of demand and demand forecasting –
requires an economic model of
consumer behaviour to guide the
analysis
• In this chapter only the most
important aspects of theory of
consumer behaviour are presented
04/17/2024 7
Introduction
• Whenever a consumer maximizes his
satisfaction, he is satisfied with his
spending pattern, does not have any
tendency to change his style of
expenditure, he is said to be in
equilibrium in economics.
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Objective of the chapter
1. Understanding Why does a consumer

buy a particular bundle of goods and
services rather than others?
2. The importance of examining these
issues will help us understand
consumer behavior and the law of
demand.
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6.1 consumer preference and utility
• As an economic model, the theory of

consumer behaviour employs some
simplifying assumptions
• These assumptions permit us to go
directly to the fundamental determinants
of consumer behaviour
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a) Complete Information
a) Have complete information pertaining
their consumption decisions
b) They know the range of goods and
services available and the capacity of
each to provide utility
c) The price of each good is known exactly
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b) Preference ordering
a) Consumer are able to rank all conceivable
bundles of commodities – prefer bundle A to B
– prefer bundle B to A – equally satisfied with A
and B (indifferent)
b) Price has nothing to do with preference
c) Preference is a theoretical concept about how
people rank bundles of goods and or services
04/17/2024 12
c) Consumer is rational
a) If three bundles A, B, and C
b) A preferred to B and B preferred to C, then
A must be preferred to C (Transitive
preference)
d) Preference for more than less (More is better)
a) Consumers always prefer to have more of a
good rather than less
04/17/2024 13
utility
• Economists name the benefits consumers obtain

from the good and services they consume
UTILITY
• The satisfaction or utility can be measured into
numbers.
• E.g. If a consumer drinks a glass of milk, the
satisfaction he derives from that glass of milk
can be represented into number like 1,2,4,5
etc.
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utility
• It is the view of the economist that the
satisfaction or utility is a cardinally
measureable quantity as length, weight
and volume.
• Therefore they accepted the existence of
unit of measurement of utility called
“util”.
04/17/2024 J.R VALERIAN DeFRE 15

utility
• Consumer preference can be presented in

a UTILITY FUNCTION: -
• UTILITY FUNCTION: an equation the
shows an individual’s perception of the
level of utility that would be attained
from consuming each conceivable bundle
or combination of goods and services
U=f(X, Y).
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Utility------
• Utility depends upon the quantities of
goods and services consumed
• The actual numbers assigned to the level
of utility are arbitrary.
– E.g. consumer prefer 20X and 30Y to
15X and 32Y
– U = f(20,30) > U = f(15,32)
– Example …..
04/17/2024 17
6.2 Indifference Curve
• Consumers are willing to trade-off or
substitute among different goods
• This willingness to substitute is
determined by the form of that persons
utility function
• A fundamental tool for analysing
consumer behaviour is an
INDIFFERENCE CURVE
04/17/2024 18
• “An indifference curve is a locus of

points representing different
combinations of goods and services like
x and y which give a consumer an equal
satisfaction”.

• “An IC shows different bundles of two

goods like x and y amongst which
consumer remains indifferent because of
all such bundles yield a specific level of
utility”.
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• That is the consumer is indifferent
between any two commodity bundles
(points) that lie on the same IC curve. U =
f(x,y) = k
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Properties
1. An indifference curve is downward
sloping – more of X added Y must be
reduced
2. Indifference curves are convex –
Diminishing marginal rate of substitution
‘consumer chooses the substitute in place of
another good rather than simultaneously
consuming more’
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70
60 A
50
Quantity of Good Y
40 B
30
20 C
10 D
0
5 10 15 20 25 30 35 40 45 50 55
Quantity of good X
04/17/2024 23
Marginal rate of substitution
(MRS)
• It is an important concept in indifference
curve analysis
• Marginal rate of substitution MRSxy =
dY/dX
• Simply the rate of exchange between two
commodities x and y is called MRS.

(MRS)
• In proper words by “MRSxy we mean
how many units of commodity Y the
consumer has to forego to get an
additional unit of commodity X while the
new combination of commodity X and Y
yields the same level of satisfaction”.

(MRS)
• MRS diminishes along an indifference curve
• MRS is also known as slope of an IC.
• If we observe the indifference schedule and
indifference curve, we find that MRS goes
on to fall.
• Such tendency of falling MRS is known as
“Principle of DMRS” between X and Y.

(MRS)
• It is well evident fact that as a consumer
has more and more of any commodity
his desire to get any more of it decreases
because of an application of law of
diminishing marginal utility.
• When consumers has a small amount of
X relative to Y, they are willing to give
up a lot of Y to gain another unit of X

Indifference maps
• An
indifference
map is made
up of two or
more
indifference
curves
• IC3 is
preferred to
IC1
Law of Diminishing Marginal Utility
(DMU)
• By utility we mean, the power of a good to
satisfy human want. i.e. Water has a
power to quench one’s thirst. For our
discussion, by utility we mean “The
satisfaction”.

(DMU)
• As we discussed above that utility or
satisfaction depends upon the units of a
particular good. It is as: U= f(Q) or
TU=f(Q). This is called utility or total
utility function.

(DMU)
• By “Marginal utility” we mean the net change
in total utility by having consumed an
additional unit of a commodity.

(DMU)
• E.g. A consumer is using the units of apple, if
the total utility of 1st apple is 10 units while
the total utility goes to 18 units if he uses the
two apples, then the net change in total
utility or marginal utility is 8.
• MU is the derivative of total utility function
or it is the slope of TU curve, it is as: U = f(Q).
• Then its derivative will be MU = dU/dQ.
TOTAL AND MARGINAL UTILITY
30
Marginal
Total Utility (utils)

Apples Total
consumed Utility, Utility, 20
per meal Utils Utils
0 0 10
1 10
0 1 2 3 4 5 6 7
Units consumed per meal
Marginal Utility (utils)

10
8
6
4
2
0
-2
1 2 3 4 5 6 7
Apples Total Marginal

20
0 0
10
1 10 10
8
2 18
0 1 2 3 4 5 6 7

10
8
6
4
2
0
-2
1 2 3 4 5 6 7

20
0 0
10
1 10 10
8
2 18
6
3 24 0 1 2 3 4 5 6 7

10
8
6
4
2
0
-2
1 2 3 4 5 6 7

20
0 0
10
1 10 10
8
2 18
6
3 24 0 1 2 3 4 5 6 7
4 Units consumed per meal

4 28
10
8
6
4
2
0
-2
1 2 3 4 5 6 7

20
0 0
10
1 10 10
8
2 18
6
3 24 0 1 2 3 4 5 6 7

4 28
10
2 8
5 30 6
4
2
0
-2
1 2 3 4 5 6 7

20
0 0
10
1 10 10
8
2 18
6
3 24 0 1 2 3 4 5 6 7

4 28
10
2 8
5 30 6
0 4
6 30 2
0
-2
1 2 3 4 5 6 7
Apples Total Marginal TU

20
0 0
10
1 10 10
8
2 18
6
3 24 0 1 2 3 4 5 6 7

4 28
10
2 8
5 30 6
0 4
6 30 2
-2 0
MU
7 28 -2
1 2 3 4 5 6 7
Apples Total Marginal TU

0 0
20
Observe
10 Diminishing
1 10 10
8
2 18 Marginal
6
3 24
4
0 1 2
Utility
3 4 5 6 7

4 28
10
2 8
5 30 6
0 4
6 30 2
-2 0
MU
7 28 -2
1 2 3 4 5 6 7

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Theory of Consumer

1. Understanding Why does a consumer

• As an economic model, the theory of

• Economists name the benefits consumers obtain

04/17/2024 J.R VALERIAN DeFRE 15

• Consumer preference can be presented in

• “An indifference curve is a locus of

04/17/2024 J.R VALERIAN DeFRE 19

• “An IC shows different bundles of two

04/17/2024 J.R VALERIAN DeFRE 24

04/17/2024 J.R VALERIAN DeFRE 25

04/17/2024 J.R VALERIAN DeFRE 26

04/17/2024 J.R VALERIAN DeFRE 27

04/17/2024 J.R VALERIAN DeFRE 29

04/17/2024 J.R VALERIAN DeFRE 30

04/17/2024 J.R VALERIAN DeFRE 31

Total Utility (utils)

Units consumed per meal

Marginal Utility (utils)

Total Utility (utils)

Units consumed per meal

Marginal Utility (utils)

Total Utility (utils)

Units consumed per meal

Marginal Utility (utils)

Total Utility (utils)

4 Units consumed per meal

Total Utility (utils)

4 Units consumed per meal

Total Utility (utils)

4 Units consumed per meal

Total Utility (utils)

4 Units consumed per meal

Total Utility (utils)

Units consumed per meal

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