Consumer

behavior

The relevance
For successful exchange outcome
To understand the impact of micro
environment on their decision
making
So as to influence those factors
affecting demand

Sequence of discussion

Utility
Cardinal Utility Approach
Ordinal Utility Approach- Indifference
curve analysis
Behavioral perspectives on decision
making

Utility subjective, post consumption

satisfaction, user specific, ethically neutral,
changes with time, perception and income.

Cardinal utility (Jevons, Menger, Walras,

Marshall)

Ordinal utility (Slutsky, Pareto, John Hicks)

Cardinal utility

Total utility
Marginal utility

Principle of diminishing marginal utility

As a person continues the
consumption of a good with ceteris
paribus condition, the total satisfaction
derived will increase but at decreasing
rate.

Nehas utility from consuming crisps (daily)

Packets of
crisps
consumed

TU in utils

MU in
utils

0
1
2
3
4
5
6

0
7
11
13
14
14
13

0
7
4
2
1
0
-1

The ceteris paribus assumptions

Are there any goods or services where
consumers
do
not
experience
diminishing marginal utility?

Utility measurements

Consumer surplus - the excess of what

a person would have been prepared to
pay for a good (i.e. the utility) over what
that person actually pays

Marginal

consumer surplus - the

excess of utility from the consumption of
one more unit of a good (MU) over the
price paid :

MCS = MU - P

Total consumer surplus - the excess of a

persons total utility from the consumption of
a good (TU) over the amount that a person
spends on it (TE):

TCS = TU - TE
Rational consumer behavior - consumer
will go on purchasing additional units as
long as she gains additional consumer
surplus (MU>P)

 Optimum

level of consumption

- MU = P

If

a good is free, what would be

the level of consumer surplus?

MU and demand curve

Water-Diamond Paradox
What determines the market value of a good?

Adam Smith (1760s) How is it that Water

which is so essential to human life, and

thus has such a high value-in-use, has
such a low market value? And how is that
diamonds which are relatively so trivial
have such a high market value?

Karl

Marx (Germany) and David Ricardo

(UK)- value depends on the amount of
resources used

 MU

revolution in 1870s - Jevons(UK) Carl

Menger(Austria) and Walras(Switzerland)
claimed that the source of market value is
its MU, not its TU.

Diminishing

marginal utility of incomemoral argument for redistributing income

The Law of Equi-marginal

Utility
the optimum combination of goods
consumed - consumer will get the
highest total utility from a given level of
income when the utility from the last
re.1 spent on each good is the same.

Ordinal utility- Indifference curve

analysis

Consumer Preferences
Budget Constraint
Basic Assumptions
Completeness- preferences ignore costs
Reflexivity- bundle is as good as others
Transitivity- preferences are consistent

and rational
More to Less

 Indifference

curve - a line showing

all those combinations of two baskets
of goods between which a consumer is
indifferent
Characteristics of an IC
slopes downward to right
two ICs cannot intersect each other
higher IC gives higher level of
satisfaction
convex to origin

Marginal rate of substitution (MRS)

between two goods in consumption

Diminishing MRS
Indifference map
Budget constraint

Which of the following diagrams correspond to which

of the following?
Y

a) x and y are left shoes and right shoes.

b) x and y are two brands of the same
product, and the
consumer cannot tell
them apart.

Optimization of satisfaction by consumer

MRSxy = Px/Py
Px/Py = MRSxy = MUx/MUy = X/ Y
Px/Py = MUx/MUy
MUx/Px = MUy/Py

 The effect of changes in income

Real income
Income-consumption curve
The effect of change in price
Price-consumption curve

 Price

effect = Substitution effect +

Income Effect

Income effect of a price change

Substitution effect of a price change
Compensating variation excludes
change in real income

the

Engel Curve (1821-96)- Indians

spend more on education, less on
food
1999-2009- food expenditure increased
by 70% in rural and 78% in urban
Education expenditure 378% in rural
and 345% in urban
63% in rural and 73% in urban people
getting their kids educated
Medical care- 152% rise in rural and
136% in urban
(NSSO 61st and 66th round reports)