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Consumer Behavior
1 April
Two Credit
The Theory of Consumer
Behavior
The principle 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).
Theory of Consumer Behavior
Useful for understanding the demand side of
the market.
0 0 0
1 4 4
2 7 3
3 8 1
4 8 0
5 7 -1
The Cardinal Approach
TU, in general, increases
with Q
At some point, TU can start
falling with Q (see Q = 5)
If TU is increasing, MU > 0
From Q = 1 onwards, MU is
declining principle of
diminishing marginal utility
As more and more of a
good are consumed, the
process of consumption will
(at some point) yield smaller
and smaller additions to
utility
Consumer Equilibrium
P
Consumer Equilibrium
Optimizing condition:
MU X MU Y
PX PY
If MU X MU Y
PX PY
Suppose: X = fishball
Y = fishcake
Assume: PX = 2
PY = 10
Cont.
Scenarios:
– If consumer’s income = 46, then the
optimum is given by combination A.
.…Combination B is not affordable
– If the consumer’s income = 60, then the
optimum is given by Combination
B….Combination A is affordable but it
yields a lower level of utility
The Ordinal Approach
goods Y
M
S
A
C
T D IC2
IC1
IC-1
O
4 7 11
goods X
PROPERTIES OF INDIFFERENCE CURVE
C A IC1
B
IC2
Good X
Budget line (BL)
Px Px X
EFFECTS OF PRICE CHANGES ON
THE BUDGET LINE
When price of good X increases, the quantity of
good X is reduced (by maintaining the quantity of
Y) & vice versa.
Points on the X axis shifted to the left (a
small quantity of X)
When the price of Y increases, the quantity Y is
reduced (by maintaining the quantity of X) &
vice versa
Point on Y axis move to the bottom
(small quantity in Y)
FACTORS SHIFT THE BUDGET LINE
Py
X
FACTORS SHIFT THE BUDGET LINE
Changes in income
Y
X
EFFECTS OF INCOME CHANGES ON
THE BUDGET LINE
Y
M
F
C Indifference Curves (IC)
IC4
O M1 X
Price Consumption Curve (PCC)
changes in Px
Y
Price Consumption Curve (PCC)
X
PCC = Line connecting the equilibrium points, E the event of changes to
the prices of goods.
Formation of Demand Curve
Outcome of PCC
Px
Dd
Qty X
Demand Curve for Normal Goods and Inferior Goods
Normal goods
Inferior goods
Qty X
Normal goods= P , Dd
Inferior goods= P , Dd
INCOME CONSUMPTION CURVE (ICC)
Y
M
ICC
IC3
IC2
IC1
O
M1 M2 M3 X
ENGEL CURVE
M
Engel curve for x
40
30
20
10
O
12 16 20 22 X
ENGEL CURVE
M Normal goods
Luxury goods
O X
Conclusion
ToCB showing how it provides users a combination of sources of income
for many goods /services
There are two types of utility theory:
– Cardinal TU and MU
– Ordinal curve IC and BL
Equilibrium and utility maximization can be either TUC or TUO
Equilibrium points of connection to produce PCC (change IN PRICE)
and ICC (change in income)
Displaying Publication = PCC curve DD & ICC = Engel curve (EC)
The types of goods obtained displaying income or price changes.
Thank You