Microeconomics chapter 2 NCERT/ Theory of consumer behaviour

  The consumer has to decide how to spend her income on different goods. Economists call this the problem of choice. Any consumer will want to get a combination of goods that gives her maximum satisfaction. The ‘likes’ of the consumer are also called ‘preferences’. Two different approaches that explain consumer behavior 

(i) Cardinal Utility Analysis and (ii) Ordinal Utility Analysis. A consumer, in general, consumes many goods; but for simplicity, we shall consider the consumer’s choice problem in a situation where there are only two goods. i.e, bananas and mangoes Use the variable x1 to denote the quantity of bananas and x2 to denote the quantity of mangoes. x1 and x2 can be positive or zero. Utility of a commodity is its want-satisfying capacity. Utility is subjective. Different individuals can get different levels of utility from the same commodity. For example, some one who likes chocolates will get much higher utility from a chocolate than some one who is not so fond of chocolates, For example, utility from the use of a room heater will depend upon whether the individual is in Ladakh or Chennai (place) or whether it is summer or winter (time). Cardinal utility analysis assumes that level of utility can be expressed in numbers. Two important measures of utility. Total utility of a fixed quantity of a commodity (TU) is the total satisfaction derived from consuming the given amount of some commodity x.Marginal utility (MU) is the change in total utility due to consumption of one additional unit of a commodity. For example, suppose 4 bananas give us 28 units of total utility and 5 bananas give us 30 units of total utility. Clearly, consumption of the 5th banana has caused total utility to increase by 2 units (30 units minus 28 units). Therefore, marginal utility of the 5th banana is 2 units. MU5 = TU5 – TU4 = 30 – 28 = 2 or In general, MUn = TUn – TUn-1, Total utility and marginal utility can also be related in the following way. TUn = MU1 + MU2 + … + MUn-1 + Mun it is seen that the marginal utility diminishes with increase in consumption of the commodity. Eg eating more of one thing does not give that much of satisfaction which it earlier give. The rate of change in total utility due to change in quantity of commodity consumed is a measure of marginal utility. This follows from the law of diminishing marginal utility. Law of Diminishing Marginal Utility states that marginal utility from consuming each additional unit of a commodity declines as its consumption increases, while keeping consumption of other commodities constant. MU becomes zero at a level when TU remains constant. Thereafter, TU starts falling and MU becomes negative.

Cardinal utility analysis can be used to derive demand curve for a commodity. The quantity of a commodity that a consumer is willing to buy and is able to afford, given prices of goods and income of the consumer, is called demand for that commodity. Demand curve is a graphic presentation of various quantities of a commodity that a consumer is willing to buy at different prices of the same commodity, The downward sloping demand curve shows that at lower prices, the individual is willing to buy more of commodity x; At higher prices, she is willing to buy less of commodity x. Therefore, there is a negative relationship between price of a commodity and quantity demanded which is referred to as the Law of Demand.

The law of diminishing marginal utility states that each successive unit of a commodity provides lower marginal utility. the consumer does not measure utility in numbers, though she often ranks various consumption bundles. This forms the starting point of this topic – Ordinal Utility Analysis. The consumer is said to be indifferent on the different bundles because each point of the bundles give the consumer equal utility. Such a curve joining all points representing bundles among which the consumer is indifferent is called an indifference curve.

It is clear that when a consumer gets one more banana, he has to forego some mangoes, so that her total utility level remains the same and she remains on the same indifference curve. Therefore, indifference curve slopes downward. The amount of mangoes that the consumer has to forego, in order to get an additional banana, her total utility level being the same, is called marginal rate of substitution (MRS). , MRS =| ∆Y/ ∆X | So, with increase in the number of bananas, the consumer will feel the inclination to sacrifice small and smaller amounts of mangoes. This tendency for the MRS to fall with increase in quantity of bananas is known as Law of Diminishing Marginal Rate of Substitution. It may be mentioned that the law of Diminishing Marginal Rate of Substitution causes an indifference curve to be convex to the origin. But in case of goods being perfect substitutes, the marginal rate of substitution does not diminish. It remains the same. i.e straight line with downward sloping. Indifference curve depicting two commodities which are perfect substitutes is a straight line. The consumer’s preferences over all the bundles can be represented by a family of indifference curves. This is called an indifference map of the consumer.

Indifference curve slopes downwards from left to right Higher indifference curve gives greater level of utility Two indifference curves never intersect each other The consumers budget The consumption bundles that are available to the consumer depend on the prices of the two goods and the income of the consumer. the consumer can afford to buy only those bundles which cost her less than or equal to her income.Suppose the income of the consumer is M and the prices of bananas and mangoes are p1 and p2 respectively. To buy x1 quantities of bananas, she will have to spend p1* x1 amount of money. Similarly, if the consumer wants to buy x2 quantities of mangoes, she will have to spend p2* x2 amount of money. Therefore, if the consumer wants to buy the bundle consisting of x1 quantities of bananas and x2 quantities of mangoes, she will have to spend p1 *x1 + p2 *x2 amount of money. the consumer can buy any bundle (x1 , x2 ) such that p1* x1 + p2* x2 ≤ M . The inequality is called the consumer’s budget constraint. The set of bundles available to the consumer is called the budget set.

The budget set consists of all bundles that are available to the consumer. The optimum bundle of the consumer is located at the point where the budget line is tangent to one of the indifference curves.