CONSUMER BEHAVIOR

Session Outline
Ordinal utility Analysis
Indifference curve
Budget line
Consumers equilibrium
Learning outcome
The study of consumer behavior will enable
us to understand the reasons as to why
individual demand more at a lesser price
and vice versa
It will give us an idea about the taste and
preferences of the consumer and how the
consumer attains maximum level of
satisfaction
Consumer Choice
Given the prices of different commodities,
consumers decide on the quantities of
these commodities according to their
paying capacity, and tastes and
preferences.
Consumers choices, tastes and
preferences rests on the following
assumptions:
Completeness: A consumer would be able to
state own preference or show indifference
between two distinct baskets of goods.
Transitivity: An individual consumers
preferences are always consistent.
Non-satiation: A consumer is never satiated
permanently. More is always wanted.
ORDINAL UTILITY ANALYSIS
The technique of indifference curves was originated
by Francis Y. Edgeworth in England in 1881. This
technique attained perfection and systematic
application in demand analysis at the hands of
Prof. John Richard Hicks and R.G.D. Allen in
1934.

Hicks discarded the Marshallian assumption of

cardinal measurement of utility and suggested
ordinal measurement which implies comparison
and ranking without quantification of the magnitude
of satisfaction enjoyed by the consumer .
 Indifference Curves
An indifference curve shows a set of
consumption bundles among which the
individual is indifferent

Quantity of y
Combinations (x1, y1) and (x2, y2)
provide the same level of utility

y1

y2 U1

Quantity of x
x1 x2
Definition :

An indifference curve is the locus of points representing all

the different combinations of two goods which yield equal
level of utility to the consumer.

Indifference Schedule :

Indifference schedule is a list of various combinations of

commodities which are equally satisfactory to the consumer
concerned.
 INDIFFERENCE
CURVES
24 A(1, 22)

INDIFFERENCE SCHEDULE 22
(Table Showing Different 4 )
2 ,1
Combinations giving Equal
20 B( 0 )
Satisfaction) 1
12 3 ,
Combination Apples Oranges (

)
C

,8
18
10

7)
(4
A 1 22 8

5,
D

E(
B 2 14 166
Oranges

C 3 10 4
142 Apples
D 4 8
0
E 5 7
1 2 3 4 5 6
 INDIFFERENCE
CURVES
24 A(1, 22)

22
INDIFFERENCE SCHEDULE
4 )
, 1
Combination Apples Oranges 20 B(2 )
0
A 1 22 12
3 ,1

)
(

,8
B 2 14 18
10 C

7)
(4
8

,
D
C 3 10

5
E(
166
D 4 8
Oranges

4 IC1
E 5 7 142
Apples
0
1 2 3 4 5
Indifference Curve Map

It represents a group of Indifference curves each of which

expresses a given level of satisfaction

Quantity of y

Increasing utility

U1 < U2 <
U3
U2 U3
U1
Quantity of x
ASSUMPTIONS OF IC ANALYSIS

Rational Consumer
Ordinal Utility
Non-satiety (more is preferred to less)
Diminishing Marginal Rate of Substitution
Consistency: If a consumer prefer A to B in one
period then he will not prefer B to A in another period
Transitivity: If a consumer prefer A to B
and B to C, then he must prefer A to C.
 PROPERTIES OF IC

1. An Indifference curve has negative slope

i.e. it slope downwards from left to
right.

2. Indifference curve is always convex to the origin. This implies

that two goods are imperfect substitutes and MRS between two
goods decreases as a consumer move along an indifference
curve. IC will be straight line if MRS is constant.
 PROPERTIES OF IC
3. Two Indifference curves never
intersect or become tangent to
each other.

This will violate the rule of

Transitivity because: on IC1 A is
equally preferred to B and on IC2 A
is equally preferred to C.
This implies B is equally preferred
to C, which can not be because
more is always preferred to less.
 PROPERTIES OF IC
4. Higher indifference curve represents
higher satisfaction.

Indifference map
This is because the
combinations lying on higher
indifference curve contain More is preferred to Less
more of either one or both
goods and more is always
preferred to less.
Marginal Rate of Substitution
The negative of the slope of the indifference
curve at any point is called the marginal rate
of substitution (MRS)

Quantity of y

dy
MRS
dx U U1
y1

y2 U1

Quantity of x
x1 x2
 MARGINAL RATE OF
SUBSTITUTION (MRS)

The marginal rate of substitution of X for Y (MRSxy) is defined as the

amount of Y, the consumer is just willing to give up to get one more
unit of X and maintain the same level of satisfaction.
-MRS is the proportion of one good that the consumer would be willing
to give up for more of another.

Decrease in the Consumption of Y = (-) Y

=
MRSxy Increase in the Consumption of X X
 DIMINISHING MARGINAL
RATE OF SUBSTITUTION

Combination Apples Oranges MRS

A 1 22 ---
B 2 14 8:1
C 3 10 4:1
D 4 8 2:1
E 5 7 1:1
As the consumer increases the consumption of apples, then for getting
every additional unit of apples, he will give up less and less of oranges,
that is, 8:1, 4:1, 2:1, 1:1 respectively This is the principle of
Diminishing MRS.
 LAW OF DIMINISHING MRS

A
24
MRS = -O/A = 8:1
22

MRS = 4:1
20
MRS is 12 B
MRS = 2:1
measured by 18
10
the slope of 8 C
the 166

D
Oranges

indifference 4 IC1

E
curve 142
0 Apples

1 2 3 4 5
Marginal Rate of Substitution
MRS changes as x and y change
reflects the individuals willingness to trade y for x

Quantity of y At (x1, y1), the indifference curve is steeper.

The person would be willing to give up more
y to gain additional units of x

At (x2, y2), the indifference curve

is flatter. The person would be
y1 willing to give up less y to gain
additional units of x
y2 U1

Quantity of x
x1 x2
Budget Constraint
Set of all the consumption basket the
consumer can afford.

What is consumption basket?

It is a list of quantities of different goods.
Budget Constraint
Budget constraint depends on
Income
Prices of goods
 BUDGET LINE

Budget line or Price Line: Shows all possible combinations of

two goods that the consumer can buy if he spends the whole of
his given sum of money on his purchases at the given prices.
The set of consumption basket that the consumer can
afford spending their entire income
 BUDGET LINE

able
ttain
Com Apples Oranges Total a
Un
binat (@ Rs. 6 @ Rs. 2 budget
ion per unit) Per unit (Rs.)=6xA
+2xO
ble
a
A 0 12 24 ia n
t
At
B 1 9 24
C 2 6 24
D 3 3 24
E 4 0 24 Budget line corresponding to budget of
Rs. 24
 CONSUMER EQUILIBRIUM

Consumers choose a combination

of goods that will maximize the
satisfaction they can achieve,
given the limited budget available
to them.

The maximising combination must satisfy two conditions:

It must be located on the budget line.
Must give the consumer the most preferred combination
of goods and services.
 CONDITIONS OF
CONSUMER EQUILIBRIUM

Condition-1:
Budget Line should be Tangent
to the Indifference Curve.
IC1
16
12 A
14
10
A Combination A can not be attained due to
8 budget constraints
6
Oranges

4
2
B
Budget Line
0
1 2 3 4 Apples
5
 CONDITIONS OF
CONSUMER
EQUILIBRIUM
Point B does not maximize satisfaction because
IC1 there exist a point C which is attainable and yields a
12 higher satisfaction.

10
B
8

6 C

4
Oranges

2
0 Budget Line

1 2 3 4 5
Apples
 CONDITIONS OF
CONSUMER
EQUILIBRIUM
Equilibrium occurs (Point C) when the consumer selects the
Combination which reaches the highest attainable Indifference
curve.

(U
na
12 A tt
ai
na At Equilibrium (Point C) we would have slope of
10 bl
e) Indifference Curve (MRSxy) equal to the slope of
Oranges

Budget Line (Px/Py)

8
6 C
IC4
4 IC3
(Attainable) IC2
2 IC1
0 B

1 2 3 4 5 6
Apples
 CONDITIONS OF
CONSUMER EQUILIBRIUM

Condition-2: Indifference Curve

must be convex to the origin.
Combination E can not be equilibrium
point Because MRS will be increasing
16 at E whereas it should be diminishing
12 A at the equilibrium point.
14
10
8
E
6 IC1
Oranges

4
2
Budget Line
0 B

1 2 3 4 Apples
5
To conclude
The theory of consumer choice helps us to
predict consumers responses to change in
price, income etc. With this understanding
manager of a firm is in a better position to
take decisions regarding pricing
,advertisement and other promotional
strategies.