THEORIES OF

CONSUMER BEHAVIOUR
Theory of Consumer Behaviour :
- describes how consumers allocate incomes among different goods
and services to maximize their utility.
- studies how individual consumers react to scarcity of income.

Here consumer behavior is best understood in three distinct steps :

1. Consumer preferences
2. Budget constraints
3. Consumer choices.
 1. Utility has no Ethical
or Moral Significance:

2. Utility is Psychological.
Characteristics of
Utility 3. Utility is always
Individual and Relative
(in relation to time and
place)
 4. Utility is not Necessarily
Equated with Usefulness:

5. Utility cannot be measured

objectively
Characteristics of 6. Utility depends on the
Utility intensity of Want

7. Utility is Different from

Pleasure
 1. Form Utility - this is
created by changing the
form or shape of the
Types materials.

of Utility 2. Place Utility - this is

created by transporting
goods from one place to
another.
 3. Time Utility - Utility of a
commodity is always more
Types at the time of scarcity.
4. Service Utility - this is
of Utility created in rendering
personal services to the
customers by various
professionals.
 1. Marginal Utility - is the
utility derived form the last or
marginal unit of consumption.
Kinds It refers to the
additional utility derived from
an extra unit of the given
commodity purchased,
of Utility acquired or consumed by the
consumer.
 • (i) Positive Marginal Utility - when the
consumption of a unit of commodity makes an
addition to the total utility.

Kinds
• (ii) Zero Marginal Utility - when the
consumption of a unit of a commodity makes no
addition to the total utility.
of Utility
(Marginal Utility)
• (iii) Negative Marginal Utility - is that the utility
where if the consumption of a commodity is
carried to excess, then instead of giving any
satisfaction, it may cause dis-satisfaction.
Marginal Utility
Marginal Utility
 2. Total Utility - is the utility
from all units of consumption.
Kinds - is the sum of the marginal
utilities of the marginal
utilities associated with the
of Utility consumption of the successive
units.
Total Utility
 3. Average Utility - is that
utility in which the total unit of
Kinds consumption of goods is
divided by the number of Total
Units. The quotient is known
as Average Utility.
of Utility
Average Utility
Average Utility
Relationship between Marginal Utility and Total
Utility
Relationship between Marginal Utility and Total
Utility

MU(x) = TU(x) – TU(x – 1)

The Marginal Utility gained from the xth unit of

consumption is equal to the difference between the total
utility gained from x units of consumption and the total
utility gained from x–1 units of consumption.
 Relationship between Marginal Utility and Total
Utility
To remember:
(1) Marginal Utility goes on diminishing with the consumption of every additional unit of
bread.
(2) Total Utility goes on increasing with the consumption of every additional unit but at a
diminishing rate.
(3) Marginal Utility is equal to the increase in the Total Utility. Total Utility is the sum total
of the Marginal Utilities derived from all the units consumed.
(4) When Marginal Utility becomes 0, total utility does not increase.
(5) When Marginal Utility becomes negative, Total Utility decreases.
(6) Increase in total Utility depends on Marginal Utility.
(7) Since Marginal Utility diminishes, Total Utility increases at a diminishing rate.
(8) When Marginal Utility is Zero, Total Utility is maximum.
(9) When Marginal Utility is negative, Total Utility declines.
 THE LAW OF DIMINISHING MARGINAL UTILITY

- states that commodities become less valuable as more of them are

acquired. During the course of consumption, as more and more units
of a commodity are used, every successive unit gives utility with a
diminishing rate, provided other things remaining the same; although,
the total utility increases.

- The law of diminishing marginal utility connects to the concept of

consumer's surplus. To quote the economist Alfred Marshall: "A
consumer is generally willing to pay more for a given quantity of good
than what he actually pays at the price prevailing in the market.:
:
Graphical Representation
: of the Law of Diminishing Marginal Utility
 :
Mathematical Interpretation of the Law of Diminishing
Marginal Utility

The law of diminishing marginal utility states the utility function is

upward sloping and concave. Neoclassical microeconomic theory
assumes that all commodities are infinitely divisible.
 Consumer Surplus

Alfred Marshall, British Economist defines consumer’s surplus as

follows: “Excess of the price that a consumer would be willing to pay
rather than go without a commodity over that which he actually
pays.”

Hence, Consumer’s Surplus = The price a consumer is ready to pay –

The price he actually pays
Further, the consumer is in equilibrium when the marginal utility is
equal to the price.
Consumer Surplus
No. of units Marginal Utility Price (Rs.) Consumer’s Surplus

1 30 20 10

2 28 20 8

3 26 20 6

4 24 20 4

5 22 20 2

6 20 20 0

7 18 20 –
Consumer Surplus

•Marginal utility is the price the consumer is

willing to pay for that unit.

•The actual price of the unit is fixed.

Consumer Surplus
Graphical Representation
 Indifference Curve

It is a curve that represents all the combinations of goods that give the
same satisfaction to the consumer. Since all the combinations give the
same amount of satisfaction, the consumer prefers them equally.
Hence the name Indifference Curve.
 Indifference Curve

It is a curve that represents all the combinations of goods that give the
same satisfaction to the consumer. Since all the combinations give the
same amount of satisfaction, the consumer prefers them equally.
Hence the name Indifference Curve.
 Indifference Curve

Peter has 1 unit of food and 12 units of clothing. Now, we ask Peter
how many units of clothing is he willing to give up in exchange for an
additional unit of food so that his level of satisfaction remains
unchanged.

Peter agrees to give up 6 units of clothing for an additional unit

of food. Hence, we have two combinations of food and clothing giving
equal satisfaction to Peter as follows:
1 unit of food and 12 units of clothing
2 units of food and 6 units of clothing
Indifference Curve
By asking him similar questions, we get various combinations as follows:

Combination Food Clothing

A 1 12

B 2 6

C 3 4

D 4 3
Indifference Curve
Graphical Representation:
Indifference Map
An Indifference Map is a set of Indifference Curves. It depicts the
complete picture of a consumer’s preferences. The following diagram
showing an indifference map consisting of three curves

:
Indifference Curve
Marginal Rate of Substitution
This is the rate at which a consumer is prepared to exchange a good X for Y. If we go back to Peter’s example above,
we have the following table:

Combina
Food Clothing MRS
tion

A 1 12 –

B 2 6 6

C 3 4 2

D 4 3 1
Indifference Curve
Marginal Rate of Substitution
This is the rate at which a consumer is prepared to exchange a good X for Y. If we go back to Peter’s example above,
we have the following table:

Combina
Food Clothing MRS
tion

A 1 12 –

B 2 6 6

C 3 4 2

D 4 3 1
:

• An IC slopes downwards to the right

• An IC is always convex to the origin

Properties of • Indifference curves never intersect each other

IC • A higher IC indicates a higher level of satisfaction as

compared to a lower IC

• An IC does not touch the axis

Indifference Curve
Budget Line
Two constraints:
1.He has to pay the price for the goods and
2.He income is limited, restricting the availability of money for purchasing these goods
 4. Consistency and transitivity of choice -
Consumers are assumed consistent in their
choices between goods (or bundles of goods)
in the sense that if A is chosen over B in one
time period, B would not later be chosen
Basic over A. Consistency also implies transitivity.
For example, if A is preferred to B, and B is

Assumptions preferred to C, then A must be preferred to

C. Transitivity can be represented
symbolically as: if A > B and B > C then A > C
5. Diminishing marginal rate of substitution
 1. Rationality – consumers seek maximum
satisfaction (utility) from the goods and
services they purchased with their fixed
income.
2. Consumer prefer more to less –

Basic
consumer will generally prefer more
than rather than less of a given
commodity.

Assumptions 3. Additional units yield decreasing utility

- Total utility increases at a decreasing
rate as an individual consumes
additional units of a good. Marginal
utility (the utility derived from the extra
unit) declines.