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Theory of Consumer Behavior

The document discusses consumer behavior theory, including: 1) Consumers aim to maximize their utility, or satisfaction, from consuming goods. Utility can be measured cardinally or ordinally. 2) The cardinal approach assumes utility can be quantitatively measured in "utils" and equates to willingness to pay. It describes concepts like total utility, marginal utility, and the law of diminishing marginal utility. 3) Consumer equilibrium occurs when the marginal utility derived from a good equals its price. The law of equi-marginal utility states consumers equalize marginal utility across goods when maximizing satisfaction within a budget.

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Neushinth Hettiarachchi
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163 views14 pages

Theory of Consumer Behavior

The document discusses consumer behavior theory, including: 1) Consumers aim to maximize their utility, or satisfaction, from consuming goods. Utility can be measured cardinally or ordinally. 2) The cardinal approach assumes utility can be quantitatively measured in "utils" and equates to willingness to pay. It describes concepts like total utility, marginal utility, and the law of diminishing marginal utility. 3) Consumer equilibrium occurs when the marginal utility derived from a good equals its price. The law of equi-marginal utility states consumers equalize marginal utility across goods when maximizing satisfaction within a budget.

Uploaded by

Neushinth Hettiarachchi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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MICROECONOMICS

03 THEORY OF CONSUMER BEHAVIOR


BY NIPUNI ABEYSIRIWARDENA
Utility

 A consumer is a utility maximizing entity


 Utility is a psychological phenomenon: it’s a feeling of satisfaction, pleasure, happiness
or well-being which a consumer derives from consumption or possession of a
commodity.
 Two measurements:
 Cardinal Approach – quantitatively measurable (weight, height, etc)
 Ordinal Approach – ordinal terms (more than, less than)
Cardinal Approach

 Util – units of utility – money as the measure of utility


 Assumptions of Cardinal Approach
 Utility of a commodity equals the money a consumer is willing to pay for it
 Marginal Utility of money remains constant
 One Util = One unit of money
The utility of a commodity for a consumer equals the money which he or
she willing to pay for the commodity.
 Total Utility (TU) – the sum of the utility derived from all the units consumed of
the commodity.
TU = U1 + U2 + U3 + U4
The Marginal Utility (MU) – the addition to the total utility derived from
consumption or acquisition of one additional unit.
Change in the total utility resulting from the consumption of one additional unit
MU = ∆TU/∆Q
Law of Diminishing Marginal Utility

 As the quantity consumed of a commodity increases per unit of time, the utility derived by the
consumer from the successive units goes decreasing, provided the consumption of all other goods
remains constant
 The law stems from the facts,
1. The utility derived from a commodity depends on the intensity or urgency of the need for that
commodity
2. As more and more quantity of a commodity is consumed, the intensity of desire decreases
Ex : Sandwich
 The relationship between quantity consumed and utility derived from each successive unit
consumed is called law of diminishing marginal utility
Sandwiches Total Utility Marginal Utility

1 40 40-0=40

2 70 70-40=30

3 90 90-70=20

4 100 100-90=10

5 100 100-100=0

6 90 100-90= -10
Consumer Equilibrium

 A utility maximizing consumer exchanges his money income for the commodity as long as
>
Assumptions : - marginal utility of commodity X is subject to diminishing
- marginal utility of money income remains constant
Therefore,
The utility maximizing consumer reaches his equilibrium with the level of his maximum satisfaction where,
=
MUx
Units of Price (Px) Marginal utility Remarks
X (Rs.) (utils)

1 10 20 MUX > Px>so
2 10 16 consumer will increase the
consumption
3 10 10 Consumer’s Equilibrium
(MUX=PX)
4 10 4 MUX < Px, so
5 10 0 consumer will decrease the
consumption

6 10 -6
Consumer Equilibrium

The General Case


In reality consumer consume a large number of goods.
MU schedules of various commodities may not be the same. Some commodities yield higher utility
and some lower.
Rational consumer picks up the commodity which yields the highest utility and next he picks up the
commodity which yields the second highest utility.
He switches his expenditure from one commodity to another in accordance with their marginal utility.
He continues to switch his expenditure from one commodity to the other till he reaches a stage where
MU of each commodity per unit of expenditure is the same. This is called the law of equi-marginal
utility
Law of Equi- Marginal Utility

 The consumer reaches his equilibrium when the marginal utility derived from each
rupee spent on two commodities X and Y is the same.
=
A utility maximizing consumer consuming several goods and services intends to
equalize the marginal utility of each unit of his money expenditure.
No of units MUx MUy  Money income = 12
1 10 5  Px = 2
 Py = 1
2 8 4
The following two conditions must be satisfied to
determine how many units he will combine from
3 6 3 x and y to reach maximum satisfaction
4 4 2  =
 M = PxQx +PyQy
5 2 1
6 0 0
Drawbacks of Cardinal Utility

 Assumption that utility is cardinally measurable is untenable. Utility is a


subjective concept which cannot be measured objectively.
 Assumption that marginal utility of money remains constant is unrealistic.
Because marginal utility of money is subject to change.

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