Theory of Consumer Behaviour

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Chapter two

In this chapter, we will study the behaviour of an individual consumer. The consumer has to decide how to spend her income on different goods. Economists call this the problem of choice. Most naturally, any consumer will want to get a combination of goods that gives her maximum satisfaction. What will be this 'best' combination? This depends on the likes of the consumer and what the consumer can afford to buy. The 'likes' of the consumer are also called 'preferences'. And what the consumer can afford to buy, depends on prices of the goods and the income of the consumer. This chapter presents two different approaches that explain consumer behaviour: Cardinal Utility Analysis and Ordinal Utility Analysis.

Preliminary Notations and Assumptions

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: bananas and mangoes. Any combination of the amount of the two goods will be called a consumption bundle or, in short, a bundle. In general, we shall use the variable x sub one, to denote the quantity of bananas and x sub two to denote the quantity of mangoes. x sub one and x sub two can be positive or zero. (x sub one x sub two) would mean the bundle consisting of x sub one quantity of bananas and x sub two quantity of mangoes. For particular values of x sub one and x sub two, (x sub one, x sub two), would give us a particular bundle. For example, the bundle (five, ten) consists of five bananas and ten mangoes; the bundle (ten, five) consists of ten bananas and five mangoes.

Two point one Utility

Two point one point one Cardinal Utility Analysis

Measures of Utility

Derivation of Demand Curve in the Case of a Single Commodity (Law of Diminishing Marginal Utility)

Two point one point two Ordinal Utility Analysis

Shape of an Indifference Curve

Monotonic Preferences

Indifference Map

Features of Indifference Curve

Three. Two indifference curves never intersect each other:

Two indifference curves never intersect each other

Two point two THE CONSUMER'S BUDGET

Two point two point one Budget Set and Budget Line

EXAMPLE two point one

Price Ratio and the Slope of the Budget Line

Two point two point two Changes in the Budget Set

Two point three Optimal Choice of the Consumer

Equality of the Marginal Rate of Substitution and the Ratio of the Prices

Two point four DEMAND

Two point four point one Demand Curve and the Law of Demand

Functions

EXAMPLE

Graphical Representation of a Function

Two point four point two Deriving a Demand Curve from Indifference Curves and Budget Constraints

Deriving a demand curve from indifference curves and budget constraints

Two point four point three Normal and Inferior Goods

Two point four point four Substitutes and Complements

Two point four point five Shifts in the Demand Curve

Two point four point six Movements along the Demand Curve and Shifts in the Demand Curve

Two point five Market Demand

Adding up Two Linear Demand Curves

Two point six Elasticity of Demand

Two point two

Two point six point one Elasticity along a Linear Demand Curve

Geometric Measure of Elasticity along a Linear Demand Curve

Constant Elasticity Demand Curve

Two point six point two Factors Determining Price Elasticity of Demand for a Good

Two point six point three Elasticity and Expenditure

Summary

Key Concepts

Budget set

Indifference

Marginal Rate of substitution

Overview

The document examines consumer behavior through the lens of utility theory, presenting cardinal and ordinal analyses to explain how consumers make choices to maximize their satisfaction with limited resources. It introduces essential concepts like total utility, marginal utility, and the law of diminishing marginal utility, as well as illustrating demand curves.

Key Points

1The concept of utility reflects the want-satisfying capacity of goods
2Cardinal utility analysis quantifies utility in numerical terms while ordinal utility ranks preferences without numbers
3The law of diminishing marginal utility states that additional units of consumption yield lower satisfaction
4Demand curves represent the relationship between price and quantity demanded, illustrating a downward slope
5Consumer choices are influenced by income, prices, and preferences.

Details

Category: Psychology

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