UNIT

2
Approaches to Consumer Behaviour
Cardinal • Propounded by Marshall
• Known as Marshalling
Utility Approach
Approach

Ordinal • Propounded by Hicks &

Allen
Utility • Known as Indifference
Approach Curve Analysis
eral Economics: Theory of Consumer
2
Behaviou-Indiffernce Curve
 Utility
• Utility → “WANT SATISFYING POWER”
of a Commodity.
• Utility is a Psychological
Phenomenon.

General Economics: Theory of Consumer

3
Behaviou-Indiffernce Curve
 Utility
• Utility refers to Abstract Quality whereby an
Object Serves our Purpose.
- Jevons
• Utility is the Quality of a Good to Satisfy a
Want.
-Hibdon
• Utility is the Quality in Commodities that
makes Individuals want to buy them.
-Mrs. Robinso n
General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
4
 Features of Utility

Not
Ethically
Subjective Relative Essentiall
Neutral
y Useful
 Concepts of Utility
Initial • The Utility Derived from the
Consumption of Ist Unit of
Utility Commodity.

• The Aggregate of Utilities obtained

Total from the Consumption of Different
Units of Commodity.
Utility • TUn= U1+U2+U3+U4+…..+Un

Marginal • Change in Total Utility resulting

from the change in Consumption.
Utility • MU = TUn+TUn-1
General Economics: Theory of Consumer
7
Behaviou-Indiffernce Curve
 Types of Marginal Utility
Positive • With Consumption of an
Additional Unit of a
Marginal Commodity, Total Utility
Utility Increases.

• With Consumption of an
Zero Marginal Additional Unit of a
Utility Commodity, Total Utility
Remains Same.

Negative • With Consumption of an

Marginal Additional Unit of a
Commodity, Total Utility
Utility Decreases.
l ono i : h r o C n m r
Behaviou-Indiffernce Curve
8
Marginal Utility Analysis (MUA)
• Formulated by Alfred Marshall.
• Theory Explains How a Consumer
spends his Income on Different
Goods & Services so as to attain
Maximum Satisfaction.
• Based on Certain Assumptions.

General Economics: Theory of Consumer

9
Behaviou-Indiffernce Curve
 Assumptions to MUA
• Cardinal Measurability of Utility
–Utility is a Measureable & Quantifiable
Entity.
–Money is the Measuring Rod of Utility

General Economics: Theory of Consumer

10
Behaviou-Indiffernce Curve
 Laws of Diminishing Marginal
Utility
• The Additional Benefit which a Person
derives from a given Increase in Stock of
a thing Diminishes with Every Increase in
the Stock that he already has.
-Marshall
• As the Amount Consumed of a Good
Increases, the Marginal Utility of the
Good tends to Decrease.
- Samuelson
General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
13
 Assumptions to Law of
Diminishing Marginal Utility
Other things being equal
- Utility can be Measured in the Cardinal
Number System.
- Marginal Utility of Money remains
Constant.
- Marginal Utility of Every Commodity is
Independent.
- Every Unit of the Commodity being used is
of Same Quality & Size.
General Economics: Theory of Consumer
14
Behaviou-Indiffernce Curve
 Assumptions of Law of
Diminishing Marginal Utility
• There is a Continuous Consumption of the
Commodity.

• There is No Change in the Income, Tastes,

Character, Fashion and Habits of the
Consumer.
• There is No Change in the Price of the
Commodity and its Substitutes.
General Economics: Theory of Consumer
15
Behaviou-Indiffernce Curve
 Explanation
Quantities of Tea
Consumed Total Utility Marginal Utility
(cups per day)
1 30 30
2 50 20
3 65 15
4 75 10
5 83 8
6 89 6
7 93 4
8 96 3
9 98 2
10 99 1
11 95 -4
 Explanation
35
30
25
20
15
10
5
0
0 2 4 6 8 10 12
-5
-10 Quantity of Tea (Cups per Day)
General Economics: Theory of Consumer
17
Behaviou-Indiffernce Curve
 Limitations of the Law
• Utility considered as Cardinally measureable
is Untenable as Utility is a Subjective
Concept.
• Unrealistic Assumption regarding Marginal
Utility of Money being Constant. Money is
subject to change.
• No Empirical Verification.
• The Derivation of Law is based on
assumption of Ceteris Paribus which is
unrealistic. General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
18
Marshallian Consumer ’s Surplus
• Consumer ’s Surplus = What a Consumer is
Willing to Pay – What he Actually Pays.
• Derived from the Law of Diminishing
Marginal Utility.

General Economics: Theory of Consumer

19
Behaviou-Indiffernce Curve
 Assumptions to Marshallian
Consumer ’s Surplus
• Perfect Competition prevails in Market

• Consumer purchases only one

Commodity.

• Price Of the Commodity is Fixed.

• Marginal Utility of Money is Constant.

General Economics: Theory of Consumer
20
Behaviou-Indiffernce Curve
Marshallian Consumer ’s Surplus
No. of Units Marginal Price (Rs.) Consumer ’s
Utility 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 -
General Economics: Theory of Consumer
21
Behaviou-Indiffernce Curve
Marshallian Consumer ’s Surplus

Y
M

Total Utility = area OMRQ

P R Price Paid = area OPRQ
Thus,
Consumer Surplus = area PMR
MU
O X
Q N
Quantity

General Economics: Theory of Consumer

22
Behaviou-Indiffernce Curve
 Limitations of Marshallian
Consumer ’s Surplus
• Consumer ’s Surplus cannot be Measured
precisely because it is difficult to measure
the Marginal Utilities of different units of a
Commodity consumed by a person.
• In case of Necessaries, the Marginal
Utilities of earlier units are infinitely large.
In such cases, Consumer ’s Surplus is
always Infinite.
General Economics: Theory of Consumer
23
Behaviou-Indiffernce Curve
 Limitations of Marshallian
Consumer ’s Surplus
• Consumer ’s Surplus derived from a
Commodity is Affected by the Availability
of Substitutes.
• No Simple rule for deriving the Utility
Scale of Articles of Distinction e.g.
Diamonds.
• Marginal Utility of Money is Assumed to
be Constant which is Unrealistic.
General Economics: Theory of Consumer
24
Behaviou-Indiffernce Curve
 Indifference Curve
• A Single Indifference Curve shows the
different Combinations of X and Y that
yield Equal Satisfaction to the Consumer.
- Leftwitch
• An Indifference Curve is a Combination of
Goods, each of which yield the Same
Level of Total Utility to which the
Consumer is Indifferent.
-
General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
 Assumptions to Indifference
Curve Analysis
• Rationality of Consumer
– The Consumer is Rational & aims at maximizing
his Total Satisfaction.
• Ordinal Utility
– Utility can be expressed Ordinally i.e.
Consumer is able to tell only Order of his
Preferences.
• Nonsatiety
– Consumer is not Oversupplied with Goods in
Question. General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
26
 Assumptions to Indifference
Curve Analysis
• Transitivity of Choice
– Means that if a Consumer prefers A to B & B
to C, he must prefer A to C.
• Consistency of Choice
– Means that if a Consumer prefers A to B in
one period, he will not prefer B to A in
another period or Treat them as Equal.
• Diminishing Marginal Rate of Substitution
General Economics: Theory of Consumer
27
Behaviou-Indiffernce Curve
Indifference Curve Schedule
Combination Apples Oranges
of apples
and oranges
A 1 + 10

B 2 + 7

C 3 + 5

D 4 + 4
28
 Indifference Curve
Y
IC

• Negative
10 A ( 1 + 10)
Slope
7 B(2+7)
5 C(3+5)
4 D (4 + 4 )
IC
• Convex

X
0 1 2 3 4 5 6
29
Apples
 Indifference Map
IC IC3 • An Indifference Map
IC1
2
Never Intersect or represents a Group of
be tangent to one
another Indifference Curves
each of which
expresses a given level
of Satisfaction.

• From the Point of View

of Satisfaction
IC3 >IC2 >IC1
Good X
30
 Marginal Rate of Substitution (MRS)
• The Rate at which an Individual must give up
“Good A” in order to obtain One More Unit of
“Good B ”, while keeping their Overall Utility
(Satisfaction) Constant.

• MRS Keeps on Declining since Consumer has

more & more units of one Good, he gives up
Less Units of Other Good.

31
 Properties of Indifference Curve
• An Indifference Curve has a Negative Slope i.e.
it Slopes Downwards.
• Indifference Curves are always Convex to the
Origin.
• Two Indifference Curves never Intersect or
become Tangent to Each other.
• Higher Indifference Curve represents Higher
Satisfaction

General Economics: Theory of Consumer

32
Behaviou-Indiffernce Curve
 Properties of Indifference Curve
• An Indifference Curve has a Negative
Slope i.e. it Slopes Downwards.
– This Property Implies that when the
amount of one Good in Combination is
Increased, the amount of the Other Good is
reduced. This is Essential if the Level of
Satisfaction is to remain the same on an
Indifference Curve.

General Economics: Theory of Consumer

33
Behaviou-Indiffernce Curve
 Properties of Indifference Curve
• Indifference Curves are always Convex to
the Origin.
– This implies that the Two Commodities are
Imperfect Substitutes for each other & that
the MRS between the two Goods Decreases
as a Consumer moves along an Indifference
Curve.
General Economics: Theory of Consumer
34
Behaviou-Indiffernce Curve
 Properties of Indifference Curve
• Indifference Curves are always Convex to
the Origin.
– Two Extreme conditions also exists.
• When 2 Goods are Perfect Substitutes,
Indifference Curve will be a Straight Line on
which MRS is Constant.
• When 2 Goods are Complementary,
Indifference Curve will consist of 2 Straight
Lines with a Right Angle bent which is convex
to the OriginGeneral
i.e. it will be L shaped.
Economics: Theory of Consumer
Behaviou-Indiffernce Curve
35
 Properties of Indifference Curve
• Two Indifference Curves never Intersect
or become Tangent to Each other.
– If Two Indifference Curves Intersect or are
Tangent, it would imply that an Indifference
Curve indicates Two different Levels of
Satisfaction (One Being Larger than the
Other) yield the Same Level of Satisfaction.
This will Violate the Rule of Transitivity.

General Economics: Theory of Consumer

36
Behaviou-Indiffernce Curve
 Properties of Indifference Curve
• Two Indifference Curves never Intersect
or become Tangent
IC
to Each other.
2
IC1

•A

•B
•C

Good X 37
 Properties of Indifference Curve
• Higher Indifference Curve represents
Higher Satisfaction
–This is because the Combinations lying
in Higher Indifference Curve Contain
More of either one or Both Goods and
More Goods are preferred to Less of
them.

General Economics: Theory of Consumer

38
Behaviou-Indiffernce Curve
 Price Line or Budget Line
• The Budget Line shows all those
Combinations of Two Goods which the
Consumer can buy Spending his Given
Money Income on two Goods at their
given Prices.
• Remember, that the Amount of a Good
that a Person can buy will depend upon
their Income and the Price of the Good.
General Economics: Theory of Consumer
39
Behaviou-Indiffernce Curve
 Price Line or Budget Line
Y

M PRICE LINE

•H

•K

O N X
Good X

General Economics: Theory of Consumer

40
Behaviou-Indiffernce Curve
 Consumer Equilibrium
• Consumer Equilibrium will be reached when
he is deriving Maximum possible Satisfaction
from the Goods & is in no Position to
Rearrange his Purchase of Goods.
• The Indifference Map in Combination with the
Budget Line allows us to Determine the One
Combination of Goods and Services that the
Consumer most wants and is able to Purchase.
This is the Consumer Equilibrium.
General Economics: Theory of Consumer
41
Behaviou-Indiffernce Curve
Consumer Equilibrium
Y • PL – Budget Line
P • Points R, S, Q, T, H
R all lie on Budget
S

N Q
IC4
T IC3
ICIC2
1
H
X
O M L
Good X
General Economics: Theory of Consumer
42
Behaviou-Indiffernce Curve
 Consumer Equilibrium
• At the Tangency Point Q, the slopes of the
Price Line PL And Indifference Curve IC3 are
equal.
• Slope of Indifference Curve shows MRS of X
for Y (MRSxy)
• At Equilibrium Point Q,

MU X PX
MRSXY = =
MU Y PY
General Economics: Theory of Consumer
43
Behaviou-Indiffernce Curve
 Equimarginal principle (Consumer Equilibrium Cardinal
Utility)

Price of Good A and B is 1$ Price of Good A 4 $ and B is 2 $

   

Units MU good A MU Good B Units MU A/ £4 MU B /£2

1 10 11
1 40 22
2 8 10
2 32 20
3 6 9
3 24 18
4 4 8
4 16 16
5 2 7
5 8 14
6 0 6
6 0 12
Dr. Mital Bhayani 42
Q1
Total Utility is Maximum when:
a) Marginal Utility is Zero.
b) Marginal Utility is at its highest
point.
c) Marginal Utility is equal to Average
Utility.
d) Average Utility is Maximum.
General Economics: Theory of Consumer
44
Behaviou-Indiffernce Curve
Q2
The Consumer is in Equilibrium at a
point where the Budget Line:
a) Is Above an indifference Curve.
b) Is Below an Indifference Curve.
c) Is Tangent to an Indifference Curve.
d) Cuts an Indifference Curve.

General Economics: Theory of Consumer

45
Behaviou-Indiffernce Curve
Q3
An Indifference Curve slopes Down
towards Right since more of one
Commodity & less of another result in:
a) Same Satisfaction.
b) Greater Satisfaction.
c) Maximum Satisfaction.
d) Decreasing Expenditure.

General Economics: Theory of Consumer

46
Behaviou-Indiffernce Curve
Q4
Which of the following is a Property of an
Indifference Curve?
a) It is Convex to the Origin.
b) The MRS is Constant as you move along
an Indifference Curve.
c) MU is Constant as you move along an
Indifference Curve.
d) Total Utility is greatest where the 45
degree line cuts the Indifference Curve.
General Economics: Theory of Consumer
47
Behaviou-Indiffernce Curve
Q5
Indifference Curve Analysis is Based on

a) Ordinal Utility.

b) Cardinal Utility.

c) Marginal Utility.

d) None of the Above.

General Economics: Theory of Consumer
48
Behaviou-Indiffernce Curve
Q6
Which is not the assumption of Indifference
Curve Analysis?
a) The Consumer is Rational & Possesses Full
Information about all aspects of Economic
Environment.
b) The Consumer is not capable of ranking all
combinations.
c) If Consumer Prefers Combination A to B, & B
to C, then he must prefer combination A to C
d) If Combination A has more Commodities
neral Eco nomics: Theory of Consum
than B, then A must be prefe rred to B.
Ge
Behaviou-Indiffernce Curve
er
49
Q7

Higher Indifference Curve Shows:

a) A higher level of Satisfaction

b) A higher level of Production

c) A higher level of Income

d) None of the above

General Economics: Theory of Consumer
50
Behaviou-Indiffernce Curve
Q8
Consumer Surplus is:
a) What a Consumer is ready to pay +
What he actually pays
b) What a Consumer is ready to pay –
What he actually pays
c) What he actually pays – What a
Consumer is ready to pay
d) None of the above
General Economics: Theory of Consumer
51
Behaviou-Indiffernce Curve
Q9
Indifference Curve is Convex to the origin
due to:

a) Falling MRS

b) Rising MRS

c) Constant MRS

d) None of the above

General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
52
Q 10
Marginal Utility Analysis was mainly
propounded by:

a) J.B.Say

b) Robbins

c) Adam Smith

d) Alfred Marshall
General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
53
Q 11
Indifference Curve Analysis is propounded
by:

a) Alfred Marshall

b) Adam Smith

c) Hicks And Allen

d) None of the Above.

General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
54
Q 12
Cardinal Measurability of Utility Means:

a) Utility can be Measured.

b) Utility cannot be Measured.

c) Utility can be Ranked.

d) Utility can be Measured in some cases.

General Economics: Theory of Consumer
55
Behaviou-Indiffernce Curve
Q 13
Slope of Indifference Curve indicates:

a) Price Ratio between two commodities.

b) Marginal Rate of Substitution.

c) Factor Substitution.

d) Level of Indifference.
General Economics: Theory of Consumer
56
Behaviou-Indiffernce Curve
Q 14
Law of Diminishing Marginal Utility does
not apply to:

a) Money

b) Butter

c) Pepsi, Coke, etc.

d) Ice Cream General Economics: Theory of Consumer

Behaviou-Indiffernce Curve
57
Q 15
Consumer Surplus is highest in the case of:

a) Necessities.

b) Luxuries.

c) Comforts.

d) None of the Above.

General Economics: Theory of Consumer
58
Behaviou-Indiffernce Curve
Q 16
If two goods were perfect substitutes of each
other, it necessarily follows that
a) An Indifference Curve relating the two goods
will be Curvilinear.
b) An Indifference Curve relating the two goods
will be linear.
c) An Indifference Curve relating the two goods
will be divided into two segments
d) An Indifference Curve relating the two goods
will be Convex to the origin.
General Economics: Theory of Consumer
Behaviou-Indiffernce Curve
59
Q 17
The Law of Consumer Surplus is Based on:

a) Indifference Curve Analysis

b) Revealed Preference Theory

c) Law of Substitution

d) Law of Diminishing Marginal Utility

General Economics: Theory of Consumer
60
Behaviou-Indiffernce Curve
Q 18
The Law of Diminishing Returns implies that:
a) For each extra unit of X consumed, holding
constant consumption of other goods, total utility
increases.
b) Total Utility remains unchanged regardless of how
many units of X are consumed.
c) Marginal Utility will increase at a constant rate as
more units of X are consumed.
d) Each extra unit of X consumed, holding constant
consumption of other goods, adds successively
less to total utility.
General Economics: Theory of Consumer
61
Behaviou-Indiffernce Curve
Q 19
Consumer Stops purchasing the Additional
Units of the Commodity when-
a) Marginal Utility starts declining.
b) Marginal Utility becomes Zero.
c) Marginal Utility is equal to Marginal
Utility of Money.
d) Total Utility is Increasing.

General Economics: Theory of Consumer

62
Behaviou-Indiffernce Curve
Q 20
Marginal Utility of a Commodity depends
on its quantity and is

a) Inversely related to its quantity

b) Not proportional to its quantity

c) Independent of its quantity

d) None of the Above 63

 THE END

Theory of Consumer Behaviour –

Indifference Curve