MICROECONOMICS

Dr. Syeda Farzana Manzoor

BSBBA Program
Department of Management Sciences
THEORY OF CONSUMER BEHAVIOR
Consumer Behavior
The behavior of a person is the way they
act or behave in a certain situation.
Every individual has different
perspectives, opinions, views, wants,
tastes and needs. Hence, consumer
behavior deals with the way consumers
spend their income on different services
and goods.
Simply, consumer behavior is the study of
consumers’ actions and reactions in the
marketplace and the reason behind their
EXAMPLE,
iI a consumer has Rs.2,000 and has
different options to spend the money,
like movies, clothes and food, there are
different ways in which he can spend
the money. He can either spend the
whole amount on one option or
distribute the amount among two or
more options. The way in which the
consumer uses his money will show his
behavior or consumer behavior
Utility
Utility is the satisfaction gained by the
consumer after the consumption of a
specific good.
Utility is subjective in nature, different
individuals gain different levels of utility
from the same good.
The more a consumer needs a commodity
after its consumption, the more will be
the utility derived from that commodity.
E.g Ice cream
 CONSUMER BEHAVIOR
APPROACHES
1. Cardinal Utility Approach
2. Ordinal Utility Approach
1: Cardinal Utility Approach
Under the cardinal utility approach, we
assume that the utility level can be
measured and expressed in numbers. For
example, we can measure the utility of a
commodity, let’s say, chocolates, and say
that a consumer gets 20 units of utility
from chocolates.
2: Ordinal Utility Approach
The cardinal utility approach has a major
drawback, as in real-life, we cannot
measure their satisfaction level in
numbers. However, we can rank our
preferences amongst the alternatives by
expressing which commodity gives less or
more utility. For example, there are two
commodities, apple and banana; the
consumer consumes both commodities, and
likes apples more than bananas. We can say
that an apple provides the consumer with
more utility than a banana
 CARDINAL AND ORDINAL UTILITY
Basis Cardinal Utility Ordinal Utility
The measurement of utility or The measurement of
satisfaction derived by a utility or satisfaction
consumer after consuming goods derived by a consumer
Meaning after consuming goods
or servicesin numerical or services in
terms. qualitative terms.

Realistic less realistic. more realistic.

Approac qualitative
h
quantitative approach.
approach.

Measure
ment measured in utils. measured in ranks.
measured by
measured by Marginal Utility Indifference Curve
Analysis
Analysis. Analysis.
 CARDINAL UTILITY
The two different measures of utility under
cardinal utility are:
 1. Total Utility
The total utility of a commodity’s fixed quantity is
the total satisfaction level derived by a
consumer from the consumption of a given
commodity. The total utility of a commodity
depends on the quantity consumed by the
consumer. For example, the total utility of a
commodity, let’s say, mango, is derived from
consuming 10 units.
 2. MARGINAL UTILITY
The marginal utility of a commodity is the change
in its total utility because of the consumption of
one additional unit of the commodity. For
example, suppose 5 chocolates give a consumer
20 units of total utility, and 6 chocolates give
him 25 units of utility. The consumption of one
extra chocolate will provide him extra utility of
5 units. Therefore, the marginal utility of the
consumer will be 5. Hence, the formula for
determining the MU of a commodity is
MUn = TUn – TUn-1 Where,
MUn = Marginal utility from nth unit
TUn = Total utility from n units
TUn-1 = Total utility from n-1 units
n = Number of units of consumption
 LAW OF DIMINISHING MARGINAL
UTILITY
states that as a consumer consumes more
of a commodity, the marginal utility
derived from every additional unit
consumed will decrease. It means that a
consumer is ready to spend less money
for more units of a product as the utility
level for the commodity decreases with
the increase in consumption.
The DMU law is universally applies to all
products and services.
It was initially proposed by a German
economist, H.H. Gossen. Thus, it is also
known as Gossen’s First Law of
Consumption.
.
 ASSUMPTIONS OF DMU LAW
 There is continuous consumption of a
commodity.
 The consumer is consuming only
standard units of a commodity.
 The satisfaction level is measured in
numerical or quantitative terms.
 The quality of a commodity does not
change.
 The consumer consuming the
commodities is rational.
 The income of the consumer and the
price of the commodity are fixed
EXAMPLE OF DIMINISHING
MARGINAL UTILITY
Law of Diminishing Marginal Utility
In the above diagram, the units of apples are
displayed on the X-axis and the MU on the Y-
axis. Points A, B, C, D, and E reflect the MU
from each successive unit.
 EXPLANATION
 Itcan be observed as the consumption
of apples rises, the rectangles (which
represent each level of satisfaction) get
smaller and smaller. When consumption
is increased from first to second and
then third, MU decreases from 25 to 17
and then to 12 utils. The fifth apple is
the Point of Satiety and has no utility
(MU= 0). When the sixth apple is
consumed, MU turns negative. The
downward-sloping MU curve indicates
that the MU of successive units is
decreasing.
 ORDINAL UTILITY--INDIFFERENCE CURVE
A curve or a graphical representation of the
combination of different goods providing the
same satisfaction level to the consumer is
known as Indifference Curve.
At any point of the indifference curve gives
the same satisfaction level to the
consumer. The same satisfaction level
gained by the different combinations of
two goods makes the consumer indifferent.
For example, a child may gain the same
satisfaction level from one ice cream and two
chocolates, or three ice creams and one
chocolate.
Indifference Map
When more than one curve is represented on a graph
showing a different combinations of two different
goods on each curve, it is known as
an Indifference Map. Each indifference curve on
that graph shows one satisfaction level all along the
curve.
 BASIC ASSUMPTIONS OF AN
INDIFFERENCE CURVE ANALYSIS
 Utility is ordinal cannot be measured in cardinal
numbers like 1, 2, 3, etc. Can be measured in ordinal
numbers like 1st, 2nd, 3rd, etc
 There are only two goods purchased and consumed
by a consumer.
 The consumer is fully aware and has complete
knowledge about the price of both goods in the
market.
 The price of both the goods is already known.
 The taste, income and habits of a consumer remain
the same all the .
 The preferences of a consumer are transitive. It
means that if a consumer prefers Good X over Good
Y and Good Y over Good Z, then he/she prefers Good
X over Good Z.
  Example:
Nisha is consuming two goods Chocolate and Ice-
Cream, and is willing to consume different
combinations of these goods to gain an equal level
of satisfaction with each combination. These
combinations are given in the below indifference
schedule. Prepare an indifference curve for the
same.
In the above graph, points or combinations A, B, C,
D, and E provide the same satisfaction level to
Nisha
 This sacrifice of units of a good to gain an
additional unit of another good is known
as the Marginal Rate of Substitution.
 Marginal Rate of Substitution can be
defined as the amount of Good Y sacrificed
to obtain an additional unit of Good X
without affecting the total satisfaction
level.
PROPERTIES OF INDIFFERENCE CURVE

1. Indifference Curve always

slopes downwards from left
to right.

2. Indifference Curves are always

convex to the point of origin
The shape of an indifference curve is based on
the Diminishing Marginal Rate of Substitution. It
means that to gain a single extra unit of a good, a
consumer is willing to sacrifice more of another good
 IMPORTANT POINT
 When two goods are the perfect
substitute for each other, the shape of
the indifference curve is a straight
line. In this case, the Marginal rate of
substitution is constant.
 When two goods are perfectly
complementary to each other, the
shape of the indifference curve is L-
shaped and is convex to the origin.
3. HIGHER INDIFFERENCE CURVES
REPRESENT A HIGHER LEVEL OF
SATISFACTION
4. TWO INDIFFERENCE CURVES CANNOT
INTERSECT EACH OTHER
5. AN INDIFFERENCE CURVE NEVER
TOUCHES EITHER OF THE AXES
 CONSUMER EQUILIBRIUM
It is a state of rest or a position of no change,
which under a situation provides the
maximum gain.
Consumer’s Equilibrium is a situation in
which a consumer has maximum satisfaction
with limited income and does not tend to
change his existing way of expenditure.
The aim of a rational consumer is to balance his
expenditure in a way that he gets maximum
satisfaction by spending a minimum amount
of income, and when the consumer
successfully accomplishes his aim, he is said
to be in equilibrium.
 CONSUMER’S EQUILIBRIUM IN SINGLE
COMMODITY CASE
It can be explained with the help of the Law of
Diminishing Marginal Utility.
Assumptions of Equilibrium:
 There is continuous consumption of a commodity.
 The consumer is consuming only standard units of a
commodity.
 The satisfaction level is measured in numerical or
quantitative terms.
 The quality of a commodity does not change.
 The consumer consuming the commodities is
rational.
 The income of the consumer and the price of the
commodity are fixed
A consumer purchasing a single commodity will be at
equilibrium when he buys the commodity in such a
quantity that gives him maximum satisfaction.
The two factors which affect the number of units of the
given commodity to be consumed are the Price of the
given commodity and the Marginal Utility.
Being a rational consumer, he will be at an equilibrium
level when
Price of the commodity = Marginal utility.
P = MU
Marginal Utility is measured in utils and the
price is expressed in rupees; therefore, to
determine the equilibrium level it is essential
to express MU in terms of money, as:
A consumer, when consuming a single
commodity (say x) will be at equilibrium when:
Marginal Utility (MUx) is equal to Price (Px)
paid for the commodity.
MUx = Px
If MUx > Px,
then the consumer will not be at equilibrium
and he continues to purchase the commodity
as the benefit gained from the consumption is
more than the cost of the commodity.
If MUx < Px,
then also the consumer will not be at
equilibrium and he will have to reduce the
consumption of the commodity in order to
increase the satisfaction level,
 Marginal
Price Marginal
Units Utility
(Px) Utility MUx – Px Remarks
of x in Rs. (MUx)
(Rs) (Utils)
1 util = Rs.1

1 10 30 30/1 = 30 20
Here, MUx > Px,
so the consumer
will increase the
2 10 20 20/1 = 20 10
consumption

Consumer’s
3 10 10 10/1 = 10 0 Equilibrium
MUx = Px

4 10 0 0/1 = 0 -10
Here, MUx < Px,
so the consumer
will decrease the
5 10 -10 -10/1 = -10 -20
consumption
In the graph, the slope of the curve is
going downward, which indicates that
the marginal utility falls when an
additional commodity of x is consumed
(because of the Law of DMU). Also, the
Price (Px) is a straight horizontal line
as the price of the commodity is fixed at
Rs.10 per unit.
With the help of the above schedule and
graph, it can be said that the consumer
will be at equilibrium at point E, when
he consumes 3 units of commodity x
because at that point MUx = Px.
 WHAT IS BUDGET LINE?
Budget line is a graphical representation of all the
potential combinations of two commodities that
can be bought within a certain income and price,
and all of these combinations provide the same
satisfaction level.
Other names of Budget Line are Price Line
Diagrammatic Explanation of Budget Line
Assume that a consumer has a total budget of
Rs.40, with which he can buy various
combinations of Good X and Good Y. The cost
of one unit of Good X is Rs.8 and the cost of
one unit of Good Y is Rs.4 respectively.
 Money Spent =
Potential Good X Good Y Individual
Combinations (Rs8 each) (Rs4 each) Income
(Rs.)

(5 x 8) + (0 x 4)
E 5 0
= 40

(4 x 8) + (2 x 4)
F 4 2
= 40

(3 x 8) + (4 x 4)
G 3 4
= 40

(2 x 8) + (6 x 4)
H 2 6
= 40

(1 x 8) + (8 x 4)
I 1 8
= 40

(0 x 8) + (10 x
J 0 10
4) = 40
 SHIFT IN BUDGET LINE
Effect of a Change in the Income of
Consumer:
While assuming that the price of Good X and
Good Y in the above example remains
constant, if there is a change in the
income of the consumer, then the budget
line will shift.
When there is an increase in the income of
the consumer, then he will be able to
purchase more bundles of Good X and
Good Y, the budget line will shift to the
right from AB to A1B1.
when there is a reduction in the income of
the consumer, then the budget line will
shift to the left from AB to A2B2.
 CONSUMER’S EQUILIBRIUM BY INDIFFERENCE
CURVE ANALYSIS
The point of equilibrium or maximum
satisfaction is achieved by the study of
the indifference map and budget
line together.
An indifference map represents every possible
indifference curve that the consumer has,
which helps in ranking their preferences.
The combination of goods on the higher
indifference curve gives a higher
satisfaction level to the consumer.
Therefore, the highest of the indifference
curves of an indifference map is preferred
by a consumer.
 CONDITIONS OF CONSUMER’S
EQUILIBRIUM

Consumer’s equilibrium can be achieved with the help

of indifference curve theory only after meeting the
following two conditions:
1. MRSXY = Ratio of Prices or
MRSxy = Px / Py
2. Another condition for consumer’s equilibrium is
that at the point of equilibrium, the indifference
curve must be convex to the origin.
EXPLANATION:

In the above graph, IC1, IC2, and

IC3 are three indifference curves, and
AB is the budget line. The highest
indifference curve that a consumer
can reach with the budget line’s
constraint is IC2. The budget line AB
is tangent to the indifference curve
IC2 at point E. This point is the point
of equilibrium, where the consumer
buys OM quantity of Good X and ON
quantity of Good Y.
The consumer maximizes his level of satisfaction at
point E when he meets both conditions of the
consumer’s equilibrium, which are:
1. MRSXY = Ratio of Prices or = Market Rate of
Exchange (MRE)
OR
Slope of Indifference Curve = Slope of Budget
Line
2: The second condition of consumer’s equilibrium
is also achieved at point E. It is because at this point
MRS is diminishing, which means that IC2 is convex
to the origin here.