THEORY OF CONSUMER

BEHAVIOR
INTRODUCTION
• There are two main approaches to the consumer
behavior of demand. The first approach is
the Marginal Utility or Cardinalist Approach. The
second is the Ordinalist Approach.
• The theory of consumer behaviour examines the role
of the individual (consumer) in the market.
• The science of marketing is increasingly important to
success in the modern marketplace. Understanding
human behavior — how people think and make
decisions — can be illuminating for marketers.
Studying consumer behavior can provide professional
marketers with the knowledge they need to develop
effective communications that motivate people to
purchase goods and services.
Conti…
• The theory will be explained by discussing the following
concepts:
• Utility
• Marginal utility
• Total utility.
• UTILITY
Utility is the amount of satisfaction, which is derived from
the consumption goods or services at any given time.
Utility influences the consumers over the choice of what to
buy and the quantity to be bought.

• TYPES OF UTILITY
We have the following types, total and marginal utility.
Conti…
• (a) Total utility (T.U)
• This is the total amount of satisfaction
derived from the consumption of a given
goods or services at any given time. Total
utility rises at decreasing rate as
consumption is increased: in other words, it
is subjected to the law of diminishing return
i.e. it declines after the point of optimum
it declines after the point of optimum
Conti…
• (b) Marginal utility (M.U)
This is the additional utility gained from the
consumption of one more unit of a given
commodity per unit of time. It is the change in
total utility, which is brought about by the
consumption of an additional unit of the
commodity at any given time.
Marginal utility diminish as consumption increases.
Hence the marginal utility curve slopes downwards
from left, to right.
Hence the marginal utility curve slopes downwards from left, to right.
Law Of Diminishing Marginal Utility
The Law Of Diminishing Marginal Utility states that
all else equal as consumption increases the
marginal utility derived from each additional unit
declines.
Marginal utility is derived as the change in utility as
an additional unit is consumed. Utility is an
economic term used to represent satisfaction or
happiness. Marginal utility is the incremental
increase in utility that results from consumption
of one additional unit.
Conti…
Marginal utility may decrease into negative utility,
as it may become entirely unfavorable to
consume another unit of any product. Therefore,
the first unit of consumption for any product is
typically highest, with every unit of consumption
to follow holding less and less utility.
Consumers handle the law of diminishing marginal
utility by consuming numerous quantities of
numerous goods.
Conti…
The Law of Diminishing Marginal Utility directly relates
to the concept of diminishing prices. As the utility of
a product decreases as its consumption increases,
consumers are willing to pay smaller dollar amounts
for more of the product.
For example, assume an individual pays $100 for a
vacuum cleaner. Because he has little value for a
second vacuum cleaner, the same individual is willing
to pay only $20 for a second vacuum cleaner.
The law of diminishing marginal utility directly impacts
a company’s pricing because the price charged for an
item must correspond to the consumer’s marginal
utility and willingness to consume or utilize the good.
 Assumptions of Law of Diminishing Marginal Utility
The law operates under certain conditions, which are
referred to as the assumptions of the law of
diminishing marginal utility.
• It is assumed that the unit of the consumer good is a
standard one, Such as, a cup of tea, bottle of drink,
glass of water, etc.
• It is assumed that the utility is measurable, and the
satisfaction of the consumers can be expressed in
the quantitative terms.
• The consumer’s tastes and preferences remain same
during the period of the consumption.
• There must be continuity in the consumption.
• It is assumed that the quality of the commodity
remains uniform during the period of consumption.
Conti…
• All the commodities consumed by the consumer
are said to be independent of each other. The
utility of one commodity has no relation with the
marginal utility of another commodity.
• It is assumed that the income of the consumer
and the price of goods and services remains
unchanged during the period of consumption.
• The marginal utility of money remains
constant for the consumer.
• The mental condition of the consumer should
remain normal during the consumption period.
The conditions of diminishing marginal utility hold
universally.
 Exceptions to the Law of Diminishing Marginal Utility
1. Hobbies
In the case of hobbies like stamp collection, collection of antique goods,
collection of old coins etc, every additional unit gives more pleasure,
that is, marginal utility, tends to increase. No doubt this is true, but each
time a new variety of stamp or coin or antique is collected by a person
but not of the same variety.
2. Alcoholics:
The law seems to be inapplicable to alcoholics as intoxicants increases
with every successive dose of liquor. This is true, but the rationality
condition of the law is violated.
3. Misers:
In the case of a miser, it is pointed out that greed increases with every
additional acquisition of money. Hence, the marginal utility of money
does not diminish for him with more and more money. But, when the
miser spends his money his utility of the commodity will be diminishing
perhaps more rapidly than in the case of others.
Conti…
4. Music and poetry:
In the case of music and poetry it’s commonly experienced
that a repeat gives a better satisfaction than the first one.
Hence, it is thought that the law of diminishing marginal
utility may not be applicable here.
5. Reading:
Since more reading gives more knowledge a scholar would
get more and more satisfaction with every additional
book. But, here we may point out that it is not a real
exception to the law as the condition of homogeneity is
violated here. Knowledge and satisfaction increases by
reading different books and not the same book over and
over again.
Consumer surplus
Consumer surplus is an economic measure of consumer
benefit. It is calculated by analyzing the difference
between what consumers are willing and able to pay
for a good or service relative to its market price, or
what they actually do spend on the good or service.
A consumer surplus occurs when the consumer is
willing to pay more for a given product than the
current market price.
Consumer surplus is defined as the difference between
the total amount that consumers are willing and able
to pay for a good or service and the total amount
that they actually do pay.
 Measuring Consumer Surplus With a Demand Curve

The demand curve is a graphic representation used

to calculate consumer surplus. It shows the
relationship between the price of a product and
the quantity of the product demanded at that
price, with price drawn on the y-axis of the graph
and quantity demanded drawn on the x-axis.
Because of the law of diminishing marginal utility,
the demand curve is downward sloping.
Cont…
• Consumer surplus is measured as the area below the
downward-sloping demand curve, or the amount a
consumer is willing to spend for given quantities of a
good, and above the actual market price of the good,
depicted with a horizontal line drawn between the
y-axis and demand curve.
• Consumer surplus can be calculated on either an
individual or aggregate basis, depending on if the
demand curve is individual or aggregated.
• Consumer surplus always increases as the price of a
good falls and decreases as the price of a good rises.
area ABQC in the diagram.
Assumptions of Consumer’s Surplus

• Marginal utility of money is constant.

• Utility can be measured.
• Definite relationship between expected
satisfaction (utility) and realized satisfaction.
• Other determinants remains unchanged.
• Independent goods and independent utility.
• Utility can be measurable in terms of money.
 Criticism of Consumer’s Surplus
1. Imaginary: It is said that this is a purely
imaginary idea. It is all hypothetical. One
may say that one is prepared to pay
anything.
2.Difficult to Measure: It is difficult to measure
consumer’s surplus exactly. Besides, different
people are prepared to pay different
amounts. It would be a hopeless task to put
down how much each individual would be
willing to pay. Hence the total consumer’s
surplus in the market cannot be measured.
Conti..
3. Not Applicable to Necessaries: The idea of
consumer’s surplus does not apply to the
necessaries of life or conventional necessaries. In
such cases the surplus is immeasurable.
4. Marginal utility of money remains constant: the
theory of consumer’s surplus assumes that the
marginal utility of money remains constant and
does not alter with increase or decrease in the
money stock with the consumer. This is not the
case. Marginal utility of money changes.
Practical Importance of Consumer’s Surplus
• In Public Finance: It is useful in imposing taxes
and fixing their rates. He will tax those commodities
in which the consumers enjoy much surplus. In such
cases, the people would be willing to pay more than
they actually pay at present. Such taxes will bring in
more revenue to the State.
• To the Businessman and Monopolist: To the
businessman also the concept is very useful. He can
raise prices of those articles in which there is a large
consumer’s surplus. In such cases, the consumers
are willing to pay more than the prevailing price.
Conti…
• Comparing Advantages of Different Places: Our
knowledge of consumer’s surplus proves useful when
we compare the advantage of living in two different
places. A place where there are greater amenities
available at cheaper rates will be better to live in. In
these places, the consumers enjoy large surplus of
satisfaction.
• Distinction between Value-in-Use and
Value-in-Exchange: Consumer’s surplus draws a clear
distinction between value-in-use and
value-in-exchange. Commodities like salt and
match-box have a great value-in-use but much less
value-in-exchange. Being necessaries and cheap
things, they yield, however, a large consumer’s
surplus. The consumer’s surplus depends on total
utility, whereas price depends on marginal utility.
Conti….
• Measuring Benefits from International Trade:
Consumer’s surplus measures benefits from
international trade. We can import things cheaply
from abroad. Before importing them, we were
paying more for similar home produced goods. The
imports, therefore, yield a surplus of satisfaction.
The larger this surplus, the more beneficial is the
international trade.
Definition of Ordinal Utility
Ordinal Utility is propounded by the modern
economists, J.R. Hicks, and R.G.D. Allen.
This theory states that it is not possible for
consumers to express the satisfaction derived
from a commodity in absolute or numerical
terms. Modern Economists hold that utility being
a psychological phenomenon, cannot be
measured quantitatively, theoretically and
conceptually. However, a person can
introspectively express whether a good or
service provides more, less or equal satisfaction
when compared to one another.
Conti…
In economics, an ordinal utility function is a function
representing the preferences of an agent on an ordinal
scale. The ordinal utility theory claims that it is only
meaningful to ask which option is better than the other,
but it is meaningless to ask how much better it is or how
good it is. All of the theory of consumer
decision-making under conditions of certainty can be,
and typically is, expressed in terms of ordinal utility.
In this way, the measurement of utility is ordinal, i.e.
qualitative, based on the ranking of preferences for
commodities. For example: Suppose a person prefers
tea to coffee and coffee to milk. Hence, he or she can
tell subjectively, his/her preferences, i.e. tea > coffee >
milk.
1. Assumptions:

• A consumer substitutes commodities rationally in

order to maximize his level of satisfaction.
• A consumer can rank his preferences according to the
satisfaction of each basket of goods.
• The consumer is consistent in his choices.
• It is assumed that each of the good is divisible.
• It is assumed that the consumer has full knowledge
of prices in the market.
• The consumer's scale of preferences is so complete
that consumer is indifferent between them.
• Two commodities are used by the consumer. It is also
known as two commodities model.
 Important tools of ordinal utility
1. Indifference curve analysis
• An indifference curve is a combinations of two
goods which yield the same level of satisfaction
(utility) to the consumers.
• Since any combination of the two goods on an
indifference curve gives equal level of satisfaction,
the consumer is indifferent to any combination he
consumes. Thus, an indifference curve is also known
as ‘equal satisfaction curve’ or ‘iso-utility curve’.
• On a graph, an indifference curve is a link between
the combinations of quantities which the consumer
regards to yield equal utility. Simply, an indifference
curve is a graphical representation of indifference
schedule.
The table given below is an example of indifference schedule
and the graph that follows is the illustration of that schedule.

Table: Indifference schedule

Combinatio
Mangoes Oranges
n
A 1 14
B 2 9
C 3 6
D 4 4
E 5 2.5
Figure: Graphical representation of indifference
curve
Assumptions of indifference curve
1. Two commodities : It is assumed that the
consumer has fixed amount of money, all of
which is to be spent only on two goods. It is also
assumed that prices of both the commodities
are constant.
2. Non satiety : Satiety means saturation. And,
indifference curve theory assumes that the
consumer has not reached the point of satiety. It
implies that the consumer still has the
willingness to consume more of both the goods.
The consumer always tends to move to a higher
indifference curve seeking for higher satisfaction.
Conti…
3. Ordinal utility : According to this theory,
utility is a psychological phenomenon and
thus it is unquantifiable. However, the theory
assumes that a consumer can express utility
in terms of rank. Consumer can rank his/her
preferences on the basis of satisfaction
yielded from each combination of goods.
4. Rational consumers : According to this
theory, a consumer always behaves in a
rational manner, i.e. a consumer always aims
to maximize his total satisfaction or total
utility.
Conti..
5. Diminishing marginal rate of substitution :
Marginal rate of substitution may be defined
as the amount of a commodity that a
consumer is willing to trade off for another
commodity, as long as the second commodity
provides same level of utility as the first one.
And, diminishing marginal rate of substitution
states that the rate by which a person
substitutes X for Y diminishes more and more
with each successive substitution of X for Y.