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Standard Xii (Isc) Economics Chapter 3: Theory of Consumer Behaviour

This document discusses consumer behavior theory, including: 1) The law of diminishing marginal utility, which states that as consumption of a good increases, the marginal utility from each additional unit decreases. 2) Indifference curve analysis, which uses indifference curves to show combinations of goods that provide equal utility to a consumer. 3) The principle of equi-marginal utility, which states that consumers maximize utility by allocating spending so the marginal utility per rupee is equal across goods.

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11K views

Standard Xii (Isc) Economics Chapter 3: Theory of Consumer Behaviour

This document discusses consumer behavior theory, including: 1) The law of diminishing marginal utility, which states that as consumption of a good increases, the marginal utility from each additional unit decreases. 2) Indifference curve analysis, which uses indifference curves to show combinations of goods that provide equal utility to a consumer. 3) The principle of equi-marginal utility, which states that consumers maximize utility by allocating spending so the marginal utility per rupee is equal across goods.

Uploaded by

sourav kumar ray
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 PDF, TXT or read online on Scribd
You are on page 1/ 7

STANDARD XII (ISC)

ECONOMICS
Chapter 3: Theory of Consumer Behaviour

Utility is the want satisfying capacity of a commodity.


Approaches to utility:-
Cardinal Approach

 Law of Diminishing Marginal Utility


 Law of Equi-Marginal Utility

Ordinal Approach

 Indifference Curve Analysis

LAW OF DIMINISHING MARGINAL UTILITY


The law states that as more and more of a commodity is consumer the marginal utility derived with
every additional unit consumed, goes on decreasing.
Assumptions to the law

Assumptions:

Following are the assumptions of the law of diminishing marginal utility.

1. The utility is measurable and a person can express the utility derived from a commodity in
qualitative terms.
2. A rational consumer aims at the maximization of his utility.
3. It is necessary that a standard unit of measurement is constant, like a glass of milk, a bottle of
cold drink ec
4. A commodity is being taken continuously. Any gap between the consumption of a
commodity should be suitable.
5. It is assumed that various units of commodity homogeneous in characteristics w.r.t. shape,
size, colour etc.
6. The taste of the consumer remains same during the consumption of the successive units of
commodity.
7. Income of the consumer remains constant during the operation of the law of diminishing
marginal utility.
8. It is assumed that the prices of the substitutes do not change. For example, the demand for
CNG increases due to rise in the prices of petroleum and these price changes effect the utility
of CNG.

Relation between Total Utility and Marginal Utility:

Total utility refers to the total amount of satisfaction derived by the consumption of ‘n’ units of a
commodity.

TUn = MU1 + MU2 + MU3 +………….MUn


(1)
Marginal Utility refer to the additional utility derived by the consumption of one additional unit of a
commodity.

MUn = TUn – TU(n-1)

1. When the MU decreases, TU increases at decreasing rate.


2. When MU becomes zero, TU is maximum. It is a saturation point.
3. When MU becomes negative, TU declines

Utility approach and consumer’s attains equilibrium

A. According to the cardinal approach of utility, a consumer will be in equilibrium when


he spends his given income on the purchase different goods and services so as to
maximize his total utility.
Since money and commodity, both give him utility he can either spend the money to
purchase the commodity (which is equivalent to the price) or keep it with himself.
If the MU of the commodity is greater than that of money, a utility maximizing
consumer will purchase the commodity. Thus if the MU of a commodity X is greater
than the price of X (MUX > PX), the consumer can increase his total utility by
purchasing more units of X. If the price of X becomes greater than the MU of X then
a utility maximizing consumer will prefer to hold the money instead of purchasing the
commodity. He will purchase the commodity till the price of it is equal to or higher
than the MU of the commodity. Symbolically the consumer’s equilibrium is attained
when MUX = PX.
The above can be illustrated with the help of following tabloid and graph:
Price of the shirt is assumed to be 10/-

Units of MU of shirt
(2)
shirt
1 20
2 16
3 10
4 4
5 0

It is evident from the graph above that consumer’s equilibrium will be attained at
point E (where MU and Price intersect).

LAW OF EQUI-MARGINAL UTILITY

This law says:


The consumer maximizing his/her total utility will allocate his/her income among various
commodities in such a way that the marginal utility of the last unit of money spent on each
commodity is equal.
As per this law a consumer will be in equilibrium when
MUx//Px = MUy/Py

Consumer’s equilibrium can be explained with the help of following numerical example

(3)
Let us now discuss the law of equi-marginal utility with the help of a numerical example. Suppose,

total money income of the consumer is Rs.40. which he wishes to spend on two commodities: ‘x’ and

‘y’. Both these commodities are priced at Rs.5 and Rs.10 per unit respectively.

From the table it is clear that the equilibrium condition can be fulfilled at 4 different combinations.

Following is the table showing the detail of each combination.

So, consumer will prefer to buy maximum 4 units of ‘x’ and 2 units of ‘y’. as he spends the entire

allotted money on this combination.

Indifference Curve Analysis

A. Indifference curve - An indifference curve is the locus of all such combinations of two
commodities (say, X and Y) which give the consumer same level of utility. The
indifference curve is denoted by IC. Here, the commodity bundles such as A, B and C
result in same level of utility. It is also referred to as Iso-utility curve.

(4)
Properties of an indifference curve are:
(i) The indifference curve is negatively sloped
(ii) The indifference curve is convex to the origin
(iii)Two indifference curve can never touch or cut each other.
(iv) A higher indifference curve gives higher satisfaction.

B. Indifference Map - A cluster of indifference curves showing different levels of utility


(an indifferent curve lying above and to the right of another indicates higher level of
utility) constitutes an indifference map. IC0 , IC1, IC2 etc. denote the indifference
curves with different levels of utility (U) such that U0 < U1 < U2< U3. They together
constitute the indifference map.

C. Marginal Rate of Substitution – MRS is the rate at which the consumer is willing to
substitute one good for another withut changing the level of satisfaction.
MRSyx states the amount of Y the a=consumer is willing to sacrifice to get one
additional unit of X.

D. Budget Line – A graphical depiction of the various combinations of two


selected products that a consumer can afford at specified prices for the products given
their particular income level.

(5)
Consumer’s equilibrium under ordinal approach

Assumptions of Indifference Curve Analysis


1. The consumer is rational
2. Utility is comparable but not measurable
3. Consumer is non satiated
4. There exists transitivity of choice
5. MRS is diminishing

Indifference curve approach explains consumer’s equilibrium with the use of consumer’s indifference
map and the budget line. Two conditions need to be fulfilled for the consumer’s to be in equilibrium:
i. MRSXY = PX/PY
ii.The indifference curve should be convex to the origin.

Let us assume that a consumer consumes two commodities X and Y, and the money income of the
consumer and the price of those two commodities (say, PX and PY ) are given.

The consumer cannot purchase any combination which lies to the right of the budget
line PT, such as combination U, because it is out of his reach with the given income
and given prices of the two commodities.
On the other hand any combination inside the budget line PT such as combination A
is within his purchasing power but will give him less utility than any combination on
the budget line because it lies on a lower indifference curve and also because the
consumer will not be able to spend to entire income. Thus the combination of food
and clothing with the highest utility should be on the budget line.
(6)
The highest indifference curve with a point on the budget line is the one that is
tangent to the budget line. The tangency point in the above graph is at C. it reflect
OH units of X and OE units of Y.

At the point of tangency the slope of Indifference curve and the budget line is the
same.
_________________________________________________________________________________

INSTRUCTIONS TO STUDY THIS CHAPTER:


 Please read your book for detailed information of the above topics.
 The length of the answer depends on the marks in the question paper and may not
only be
substituted with what is mentioned in the notes.
 Examples can be used to elaborate your points for this chapter.

(7)

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