Revision Notes

Class - 12 Micro Economics

Chapter 2 – Theory Of Consumer Behaviour

CONSUMER BEHAVIOUR:
The study of how individual customers, groups, or organisations select, buy, use,
and dispose of the ideas, goods, and services to meet their needs and wants is
known as consumer behaviour.

It refers to the consumer's actions in the marketplace and the motivations behind
those actions.

UTILITY:
The capacity of a commodity to meet a need is its utility. The more the utility
obtained from an item, the greater the need for it or the stronger the desire to have
it. Utility is a subjective concept. The same product can provide various levels of
utility to different people. A consumer's desire for an item is usually determined
by the utility (or satisfaction) he obtains from it.

TYPES OF UTILITY
1. Cardinal Utility Analysis: This analysis suggests that utility may be stated
numerically. It describes how the level of pleasure following the consumption
of any goods or services can be graded in terms of countable numbers.

There can be two measures of utility, such as:

● Total Utility (TU): The total satisfaction derived from the consumption of a
given quantity of a commodity at a given time is known as total utility. To put
it another way, it is the total of marginal utility.

TU   MU ORTU  MU1  MU2  MU3  ...  MUn

● Marginal Utility (MU): The marginal utility is the change in overall utility
caused by the consumption of an additional unit of the commodity. To put it
another way, it's the value gained from each additional unit.
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 MUn  TUn  TUn 1

2. Ordinal Utility Analysis: It explains that the level of satisfaction following

the consumption of any goods or services cannot be quantified. These items, on
the other hand, can be placed in order of preference. The utility of a product is
determined by its level of satisfaction. It is more realistic and logical.

RELATIONSHIP BETWEEN TU AND MU:

● As long as the MU is positive, the TU rises in proportion to the increase in
commodity consumption.
● TU grows/increases at a slower rate when MU from each succeeding unit starts
decreasing.

● The MU becomes zero when the TU achieves its maximum value. TU stops
expanding at this point, which is referred to as the point of safety. (Point c,
where MU=0, and and point a where TU is maximum)

● When consumption exceeds the point of satisfaction, the MU turns negative

and the TU begins to decline. (Situation after point c and a in the diagram).

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LAW OF DIMINISHING MARGINAL UTILITY:
According to the law of diminishing marginal utility, as a consumer consumes
more units of a commodity, the marginal benefit received from each succeeding
unit declines.

The law of demand is founded on this principle, as the concept of reduced pricing
is related to the Law of Diminishing Marginal Utility.

Consumers are prepared to spend lesser monetary amounts for more of a product
as its utility falls with increased consumption.

Assumptions for this law:

● Only standard units are consumed of a commodity.
● Continuous consumption of the commodity takes place.

Table

Units TU MU

1 10 10

2 19 9

3 25 6

4 28 3

5 28 0

6 27 -1

In the table we can see that,

● TU keeps on increasing at decreasing rate and MU is falling.
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● When TU is maximum, that is 28 at 5th unit, MU becomes 0.

● After this point, MU becomes negative, as TU starts falling.

● TU will increase only upto the situation when MU is positive, once Mu turns
negative, TU starts falling.

INDIFFERENCE CURVE:
● An indifference curve is a graphical representation which shows all of the
product combinations that gives the same level of satisfaction to the consumer.

● Since all of the combinations provide the same level of satisfaction, the
consumer favours them all equally. As a result, the indifference curve got its
name.
● A simple two-dimensional graph is used for standard indifference curve
analysis.

● Each axis represents a different form of economic good. The customer along
the indifference curve is unconcerned with any of the combinations of
commodities indicated by points on the curve since all of the combinations of
products on an indifference curve deliver the same degree of utility to the
consumer.

Table

Combination Good Y Good Z

A 1 10

B 2 10

C 3 10

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Diagram

Explanation
In the diagram we can see that IC3 is the highest indifference curve, as here, there
are 10 units of Good Z, and 3 units of Good Y. Hence point C depicts the highest
level of satisfaction.

Slope of IC: Marginal Rate of Substitution (MRS):

The rate at which a consumer substitutes one good for another as long as the latter
good is providing equal satisfaction is known as the marginal rate of substitution.

The marginal rate of substitution is the slope of the indifference curve. It is

because of the MRS diminishing, that the indifference curve is convex in nature.
As with increase in quantity of one good, the consumer forgoes less and less of
the ther good.

Loss of Good Y Y
MRS  or 
Gain of Good X X

Characteristics of the Indifference Curve:

● Downward slope: Indifference curves have a downward slope i.e., slopes
downward from left to right.

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● Diminishing MRS: To the point of origin, indifference curves are convex. It's
because the marginal rate of substitution is decreasing.

● IC’s never intersect: The curves of indifference never meet or intersect. Two
points on two different ICs can't possibly provide the same level of satisfaction.

● Higher Indifference curve: A higher level of satisfaction is represented by a

higher indifference curve.

● IC never touch x-axis or y-axis: An indifference curve never touches any of

the axis because if it touches any one axis, that would mean the consumption
of other good is zero. And, this is not possible, as IC focus on the consumption
of two goods.

Indifference Map:
A set of Indifference Curves constitutes an Indifference Map. It provides a
comprehensive picture of a consumer's preferences.

The diagram below depicts an indifference map made up of three curves:

CONSUMER BUDGET
● A budget limitation refers to the many combinations of goods and services that
a consumer can purchase based on current prices and income.

● The term "consumer budget" refers to the consumer's real money or purchasing
power, which he can use to purchase quantitative bundles of two items at a set
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 price. It means that a consumer can only buy goods in combination (bundles)
that cost less than or equal to his income.

Budget Set:
● A budget set is a quantitative collection of bundles that a consumer can buy
with his current income at current market prices.

● The budget set of a consumer is the collection of all the bundles that the
consumer can purchase with his or her income at current market prices.

● A consumer's budget set is essentially a collection of all bundles of goods and

services that a consumer can purchase with available funds.

 p1x1  p2 x 2  M

Budget Line:
The budget line is a graphical representation of all the bundles that cost the same
as the consumer's income. The budget line depicts two different combinations of
goods that a consumer can buy based on his or her income and commodity prices.

PXQX  PYQY  S

Here,

PX = Price of commodity X

QX = Quantity of commodity X

PY = Price of commodity Y

QY = Quantity of commodity Y

S = Consumer Income

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Attainable and Non Attainable Combinations
Any point within the area budget line is an attainable combination that a consumer
can buy given his income and price of goods. Any point outside the area is a non-
attainable combination, which the consumer cannot afford to buy.

Budget Constraint:
The budget constraint includes all the different combinations of goods or products
that a person can afford based on the cost of goods and consumer income.
For example:
Q1 is the quantity of Good 1,

Q2 is the quantity of Good 2,

P1 is the price of Good 1,

P2 is the price of Good 2.

P1q1 = Total amount spent on Good 1.

P2q2 = Total amount spent on Good 2.

As a result, the budget line equation will be p1q1 + p2q2 = X. The budget line is
always slanted downward, so consumers can only raise their consumption of
Good 1 by decreasing their consumption of Good 2.

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If customers want to buy one more unit of Item 1, they may only do so if they are
willing to give up some quantity of another good. Consumers have a restricted
budget. They must decide whether to spend money on Good 1 or Good 2.

Changes or Shifts in Budget Line:

● Due to changes in the consumer's income and the price of goods, there may be
a parallel shift such as leftwards or rightwards shift.

● A rise in consumer income shifts the budget line to the right, and vice versa.

● There will be a rotation in the budget line if the price of one good changes.
When prices fall, purchasing power rises, causing outward rotation, and vice
versa.
● In Figure A, when the consumer income increases, budget line shifts from BB’
to CC’, as now the consumer can afford more of both the goods, keeping price
constant.

● In the figure B, when the consumer income increases, budget line shifts from
CC’ to BB’, as now the consumer can afford less of both the goods, keeping
price constant.

y y

C’ C’
Good B

Good B

B’ B’

0 B C 0 B C
x x
Good A Good A

Figure A Figure B

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Derivation of the Slope of the Budget Line:
The budget line's slope indicates how much change in good 2 is necessary per unit
of change in good 1 along the budget line.

Let us now calculate the slope of the budget line as follows:

On the budget line, take two points.

Say,  x1 , x 2  and  x1  x1 , x 2  x 2 

p1x1  p 2 x 2  M ..... 1 \\p1  x1  x1   p 2  x 2  x 2   M .....  2 

Subtracting (1) from (2), we get

p1 x1  p 2 x 2  0
x2 p
 1
x1 p2

Changes in Budget Set:

● The available bundles are determined by the prices of the two commodities and
the customer's earnings.

● The set of available bundles is likely to change when the price of either of the
commodities or the customer's earnings changes.

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Assume the customer's earnings increase from N to N′ while the prices of the
two(2) commodities stay unchanged. The customer will be able to purchase all
bundles with his new earnings  x1 , x 2  such as p1x1  p2 x 2  N

The budget line's equation is now:

p1x1  p2 x 2  N

N1 p1
The above equation can also be written as x 2   x1
p2 p2

It is worth noting that the slope of the new budget line is identical as it was before
the customer's earnings changed.

CONSUMER’S OPTIMUM CHOICE:

● The Indifference Curve and Budget Line can be used to explain the condition
for a consumer's optimal choice of two goods.

● The satisfaction curve is represented by the indifference curve, whereas the

budget line is represented by the budget line.

● Given a budget constraint, a consumer would want to get the most out of two
goods. As a result, he will strive for the highest IC possible while staying within
his financial constraints.

● A consumer equilibrium can occur when:

○ IC is convex to the point of equilibrium.

○ Slope of IC = Budget Line Slope

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In the diagram, where the IC curve is tangent to the budget line, that is point E is
the optimal choice, and also a point of consumer equilibrium. This is the point
where the slope of both, the indifference curve and budget line are equal to each
other.

DEMAND:
The quantity that a consumer is able and willing to purchase at a specific price
and within a specific time frame.

DEMAND FUNCTION:
The demand function represents the functional relationship taking place between
a commodity's quantity demanded and its various determinants.

Dx= f(Px, PR, Y, T, E)

Here,

Dx= Quantity Demand

f= Functional Relationship
Px= Own price of good

PR= Related price of good

Y = Income

T= Taste and Preferences

E= Expectations

Factors affecting Demand:

● Product Price: The price of a commodity has an inverse (negative) relationship
with the amount of that commodity that buyers are willing and able to buy.
Consumers prefer to buy more of a low-priced commodity and less of a high-
priced commodity. The inverse relationship between price and the amount of
money people are willing and able to spend is known as The Law of Demand.

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● Consumer’s Income: The impact that pay has on the measure of a product that
purchasers are willing and ready to purchase relies upon the sort of good we're
discussing.

o Normal Goods: For most products, there is a positive (direct) connection

between a consumer's income and the measure of the decency that one is willing
and ready to purchase. At the end of the day, for these merchandise when
income grows the interest for the product will increase; when the income falls,
the interest for the product will diminish. These are referred to as normal goods.

o Inferior Goods: However, for other commodities, a change in income has the
opposite impact. An inferior good is one whose demand decreases as wealth
grows. In other words, customer demand for inferior items is inversely
connected to income. In economics, inferior suggests that there is an inverse
association between one's income and the interest or demand for that
commodity.

Furthermore, whether a good is normal or inferior may differ from one

individual to the next. For you, a commodity could be normal good, but for
someone else, it might be inferior.

● Price of Related Goods: Assuming that the commodity price remains constant,
there are two categories of linked products that impact demand for the
commodity.

o Complementary Goods: Complementary goods are linked products that are

consumed together because their utility is reduced if consumed alone. As a
result, if demand for one of the two products rises, demand for the other rises
as well, even though the price of this commodity stays unchanged, and vice
versa.

o Substitute Goods: Substitute goods are commodities that are diametrically

opposed to one another. As a result, if demand for one of the two products
increases, demand for the other product falls even though the price of this
product stays constant, and vice versa.

● Taste and preferences of consumer: A favourable change in tastes and

preferences of consumer leads to increase in demand, while the opposite
happens when there is a negative change in taste and preference of consumers.

● Expectation: If the consumer expects that the availability of a good in the

future is going to fall, his present demand of that good would increase, and vice
versa, keeping the price constant.

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DERIVATION OF DEMAND CURVE:
According to the IC analysis, a buyer maximises his utility by selecting a package
of two commodities that is also within his budget. This will be used to calculate
a commodity's demand curve.

● Consider the following two items: X and Y. Let the two items' prices be Px and
Py , and the monetary income will be ‘M.’

● At the point where the consumer's budget line intersects the indifference curve,
he can maximise his utility. In the diagram, this would be point ‘E.' X1 is the
amount of X consumed.

● We now modify the price level of good X while maintaining the price of good
Y and the amount of money income constant.

● Allow Px to fall. With the same amount of money, the consumer's real
purchasing power has increased.

● Because ‘M’ remains constant, the greatest amount of good X he can buy grows
as Px declines.

● As a result, the budget line's horizontal intercept changes (shifts to the right).
However, the vertical intercept remains unchanged since ‘M’ and Py remain
constant.

● As a result, as Px declines, the budget line must pivot away from the origin
along the horizontal axis.

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LAW OF DEMAND
The effects of price changes on the amount desired of an item are described in the
form of a law known as the law of demand.
It asserts that when the price of an item decreases, the amount required rises, and
when the price of a commodity rises, the quantity demanded declines. In other
words, if everything else remains constant, the price of a commodity and its
quantity requested have an inverse relationship.

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Exception to the Law of Demand
In some circumstances, when the price rises, the amount demanded ascents as
well (and vice versa). The exceptions are:

1. Articles of Distinction: When the good in consideration is one of status. As

the price grows, so must the amount requested in order to maintain the prestige
value. For example, antique pieces, precious jewels etc. Also, the demand for
these goods is only because of their high prices.

2. Goods of Necessity: When the good is of basic necessity, demand rises even if
the price rises since the good is a requirement.

3. Giffen Good: When the good under consideration is a Giffen good.

Types of Goods
● Normal Goods: A normal good is one whose demand rises in response to an
increase in the consumer's income or pay.

● Inferior Goods: Inferior goods are those whose demand declines as the
consumer's income rises. As a result, as consumer affordability rises, so does
the demand for lower-quality goods.

● Giffen Goods: It is a low-income, non-luxury item that contradicts

conventional economic and consumer demand theories. When the price rises,
demand for Giffen items rises, and when the price falls, demand for Giffen
goods reduces.

● Substitutes Goods: These are identical goods that can be utilised

interchangeably to some extent. For example, tea and coffee are substitutes.

● Complementary Goods: These are items that are typically consumed together
and complement one another. For example car and petrol.

Shift in demand curve:

● A shift in the demand curve indicates changes in demand at each potential price
as a result of changes in one or more non-price factors such as the price of
comparable commodities, income, taste & preferences, and consumer
expectations.
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● The equilibrium point shifts whenever the demand curve shifts.

● The demand curve shifts to one of two directions:

○ rightward shift or

○ leftward shift.

● The price does not change, factors other than price cause a shift in demand.

Movement along the Demand Curve:

● The movement of the demand curve indicates the variation in both the price
and the quantity demanded from one position to the other.
● When the quantity demanded changes owing to a change in the price of the
product or service, the demand curve moves.
● The movement along the curve can occur in either of two directions:

○ upward movement or

○ downward movement.

Difference - Movements along the Demand Curve and Shifts in the Demand
Curve:
The following points are noteworthy in terms of the distinction between
movement and shift in the demand curve:

Basis Movement along the

Shift in Demand Curve
Demand Curve

Meaning Movement in the demand Shift in demand curve occurs

curve occurs when a when the price of a
commodity experiences a commodity remains
change in both quantity unchanged however the
demanded and price, quantity demanded changes

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 leading the curve to move due to other factors, allowing
in a specific direction. the curve to shift to one side.

Caused Movement along a A shift in the demand curve

by demand curve occurs is caused by changes in non-
when changes in quantity price factors, such as income,
sought are connected with taste, expectation,
variations in commodity population, price of
price. comparable commodities,
and so on.

Indicated Changes in the quantity A shift in the demand curve

by demanded are indicated reflects a shift in the
by movement along the commodity's demand.
demand curve.

Includes Upward and Downward Rightward and Leftward shift

movement

Diagrammatic Representation of Movements along the Demand Curve and

Shifts in the Demand Curve

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MARKET DEMAND:
● The total quantity of an item sought in the market by all consumers at various
prices at a given moment is known as market demand.

ELASTICITY OF DEMAND:
● The price elasticity of demand measures how a change in price affects the
demand for a product among its consumers.

● It is calculated by dividing the percentage change in a product's required

quantity by the percentage change in the product's cost. This is also called
percentage method of elasticity of demand,

percentage change in demand for the good

ed 
percentage change in the price of the good
Q P
ed  
P Q

Here,

ed = Elasticity of demand

Q = Change in quantity

P = Change in price
P = Initial price

Q = Initial Quantity

Situations of Elasticity of Demand:

a. Ed= 1: Also, called unitary elastic demand, or rectangular hyperbola. When
change in demand and change in price is in the same proportion. A 10%
increase in price leads to a 10% decrease in demand.

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b. Ed> 1: When change in demand is greater than the change in price. A 10% fall
in price leads to a 30% increase in demand.

c. Ed< 1: When change in demand is less than the change in price. A 30% decrease
in price leads to a 10% increase in demand.

d. Ed= ∞: It is also called perfectly elastic demand, as here the demand is infinity
at the current price. Any change in price would cause demand to fall to zero.

e. Ed= 0: It is called perfectly inelastic demand, as here, irrespective of price

change, demand remains constant.

y Ed>1 Ed<1
y
D D
Price

Price

D
0 Quantity x 0 Quantity x

y y
D

D
Price

D D
Price

D
0 Quantity 0 x
x Quantity
E d= ∞ Ed= 0

Rectangular Hyperbola (ed=1) :

A rectangular hyperbola is a curve with equal rectangular areas on all sides. When
the elasticity of demand equals one (ed = 1) at all points along the demand curve,
the demand curve is indeed a rectangular hyperbola. As given in the figure beneath
it is a downward-sloping curve.

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Geometric Method of Elasticity of Demand:
Elasticity of demand is measured at any location by dividing the length of the
lower segment of the demand curve by the length of the upper segment of the
demand curve at that point. At the midpoint of any linear demand curve, the value
of ed is unity.

A linear demand curve's elasticity may be simply assessed graphically. The

elasticity of demand at each point on a straight line demand curve is determined
by the ratio between the demand curve's lower and upper segments at that
position.

DA
ed 
DB

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Total Expenditure Method of Elasticity of demand:
● It calculates the price elasticity of demand based on the change in total
expenditure(Product of Price and quantity) incurred by a household on the
commodity as a result of a price change.

● The price of a commodity and its demand are inversely linked.

● The responsiveness of the demand for the commodity to price changes
determines whether expenditure on the good increases or decreases as a result
of a rise in its price.

Relationship between Total Expenditure and Price of Elasticity of Demand:

● Ed  1 When total spending (price X quantity) remains constant despite a rise

or reduction in the price of a good.

● Ed  1 When prices fall, total expenditure rises, and when prices rise, total
expenditure falls.

● Ed  1 When total expenditure falls as a result of a price decrease and total

expenditure rises as a result of a price increase.

Factors that influence price elasticity of demand:

● Availability of close substitutes: Demand for a commodity with many
equivalents is typically more elastic than demand for goods with no
replacements. Coca-Cola, Pepsi, Limca, and other similar beverages are
suitable replacements. Even a minor increase in the price of coke will entice
purchasers to seek alternatives. Electricity demand, on the other hand, will be
less elastic because there are no close substitutes.

● Nature of the Commodity: Demand for essentials such as medicines and food
grains is less elastic since we must consume them in the lowest quantity
required, regardless of price. In any case, elasticity for comfort and
extravagances like refrigerators, air conditioners and so on is more flexible on
the grounds that their utilization might be delayed in the future if their cost
rises.

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● Price level: Demand for a higher-priced commodity such as air conditioners or
automobiles is often more elastic than demand for a lower-priced commodity
such as match box or pencils.

● Income level: Higher income groups have less elastic demand for commodities
than lower income groups. For example, if the price of a commodity rises, a
wealthy consumer is unlikely to cut his demand, whereas a poor buyer may.

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