Theory of Consumer Behavior
1. Utility: Utility is the want-satisfying power of the commodity.
2. Marginal Utility: The marginal utility of a commodity is the change in total utility which results from a unit increase in consumption.
MV = TUn – TUn-1 or Δ in TV/Δin unit of commodity.
Here, MV = Marginal utility
TUn = Total utility of n units of the commodity
TUn-1= Total utility of n – 1 unit of commodity
3. Total utility: Total utility is the sum of marginal Utilities obtained from the consumption of different units of a commodity
Here, TU = Total utility
EMU = Sum of total marginal utilities
4. Budge:t Set It refers to attainable combinations of a set of two goods, given prices of goods and income of the consumer.
5. Budget Line: It is a line showing different possible combinations of Good-l and Good-2, which a consumer can buy, given his budget and the prices of Good-l and Good-2.
6. Monotonic Preferences: A consumer preferences are monotonic if and only if between any two bundles. The consumer prefers the bundles, which has more of at least one of the goods and no less of the other good as compared to the other bundle.
7. Indifference Curve: A curve which is a diagrammatic presentation of an indifference set. It shows different combinations of two commodities between which a consumer is indifferent. Each combination offers him the same level of satisfaction.
8. Marginal Rate of Substitution: It refers to the rate which the consumer is willing to substitute Good-x for Good-y or it refers to the number of units of Good-y which the consumer is willing to sacrifice for an additional unit of Good-x, it is expressed as Δy/Δx
9. Diminishing Rate of Substitution: The law states that as good-l is the substitution for good-2, the marginal rate of substitution of good-1 for good-2 goes on diminishing.
10. Indifference Map: The collection of the indifference curve is called the indifference map.
11. Properties of Indifference Curve
(i) Indifference curves are negatively sloped.
(ii) Indifference curves are convex to the point of origin.
(iii) Indifference curves never touch or intersect. each other.
(iv) Indifference curve touches neither X-axis nor Y-axis
12. Conditions for Consumer’s optimum
(i) Budget line should be tangent to the [C.
(ii) The slope of IC = Slope to the budget line
(MRS = Price ratio)
13. Demand: Demand refers to the desire to buy a commodity backed by the willingness and ability to purchase that commodity at a given point of time.
According to Prof RG Lipsey, “The amount of a commodity that households wish to purchase is called the quantity demanded of that commodity”
14. Demand Function
qx = F(Px)
Here, qx = quantity of x Commodity
Px = Price of x commodity
15. Demand Schedule: Tabular presentation of the relationship between price and demand of a commodity is called Demand schedule.
16. Demand Curve: Graphical presentation of the relationship between price and demand of a commodity is called Demand curve.
17. Linear Demand
d = a – bp
Here, d = Quantity demanded
a = Vertical intercept
b = Slope of the demand curve
p = Price of the commodity
18. Law of demand: The law states that other things remaining the same, the demand for a commodity expands with falling in its price and contracts with a rise in its price.
19. Exceptions to the Law of Demand
(i) Expectations of further changes in price
(ii) Prestige goods
(iii) Giffen goods
20. Determinants of Den land
(i) Price of the commodity
(ii) Income of the consumer
(iii) Price of related goods
(iv) Taste and preference
21. Normal Goods: It is a good whose demand increases with the rise in income and decreases with fall in income of the consumer. e.g; full-cream milk, wheat.
22. Inferior Goods: It is a good whose demand decreases with rising in income and increases with fall in income of the consumer. e.g; bajra, toned milk.
23. Giffen Goods: Giffen goods arc those inferior goods in case of which there is a positive relationship between price and quantity demanded and inverse relationship between income and quantity demanded.
24. Cross-Price Effect: It refers to change in demand for one commodity owing to change in the price of another commodity.
25. Substitute Goods: These are those goods which can be interchanged for use. If the price of the substitute goods increase, the demand for the concerned goods increase and vice-versa e.g., tea and coffee.
26. Complementary Goods: These are those goods which are used simultaneously. If the price of one good increases, the demand for its complementaries will decrease and vice-versa. e.g., pen and ink.
27. Price Elasticity of Demand: It is the degree of responsiveness of quantity demanded of a commodity to the change in its price.
28. Methods of Measuring Elasticity of Demand
(i) Percentage Method
ed = % change in quantity demanded/% change in price
ΔQ/ ΔP x P/Q
Here,P= Actual price, Q = Actual quantity
ΔP = Change in price, ΔQ = Change in quantity
(ii) Total Expenditure Method
P = Price, Q= quantity, TE = Total expenditure
(iii) Geometric or Print Method
ed = Lower Segment of demand curve/Upper segment of the demand curve
29. Degrees of Price Elasticity of Demand
(i) Perfectly Elastic Demand (ed= ∞)
(ii) More than unit elastic or elastic demand (ed > 1)
(iii) Less than unit elastic or inelastic demand (ed < 1)
(iv) Unit elastic demand (ed = 1)
(v) Perfectly inelastic demand (ed = 0)
30. Factors Influencing the Elasticity of Demand
(i) Substitute Goods
(ii) postponement of consumption
(iii) Proportion of expenditure
(iv) Nature of the commodity
(v) Uses of the commodity
(vi) The time period