3The theory of consumer behaviourPurpose of the theory-Analising the behaviour of a rational consumer.-This is very important in firm level decision makingAssumptions1Satisfaction or happiness of the consumer is determined by their choices2Consumers face constraints when makeing choices Biggest one is income.3 Maximising the satisfaction subjected to budget constraintsApproaches to theory of consumer behaviour1Cardinal utility theory -Ordinal utility thear codice 060Revealed preference theorysause human wantscoarenariassoUtilityabilitySatisfaction or happiness we receive by consuming goods and servicesUtil-the standard measurement of utility-equal to the maximum price willing to pay by a consumer for a particular productTotal utilityTO IS the satisfaction which can be received by consuming particular quantityof a product.-It bases on the quantityTU is a function - of quantityMarginal UtilityChange in TU as a result of changing one unit of consumption of the productRATHMA -Additional TU result by consuming additional unit of the product when consumptionof other goods remain unchangedMU = ATUseCardinalOrdinal-Utility is measured in numericalUtility cannot be measured but is can benumberscompared.componsions are used. and satisfaction levelsare rankedeg- utility from breakfast is better thanlunchThe law of diminishing marginal utilityWhen a consumer consumes one unit by one unit continuosly , when the consumptionof other commodities beng held constant , MU of the commodies graduallydecreasesAssumptionsOUnit of the good must be standard.eg. same ale same tasts pizza2Consumer taste remain unchanged during the period of consumptioneg- choice/ focus should be limited only to pizza, can't eat cake.if vege pizza only vege no chicken3Commodities should be consumed continiously without keeping significant time gups4Normal mensal condition of consumerSaubaraeg:lizaorRAINNA toApplicability1Breaking the low bu the supplier (teacher . manager) IS important to customersatisfactioneg. PIZZA hut offerbuffer with many meals- Equilbrium is a situation where R opposite forces are balanced-Firm's egulibrium is the situation where profit IS maximised OF loss is minimised.Consumer equlibrium IS a situation where consumer satusfaction is maximised. subjectto the budget constraintsThere are 2 conditions : For consumer equilibrium - when the consumer consume oneproductIMU PUMIThis condition may differ in practical scendnoseo- MU>PMULP100SOUMMU>PConsumer shints price is advantagous so ha increas&ses the Quantity Then MU is decreased.so40MUPMU equals to the price2soMULPConsumer thinks price is not fair So hedecreases the quantity. Then Mu is increasedCLA MULPatende inconclusive 10consumptonMO>PdeclaratePEPe2PQ SIMULPconsumerPQ is the total expenditureoPEI is the incomeMUPlanned expenditure should be equal O less than income.According to the change in price . quantity is also changedpkoAdditional dissatisfactionruMathematical approachMU is the slope of TOeMU. ATUAQAUTOMUDenvation of individual demand come under cardinal other theyIndividual demand curve under cardinal utility theory is the MUnicurvePricePrice/MUP1PriceDMUQuantityOQuantityP/MUP/MUUMPrP2P3beens04PqMOoQ1@Q2Q4teoQMarginal benifit is maximused at theseeach point. so demand curve undercardinal utilizes theory equals MU curveRATHNA Equi-proportional dulity rule- The consumer with distribute his money incomeAllbetween she goods in such a way that theultray denved from the last rupee spend onach good IC equal.There are 2 conditions at the consumer equilibrium for 2 produces1MUxMUy-Optimum purchasing rulePxPyMUxMUY Utility per rupee on x is greater than that of Su. If youPxPywithdraw I rupee From y and spend it on J. the loss ofsatisfaction from Y is or less than the adidecquired from 5In this condition consumer the to reduce the quantity of y and the quantityof x.But because of the law of drminishing MU,When quanties of x increases - MUZ decreaseswhen quantity of C decreases - MU, increasesSo the situation converts to MUX/PX = MU, / Py againMU xMUyUnited per rupee on Y 15 greater than that of x . If you.P,Pywithdraw I rupee from x and spend it on Y the lossis greatof satisfaction from x is less than the agin acquiredfrom Y.In thic condition consumer tries to reduce the quantity of x and thequantity ofY.But because of the low of dimnishno MU.when quantity of 9 increases - MUY decreaseswhen quantity of x decreases MUx increasesso the situation converts to MUx/PxMUY/PY,2Px Qx + PyQy IPlanned expenditure of x and Y should be equal a less than 1 the IncomeavailableCHere we see the combination of 2 commodities must be bought tomaximise the total utilityRATHNA QuantityTUBMUBTUIMUIMUBMUIPB = Rs: 200MPBPIPr= Rs: 40OOoing6I2000200070070010<17.523000100095025056.253370070011502003.5 <54420050012501002.5=2.554400200132070I1.751st conditionMUBMUI2 units of burgers + 3 units of cecreamPBPI2 4 crass of burgers f 4 LISTS of icecteamnd conditionPIRGB + PIRI IBurgerIcecteamExpenseIncome ofC Rs Dconsumer2003.4405205202004140960>5206Buying thiscombination IS not possible.+To maximise the consumer's satisfaction consumers, has to buy 2 unitsof burgets and 3 units of icecreamTUB + TUI13000 + 1150 415024200 +1250 # 5450Equilbrum is not the point which maximize the TU.soF4400 5720Bucause it subjected to budget constraints.RATHRA DateWhen consumer purchase more than 2 goods1MU, MUs - MU3MUnPIP2P3Pn2P'Q'+Pn onBB>CThen, according to transitivityA>C3More is betterAny rational consumer always beleive that more quantity ofa commodity IS better than less quantity of the same commodityIndifference curve C coding eg)-A model which explains ordinal utility approach-This shows various combinations of 2 products that yelld the samelevel of satisfaction titclothBAaDIndifference curveEfoodOC prefers DB prefers Cmore is betterB prefers DA and C are indifferentC and E are indifferentcompletenessA and E are indifferentThere should be a minimum requirement from both 2 comm.odoties. so there's no intersection points Always line goesin pairallel with x andIndifference curve isa curve which connect combinations of productswhich derive same level of satisfactionMap of indifference curveyIC4IC3IC2IC, RATHNAx Properties / Features of Indifference curveODConsumer satisfaction / utility of bundles of goods on indifferencecurves Farther From origin is greater than consumers utility orbundles of goods on indifference culves closer to arigin(consumer satisfaction indicated by upper IC IS greater than lowerone Because more is better)02)( and moleis-batterIndifference curves cannot be intersectedBecause if it is intersected. it undates transitivity]03An indifference curve has a negative slope or IC IS a downwardsloping curve.(This IS because of more is better property04There IS an indifference curve through every possible combination ofgoods.C Any combination is located on a curve)( This IS because of completenessdosSlope of an indifference curveslope09AurMarginal rate of substitationorMRS, / Willingness toBYetradeY3Y4(x,X2X3X4oxRATHINA a mMRS IS the maximum 604 amount of one commodity willing tobe sacrificed by a consumer in order to obtain /increase oneadditional unit of other commodity while the utility level isremained unchangedeg-MRS of x for Y C Y essen x F20200 580)maximum amount of Y willing to be sacrificed by the consumerin order to obtain one additional unit of x while level of utilityIS remain unchangedDY. MUy + AX.MUx =0OY. MUy = - ox MUXwhen the combination isOYMUX==DXMRSymoving from A to BMUyMRS IS perhaps called willinghess to tradeincreaseeg- MRS x for YNumber of units willing to trade of Y for x.D MUx Rs soMU of increased goodMUG. Rs: 100MRSISMU of socificed goodThenMRG MUXactiveMUYTo increase the quantity of scuntsassothe amount willing to sacrifice100from y is 8 0.5 units.= 0.52 MUxRs: 400MUy-Rs:100TO increase the quantity of xMUX400MRS = MU a 100=4the amount willing to sacificefom y IS 4 unitsEATHMA The law of diminishing Marginal rate of substitution-When a consumer increases consumption of one commodity oneunit by one unit on the same indifference curve, quantity ofanother commodity sacrificed gradually decreasesThis is called the law of diminishing maiginal rate of substi-lution-This is true because, when decreasing the quantity of one goodIES marginal utility is increasing So the value in the mind of theconsumer about the good sacrificeing IS increasing rapidly and theamount of decreasing IS becoming lessIndifference clive and nature of the commodotiesyIf goods are imperfects substitutes.Ates or if goods are imperfectcomplements and not perfectsubstitutes IC is cohvexBto the organCBy increasing the consumption ofCDICone commodity only, utility canxbe increased movie to another IC)HoneyIf goods are perfectcomplements IC is 20 rightangle curveIC2C By increasing both 2 commoditiesIConly the satisation can beCurdincreased0BATHNA a good that gives zero whilevegetable- when a vegetarian person 12owen with Fish , doesn moveICany adidas so he is not wassacrifice vegetable for (12)FishIf goods are perfect substitutesIC ISC straight line which isdownward negative slope.(100% identical productsC same oblied can be maintained atzelo level of one commodity andICother Also quantity to be sacrificedOsignalIS same on the ICAn absolute necessarychangejureconsumption of waterBudget lineU.UwaterA kind of culve which shows number of alternative combinationsof 2 commodities which could be bought by a consumer oubjectto budget / given level of income / budget constrant/income limitation330MSEquation for Budget linePxact PH QgiandXCBVeg- I = RST 20 Px Rs 2 Py = Rs 4PxQ: T PyQy . I2Qx + 4Qy = 20GryThough there are differentOILcombinations on the budget Ine each5Band every combinations expendituresBudget lineare equalevidence%more AA possible Cexpenditure < Incomesd aB Impossible10have(expenditure > incomeRATHNA ExersiseConsumer income = 100Px = Rs: 10Py = Rs : Swrite the equation For budget line and graphically illustrate11-Suppose Px is reduced by Rs: 5 while other factors are he'd constant.Write equation for new budget line and graphically illustrate on sameset of axis.Suppose consumer income has been increased by RS: 100 while otherfactors are held constraint Write the equation For new budget lineand graphically illustrate on the same diagram.i10Qx + 5Qy = 100y11.5Qx + SQy - 100III.10Qx + SQy . 20040209o1020xRATHMA 1st conclusionIf the price of a commodity is reduced budget line would beshifted a rotated rightward from the related axis.If the pikee of a commodity increases budget line would bestrifted inward / leftward from the related axis.and conclusion-If the consumer income increases while plices of goods are heldconstant budget line will be parallely shifted rightward Therewill be parallel rightward shift in this case. -If consumer Income decreases while other plices of goods areremain unchanged budget line will porallely shifted leftwardConsumer equilibrium in ordinal utility approach.Slope of the budget liney= 10 + 20Cm = 2 C slope equals the coefficient of independentvariable in an knear equationPxQI T PyQu = IPuQy - I- PxQsOu: I Py- DxQx PyTP30Qy = PyOx-PyslopePxMarginal rate of tranformation / Price rabioPywhen Quantity of x increase by I unit howmany units of y will be decreased along the line.when quantity of x decrease by L unit how manyunits of x will be increased along the line.RATHNA 9MUXMUYPxPyAMUX MUYConsumer equilibriumPxPyEy,BIC3MUXMUYPxPyDMOMDIC2CIC,Budget linexOx,StatementConsumer utility is maximised at point B under the budget constraints soit is the consumer equilibrium.Consumer has to buy x, from x commodity and v from v commodity tomaxmise his satisfactionLost rupee spent on x and g gives similar satisfaction so no needof increasing or decreasing the quantitiesformSIMONDifferent waysin indicating consumer equilibizum1Consumer equilibrium is the point where slope of the budget lineequalsslopeofanindifferencecurveBecauseat02MRSMUXAYPx-xyMUyLOCEorPyeaisitSlope of ICslope of budget lineIMRS =MUYAX Py=-yxMUXDyPxeRATHNAU =Shape of a engle curve depend on,Engle curvenature of the goodnature of consumer preferenceIThis describes howlevel at which commodity priceshousehold expenditureare held constantparticular good or servicevalies with householdincomeIncome consumption curveIncome consumption for normal goodsI(positive relationship betweendemand and income)ICC93Money incomecEhaleyocurveBIC3fornormaly.goodsICRIC,cIncome pheeny change, JonstonB,B2B3xxL2X3OQuantifyconsumecibouFoco 13 the curve which shows various equilibria at different levelsof income while prices of goods are held constantbookIncome consumption for inferior goodsnormal goodmoneyEngle curve for anincomeinferior goodIC4ICOIC2OQuantityB4ICIconsumeBIB2B3inferior goodONegativeslopeButatthebeginingthere'sapositiveslope-Butgradually it become a negative slope.BAMRATENA moneyincomeenale foresgaodsIncome consumption for essential curve goody (normal goodICCeg- nceoQuantyconvenedIC4vegetablesfuelIC3Essential goods mean consu.ming is not a must But peopleIC2consume them as a habitIGB4B8aB3(essential good)At the begining there's a positive slope and then gradually it goesparallel with 9 axis.(Reson to the positive slope is at the beaning poor familes may increasethe quantity of consumption of nce than their usual consumption with theincome)Income consumption for compulsory goodsComaulsore goods mean consuming a specific quantity is musteg-: coffinmoneyangle curve forincomecompulsoryinjectionsgoods(normalyICCgoodIC4IC3QuantityO1C2KCIx (compulsory goodRATHINAof ph:townDRIVEPrice consumption curveonebeginning.Pa-Pu.ThenPCC JI. Pr.- PX2 Py,Budget line shifts rightwardA.1 the old oquilation8 is the now equilibram. Her :SBIC2quantity should be bough@ PX2 areTC,B.B 2Iox, x2price of x decreases from px to PX2]Price consumption culve is a cuive which shows different equilbriaat different plices of a good when other factors (consumerincome and prices of other goods) are held constantDerivation of the demand curve from price consumption curveyPCCIC2usv.ICB.B2OXIX2Pxprice of x decreases from Px, to PI2px.totalPX2DxxOx X2names intoIncome and substitution effect based on indifferencecurve analysis Cordinal utility approach)Types of goodsOLDNormal goodsPositive relationship between income and demand C IED +)Negative relationsho between price and demand C PED -)02Inferior goods10Negative relationship between income and demand C IED -)Negative relationship between picce and demand CPED-( Generally gifton ours belong to inferior goods But hele this meansinferior goods without gifton goods)03.Giffon goodsNegative relationship between income and demand CIED )Positive relationship between price and quantity demand (PED+)Definitely these are inferior goodsIncome effect and substitution effect of a price changeIncome effectIncome effect is defined as change in quantity demand of a good asa result of change in purchasing power.print real income due to changein the pilce of the respective good when relative prices are heldconstantSubstitution effectSubstitution effect is defined as change in quantity demand as a resultofof change in relative price due to change in price of the respective goodwhen real income is held constantHATHNA Income and substitution effect for a normal goodPriceIncomeSubstitutionPrice effect /effecteffectTotal effectaccountP tQdDdDd 1I'm" saleP4OdQd !Qd tIncome effect of a normal good is called negative . pfp!Substitution effect of a normal good is negative also . Pf ofIncome and substitution effect for inferior goods.PriceIncome effect Substriution effect plice effect / Total effectPtQd + QdQdmin, scardptQd+QdQd*Income effect of an inferior goods is positiveSubstitution effect of an inferior good is negativeIncome and substitution effect for ziffon goodPrice Income effect Substitution effect Price effect / Total effectPLQdQd 4Qd tPfQdQd tQd t toIncome effect for am Oiffon good is positive which meansthere'sa positive relationship between P and Qd under income effectRATHON DateSubstitution effect of gifton good is negative which means there'san negative relationship between P and Dd under substitution effectSince income effect is greater than substitution effect there ISa positive relationship between Price and Final effect the quantitySo. it is called as a distraction to law of demandSubstitution effect is always negative irrespective of the typeof good.Income and substitution effect of a normal goodbased on indifference curves3.8OVIDS 10boneIS.problemSmole brownwab isBr.5So. Qdx changed from X100theFram initial equilibrium to the tangentpont of pink line substitution effectdue us(x1-x()andeffectAFrom tangent point of pink line to themequilibrium income effect (I3-I2)Bbiolo02cFrom initial equilibrium to the new caulbertheTotal effect / Price effect (x4-x2)IC2IC,haveamountB1BexSEX3reX2(normal good)TE/PEPxDerivation of demand curve of apx,normal goodPX2DQdxOIx emelasticdownward slopingnegativeBATHMA Income and substitution effect of an inferior goodbased on indifference curveQuantity demand increases frombecauseof substitution effectQuantity demand decreases frombecauseof income effectSince increase in Qd of substitution effect is gleaterBthan decrease in Dd due to income effect. finalquantity demand increases from to dueto price effectcIC2IC,SEBIB2x.xrx3xCinferiorPzgood)boodDenvation of demand curve ofan infenor goodPx,px2DQdxGXI X2isO.inelasticdownward slopingnegativeRATHNA Income and substitution effect of a giffon goodbased on indifferent curveyQd increases From x to x3 due tosubstitution effectDd decreases from x to x due toincome effectSince decrease in Qd due to income effect ISgreater than increase in Rd due w subst.Baction effect final od decreases fiomIC2 xico Is due to total effal.ACSGIFIC,TEB.B2xCoiffonoIfx18 L3good)8nonsin>2(boieyDelivation of demand curveof giffon goodLIDPX,T2DoX2XIoverlandmelasticcargols browgwalspositiveoverRATHMA 310Revealed preference theoryIn order to draw or create an indifference curve we have to ask aquestion From consumer to give alternative combinations of 2commodities which derive same level of utility.But we cannot expect trustworthy answers from consumers becausethere's a difference between stated preference and revealedpreference Therefore revealed preference theory says that decisionmaking must be based on fev analysis of revealed preference ratherthan analysing stated preferenceeg- Amazon comYoutubeAll supermarket networks in SI LankaAssumptionsTheoratical explanation- Taste of consumer don'tchange over the pered of analysis-MTase of consumer is consistent.BE- Taste of consumer is transitive- Consumer can be induced toAkpurchase any basket of commod t's1f its price 5 bureed su friendsCDBudget lineOANIf the consumer selected I bought combination A. it is superior than Band C who Combination AIS superson than D . because more quantity ofx and Y is reflexted by combination A compared with D.(superor)Combination E is better than combination A. because more quantityof x and 9 IS reflexted by combination AHAINNA There are 3 main conclusions in this theory.If combination A is the revealed preference ,01.) MNO is called zone of inferior because all other combinationslocated in this area are inferior compared with A02 LAK IS called zone of superior / preferred zone. because allother combinationsin this area are superior than A (Theyrepresent more of both x and Y compared with A)03.) MAL area and KAN area are called zone of ignorancebecause a compansion between a combination in this areawith combination cannot be done such a compination impliesmore of one commodity and less of another commoditycompared with combination A.If a consumer bought a particular combination of goods allother combination of goods which can. be bought THE at thesame cost or lesser cost are inferior compared with therevealed combinationyZohyperior, ofZones of110profession 2 oneIgnorancetoozoneofFinferior,sobro

The Theory of Consumer Behaviour

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