•The consumer has to decide how to spend her income on different goods.
•Economists call this the problem of choice.
•A consumer tries to have a combination of goods and services that maximizes his satisfaction.
•The ‘best’ combination depends on the likes of the consumer and what the consumer can afford to buy.
•The ‘likes’ of the consumer are also called ‘preferences’.
Two different approaches to explain consumer behaviour
(i) Cardinal Utility Analysis: This theory provides an explanation of consumer’s demand for a product and derives the law of demand which establishes an inverse relationship between price and quantity demanded of a product.
(ii) Ordinal Utility Analysis/Indifference Curve Analysis: The indifference curve indicates the various combinations of two goods which yield equal satisfaction to the consumer.
Preliminary Notations and Assumptions
•Let us consider the consumer’s choice problem in a situation where there are only two goods:
•Any combination of the amount of the two goods will be called a consumption bundle or, in short, a bundle.
•Let variable x1 to denotes the quantity of bananas and x2 denotes the quantity of mangoes.
•(x1, x2) would mean the bundle consisting of x1 quantity of bananas and x2 quantity of mangoes.
•A consumer usually decides his demand for a commodity on the basis of utility (or satisfaction) that he derives from it.
•Utility of a commodity is its want-satisfying capacity.
•The more the need of a commodity or the stronger the desire to have it, the greater is the utility derived from the commodity.
Change of Utility value
•Utility is subjective and different individuals can get different levels of utility from the same commodity.
•One who likes chocolates will get much higher utility from a chocolate than some one who is not so fond of chocolates,
•Utility that one individual gets from the commodity can change with change in place and time.
•Utility from the use of a room heater will depend upon whether the individual is in Ladakh or Chennai (place) or whether it is summer or winter (time).
Cardinal Utility Analysis
•Cardinal utility analysis assumes that level of utility can be expressed in numbers.
•There are two important measures of utility
•Total utility of a fixed quantity of a commodity (TU) is the total satisfaction derived from consuming the given amount of some commodity x.
•More of commodity x provides more satisfaction to the consumer.
•TU depends on the quantity of the commodity consumed and it refers to total utility derived from consuming n units of a commodity x.
•Marginal utility (MU) is the change in total utility due to consumption of one additional unit of a commodity.
•Suppose 4 bananas give us 28 units of total utility and 5 bananas give us 30 units of total utility.
•Thus the consumption of the 5th banana has caused total utility to increase by 2 units (30 units minus 28 units).
•Therefore, marginal utility of the 5th banana is 2 units.
•MU5 = TU5 – TU4 = 30 – 28 = 2
•In general, MUn = TUn – TUn-1, where subscript n refers to the nth unit of the commodity
Relationship between TU and MU
•The TU derived from consuming n units of bananas is the sum total of marginal utility of first banana (MU1), marginal utility of second banana (MU2), and so on, till the marginal utility of the nth unit.
•TUn = MU1 + MU2 + … + MUn-1 + Mun