BBM 202 Lesson 3: Theory of Consumer Behavior
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LESSON 3
THEORY OF CONSUMER BEHAVIOR
____________________________________________________
Structure of the Lesson
3.1 Utility: Meaning and Types
3.2 Law of Diminishing Marginal Utility
3.3 Law of Equi - Marginal Utility
3.4 Consumer’s Surplus
3.5 Indifferent Curve Analysis
3.6 Consumer’s Equilibrium
3.7 Effects on Consumer’s Equilibrium
3.8 Summary
3.9 Self check Questions
3.10 Suggested Readings
Objectives of the Lesson
To understand the concept of utility in relation to economic behavior of
individuals.
To discuss economic laws governing consumer behavior e.g. Law of Diminishing
Marginal Utility and the Law of Equi-marginal Utility.
To explain the meaning and features of indifference curves, and to
understand the concept of consumer’s equilibrium.
3.1 UTILITY: MEANING AND TYPES
There are two basic approaches to the study of consumer demand theory. The first
approach is the utility approach. It involves the use of measurable (cardinal) utility to
study consumer behavior. Marshall is the chief exponent of the utility approach to the
theory of demand. It is known as cardinal utility analysis or marginal utility analysis or
Marshallian utility analysis. The second approach is the indifference curve approach
which uses the idea of comparable utility (ordinal utility). JR Hicks and RGD Allen
introduced the indifference curve approach.
In the ordinary language, ‘utility’ means ‘usefulness’. In Economics, utility is defined as
the power of a commodity or a service to satisfy a human want. Utility is a subjective or
psychological concept. The same commodity or service gives different utilities to
20
,BBM 202 Lesson 3: Theory of Consumer Behavior
____________________________________________________________________________
different people. For a vegetarian, mutton has no utility. Warm clothes have little utility
for the people in hot countries. So utility depends on the consumer and his need for the
commodity.
Total Utility: Total Utility refers to the sum of utilities of all units of a commodity
consumed. For example, if a consumer consumes ten biscuits, then the total utility is the
sum of satisfaction of consuming all the ten biscuits.
Marginal Utility: Marginal Utility is the addition made to the total utility by consuming
one more unit of a commodity. For example, if a consumer consumes 10 biscuits, the
marginal utility is the utility derived from the 10th unit. It is nothing but the total utility of
10 biscuits minus the total utility of 9 biscuits.
Thus, MU n = TU n – TU n-1
Where: MU n = Marginal Utility of ‘nth’ commodity; TU n = Total Utility of n units; and
TU n-1= Total Utility of n-1 units.
3.2 LAW OF DIMINISHING MARGINAL UTILITY
If a consumer takes more and more units of a commodity, the additional utility he
derives from an extra unit of the commodity goes on falling. Thus, according to this law,
the marginal utility decreases with the increase in the consumption of a commodity.
When marginal utility decreases, the total utility increases at a diminishing rate.
The law of diminishing marginal utility explains an ordinary experience of a consumer.
Gossen, Bentham, Jevons, contributed initially for the development of these ideas. This
Law is also known as Gossen’s First Law. But Alfred Marshall perfected these ideas
and made it as a law. According to Marshall, “The additional benefit which a person
derives from a given increase of his stock of a thing diminishes with every increase in
the stock that he already has”.
Assumptions:
The units of consumption must be in standard units e.g., a cup of tea, a bottle of
cool drink etc.
All the units of the commodity must be identical in all aspects like taste, quality,
color and size.
21
, BBM 202 Lesson 3: Theory of Consumer Behavior
____________________________________________________________________________
The law holds good only when the process of consumption continues without any
time gap.
The income of the consumer remains constant.
Utility is measurable.
The prices of the commodity consumed and its substitutes are constant.
The consumer is assumed to be a rational economic man. As a rational
consumer, he wants to maximize the total utility.
The consumer’s taste, habit or preference must remain the same during the
process of consumption.
Explanation
Suppose Alex is hungry and eats apple one by one. The first apple gives him great
pleasure (higher utility) as he is hungry; when he takes the second apple, the extent of
his hunger will reduce. Therefore he will derive less utility from the second apple. If he
continues to take additional apples, the utility derived from the third apple will be less
than that of the second one. In this way, the additional utility (marginal utility) from the
extra units will go on decreasing. If the consumer continues to take more apples,
marginal utility falls to zero and then becomes negative. Following table gives the utility
derived by a person from successive units of consumption of apples.
TOTAL AND MARGINAL UTILITY SCHEDULE
Units of apple Total Utility Marginal Utility
1 20 20
2 35 15
3 45 10
4 50 5
5 50 0
6 45 -5
7 35 -10
The Table makes it clear that the marginal utility (addition made to the total utility) goes
on declining. The consumer derives 20 units of utility from the first apple he consumes.
When he consumes the apples continuously, the marginal utility falls to 5 units for the
fourth apple and becomes zero for the fifth apple. The marginal utilities are negative for
22
____________________________________________________________________________
LESSON 3
THEORY OF CONSUMER BEHAVIOR
____________________________________________________
Structure of the Lesson
3.1 Utility: Meaning and Types
3.2 Law of Diminishing Marginal Utility
3.3 Law of Equi - Marginal Utility
3.4 Consumer’s Surplus
3.5 Indifferent Curve Analysis
3.6 Consumer’s Equilibrium
3.7 Effects on Consumer’s Equilibrium
3.8 Summary
3.9 Self check Questions
3.10 Suggested Readings
Objectives of the Lesson
To understand the concept of utility in relation to economic behavior of
individuals.
To discuss economic laws governing consumer behavior e.g. Law of Diminishing
Marginal Utility and the Law of Equi-marginal Utility.
To explain the meaning and features of indifference curves, and to
understand the concept of consumer’s equilibrium.
3.1 UTILITY: MEANING AND TYPES
There are two basic approaches to the study of consumer demand theory. The first
approach is the utility approach. It involves the use of measurable (cardinal) utility to
study consumer behavior. Marshall is the chief exponent of the utility approach to the
theory of demand. It is known as cardinal utility analysis or marginal utility analysis or
Marshallian utility analysis. The second approach is the indifference curve approach
which uses the idea of comparable utility (ordinal utility). JR Hicks and RGD Allen
introduced the indifference curve approach.
In the ordinary language, ‘utility’ means ‘usefulness’. In Economics, utility is defined as
the power of a commodity or a service to satisfy a human want. Utility is a subjective or
psychological concept. The same commodity or service gives different utilities to
20
,BBM 202 Lesson 3: Theory of Consumer Behavior
____________________________________________________________________________
different people. For a vegetarian, mutton has no utility. Warm clothes have little utility
for the people in hot countries. So utility depends on the consumer and his need for the
commodity.
Total Utility: Total Utility refers to the sum of utilities of all units of a commodity
consumed. For example, if a consumer consumes ten biscuits, then the total utility is the
sum of satisfaction of consuming all the ten biscuits.
Marginal Utility: Marginal Utility is the addition made to the total utility by consuming
one more unit of a commodity. For example, if a consumer consumes 10 biscuits, the
marginal utility is the utility derived from the 10th unit. It is nothing but the total utility of
10 biscuits minus the total utility of 9 biscuits.
Thus, MU n = TU n – TU n-1
Where: MU n = Marginal Utility of ‘nth’ commodity; TU n = Total Utility of n units; and
TU n-1= Total Utility of n-1 units.
3.2 LAW OF DIMINISHING MARGINAL UTILITY
If a consumer takes more and more units of a commodity, the additional utility he
derives from an extra unit of the commodity goes on falling. Thus, according to this law,
the marginal utility decreases with the increase in the consumption of a commodity.
When marginal utility decreases, the total utility increases at a diminishing rate.
The law of diminishing marginal utility explains an ordinary experience of a consumer.
Gossen, Bentham, Jevons, contributed initially for the development of these ideas. This
Law is also known as Gossen’s First Law. But Alfred Marshall perfected these ideas
and made it as a law. According to Marshall, “The additional benefit which a person
derives from a given increase of his stock of a thing diminishes with every increase in
the stock that he already has”.
Assumptions:
The units of consumption must be in standard units e.g., a cup of tea, a bottle of
cool drink etc.
All the units of the commodity must be identical in all aspects like taste, quality,
color and size.
21
, BBM 202 Lesson 3: Theory of Consumer Behavior
____________________________________________________________________________
The law holds good only when the process of consumption continues without any
time gap.
The income of the consumer remains constant.
Utility is measurable.
The prices of the commodity consumed and its substitutes are constant.
The consumer is assumed to be a rational economic man. As a rational
consumer, he wants to maximize the total utility.
The consumer’s taste, habit or preference must remain the same during the
process of consumption.
Explanation
Suppose Alex is hungry and eats apple one by one. The first apple gives him great
pleasure (higher utility) as he is hungry; when he takes the second apple, the extent of
his hunger will reduce. Therefore he will derive less utility from the second apple. If he
continues to take additional apples, the utility derived from the third apple will be less
than that of the second one. In this way, the additional utility (marginal utility) from the
extra units will go on decreasing. If the consumer continues to take more apples,
marginal utility falls to zero and then becomes negative. Following table gives the utility
derived by a person from successive units of consumption of apples.
TOTAL AND MARGINAL UTILITY SCHEDULE
Units of apple Total Utility Marginal Utility
1 20 20
2 35 15
3 45 10
4 50 5
5 50 0
6 45 -5
7 35 -10
The Table makes it clear that the marginal utility (addition made to the total utility) goes
on declining. The consumer derives 20 units of utility from the first apple he consumes.
When he consumes the apples continuously, the marginal utility falls to 5 units for the
fourth apple and becomes zero for the fifth apple. The marginal utilities are negative for
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