Lesson 3
Theory of Consumer Behavior
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction In this lesson, basic concepts of utility have been
introduced. After developing an understanding of
– Utility
the basic concepts, cardinal and ordinal analysis
– Meaning of consumer behavior is done. The understanding
– Cardinal Utility Approach of consumer behavior is incomplete without
cardinal and ordinal utility analysis. Finally, it has
– Assumptions been discussed as to what the conditions to
– Basic Concepts consumer equilibrium are and how consumer
attains equilibrium under the two types of utility
– Law of Diminishing Marginal Utility analysis. The learning objectives of the lesson are
– Law of Equi-Marginal Utility as follows :
– Consumer Equilibrium – To understand the concept of utility in
economics.
– Ordinal Utility Approach or Indifference
Curve Analysis – To learn about the cardinal and ordinal
concepts of utility.
– Meaning of Indifference Curve
– To analyse the cardinal utility theory as well
– Indifference Map
as ordinal utility theory of consumer
– Marginal Rate of Substitution behavior.
– Assumptions – To understand the concept and conditions
of consumer equilibrium under the two
– Properties of Indifference Curves
theories.
– Budget line
– Consumer Equilibrium
– Lesson Round Up
– Glossary
– Self-Test Questions
,INTRODUCTION
The theory of consumer behavior deals with the problem of constrained optimization that a consumer faces
while making choices among various goods and services. In other words, the theory is concerned with the
behavior of consumer, faced with resource constraints, in the market while demanding goods and services in
order to maximize satisfaction. Consumer demands goods as they provide utility to him. Utility is nothing but
the satisfaction derived from the consumption of goods and services. The concept of utility of a good or
service is central to understand the consumer behavior because it influences the demand and price of a good
or service. The different theories of consumer behaviour assume that consumer would always strive to maximize
his utility. Being a rational individual, consumer wants to maximize his satisfaction given the income constraint.
Therefore, it can be said that theories of consumer behavior are concerned with the question as to how a
consumer should spend his limited income on different combinations of goods and services so that he may
get maximum utility.
Economists have developed various theories of consumer behavior to understand the choices that people
make in order to maximize their level of satisfaction. These include Cardinal Utility analysis, Indifference Curve
analysis and Revealed Preference analysis. Cardinal Utility analysis is the oldest theory which was developed
by neo classical economists in the 19th century. Marshall further developed the cardinal utility analysis in the 20th
century. According to this analysis, utility can be measured in terms of numerical numbers. The technique of
indifference curves was first originated by a classical economist Edge worth in 1881. He did not use it to explain
the consumer demand analysis rather his main focus was to explain the possibilities of the exchange between
two consumers. J.R. Hicks and R.G.D. Allen developed Indifference curve analysis in their well-known paper ‘A
Reconsideration of the Theory of Value’. They had criticized the Marshallian cardinal approach of utility and
used the notion of ordinal utility approach to understand the consumer behavior. According to Indifference
Curve Analysis, utility is ordinal as consumer can only rank or order the satisfaction he derives from different
combinations of goods. In this lesson, the discussion is limited to cardinal and ordinal utility analysis.
UTILITY
MEANING OF UTILITY
Utility is want satisfying power of a good or service. It is also defined as the property of a good or service to
satisfy the want of the consumer. Utility is subjective. It depends upon the mental assessment of the consumer
and is determined by several factors which influence the consumer’s judgment. These factors include, for example,
the intensity of the want(s) to be satisfied. Utility of a good varies with the intensity of the want to be satisfied by
its consumption. Thus, the satisfaction derived from same set of goods and services is different for different
consumers. Alternatively, same set of goods give different satisfaction to different consumers. For instance,
intake of a cup of tea may derive more utility to person A as compared to person B. This fact leads to a few
important inferences:
– Utility of a good differs from consumer to consumer. This is because a given want can be felt in different
intensities by different consumers.
– The utility of a good keeps changing even for the same consumer on account of changes in the intensity
of the want(s) to be satisfied by its use. This change may be the result of a shift in the circumstances
faced by the consumer, or it may take place in the process of the satisfaction of the want itself.
– The utility of a good is not to be equated with its usefulness. Satisfaction of a want need not add to the
welfare of the consumer. For example, smoking, drug taking or consumption of similar other things are
considered to be harmful to the health of the consumer. But the consumer may believe that they have
, utility for him because he can use these to satisfy his wants.
In economics, we are not concerned with the ‘normative’ aspect of utility. It does not matter whether a good’s
consumption adds to the individual’s well-being or not. So long as the consumers expect to derive some
‘satisfaction’ from a good (that is, so long the good has a ‘utility’ for them), they will be ready to buy it at some
price and create a demand for it in the market.
A question here arises as to why it is important to define and measure utility? The measurement of utility helps
us in understanding the demand behavior of individual consumers, and therefore, the market as a whole. The
basis of the reasoning is that a consumer compares utility of a good with the price he has to pay for it. A
consumer purchases additional units of same commodity so long as the utility from them is at least equal to the
price to be paid for them. To understand the concept and its measurement further, we are discussing the following
two economic approaches in relation to utility:
– Cardinal Utility
– Ordinal Utility
CARDINAL UTILITY APPROACH
Cardinal Utility approach to consumer behavior states that utility can be measured in cardinal numbers or
definite numbers such as 1, 2, 3, 4, etc. Cardinal numbers are those definite numbers which can be subtracted
or added. Fisher used the ‘Util’ as a measure of utility. In cardinal measurement, utility is expressed in absolute
standard units, such as there being 20 units (utils) of utility from the first glass of water and 11 units from the
second.
ASSUMPTIONS
Cardinal Utility analysis is based on certain assumptions. These are as follows:
– Rational Consumer: consumer is believed to be rational and his aim is to maximize utility subject to the
income constraint.
– Utility is Cardinally Measurable: the utility is measurable and quantifiable in definite numbers. For
example, a consumer can state that he obtains utility equal to 20 utils from the consumption of good X
and 10 utils from the consumption of good Y.
– Independent Utilities: according to this school of thought, utility which a consumer derives from the
consumption of a good completely depends upon the quantity of that commodity alone. It implies that the
utility which a consumer gets from one commodity is independent of the consumption of other commodities.
– Additive Utility: the utility derived from the consumption of each commodity can be added to arrive at
total utility derived by the consumer by consuming all the products purchased with his limited income.
– Constant Marginal Utility of Money: it is assumed that change in consumer’s income do not lead to
change in marginal utility of money for him. In other words, marginal utility of money does not vary with
the amount of money an individual holds.
– Diminishing Marginal Utility: it is believed that the marginal utility gained by the consumer from additional
units of commodity diminishes as quantity of consumption of the same commodity increases.
BASIC CONCEPTS
As discussed before, the consumer derives utility from the good he consumes and utility derived from the
consumption of a good varies with the quantity of good consumed. It generates three concepts:
Theory of Consumer Behavior
LESSON OUTLINE
LEARNING OBJECTIVES
– Introduction In this lesson, basic concepts of utility have been
introduced. After developing an understanding of
– Utility
the basic concepts, cardinal and ordinal analysis
– Meaning of consumer behavior is done. The understanding
– Cardinal Utility Approach of consumer behavior is incomplete without
cardinal and ordinal utility analysis. Finally, it has
– Assumptions been discussed as to what the conditions to
– Basic Concepts consumer equilibrium are and how consumer
attains equilibrium under the two types of utility
– Law of Diminishing Marginal Utility analysis. The learning objectives of the lesson are
– Law of Equi-Marginal Utility as follows :
– Consumer Equilibrium – To understand the concept of utility in
economics.
– Ordinal Utility Approach or Indifference
Curve Analysis – To learn about the cardinal and ordinal
concepts of utility.
– Meaning of Indifference Curve
– To analyse the cardinal utility theory as well
– Indifference Map
as ordinal utility theory of consumer
– Marginal Rate of Substitution behavior.
– Assumptions – To understand the concept and conditions
of consumer equilibrium under the two
– Properties of Indifference Curves
theories.
– Budget line
– Consumer Equilibrium
– Lesson Round Up
– Glossary
– Self-Test Questions
,INTRODUCTION
The theory of consumer behavior deals with the problem of constrained optimization that a consumer faces
while making choices among various goods and services. In other words, the theory is concerned with the
behavior of consumer, faced with resource constraints, in the market while demanding goods and services in
order to maximize satisfaction. Consumer demands goods as they provide utility to him. Utility is nothing but
the satisfaction derived from the consumption of goods and services. The concept of utility of a good or
service is central to understand the consumer behavior because it influences the demand and price of a good
or service. The different theories of consumer behaviour assume that consumer would always strive to maximize
his utility. Being a rational individual, consumer wants to maximize his satisfaction given the income constraint.
Therefore, it can be said that theories of consumer behavior are concerned with the question as to how a
consumer should spend his limited income on different combinations of goods and services so that he may
get maximum utility.
Economists have developed various theories of consumer behavior to understand the choices that people
make in order to maximize their level of satisfaction. These include Cardinal Utility analysis, Indifference Curve
analysis and Revealed Preference analysis. Cardinal Utility analysis is the oldest theory which was developed
by neo classical economists in the 19th century. Marshall further developed the cardinal utility analysis in the 20th
century. According to this analysis, utility can be measured in terms of numerical numbers. The technique of
indifference curves was first originated by a classical economist Edge worth in 1881. He did not use it to explain
the consumer demand analysis rather his main focus was to explain the possibilities of the exchange between
two consumers. J.R. Hicks and R.G.D. Allen developed Indifference curve analysis in their well-known paper ‘A
Reconsideration of the Theory of Value’. They had criticized the Marshallian cardinal approach of utility and
used the notion of ordinal utility approach to understand the consumer behavior. According to Indifference
Curve Analysis, utility is ordinal as consumer can only rank or order the satisfaction he derives from different
combinations of goods. In this lesson, the discussion is limited to cardinal and ordinal utility analysis.
UTILITY
MEANING OF UTILITY
Utility is want satisfying power of a good or service. It is also defined as the property of a good or service to
satisfy the want of the consumer. Utility is subjective. It depends upon the mental assessment of the consumer
and is determined by several factors which influence the consumer’s judgment. These factors include, for example,
the intensity of the want(s) to be satisfied. Utility of a good varies with the intensity of the want to be satisfied by
its consumption. Thus, the satisfaction derived from same set of goods and services is different for different
consumers. Alternatively, same set of goods give different satisfaction to different consumers. For instance,
intake of a cup of tea may derive more utility to person A as compared to person B. This fact leads to a few
important inferences:
– Utility of a good differs from consumer to consumer. This is because a given want can be felt in different
intensities by different consumers.
– The utility of a good keeps changing even for the same consumer on account of changes in the intensity
of the want(s) to be satisfied by its use. This change may be the result of a shift in the circumstances
faced by the consumer, or it may take place in the process of the satisfaction of the want itself.
– The utility of a good is not to be equated with its usefulness. Satisfaction of a want need not add to the
welfare of the consumer. For example, smoking, drug taking or consumption of similar other things are
considered to be harmful to the health of the consumer. But the consumer may believe that they have
, utility for him because he can use these to satisfy his wants.
In economics, we are not concerned with the ‘normative’ aspect of utility. It does not matter whether a good’s
consumption adds to the individual’s well-being or not. So long as the consumers expect to derive some
‘satisfaction’ from a good (that is, so long the good has a ‘utility’ for them), they will be ready to buy it at some
price and create a demand for it in the market.
A question here arises as to why it is important to define and measure utility? The measurement of utility helps
us in understanding the demand behavior of individual consumers, and therefore, the market as a whole. The
basis of the reasoning is that a consumer compares utility of a good with the price he has to pay for it. A
consumer purchases additional units of same commodity so long as the utility from them is at least equal to the
price to be paid for them. To understand the concept and its measurement further, we are discussing the following
two economic approaches in relation to utility:
– Cardinal Utility
– Ordinal Utility
CARDINAL UTILITY APPROACH
Cardinal Utility approach to consumer behavior states that utility can be measured in cardinal numbers or
definite numbers such as 1, 2, 3, 4, etc. Cardinal numbers are those definite numbers which can be subtracted
or added. Fisher used the ‘Util’ as a measure of utility. In cardinal measurement, utility is expressed in absolute
standard units, such as there being 20 units (utils) of utility from the first glass of water and 11 units from the
second.
ASSUMPTIONS
Cardinal Utility analysis is based on certain assumptions. These are as follows:
– Rational Consumer: consumer is believed to be rational and his aim is to maximize utility subject to the
income constraint.
– Utility is Cardinally Measurable: the utility is measurable and quantifiable in definite numbers. For
example, a consumer can state that he obtains utility equal to 20 utils from the consumption of good X
and 10 utils from the consumption of good Y.
– Independent Utilities: according to this school of thought, utility which a consumer derives from the
consumption of a good completely depends upon the quantity of that commodity alone. It implies that the
utility which a consumer gets from one commodity is independent of the consumption of other commodities.
– Additive Utility: the utility derived from the consumption of each commodity can be added to arrive at
total utility derived by the consumer by consuming all the products purchased with his limited income.
– Constant Marginal Utility of Money: it is assumed that change in consumer’s income do not lead to
change in marginal utility of money for him. In other words, marginal utility of money does not vary with
the amount of money an individual holds.
– Diminishing Marginal Utility: it is believed that the marginal utility gained by the consumer from additional
units of commodity diminishes as quantity of consumption of the same commodity increases.
BASIC CONCEPTS
As discussed before, the consumer derives utility from the good he consumes and utility derived from the
consumption of a good varies with the quantity of good consumed. It generates three concepts:
