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Theory of consumer behaviour part 1
Consumer equilibrium utility analysis
Introduction
Consumer behavior is a fundamental concept in microeconomics, explaining how individuals and groups use limited resources to maximize satisfaction. Utility, the satisfaction derived from consuming goods or services, plays a central role in understanding this behavior.
1. Who is a Consumer?
A consumer is any economic agent who uses goods and services for direct satisfaction of their wants. While typically considered as individuals, consumers also include households, institutions, and groups.
Consumer Behavior
Consumer behavior involves decision-making processes for spending income, aiming to derive maximum utility given income constraints and prices. For instance:
A consumer evaluates how to allocate money across goods to achieve the greatest overall satisfaction.
2. Concept of Utility
Definition
Utility is the satisfaction derived from consuming goods or services, often referred to as the "want-satisfying power" of a commodity.
Features of Utility
1.
Function of Want Intensity: Higher urgency of want leads to higher utility.
Example: A fan has more utility in summer than in winter.
2.
Subjective Nature: Utility varies across individuals.
Example: Tea might offer more satisfaction to one person than another.
3.
Not Related to Usefulness: Utility does not always align with practical value.
Example: Alcohol may provide utility to a consumer but has no inherent usefulness.
3. Measurement of Utility
Cardinal vs. Ordinal Utility
1. Cardinal Measurement: Assumes utility can be quantified in numerical terms (e.g., 1, 2, 3 utils).
Proposed by
Alfred Marshall.
Example: A cup of tea provides 3 utils of utility, while coffee provides 2 utils.
2. Ordinal Measurement: Satisfaction is ranked but not quantified.
Introduced by
J.R. Hicks.Example: Tea is preferred over coffee, but no numerical value is assigned.
Key Assumptions
- Utility is subjective.
- Measurement is simplified for analysis.
4. Total and Marginal Utility
Total Utility (TU)
The sum of all satisfaction derived from consuming multiple units of a commodity.
Formula:
TU = MU¹ + MU² + ... + MU_n
Marginal Utility (MU)
The additional satisfaction gained from consuming one more unit of a good.
Formula:
MU = TU_n - TU_{n-1}
Relationship Between TU and MU
- TU increases as long as MU is positive.
- TU reaches a maximum when MU is zero.
- TU declines when MU becomes negative.
5. Law of Diminishing Marginal Utility (DMU)
Statement
As more units of a commodity are consumed, the additional satisfaction (MU) derived from each successive unit decreases.
Graphical Explanation
TU Curve: Increases initially, reaches a peak (point of saturation), then declines.
MU Curve: Slopes downward, intersects the x-axis (MU = 0) at the point of saturation, and then turns negative.
Key Observations
1. MU is positive when TU increases.
2. MU is zero when TU is at its maximum.
3. MU is negative when TU starts to decline.
Assumptions of DMU
1. Only standard units of the commodity are consumed (e.g., a cup of tea, not a drop).
2. Consumption is continuous, without breaks.
Exceptions to the Law
1. Addictive Goods: MU may increase temporarily (e.g., alcohol for a drunkard).
2. Hobbies: Collectors may derive increasing satisfaction.
3. Money: Utility from money does not always diminish for misers.
6. Consumer’s Equilibrium
Definition
Consumer equilibrium refers to a state where a consumer achieves maximum satisfaction from their available income without the need to reallocate expenditures. This occurs when the consumer balances the utility derived from different goods and services relative to their prices.
Key Conditions for Consumer Equilibrium
1. Rational Consumer
The consumer is assumed to act rationally, aiming to maximize satisfaction with the given income.
2. Utility Measurability
For the analysis, utility is assumed to be measurable in cardinal terms (e.g., utils).
3. Independence of Utility
The utility derived from one good is independent of the consumption of other goods.
4. Constant Marginal Utility of Money (MUₘ)
Money’s utility is assumed to remain constant, serving as a reliable measure of the satisfaction derived from goods.
Consumer Equilibrium for a Single Commodity
The consumer achieves equilibrium when the marginal utility (MU) of the commodity equals the price of the commodity in terms of money:
MUx = Px
MUx: Marginal utility of the commodity.
Px: Price of the commodity.
Consumer Equilibrium for Multiple Commodities
When multiple goods are involved, equilibrium is achieved when the consumer distributes their income such that the marginal utility per rupee is equal across all goods:
This condition adheres to the law of equi-marginal utility, which states that the consumer should allocate their spending to equalize the satisfaction derived from the last rupee spent on each good.
Illustration for Two Commodities
Graphical Representation of Single Commodity Equilibrium
In a graph:
1. Marginal Utility Curve (MU) slopes downward, reflecting diminishing marginal utility.
2. Price Line (P) is horizontal, indicating a constant price.
The equilibrium point is where the MU curve intersects the price line.
At this point, , and the consumer has no incentive to buy more or less.
Graphical Representation of Two Commodities
For two commodities, equilibrium can be represented on a graph with:
Commodity on the x-axis.
Commodity on the y-axis.
The equilibrium point occurs where the marginal utility per rupee for both goods is equal, adhering to the law of equi-marginal utility.
Marginal Utility of Money
To simplify, economists often calculate equilibrium using the marginal utility of money ():
When a consumer allocates spending, they aim to equalize:
This condition reflects optimal allocation of income for maximum satisfaction.
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