Consumer's behavior

Learning objectives:
1. What do you mean by utility? Explain different concepts of utility.
2. Discuss the relationship between total utility and marginal utility.
3. Explain the law of diminishing margin utility and the law of equi-marginal utility with
the help of schedule and diagram.
4. Explain the equilibrium of consumer in terms of utility analysis.
A consumer is a man who consumes goods and services to satisfy his wants. Each consumer has
to face the problems of unlimited wants and limited resources. In such state of affairs it is the
desire of each consumer to maximize his satisfaction in the presence of limited income.
Whenever a consumer maximizes his level of satisfaction, he is satisfied with is spending
pattern. Then he is said to be in equilibrium condition. This pattern of spending income and
getting possible maximum level of satisfaction is known as consumer's behavior. There are two
main approaches to describe consumer's equilibrium. These are cardinal approach and ordinal
approach. Both the approaches are discussed here.

Cardinal utility approach

Relationship between total utility and marginal
Law of diminishing marginal utility
Derivation of demand curve
Law of equi marginal utility
Ordinal utility approach
Marginal rate of substitution

Cardinal Utility Approach:

According to this approach, the utility is measurable and can be expressed in quantitative terms.
Cardinal utility approach is also known as classical approach because it was presented by
classical economists.

Concepts of Utility:
Following are important concepts of utility:

Utility:

The characteristics of a commodity or service is to satisfy a human want. The amount of

satisfaction a person derives from some commodity or service, is called utility.
Total Utility:

The amount of satisfaction a person derives from some commodity or service over a period of
time, is called utility. In other words, it is the sum of marginal utilities obtained from
consumption of each successive unit of a commodity or service. If continuous units of a
commodity 'X' are consumed, then TUx = MUx
Marginal Utility:

The extra amount of satisfaction to be obtained from having an additional increment of a

commodity or service. In brief, the change in total utility resulting from one unit change in the
consumption of a commodity or service per unit of time is called marginal utility. The following
formula may be used to measure it.
Marginal utility = Change in total utility / Change in quantity consumed
or
MU = TU / Q
or
MU = d TU / d Q
Initial Utility:

The amount of satisfaction to be obtained from the consumption of very first unit of a
commodity or service is called the initial utility e.g. the amount of satisfaction to be obtained
from consumption of the first apple is units. It is called initial utility of the consumer.
Positive Utility:

When a consumer consumes successive units of a commodity or service, its marginal utility
decreases. The utility obtained from the consumption of all the units of a commodity or service
before reaching the marginal utility equal to zero, is called positive utility.

Saturation Point:

By the consumption of that unit of a commodity where the marginal utility drops down to zero, is
called the saturation point.
Negative Utility:

By using the next unit of a commodity after saturation point, that unit gives negative satisfaction
to the consumer and marginal utility becomes negative, it is known as negative utility.
Util:

Although utility cannot be measured but in cardinal approach of consumer behavior, the term
which is used as a unit of utility is known as util and arithmetic numbers (1, 2, 3, .......) are used.
For example X ate an apple and got 10 util of utility.
Relationship Between Total Utility (TU) and Marginal Utility (MU):
When a consumer goes on to consume the units of a commodity continuously the marginal utility
derived from the successive units of the commodity goes on to fall constantly while other factors
are held constant.
From the above statement regarding the consumer behavior the relationship between total utility
(TU) and marginal utility (MU) is deducted as under:
1. MU is the rate of change of TU.
2. When the MU decreases, TU increases at decreasing rate.
3. When MU becomes zero, TU is maximum. It is a saturation point.
4. When MU becomes negative, TU declines
The standard quadratic form of the TU function is written as follows:
TU = aQ - bQ2
and MU = dTU / dQ = a - 2bQ
Slope of MU = dMU/dQ = -2b
By taking the successive values of Q, the relationship between MU and TU is represented in the
following schedule:
Quantity

Total Utility

Marginal Utility

1
2
3
4
5
6
7

10
18
24
28
30
30
28

10
8
6
4
2
0
-2

With the help of above schedule the relationship between TU and MU is explained as:
1. In the above schedule MU decreases and TU increases at a decreasing rate upto 5th unit
of commodity.
2. MU becomes zero at 6th unit and TU = 30 become maximum.
3. When MC becomes negative, the TU declines from 30 to 28 units at 7th units of a
commodity.
With the help of the above schedule the relationship between MU and TU can be represented in
the diagram.

1. In figure (2), MU curve moves downward having negative slope while in figure (1) TC
curve, having negative positive slope moves upward but tendency to move is towards xaxis, which shows decreasing rate.
2. A point F in figure (2) MU curve cuts the s-axis at the 6th unit and TU curve has its
maximum point F which is saturation point.
3. At 7th unit MU curve is below x-axis as in figure (2) and TU curve declines from point
'F' to 'G' as in figure (1).
Mathematically:
MU = Change in TU / change in quantity consumed
MU = TU / Q
=8/1
=8
From point B to C
MU = TU / Q
=6/1
=6
This process remains upto point E and MU decreases.
From E to point F
MU = TU / Q
=0/1
=0
It is the representation of zero marginal utility.
While from point F to G
MU = TU / Q
-2 / 1

= -2
It is the representation of negative utility and total utility declines.

Law of Diminishing Marginal Utility:

Definition of the Law:

"Other things remaining the same when a person takes successive units of a commodity, the
marginal utility diminishes constantly".
The marginal utility of a commodity diminishes at the consumer gets larger quantities of it.
Marginal utility is the change in the total utility resulting from one unit change in the
consumption of a commodity per unit of time.
Assumptions:
Following are the assumptions of the law of diminishing marginal utility.
1. The utility is measurable and a person can express the utility derived from a commodity
in qualitative terms such as 2 units, 4 units and 7 units etc.
2. A rational consumer aims at the maximization of his utility.
3. It is necessary that a standard unit of measurement is constant
4. A commodity is being taken continuously. Any gap between the consumption of a
commodity should be suitable.
5. There should be proper units of a good consumed by the consumer.
6. It is assumed that various units of commodity homogeneous in characteristics.
7. The taste of the consumer remains same during the consumption o the successive units of
commodity.
8. Income of the consumer remains constant during the operation of the law of diminishing
marginal utility.
9. It is assumed that the commodity is divisible.
10. There should be not change in fashion. For example, if there is a fashion of lifted shirts,
then the consumer may have no utility in open shirts.

11. It is assumed that the prices of the substitutes do not change. For example, the demand
for CNG increases due to rise in the prices of petroleum and these price changes effect
the utility of CNG.
Explanation With Schedule and Diagram:
We assume that a man is very thirsty. He takes the glasses of water successively. The marginal
utility of the successive glasses of water decreases, ultimately, he reaches the point of satiety.
After this point the marginal utility becomes negative, if he is forced further to take a glass of
water. The behavior of the consumer is indicated in the following schedule:
Units of commodity

Marginal utility

Total utility

1st glass

10

10

2nd glass

18

3rd glass

24

4th glass

28

5th glass

30

6th glass

30

7th glass

-2

28

On taking the 1st glass of water, the consumer gets 10 units of utility, because he is very thirsty.
When he takes 2nd glass of water, his marginal utility goes down to 8 units because his thirst has
been partly satisfied. This process continues until the marginal utility drops down to zero which
is the saturation point. By taking the seventh glass of water, the marginal utility becomes
negative because the thirst of the consumer has already been fully satisfied.
The law of diminishing marginal utility can be explained by the following diagram drawn with
the help of above schedule:

In the above figure, the marginal utility of different glasses of water is measured on the y-axis
and the units (glasses of water) on X-axis. With the help of the schedule, the points A, B, C, D,
E, F and G are derived by the different combinations of units of the commodity (glasses of
water) and the marginal utility gained by different units of commodity. By joining these points,
we get the marginal utility curve. The marginal utility curve has the downward negative slope. It
intersects the X-axis at the point of 6th unit of the commodity. At this point "F" the marginal
utility becomes zero. When the MU curve goes beyond this point, the MU becomes negative. So
there is an inverse functional relationship between the units of a commodity and the marginal
utility of that commodity.
Exceptions or Limitations:
The limitations or exceptions of the law of diminishing marginal utility are as follows:
1. The law does not hold well in the rare collections. For example, collection of ancient
coins, stamps etc.
2. The law is not fully applicable to money. The marginal utility of money declines with
richness but never falls to zero.
3. It does not apply to the knowledge, art and innovations.
4. The law is not applicable for precious goods.
5. Historical things are also included in exceptions to the law.

6. Law does not operate if consumer behaves in irrational manner. For example, drunkard is
said to enjoy each successive peg more than the previous one.
7. Man is fond of beauty and decoration. He gets more satisfaction by getting the above
merits of the commodities.
8. If a dress comes in fashion, its utility goes up. On the other hand its utility goes down if it
goes out of fashion.
9. The utility increases due to demonstration. It is a natural element.
Importance of the Law of Diminishing Marginal Utility:
The importance or the role of the law of diminishing marginal utility is as follows:
1. By purchasing more of a commodity the marginal utility decreases. Due to this
behaviour, the consumer cuts his expenditures to that commodity.
2. In the field of public finance, this law has a practical application, imposing a heavier
burden on the rich people.
3. This law is the base of some other economic laws such as law of demand, elasticity of
demand, consumer surplus and the law of substitution etc.
4. The value of commodity falls by increasing the supply of a commodity. It forms a basis
of the theory of value. In this way prices are determined
Derivation of Demand Curve:
The consumer purchases various units of a commodity 'X'. He can either buy a commodity X or
retain or retain his money with him. Under these conditions, the consumer is in equilibrium when
the marginal utility of a commodity 'X' is equal to its market price Px.
It is written as:
MUx = Px
If the marginal utility of a commodity is measured in terms of money, the demand curve for a
commodity is identical to the positive portion of the marginal utility curve. The negative portion
of the marginal utility curve does not form part of the demand curve, since negative quantities do
not make sense in economics.

In figure A, at Q1, the marginal utility is MU1 = 10, which is equal to P1 = 10 by definition.
Hence at P1, the consumer demands Q1 quantity of the commodity in figure B.
Similarly at Q2, the marginal utility is MU2 = 8, which is equal to P2 = 8. Hence, at P2 = 8 the
consumer will buy Q2 in figure B and so on.
As the consumer consumes more and more units of a commodity its marginal utility goes on
diminishing. So the consumer would like to demand more products at a diminishing price as
shown in figure B. It reflects that there is an inverse relation between price and the quantity
demanded of a commodity having negatively slopped demand curve in figure B that is derived
with the help of the marginal utility curve in figure A which is also negatively slopped.
Law of Equi Marginal Utility:
The law of equi marginal utility was presented in 19th century by an Australian economists H.
H. Gossen. It is also known as law of maximum satisfaction or law of substitution or Gossen's
second law. A consumer has number of wants. He tries to spend limited income on different
things in such a way that marginal utility of all things is equal. When he buys several things with
given money income he equalizes marginal utilities of all such things. The law of equi marginal
utility is an extension of the law of diminishing marginal utility. The consumer can get maximum
utility by allocating income among commodities in such a way that last dollar spent on each item
provides the same marginal utility.

Definition:
"A person can get maximum utility with his given income when it is spent on different
commodities in such a way that the marginal utility of money spent on each item is equal".
It is clear that consumer can get maximum utility from the expenditure of his limited income. He
should purchase such amount of each commodity that the last unit of money spend on each item
provides same marginal utility.
Assumptions of the Law of Equi Marginal Utility:
1. There is no change in the prices of the goods.
2. The income of consumer is fixed.
3. The marginal utility of money is constant.
4. Consumer has perfect knowledge of utility obtained from goods.
5. Consumer is normal person so he tries to seek maximum satisfaction.
6. The utility is measurable in cardinal terms.
7. Consumer has many wants.
8. The goods have substitutes.
Explanation With Schedule and Diagram:
The law of substitution can be explained with the help of an example. Suppose consumer has six
dollars that he wants to spend on apples and bananas in order to obtain maximum total utility.
The following table shows marginal utility (MU) of spending additional dollars of income on
apples and bananas:

Money (Units)

MU of apples

MU of bananas

10

The above schedule shows that consumer can spend six dollars in different ways:
1. $1 on apples and $5 on bananas. The total utility he can get is:
[(10) + (8+7+6+5+4)] = 40.
2. $2 on apples and $4 on bananas. The total utility he can get is:
[(10+9) + (8+7+6+5)] = 45.
3. $3 on apples and $3 on bananas. The total utility he can get is:
[(10+9+8) + (8+7+6)] = 48.
4. $4 on apples and $2 on bananas. This way the total utility is:
[(10+9+8+7) + (8+7)] = 49.
5. $5 on apples and $1 on bananas. The total utility he can get is:
[(10+9+8+7+6) + (8)] = 48.
Total total utility for consumer is 49 utils that is the highest obtainable with expenditure of $4 on
apples and $2 on bananas. Here the condition MU of apple = MU of banana i.e 7 = 7 is also
satisfied. Any other allocation of the last dollar shall give less total utility to the consumer.
The same information can be used for graphical presentation of this law:

The diagram shows that consumer has income of six dollars. He wants to spend this money on
apples and bananas in such a way that there is maximum satisfaction to the consumer.
Limitations:
1. The law is not applicable in case of knowledge. Reading of books provides more
satisfaction and knowledge to the scholar. Different books provide variety of knowledge
and satisfaction.
2. The law is not applicable in case of indivisible goods. The consumer is unable to divide
the goods to adjust units of utility derived from consumption of goods.
3. There is no measurement of utility. It is psychological concept. It is not possible to
express it into quantitative form.
4. The law does not hold well in case fashion and customs. The people like to spend money
on birthdays, marriages and deaths.
5.

The does not hold well in case of very low income. The maximization of utility is not
possible due to low income.

6. The law is not applicable in case of durable goods. The calculation of marginal utility of
durable goods is impossible.
7. The law fails when goods of choice are not available. The consumer is bound to use
commodity, which provides low utility due to non availability of goods having high
utility.
8. There are certain lazy consumers. They do not care for maximum utility. The law fails to
operate in case of laziness of consumers. They go on consuming goods with comparing
utility.
9. It does not work when there are frequent prices changes. The consumer is unable to
calculate utility of different commodities. Changing price levels create confusion in the
minds of consumers.
10. There may be unlimited resources. The does not work due to unlimited resources. There
is no need to change the direction of expenditure from one item to another when there are
gifts of nature.
Importance:
1. The law of equi marginal utility is helpful in the field of production. The producer has
limited resources. He uses limited resources to purchase production factors. He tries to
equalize marginal utility of all factors. He wishes to get maximum output and profit.

2. National income is distributed among factors of production according to this law. An

entrepreneur can pay factors of production equal to marginal product measured in money
terms. He will substitute one factor for another until marginal productivity of all factors is
equal to prices of their services.
3. The law is used in the field of exchange. The people like to exchange a commodity
having low utility with a commodity having high utility. There is maximum benefit from
exchange of commodities. The law is helpful in exchange of wealth, trade, import and
export.
4. The law is applicable in consumption. A rational consumer tries to get maximum
satisfaction when he spends his limited resources on various things. He tries to equalize
weighted marginal utility of all the things.
5. The law is applicable in public finance. The government can spend its revenue to get
maximum social advantage. The marginal utility of each dollar spent in one sector must
be equal to marginal utility derived from all other sectors.
6. The law is useful for workers in allocating the time between work and rest. They can
compare the marginal utility of work and the marginal utility of rest. They can decide
working hours and rest hours.
7. The law holds well in case of saving and spending. The consumer can make choice
between present wants and future wants. He can feel that a dollar saved has greater utility
than a dollar spent, he can save more and spend less. He will substitute saving and
spending till marginal utility of a dollar spent and a dollar saved are equal.
8. The law is helpful in prices. Due to scarcity of commodity its prices go up. The law tells
us to use substitute commodity, which is less scarce. The result is that the price of
commodity comes down.
Ordinal Utility Approach:
The basic idea behind ordinal utility approach is that a consumer keeps number of pairs of two
commodities in his mind which give him equal level of satisfaction. This means that the utility
can be ranked qualitatively.
The ordinal utility approach differs from the cardinal utility approach (also called classical
theory) in the sense that the satisfaction derived from various commodities cannot be measured
objectively.
Ordinal theory is also known as neo-classical theory of consumer equilibrium, Hicksian theory of
consumer behavior, indifference curve theory, optimal choice theory. This approach also
explains the consumer's equilibrium who is confronted with the multiplicity of objectives and
scarcity of money income.

The important tools of ordinal utility are:

1. The concept of indifference curves.
2. The slop of I.C. i.e. marginal rate of substitution.
3. The budget line.
Assumptions:
The ordinal utility approach is based on the following assumptions:
1. A consumer substitutes commodities rationally in order to maximize his level of
satisfaction.
2. A consumer can rank his preferences according to the satisfaction of each basket of
goods.
3. The consumer is consistent in his choices.
4. It is assumed that each of the good is divisible.
5. It is assumed that the consumer has full knowledge of prices in the market.
6. The consumer's scale of preferences is so complete that consumer is indifferent between
them.
7. Two commodities are used by the consumer. It is also known as two commodities model.
8. Two commodities X and Y are substitutes of each other. These commodities can be easily
substituted in various pairs.
Marginal rate of substitution (MRS):
Marginal rate of substitution is a tool of indifference curve analysis. Indifference curve shows
that when a consumer gets one more unit of the commodity on horizontal axis his total
satisfaction is increased. He can maintain his satisfaction at the same level, by sacrificing some
units of the commodity on the vertical axis. A consumer can get one unit of commodity X by
giving up five units of commodity Y and maintains his satisfaction at the same level. It means
one units of commodity X is the marginal rate of . substitution for five units of commodity Y. In
fact marginal rate of substitution is the rate of exchange between some units of goods X and Y
that are equally preferred. The marginal rate of substitution of X for Y is the amount of Y that
will be given up for obtaining each additional unit of X.

Definition:
Professor BILAS says that the marginal rate of substitution of X for Y is defined as the amount
of Y the consumer is just willing to give up to get one more unit of X and maintains the same
level of satisfaction.
Explanation:
The marginal rate of substitution can be explained with the help of a table. The table shows that
all combinations provide same satisfaction to consumer.

Schedule:
Combination

MRS of X for Y

30

--

22

1:8

16

1:6

12

1:4

10

1:2

When he chooses combination A, he can get one unit of commodity X and 30 units of
commodity Y. In combination B he can get 2 units of commodity X and 22 units of commodity
Y. The marginal rate of substitution in this case is 1:8. If the consumer chooses combination C
he can get 3 units of commodity X and 16 units of commodity Y. The marginal rate of
substitution in this combination is 1:6. The marginal rate of substitution decreases in successive
combinations. The consumer sacrifices smaller and smaller amount of commodity Y for every
additional unit of commodity X. This behavior of the consumer is called principle of diminishing
marginal rate of substitution.

Diagram

The slope of indifference curve measures the marginal rate of substitution. It is negative and
falling from left down to the right that shows the law of diminishing marginal rate of
substitution. The marginal rate of substitution diminishes because (1) each particular want is
satiable and (2) goods are not perfect substitutes of one another. When wants are satiable a
consumer obtains more and more of one commodity and ultimately his demand goes on
decreasing. Consumer is ready to sacrifice less amount of other commodity to get more of this
commodity. When goods are not perfect substitutes the marginal rate of substitution of one for
the other must decrease.