An anaylsis of consumer behaviour i.e. how much they are rational in taking decision in term of consumption of the commodities.

1. Consumer behaviour and
analysis
Dr. Mohsina Hayat

2. • Managerial economics bridges the gap between economic theory and
business practices.?
• What are the major areas of business decision- making ? How does
economic theory contribute to managerial economic decision?

3. Introduction
• Consumer demand is the basis of all productivity activities.
• Demand is the mother of production i.e
• Demand for the product offer business prospects for the future { vice verse}
• Following are the question arise in mind of manager
• What is the basis of demand for a commodity?
• What are the determinants of demand ?
• How do the buyers decide the quantity of a product to be purchased ?
• How do the buyers respond to change in the product prices, their incomes and price of the related
goods?
• How can the total or market demand for the product be assessed and forecasted?

4. Meaning of Demand
A relation showing the quantities of a good that consumers are
willing and able to buy at various prices per period, other things
constant.
• Element of demand
• Demand for commodity implies
• Desire to acquire it
• Willingness to pay for it
• Ability to pay for it
• Price
• Time
Effective Demand = desire+ ability+ willing to spend (at specific price in given time)
The desire without adequate purchasing power and willingness to pay do not affect
the market /generate production activity.
Only effective demand effect business analysis and decision making.

5. Continue
Any statement regarding the dd. For commodity without reference to price,
time of purchase and place is meaning less & without practical uses.
DD. Analysis possess following information
The quantity demand
The price at which commodity is dd.
Time period of demand.
The market (place) are in which commodity is demand.
e.g. the annual demand for TV sets in Delhi at price of Rs. 25000 per unit is
Rs. 50000 units.
Consumer demand a commodity because they derive or expect to derive
utility from the consumption of that commodity

6. Utility
• Utility have two sides
• Product side : utility is the want- satisfying property of a commodity. It is
absolute concept.
• Consumer sides: satisfaction derive by consumer from the consumption of
the commodity ( psychological feeling ). It is subjective concept.
• Because
• a commodity need not be useful for all
• Utility of commodity varies from person to person and from time
• Commodity need not have the same utility for the same consumer at different points
of time, at different levels of consumption and for different moods of a consumer.

7. Concepts of Utility
• Total Utility: Sum of Utiliity derived by a consumer from the various units
of a good or services consumer , consume at a point or over a period of
time.
TUx = U1+U2+U3+……………..UN
Average Utility :per unit Utility = TU/ Q
Marginal Utility : Utility derive from the consumption of one addition unit or
addition to the total utility resulting from the consumption of one additional
unit.
It is the slope of Total Utility
MUx = TUx/ Qx
MUx= TUN-TUN-1

8. Cardinal Utility / Ordinal utility
• There are two approaches to analysis of consumer behaviour Based
upon the Cardinal Utility / Ordinal utility concepts
• Cardinal Utility :  Alfred Marshall  Neo- classical Approach
• Ordinal utility :  J.R. Hicks & R.G.D. Allen  Indifference curve
analysis
• Theses are two level sophistication in the analysis of consumer
behaviour
• Hicks used a new tool to analysis the consumer behaviour called
indifference curve on the basis of ordinal utility

9. Ordinal utility analysis
• Ordinal Utility means giving the rank to the utility dervied by the
consimption of goods and services.
• This Concept was given by J.R. Hicks.
• This is more realistic and better than cardinal utility.
• This is totally based on Introspection.

10. Assumptions
• Rational Consumer Ordinal Utility Non-Satiety (More is Preferred to Less)
Diminishing Marginal Rate of Substitution.
• Consistency: If a consumer prefer A to B in one period then he will not prefer B to
A in another period.
• Transitivity: If a consumer prefer A to B and B to C, then he must prefer A to C.
• Nonsatiety : consumer cannot reach at point of saturation of consumption.
Consumer always prefer more on less quantity
• Law of Marginal diminishing rate of substitution: total remain same

11. Meaning and Nature of Indifference curve
• The locus of points each representing a different combination of two
substitutes goods, which yield the same utility or level of satisfaction
to the consumer.
• Therefore, he is indifferent between any two combinations of two goods
when it comes to making a choices between them .
• Because
• Consumer can consume large number of goods and services and often finds
that one commodity can be substituted for another
• That makes various combination of two goods which gives same level of
satisfaction.
• When such combination are plotted graphically it produce curve:
“indifference curve/Iso- utility curve / equal utility curve”

12. Indifference Schedule and Curve
A
B
C
D
E
0
5
10
15
20
25
30
3 5 9 17 30
Units
of
commodity
X
Units of Commodity Y
Indifference curve
indiffernece curve
Combinati
on
Units of
commodit
y Y
Units of
commodit
y X
Total
Utility
A 25 3 U
B 15 5 U
C 8 9 U
D 4 17 U
E 2 30 U

13. 13
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Indifference Map
• An indifference map is a complete set of indifference curves.
• It indicates the consumer’s preferences among all combinations of goods and services.
• Indifference curve map may contain any number of indifference curves, ranked in the
order of consumer’s preferences.
• Higher indifference curve represents higher satisfaction . This is because the combinations
lying on higher indifference curve contain more of either one or both goods and more is
always preferred to less

14. Marginal Rate of Substitution
the rate at which one good must be added when the other is taken away in
order to keep the individual indifferent between the two combinations.
Or
Rate at which one good is substituted for another level of satisfaction
remains same.
This implies that the utility of X(or Y) given up is equal to the Utility of
additional unit of Y(or X) added to the combination.
MRSxy = Y / X
MRSxy = MUx/MUy
It is moving downward to the curve

15. Deriving the marginal rate of substitution (MRS)
3, 25 -
5, 15 , -5
9, 8, -1.75
17, 4 , -0.50
30, 2, -0.15
0
5
10
15
20
25
30
3 5 9 17 30
Commodity
X
Commodity Y
Marginal Rate of subsitution
Marginal Rate of subsitution
Indiffere
nce
point
Combina
tions
Y+X
Change
in X
Change
in Y
MRS xy
A 25+3 - - -
B 15+5 2 -10 -5
C 8+9 4 -7 -1.75
D 4+17 8 -4 -0.50
E 2+30 13 -2 -0.15
The diminishing marginal rate of substitution causes
the indifference curves to be convex to the orgin.

16. • The slope or steepness of indifference curves is determined by consumer
preferences.
• In most cases, no two goods are perfect substitutes for one another.
• It reflects the amount of one good that a consumer must give up to get an additional unit of the other
good while remaining equally satisfied.
• This relationship changes according to diminishing marginal utility—the more a consumer has of a good,
the less the consumer values an additional value of that good. This is shown by an indifference curve that
bows in toward the origin.
• It is observed behavioral rule that consumer’s willingness and capacity to sacrifice a commodity is greater
when it stock is greater and it is lower when the stock of a commodity is smaller.
3, 25 -
5, 15 , -5
9, 8, -1.75
17, 4 , -0.50
30, 2, -0.15
0
5
10
15
20
25
30
3 5 9 17 30
Commodity
X
Commodity Y
Marginal Rate of subsitution
Marginal Rate of subsitution

17. 4- Properties of Indifference Curve
1. Indifference curves slope downward to right
2. Indifference curve of imperfect substitutes are convex to the origin
3. Indifference curves do not intersect nor are they tangent to one
another
4. Upper indifference curves indicates a higher level of satisfaction.
these properties of indifference curves reveal the
consumer’s behaviours his choices and preference.

18. Indifference curves slope downward to right
• Hicks said – so long as each commodity has a positive marginal Utility,
IC curve must slope downward to the right.
• The negative slope of IC curve implies two requisite
1. The two commodities can be substitute for each other
2. If the quantity of one commodity decrease , quantity of the other
commodity must so increase that the consumer stays at the same level of
satisfaction
• If two are perfect substitutes, then change in two goods produces an
indifferences lines not a curve.

19. Indifference curve of imperfect substitutes
are convex to the origin
• IC curve are convex to origin because of the
• Two commodities are imperfect substitutes for one another
• MRSxy between the two goods decrease as consumer moves along an
indifference curve.
• The postulate of diminishing MRSyx is based on
If a consumer substitutes one commodity (X)for another (Y), his willingness to
sacrifice more units of y for one additional unit of X decrease, as quantity of Y
decreases.
There are two reason as
1. Two commodities are not perfect substitutes for one another
2. MU of a commodity increases as its quantity decreases and vice versa,
therefore, more and more units of the other commodity are needed to keep
the total Utility constant.

20. Indifference curves do not intersect nor are they
tangent to one another
• Indifference curves cannot cross.
• If the curves crossed, it would mean that the same bundle of goods would offer two
different levels of satisfaction at the same time.
• If we allow that the consumer is indifferent to all points on both curves, then the
consumer must not prefer more to less.
• There is no way to sort this out. The consumer could not do this and remain a rational
consumer

21. Upper indifference curves indicates a higher
level of satisfaction
• Upper IC curve represent higher level of satisfaction because higher IC
curve contains large quantity of one or both the goods than lower IC curve.
• Large basket of commodities is yield a greater satisfaction than the smaller
one , provided MU of goods is greater than Zero.

22. Budgetary Constraints on Consumer’s Choice:
Limited Income and prices
• According to Utility maximizing behaviour of consumer, he/she would like to
reach the higher possible indifference curve on the indifference curve on
his/her indifference map. BUT
• Consumer has two constraints
• Consumer has a limited income
• Consumer has to pay a price for the goods.
On the given price, limited income act as constraint to moves on higher
indifference curve called budgetary constraint
Budgetary constraint refers budget equation
PxQx + PyQy = M
Expenditure on commodity X+ Expenditure on Commodity Y = Income of the
consumer

23. Budget line/Price Line
• It tells us what the consumer is willing to buy.
• It does not tell us what the consumer is able to buy. It does not tell us anything
about the consumer’s buying power.
• The budget line shows all the combinations of goods that can be purchased with a
given level of income and price of commodities
• The mathematical expression for budget
constraint is:
M= Px QX + Py QY
QY= M/Py – Px Qx /Py
Qx= M/Px – PyQy /Px
Example: M = Rs 200
Px= Rs 2
Py= Re1
Non feasible region
Feasible
region

24. Shift in budget line
Income Effect when price is given Price Effect when Income given

25. Slope of Budget Line
• Slope of budget line is an important determinant of consumer
equilibrium
Slope = M/Py = Px
M/Px Py
Slope of the budget line similar the price ratio of two
commodities

26. Consumer Equilibrium
• The indifference map in combination with the budget line allows us to
determine the one combination of goods and services that the
consumer most wants and is able to purchase. This is the consumer
equilibrium.

27. Conti.
• Consumer attains his equilibrium when he maximizes his total Utility, given
his income and market prices of the goods & services that consumer
consume
• The ordinal Utility approach specifies two conditions for the Consumer’s
Equilibrium :
• Necessary Condition i.e. first order condition
• Supplementary (sufficient) condition i.e. the second order condition
• First order condition
MUx/MUy = Px/Py
MUx/Muy = MRSyx
So MRSyx = MUx/Muy =Px/Py

28. • Second order condition
• Indifference Curve should tangent to budget line indicates highest possible IC
curve which the consumer can reach, given his income and the prices.
i.e. slope of budget line = slope of price line
So E is the Consumer Equilibrium.
F&G are not a equilibrium because these point are not satisfying second order
condition i.e it lies on lowest IC curve
Because
• Necessary condition required equilibrium at highest IC curve
• Utility maximizing behaviour of consumer would not lead the consumer to
settle on lower IC.
• Budget constraint

29. Effects of change in Income on Consumption
• The change in consumption basket due to change in income is called
income effect
• various Equilibrium point are joined by a curve that reflects path of
increase in consumption due to increase in Income all other things
remain same
ICC curve positive
when both goods
are normal
ICC should be
negative for inferior
goods

30. Effects of change in Price on Consumption
• When the price of commodity change (income and price of other
commodity remain same) leads a change in real income and slope of
budget that resulted change in consumer equilibrium
• Change in consumption market due change in the price is called Price
effects

31. Income and Substitution Effects of Price
Change

32. Applicability of Income and Substitution
effects
• Hicks said “ substitution effect is absolutely certain ; it must always
work in favour of an increase in demand for a commodity when the
price of that commodity falls.”
• behaviour of substitution effect is predictable as it follow LDMRS.
• On the contrary, “ income effect is not so reliable” and it behaviour is
unpredictable
• Income effect is + ve or –ve depends of consumer assumption of
inferior and superior goods

33. 4 possible combination of income effect and
substitution effect
• Substitution effect is negative and income effect is positive ( Qx
increase as Px decrease) (normal goods)
• Income effect is negative but less than substitution effect negative
effects (inferior goods)
• Income effect is zero , demand curve follows the substation effect
(price increase, demand decease) (flatter demand gets)
• Income effect is negative and more powerful than substitution effect
(giffen goods) demand curve is backward bending.

34. Income and substitution effects by slutsky’s
approach
• Eugene Slutsky introduce this concept which is similar to Hicksian
method but
• Slutsky’s method, consumer income has to be so reduce that he move
back not only to the orginal indifference curve but also to his original
equilibrium point.

35. Applicability of Income and Substitution
effects
• Hicks: “substitution effects is absolutely certain; it must always work
in favour of an increase in demand for a commodity when the price of
that commodity falls”.
• Behaviour of substitution effect is predictable ; it follows directly from the
principle of diminishing marginal rate of substitution
• “Income effect is not so reliable”
• Behaviour is unpredictable in general. Whether income-effect is positive or
negative depends on who a commodity is treated by the consumer as a
superior or an inferior good.
• Because subjective value of goods differ from person to person in
response to change in real income.

36. Derivation of Individual Demand Curve
• The basic purpose of the entire analysis of indifference curve technique is
to construct individual demand curve for a commodity.
• It can be derive by Price consumption curve .
• Possible shape and slope of demand curve derived from IC curve depends
on the direction in which income and substitution effect works as a result
of fall in the price of a commodity
Or
• Substitution effect is always negative but income effect is uncertain .
Therefore given negative substitution effect leads shape and nature of
demand curve depends on direction and magnitude of Income effect

38. Possible shape of demand curve
• When substitution effect is negative and income-effect is positive (dd
curve is downward sloping)
• When income-effect is negative but less than (negative )substitution
(inferior goods) (dd curve is downward sloping but steepy )
• If income effect is zero, the dd. curve follows the substitution effect.
dd curve is downward sloping but flatter)
• If income effect is negative and more power full the substitution
effect (giffen goods) ( ddd.curve is backward bending)

39. Applications and Uses of Indifference Curves (explained with diagram)
• Effect of Subsidies to Consumers: Price Subsidy Vs. Cash Subsidy:
• Price Subsidy : Let us take the case of food subsidy which is given by
the Government to help the needy families.

40. The cash money equivalent of the price subsidy to the
individual is less than the cost of the subsidy to the
Government. “In fact, it would always be so whatever
the subsidy and whatever the preferences of
consumers so long as only the indifference curves
remain convex and smooth. Thus the cost of giving
subsidies to consumers is always greater than the
money equivalent of the subjective gain to the
consumers”.

41. Lump-Sum Cash Subsidy: if instead of providing price
subsidy on food, the Government gives lump-sum cash grant
to the consumer equivalent to the cost of price subsidy on
food, what will be its impact on the individual’s welfare and
consumption of food by him.

42. The individual with cash transfer must be BETTER OFF and his food consumption must be less as compared with price subsidy on
food
lump-sum cash subsidy: the consumer will be better off and consume less food relative to the EQUILIBRIUM POSITION under
price subsidy on food.
lump-sum cash transfer and price subsidy on a commodity produces INCOME EFFECT making the individual better off, under cash
grant the individual is free to buy different goods according to his own TASTES AND PREFERENCES which ensures a higher level of
welfare as compared to the policy of price subsidy on food which imposes a certain pattern of consumption favouring food.
a lower price of food due to price subsidy on it induces the consumer to substitute food for other goods causing greater
consumption of food as compared to the scheme of lump-sum cash grant which have no such substitution effect and permits free
choice of goods to the individual according to his own preference.
relief payments in cash are preferable to a food subsidy because they are economically more efficient, giving the relief receipts
either a greater gain at the same cost to the Government or the same gain at a lower cost.”
Limitation: the aim of Government’s food subsidy programme may be that the needy families should consume more food so that
their health and efficiency may be improved.

43. Direct Tax versus Indirect Tax:
• An important application of indifference curves is to judge the welfare
effects of direct and indirect taxes on the individuals.
• if the Government wants to raise a given amount of revenue whether it will
be better to do so by levying a direct tax or an indirect tax from the view
point of welfare of the individuals.
• indirect tax such as excise duty income causes excess burden on the
individuals, that is, indirect tax reduces welfare more than the direct tax,
say income tax when an equal amount of revenue is raised through them

44. why an indirect tax (an excise duty or a sales tax on a commodity) causes excess burden on
the consumer in terms of loss of welfare or satisfaction. ?
The basic reason for this is that whereas both the lump-sum tax (or any other general income
tax) and an indirect tax reduce consumer’s income and produce income effect, the indirect tax
in addition to the income effect, also raises the relative price of the good on which it is levied
and therefore causes substitution effect.
The imposition of a lump-sum tax (or any income tax) does not affect the prices of goods
because it is not levied on any saleable goods. Since lump-sum tax or any income tax does not
alter the relative prices of goods it will not result in any substitution effect.
With the imposition of a lump-sum tax (or any other income tax), a certain income is taken
away from the consumer and he is pushed to the lower indifference curve (or a lower level of
welfare) but he is free to spend the income he is left with as he likes without forcing him to
substitute one commodity for another due to any change in relative price.
an indirect tax not only reduces the purchasing power or real income of the consumer causing
income effect, but also produces price-induced substitution effect and thus forcing him to
purchase less of the commodity on which indirect tax has been levied and buy more of the
non-taxed commodity. Due to price-distortion by the indirect tax further reduces his welfare.

45. • END