The document discusses theories of consumer choice, including the cardinal and ordinal approaches. It provides details on: - The cardinal approach, also known as the law of diminishing marginal utility, which assumes utility can be measured and that marginal utility decreases with increasing consumption. - Indifference curves and marginal rate of substitution, which are tools of the ordinal approach that does not measure utility directly but rather analyzes consumer preferences. - Assumptions of both approaches, such as consumers rationally substituting goods to maximize satisfaction and preferences being consistent. - Concepts like consumer surplus, which is the difference between what a consumer would be willing and able to pay for a good or service.

1. Theory Of
Consumer Choice

2. Content
• Meaning: Consumer behaviour
• Approaches to the Study of Consumer Behaviour
• Cardinal approach – Law of Diminishing Marginal Utility
• Ordinal Utility Analysis Accordingly
• Law of Diminishing Marginal Utility
• Assumptions:
• Exceptions or Limitations
• Importance

3. Consumer Behaviour
Consumer behaviour is the study of how individual customers, groups or
organizations select, buy, use, and dispose ideas, goods, and services to
satisfy their needs and wants.
• It refers to the actions of the consumers in the marketplace and the
underlying motives for those actions.

4. Approaches to the Study of Consumer
Behaviour:
The theory of consumer’s behaviour seeks to explain the determination of
consumer’s equilibrium
Consumer’s equilibrium refers to a situation when a consumer gets maximum
satisfaction out of his given resources.
A consumer spends his money income on different goods and services in such a
manner as to derive maximum satisfaction

5. Economic theory has approached the problem of determination of
consumer’s equilibrium in two different ways:
(1)Cardinal Utility Analysis
(2) Ordinal Utility Analysis Accordingly,

6. Cardinal approach–Law of
Diminishing Marginal Utility
 Meaning of Utility
 Utility Measurement
 Utility Analysis or Cardinal Approach
 Law of Diminishing Marginal Utility

7. Cardinal Utility Analysis:-
Meaning of Utility:
Utility is defined as the want satisfying power of a commodity.
Definition : - According to Hibdon, “Utility is the quality of a good to satisfy a want.” Law of
Diminishing.
 Utility Measurement :
According to this approach, utility can be measured in cardinal numbers, like 1,2,3,4 etc.
Fisher has used the term ‘Utile’ as a measure of utility.
Thus in terms of cardinal approach it can be said that one gets from a cup of tea 5
utile, from a cup of coffee 10 utile

8. Utility Analysis or Cardinal Approach:
• Utility Analysis or Cardinal Approach:
• The Cardinal Approach to the theory of consumer behaviour is based upon the
concept of utility.
• It assumes that utility is capable of measurement.
The utility or satisfaction obtained from the consumption of goods and
services can be measured by an imaginary unit called “Utils”.

9. Law of Diminishing Marginal Utility
• Introduction :- It basically falls in the category of Microeconomics, but it is of
equal and significant importance in our day-to-day decisions.
• The law of diminishing marginal utility holds that as we consume more
of an item, the amount of satisfaction produced by each additional unit of that
good declines

10. Explanation for the Law of Diminishing
Marginal Utility (Marshall’s theory)
• Assume that a consumer consumes 6 apples one after another
• The first apple gives him 20 utils (units for measuring utility).
• When he consumes the second and third apple, the marginal utility of each
additional apple will be lesser
• This is because with an increase in the consumption of apples, his desire to
consume more apples falls.

11. We can explain this more clearly with the help of a schedule and
diagram.
In the above table, the (1) total utility obtained from the first apple is 20 utile, which keep on increasing (total utility)
until we reach our saturation point at 5th apple.
On the other hand, (2)marginal utility keeps on diminishing with every additional apple consumed. When we
consumed the 6th apple, we have gone over the limit. Hence, the marginal utility is negative and the total utility falls.

12. Law of Diminishing Marginal Utility:
• Saturation Point:
• The point where the desire to
consume the same product
anymore becomes zero.
• Dis-utility:
• If you still consume the product
after the saturation point, the total
utility starts to fall. This is known
as disutility.

13. 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 of 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 no change in fashion. For example, if there is a fashion of lifted shirts, then the consumer
may have no utility in open shirts.

14. 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.

15. Importance of the Law of Diminishing Marginal Utility:
The importance or the role of the law of diminishing marginal utility is as follows:
 By purchasing more of a commodity the marginal utility decreases. Due to this behaviour, the
consumer reduce his expenditures to that commodity.
 In the field of public finance, this law has a practical application, imposing a heavier burden on the
rich people.
 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.
 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

16. Consumer Surplus
• . Regarding this Prof. Marshall has said that
“The excess of price which he (consumer) would be willing to pay rather than
go without. The thing over that which he actually does pay, is the economic measure of
this surplus satisfaction. It may be called “Consumer’s Surplus”.
Definition:-
• According to Penson – “The difference between what we would pay and what we
have to pay is called Consumer’s Surplus.”

17. Consumer surplus,
also called social surplus and consumer's surplus,
in economics, the difference between the price a consumer
pays for an item and the price he would be willing to pay
rather than do without it.
Example : -
For example, let's say that you bought an airline ticket for a flight to
Disney World during school vacation week for $100, but you were
expecting and willing to pay $300 for one ticket.
The $200 represents your consumer surplus.

18. Importance of Consumer’s Surplus:
 Theoretical importance: The idea of consumer’s surplus reveals the benefits which we derive from our purchase of
the commodity in the market.
 For example, a consumer would be willing to pay ₹10 for a match box rather than go without it but he actually
pay Re one only on the purchase of a match box. Consumer’s surplus on the purchase of match box thus is ₹ 9.0.
 Practical importance: A monopolist can charge higher price for his product if the consumers are enjoying large
consumers surplus on the use of his product.
 The inhabitants of a country derive consumer's surplus when they import commodities from abroad. They are
usually prepared to pay more for than what they actually pay.
 A finance minister imposes taxes of the commodities yielding consumer's surplus.
 6. An entrepreneur before investing capital in a project evaluates the consumer's surplus to be derived from it. If
the benefits to the obtained are greater than the costs, the investment is undertaken.

20. Ordinal Utility Approach:
• 1. Ordinal theory is also known as neo-classical theory of consumer
equilibrium , Hicksian theory of consumer behaviour, indifference
curve theory, optimal choice theory.
• The concept of ordinal utility states that ”the level of satisfaction a
consumer obtains after consuming various commodities cannot be
measured in numbers but can be arranged in the order of
preference.

21. 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.

22. Assumptions:
A consumer substitutes commodities rationally in order to maximize his level of
satisfaction.
A consumer can rank his preferences according to the satisfaction of each basket of
goods.
The consumer is consistent in his choices.
It is assumed that each of the good is divisible.
It is assumed that the consumer has full knowledge of prices in the market.
The consumer's scale of preferences is so complete that consumer is indifferent between
them.
Two commodities are used by the consumer. It is also known as two commodities model.
Two commodities X and Y are substitutes of each other. These commodities can be easily
substituted in various pairs.

23. Theory of Indifference Curve Analysis
• Definition and Explanation:
• The indifference curve indicates the various combinations of two goods
which yield equal satisfaction to the consumer.
• By definition: "An indifference curve shows all the various combinations of
two goods that give an equal amount of satisfaction to a consumer".

24. Assumptions: The indifference curve analysis is based on four main assumptions
I. Rational behaviour of the consumer ; (a decision-making process that is based on making choices that
result in the optimal level of benefit or utility for an individual) rational in making decisions from their
expenditures on consumer goods.
II. Utility is ordinal: Utility cannot be measured cardinally. It can be, however, expressed ordinally.
III. Diminishing marginal rate of substitution:
IV. Consistency in choice :- For insistence, if the consumer prefers combinations of A of good to the combinations
B of goods, he then remains consistent in his choice. His preference, during another period of time does not
change. Symbolically, it can be expressed as:
If A > B, then B > A
V. Consumer’s preference not self-contradictory : (If A > B and B > C, then A > C)
VI. Goods consumed are substitutable

25. Here is an example to understand the indifference curve better.
Peter has 1 unit of food and 12 units of clothing. Now, we ask Peter how many units of clothing is he
willing to give up in exchange for an additional unit of food so that his level of satisfaction remains
unchanged.
Peter agrees to give up 6 units of clothing for an additional unit of food. Hence, we have two combinations
of food and clothing giving equal satisfaction to Peter as follows:
1 unit of food and 12 units of clothing Graphical Representation
2 units of food and 6 units of clothing
By asking him similar questions,
we get various combinations as follows:
Combination Food Clothing
A 1 12
B 2 6
C 3 4
D 4 3

26. Indifference curve analysis
• It is a curve that represents all the combinations of goods that give the same
satisfaction to the consumer. Since all the combinations give the same amount of
satisfaction, the consumer prefers them equally. Hence the name Indifference Curve.
1. Indifference curve slope downwards to right
Thus, Indifference curve is always convex (neither concave nor straight)
1. Indifference curve cannot intersect each other
2. Higher indifference curve represents higher level of satisfaction

27. Property 1: Indifference curve slope
downwards to right
When a consumer wants to have more of a
commodity, he/she will have to give up some
of the other commodity, given that the consumer
remains on the same level of utility at constant
income. As a result, the indifference curve slopes
downward from left to right.

28. 1 (a). indifference curve is always convex
(neither concave nor straight).
Due to the diminishing marginal rate of substitution.
The rate gives a convex shape to the indifference
curve, always indifference curve in convex shape
neither concave nor straight

29. 2. Two Indifference curve cannot
intersect each other
Each indifference curve is a representation of particular level of
satisfaction. The level of satisfaction of consumer for any given
combination of two commodities is same for a consumer throughout
the curve. Thus, indifference curves cannot intersect each other

30. 3. Higher indifference curve represents
higher level of satisfaction
Higher the indifference curves, higher will be the
level of satisfaction. This means, any combination
of two goods on the higher curve give higher level
of satisfaction to the consumer than the
combination of goods on the lower curve.

31. Consumer Equilibrium
The theory of consumer’s behaviour seeks to explain the determination of
consumer’s equilibrium
Consumer’s equilibrium refers to a situation when a consumer gets
maximum satisfaction out of his given resources.

32. Consumer Equilibrium
When consumers make choices about the quantity of goods and services to consume, it
is presumed that their objective is to maximize total utility.
In maximizing total utility, the consumer faces a number of constraints, the most
important of which are the consumer's income and the prices of the goods and services
that the consumer wishes to consume.
The consumer's effort to maximize total utility, subject to these constraints, is referred to as
the consumer's problem.
The solution to the consumer's problem, which entails decisions about how much the
consumer will consume of a number of goods and services, is referred to as consumer
equilibrium.

33. Consumer Equilibrium Changes
Change on the consumer's
equilibrium
Income effect
of a price
change
Substitution
effect of a
price change
Price

34. Consumer Equilibrium Changes in Prices –
Price Effect
The consumer's choice of how much to consume of various goods depends on the
prices of those goods. If prices change, the consumer's equilibrium choice will also
change. If prices change, the consumer's equilibrium choice ( satisfaction and resource)
will also change.

35. The consumer's equilibrium choice is often divided into two effects-
the (1)substitution effect of a price change and the (2) income
effect of a price change.(Within Budget)
substitution effect of a price
change
• When the price of a good changes, the
price of that good relative to the price of
other goods also changes.
• Ex : Goods 1 - $3 ($2) and Goods 2 - $1
($3) and the budget =5$
• Person can purchase Goods 1 (1Q) and
goods 2(2Q)
income effect of a price
change
• Changing the real purchasing power
• Real income of the consumer
• Ex : Goods 1 - $2 or $3 and Goods 2 -
$3 or $3 and the budget =5$
• Person can purchase Goods 1 (1Q) and
goods 2(1Q)

36. The budget line
• The budget line is a graphical delineation of all possible combinations of
the two commodities that can be bought with provided income and cost
so that the price of each of these combinations is equivalent to the monetary
earnings of the customer.