This document provides an overview of consumer behavior theory and key concepts including: 1) Marginal utility analysis and the law of diminishing marginal utility which states that additional utility from consumption declines as more is consumed. 2) Indifference curve analysis which uses indifference curves to model equal levels of satisfaction from different consumption bundles. 3) The budget line and budget set which represent the consumer's purchasing constraints given prices and income. 4) Consumer equilibrium which occurs where the budget line is tangent to the highest indifference curve, maximizing satisfaction within constraints.

1. Theory of consumer
behavior

2. Muhammad Shahzaib khan
harris bin shahid
Arslan malik
Muhammad sammad
saqib azad
najam ul saqib
BBA 6th A
MANAGERIAL ECONOMICS

3. Contents:
 Introduction
 Marginal Utility Analysis, Law of marginal
 utility graphical representation
 Ordinal Utility and Cardinal Utility Approach
 Concept of Consumer Behavior – Budget Line
 and Budget Set
 Indifference Curve Analysis:- Meaning, Map
 and Properties
 Consumer's Equilibrium Marginal rate of
 substitution

4. introduction
The purpose of the theory of demand is to determine the various
factors that affect demand.
Determinants:
1. The price of the commodity
2. Other prices
3. Income
4. Tastes
5. Income distribution
6. Total population
7. Wealth
8. Government policy

5. Introduction:
the traditional theory of demand emphasis on consumer’s
demand for durable and non-durable goods.
It does not deal with investment goods.
It is only a fraction of the total demand in the economy as a
whole.
The market demand is assumed to be the summation of the
demands of individual consumers.
If a consumer gets more utilities from a commodity, he would
be willing to pay a higher price and vice-versa

6. Definitions:
utility: Utility is wants satisfying power of a commodity which varies from person
to person. The concept of utility is ethically neutral as harmful and useful things
are both considered. The value-in-use of a commodity is the satisfaction which
we get from the consumption of a commodity.
Marginal utility: The additional utility derived from additional unit of a
commodity. It refers to net addition made to the total utility by the consumption
of an extra unit of a commodity.
Total utility: The sum of utility derived from the different units of a commodity
consumed by a consumer. The amount of utility derived from consumption of all
units of a commodity which are at the disposal of the consumer

7. Marginal Utility Analysis:
 This theory is formulated by Alfred Marshall, a British Economist, seeks to
explain how a consumer spends his income on different goods and services so
as to attain maximum satisfaction.
Assumptions of utility analysis:
1. Utility is based on the cardinal concept.
2. Utility is measurable and additive of goods.
3. The marginal utility of money is assumed to be constant
4. The hypothesis of independent utility

8. Marginal Utility Analysis:
5. The consumer is rational.
6. He has full knowledge of the availability of commodities and
their technical qualities.
7. Possesses perfect knowledge of the choice of commodities.
8. There are no substitutes.
9. Utilities are not influenced by variations in their prices.
10. The theory ignores complementary between good

9. Law of diminishing marginal utility:
 The law of marginal utility is based on the human wants. The law was first
developed by German Economist H.H Gossen which is known as “Gossen’s First
law”. Later it was popularized by Prof. Alfred Marshal
 “The additional benefit which a person derives from a given increase of his
stock of a thing diminishes with every increase in the stock that he already
has”. - Alfred Marshall

10. Law of diminishing marginal utility
Assumptions:
1. Tastes, preferences, etc. of the customer remain constant.
2. Income of the consumer also remain constant
3. Units of the goods are identical or similar
4. The process of consumption is continuous.
5. Units of the goods are not very small in size
Importance:
1. Framing taxation policy by the government.
2. Useful to consumer to regulate his expenditure.
3. Useful to monopolist producer in fixing the prices of his products.
4. Basis for law of demand.
5. Differentiate value-in-use and value-in-exchange

11. Law of diminishing marginal utility
Explanation of the law
•Suppose a person consumes the first apple, he derives the
highest level of utility and the intensity of his desire declines.
•If he consumes the second apple, he will get lesser satisfaction
than first apple.
•The utility that he gets from the third apple will be still less.
•If he continues to consume more and more apples, utility from
each apple goes on diminishing as the intensity of his desire goes
on diminishing.
Thus, the law of diminishing marginal utility simply tells us that
we obtain less and less marginal utility from the successive units
of a commodity as we consume more and more of it

13. Explanation to the graph:
 The Total Utility (TU) declines in positive rate but the Marginal Utility (MU)
declines in a negative rate.
 Total utility rises by smaller amounts.
 The negative slope of the marginal utility curve reflects the law of
diminishing marginal utility.
 Saturation point is when the total utility is unchanged. Marginal utility
declines from larger to smaller units

14. Limitations:
1. Different units consumed must be identical and the habit, taste, income and
treatment of the consumer also remain unchanged
.2. Different units consumed should be standard units.
3. Continuous consumption. I.e. no gap between two consumption of one unit
and another unit.
4. Law does not apply to articles like gold, cash, money, music, hobbies,
5. The shape of the utility curve may be affected by the presence or absence of
articles which are substitutes to it.

15. Conclusion:
Utility reflects the tastes of a particular individual, uniqueness to the
individual and reflects his or her own particular subjective preferences
and perceptions. Utility remain unchanged so long as the individual’s
tastes remain the same

16. Ordinal and cardinal approach:
In order to attain this objective the consumer must be able to compare the
utility of the various commodities which can buy with his income. There are two
basic approaches to the problem of comparison of utilities
Ordinal approach: The ordinalist school postulated that utility is not
measurement, but is an ordinal magnitude. The consumer need not know in
specific units the utility of various commodities to make his choice. It is needed
for him to rank the various commodities. He must be able to determine his order
of preference among the different bundles of goods. The main ordinal theories
are the indifference-curves approach and the revealed preference hypothesis

17. Cardinal approach:
 2. The cardinal approach The cardinalist school postulated that utility can be
measured. Various suggestions have been made for the measurement of
utility. Under certainty of full knowledge about the market conditions and
income levels, some economists have suggested that utility can be measured
by monetary units; utility, by the amount of money the consumer is willing to
sacrifice for another unit of a commodity

20. concept of consumer behavior:
• Consumer behavior is the study of how individual customers ,groups or
organizations; select, buy, use, and dispose ideas, goods, and services to satisfy
their needs and want
It refers to the actions of the consumers in the market place and the underlying
motives for those actions. "Consumer behavior is the decision process and
physical activity, which individuals engage in when evaluating, acquiring, using or
disposing of goods and
services". - Louden and Bit

21. Nature of Consumer Behavior:
1. Influenced by various factors:
Factors which influence consumer behavior
Marketing factors such as product design, price, promotion, packaging,
positioning and distribution.
Personal factors such as age, gender, education and income level.
Psychological factors such as buying motives, perception of the product and
attitudes towards the product.
Situational factors such as physical surroundings at the time of purchase, social
surroundings and time factor.
Social factors such as social status, reference groups and family.
Cultural factors, such as religion, class,

22.  Nature of Consumer Behavior
2. Consumer behavior is not static
3. Varies from consumer to consumer
4. Varies from region to region and country to county
5. Information on consumer behavior is important to
the marketers:
Factors for marketing decisions:
a) Product design/model
b) Pricing of the product
c) Promotion of the product
d) Packaging
e) Positioning
f) Place of distribution Part

23. Nature of consumer behavior:
6.Leads to purchase decision
7. Varies from product to product
8. Improves standard of living
9. Reflects status of a customer

24. Budget line:
 A higher indifference curve shows a higher level of
 satisfaction than a lower one.• A consumer in his attempt to maximize
satisfaction will try to
 reach the higher possible indifference curve• In pursuit of buying more and
more goods, he will obtain more
 and more satisfaction .It includes two constraints:1. He has to pay the prices
for the goods 2. He has a limited money income with which to purchase the
good

25. Budget line:
 A budget line shows all those combinations of two goods.
 The consumer can buy spending his given money income at their given prices.
 All those combinations which are within the reach of the consumer will lie on
the budget line. Consumer Budget states the real income or purchasing power
of the consumer from which he can purchase certain quantitative bundles of
two goods at given price

26. Indifference Curve Analysis:
A very popular, easier and scientific method of explaining
consumer’s demand is the indifference curve analysis.
• This approach to consumer behavior is based on consumer preferences.
• Human satisfaction is psychological phenomenon which cannot be measured in
terms of monetary terms.
• This approach is more realistic to order preferences.
• Consumer preference approach is therefore an ordinal concept based on
ordering of preferences compared with Marshall’s approach of cardinality

27. Indifference curve analysis:
 Indifference curve
An indifference curve is the locus of points- particular combinations or bundles of
goods- which yield the same utility(level of satisfaction) to the consumer, so that
he is indifferent as to the particular combination he consumes. In other words,
an indifference curve is a graph showing combination of two goods that give the
consumer equal satisfaction and utility. Each point on an indifference curve
indicates that a consumer is indifferent between the two and al points give him
the same utility. U = F(X, Y) = K

31. Indifference map:
 Map shows all the indifference curves which rank the preferences of the
consumer. Combinations of goods situated on an indifference curve yield
 higher level of satisfaction and are preferred. Combinations on the lower
indifference curve yield a lower utility

32. Marginal Rate of Substitutie:
 MRS is the rate at which the consumer is prepared to exchange goods X and Y.
Under the standard assumption of Neo-classical Economics, the goods and
services are: Continuously divisible
 The marginal rates of substitution will be the same regardless of direction of
exchange
• It will correspond to the slope of an indifference passing through the
consumption bundle

33. Marginal Rate of Substitution:
Explanation of law
•A person consumes1 unit of food and 12 units of clothing.
• Then, he gives up 6 units of clothing to get an extra unit of food, his level of
satisfaction remaining the same. The MRS is 6.
• Hence, He moves from B to C and from C to D in his indifference schedule, the
MRS is 2 and 1 respectively.
• MRS of X for Y as the amount of Y whose loss can just be compensated by a unit
gain of X, the level of satisfaction remains the same.
• As the consumer have more and more units of food; he is prepared to give up
less and less units of cloths. Thus MRS is diminishing

34. Optimal choice of the consumer/
Consumer’s equilibrium:
After attaining the stage of indifference curve and budget constraint, consumer has to
reach equilibrium position.
A consumer derives maximum possible satisfaction from the goods at equilibrium
position.
A consumer cannot rearrange his purchase of goods at that level.
Assumptions:
1. The consumer has given indifference map which shows his
scale of preferences for various combinations of two goods X and Y.
2. He has a fixed money income which he has to spend wholly on
goods X and Y.
3. The prices of goods X and Y are given fixed for him.

35. Consumer’s equilibrium
According to the graph:
• IC1, IC2, IC3, IC4, IC5 are the indifference curves
• PL is the budget line for goods X and Y.
• Combinations R, S, Q, T, H cost the same
The customer’s aim is to reach highest indifference curve which maximises his
satisfaction.R or H lies on a lower
indifference curve IC1, S or T lies on a lower indifference curve IC2,Whereas IC4
and IC5 are beyond the consumer’s money income

36. Consumer’s equilibrium:

37. Consumer’s equilibrium:
Conclusion:
• Thus the consumer will be at equilibrium at point Q on IC3.
• The consumer will buy OM of X and ON of Y.
•Since there is a budget constraint, he will be forced to remain on the given
budget line.
• He will have to choose only combinations which lie on
the given price line.