Theory of Consumer Behaviour
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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. The study of Consumer Behaviour assumes that the consumers are actors in the marketplace.
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Theory of Consumer Behaviour
- 1. By Harshitha.S and Imran Pasha
- 2. 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 PartPart 1 Part Part 3 Part Part Part Part 2 Part 3 Part 4 Part 5 Part 6
- 3. Introduction Part 1 Part 2 Part 3 Part 4 Part 5 The purpose of the theory of demand is to determine the various factors that affect demand. Part 6 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
- 4. Introduction Part 1 Part 2 Part 3 Part 4 Part 5 • 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. Part 6
- 5. Definitions: Part 1 Part 2 Part 3 Part 4 Part 5 1. 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. Part 6 2. 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. 3. Total utility: The sum of utility derived from the different units of a commodity consumed by a consumer. The amount of utility derived from the consumption of all units of a commodity which are at the disposal of the consumer.
- 6. Marginal Utility Analysis Part 1 Part 3 Part 4 Part 5 Part 6 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. Part 2
- 7. Marginal Utility Analysis Part 3 Part 4 Part 5 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. 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 goods.Part 6 Part 1 Part 2
- 8. Law of diminishing marginal utility Part 3 Part 4 Part 5 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 Marshall. Part 6 “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 Part 1 Part 2
- 9. Law of diminishing marginal utility Part 3 Part 4 Part 5 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.Part 6 Part 1 Part 2
- 10. Law of diminishing marginal utility Part 3 Part 4 Part 5 Part 6 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 Part 1 Part 2
- 11. Graphical representation Part 3 Part 4 Part 5 Part 6 Units of apple consumed Total utility Margin al utility 1 8 8 2 13 5 3 16 3 4 18 2 5 18 0 6 15 -3 8 13 16 18 18 15 8 5 3 2 0 -3 -5 0 5 10 15 20 1 2 3 4 5 6 DiminishingMarginal Utility Units of apple consumed Utility TU MU Part 1 Part 2
- 12. Explanation to the graph Part 3 Part 4 Part 5 •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. Part 6 Part 1 Part 2
- 13. Limitations Part 3 Part 4 Part 5 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. Part 6 Part 1 Part 2
- 14. Conclusion Part 3 Part 4 Part 5 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. Part 6 Part 1 Part 2
- 15. Ordinal and cardinal approach Part 3 Part 2 Part 1 Part 4 Part 5 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: 1. Cardinal approach 2. Ordinal approach Part 6
- 16. Ordinal and cardinal approach Part 2 Part 4 Part 5 1. 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. Part 6 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. Part 3 Part 1
- 17. Ordinal and cardinal approach Part 2 Part 4 Part 5 2. The cardinal approach The cardinalist school postulated that utility can be measured. Various suggestions have been made for the measurement of utility. Part 6 Under certainty of full knowledge about the market conditions and income levels, some economists have suggested that utility can be measured by monetary units; utils, by the amount of money the consumer is willing to sacrifice for another unit of a commodity. Part 3 Part 1
- 18. Ordinal and cardinal approach Part 2 Part 4 Part 5 Part 6 Ordinal Utility Cardinal Utility Consumption can’t be measured Consumption can be measured Utility is used for grading/ranking of the products depending on the preferences of the consumer Uses utils which help in understanding how much utility is derived from consumption of a product. Much less compared Comparative study Conceptual and practical Preceded the ordinal approach Convex function Concave function Qualitative measure Quantitative measure Part 3 Part 1
- 19. Conclusion Part 2 Part 4 Part 5 Part 6 Satisfaction from the consumption of a combination of goods and services Satisfaction through consumption of one good at a time. Comparisons can be made of the utility derived from two products, but the utility cannot be computed quantitatively. Focuses on the independent utility derived from a product The ordinal approach will give a sense of preferences, likes and dislikes but there is no numerical measurement and this approach is used in grading the preferences of the consumer depending upon the alternatives that are available to him/her. Though this approach brings out the preference of one product over other through utils but this does not imply any conclusion or relation between the choices Part 3 Part 1
- 20. Concept of consumer behaviour: Part 4 Part 2 Part 3 Part 1 Part 5 • 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. Part 6 "Consumer behaviour is the decision process and physical activity, which individuals engage in when evaluating, acquiring, using or disposing of goods and services". - Louden and Bitta
- 21. Nature of Consumer Behaviour Part 2 Part 3 Part 5 1. Influenced by various factors: Factors which influence consumer behaviour: 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, caste & sub-castes.Part 6 Part 4 Part 1
- 22. Nature of Consumer Behaviour Part 2 Part 3 Part 5 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 6 Part 4 Part 1
- 23. Nature of Consumer Behaviour Part 2 Part 3 Part 5 6. Leads to purchase decision 7. Varies from product to product 8. Improves standard of living 9. Reflects status of a customer Part 6 Part 4 Part 1
- 24. Budget line: Part 2 Part 3 Part 5 Part 6 •A higher indifference curve shows a higher level of satisfaction than a lower one. • A consumer in his attempt to maximise 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 goods. Part 4 Part 1
- 25. Budget line Part 2 Part 3 Part 5 Part 6 • 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. 20 16 12 8 4 0 4 8 12 16 20 24 28 32 36 40 ----------Books-------- -------------Movies--------- 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. Part 4 Part 1
- 26. Key points for Budget line Part 2 Part 3 Part 5 1. A Budget line separates what is affordable from what is not affordable 2. Budget line slopes downwards as more of one good can be bought by decreasing some units of the other good. 3. Bundles which cost exactly equal to consumer’s money income lie on the budget line. 4. Bundles which cost less than consumer’s money income shows under spending. They lie inside the budget line. 5. Bundles which cost more than consumer’s money income are not available to the consumer. They lie outside the budget line. Part 6 Part 4 Part 1
- 27. Budget set Part 2 Part 3 Part 5 A budget set or opportunity set includes all possible consumption bundles that someone can afford with given the prices of goods and the person's income level. The budget set is bounded above by the budget line. Part 6 According to the graph •Good X and good Y are the two commodities. •PQ is the budget constraint or budget line. •The possible consumption bundles of X and Y are represented as A, B, C, D, E, F are within or on the budget constraint. •If the combination of goods are above the budget constraint, it is not taken into consideration. GoodY Good X 0 F C B E A D Budget set X Y Budget line P Q Part 4 Part 1
- 28. Indifference Curve Analysis Part 2 Part 3 Part 4 • A very popular, easier and scientific method of explaining consumer’s demand is the indifference curve analysis. • This approach to consumer behaviour 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.Part 6 Part 5 Part 1
- 29. Indifference Curve Analysis Part 2 Part 3 Part 4 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 all points give him the same utility. U = F(X, Y) = K Part 6 Part 5 Part 1
- 30. Indifference Curve Analysis Part 2 Part 3 Part 4 Assumptions of an indifference curve: 1. Rational consumers. 2. Two commodities 3. Utility is ordinal 4. Diminishing marginal rate of substitution 5. Total utility of the consumer depends on the quantities of the commodities consumed. 6. Consistency and transitivity of choicePart 6 Properties of an indifference curve: 1. Negative downward slope 2. Further away from the origin an indifference curve lies.(Higher Indifference curves represent higher levels of satisfaction) 3. Indifference curve does not intersect 4. Convex to the origin. Part 5 Part 1
- 31. Indifference Curve Analysis Part 2 Part 3 Part 4 Part 6 Quantity of Good A 0 X Y QuantityofGoodA U3 U2 U1 ( , ) The equation of indifference curve is: ( , ) where is a constant. The total differential of utility function is: ( ) ( ) U f x y U f x y k k U U dU dy dx MUy dy MUx dx y x Part 5 Part 1
- 32. Indifference Curve Analysis Part 2 Part 3 Part 4 Part 6 0 X Y All combinations of X and Y below the curve are inferior to those combinations on or above the curve A level of Utility is associated with each Indifference Curve. All combinations of X and Y above the curve are preferable to combinations along ow belove the curve The individial is Indifferent between all combinations of X and Y along the curve A Part 5 Part 1
- 33. Indifference Curve Analysis Part 2 Part 3 Part 4 Part 6 Combi- nation Food Clothing MRS A 1 12 0 B 2 6 6 C 3 4 2 D 4 3 1 Utility obtained from point A,B,C,D are same Convex to the origin 0 X Y Clothing 12 10 8 6 4 2 1 2 3 4 5 6 A B C D IC Food Part 5 Part 1
- 34. Indifference map Part 2 Part 3 Part 4 Part 6 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. Part 5 Part 1
- 35. Marginal Rate of Substitution Part 2 Part 3 Part 4 Part 6 MRS is the rate at which the consumer is prepared to exchange goods X and Y. Under the standard assumption of 0 X Y Clothing 12 10 8 6 4 2 1 2 3 4 5 Food D A B C -6 -2 -1 1 1 1 MRS=6 MRS=1 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. Part 5 Part 1
- 36. Marginal Rate of Substitution Part 2 Part 3 Part 4 Part 6 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. Part 5 Part 1
- 37. Optimal choice of the consumer/ Consumer’s equilibrium Part 2 Part 3 Part 4 Part 5 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.Part 6 Part 1
- 38. Part 2 Part 3 Part 4 Part 5 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. 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. IC5 IC4 IC3 IC2 IC1 X Y R S Q T H P L N M0 Consumer’s equilibrium Part 6 Part 1
- 39. Consumer’s equilibrium Part 2 Part 3 Part 4 Part 5 Utility maximisation rule: if buy more of ' ' if buy more of ' ' MUx MUy Px Py MUx MUy x Px Py MUx MUy y Px Py Part 6 Part 1 “Consumer will decide Q as the best choice which lies on the budget line and also puts him on highest possible indifference curve IC3”.
- 40. Consumer’s equilibrium Part 2 Part 3 Part 4 Part 5 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. Part 6 Part 1