This document provides an overview of consumer behavior theory and the concept of utility. It discusses that consumers spend money on goods that provide the most utility or satisfaction based on their preferences. The theory aims to characterize the optimal consumption bundle for a consumer given their preferences and budget constraints. It also distinguishes between cardinal utility, where utility numbers represent satisfaction levels, and ordinal utility, where numbers simply represent preference rankings but do not indicate differences in satisfaction. The modern theory is based on ordinal utility as developed by Pareto.

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THEORY OF CONSUMER BEHAVIOUR
Consumers spend their money on the products that give them the most pleasure. If
someone likes music and does not like a sweet candy, she spends a lot of money on concerts,
ipods, and CDs and relatively little on candy. By contrast, her chocoholic friend may spend a lot
on Cadbury and very little on music.
The theory of consumer behaviour relates to the behaviour of the individual economic
agents or decision-takers, who are usually classified as consumers. A consumer is regarded as an
individual who may own initially certain stocks of commodities, his ‘initial endowment’, and who
has to choose an amount of each commodity he wishes to consume. For sake of simplicity, we
assume that his initial endowment takes the form of ‘income’, and then analyse simply his
consumption decision.
The theory of the consumer behaviour is basically a theory of optimization: given the
feasible set of consumption bundles open to the consumer, he chooses the one he prefers. The
purpose of the theory is to characterize the bundle of goods which will be chosen, and second to
predict how the optimal choice will change in response to changes in the feasible set.
In analysing the consumer’s optimal choice, we proceed in three steps:
Step 1: We construct a model of the consumer’s preferences. (Utility Function and
Indifference Curve)
Step 2 : We examine how the prices of the commodities in conjunction with the
consumer’s income together determine his feasible set of consumption
bundles. (Budget Line)
Step 3: Finally, by applying the model of the consumer’s preference ordering to the
feasible set, we are able to determine the characteristics of the optimal choice.
(Consumer Equilibrium).

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Cardinal and Ordinal Utility
There are two types of utility measurements: cardinal and ordinal.
Utility is said to be measurable in the cardinal sense if not only the utility numbers
assigned to bundles but also their differences are meaningful. For example, say that a person
presently has a chocolate bar to which his utility function assigns the number 10 and someone
offers him a compact disk to which his utility function assigns the number 30. These numbers
imply that a compact disk is three times as good as a chocolate bar to the person because the
disk has been given a utility number that is three times as large as the number given to the
chocolate. Hence his utility is said to be cardinal in a strong sense.
Economists who believed in cardinal utility can be divided into two groups: Those who
believed in (1) cardinal and additive utility and
(2) cardinal but not additive utility.
Nineteenth-century economists such as Jevons, Walras, and Marshall (1842-1924)
belonged to the first group. They considered utility to be not only measurable but also additive,
that is, if an orange gives 5 utils of utility and an apple gives 6 utils of utility then the utility of
both an orange and an apple is 5 +6 = 11 utils.
Economists such as Edgeworth (1845-1926) and Irving Fisher (1867-1947) belonged to the
second group. They argued that utility is measurable but not additive, that it depends
simultaneously on all the amounts of the different goods consumed. In the above example, the
utility of both an apple and an orange could be less than 11 utils. This approach assumes some.
amount of interdependence in the satisfaction derived from each good. The marginal utility a
consumer derives from another ounce of butter normally depends on the consumer's current
rate of consumption of other commodities such as margarine or bread. With additive utility, the
marginal utility of any commodity is independent of the amounts consumed of other
commodities. Clearly, the assumption that utility is additive is not a reasonable assumption to
make given the interdependencies that exist in the consumption of several goods.

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In mathematical terms, we say that utility is a function of the quantity consumed of all the
commodities. If there are two commodities, we write this function as
U = U (x , y)
where U = utility, and x and y are the quantities consumed of the two goods.
With additive utility, we can write
U = U (x , y) = U1(x) +U2 (y)
where U1(x) is the utility derived from the consumption of good X alone, and U2 (y) is the utility
derived from the consumption of the good Y alone.
If the commodities are substitutes in consumption U (x , y) will be less than U1 (x) plus
U2 (y). Examples are butter and margarine, apples and oranges. If the commodities are
complements, so that when used together, the consumer derives more satisfaction than when
used separately, then U (x , y) will be greater than U1 (x) plus U2 (y). An example is tomato sauce
and French fries.
Utility is measurable in the ordinal sense if the utility numbers we assign to objects have
no meaning other than to represent the ranking of these goods in terms of a person's
preferences. For example, say that you like a Honda more than a Kawasaki. If you had an ordinal
utility function representing your preference between these two objects, it would have to assign
the Honda a larger number. With ordinal utility functions, however, the nature of the number is
not important as long as it is larger. Hence, a perfectly legitimate ordinal utility function might
assign the Honda a number of 90 and the Kawasaki a number of 89, or it might assign the Honda
a number of 1,000,000 and the Kawasaki a number of 1. In both cases, the ordinal utility functions
would represent the fact that the person value the Honda more highly than the Kawasaki. The
actual utility numbers assigned are unimportant as long as they preserve the ranking of the
objects.
The Italian economist, Wilfredo Pareto (1848-1923), laid the foundations for the
modern theory of consumer behavior by removing the measurability associated with the cardinal
theory of utility. It is assumed that the consumer need not be able to assign numbers that
represent utility, but can rank commodities in order of preference.