2. Theory of Consumer Behaviour

In this chapter, we will study the behaviour of an individual consumer. The consumer has to decide how to spend her income on different goods. Economists call this the problem of choice. Most naturally, any consumer will want to get a combination of goods that gives her maximum satisfaction. What will be this ‘best’ combination? This depends on the likes of the consumer and what the consumer can afford to buy.

This introduction sets the stage for understanding consumer behavior in economics. It explains that consumers face a choice regarding how to allocate their limited income among various goods and services to maximize their satisfaction. The 'best' combination of goods will differ for each consumer based on their preferences and budget constraints.

Imagine going to a grocery store with a fixed amount of money. You might want to buy fruits, snacks, and drinks. Depending on what you like and how much each item costs, you'll choose a combination that gives you the most enjoyment without exceeding your budget.

The ‘likes’ of the consumer are also called ‘preferences’. And what the consumer can afford to buy depends on prices of the goods and the income of the consumer.

Preferences are the individual tastes and desires that guide consumer choices. A consumer’s income and the prices of goods determine what is affordable. This interaction between preferences and budget constraints is crucial for understanding how consumers make choices in the marketplace.

Consider two friends, Sarah and John. Sarah loves coffee, while John prefers tea. Even if they both have the same amount of money to spend at a café, Sarah will spend it on coffee, while John will choose tea, reflecting their individual preferences.

A consumer usually decides his demand for a commodity on the basis of utility (or satisfaction) that he derives from it. What is utility? Utility of a commodity is its want-satisfying capacity. The more the need of a commodity or the stronger the desire to have it, the greater is the utility derived from the commodity.

Utility is a measure of the satisfaction gained from consuming goods. It varies from person to person and can change based on circumstances such as location or time. Understanding utility helps explain consumer behavior.

Think of a pizza: one person might find immense satisfaction in a cheese pizza, while another may prefer a veggie pizza. Their differing utility derived from the same good (pizza) illustrates how subjective preferences are.

Marginal utility (MU) is the change in total utility due to consumption of one additional unit of a commodity. For example, suppose 4 bananas give us 28 units of total utility and 5 bananas give us 30 units of total utility. Clearly, consumption of the 5th banana has caused total utility to increase by 2 units.

Marginal utility is a critical concept in understanding how consumers make decisions about consumption. As consumers continue to add more units of a good, the extra satisfaction they receive from each additional unit tends to decrease, which is known as the law of diminishing marginal utility.

Consider ice cream on a hot day: the first scoop might bring a lot of joy, the second scoop still feels great, but by the third or fourth scoop, you may not enjoy it as much, indicating diminishing utility.

Cardinal utility analysis assumes that level of utility can be expressed in numbers. It measures total utility and marginal utility. In contrast, ordinal utility analysis ranks preferences without assigning numerical values.

This distinction is important in economics. Cardinal utility quantifies satisfaction, while ordinal utility focuses on the order of preferences. Consumers might not assign specific numerical values but can express that they prefer one bundle over another.

Imagine a ranking of favorite things: you might say you prefer chocolate ice cream over vanilla, but you wouldn't necessarily assign scores like 8 for chocolate and 6 for vanilla—it's simply a matter of preference.

The quantity of a commodity that a consumer is willing to buy and is able to afford is called demand for that commodity. The demand curve is a graphical representation of the relationship between the quantity demanded and the price of the commodity.

The demand curve illustrates how demand changes with price, typically showing that as the price decreases, the quantity demanded increases, demonstrating the law of demand. This relationship is fundamental for understanding market behavior.

Visualize a market for sneakers: if the price drops from $100 to$70, more people will buy them. The demand curve would slope downward, capturing this relationship visually.

The demand curve shifts due to changes in consumers' income, preferences, or prices of related goods. For instance, an increase in consumer income typically shifts the demand curve for normal goods to the right.

Shifts in the demand curve show how demand can change without a change in the price of the good itself. Understanding what causes these shifts helps in predicting consumer behavior in response to external factors.

If new health studies come out showing that eating vegetables is incredibly beneficial, more people might start buying them even if the price doesn’t change, resulting in a rightward shift in the demand curve for vegetables.

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