Class 12 Economics Notes Chapter 2 (Theory of consumer behaviour) – Introduction MicroEconomics Book
Alright class, let's delve into Chapter 2: Theory of Consumer Behaviour from your Microeconomics textbook. This is a foundational chapter, crucial for understanding how individuals make choices and how markets function. Pay close attention, as these concepts frequently appear in various government examinations.
Chapter 2: Theory of Consumer Behaviour - Detailed Notes
1. Introduction
- Consumer: An economic agent (individual, household) who consumes goods and services to satisfy their wants.
- Consumer Behaviour: The study of how consumers allocate their limited income among various goods and services to maximize their satisfaction.
- Basic Problem: Wants are unlimited, but resources (income) are limited. This scarcity forces consumers to make choices.
2. Utility
- Utility: The want-satisfying power of a commodity. It's a subjective concept, varying from person to person, place to place, and time to time.
- Measurement of Utility:
- Cardinal Utility Analysis (Given by Alfred Marshall): Assumes utility can be measured in cardinal numbers (like 1, 2, 3) using a hypothetical unit called 'utils'. Also assumes the marginal utility of money remains constant.
- Ordinal Utility Analysis (Given by J.R. Hicks & R.G.D. Allen): Assumes utility cannot be measured numerically but can be ranked or compared (e.g., preferring combination A over B). This uses Indifference Curve analysis.
3. Concepts under Cardinal Utility Analysis
-
Total Utility (TU): The total satisfaction derived from consuming all units of a commodity.
- TU = ΣMU (Sum of Marginal Utilities) or TU = f(Qx)
-
Marginal Utility (MU): The additional utility derived from consuming one more unit of a commodity.
- MU = ΔTU / ΔQ (Change in Total Utility / Change in Quantity)
- MUn = TUn - TUn-1 (TU from n units - TU from n-1 units)
-
Relationship between TU and MU:
- When MU decreases but is positive, TU increases at a decreasing rate.
- When MU is zero, TU is maximum (Point of Satiation).
- When MU is negative, TU starts decreasing.
-
Law of Diminishing Marginal Utility (LDMU) / Gossen's First Law:
- Statement: As a consumer consumes more and more units of a specific commodity, the marginal utility derived from each successive unit goes on diminishing, assuming other factors remain constant.
- Assumptions:
- Cardinal measurement of utility.
- Consumption is continuous.
- Units consumed are standard/homogeneous.
- Consumer is rational.
- Marginal utility of money is constant.
- Income, tastes, and prices of related goods are constant.
- Basis for the Law of Demand: Explains why the demand curve slopes downwards.
4. Consumer's Equilibrium (Cardinal Utility Approach)
- Meaning: A state of rest or maximum satisfaction, given the consumer's income and prices, where the consumer doesn't want to change their level of consumption.
- One-Commodity Case:
- Condition: MUx = Px (Marginal Utility of commodity X equals its Price).
- Alternatively, in terms of money: MUx / Px = MUM (Marginal Utility of Money).
- Explanation: If MUx > Px, the consumer gains more satisfaction than the price paid, so they buy more. If MUx < Px, the satisfaction is less than the price, so they buy less. Equilibrium is reached when the utility gained equals the utility sacrificed (price).
- Two (or More) Commodities Case (Law of Equi-Marginal Utility / Gossen's Second Law / Law of Substitution):
- Condition: MUx / Px = MUy / Py = MUM
- Explanation: The consumer allocates their income such that the marginal utility derived from the last rupee spent on each commodity is equal. If MUx/Px > MUy/Py, the consumer will shift expenditure from Y to X until equality is restored.
5. Ordinal Utility Approach (Indifference Curve Analysis)
- Assumptions:
- Rational consumer.
- Ordinal measurement of utility (ranking preferences).
- Diminishing Marginal Rate of Substitution.
- Consistency and Transitivity of choice (If A>B and B>C, then A>C).
- Monotonic Preferences: Consumer prefers a bundle with more of at least one good and no less of the other good.
- Indifference Curve (IC): A curve showing different combinations of two goods that give the consumer the same level of satisfaction.
- Properties of Indifference Curves:
- Downward Sloping: To consume more of one good, the consumer must give up some of the other good to maintain the same satisfaction level.
- Convex to the Origin: Due to the Diminishing Marginal Rate of Substitution (MRS).
- Higher IC represents Higher Satisfaction: Due to monotonic preferences.
- ICs Never Intersect: Intersection would violate the assumption of transitivity and consistent satisfaction levels.
- Indifference Map: A set or collection of indifference curves, representing different levels of satisfaction.
- Marginal Rate of Substitution (MRS): The rate at which a consumer is willing to substitute one good (Y) for another good (X) without changing the level of satisfaction.
- MRSxy = ΔY / ΔX (Amount of Y sacrificed / Amount of X gained)
- It is the slope of the Indifference Curve.
- Diminishing MRS: As the consumer gets more of good X, their willingness to give up good Y for an additional unit of X decreases. This makes the IC convex.
- Budget Line (Price Line): Shows all possible combinations of two goods that a consumer can purchase with their given income and the prevailing market prices.
- Equation: Px * Qx + Py * Qy = M (Income)
- Slope: -Px / Py (Ratio of prices of the two goods). It represents the rate at which the market allows substitution of Y for X.
- Shifts: Changes in income shift the budget line parallelly (outward for increase, inward for decrease).
- Rotations: Changes in the price of one good rotate the budget line (pivots on the axis of the good whose price didn't change).
- Consumer's Equilibrium (Ordinal Utility Approach):
- Conditions:
- MRSxy = Px / Py (Slope of IC = Slope of Budget Line). The rate at which the consumer is willing to substitute equals the rate at which the market allows substitution.
- IC must be convex to the origin at the point of equilibrium (ensures diminishing MRS).
- Explanation: Equilibrium occurs at the point where the budget line is tangent to the highest possible indifference curve the consumer can reach.
- Conditions:
6. Demand
- Demand: The quantity of a commodity that a consumer is willing and able to buy at a given price during a given period of time. (Note: Willingness + Ability = Demand).
- Determinants of Individual Demand (Demand Function): Dx = f(Px, Pr, Y, T, E)
- Px (Price of the Commodity): Inverse relationship (Law of Demand).
- Pr (Price of Related Goods):
- Substitutes (Tea, Coffee): Price of substitute increases -> Demand for the good increases (Direct relationship).
- Complements (Car, Petrol): Price of complement increases -> Demand for the good decreases (Inverse relationship).
- Y (Income of the Consumer):
- Normal Goods: Income increases -> Demand increases (Direct relationship).
- Inferior Goods: Income increases -> Demand decreases (Inverse relationship).
- T (Tastes and Preferences): Favourable change -> Demand increases. Unfavourable change -> Demand decreases.
- E (Expectations): Expectation of future price rise -> Current demand increases. Expectation of future price fall -> Current demand decreases.
- Law of Demand: States that, other things remaining equal (ceteris paribus), the quantity demanded of a commodity increases when its price falls and decreases when its price rises. There is an inverse relationship between price and quantity demanded.
- Demand Schedule: A table showing quantities demanded at different possible prices.
- Demand Curve: A graphical representation of the demand schedule. It slopes downwards from left to right.
- Reasons for Downward Slope of Demand Curve / Operation of Law of Demand:
- Law of Diminishing Marginal Utility (LDMU).
- Income Effect: Change in real income (purchasing power) due to price change.
- Substitution Effect: Substituting the cheaper good for the relatively expensive one.
- Size of Consumer Group (New Consumers): Lower price attracts new buyers.
- Different Uses: A commodity may be put to more uses when its price falls.
- Exceptions to the Law of Demand: (Situations where demand curve slopes upwards)
- Giffen Goods: Highly inferior goods where the negative income effect outweighs the substitution effect (very rare).
- Veblen Goods / Articles of Snob Appeal: Goods demanded for their prestige value (diamonds, luxury cars). Higher price increases perceived status and demand.
- Emergency / Necessity: Life-saving drugs might be bought regardless of price increases.
- Movement Along the Demand Curve vs. Shift in Demand Curve:
- Movement (Change in Quantity Demanded): Occurs due to a change in the price of the commodity itself. Results in Expansion (downward movement) or Contraction (upward movement) of demand.
- Shift (Change in Demand): Occurs due to changes in factors other than price (Income, Tastes, Price of related goods, etc.). Results in Increase (rightward shift) or Decrease (leftward shift) in demand.
7. Price Elasticity of Demand (PED / Ed)
- Meaning: Measures the degree of responsiveness of quantity demanded of a commodity to a change in its price.
- Formula: Ed = (-) [% Change in Quantity Demanded] / [% Change in Price]
- Ed = (-) (ΔQ/Q) / (ΔP/P) = (-) (ΔQ/ΔP) * (P/Q)
- (Note: The negative sign is often used to make the coefficient positive, as price and quantity demanded usually move in opposite directions).
- Degrees of Price Elasticity of Demand:
- Perfectly Elastic Demand (Ed = ∞): Infinite demand at a particular price; zero demand if price changes slightly. Horizontal demand curve. (Theoretical)
- Perfectly Inelastic Demand (Ed = 0): Quantity demanded does not change at all, regardless of price change. Vertical demand curve. (e.g., essential medicines).
- Unitary Elastic Demand (Ed = 1): Percentage change in quantity demanded is exactly equal to the percentage change in price. Rectangular hyperbola demand curve.
- Relatively Elastic Demand (Ed > 1): Percentage change in quantity demanded is greater than the percentage change in price. Flatter demand curve. (e.g., luxuries, goods with many substitutes).
- Relatively Inelastic Demand (Ed < 1): Percentage change in quantity demanded is less than the percentage change in price. Steeper demand curve. (e.g., necessities, goods with few substitutes).
- Factors Affecting Price Elasticity of Demand:
- Nature of Commodity: Necessities (inelastic), Luxuries (elastic).
- Availability of Substitutes: More substitutes (elastic), Fewer substitutes (inelastic).
- Income Level: High income group (inelastic), Low income group (elastic).
- Level of Price: Very high/low priced goods (inelastic), Medium priced goods (elastic).
- Postponement of Consumption: Possible to postpone (elastic), Not possible (inelastic).
- Number of Uses: Multiple uses (elastic), Specific use (inelastic).
- Time Period: Longer period (elastic), Shorter period (inelastic).
- Habits: Habitual goods (inelastic).
Multiple Choice Questions (MCQs)
-
The want-satisfying power of a commodity is known as:
a) Demand
b) Utility
c) Supply
d) Production -
The Law of Diminishing Marginal Utility states that as more units of a commodity are consumed, the marginal utility derived from each successive unit:
a) Increases
b) Decreases
c) Remains constant
d) Becomes zero -
In the case of a single commodity, consumer equilibrium (Cardinal approach) is achieved when:
a) MUx > Px
b) MUx < Px
c) MUx = Px
d) TUx = Px -
An Indifference Curve is:
a) Convex to the origin
b) Concave to the origin
c) A straight line sloping upwards
d) A straight line sloping downwards -
The slope of the Budget Line represents:
a) Marginal Rate of Substitution (MRS)
b) Price Ratio (-Px/Py)
c) Income level
d) Utility level -
If the price of coffee increases, the demand for tea (assuming they are substitutes) will likely:
a) Decrease
b) Increase
c) Remain unchanged
d) Become zero -
A movement along the demand curve occurs due to a change in:
a) Income of the consumer
b) Price of the commodity itself
c) Tastes and preferences
d) Price of related goods -
If the percentage change in quantity demanded is less than the percentage change in price, the demand is said to be:
a) Perfectly elastic
b) Unitary elastic
c) Relatively inelastic
d) Relatively elastic -
Which of the following is an assumption of the Law of Diminishing Marginal Utility?
a) Ordinal measurement of utility
b) Consumption is intermittent
c) Marginal utility of money is constant
d) Units consumed are heterogeneous -
Consumer equilibrium using Indifference Curve analysis occurs at the point where:
a) MRSxy > Px/Py
b) MRSxy < Px/Py
c) The budget line intersects the highest possible indifference curve
d) The budget line is tangent to an indifference curve (MRSxy = Px/Py) and IC is convex.
Answer Key for MCQs:
- b) Utility
- b) Decreases
- c) MUx = Px
- a) Convex to the origin
- b) Price Ratio (-Px/Py)
- b) Increase
- b) Price of the commodity itself
- c) Relatively inelastic
- c) Marginal utility of money is constant
- d) The budget line is tangent to an indifference curve (MRSxy = Px/Py) and IC is convex.
Remember to revise these concepts thoroughly. Understand the assumptions behind each law and theory, the conditions for equilibrium, and the graphical representations. Good luck with your preparation!