Theory Of Consumer Behavior PDF

Theory Of Consumer Behavior  Theory Of Consumer Behavior Human wants are unlimited and they are of different intensity. The means at the disposal of a man are not only scarce but they have alternative uses. As a result of scarcity of recourses, the consumer cannot satisfy all his wa...

Theory Of Consumer Behavior  Theory Of Consumer Behavior Human wants are unlimited and they are of different intensity. The means at the disposal of a man are not only scarce but they have alternative uses. As a result of scarcity of recourses, the consumer cannot satisfy all his wants. He has to choose as to which want is to be satisfied first and which afterward if the recourses permit. The consumer is confronted in making a choice. Consumer behavior is the study of individuals, groups, or organizations and all the activities associated with the purchase, use and disposal of goods and services. We now examine the approaches which are used in the analyzes of consumer behavior. There are two main approaches to analysis consumer behavior. The first approach is the Marginal Utility or Cardinalist Approach. The second is the Ordinalist Approach.  Theory Of Consumer Behavior Cardinal approach &Ordinal Approach 1.Cardinal approach Alfred Marshall gave the concept of cardinal utility approach.He that utility can be measured and quantified. It means, it is possible to express utility that an individual derives from consuming a commodity in quantitative terms like 1,2,3,4. 2. Ordinal Approach J. R. Hicks and R.G.Allen introduced the ordinal approach in 1928 They said that utility cannot be measured in quantitative terms.it can be ranked and ordered. Cardinal Approach is based on the concept of utility So we first explain the concept of utility ,total utility marginal utility.  Utility Analysis Concept of Utility Jevon (1835 -1882) was the first economist who introduces the concept of utility in economics. According to him: “ Utility is the basis on which the demand of a individual for a commodity depends upon". Utility is defined as:“ The power of a commodity or service to satisfy human want". Utility is thus the satisfaction which is derived by the consumer by consuming the goods. For example, cloth has a utility for us because we can wear it. Pen has a utility who can write with it. The utility is subjective in nature. It differs from person to person. The utility of a bottle of wine is zero for a person who is non drinker while it has a very high utility for a drinker. Here it may be noted that the term ‘utility’ may not be confused with pleasure or use- fulness which a commodity gives to an individual. Utility is a subjective satisfaction which consumer gets from consuming any good or service. For example, poison is injurious to health but it gives subjective satisfaction to a person who wishes to die. We can say that utility is value neutral.  Utility Analysis. Total Utility and Marginal Utility: Difference Between Total Utility and Marginal Utility Total Utility (TU): "Total utility is the total satisfaction obtained from all units of a particular commodity consumed over a period of time". For example, a person consumes eggs and gains 50 utils of total utility. This total utility is the sum of utilities from the successive units (30 utils from the first egg, 15 utils from the second and 5 utils from the third egg). Formula:TU =U1+u2+u3+u4+u5…Un Marginal Utility (MU) "Marginal utility means an additional or incremental utility. Marginal utility is the change in the total utility that results from unit one unit change in consumption of the commodity within a given period of time". For example, when a person increases the consumption of eggs from one egg to two eggs, the total utility increases from 30 utils to 45 utils. The marginal utility here would be the15 utils of the 2nd egg consumed. Marginal utility, thus, can also be described as difference between total utility derived from one level of consumption and total utility derived from another level of consumption. Formula: ∆TU MU = ∆Q  Utility Analysis Relationship between Tu and MU Units of Marginal Total Utility Apples Utility in in Utils Per Consumed Utils Per Day Daily Day 1 7 7 2 11 4 (11-7) 3 13 2 (13-11) 4 14 1 (14-13) 5 14 0 (14-14) 6 13 -1 (13-14) (i) The total utility curves starts at the origin as zero consumption of apples yield zero utility. (ii) The TU curve reaches at its maximum or a peak of M when MU is zero(iii) The MU curve falls through the graph. A special point occurs when the consumer consumes fifth apple. He gains no marginal utility from it. After this point, marginal utility becomes negative.(iv) The MU curve can be derived from the total utility curve. It is the slope of the line joining two adjacent quantities on the curve. For example, the marginal utility of the third apple is the slope of line joining points a and b.:  Cardinal Utility Approach Cardinal utility approach can be explained with the help of two laws Law of Diminishing marginal utility Law of equi marginal utility  Law of Diminishing marginal utility Definition and Statement of the Law: The law of diminishing marginal utility describes a familiar and fundamental tendency of human behavior. The law of diminishing marginal utility states that: “As a consumer consumes more and more units of a specific commodity, the utility from the successive units goes on diminishing”. Mr. H. Gossen, a German economist, was first to explain this law in 1854. Alfred Marshal later on restated this law in the following words: “The additional benefit which a person derives from an increase of his stock of a thing diminishes with every increase in the stock that already has”  Law of Diminishing marginal utility Law is Based Upon Three Facts: The law of diminishing marginal utility is based upon three facts. First, total wants of a man are unlimited but each single want can be satisfied. As a man gets more and more units of a commodity, the desire of his for that good goes on falling. A point is reached when the consumer no longer wants any more units of that good. Secondly, different goods are not perfect substitutes for each other in the satisfaction of various particular wants. As such the marginal utility will decline as the consumer gets additional units of a specific good. Thirdly. There is no change in the taste of the consumers  Example of Law of Diminishing Marginal Utility: Example This law can be explained by taking a very simple example. Suppose, a man is very thirsty. He goes to the market and buys one glass of sweet water. The glass of water gives him immense pleasure or we say the first glass of water has great utility for him. If he takes second glass of water after that, the utility will be less than that of the first one. It is because the edge of his thirst has been blunted to a great extent. If he drinks third glass of water, the utility of the third glass will be less than that of second and so on. The utility goes on diminishing with the consumption of every successive glass water till it drops down to zero. This is the point of satiety. It is the position of consumer’s equilibrium or maximum satisfaction. If the consumer is forced further to take a glass of water, it leads to disutility causing total utility to decline. The marginal utility will become negative. A rational consumer will stop taking water at the point at which marginal utility becomes negative even if the good is free..  Law of Diminishing marginal utility Schedule &Diagram Marginal Units Total Utility Utility 1st glass 20 20 2nd glass 32 12 3rd glass 40 8 4th glass 42 2 5th glass 42 0 6th glass 39 -3  Law of Diminishing marginal utility Explanation & assumptions of the law Explanation of the figure :In the figure along OX we measure units of a commodity consumed and along OY is shown the marginal utility derived from them. The marginal utility of the first glass of water is called initial utility. It is equal to 20 units. The MU of the 5th glass of water is zero. It is called satiety point. The MU of the 6th glass of water is negative (-3). The MU curve here lies below the OX axis. The utility curve MM/ falls left from left down to the right showing that the marginal utility of the success units of glasses of water is falling. Assumptions of Law of Diminishing Marginal Utility: The law of diminishing marginal utility is true under certain assumptions. These assumptions are as under: I. Rationality: In the cardinal utility analysis, it is assumed that the consumer is rational. He aims at maximization of utility subject to availability of his income. II. Constant marginal utility of money: It is assumed in the theory that the marginal utility of money based for purchasing goods remains constant. If the marginal utility of money changes with the increase or decrease in income, it then cannot yield correct measurement of the marginal utility of the good. Assumptions of the law Diminishing marginal utility (iii) Diminishing marginal utility: Another important assumption of utility analysis is that the utility gained from the successive units of a commodity diminishes in a given time period. (iv) Utility is additive: In the early versions of the theory of consumer behavior, it was assumed that the utilities of different commodities are independent. The total utility of each commodity is additive. U = U1 (X1) + U2 (X2) + U3 (X3)………. Un (Xn). v) Consumption to be continuous: It is assumed in this law that the consumption of a commodity should be continuous. If there is interval between the consumption of the same units of the commodity, the law may not hold good. For instance, if you take one glass of water in the morning and the 2nd at noon, the marginal utility of the 2nd glass of water may increase. (vi) Suitable quantity: It is also assumed that the commodity consumed is taken in suitable and reasonable units. If the units are too small, then the marginal utility instead of falling may increase up to a few units..  Assumptions of the law Diminishing marginal utility (vii) Character of the consumer does not change: The law holds true if there is no change in the character of the consumer. For example, if a consumer develops a taste for wine, the additional units of wine may increase the marginal utility to a drunkard. (viii) No change to fashion: Customs and tastes: If there is a sudden change in fashion or customs or taste of a consumer, it can than make the law inoperative. (ix) No change in the price of the commodity: there should be any change in the price of that commodity as more units are consumed.  Limitations/Exceptions of Law of Diminishing Marginal Utility: There are some exceptions or limitations to the law of diminishing utility. (i) Case of intoxicants: Consumption of liquor defies the low for a short period. The more a person drinks, the more likes it. However, this is truer only initially. A stage comes when a drunkard too starts taking less and less liquor and eventually stops it. (ii) Rare collection: If there are only two diamonds in the world, the possession of 2nd diamond will push up the marginal utility. (iii) Application to money: The law equally holds good for money. It is true that more money the man has, the greedier he is to get additional units of it. However, the truth is that the marginal utility of money declines with richness but never falls to zero. Summing up, we can say that the law of diminishing utility, like other laws of Economics, is simply a statement of tendency. It holds good provided other factors remain constant.  Practical Importance of Law of Diminishing Marginal Utility: The law of diminishing utility has great practical importance in economics. The law of demand, the theory of consumer’s surplus, and the equilibrium in the distribution of expenditure are derived from the law of diminishing marginal utility. Basis of the law of demand: The law of marginal diminishing utility and the law of demand are very closely related to each other. In fact they law of diminishing marginal utility, the more we have of a thing, and the less we want additional increment of it. In other words, we can say that as a person gets more and more of a particular commodity, the marginal utility of the successive units begins to diminish. So every consumer while buying a particular commodity compares the marginal utility of the commodity and the price of the commodity which he has to pay. Consumer’s surplus concept: The theory of consumer’s surplus is also based on the law of diminishing marginal utility  Practical Importance of Law of Diminishing Marginal Utility Importance to the consumer: A consumer in order to get the maximum satisfaction from his relatively scare resources distributes his income on commodities and services in such a way that the marginal utility from all the uses are the same Importance to finance minister: The system of modern taxation is therefore, based on the law of diminishing marginal utility. or example, a person who earns $90,000 per month attaches less importance to $10. But a man who gets $1000 per month, the value of $10 to him is very high. A finance minister knowing this fact that the utility of money to a rich man is low and to poor man. So he imposes the system of taxation in such a way that the rich persons are taxed at a progressive rate.  Questions Related To Law Of Diminishing Marginal Utility Q.1 A consumer buys 7 units of apples with total utilities10,18,24,28,30,30,28. fine out the marginal utility of these. Make a table and draw a diagram by using the above mentioned data. Q.2 A consumer consumes 3 units of coffee with utilities 18, 15, and 12. What is the marginal utility of the 2nd unit? Q.3If a consumer consumes 4 units of video games with utilities 40, 35, 30, and 25, at which unit does the Law of Diminishing Utility start applying. Q.4 If a consumer consumes 6 units of a product with utilities 50, 45, 40, 35, 30, and 25, what is the marginal utility of the 5th unit? Q.5 A consumer consumes 5 units of pizza with total utilities 25, 45 ,60 ,70,70 and 60 Construct a table and diagram.