Microeconomics: Theory of Consumer Behavior

Key Concepts

Utility

• Definition: Amount of satisfaction derived from consumption of a commodity.
• Measurement Unit: Utils.

Approaches to Utility

• Cardinal Utility Approach: Measures utility in numeric terms.
• Ordinal Utility Approach: Measures utility based on preferences (qualitative basis).

Total Utility (TU) and Marginal Utility (MU)

• Total Utility (TU): Overall satisfaction from consuming a certain amount of a commodity.
• Marginal Utility (MU): Additional satisfaction from consuming one more unit of a commodity.
• Relationship: As long as TU is increasing, MU is positive. When TU is at its maximum, MU is zero. After that, if TU decreases, MU becomes negative.

Diminishing Marginal Utility

• Law of Diminishing Marginal Utility (DMU): Consuming more units of a particular commodity will eventually lead to a decrease in additional satisfaction (MU).
• Assumptions: Utility is measured in numerical units, the consumer is rational, consumption is continuous, etc.

Consumer Equilibrium

• Single Commodity Case: Consumer equilibrium is when MU = Price (MUx = Px)
• Two Commodities Case: Equilibrium is reached when MUx/Px = MUy/Py

Law of Equi-Marginal Utility

• Consumers allocate their income in such a way that the last unit of money spent on each commodity provides the same level of marginal utility.

Ordinal Utility Approach: Indifference Curve Analysis

Budget Constraint

• Budget: Real purchasing power enabling the consumer to buy certain bundles of goods.
• Budget Line: Represents all possible combinations of two goods that a consumer can buy with a given budget.
• Shifts: Change in income or prices of goods can shift the budget line.

Consumer Preferences

• Monotonic Preferences: Consumers prefer bundles with more quantities of goods.
• Indifference Curve: Represents combinations of two goods providing the same level of satisfaction to the consumer.
• Properties: Convex to the origin, higher ICs represent higher satisfaction, ICs never intersect, and do not touch axes.

Demand

• Definition: Quantity of a commodity that a consumer is willing and able to buy at possible prices during a given period of time.
• Determinants: Price of the commodity, prices of related goods, consumer income, tastes and preferences, expectations about future prices.
• Types of Demand: Price demand, income demand, cross demand.

Demand Curve

• Nature: Usually downward sloping because of the inverse relationship between price and quantity demanded.
• Movements vs Shifts:
  • Movement along Demand Curve: Changes due to change in the price of the commodity itself.
  • Shift in Demand Curve: Changes due to other factors like consumer income, tastes, and preferences.

Elasticity of Demand

• Price Elasticity of Demand: Measure of the responsiveness of quantity demanded to a change in its price.
• Degrees:
  • Perfectly Elastic: ED = infinity (horizontal line)
  • Perfectly Inelastic: ED = 0 (vertical line)
  • Highly Elastic: ED > 1
  • Less Elastic: ED < 1
  • Unitary Elastic: ED = 1 (45-degree downward slope)

Types of Goods

• Normal Goods: Demand increases as income increases.
• Inferior Goods: Demand decreases as income increases.