Principle of Management and Economics - Consumer Behaviour, Study notes for Economics. Indian Institute of Information Technology (IIIT)
krithika3 September 2011

Principle of Management and Economics - Consumer Behaviour, Study notes for Economics. Indian Institute of Information Technology (IIIT)

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Detail Summery about CONSUMER BEHAVIOUR, Human wants, Utility of the product, Consumption, Willingness to purchase a product, Resources for fulfilling the desire.
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Human wants. Utility of the product. Consumption.

Human wants are characterized by: 1. Willingness to purchase a product. 2. Resources for fulfilling the desire. 3. Willingness to acquire the product/service. (utility of the product)

Determinants of Household Demand 1. The price of the product. 2. The income available to the household. 3. The household’s amount of

accumulated wealth. 4. The prices of other products available

to the household. 5. Tastes and preferences. 6. Expectations about future

income,wealth and prices.

Features of Human Wants

1. Unlimited wants. 2. Some wants are complementary. 3. Substitutability of wants. 4. Wants are competitive. 5. Wants multiply. 6. Wants re-occur. 7. Some wants are postponed. 8. Wants differ in urgency and intensity.

UTILITY The satisfaction,or reward, a product yields relative

to its alternatives. The basis of choice. • Total Utility:(TU) The total amount of

satisfaction gained by the consumption or use of a good or service.

Marginal Utility:(MU)The additional satisfaction obtained from consumption of a good or service.

Law of Diminishing Marginal Utility: The more of any one good consumed in a given period, the less satisfaction(utility) generated by consuming each additional (marginal) unit of the same good.

Law of Diminishing Marginal Utility Assumptions: 1. All the units of a commodity must be

same in all respects. 2. The unit of the good must be standard. 3. There should be no change in taste

during the process of consumption. 4. There must be continuity in

consumption. 5. There should be no change in the price

of the substitute goods.

Consumer’s Equilibrium Consumer will attain its equilibrium (maximum

satisfaction) at the point, where marginal utility of a product divided by the marginal utility of a rupee, is equal to the price.

Consumer’s equilibrium = Marginal utility of a product Marginal utility of a rupee

= its price Steps:

Generation of alternatives. Evaluation of alternatives. Choice of the best alternative.

Assumptions: Consumer behaviour is rational. Consumer behaviour is consistent. There are two commodities in consideration.

Law of Equi-Marginal Utility The consumer will spend his money income on

different goods in such a way that marginal utility of each good is proportional to its price.

Limitations: •It is difficult for the consumer to know the marginal utilities from different commodities because utility cannot be measured. Consumer are ignorant and therefore are not in a position to arrive at an equilibrium. It does not apply to indivisible and inexpensive commodity.

Consumer Surplus The excess of satisfaction is called Consumer

satisfaction and hence Consumer Surplus. Consumer Surplus = Total Utility – (Mkt. Price

* No. of units consumed) = T.U – ( P * N)

Criticisms: A Vague Idea. Too many assumptions. Applicable to a small number of cases only. Neglects the income effect of the price change.


Definition of Demand “The demand for anything, at a given price, is the

amount of it, which will be bought per unit of time, at that price.”

“By demand we mean the various quantities of a given commodity or service which consumers would buy in one market in a given period of time at various prices.”

Requisites: Desire for specific commodity. Sufficient resources to purchase the desired

commodity. Willingness to spend the resources. Availability of the commodity at (i) Certain price (ii) Certain place (iii) Certain time.

Kinds of Demand o Individual demand. o Market demand. o Income demand. 1. Demand for normal goods (price –ve, income +ve). 2. Demand for inferior goods (e.g.., coarse grain). o Cross demand. 1. Demand for substitutes or competitive goods (e.g..,

tea & coffee, bread and rice). 2. Demand for complementary goods (e.g.., pen & ink). o Joint demand (same as complementary, e.g.., pen &

ink). o Composite demand (e.g.., coal & electricity). o Direct demand (e.g.., ice-creams). o Derived demand (e.g.., TV & TV mechanics). o Competitive demand (e.g.., desi ghee and vegetable

oils). o Demand of unrelated goods.


1. Individual Demand Schedule: Shows various quantities of a product that would be purchased at different prices by a household.

2. Market Demand Schedule: is found by adding together the quantities demanded by all individuals at each price.

Forces Behind Demand Curve

The average income of consumers. The size of the market. The prices and the availability of the

related goods. Tastes and preferences. Other factors.

Demand Curve Movement along demand curve Vs. Shift in

demand curve: Distinction between change in quantity

demanded and change in demand.

A. Change in quantity demanded – When quantity demanded changes ( rise or fall ) as a result of change in price alone, other factors remaining the same.

Contraction/fall in quantity demanded Extension/Rise in quantity demanded.

Demand Curve B. Change in demand – When the amount

purchased of a commodity rises or falls because of the change in factors other than the price of the commodity. It is called change in demand.

Types of Changes Increase in demand. • Decrease in demand

Law of Demand

Prof. Samuelson: “Law of demand states that people will buy more at lower price and buy less at higher prices, other things remaining the same.”

Assumptions: No change in tastes and preference of the consumers. Consumer’s income must remain the same. The price of the related commodities should not change. The commodity should be a normal commodity.

Law of Demand

Exceptions: 1. Inferior goods. 2. Articles of snob appeal. 3. Expectation regarding future prices. 4. Emergencies. 5. Quality-price relationship. 6. Conspicuous necessities. 7. Ignorance. 8. Change in fashion, habits, attitudes, etc..

Elasticity of Demand Definition: “Elasticity of demand is defined as the

responsiveness of the quantity demanded of a good to changes in one of the variables on which demand depends.”

These variables are price of the commodity, prices of the related commodities, income of the consumer & other various factors on which demand depends. Thus, we have Price Elasticity, Cross Elasticity, Elasticity of Substitution & Income Elasticity. It is always price elasticity of demand which is referred to as elasticity of demand.

Factors affecting Elasticity of Demand

1. Availability of substitutes 2. Postponement of consumption 3. Proportion of expenditure (needles: inelastic; TV:

elastic) 4. Nature of the commodity (necessity vs. luxury) 5. Different uses of the commodity (paper vs. ink) 6. Time period (elastic in the long term) 7. Change in income (necessaries: inelastic) 8. Habits 9. Joint demand 10. Distribution of income 11. Price level (very costly & very cheap goods:


Types of Elasticity of DemandA.Price Elasticity

Measures how much the quantity demanded of a good changes when its price changes. Or

It may be defined as “Percentage Change in Quantity demanded over percentage change in price”.

PED = % Change in Qty Demanded % Change in Price

Points to Remember: We drop the minus sign from the numbers by treating all %

changes as positive. That means all elasticity’s are positive, even though prices and quantities move in the opposite direction because of the law of downward sloping demand.

Definition of elasticity uses percentage changes in price and demand rather than actual changes. That means that a change in the units of measurement does not affect the elasticity. So whether we measure price in Rupees or paisa, the price elasticity stays the same.

Elasticity & Revenue: When demand is price inelastic, a price decrease reduces total

revenue. When demand is price elastic, a price decrease increases total

revenue. In the borderline case of unit elastic demand, a price decrease

leads to no change in the total revenue

B. Income Elasticity of Demand: Is the degree of responsiveness of quantity demanded of a good to a small change in the income of the consumer.

If the proportion spent on a good increases, then the income elasticity for the good is greater than one.

If the proportion decreases as income rises, then income elasticity for the good is less than one.

If the proportion of income spent on a good remains the same as income increases, then income elasticity for the good is equal to one.

Elasticity of Demand C.Cross Elasticity: A change in the demand for one

good in response to a change in the price of another good represents cross elasticity of demand of the former good for the latter good.

If two goods are perfect substitutes for each other cross elasticity is infinite and if the two goods are totally unrelated, cross elasticity between them is zero.

Goods between which cross elasticity is positive can be called Substitutes, the good between which the cross elasticity is negative are not always complementary as this is found when the income effect on the price change is very strong.

Elasticity of Demand D.Elasticity of Substitution: Measures the

ease with which one good can be substituted for another.

• If two goods are perfect substitutes elasticity of substitution will be infinite.

• If two goods are to be used in fixed proportion elasticity of substitution will be zero

• When it is difficult to substitute one good for another, then in that case elasticity will be lying between zero & infinity.

Methods of measurement of Elasticity

1.Percentage or Proportionate Method = Percentage change in demand or; Percentage change in price = Proportionate change in demand Proportionate change in price

2. Total Outlay (Expenditure) Methods TO=TQ * P ; where, TO=total outlay; TQ=total quantity; P=price of the commodity

3. Geometric (Point) method – at any given point on the curve

= lower segment of demand curve upper segment of demand curve

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