Class 12 Micro Economics Chapter 3-Theory Of Consumer Behaviour notes in English medium

Consumer Behavior, Budget Line & Marginal Rate of Substitution

In this post of Economics Online Class, we will learn about Consumer Behavior, Budget Line & Marginal Rate of Substitution.

Chapter 3- Theory of Consumer Behaviour

Perception of consumer behavior/Concept of Consumer Behaviour

Before we do not study the concept of consumer behavior, it is necessary to know the following  concepts-

Who is the consumer?

Usually a person is called a consumer but in economics the term consumer is used for institutions, individuals or group of persons i.e. families. A consumer is a rational person who spends his limited income on goods and services and satisfy his needs. Consumer gets utility from his own expenditure. The consumer spends his income in such a way that he can get maximum utility from the given income and the prices of goods and services. In other words, consumer’s objective is to achieve consumer equilibrium.

Consumer Equilibrium

A consumer is in a state of equilibrium when he considers his behaviour to be the best in the present circumstances and does not like to make any changes in it as long as the circumstances change.

In the words of Samuelson, “ A consumer is in equilibrium when he maximizes his given income and satisfaction from market prices. ,

What is utility?

The power of a thing by which a need is satisfied is called utility. For example, when we are thirsty, we get satisfied by drinking water. This power of water by which we can satisfy our thirst is called utility of water. According to Lipsey , “ Utility is the satisfaction that a person obtains as a result of consumption. ,

What is Consumer Behaviour

Consumer behavior refers to the method by which consumers choose how they will spend their income. The study of this behavior of the consumer is called consumer behavior study.

Consumer’s Budget

(Budget Set and Budget Line)

Consumer budget refers to the fixed income of the consumer .

To study the behavior of the consumer, we assume that he has a certain income. Simultaneously, it is also assumed that the consumer spends this fixed income on the purchase of two goods and that the prices of those two goods are already determined by the consumer. Suppose a consumer has a budget of ₹ 60 and apples and oranges are the two items on which the consumer spends ₹ 60 . The cost of an apple is ₹ 2 per unit and that of an orange is ₹ 1 per unit. A consumer can buy these goods in different proportions , which we can show from the following table.

              Various consumption possibilities for the consumer

Units of item-1 (apple)	Units of Object-2 (Orange)
0	60
10	40
20	20
30	0

It is clear from the above table that if a consumer spends all his income on buying the first item i.e. apple, then he can get 30 units of it. Conversely, if he spends all his income on another item i.e. oranges , then he can get 60 units of it.

Similarly, the consumer can also think of various combinations that a consumer can buy given his income and the prices of Goods -1 and Goods – 2 .

Budget Set

It expresses the attainable sums of a set of two things . When the prices of the goods and the income of the consumer are given .

We can also explain the above concept with the help of a diagram –

In the diagram, Apples are shown on the OX axis and orange are shown on the OY axis . A line AD  can be drawn on the basis of various points shown in the consumption potential table. This AD  line is called the BUDGET LINE .

BUDGET LINE _

Budget line is the line which shows all the possible combinations of Goods- 1 and Goods -2 that a consumer can buy at a given budget and given price of both the goods. At any point on the budget line, the consumer is spending all his income on Good -1 or Good- 2 or a combination of both .

This budget line is also called the price line.

This is because this budget line (AD) reveals that 30 units of Good-1 is equal to 60 units of Good-2 in the market. Therefore –

Price of one unit of article -1 = Cost of two units of article

This   P1/P2=60/30 =2/1

Hence , the price line shows the price ratio between Good – 1 and Good -2 . This shows that to get one unit of Good -1 , two units of Good-2 will have to be sacrificed .

Attainable (or Feasible) and Non-Attainable (Non-feasible) Combinations

A consumer cannot go beyond the limits of his/her budget line . So any point outside the range of the budget line represents an unlikely coincidence . Similarly any coincidence within the limits of the budget line (AD) is attainable .

The OAD  region in the diagram is called the potential region. The consumer has the ability to buy any combination in this area . Conversely, the region outside the OAD region is called the unlikely region because the consumer does not have the ability to buy those combinations .

Indifference Set

Neutrality/indifference group is the set of combinations of two goods which give the same level of satisfaction to the consumer. Hence the consumer is neutral to all these combinations .

We can explain this by the following table –

indifference group table

combination of apples and oranges	Apple	Oranges
A	1	10
B	2	7
C	3	5
D	5	4

In the above table we assume that combinations A, B, C, D give equal satisfaction to the consumer . The consumer’s choice will be such that Satisfaction from A=Satisfaction from B=Satisfaction from C =Satisfaction from D

The consumer finds no difference in the combinations ABCD and is equally satisfied with the combinations ABCD. Hence consumer is neutral between the combinations ABCD. Hence these combinations are called neutral or indifference combinations.

Law of Diminishing Marginal Rate of Substitution & Consumer Behavior

As the quantity of a commodity with the consumer increases, so does the intensity of desire for that commodity. Conversely, as the quantity of a commodity with the consumer decreases, so does the intensity of desire for that commodity .

We can make this clear by the following example. Suppose a person is very thirsty. If he is asked to choose between 4 glasses of water or 4 rotis, he will definitely choose the water. Along with this, as soon as the thirst quenches , his desire to get the rotis will increase.

In other words , we can say that the rate at which he will give up the second item i.e. bread , for every unit of the first item i.e. 

water, that rate goes on decreasing. This tendency of the consumer follows the rule. Hence this tendency of consumer is called Law of Diminishing Marginal Rate of Substitution .

It is also worth mentioning here that when the consumer substitutes another good in exchange for some units of one good, his total satisfaction level remains the same. That is, there is no increase or decrease in his total satisfaction level.

This can be further explained by the indifference group table.

Indifference Group Table and Law of Depreciation Marginal Substitution Rate

combination of apples and oranges	Apple	Oranges	marginal substitution rate(Marginal rate of Substitution-MRS)
A	1	10
B	2	7	3:1 (consumer is willing to sacrifice 3 oranges for 1 extra apple)
C	3	5	2:1 (consumer is willing to sacrifice 3 oranges for 1 extra apple)
D	5	4	1:1 (consumer willing to sacrifice 3 oranges for 1 extra apple)

As it is clear from the table that initially the consumer takes one apple and 10 oranges. Then he is ready to sacrifice three oranges to get an extra apple in coincidence B. Here the marginal substitution rate is 3:1. In coincidence C, the consumer is ready to sacrifice only two oranges in exchange for one more apple . Now the marginal substitution rate comes down to 2:1 . After this the consumer is willing to sacrifice only one orange in exchange for one more apple in coincidence D. i.e. reducing its marginal substitution rate to 1:1 remains. Under no circumstances, there is any increase or decrease in the total satisfaction level of the consumer. The satisfying tax obtained from different combinations of apples and oranges and ABCD remains the same.

If you have any doubt or query regarding above then you can comment us. 

~Admin

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