Theory of Consumer's Behaviour - Learn Something New With BIKRAM ADHIKARI

 Introduction 

In  the  previous ,  we  studied  about  the  demand  and  supply,  and  their  elasticities. We defined demand as the quantity of a commodity that a consumer is willing to buy at a given price and period of time. In this unit of the book, we are concerned  with  the  questions:  (i)  How  does  a  consumer  decide  how  much  of  a  commodity  to  buy  at  a  given  price?  and  (ii)  How  does  the  consumer  respond  to  change  in  price  of  the  commodity,  given  his/her  income,  and  price  of  the  related  goods? These questions take us to the theory of consumer behaviour. The theory of consumer  behaviour  is  based  on  a  fundamental  assumption  that  consumers  always  seek  to  maximise  their  total  utility  or  satisfaction,  under  certain  given  conditions.   This   applies   to   both   cardinal   and   ordinal   utility   approaches   of   consumer's  behaviour.  But  economists  have  different  views  on  whether  utility  is  measurable  in  absolute  terms.  The  classical  and  neo-classical  economists  held  the  view that utility is cardinally or quantitatively measurable. Modern economists, on the other hand, hold the view that utility can be measured in the ordinal terms, i.e. in terms of 'less than' or 'more than'. In this unit, we have discussed both cardinal and  ordinal  utility  analysis.  The  unit  begins  with  the  concept  of  cardinal  and  ordinal   utility   analysis.   Thereafter,   we   study   indifference   curve   analysis,   consumer's equilibrium, price effect, income effect and substitution effect. Finally, we study the application of indifference curve.  

Concept of Utility, Cardinal Utility and Ordinal Utility 

Concept of Utility 

Utility is defined as the want satisfying power of a commodity. In other words, utility   is   the   satisfaction   that   a   person   gets   from   the   consumption   of   a   commodity. The basic idea which the theory of utility analysis tries to convey is that  a  consumer  buys  a  certain  commodity  or  service  because  of  its  utility  that  satisfies  wants.  Every  economic  good  has  power  to  satisfy  particular  want  of  a  consumer whatever its nature may be. Utility is an economic concept that resides in the mind of consumer. The consumer knows it by introspection. The concept is  ethically  neutral  and  the  commodity  need  not  to  be  useful  in  the  ordinary  sense of the word. For example, alcohol satisfies drunkards and therefore posses utility although it is harmful to health. 

Total Utility (TU) 

Total  utility  is  defined  as  the  total  satisfaction  obtained  from  the  consumption  of  given units of a commodity by a consumer within a given period of time. It is also defined  as  the  sum  of  all  marginal  utilities  obtained  from  the  consumption  of  given units of a commodity.

Marginal Utility (MU) 

Marginal   utility   is   defined   as   the   addition   in   total   utility   as   a   result   of   consumption  of  one  additional  unit  of  the  commodity.  In  other  words,  it  is  the  ratio of change in total utility and change in quantity of a commodity consumed. 

Cardinal Utility Analysis 

The  cardinal  utility  analysis  was  started  by  classical  economists  of  the  late  eighteenth  and  nineteenth  centuries  but  matured  at  the  hands  of  twentieth  century  economists  like  Alfred  Marshall,  A.C.  Pigou,  D.H.  Robertson,  etc.  These  twentieth  century  economists  are  known  as  the  neoclassical  economists.  Therefore, cardinal utility analysis is also known as the neoclassical approach of utility analysis.

The  cardinal  utility  analysis  approach  is  based  on  the  cardinal  or  quantitative  measurement  of  utility,  which  assumes  utility  is  measurable  and  additive.  It  is  expressed as a quantity measured in a hypothetical units, which is called utils. It means that utility derived by a consumer from the consumption of a commodity can  be  measured  in  quantity  and  the  measurement  can  be  given  by  assigning  definite numbers, such as 1, 2, 3, 4, etc

Assumptions 

The cardinal utility analysis is based on the following assumptions: 

1.      Rational      consumer: 

The  consumer  is  rational.  S/he  aims  to  maximize  his/her total utility subject to the income constraint. 

2.Cardinal  utility: 

 The  utility  of  each  commodity  is  measurable.  Utility  is  cardinal  concept.  The  most  convenient  measure  is  money.  Thus,  utility  is  measured quantitatively in monetary units that the consumer is prepared to pay  for  another  unit  of  the  commodity.  It  means  that  a  consumer  can  express  the  level  of  utility  obtained  from  the  commodity  in  quantitative  terms or absolute terms or numbers. 

3.Constant marginal utility of money:

 The utility derived from a commodity is measured in terms of money. So,  money  is  unit  of  measurement  in  cardinal approach. Hence, marginal utility of money should be constant. 

4.Diminishing marginal utility: 

The utility derived from the successive unit of  a  commodity  diminishes.  In  other  words,  the  marginal  utility  of  a  commodity decreases as consumer consumes larger quantities of it. 

5.Independent   utilities:   

Utilities   are   independent.   It   means   that   utility   obtained  from  the  commodity  X  is  not  dependent  on  the  utility  obtained  from the commodity Y. Utility of one commodity does not affect the utility of   other   commodities   and   also   not   affected   by   the   utility   of   other   commodity.   Therefore,   total   utility   is   additive.   It   can   be   expressed   symbolically as 

TU   = U(X1) + U(X2) + ... + U(Xn) 

where TU = Total utility  

U(X1) + U(X2) + ... + U(Xn) refer to utilities obtained from the commodities X1, X2, ..., Xn

Ordinal Utility Analysis 

The  ordinal  utility  approach  was  invented  by  F.Y.  Edgeworth  in  1881  to  show  the possibility of commodity exchange between two individuals. Latter, in 1934, J.R.  Hicks  and  R.G.D.  Allen  fully  developed  the  ordinal  utility  approach  as  a  powerful analysitical tool of consumer behaviour. Ordinal  utility  analysis  is  based  on  the  ordinal  measurement  of  utility  or  satisfaction.  It  does  not  quantitatively  measure  the  utility  derived  from  the  consumption  of  a  commodity.  In  other  words,  it  is  not  a  quantity  or  numerical  value.  It  is  only  an  expression  of  the  consumer's  preference  for  one  commodity  over  another  or  for  one  basket  of  goods  over  another.  Under  this  approach,  the  consumer  ranks  the  alternative  combinations  available  for  him  or  her  by  a  simple  comparison  of  satisfaction  obtained  from  the  given  combinations  of  goods  and  services.  This  approach  of  utility  analysis  uses  indifference  curve  to  analyse consumer's behaviour. The concept of ordinal utility analysis is based on the following two axioms: 

1  It  is  not  possible  to  express  utility  in  quantitative  terms.  But  is  possible  to  tell  which  of  any  two  commodity  is  preferred.  For  example,  a  consumer  may  not  specify  how  much  utility  or  satisfaction  s/he  derives  by  eating  a  plate  mo:mo.  But  s/he  can  tell  what  s/he  prefers  among  mo:mo,  samosa  and pizza. 

2.  A  can  consumer  can  list  all  the commodities  s/he  consumes  in  order  of  his/her preference. 

According to ordinal utility analysis, cardinal or absolute measurement of utility is neither feasible nor necessary for analysing consumer's behaviour.

Assumptions  

The ordinal utility analysis is based on the following assumptions:

 1.      Rational      consumer:

 The consumer is assumed to be rational, i.e. s/he aims to  maximize  his/her  utility,  given  his/her  income  and  market  prices.  It  is  also assumed that s/he has full knowledge of all relevant information.

.2. Ordinal  measurement  of  utility: 

 Ordinal  utility  approach  assumes  that  utility is only ordinally measurable by consumer's subjective evaluation, i.e. a consumer is able to express only the order of his or her preference.  

3.Diminishing   marginal   rate   of   substitution:

 The marginal rate of substitution  is  the  rate  at  which  one  commodity  is  substituted  for  another  so that total utility remains constant. The ordinal utility analysis is based on the assumption that the marginal rate of substitution diminishes when one commodity is substituted for another.

 4.Non-satiety: 

 Non-satiety  means  that  the  consumer  has  not  reached  the  point of saturation in case of any commodity. Therefore, a consumer always prefers larger quantities of all goods and services. 

5.      Consistency  and  transitivity  in  choice:  

It  is  assumed  that  consumer  is  consistent in choice, i.e. if in one period s/he chooses bundle A over B, s/he will  not  choose,  bundle  B  over  A  in  another  period  if  both  bundles  are  available  to  him  or  her.