NCERT Textbook: Theory of Consumer Behaviour | Indian Economy for UPSC CSE PDF Download

 Page 1


Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer. The consumer has to decide how to spend her income
on different goods
1
. Economists call this the problem of choice.
Most naturally, any consumer will want to get a combination of
goods that gives her maximum satisfaction. What will be this ‘best’
combination? This depends on the likes of the consumer and what
the consumer can afford to buy. The ‘likes’ of the consumer are
also called ‘preferences’. And what the consumer can afford to buy,
depends on prices of the goods and the income of the consumer.
This chapter presents two different approaches that explain
consumer behaviour (i) Cardinal Utility Analysis and (ii) Ordinal
Utility Analysis.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods
2
: bananas and mangoes. Any
combination of the amount of the two goods will be called a
consumption bundle or, in short, a bundle. In general, we shall
use the variable x
1
 to denote the quantity of bananas and x
2 
to
denote the quantity of mangoes. x
1
 and x
2
 can be positive or zero.
(x
1, 
x
2
) would mean the bundle consisting of x
1
 quantity of bananas
and x
2
 quantity of mangoes. For particular values of x
1
 and x
2
, (x
1
,
x
2
), would give us a particular bundle. For example, the bundle
(5,10) consists of 5 bananas and 10 mangoes; the bundle (10, 5)
consists of 10 bananas and 5 mangoes.
2.1 UTILITY
A consumer usually decides his demand for a commodity on the
basis of utility (or satisfaction) that he derives from it. What is
utility? Utility of a commodity is its want-satisfying capacity. The
more the need of a commodity or the stronger the desire to have it,
the greater is the utility derived from the commodity.
Utility is subjective. Different individuals can get different levels
of utility from the same commodity. For example, some one who
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
Reprint 2024-25
Page 2


Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer. The consumer has to decide how to spend her income
on different goods
1
. Economists call this the problem of choice.
Most naturally, any consumer will want to get a combination of
goods that gives her maximum satisfaction. What will be this ‘best’
combination? This depends on the likes of the consumer and what
the consumer can afford to buy. The ‘likes’ of the consumer are
also called ‘preferences’. And what the consumer can afford to buy,
depends on prices of the goods and the income of the consumer.
This chapter presents two different approaches that explain
consumer behaviour (i) Cardinal Utility Analysis and (ii) Ordinal
Utility Analysis.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods
2
: bananas and mangoes. Any
combination of the amount of the two goods will be called a
consumption bundle or, in short, a bundle. In general, we shall
use the variable x
1
 to denote the quantity of bananas and x
2 
to
denote the quantity of mangoes. x
1
 and x
2
 can be positive or zero.
(x
1, 
x
2
) would mean the bundle consisting of x
1
 quantity of bananas
and x
2
 quantity of mangoes. For particular values of x
1
 and x
2
, (x
1
,
x
2
), would give us a particular bundle. For example, the bundle
(5,10) consists of 5 bananas and 10 mangoes; the bundle (10, 5)
consists of 10 bananas and 5 mangoes.
2.1 UTILITY
A consumer usually decides his demand for a commodity on the
basis of utility (or satisfaction) that he derives from it. What is
utility? Utility of a commodity is its want-satisfying capacity. The
more the need of a commodity or the stronger the desire to have it,
the greater is the utility derived from the commodity.
Utility is subjective. Different individuals can get different levels
of utility from the same commodity. For example, some one who
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
Reprint 2024-25
likes chocolates will get much higher utility from a chocolate than some one
who is not so fond of chocolates, Also, utility that one individual gets from the
commodity can change with change in place and time. For example, utility from
the use of a room heater will depend upon whether the individual is in Ladakh
or Chennai (place) or whether it is summer or winter (time).
2.1.1 Cardinal Utility Analysis
Cardinal utility analysis assumes that level of utility can be expressed in
numbers. For example, we can measure the utility derived from a shirt and say,
this shirt gives me 50 units of utility. Before discussing further, it will be useful
to have a look at two important measures of utility.
Measures of Utility
Total Utility: Total utility of a fixed quantity of a commodity (TU) is the total
satisfaction derived from consuming the given amount of some commodity x.
More of commodity x provides more satisfaction to the consumer. TU depends
on the quantity of the commodity consumed. Therefore, TU
n
 refers to total utility
derived from consuming n units of a commodity x.
Marginal Utility: Marginal utility (MU) is the change in total utility due to
consumption of one additional unit of a commodity. For example, suppose 4
bananas give us 28 units of total utility and 5 bananas give us 30 units of total
utility. Clearly, consumption of the 5
th
 banana has caused total utility to increase
by 2 units (30 units minus 28 units). Therefore,  marginal utility of the 5
th
 banana
is 2 units.
MU
5
 =  TU
5
 – TU
4
 = 30 – 28 = 2
In general, MU
n
 = TU
n
 – TU
n-1
, where subscript n refers to the n
th
 unit of the
commodity
Total utility and marginal utility can also be related in the following way.
TU
n
 = MU
1
 + MU
2
 + … + MU
n-1
 + MU
n
This simply means that TU derived from consuming n units of bananas is
the sum total of marginal utility of first banana (MU
1
), marginal utility of second
banana (MU
2
), and so on, till the marginal utility of the n
th
 unit.
Table No. 2.1 and Figure 2.1 show an imaginary example of the values of
marginal and total utility derived from consumption of various amounts of a
commodity. Usually, it is seen that the marginal utility diminishes with increase
in consumption of the commodity. This happens because having obtained some
amount of the commodity, the desire of the consumer to have still more of it
becomes weaker. The same is also shown in the table and graph.
Table 2.1: Values of marginal and total utility derived from consumption
of various amounts of a commodity
9
Theory of Consumer
Behaviour
         Units    Total Utility     Marginal Utility
1 12 12
2 18  6
3 22  4
4 24  2
5 24  0
6 22 -2
Reprint 2024-25
Page 3


Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer. The consumer has to decide how to spend her income
on different goods
1
. Economists call this the problem of choice.
Most naturally, any consumer will want to get a combination of
goods that gives her maximum satisfaction. What will be this ‘best’
combination? This depends on the likes of the consumer and what
the consumer can afford to buy. The ‘likes’ of the consumer are
also called ‘preferences’. And what the consumer can afford to buy,
depends on prices of the goods and the income of the consumer.
This chapter presents two different approaches that explain
consumer behaviour (i) Cardinal Utility Analysis and (ii) Ordinal
Utility Analysis.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods
2
: bananas and mangoes. Any
combination of the amount of the two goods will be called a
consumption bundle or, in short, a bundle. In general, we shall
use the variable x
1
 to denote the quantity of bananas and x
2 
to
denote the quantity of mangoes. x
1
 and x
2
 can be positive or zero.
(x
1, 
x
2
) would mean the bundle consisting of x
1
 quantity of bananas
and x
2
 quantity of mangoes. For particular values of x
1
 and x
2
, (x
1
,
x
2
), would give us a particular bundle. For example, the bundle
(5,10) consists of 5 bananas and 10 mangoes; the bundle (10, 5)
consists of 10 bananas and 5 mangoes.
2.1 UTILITY
A consumer usually decides his demand for a commodity on the
basis of utility (or satisfaction) that he derives from it. What is
utility? Utility of a commodity is its want-satisfying capacity. The
more the need of a commodity or the stronger the desire to have it,
the greater is the utility derived from the commodity.
Utility is subjective. Different individuals can get different levels
of utility from the same commodity. For example, some one who
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
Reprint 2024-25
likes chocolates will get much higher utility from a chocolate than some one
who is not so fond of chocolates, Also, utility that one individual gets from the
commodity can change with change in place and time. For example, utility from
the use of a room heater will depend upon whether the individual is in Ladakh
or Chennai (place) or whether it is summer or winter (time).
2.1.1 Cardinal Utility Analysis
Cardinal utility analysis assumes that level of utility can be expressed in
numbers. For example, we can measure the utility derived from a shirt and say,
this shirt gives me 50 units of utility. Before discussing further, it will be useful
to have a look at two important measures of utility.
Measures of Utility
Total Utility: Total utility of a fixed quantity of a commodity (TU) is the total
satisfaction derived from consuming the given amount of some commodity x.
More of commodity x provides more satisfaction to the consumer. TU depends
on the quantity of the commodity consumed. Therefore, TU
n
 refers to total utility
derived from consuming n units of a commodity x.
Marginal Utility: Marginal utility (MU) is the change in total utility due to
consumption of one additional unit of a commodity. For example, suppose 4
bananas give us 28 units of total utility and 5 bananas give us 30 units of total
utility. Clearly, consumption of the 5
th
 banana has caused total utility to increase
by 2 units (30 units minus 28 units). Therefore,  marginal utility of the 5
th
 banana
is 2 units.
MU
5
 =  TU
5
 – TU
4
 = 30 – 28 = 2
In general, MU
n
 = TU
n
 – TU
n-1
, where subscript n refers to the n
th
 unit of the
commodity
Total utility and marginal utility can also be related in the following way.
TU
n
 = MU
1
 + MU
2
 + … + MU
n-1
 + MU
n
This simply means that TU derived from consuming n units of bananas is
the sum total of marginal utility of first banana (MU
1
), marginal utility of second
banana (MU
2
), and so on, till the marginal utility of the n
th
 unit.
Table No. 2.1 and Figure 2.1 show an imaginary example of the values of
marginal and total utility derived from consumption of various amounts of a
commodity. Usually, it is seen that the marginal utility diminishes with increase
in consumption of the commodity. This happens because having obtained some
amount of the commodity, the desire of the consumer to have still more of it
becomes weaker. The same is also shown in the table and graph.
Table 2.1: Values of marginal and total utility derived from consumption
of various amounts of a commodity
9
Theory of Consumer
Behaviour
         Units    Total Utility     Marginal Utility
1 12 12
2 18  6
3 22  4
4 24  2
5 24  0
6 22 -2
Reprint 2024-25
10
Introductory
Microeconomics
Notice that MU
3
 is less than
MU
2
. You may also notice that
total utility increases but at a
diminishing rate: The rate of
change in total utility due to
change in quantity of commodity
consumed is a measure of
marginal utility. This marginal
utility diminishes with increase
in consumption of the
commodity from 12 to 6, 6 to 4
and so on. This follows from the
law of diminishing marginal
utility. Law of Diminishing
Marginal Utility states that
marginal utility from consuming each additional unit of a commodity declines
as its consumption increases, while keeping consumption of other commodities
constant.
MU becomes zero at a level when TU remains constant. In the example, TU
does not change at 5
th
 unit of consumption and therefore MU
5
= 0. Thereafter,
TU starts falling and MU becomes negative.
Derivation of Demand Curve in the Case of a Single Commodity (Law of
Diminishing Marginal Utility)
Cardinal utility analysis can be used to derive demand curve for a commodity.
What is demand and what is demand curve? The quantity of a commodity that
a consumer is willing to buy and is able to afford, given prices of goods and
income of the consumer, is called demand for that commodity. Demand for a
commodity x, apart from the price of x itself, depends on factors such as prices
of other commodities (see substitutes and complements 2.4.4), income of the
consumer and tastes and preferences of the consumers. Demand curve is a
graphic presentation of various quantities of a commodity that a consumer is
willing to buy at different prices of the same commodity, while holding constant
prices of other related commodities
and income of the consumer.
Figure 2.2 presents hypothetical
demand curve of an individual for
commodity x at its different prices.
Quantity is measured along the
horizontal axis and price is measured
along the vertical axis.
The downward sloping demand
curve shows that at lower prices, the
individual is willing to buy more of
commodity x; at higher prices, she is
willing to buy less of commodity x.
Therefore, there is a negative
relationship between price of a
commodity and quantity demanded which is referred to as the Law of Demand.
An explaination for a downward sloping demand curve rests on the notion
of diminishing marginal utility. The law of diminishing marginal utility states
that each successive unit of a commodity provides lower marginal utility.
Demand curve of an individual for
commodity x
The values of marginal and total utility derived
from consumption of various amounts of a
commodity. The marginal utility diminishes with
increase in consumption of the commodity.
Reprint 2024-25
Page 4


Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer. The consumer has to decide how to spend her income
on different goods
1
. Economists call this the problem of choice.
Most naturally, any consumer will want to get a combination of
goods that gives her maximum satisfaction. What will be this ‘best’
combination? This depends on the likes of the consumer and what
the consumer can afford to buy. The ‘likes’ of the consumer are
also called ‘preferences’. And what the consumer can afford to buy,
depends on prices of the goods and the income of the consumer.
This chapter presents two different approaches that explain
consumer behaviour (i) Cardinal Utility Analysis and (ii) Ordinal
Utility Analysis.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods
2
: bananas and mangoes. Any
combination of the amount of the two goods will be called a
consumption bundle or, in short, a bundle. In general, we shall
use the variable x
1
 to denote the quantity of bananas and x
2 
to
denote the quantity of mangoes. x
1
 and x
2
 can be positive or zero.
(x
1, 
x
2
) would mean the bundle consisting of x
1
 quantity of bananas
and x
2
 quantity of mangoes. For particular values of x
1
 and x
2
, (x
1
,
x
2
), would give us a particular bundle. For example, the bundle
(5,10) consists of 5 bananas and 10 mangoes; the bundle (10, 5)
consists of 10 bananas and 5 mangoes.
2.1 UTILITY
A consumer usually decides his demand for a commodity on the
basis of utility (or satisfaction) that he derives from it. What is
utility? Utility of a commodity is its want-satisfying capacity. The
more the need of a commodity or the stronger the desire to have it,
the greater is the utility derived from the commodity.
Utility is subjective. Different individuals can get different levels
of utility from the same commodity. For example, some one who
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
Reprint 2024-25
likes chocolates will get much higher utility from a chocolate than some one
who is not so fond of chocolates, Also, utility that one individual gets from the
commodity can change with change in place and time. For example, utility from
the use of a room heater will depend upon whether the individual is in Ladakh
or Chennai (place) or whether it is summer or winter (time).
2.1.1 Cardinal Utility Analysis
Cardinal utility analysis assumes that level of utility can be expressed in
numbers. For example, we can measure the utility derived from a shirt and say,
this shirt gives me 50 units of utility. Before discussing further, it will be useful
to have a look at two important measures of utility.
Measures of Utility
Total Utility: Total utility of a fixed quantity of a commodity (TU) is the total
satisfaction derived from consuming the given amount of some commodity x.
More of commodity x provides more satisfaction to the consumer. TU depends
on the quantity of the commodity consumed. Therefore, TU
n
 refers to total utility
derived from consuming n units of a commodity x.
Marginal Utility: Marginal utility (MU) is the change in total utility due to
consumption of one additional unit of a commodity. For example, suppose 4
bananas give us 28 units of total utility and 5 bananas give us 30 units of total
utility. Clearly, consumption of the 5
th
 banana has caused total utility to increase
by 2 units (30 units minus 28 units). Therefore,  marginal utility of the 5
th
 banana
is 2 units.
MU
5
 =  TU
5
 – TU
4
 = 30 – 28 = 2
In general, MU
n
 = TU
n
 – TU
n-1
, where subscript n refers to the n
th
 unit of the
commodity
Total utility and marginal utility can also be related in the following way.
TU
n
 = MU
1
 + MU
2
 + … + MU
n-1
 + MU
n
This simply means that TU derived from consuming n units of bananas is
the sum total of marginal utility of first banana (MU
1
), marginal utility of second
banana (MU
2
), and so on, till the marginal utility of the n
th
 unit.
Table No. 2.1 and Figure 2.1 show an imaginary example of the values of
marginal and total utility derived from consumption of various amounts of a
commodity. Usually, it is seen that the marginal utility diminishes with increase
in consumption of the commodity. This happens because having obtained some
amount of the commodity, the desire of the consumer to have still more of it
becomes weaker. The same is also shown in the table and graph.
Table 2.1: Values of marginal and total utility derived from consumption
of various amounts of a commodity
9
Theory of Consumer
Behaviour
         Units    Total Utility     Marginal Utility
1 12 12
2 18  6
3 22  4
4 24  2
5 24  0
6 22 -2
Reprint 2024-25
10
Introductory
Microeconomics
Notice that MU
3
 is less than
MU
2
. You may also notice that
total utility increases but at a
diminishing rate: The rate of
change in total utility due to
change in quantity of commodity
consumed is a measure of
marginal utility. This marginal
utility diminishes with increase
in consumption of the
commodity from 12 to 6, 6 to 4
and so on. This follows from the
law of diminishing marginal
utility. Law of Diminishing
Marginal Utility states that
marginal utility from consuming each additional unit of a commodity declines
as its consumption increases, while keeping consumption of other commodities
constant.
MU becomes zero at a level when TU remains constant. In the example, TU
does not change at 5
th
 unit of consumption and therefore MU
5
= 0. Thereafter,
TU starts falling and MU becomes negative.
Derivation of Demand Curve in the Case of a Single Commodity (Law of
Diminishing Marginal Utility)
Cardinal utility analysis can be used to derive demand curve for a commodity.
What is demand and what is demand curve? The quantity of a commodity that
a consumer is willing to buy and is able to afford, given prices of goods and
income of the consumer, is called demand for that commodity. Demand for a
commodity x, apart from the price of x itself, depends on factors such as prices
of other commodities (see substitutes and complements 2.4.4), income of the
consumer and tastes and preferences of the consumers. Demand curve is a
graphic presentation of various quantities of a commodity that a consumer is
willing to buy at different prices of the same commodity, while holding constant
prices of other related commodities
and income of the consumer.
Figure 2.2 presents hypothetical
demand curve of an individual for
commodity x at its different prices.
Quantity is measured along the
horizontal axis and price is measured
along the vertical axis.
The downward sloping demand
curve shows that at lower prices, the
individual is willing to buy more of
commodity x; at higher prices, she is
willing to buy less of commodity x.
Therefore, there is a negative
relationship between price of a
commodity and quantity demanded which is referred to as the Law of Demand.
An explaination for a downward sloping demand curve rests on the notion
of diminishing marginal utility. The law of diminishing marginal utility states
that each successive unit of a commodity provides lower marginal utility.
Demand curve of an individual for
commodity x
The values of marginal and total utility derived
from consumption of various amounts of a
commodity. The marginal utility diminishes with
increase in consumption of the commodity.
Reprint 2024-25
11
Theory of Consumer
Behaviour
Therefore the individual will not be willing to pay as much for each additional
unit and this results in a downward sloping demand curve. At a price of Rs. 40
per unit x, individual’s demand for x was 5 units. The 6
th
 unit of commodity x
will be worth less than the 5
th
 unit. The individual will be willing to buy the 6th
unit only when the price drops below Rs. 40 per unit. Hence, the law of
diminishing marginal utility explains why demand curves have a negative slope.
2.1.2 Ordinal Utility Analysis
Cardinal utility analysis is simple to understand, but suffers from a major
drawback in the form of quantification of utility in numbers. In real life, we
never express utility in the form of numbers. At the most, we can rank various
alternative combinations in terms of having more or less utility. In other words,
the consumer does not measure utility in numbers, though she often ranks
various consumption bundles. This forms the starting point of this topic – Ordinal
Utility Analysis.
A consumer’s preferences over the set of available bundles can often be
represented diagrammatically. We
have already seen that the bundles
available to the consumer can be
plotted as points in a two-
dimensional diagram. The points
representing bundles which give the
consumer equal utility can generally
be joined to obtain a curve like the
one in Figure 2.3. The consumer is
said to be indifferent on the different
bundles because each point of the
bundles give the consumer equal
utility.  Such a curve joining all points
representing bundles among which
the consumer is indifferent is called
an indifference curve. All the points
such as A, B, C and D lying on an
indifference curve provide the consumer with the same level of satisfaction.
It is clear that when a consumer gets one more banana, he has to forego
some mangoes, so that her total utility level remains the same and she remains
on the same indifference curve. Therefore, indifference curve slopes downward.
The amount of mangoes that the consumer has to forego, in order to get an
additional banana, her total utility level being the same, is called marginal rate
of substitution (MRS). In other words, MRS is simply the rate at which the
consumer will substitute bananas for mangoes, so that her total utility remains
constant. So, / MRS Y X =|? ? |
3
.
One can notice that, in the table 2.2, as we increase the quantity of bananas,
the quantity of mangoes sacrificed for each additional banana declines. In other
words, MRS diminishes with increase in the number of bananas. As the number
3 
/ / ( / ) 0 Y X Y Xif Y X |? ? |=? ? ? ? =
            / ( / ) 0 Y Xif Y X =-? ? ? ? <
/ MRS Y X =|? ? | means that MRS equals only the magnitude of the expression / Y X ? ? . If
/ 3/1 Y X ? ? =- it means MRS=3.
Indifference curve. An indifference curve joins
all points representing bundles which are
considered indifferent by the consumer .
A
Reprint 2024-25
Page 5


Chapter 2
Theor Theor Theor Theor Theory of y of y of y of y of
Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour Consumer Behaviour
In this chapter, we will study the behaviour of an individual
consumer. The consumer has to decide how to spend her income
on different goods
1
. Economists call this the problem of choice.
Most naturally, any consumer will want to get a combination of
goods that gives her maximum satisfaction. What will be this ‘best’
combination? This depends on the likes of the consumer and what
the consumer can afford to buy. The ‘likes’ of the consumer are
also called ‘preferences’. And what the consumer can afford to buy,
depends on prices of the goods and the income of the consumer.
This chapter presents two different approaches that explain
consumer behaviour (i) Cardinal Utility Analysis and (ii) Ordinal
Utility Analysis.
Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity,
we shall consider the consumer’s choice problem in a situation
where there are only two goods
2
: bananas and mangoes. Any
combination of the amount of the two goods will be called a
consumption bundle or, in short, a bundle. In general, we shall
use the variable x
1
 to denote the quantity of bananas and x
2 
to
denote the quantity of mangoes. x
1
 and x
2
 can be positive or zero.
(x
1, 
x
2
) would mean the bundle consisting of x
1
 quantity of bananas
and x
2
 quantity of mangoes. For particular values of x
1
 and x
2
, (x
1
,
x
2
), would give us a particular bundle. For example, the bundle
(5,10) consists of 5 bananas and 10 mangoes; the bundle (10, 5)
consists of 10 bananas and 5 mangoes.
2.1 UTILITY
A consumer usually decides his demand for a commodity on the
basis of utility (or satisfaction) that he derives from it. What is
utility? Utility of a commodity is its want-satisfying capacity. The
more the need of a commodity or the stronger the desire to have it,
the greater is the utility derived from the commodity.
Utility is subjective. Different individuals can get different levels
of utility from the same commodity. For example, some one who
1
We shall use the term goods to mean goods as well as services.
2
The assumption that there are only two goods simplifies the analysis considerably and allows us
to understand some important concepts by using simple diagrams.
Reprint 2024-25
likes chocolates will get much higher utility from a chocolate than some one
who is not so fond of chocolates, Also, utility that one individual gets from the
commodity can change with change in place and time. For example, utility from
the use of a room heater will depend upon whether the individual is in Ladakh
or Chennai (place) or whether it is summer or winter (time).
2.1.1 Cardinal Utility Analysis
Cardinal utility analysis assumes that level of utility can be expressed in
numbers. For example, we can measure the utility derived from a shirt and say,
this shirt gives me 50 units of utility. Before discussing further, it will be useful
to have a look at two important measures of utility.
Measures of Utility
Total Utility: Total utility of a fixed quantity of a commodity (TU) is the total
satisfaction derived from consuming the given amount of some commodity x.
More of commodity x provides more satisfaction to the consumer. TU depends
on the quantity of the commodity consumed. Therefore, TU
n
 refers to total utility
derived from consuming n units of a commodity x.
Marginal Utility: Marginal utility (MU) is the change in total utility due to
consumption of one additional unit of a commodity. For example, suppose 4
bananas give us 28 units of total utility and 5 bananas give us 30 units of total
utility. Clearly, consumption of the 5
th
 banana has caused total utility to increase
by 2 units (30 units minus 28 units). Therefore,  marginal utility of the 5
th
 banana
is 2 units.
MU
5
 =  TU
5
 – TU
4
 = 30 – 28 = 2
In general, MU
n
 = TU
n
 – TU
n-1
, where subscript n refers to the n
th
 unit of the
commodity
Total utility and marginal utility can also be related in the following way.
TU
n
 = MU
1
 + MU
2
 + … + MU
n-1
 + MU
n
This simply means that TU derived from consuming n units of bananas is
the sum total of marginal utility of first banana (MU
1
), marginal utility of second
banana (MU
2
), and so on, till the marginal utility of the n
th
 unit.
Table No. 2.1 and Figure 2.1 show an imaginary example of the values of
marginal and total utility derived from consumption of various amounts of a
commodity. Usually, it is seen that the marginal utility diminishes with increase
in consumption of the commodity. This happens because having obtained some
amount of the commodity, the desire of the consumer to have still more of it
becomes weaker. The same is also shown in the table and graph.
Table 2.1: Values of marginal and total utility derived from consumption
of various amounts of a commodity
9
Theory of Consumer
Behaviour
         Units    Total Utility     Marginal Utility
1 12 12
2 18  6
3 22  4
4 24  2
5 24  0
6 22 -2
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Introductory
Microeconomics
Notice that MU
3
 is less than
MU
2
. You may also notice that
total utility increases but at a
diminishing rate: The rate of
change in total utility due to
change in quantity of commodity
consumed is a measure of
marginal utility. This marginal
utility diminishes with increase
in consumption of the
commodity from 12 to 6, 6 to 4
and so on. This follows from the
law of diminishing marginal
utility. Law of Diminishing
Marginal Utility states that
marginal utility from consuming each additional unit of a commodity declines
as its consumption increases, while keeping consumption of other commodities
constant.
MU becomes zero at a level when TU remains constant. In the example, TU
does not change at 5
th
 unit of consumption and therefore MU
5
= 0. Thereafter,
TU starts falling and MU becomes negative.
Derivation of Demand Curve in the Case of a Single Commodity (Law of
Diminishing Marginal Utility)
Cardinal utility analysis can be used to derive demand curve for a commodity.
What is demand and what is demand curve? The quantity of a commodity that
a consumer is willing to buy and is able to afford, given prices of goods and
income of the consumer, is called demand for that commodity. Demand for a
commodity x, apart from the price of x itself, depends on factors such as prices
of other commodities (see substitutes and complements 2.4.4), income of the
consumer and tastes and preferences of the consumers. Demand curve is a
graphic presentation of various quantities of a commodity that a consumer is
willing to buy at different prices of the same commodity, while holding constant
prices of other related commodities
and income of the consumer.
Figure 2.2 presents hypothetical
demand curve of an individual for
commodity x at its different prices.
Quantity is measured along the
horizontal axis and price is measured
along the vertical axis.
The downward sloping demand
curve shows that at lower prices, the
individual is willing to buy more of
commodity x; at higher prices, she is
willing to buy less of commodity x.
Therefore, there is a negative
relationship between price of a
commodity and quantity demanded which is referred to as the Law of Demand.
An explaination for a downward sloping demand curve rests on the notion
of diminishing marginal utility. The law of diminishing marginal utility states
that each successive unit of a commodity provides lower marginal utility.
Demand curve of an individual for
commodity x
The values of marginal and total utility derived
from consumption of various amounts of a
commodity. The marginal utility diminishes with
increase in consumption of the commodity.
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11
Theory of Consumer
Behaviour
Therefore the individual will not be willing to pay as much for each additional
unit and this results in a downward sloping demand curve. At a price of Rs. 40
per unit x, individual’s demand for x was 5 units. The 6
th
 unit of commodity x
will be worth less than the 5
th
 unit. The individual will be willing to buy the 6th
unit only when the price drops below Rs. 40 per unit. Hence, the law of
diminishing marginal utility explains why demand curves have a negative slope.
2.1.2 Ordinal Utility Analysis
Cardinal utility analysis is simple to understand, but suffers from a major
drawback in the form of quantification of utility in numbers. In real life, we
never express utility in the form of numbers. At the most, we can rank various
alternative combinations in terms of having more or less utility. In other words,
the consumer does not measure utility in numbers, though she often ranks
various consumption bundles. This forms the starting point of this topic – Ordinal
Utility Analysis.
A consumer’s preferences over the set of available bundles can often be
represented diagrammatically. We
have already seen that the bundles
available to the consumer can be
plotted as points in a two-
dimensional diagram. The points
representing bundles which give the
consumer equal utility can generally
be joined to obtain a curve like the
one in Figure 2.3. The consumer is
said to be indifferent on the different
bundles because each point of the
bundles give the consumer equal
utility.  Such a curve joining all points
representing bundles among which
the consumer is indifferent is called
an indifference curve. All the points
such as A, B, C and D lying on an
indifference curve provide the consumer with the same level of satisfaction.
It is clear that when a consumer gets one more banana, he has to forego
some mangoes, so that her total utility level remains the same and she remains
on the same indifference curve. Therefore, indifference curve slopes downward.
The amount of mangoes that the consumer has to forego, in order to get an
additional banana, her total utility level being the same, is called marginal rate
of substitution (MRS). In other words, MRS is simply the rate at which the
consumer will substitute bananas for mangoes, so that her total utility remains
constant. So, / MRS Y X =|? ? |
3
.
One can notice that, in the table 2.2, as we increase the quantity of bananas,
the quantity of mangoes sacrificed for each additional banana declines. In other
words, MRS diminishes with increase in the number of bananas. As the number
3 
/ / ( / ) 0 Y X Y Xif Y X |? ? |=? ? ? ? =
            / ( / ) 0 Y Xif Y X =-? ? ? ? <
/ MRS Y X =|? ? | means that MRS equals only the magnitude of the expression / Y X ? ? . If
/ 3/1 Y X ? ? =- it means MRS=3.
Indifference curve. An indifference curve joins
all points representing bundles which are
considered indifferent by the consumer .
A
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Introductory
Microeconomics
of bananas with the consumer increases, the MU derived from each additional
banana falls. Similarly, with the fall in quantity of mangoes, the marginal utility
derived from mangoes increases. So, with increase in the number of bananas,
the consumer will feel the inclination to sacrifice small and smaller amounts of
mangoes. This tendency for the MRS to fall with increase in quantity of bananas
is known as Law of Diminishing Marginal Rate of Substitution. This can be
seen from figure 2.3 also. Going from point A to point B, the consumer sacrifices
3 mangoes for 1 banana, going from point B to point C, the consumer sacrifices
2 mangoes for 1 banana, and going from point C to point D, the consumer
sacrifices just 1 mango for 1 banana. Thus, it is clear that the consumer sacrifices
smaller and smaller quantities of mangoes for each additional banana.
Shape of an Indifference Curve
It may be mentioned that the law of Diminishing Marginal Rate of Substitution
causes an indifference curve to be convex to the origin. This is the most common
shape of an indifference curve. But in case of goods being perfect substitutes
4
,
the marginal rate of substitution does not diminish. It remains the same. Let’s
take an example.
Here, the consumer is indifferent for all these combinations as long as the total
of five rupee coins and five rupee notes remains the same. For the consumer, it
hardly matters whether she gets a five rupee coin or a five rupee note. So,
irrespective of how many five rupee notes she has, the consumer will sacrifice
only one five rupee coin for a five rupee note. So these two commodities are
perfect substitutes for the consumer and indifference curve depicting these will
be a straight line.
In the figure.2.4, it can be seen that consumer sacrifices the same number of
five-rupee coins each time he has an additional five-rupee note.
Table 2.2: Representation of Law of Diminishing Marginal Rate of Substitution
    Combination    Quantity of bananas (Qx)  Quantity of Mangoes (Qy)     MRS
             A                                    1                                              15                              -
             B                                    2                                              12                           3:1
             C                                    3                                               10                          2:1
             D                                   4                                                 9                           1:1
Table 2.3: Representation of Law of Diminishing Marginal Rate of Substitution
    Combination             Quantity of five                      Quantity of five               MRS
                                  Rupees notes (Qx)                 Rupees coins  (Qy)
             A                                    1                                               8                                 -
             B                                    2                                               7                               1:1
             C                                    3                                               6                                1:1
             D                                   4                                                5                               1:1
4 
Perfect Substitutes are the goods which can be used in place of each other, and provide exactly
the same level of utility to the consumer.
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