THEORY OF CONSUMER BEHAVIOUR : UTILITY APPROACH

 

 

• THEORY OF CONSUMER BEHAVIOUR
  
  
  
  UTILITY APPROACH
• RELATION BETWEEN MU AND TU
• LAW OF DIMINISHING MARGINAL UTILITY
  CA  FOUNDATION
• PRINCIPLE OF ECONOMICS/ MICRO ECONOMICS
• BY DR. SHASHI AGGARWAL
• UTILITY MEANING AND FEATURES
• RELATION BETWEEN MU AND TU
• LAW OF DIMINISHING MARGINAL UTILITY
• THEORY OF CONSUMER BEHAVIOR

1. THE FUNDAMENTAL POSTULATES OF THE CONSUMPTION THEORY IS THAT A CONSUMER AN INDIVIDUAL OR HOUSEHOLD IS AN UTILIZING MAXIMIZING ENTITY
2. THE CONSUMER WANTS TO GET MAXIMUM TOTAL UTILITY GIVEN HIS RESOURCES AND MARKET CONDITIONS
3. ALFRED MARSHALL WAS THE MAIN EXPONENT OF THIS UTILITY THEORY

• MEANING OF UTILITY??????
• 
  
  
  
• MEANING OF UTILITY

1. THE UTILITY IS TO DENOTE THAT QUALITY IN A COMMODITY OR SERVICES BY VIRTUE OF WHICH OUR WANTS ARE SATISFIED
2. WANT SATISFYING POWER OF A GOOD IS CALLED UTILITY.
3. ACCORDING HIBBDON,” UTILITY IS THE QUALITY OF A GOOD TO SATISFY A WANT.
4. MRS ROBINSON,” UTILITY IS THE QUALITY IN COMMODITY THAT MAKES INDIVIDUAL WANT TO BUY THEM.
   
   
   
   
   
   

• FEATURES
  
  
  
• UTILITY IS SUBJECTIVE:-BECAUSE IT DEALS WITH THE MENTAL SATISFACTION OF  A MAN. A THING MAY HAVE DIFFERENT UTILITY FOR DIFFERENT PERSONS. LIKE A MAY BE  DERIVING UTILITY FROM TEA BUT B HATES TEA AND GET UTILITY FROM COLD BEVERAGES
• UTILITY IS RELATIVE:- NEVER REMAIN THE SAME. IN SUMMER WE GET UTILITY FROM AC BUT IN WINTER WE GET UTILITY FROM HEATER.
• UTILITY IS NOT ESSENTIAL USEFUL : A COMMODITY HAVING UTILITY NEED NOT USEFUL.A CHAIN SMOKER DERIVE UTILITY FROM CIGARETTE BUT CONSUMPTION OF CIGARETTE IS INJURIOUS TO HEALTH.
• UTILITY IS INDEPENDENT OF MORALITY:-UTILITY OF DRUGS MAY NOT BE GOOD FROM THE MORAL POINT OF VIEW BUT STILL THEY SATISFY THE DEMAND OF DRUG TAKERS.
• UTILITY IS DIFFERENT FROM SATISFACTION:-IT IS THE QUANTITY OF GOOD THAT SATISFIES OUR WANT. ONE GETS SATISFACTION AFTER ONE’S WANT IS FULFILLED. UTILITY IS THE CAUSE AND SATISFACTION IS THE EFFECT.
• CONCEPTS OF UTILITY
• INITIAL UTILITY:- THE UTILITY IS DERIVED FROM THE FIRST UNIT OF A COMMODITY
• MARGINAL UTILITY:- CHAPMAN, MARGINAL UTILITY IS THE ADDITION MADE TO TOTAL UTILITY BY CONSUMING ONE MORE UNITS OF COMMODITY
• MU_N=TU_N-TU_N-1
• OR MU=∆TU/∆Q

 

• MARGINAL UTILITY CAN BE POSITIVE,: WHEN by CONSUMING ADDITIONAL UNITS TU GOES ON INCREASING
• ZERO MU=CAUSES NO CHANGE IN THE TOTAL UTILITY
• NEGATIVE MARGINAL UTILITY:- CAUSES FALL IN TOTAL UTILITY
• TOTAL UTILITY : THE UTILITY DERIVED FROM THE TOTAL NUMBER OF UNITS OF A COMMODITY CONSUMED TU_N=U₁+U_{2------------}            +U_N

 

 

• RELATION BETWEEN TOTAL UTILITY AND MARGINAL UTILITY
• 
  
  
  
• 
  
  
  
  
  
  
  
  
  
  
  
  
• JEVONS A NEO CLASSICAL WAS THE FIRST ECONOMISTS TO HIGHLIGHT THE RELATIONSHIP BETWEEN MARGINAL UTILITY AND TOTAL UTILITY
• TOTAL UTILITY IS THE SUMMATION OF MARGINAL UTILITY
• TU _4TH = MU₁ +MU₂+MU₃ +MU₄

 

• SIGNIFICANCE OF THE DIFFERENCE BETWEEN TOTAL AND MARGINAL UTILITY
• PARADOX OF VALUE:-

1. BELIEF OF ECONOMISTS THAT PRICE OF A COMMODITY WAS EQUAL TO TOTAL UTILITY
2. GOODS WHICH GIVE MORE VALUE SHOULD BE PRICED HIGH AND WHICH GIVES LOW VALUE SHOULD BE PRICED LOW BUT NOT IN REAL LIFE
3. WATER IS VERY MUCH ESSENTIAL FOR LIFE AND WE CAN NOT SURVIVE  WITHOUT WATER AND DIAMONDS WHICH ARE NOT AT ALL ESSENTIAL. BUT DIAMONDS ARE VERY EXPENSIVE ,THE PRICE OF WATER IS VERY LOW. WHY THIS HAPPEN. IT IS CALLED PARADOX OF VALUE.
4. THIS PARADOX HAS BEEN EXPLAINED BY JEVONS
5. PRICE IS DETERMINED BY ITS MARGINAL UTILITY AND NOT BY UTILITY. THINGS WHICH ARE AVIALABLE IN ABUNDENCE, WE GET SATURATION POINT SO THEIR UTILITY BECOMES ZERO DIAMONDS ARE VERY RARE SO THEIR TOTAL UTILITY NEVER REACHES ZERO. THEY COMMAND MORE PRICE.

• CONSUMER’S SURPLUS : A CONSUMER IS READY  AND WILLING TO PAY  FOR A COMMODITY MORE THAN ACTUAL PRICE
• THE DIFFERENCE BETWEEN THE PRICE IS HE IS READY TO PAY AND ACTUAL PAY IS CALLED CONSUMER SURPLUS.
• THE CONSUMER IS PREPARED TO PAY THE PRICE EQUIVALENT TO MARGINAL UTILITY OF THE MARGINAL UNIT OF THE COMMODITY.
• LAW OF DIMINISHING MARGINAL UTILITY
  
  
• HOW TO ATTEMPT IN EXAMINATION????
• DISCUSS THE LAW OF DIMINISHING MARGINAL UTILITY ????

1.     BRIEF MEANING OF UTILITY AND MARGINAL UTILITY

2.     CONCEPT OF DIMINISHING MARGINAL UTILITY

3.     DEFINITION

4.     ASSUMPTIONS

5.     EXPLANATION WITH DIAGRAM

6.     EXCEPTION

7.     CRITICISM

• LAW OF DIMINISHING MARGINAL UTILITY
• FUNDAMENTAL LAW OF UTILITY ANALYSIS. THE LAW OF DIMINISHING MARGINAL UTILITY EXPLAINS THE RELATION UTILITY AND QUANTITY OF A COMMODITY. IT IS A PSYCHOLOGICAL FACT THAT WHEN A CONSUMER GETS MORE AND MORE UNITS OF A COMMODITY DURING A PARTICULAR TIME, THE UTILITY FROM THE SUCCESSIVE UNITS GOES ON DIMINISHING.
• DR. MARSHALL ,” THE ADDITIONAL BENEFIT WHICH A PERSON DERIVES FROM A GIVEN INCREASE OF HIS STOCK OF A THING DIMINISHES WITH EVERY INCREASE IN THE STOCK THAT HE ALREADY HAS.
• PROF BOULDING,” AS A CONSUMER INCREASES THE CONSUMPTION OF ANY ONE COMMDOITY KEEPING CONSTANT THE CONSUMPTION OF ALL OTHER COMMODITIES,THE MARGINAL UTILITY OF THE VARIABLE COMMODITY MUST EVENTUALLY DECLINE.
• ASSUMPTIONS

1.  UTILITY CAN BE MEASURED IN CARDINAL NUMBERS
2. MARGINAL UTILITY OF MONEY REMAINS CONSTANT
3. MARGINAL UTILITY OF EVERY COMMODITY IS INDEPENDENT
4. EVERY UNIT OF THE COMMODITY BEING USED IS OF SAME QUALITY AND SIZE.
5. CONTINUOUS CONSUMPTION
6. SUITABLE AND PROPER QUANTITY OF THE COMMODITY IS CONSUMED
7. NO CHANGE IN THE INCOME, FASHION ,HABITS AND PRICE OF THE COMMODITY
8. THE GOODS AND PERSONS ARE NORMAL
9. GOODS ARE DIVISIBLE

• EXPLANATION
• 
• EXPLANATION OF THE LAW
•  

 

• EXPLANATION
• MARGINAL  UTILITY SLOPES DOWN WARD FROM LEFT TO RIGHT. WHICH INDICATES AS WE CONSUME MORE UNITS THE MARGINAL UTILITY GOES ON DECLINING. AT FIFTH UNIT IT BECOMES ZERO AND AT SIXTH UNIT  AT BECOMES NEGATIVE.
• CAUSES
  
  
• COMMODITIES ARE NOT PERFECT SUBSTITUTE:THEY ARE IMPERFECT SUBSTITUTE. TEND TO BE CONSUMED IN CERTAIN APPROPRIATE PROPORTION FOR GETTING MAXIMUM SATISFACTION.  WHEN THESE PROPORTION IS DISTURBED,CONSUMER WILL NOT GET THE MAXIMUM SATISFACTION
• SATISFACTION OF PARTICULAR WANTS: ALTHOUGH ALL THE WANTS OF MAN CAN NOT BE SATISFIED BUT ONE PARTICULAR WANT IS FULLY SATIABLE
• WE GIVE TOP PRIORITY TO THE MOST IMPORTANT USE:-EACH COMMODITY HAS MANY ALTERNATIVES,SOME USES  ARE MORE IMPORTANT WHILE OTHERS ARE LESS
• EXCEPTION
• INITIAL UNITS: WHEN THE INITIAL UNITS OF A COMMODITY ARE USED IN VERY SMALL THAN APPROPRIATE QUANTITY,THEN THE MARGINAL UTILITY FROM THE ADDITIONAL UNITS GOES ON INCREASING AND THE LAW WILL NOT OPERATE BUT THIS EXCEPTION IS ALSO NOT CORRECT. THE ASSUMPTION IS OF THE USE OF APPROPRIATE QUANTITY.
• RARE AND CURIOUS THINGS:THE LAW DOES NOT APPLY TO RARE AND CURIOUS THINGS LIKE OLD COINS,RARE PAINTING,OLD STAMPS ETC AS WE COLLECT THEM MORE THE UTILITY GOES ON INCREASING BUT THIS ASSUMPTION IS NOT CORRECT. BECAUSE WHEN A STAMP COLLECTOR COLLECT GO ON THE SAME KIND THEN MARGINAL UTILITY GOES ON DIMINISHING
• DRUNKARDS: LAW DOES NOT OPERATE  TO DRUNKARD AS HE TAKES MORE PEG HIS DESIRE TO TAKE MORE GOES ON INCREASING BUT THIS EXCEPTION IS NOT TRUE A STAGE COMES WHERE HE LOSES HIS SENSES
• MISERS: THEIR DESIRE FOR MONEY IS INSATIABLE,  BUT THIS IS NOT TRUE. BUT AS THE AMOUNT OF WEALTH INCREASES UTILITY GOES ON DECEASING
• GOOD BOOKS, POEMS AND MUSIC: WE WANT TO READ GOOD BOOK AGAIN AND AGAIN BUT THIS EXCEPTION IS NOT TRUE BECAUSE AFTER ONE STAGE  WE WILL START LOSING OUR INTEREST.

 

• CRITICISM AND SIGNIFICANCE OF LAW OF DIMINSHING MARGINAL UTILITY
  CRITICISM

1. MEASUREMENT OF THE UTILITY IS NOT POSSIBLE: BUT UTILITY OR SATISFACTION REFERS TO STATE OF MIND AND IS INCAPABLE OF BEING MEASURED.
2. MARGINAL UTILITY OF MONEY DOES NOT  REMAIN CONSTANT:AS THE STOCK OF MONEY DECREASES THEN UTILITY INCREASES AND VICE VERSA
3. UTILITY IS NOT RELATIVELY INDEPENDENT: IT IS AFFECTED BY CONSUMPTION OF OTHER GOODS
4. DOES NOT SPECIFY AT WHAT RATE MARGINAL UTILITY DECLINES
5. BASED ON UNREALISTIC ASSUMPTIONS:
• FASHION,TASTE ,HABITS ,INCOME ARE NOT CONSTANT
• MARGINAL UTILITY OF MONEY IS NOT CONSTANT
• UTILITY CAN NOT BE MEASURED

 

• SIGNIFICANCE OF THE LAW
• BASIS OF THE LAW OF CONSUMPTION:PROVIDES THE FOUNDATION OF VARIOUS LAWS OF ECONOMICS
• EQUI MARGINAL UTILITY: A CONSUMER DOES NOT SPEND ALL HIS INCOME ON ONE COMMODITY. TO GET THE MAXIMUM SATISFACTION HE SPENDS HIS LIMITED INCOME IN SUCH A WAY THAT THE LAST UNIT OF MONEY SPEND ON DIFFERENT GOODS YIELD EQUAL SATISFACTION
• BASIS OF THE LAW OF DEMAND: BASED ON LAW OF DIMINISHING MARGINAL UTILITY. MORE QUANITY IS PURCHASED AT LOW PRICE BECAUSE MARGINAL UTILITY OF THE ADDITIONAL UNITS BECOME LESS AND LESS. SO THE CONSUMER WILL BE READY TO PAY LESS PRICE
• BASIS OF CONCEPT OF CONSUMER’S SURPLUS:-A CONSUMER PURCHASE AS MANY UNITS OF A COMMODITY,THE MARGINAL UTILITY OF WHICH IS EQUAL TO PRICE. IN THIS WAY THE CONSUMER OBTAINS SOME SURPLUS UTILITY FROM THE EARLIER UNITS.CALLED CONSUMER’S SURPLUS.

 

• IMPORTANCE FOR THE CONSUMER:-IT HELPS THE CONSUMER TO PLAN HIS EXPENDITURE.FROM THIS LAW HE LEARNS THAT HE SHOULD NOT PURCHASES MORE OF THE SAME COMMODITY RATHER SHOULD BUY SOME UNITS OF SOME OTHER COMMDOITES
• VARIETY IN PRODUCTION:-IT IS BECAUSE OF THE APPLICATION OF THE LAW OF DIMINISHING MARGINAL UTILITY VARIETY IN PRODUCTION IS FOUND
• THE LAW HELPS IN PRICE DETERMINATION: THE LAW OF DIMINISHING MARGINAL UTILITY HELPS IN PRICE FIXATION
• DIFFERENCE IN VALUE IN USE AND VALUE IN EXCHANGE:  IT EXPLAINS DIAMOND WATER PARADOX  WHICH WAS NOT FULLY EXPLAINED BY ADAM SMITH. WHY VALUE OF DIAMOND IS MORE THAN WATER BUT UTILITY OF WATER IS MORE THAN DIAMOND.ADAM SMITH EXPLAINED  AND DIVIDED VALUE IN TWO PARTS :
• VALUE IN USE AND VALUE IN EXCHANGE
• GOODS HAVING MORE VALUE COMMAND LOW PRICE AND GOODS HAVING MORE VALUE IN EXCHANGE HIGH PRICES, BUT DID NOT TELL ANY REASON FOR IT.

·         NEO CLASSICAL ECONOMISTS EXPLAINS ON THE BASIS OF MARGINAL UTILITY. ACCORDING TO THEM THERE IS ABUNDANCE SUPPLY OF WATER AND SO THEIR MARGINAL UTILITY FALL QUICKLY AND PRICE ALSO

·         ON THE OTHER HAND DIAMOND ARE LIMITED AND HAVE MORE VALUE IN EXCHANGE AND SO THEIR MARGINAL UTILITY FALLS SLOWLY AND THE COMMAND HIGH VALUE.

• BASIS OF PROGRESSIVE TAXATION:
• THE SYSTEM  OF PROGRESSIVE TAXATION WHICH LEVIES HIGHER TAXES ON HIGHER INCOME AND LOW TAXES ON LOW INCOME IS ALSO BASED ON THE APPLICATION OF LAW TO MONEY SINCE THE MARGINAL UTILITY OF MONEY TO THE RICH IS LESS AND SO THEY ARE TAXED MORE AS COMPARED TO POOR WHOSE MARGINAL UTILITY IS MORE
• BASIS OF REDISTRIBUTION:WEALTH IS DISTRIBUTED IN FAVOR OF THE POOR THE TOTAL WELFARE OF THE NATION WILL INCREASE.