SSC CGL Economics Notes: Consumer Behavior
SSC CGL Economics Notes: Consumer Behavior
Theory of Consumer Behaviour
THE CONSUMER’S BUDGET
The consumption bundles that are available to the consumer depend on the prices of the two goods and the income of the consumer
With a fixed income a consumer can buy only those combination of goods which will
cost him less.
The set of bundles available to the consumer is called the budget set.
The budget set is thus the collection of all bundles that the consumer can buy with her
income at the prevailing market prices.
PREFERENCES OF THE CONSUMER
The budget set consists of all bundles that are available to the consumer.
The consumer can choose her consumption bundle from the budget set. But on what basis does she choose her consumption bundle from the ones that are available to her?
In economics, it is assumed that the consumer chooses her consumption bundle on the basis of her tastes and preferences over the bundles in the budget set.
a consumer’s preferences are monotonic if and only if between any two bundles, the
consumer prefers the bundle which has more of at least one of the goods and no less of
the other good as compared to the other bundle.
Substitution between Goods:
The rate of substitution is the amount of good 2 that the consumer is willing to give up
for an extra unit of good 1.
It measures the consumer’s willingness to pay for good 1 in terms of good 2.
The rate of substitution between the two goods captures a very important aspect of the
Diminishing Rate of Substitution:
As the amount of good 1 increases, the rate of substitution between good 2 and good 1
diminishes. Preferences of this kind are called convex preferences.
The points representing bundles which are considered indifferent by the consumer can
generally be joined to obtain a curve.
Such a curve joining all points representing bundles among which the consumer is
indifferent is called an indifference curve.
An indifference curve joins all points representing bundles which are
considered indifferent by the consumer.
monotonicity of preferences implies that any point above the indifference curve
represents a bundle which is preferred to the bundles on the indifference curve.
For small changes, the rate of substitution between good 2 and good 1 is called the marginal rate of substitution (MRS).
The indifference curve slopes downward.
Diminishing Rate of Substitution. The amount of good 2 the consumer is willing to give up for an extra unit of good 1 declines as the consumer has more and more of good 1.
Indifference Map. A family of indifference curves. The arrow indicates that bundles on higher indifference curves are preferred by the consumer to the bundles on lower indifference curves.
Utility, or usefulness, is the (perceived) ability of something to satisfy needs or wants. It represents satisfaction experienced by the consumer of a good. Not coincidentally, a good is something that satisfies human wants and provides utility, for example, to a consumer making a purchase.
Though literally there is almost no difference between desire and demand, economics
treat them as two aspects. While desire refers to the willingness to purchase or buy a
commodity, on the other hand demand refers to willingness to pay and ability to pay.
The change in the optimal quantity of a good when its price changes and the consumer’s income is adjusted so that she can just buy the bundle that she was buying before the price change is called the substitution effect.
Law of Demand:
If a consumer’s demand for a good moves in the same direction as the consumer’s
income, the consumer’s demand for that good must be inversely related to the price of the good.
Law of demand states that people will buy more at lower prices and buy less at higher prices.
The amount demanded increases with a fall in price and diminishes with a rise in price.
Types of Demand:
Price demand-Inverse relationship between price and demand.
Income Demand: Direct relationship between price and demand
Cross Demand: Largely influenced by Substitutes.
Joint and composite Demand: leading to the demand for another commodity. E.g.Demand for coal and rubber. Direct and Indirect Demand, Alternate demand, Competitive demand.
The demand curve is a relation between the quantity of the good chosen by a consumer and the price of the good. The independent variable (price) is measured along the vertical axis and dependent variable (quantity) is measured along the horizontal axis. The demand curve gives the quantity demanded by the consumer at each price.
Normal and Inferior Goods:
For most goods, the quantity that a consumer chooses, increases as the consumer’s
income increases and decreases as the consumer’s income decreases. Such goods are called normal goods. Thus, a consumer’s demand for a normal good moves in the same direction as the income of the consumer.
However, there are some goods the demands for which move in the opposite direction of the income of the consumer. Such goods are called inferior goods.
Substitutes and Complements:
The quantity of a good that the consumer chooses can increase or decrease with the rise
in the price of a related good depending on whether the two goods are substitutes or
complementary to each other.
Goods which are consumed together are called complementary goods.
And those which can replace each other are called as substitutes.
Shifts in the Demand Curve:
Refers to a change in demand either relationship between price or the other factors. If
change results from the change in price, it may either be an extension or a contraction. On
the other hand when the demand curve shifts on account of other factors other than price,
it is called either an increase or decrease in demand.
For normal goods, the demand curve shifts rightward and for inferior goods, the demand curve shifts leftward.
If there is an increase in the price of a substitute good, the demand curve shifts rightward. On the other hand, if there is an increase in the price of a complementary good, the demand curve shifts leftward.
If the consumer’s preferences change in favour of a good, the demand curve for such a good shifts rightward. On the other hand, the demand curve shifts leftward due to an unfavorable change in the preferences of the consumer.
The market demand for a good at a particular price is the total demand of all consumers taken together.
The market demand for a good can be derived from the individual demand curves.
The market demand for the good at each price can be derived by adding up the demands of the two consumers at that price. If there are more than two consumers in the market for a good, the market demand can be derived similarly.
ELASTICITY OF DEMAND:
Responsiveness of demand to the change in price and the other factors of demand is known as elasticity of demand. Or %age change in quantity demanded to the %age change in price.
The demand for a good moves in the opposite direction of its price.
The impact of the price change is always not the same.
Sometimes, the demand for a good changes considerably even for small price changes.
On the other hand, there are some goods for which the demand is not affected much by price changes.
Demands for some goods are very responsive to price changes while demands for certain others are not so responsive to price changes.
Price-elasticity of demand is a measure of the responsiveness of the demand for a good to changes in its price. Price-elasticity of demand for a good is defined as the percentage change in demand for the good divided by the percentage change in its price. Price elasticity of demand for a good eD =percentage change in demand for the good/percentage change in the price of the good Summary: The budget set is the collection of all bundles of goods that a consumer can buy with her income at the prevailing market prices.
• The budget line represents all bundles which cost the consumer her entire income. The budget line is negatively sloping.
• The budget set changes if either of the two prices or the income changes.
• The consumer has well-defined preferences over the collection of all possible bundles. She can rank the available bundles according to her preferences over them.
• The consumer’s preferences are assumed to be monotonic.
• An indifference curve is a locus of all points representing bundles among which the consumer is indifferent.
• Monotonicity of preferences implies that the indifference curve is downward sloping.
• A consumer’s preferences, in general, can be represented by an indifference map.
• A consumer’s preferences, in general, can also be represented by a utility function.
• A rational consumer always chooses her most preferred bundle from the budget set.
• The consumer’s optimum bundle is located at the point of tangency between the budget line and an indifference curve.
• The consumer’s demand curve gives the amount of the good that a consumer chooses at
different levels of its price when the price of other goods, the consumer’s income and her tastes and preferences remain unchanged.
• The demand curve is generally downward sloping.
• The demand for a normal good increases (decreases) with increase (decrease) in the consumer’s income.
• The demand for an inferior good decreases (increases) as the income of the consumer increases (decreases).
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