UNIT:-2

Consumers Demand Theory :-

The theory of consumers behavior seeks to explain how a consumer tries to maximize his or her
satisfaction by consuming various combination of goods & services. There are many
approaches that explain the consumer behavior because of the unlimited wants & limited
resources. A consumer always wants to maximize the level of satisfaction by the best utilization
of available resources. So, the study, by w hich, consumer selects the commodities from the bulk
by the use of available budget is consumer's behavior.
Utility:
Utility means want satisfying power of a commodity
"Utility is defined as property of a commodity or goods which satisfies the want of the
consumer."

Goods that possess utility may not give pleasure when consumed. Bitter tasting commodity like
quinine, is purchased and consumed because it fulfills human want, But it does not provide
pleasure to the consumer. thus,
Any goods whether that may give pleasure to the consumer or not, can have utility.
Those utility differs from place from person to person according to their use.
There are three main forms of utility, they are:-
i) Form utility ii) Place utility iii) Time utility
Characteristics of Utility :
1) Utility is the want satisfying capacity contained in goods & services.
2) Usefulness is not essential to have utility, instead, it should fulfill the wants.
3) Utility depends on the intensity of need of human being.
4) It is also affected by time or situation.
5) It is not own feature of commodity.
6) It is based on the introspection of the consumers.

Kinds of Utility:
1. Total Utility
2. Marginal Utility
3. Average Utility
1) Total Utility:
The Utility obtains by the consumes from all consumption units in a given periods of
time is known as T.U. It can be expressed as the sum of M.U. Hence.
TU =
or
TU= AU×Q
Q= Total No of commodity.
2) Average Utility:
A.U. May Be Defined as the Utility per Unit of consumption. It is obtained by dividing
the TU with the number of consumption units.

i.e. AU =

3) Marginal Utility:
Utility obtained by the consumer from the last unit of consumption goods at a specific
time is known as M.U.
M.U. also defines as the change in T.U. due to one unit change in consumption.
Formula:

M.U. =

Example:-

Units TU MU AU
0 0 0 0
1 12 12 12
2 20 8 10
3 24 4 8
4 24 0 6
5 20 -4 4
6 12 -8 2
 Y
Combined diagram:-

60

50
TU Satiation Point
40
D
C E
30
B F
20
A
10
Y
O X
1A 2 3 4 5 6
12 b

10 b
B
AU 8 d

MU 6 e
C
4 f
(+)
2
AU
D
O
1 2 3 4 5 6
Satiation Point
(-) -2
E
-4

-6
F
-8 MU
Relationship between TU & MU :
1) TU increases until MU is positive but the rate of increase in TU is decreasing.
Therefore, TU curve is increasing until the MU curve is positive.
2) TU is highest when MU is zero. Hence TU curve is highest when MU curve touches X-
axis.
3) TU decreases when MU is negative so, TU curve decreases when MU curve touches
below x-axis.

Measurement of Utility:
There are two approaches regarding consumer's behavior or utility analysis. They are
1) Cardinal utility approach
2) Ordinal Utility approach
Cardinal Utility Approach
Prof. Marshall & Pigou described/ explained that utility can be measured by money. If a
person is purchasing any commodity then generally he pays money so that money is the
measurement of utility. e.g. If a person is paying 200 Rs. for a commodity than the utility he is
getting through that good is equal to the money that he pays for purchasing that particular
commodity. Hence, According to this approach utility derived from consumption of any goods
& services can be expressed in numbers like, 1, 2, 3 etc. & the unit used to denote utility is utils.
Assumptions of Cardinal Marginal Utility :
1) The cardinal Measurability of Utility :
C.M.U. hold the view that utility is a measurable and certifiable entity. According to that, a
person can express the utility or satisfactory he derives from the goods in quantitative terms.
Moreover the, cardinal measurement of utility assumes that the person can compare in suspect
of size how much one level of utility is greater than another, that is, a person can say that utility
he gets from the consumption of one unit of good B is double the utility he obtains from the
consumption of one unit of good A.
2.) Measurability of utility may mean two thing:
According to marshall, marginal utility, measurable in principle, is also actually measurable in
terms of money. Money represents the neutral purchasing power and it can therefore be
regarded as command over all tentative utility yielding goods. the amount of money which a
person is prepared to pay for a unit of a good rather than go without it, is a measure of the
utility he derives from that good. thus, money is the measuring rod of utility.
3.) The hypothesis of independent utility:
The second important tenet of the cardinal utility analysis is the hypothesis of independent
utilities. The utility which a consumer obtains from a good does not depend upon the quantity
consumed of other goods. It depends upon the quantity purchased of that good alone.
4.) Constancy of the marginal utility of money-
Another important assumption of the marginal utility analysis is the constancy of the marginal
utility of money. Thus while the marginal utility analysis assumes that marginal utilities of the
commodities diminish as no of them are purchased or consumed, but the M.U. of money
remains constant throughout when the individual is spending money on a good and due to
which the amount of money with them varies.
Laws of cardinal marginal utility Analysis :-
cardinal M.U. analysis have developed two laws which occupy an important place in
economic theory.
1.) Law of diminishing marginal utility.
2.) Law of equi - marginal utility.

Law of diminishing marginal Utility:

One of the most important propositions of the consumption theory is the law of diminishing
marginal utility.
"When a man consumes more of a thing, less of the utility he obtains."
Intro :
Law of diminishing marginal utility is based on the consumption behaviors of the
consumes. As this law was first propounded by H.H. Gossen (1854) it is known as first law of
Gossen. If was modified & Popularized by Prof. Alfred marshall. in (1890)
H.H.= Herman Heinrish Gossen

According to Prof. Marshall

"As a consumer increases the consumption of any one commodity, keeping constant the
consumption of other commodities the M.U. Of the variable commodity must eventually
decline.
In other words of Prof. Briggs-
"The M.U. of a stock of similar goods decreases with increases the numbers of units of
the stock."
In
No. of Bread M.U. T.U.
0 0 0
1 20 20
2 15 35
3 10 45
4 5 50
5 0 Full Satisfactory 50
6 -5 45
other words "the law of diminishing marginal utility states that as a person consumes more of a
given commodity the marginal utility of the commodity declines & eventually becomes zero.
With every additional unit of goods, its utility decreases. the utility obtained from the first unit
is more than that from the second unit & the utility obtained. From the 2nd Unit is more than
that of the 3rd unit & so on. If the consumer continues to consume certain goods, at one Point,
the utility of these partial goods becomes zero. This point known as saturation point if more
units of the goods are consumes after saturation point the utility becomes negative. This is
known negative utility or disutility
DIAGRAM:-
EXPLANATION:-
TU=?
MU=?
AU=?
Assumption
1) Similar Units of commodity
2) Suitable unit of commodity
3) Continues consumption
4) Unchanged mental condition
5) Unchanged habit & fashion
6) Constant Price of commodity
7) Constant level of income
8) Normal persons
9) Normal good.
Exception of law of D.M.U.
1) Rare & curious goods
2) Public goods
3) Intoxicants
4) Poetry music & good books
5) Goods of display
6) Money
7) Durable goods
8) Unstable price
9) Change in other's stock
Importance of the law of DMU
1) Base of economic law
2) Base of socializing
3) Base of Taxation
4) Base of Price theory
5) Base of household expenditure
 6) To differentiate value in use & valve in exchange.
7) Useful in sales promotion
8) Determination of social service
Criticism of the law of DMU
1) It is difficult to measure utility boozed it is a psychological concept.
2) It is unreal bacon I this law gives prurience to personal sediments
3) The assumption of "other things remaining the same" is unreal.
4) The utility of a commodity does not depend upon the same commodity but still depends
upon related goods.
5) This law is related to micro analysis not macro analysis

Law of equi - marginal utility Analysis

or
Law of substitution
Law of equi - marginal utility is related to the consumption behaviors of the consumers. It is
based on the law of diminishing marginal utility. As this law was propounded by H.H. gossen, it
is known as the second law of gossen. further development in it was made by famous neo-
classical economist Alfred mar shall.
Statement- A consumer has various wants but the resources to fulfill is limited & wants are
unlimited, so he must have to purchase commodities in such a way that the marginal utility
from last unit of money expenditure would be equal, which would yield maximum level of
satisfaction to him.
According to marshall ,"If a person has a commodity which can be put into several
uses, he will distribute it among these uses in such a way that he has same marginal utility, for it
had a greater M.U. in one use then the others, he would gain by taking away some of it from the
second use and applying it to the first."
Assumptions-
i) consumer is a rational being and can goes the M.U of various commodities.
ii) Income of the consumer remains constant.
iii) Interest, habit and fashion of the consumer do not change.
iv) Money is the measuring unit of utility. so, M.U. of money remains constant.
v) Commodities are divisible.
vi) The budget of the consumer should be given throughout the experiment.
vii) M.U. form different commodity should be different and independent.
Explanation-
According to this law consumers have to use their resources in more than one commodity and
should allocate the resources in such a way that the M. U. of all uses is equal. This maximizes
the utility of the consumer from their limited resources. This condition of maximum satisfaction
is known as consumer's equilibrium. As if consumer uses his all resources in single commodity,
it's MU decreases successively & TU will be lowered. As the consumer is the rational being, he
wants to maximize his utility. The consumer uses his resources in more than one commodity to
do so. As MU of all commodities is made equal in the process of utility maximization, this law is
known as law of equi-marginal utility.
Since, less useful commodities are substituted by more useful commodities; it is called
law of substitution.
Law of equi-marginal utility is based on the fact that, a consumer will go on substituting one
good with a higher MU for another with a lower MU until the MU of each good is in proportion
to its price & the rate is equal to the MU of money.
Mathematically,

Where,
MUA, MUB, MUC = MU of goods A, B & C
PA, PB, PC = Price of goods A, B & C
MUM =MU of money
Unit of Money Marginal Utility from Apple Marginal Utility from Banana
(MUA) (MUB)
1 10 7
2 8 6
3 6 5
4 4 4
5 2 3
Total Utility 30 25
If a consumer spends all his money in purchasing apples, he would be able to receive 30
utils of utility & in consuming all 5 units of banana, he would receive only 25 utils of utility. But
on purchasing 3 units of apple & 2 units of banana, he will receive 37 utils of TU which no other
combinations can provide him.

Diagram:-

Limitations-
i. Ignorance of the consumer ii. Measurement of utility
iii. MU of money is not constant iv. Addiction
v. Does not apply during customs & traditions
vi. Does not apply in case of indivisible goods
vii. Non availability of goods viii. Price change
ix. Complementary goods x. Irrational consumer
xi. Durable goods xii. Rationing of goods

Importance-
i. In the area of consumption ii. In the area of production
iii. In the area of exchange iv. In the area of distribution
v. In the area of public finance vi. In price determination
vii. Allocating time between work & leisure
viii. Spending of saving in different type of assets

Critical Evaluation of Cardinal Marginal Utility Analysis

1. Utilitarian Hedonistic Premises of Utility Analysis Challenged:
First, it has been pointed out that hedonistic interpretation of utility as pleasure, gratification,
decidedness, & to attribute motive to the consumer, has been criticized as unrealistic.
2. Cardinal Measurability of Utility is Unrealistic: MU analysis of demand is based on the
assumption that utility can be measured. In other words, utility is cardinally measurable.
According to this, how much utility a consumer obtains from goods can be expressed in such
quantitative or cardinal numbers 1, 2, 3, 4, & so forth. But in actually practice utility cannot be
measured in such quantitative & cardinal terms.
3. Hypothesis of Independent Utilities is Wrong:
Cardinal utility analysis also assumes that utilities derived from various goods are
independent. But in real life it is not so. In actual life, the utility or satisfaction derived from a
good depends upon the availability of some other goods which may either be substitute for or
complementary with the former.
4. Assumption of MU of Money is not valid:
It increases because when the price rises or decreases.
5. MU analysis assumes too much & explains too little