2.

CONSUMER BEHAVIOUR
In this topic, we are going to explore the foundational aspects of Consumer Behavior, a
key area in economics that examines how individuals make decisions about spending their
limited resources. Specifically, we will:
• Understand Consumer Choices: Learn how consumers prioritize their needs and wants
based on preferences and constraints.
• Analyze Utility: Explore the concept of utility, both total and marginal, to understand
how satisfaction influences decision-making.
• Examine Budget Constraints: Study how income and prices limit consumer choices and
affect purchasing decisions.
• Use Economic Models: Delve into tools like indifference curves and budget lines to
visualize and analyze consumer equilibrium.
• Apply Real-World Insights: Connect these theories to real-life scenarios, such as
changes in demand due to price shifts or income variations.
• By the end of this topic, you will have a solid grasp of how and why consumers behave the
way they do, setting the stage for understanding broader economic principles like demand
and market interactions."
 2.1 DEMAND AND SUPPLY ANALYSIS
• Demand and Supply are the fundamental concepts of economics, forming the
backbone of market theory. Together, they explain how prices and quantities of goods
and services are determined in a market economy.
 DEMAND

Demand refers to the quantity of a good or service that

consumers are willing and able to purchase at various prices
over a specific period of time.
The Law of Demand: There is an inverse relationship between
price and quantity demanded, ceteris paribus (all other things
being equal).
• As the price decreases, the quantity demanded increases.
• As the price increases, the quantity demanded decreases.

The Demand Curve: A graphical representation of the

relationship between price and quantity demanded. It slopes
• As a quick example, tickets to a Yo Maps concert next weekend are being sold at a price
of ZMW 5,000 per ticket. Yo Maps may be your favorite artist, but at this price, you may
be unwilling to purchase even a single ticket. If the show organizers were to lower the
price, the quantity of tickets you’d be willing to purchase would likely increase.
If the price is set at ZMW 250, you may be willing to purchase 3 tickets. If they lowered the
price further to ZMW 50, you may be willing to buy 10 tickets. This is the law of demand at
work. Despite a strong desire to see an artist on stage or despite a desire to purchase a
good you’ve been longing to have, price matters. This information can be presented
graphically with the price on the vertical axis while quantity on the horizontal axis.
 Demand curve for Yo maps' concert tickets)

250

200

150
Price (ZMW)

100

50

0
0 0.5 1 1.5 2 2.5

Quantity (Q)
 DETERMINANTS OF DEMAND
1. Price of the good (movement along the curve).

2. Income
•Normal goods: Demand increases with income.
•Inferior goods: Demand decreases with income.

3. Prices of related goods:

•Substitutes: Increase in the price of one leads to an increase in demand for the
other.
•Complements: Increase in the price of one leads to a decrease in demand for the
other.
4. Consumer preferences.

5. Expectations about future prices and income.

6. Population size: Larger populations increase demand.

• When we talk of determinants of demand , we are simply talking about factors that may
bring about an upward or downward movement of the demand curve.
•
Demand curve
250

200

150
Prce

100

50

0
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5

Quantity
 SUPPLY
Supply refers to the quantity of a good or service that producers are willing and able to
offer for sale at various prices over a specific period of time.
• The Law of Supply: There is a direct relationship between price and quantity supplied,
ceteris paribus.
• As the price increases, the quantity supplied increases.
• As the price decreases, the quantity supplied decreases.

• The Supply Curve: A graphical representation of the relationship between price and
quantity supplied. It slopes upward from left to right.
 DETERMINANTS OF SUPPLY

1. Price of the good (movement along the curve).

2. Costs of production: Higher costs reduce supply.
3. Technology: Improvements increase supply.
4. Prices of related goods: Opportunity costs of producing one good
over another.
5. Expectations about future prices.
6. Taxes and subsidies: Taxes decrease supply, subsidies increase
supply.
7. Number of producers: More producers increase market supply.
 NON PRICE DETERMINANTS OF SUPPLY
• Costs of the factors of production - assuming price stays constant, an increase in
costs, such as labour costs, will reduce the firm's willingness and ability to supply. A
reduction in costs will increase a firm's willingness and ability to supply. For example,
an increase in the wages of restaurant waiters will make it more expensive to supply
meals, and the restaurant will supply fewer meals at all prices. Changes in exchange
rates will alter the costs of imported raw materials - a fall in the exchange rate will
increase import costs and a rise in the exchange rate will reduce imported costs.
• Changes in the availability of factors of production - if there are problems in
the supply chain meaning fewer raw materials are available, there will be a reduction
in supply at all prices. Labour shortages, strikes by workers and bad weather can all
disrupt supply.
• Weather and natural supply shocks - poor weather or natural disasters will reduce
supply at all prices and shift the supply curve to the left. Better than normal weather
conditions can shift supply to the right.
• Changes in indirect taxes - taxes on goods and services have the same
effect as an increase in costs. A tax rise will shift the whole supply curve
vertically upwards by the amount of the tax per unit.
• Changes in subsidies - a subsidy will reduce production costs and shift
the supply curve downwards.
• Expectations - producers may change their current supply based on
how they expect the market to change in the future. If there is a view
that demand for a good or service will increase in the future, producers
may increase production today in readiness for these increases in
demand.
• Changes in stock levels - producers can control the supply that goes to
market by adding to their stocks or by releasing from stocks. Releasing
from stocks will shift the supply curve to the right.
 Movements and shifts of the supply curve
• Movement Along the Curve: Caused by a change in the price of the good itself.
• Shift of the Curve: Caused by changes in determinants other than price (e.g.,
income, preferences for demand; costs of production, technology for supply).
Interaction of Demand and Supply
• Changes in demand and supply can lead to new equilibrium prices and quantities.
• Understanding these interactions is key to analyzing markets, forecasting trends, and
assessing policy impacts.
 REAL-WORLD APPLICATIONS

• Price Controls: Governments may impose price ceilings (maximum prices) or price
floors (minimum prices) to intervene in markets.
• Elasticity: Examines how responsive demand and supply are to changes in price,
income, or other factors.
• Market Dynamics: Demand and supply analysis is used to understand shifts in
housing markets, labor markets, and commodity prices.
• By studying demand and supply, we can predict how markets respond to changes in
economic conditions and make informed decisions in business and policy-making.
 2.2 ELASTICITY OF DEMAND AND SUPPLY
• Elasticity measures the responsiveness of one variable to changes in
another. In economics, it is widely used to analyze how changes in price,
income, or other factors affect demand and supply. It helps businesses,
governments, and consumers understand how sensitive the market is to
changes.
 PRICE ELASTICITY OF DEMAND (PED)

The responsiveness of the quantity demanded of a good or service to changes

in its price.

• Elastic Demand (PED > 1): Quantity demanded changes by a larger

percentage than the price change.Example: Luxury goods.
• Inelastic Demand (PED < 1): Quantity demanded changes by a smaller
percentage than the price change.Example: Necessities like medicine and
staple food.
• Unitary Elastic Demand (PED = 1): Quantity demanded changes by the same
percentage as the price change.
 DETERMINANTS OF PED
• Availability of substitutes: More substitutes → Higher elasticity.
• Proportion of income spent: Larger proportion → Higher elasticity.
• Necessity vs. luxury: Necessities → Inelastic; Luxuries → Elastic.
• Time period: Demand tends to be more elastic in the long run as
consumers adjust
 PRICE ELASTICITY OF SUPPLY (PES)

The responsiveness of the quantity supplied of a good or service to

changes in its price.

•Elastic Supply (PES > 1): Quantity supplied changes more than the price.
•Inelastic Supply (PES < 1): Quantity supplied changes less than the price.
•Unitary Elastic Supply (PES = 1): Quantity supplied changes proportionally with price.
 DETERMINANTS OF PES

• Production time: Faster production → Higher elasticity.

• Availability of resources: More resources → Higher elasticity.
• Spare capacity: Excess capacity → Higher elasticity.
• Time period: Long run → Higher elasticity due to adjustments
in production.
 INCOME ELASTICITY OF DEMAND (YED)

The responsiveness of quantity demanded to changes in consumer income.

• Normal goods (YED > 0): Demand increases as income rises.

Luxury goods (YED > 1): Demand rises more than income.
Necessities (0 < YED < 1): Demand rises less than income.
• Inferior goods (YED < 0): Demand decreases as income rises.
 CROSS-PRICE ELASTICITY OF DEMAND (XED)

The responsiveness of the quantity demanded of one good to changes in the price of
another good.

• Substitutes (XED > 0): Demand for Good A increases when the price of Good B rises.
• Complements (XED < 0): Demand for Good A decreases when the price of Good B rises.
• Unrelated goods (XED = 0): No relationship between the goods.
 POINT ELASTICITY
• Point Elasticity measures elasticity at a specific point on a demand
curve, rather than over a range. It is used when we need to determine
the responsiveness of quantity demanded to price changes at a
particular price and quantity.
 APPLICATIONS OF ELASTICITY

• Pricing Strategy:Firms use PED to set optimal prices (e.g.,

lowering prices for elastic goods to boost revenue).
• Tax incidence:Governments analyze PED and PES to predict
the burden of taxes on consumers and producers.
• Forecasting:Elasticity helps predict market responses to
changes in price, income, or policy.
• Subsidies and Regulation: Elasticity insights guide decisions
on subsidies for inelastic goods or regulating complements
like fuel and vehicles
 EXAMPLES
• Refere to questions on topic 2.1
 2.3 THE BUDGET LINE(BUDGET CONSTRAINT)
• The budget line, also known as the budget constraint,
represents all possible combinations of two goods that a
consumer can purchase given their income and the prices of
the goods. It illustrates the trade-offs a consumer faces when
allocating their limited resources.
• Mathematically ,the budget line is written as , where I is a
consumer’s income to be spent on the two goods X and Y(X
and Y are quantities of the goods a consumer can purchase
given the prices). -price of good X, -price of good y.
GRAPH OF A BUDGET LINE/CONSTRAINT
 APPLICATIONS OF THE BUDGET LINE

• Consumer Choice:
• The budget line helps determine the combination of goods that
maximizes utility (consumer equilibrium).
• Policy Analysis:
• Governments can predict how changes in income or prices
(taxes/subsidies) affect consumption.
• Opportunity Cost:
• The slope of the budget line shows the opportunity cost of one good in
terms of the other.
 2.4 UTILITY AND INDIFFERENCE CURVES
• Utility and indifference curves are core concepts in consumer behavior
analysis. They explain how individuals make choices to maximize
satisfaction (utility) given their preferences, income, and the prices of
goods.
• Utility is the satisfaction or benefit a consumer derives from consuming
goods and services.
• An indifference curve represents all combinations of two goods that
provide the same level of utility to the consumer. The consumer is
indifferent between these combinations.
 UTILITY
• Utility is the satisfaction or benefit a consumer derives from consuming
goods and services.
• Economists analyze utility using two primary approaches: cardinal
utility and ordinal utility. These approaches differ in how they measure
and interpret consumer satisfaction.
 CARDINAL UTILITY APPROACH
• The cardinal utility approach assumes that utility can be
measured in exact numerical terms (utils). This approach is
quantitative and enables direct comparison of utility levels.
Key Features
1. Measurability: Utility is measured in absolute units (e.g., consuming
an apple provides 10 utils).
2. Total and Marginal Utility:
o Total Utility (TU): The overall satisfaction from consuming a certain quantity of
goods.
o Marginal Utility (MU): The additional utility derived from consuming one more
unit of a good.
 CARDINAL UTILITY APPROACH
3. Law of Diminishing Marginal Utility: Marginal utility decreases as
more units of a good are consumed.
• Let us use a numerical example to illustrate the law of diminishing
marginal utility.
• Assume Chola consumes bread for breakfast and the data is recorded in
the table on the next slide.
• From the table , we can observe that as the individual consumes more
slices of bread, the additional satisfaction (marginal utility) derived from
each additional slice decreases, demonstrating the concept of diminishing
marginal utility.
Number of Utility per Total Marginal
slices slice(utils) Utility(utils) Utility(utils)
1 10 10 -

2 7 17 7

3 4 21 4

4 1 22 1

5 0 22 0

6 -2 20 -2
Assumptions under cardinal utility analysis
• Utility is measurable and additive.
• Consumer behavior is rational and aimed at maximizing satisfaction.
• Marginal utility of money remains constant.
 ORDINAL UTILITY APPROACH
• The ordinal utility approach assumes that utility cannot be measured in
numerical terms but can be ranked or ordered. Consumers can rank their
preferences for different combinations of goods.
Key Features

• Ranking of Preferences: Consumers rank combinations of goods based

on satisfaction .For example , a consumer might prefer good A to good B
(A > B) or B to A (B > A).
• Indifference Curves:
• Represent combinations of goods that yield the same satisfaction.
• Higher indifference curves indicate higher utility levels.

• Marginal Rate of Substitution (MRS): The rate at which consumers are

willing to trade one good for another while maintaining the same utility.
Assumptions
• Consumers are rational and aim to maximize utility.
• Preferences are transitive (if A > B and B > C, then A > C).
• Indifference curves are convex due to diminishing MRS.

Applications
• Used in modern consumer theory (indifference curve analysis).
• Explains consumer equilibrium as the tangency between the budget line
and the highest indifference curve.
A COMPARISON BETWEEN 0RDINAL AND CARDINAL UTILITY
APPROACHES
 2.5 INDIFFERENCE CURVES
• A popular alternative to the marginal utility analysis of demand is the
Indifference Curve Analysis. This is based on consumer preference and
believes that we cannot quantitatively measure human satisfaction in
monetary terms. This approach assigns an order to consumer
preferences rather than measure them in terms of money. Let us take a
look.
• An indifference curve is a curve that represents all the combinations
of goods that give the same satisfaction to the consumer. Since all the
combinations give the same amount of satisfaction, the consumer
prefers them equally. Hence the name indifference curve.
• Let us look at this example to understand the indifference curve better.
John has 1 unit of food and 12 units of clothing. Now, we ask John how
many units of clothing is he willing to give up in exchange for an
additional unit of food so that his level of satisfaction remains unchanged.
• Peter agrees to give up 6 units of clothing for an additional unit of food.
Hence, we have two combinations of food and clothing giving equal
satisfaction to Peter as follows:
* 1 unit of food and 12 units of clothing
* 2 units of food and 6 units of clothing
• By asking him the same question several times, we may get various
combinations as as shown in the table .
GRAPHICAL ILLUSTRATION
• The diagram shows an Indifference curve (IC). Any combination
lying on this curve gives the same level of consumer
satisfaction. We Can also call it as an Iso-Utility Curve.
 INDIFFERENCE MAP

• An Indifference Map is a set of Indifference Curves. It depicts the complete picture of a

consumer’s preferences. The following diagram shows an indifference map consisting
of three curves:

• A higher indifference curve implies a higher level of satisfaction. Therefore, all

combinations on IC1 offer the same satisfaction, but all combinations on IC2 give
greater satisfaction than those on IC1.
 PROPERTIES OF AN INDIFFERENCE CURVE
1.An IC slopes downwards to the right
• This slope signifies that when the quantity of one commodity in combination is
increased, the amount of the other commodity reduces. This is essential for the level of
satisfaction to remain the same on an indifference curve.
2. An IC is always convex to the origin
From our discussion above, we understand that as John substitutes clothing for food, he is
willing to part with less and less clothing. This is the diminishing marginal rate of
substitution. The rate gives a convex shape to the indifference curve. However, there are
two extreme scenarios:
• Two commodities are perfect substitutes for each other – In this case, the indifference
curve is a straight line, where MRS is constant.
• Two goods are perfect complementary goods – An example of such goods would be
gasoline and water in a car. In such cases, the IC will be L-shaped and convex to the
origin.
3. Indifference curves never intersect each other

4. A higher IC indicates a higher level of satisfaction as compared to a lower IC

5. An IC does not touch the axis
• This is so because of our assumption that a consumer considers different combinations of two
commodities and wants both of them. If the curve touches either of the axes, then it means
that he is satisfied with only one commodity and does not want the other, which is contrary to
our assumption.
 CONSUMER’S EQUILIBRIUM=THE LAW OF EQUI-MARGINAL UTILITY

• Consumer’s equilibrium refers to a situation where a consumer maximizes

their satisfaction (utility) given their income and the prices of goods. At this
point, the consumer has allocated their resources in such a way that they
cannot increase their utility by reallocating expenditure between goods.

• The Equi-marginal Principle, also known as the Law of Equi Marginal Utility or
Gossen's Second Law, implies that a consumer will distribute his/her income
on various commodities in a manner that marginal utility derived from the last
unit of money spent on each good is equal.
• The two statements above mean the same thing. Graphicacally, the
consumer’s equilibrium or optimal point is at the point of tangency between
the indifference curve and budget line. The slope of the budget line is
equivalent to the slope of the indifference curve.
CONSUMER EQUILIBRIUM
• At point E the slope of the budget line () is equal to the slope of the
indifference curve (=MRS)

= OR
• This id the equal marginal principle.