# NCERT Class 12 Economics Chapter 2: Consumer Behavior YouTube Lecture Handouts

Doorsteptutor material for IEcoS is prepared by world's top subject experts: Get detailed illustrated notes covering entire syllabus: point-by-point for high retention.

Get video tutorial on: Examrace YouTube Channel

• Consumer decides how to spend on different goods – problem of choice
• Combination of goods that gives maximum satisfaction – depends on likes of consumer or preferences (depends on price of goods and income) – cardinal utility and ordinal utility
• Choice of corns or coconuts (as bundles – 5 corns and 10 coconuts)

## Utility

• Consumer decides demand of commodity based on utility that he derives from it
• Utility – want satisfying capacity – more the needs, stronger is the desire to have and greater is the utility, it is subjective
• Different individuals can have different levels of utility for the same commodity
• Utility that one individual gets from the commodity can change with change in place and time

## Cardinal Utility Analysis

• Assumes that level of utility can be expressed in numbers
• Total Utility of a fixed quantity of a commodity (TU) is the total satisfaction derived from consuming the given amount of some commodity . TU depends on the quantity consumed. TU refers to total utility derived from consuming n units of commodity x
• Marginal utility (MU) is the change in total utility due to consumption of one additional unit of a commodity. For example, suppose 4 corns give us 28 units of total utility and 5 corns give us 30 units of total utility. Therefore, marginal utility of the 5th corn is 2 units.
• MU diminishes with increase in consumption of commodity (having some commodity, desire to have few more of it weakens)
• 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.
• The law of diminishing marginal utility states that each successive unit of a commodity provides lower marginal utility.
• MU becomes zero at a level when TU remains constant (as TU falls, MU gets negative)
• Demand for Commodity: 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 – depends on prices & other commodities (at lower price individual is willing to buy more)
• Law of Demand: There is negative relationship between price of commodity and quantity demanded

## Ordinal Utility Analysis

• Limitation of cardinal utility is quantification of utility in numbers
• In real life, it is not expressed as numbers – we can rank it
• Indifference Curve: Such a curve joining all points representing bundles among which the consumer is indifferent
• To get one more corn, consumer forgoes some coconuts – so that total utility remains same. Amount of corn the consumer has to forego in order to get additional coconut so that total utility remains same is Marginal Rate of Substitution
• With the fall in quantity of coconuts, MU derived from coconut increases – called as law of diminishing MRS (convex to origin – most common)
• When goods are perfect substitutes (provides exactly same level of utility) – MRS does not diminish (straight line)
• 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.
 Combination Quantity of Corn Quantity of Coconut MRS A 1 15 - B 2 12 3: 1 C 3 10 2: 1 D 4 9 1: 1

Indifference Map: A family of indifference curves. Bundles on higher indifference curves are preferred by the consumer to the bundles on lower indifference curves

## Features of Indifference Curve

Indifference Curve slopes from left to right – in order to have more coconuts you will have to forego corns

Higher indifference curve gives greater level of utility -

Two indifference curves never intersect each other - utility from A and B versus A and C cannot be same.

## Consumer Budget

Consumer has fixed amount of money and cannot buy any or every combinations

Consumption bundle depends on price of two goods and income of customer

Price (p) multiplied by Quantity (x) for both commodities should be less than or equal to income (M) – set of bundles available is budget set; inequality is budget constraint ()

The budget line is a straight line with horizontal intercept & vertical intercept . The horizontal intercept represents the bundle that the consumer can buy if she spends her entire income on bananas.

Slope is =

The absolute value of the slope of the budget line measures the rate at which the consumer is able to substitute coconuts for corns when she spends her entire budget.

Price of both commodities vary: A decrease in income causes a parallel inward shift of the budget line. An increase in income causes a parallel outward shift of the budget line.

Price of one commodity remains same: An increase in the price of bananas makes the budget line steeper. A decrease in the price of bananas makes the budget line flatter.

## Optimal Choice of Consumer

Consumer can choose any consumption bundle from the budget set

Consumer chooses her consumption bundle on the basis of her taste and preferences over the bundles in the budget set. It is generally assumed that the consumer has well defined preferences over the set of all possible bundles.

The optimum bundle of the consumer is located at the point where the budget line is tangent to one of the indifference curves. If the budget line is tangent to an indifference curve at a point, the absolute value of the slope of the indifference curve (MRS) and that of the budget line (price ratio) are same at that point. If MRS is greater or less, price ratio cannot be optimum

In economics – consumer is rational – knows what is good or bad (consumer has preferences but also acts based on the preferences) – choose one that gives maximum satisfaction

If the consumer՚s preferences are monotonic, for any point below the budget line, there is some point on the budget line which is preferred by the consumer.

Bundles on indifference curve above the optimum line are not affordable. Points below this indifference curve are inferior

## Demand

The quantity of a commodity that a consumer is willing to buy and is able to afford, given prices of goods and consumer՚s tastes and preferences

If the prices of other goods, consumer՚s income and her tastes and preferences remain unchanged, amount of a good that the consumer optimally chooses, becomes entirely dependent on its price. The relation between the consumer՚s optimal choice of the quantity of a good and its price is very important and this relation is called the demand function.

The graphical representation of the demand function is called the demand curve.

Usually, in a graph, the independent variable is measured along the horizontal axis and the dependent variable is measured along the vertical axis.

In economics, often the opposite is done. The demand curve, for example, is drawn by taking the independent variable (price) along the vertical axis and the dependent variable (quantity) along the horizontal axis.

Deriving Demand Curve from Indifference Curve and Budget Line

Demand curve for banana is negatively sloped

The negative slope of the demand curve can also be explained in terms of the two effects namely, substitution effect and income effect that come into play when price of a commodity changes. When bananas become cheaper, the consumer maximizes his utility by substituting bananas for mangoes in order to derive the same level of satisfaction of a price change, resulting in an increase in demand for bananas

Law of Demand: Law of Demand states that other things being equal, there is a negative relation between demand for a commodity and its price. In other words, when price of the commodity increases, demand for it falls

At price 0, the demand is a, and at price equal to , the demand is 0.

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. For normal goods, the demand curve shifts rightward and for inferior goods, the demand curve shifts leftward.

Inferior goods: As the income of the consumer increases, the demand for an inferior good falls (low quality coarse cereals)

Giffen Goods: If the income effect is stronger than substitution effect, the demand for the good would be positively related to its price.

Complementary Goods: Goods which are consumed together, like tea and sugar

Substitute Goods: Tea and coffee

The demand curve can also shift due to a change in the tastes and preferences of the consumer. If the consumer՚s preferences change in favor of a good, the demand curve for such a good shifts rightward. (ice cream demand to shift rightward in summer)

Changes in other parameters lead to movement along demand curve and shift in demand curve

## Market Demand

• The market demand for a good at a particular price is the total demand of all consumers taken together.
• It is derived from the individual demand curves by adding up the individual demand curves horizontally (method known as horizontal summation)

## Elasticity of Demand

Demand for good moves in opposite direction to its price. This demand change for goods can be high for small change in price sometimes.

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.

If , demand for the good is inelastic (essential goods)

If , demand for the good is elastic (luxury goods)

If , demand for the good is unitary-elastic

When p = 0, while with Q = 0,

Elasticity is 0 at the point where the demand curve meets the horizontal axis and it is at the point where the demand curve meets the vertical axis

Vertical demand curve is perfectly inelastic while horizontal demand curve is perfectly elastic

At midpoint of demand curve

Price elasticity depends on

Nature of goods

Availability of close substitutes of goods

Demand for food does not change much even if food prices go up while demand for luxuries can be very responsive to price changes.

If close substitutes are available demand is elastic (like pulses – shift to another pulses) while it is inelastic if the close substitutes are not available

The expenditure on a good is equal to the demand for the good times its price.

If the percentage decline in quantity is less than the percentage increase in the price, the expenditure on the good will go up or if the percentage increase in quantity is greater than the percentage decline in the price, the expenditure on the good will go up

## Relation of Elasticity with Change in Expenditure

Monotonic Preference - Agent prefers all consumption bundles that have more of at least one good, and not less in any other good.

Developed by: