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Class 12 Commerce

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Theory of Consumer Behaviour

Theory of Consumer Behaviour

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Study Action Plan (Sorted by Difficulty)
Budget Constraint and Budget Line
Accuracy: 0%
Total Attempted2
Total Correct0
Total Incorrect2
Difficulty Level:
High
Income and Substitution Effects
Accuracy: 0%
Total Attempted2
Total Correct0
Total Incorrect2
Difficulty Level:
High
Normal and Inferior Goods
Accuracy: 0%
Total Attempted1
Total Correct0
Total Incorrect1
Difficulty Level:
High
Ordinal Utility Analysis
Accuracy: 0%
Total Attempted3
Total Correct0
Total Incorrect3
Difficulty Level:
High
Price Elasticity of Demand
Accuracy: 25%
Total Attempted4
Total Correct1
Total Incorrect3
Difficulty Level:
High
Market Demand
Accuracy: 33%
Total Attempted3
Total Correct1
Total Incorrect2
Difficulty Level:
High
Cardinal Utility Analysis
Accuracy: 40%
Total Attempted5
Total Correct2
Total Incorrect3
Difficulty Level:
High
Substitutes and Complements
Accuracy: 75%
Total Attempted4
Total Correct3
Total Incorrect1
Difficulty Level:
Low
Elasticity and Expenditure
Accuracy: 100%
Total Attempted2
Total Correct2
Total Incorrect0
Difficulty Level:
Low
Law of Demand
Accuracy: 100%
Total Attempted1
Total Correct1
Total Incorrect0
Difficulty Level:
Low

Learning Objectives

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Learning Objectives

  • Understand the concept of consumer behavior and the problem of choice.
  • Analyze the factors influencing consumer preferences and affordability.
  • Differentiate between Cardinal Utility Analysis and Ordinal Utility Analysis.
  • Define and explain the utility of goods and its subjective nature.
  • Identify the components of a consumption bundle and how they relate to consumer choice.
  • Explain the significance of the budget set and budget line in consumer decision-making.
  • Describe the concepts of demand, demand curve, and the law of demand.
  • Understand the relationship between price elasticity of demand and total expenditure.
  • Analyze the effects of changes in income and prices on the demand for normal and inferior goods.
  • Explore the concepts of substitutes and complements in consumer choice.

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Revision Notes & Summary

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Chapter 2: Theory of Consumer Behaviour

Overview

In this chapter, we will study the behaviour of an individual consumer, focusing on how they decide to spend their income on different goods. This involves understanding the problem of choice, preferences, and the approaches to consumer behaviour.

Key Concepts

  • Consumer Choice Problem: The consumer aims to maximize satisfaction based on preferences and affordability.
  • Preferences: The likes of the consumer that influence their choices.
  • Income and Prices: The consumer's ability to purchase goods is determined by their income and the prices of goods.

Approaches to Consumer Behaviour

  1. Cardinal Utility Analysis: Assumes utility can be measured numerically.
  2. Ordinal Utility Analysis: Focuses on the ranking of preferences without assigning numerical values.

Preliminary Notations and Assumptions

  • Consumption Bundle: A combination of two goods, e.g., bananas (x₁) and mangoes (x₂).
  • Utility: The satisfaction derived from consuming goods.
    • Total Utility (TU): Total satisfaction from consuming a quantity of a commodity.
    • Marginal Utility (MU): Change in total utility from consuming one additional unit.

Demand

  • Demand Definition: The quantity of a commodity that a consumer is willing and able to purchase at various prices.
  • Demand Curve: Represents the relationship between the quantity demanded and the price of a good.
  • Law of Demand: As price decreases, quantity demanded increases, and vice versa.

Elasticity of Demand

  • Price Elasticity of Demand: Percentage change in demand divided by the percentage change in price.
  • Normal Goods: Demand increases with income.
  • Inferior Goods: Demand decreases with income.

Budget Set and Budget Line

  • Budget Set: All bundles of goods a consumer can buy with their income.
  • Budget Line: Represents all bundles that cost the consumer their entire income; it is negatively sloping.

Indifference Curves

  • Indifference Curve: A graph showing combinations of goods that provide the same level of satisfaction.
  • Monotonic Preferences: Consumers prefer more of a good to less, leading to downward sloping indifference curves.

Shifts in Demand Curve

  • Factors Causing Shifts:
    • Changes in income (rightward shift for normal goods, leftward for inferior goods).
    • Changes in prices of related goods (rightward shift for substitutes, leftward for complements).
    • Changes in consumer preferences.

Examples

  • Example of Utility: A consumer derives different levels of utility from the same good based on personal preferences and circumstances.
  • Example of Demand Curve: If the price of a good decreases, the quantity demanded increases, illustrating the law of demand.
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Practice Test – MCQs, True/False

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Multiple Choice Questions

A.

d(p)=40−3pd(p) = 40 - 3p

B.

d(p)=50−3pd(p) = 50 - 3p

C.

d(p)=25−pd(p) = 25 - p

D.

d(p)=45−3pd(p) = 45 - 3p
Correct Answer: B

Solution:

At p=10p = 10, d1(10)=20−10=10d_1(10) = 20 - 10 = 10 and d2(10)=30−2(10)=10d_2(10) = 30 - 2(10) = 10. Therefore, the market demand is 10+10=2010 + 10 = 20. Hence, the market demand function at p=10p = 10 is d(p)=50−3pd(p) = 50 - 3p.

Chapter Concept:

Market Demand

A.

Marginal utility increases.

B.

Marginal utility remains constant.

C.

Marginal utility decreases.

D.

Marginal utility becomes negative.
Correct Answer: C

Solution:

The law of diminishing marginal utility states that as the consumption of a commodity increases, the marginal utility derived from each additional unit decreases.

Chapter Concept:

Cardinal Utility Analysis

A.

The demand of a single consumer for a good.

B.

The total demand of all consumers for a good at a particular price.

C.

The supply of a good in the market.

D.

The price of a good in the market.
Correct Answer: B

Solution:

The market demand for a good is the total demand of all consumers taken together at a particular price.

Chapter Concept:

Market Demand

A.

0.5

B.

1

C.

2

D.

3
Correct Answer: C

Solution:

Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. Here, it is 30%15%=2\frac{30\%}{15\%} = 2, indicating that the demand is elastic.

Chapter Concept:

Price Elasticity of Demand

A.

Normal good

B.

Inferior good

C.

Giffen good

D.

Substitute good
Correct Answer: B

Solution:

An inferior good is one where demand decreases as consumer income rises, as consumers opt for higher-quality alternatives.

Chapter Concept:

Normal and Inferior Goods

A.

1%

B.

5%

C.

10%

D.

0.1%
Correct Answer: A

Solution:

The price elasticity of demand is given by ed=%ΔQ%ΔPe_d = \frac{\% \Delta Q}{\% \Delta P}. Thus, −0.2=%ΔQ5-0.2 = \frac{\% \Delta Q}{5}, leading to %ΔQ=−1%\% \Delta Q = -1\%. Therefore, the quantity demanded will decrease by 1%.

Chapter Concept:

Market Demand

A.

All bundles that cost more than the consumer's income.

B.

All bundles that cost less than the consumer's income.

C.

All bundles that cost exactly equal to the consumer's income.

D.

All bundles that the consumer cannot afford.
Correct Answer: C

Solution:

The budget line represents all bundles which cost the consumer her entire income.

Chapter Concept:

Budget Constraint and Budget Line

A.

Through the law of increasing marginal utility.

B.

By assuming utility cannot be measured.

C.

By using the law of diminishing marginal utility to show a downward sloping demand curve.

D.

By assuming all consumers have the same preferences.
Correct Answer: C

Solution:

Cardinal Utility Analysis uses the law of diminishing marginal utility to explain why the demand curve slopes downward, as consumers are willing to pay less for additional units of a commodity.

Chapter Concept:

Cardinal Utility Analysis

A.

The rate at which a consumer substitutes one good for another while maintaining the same level of utility.

B.

The total utility derived from consuming a bundle of goods.

C.

The numerical value of utility assigned to a bundle.

D.

The price of a good in the market.
Correct Answer: A

Solution:

The marginal rate of substitution (MRS) is the rate at which a consumer will substitute one good for another while maintaining the same level of utility.

Chapter Concept:

Ordinal Utility Analysis

A.

Law of Increasing Marginal Utility

B.

Law of Diminishing Marginal Utility

C.

Law of Constant Marginal Utility

D.

Law of Increasing Returns
Correct Answer: B

Solution:

The Law of Diminishing Marginal Utility explains why demand curves have a negative slope, as each additional unit of a commodity provides lower marginal utility.

Chapter Concept:

Law of Demand

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True or False

Correct Answer: False

Solution:

Ordinal Utility Analysis ranks consumer preferences without assigning numerical values, using indifference curves to represent different levels of satisfaction.

Chapter Concept :

Ordinal Utility Analysis

Correct Answer: False

Solution:

Inferior goods see a decrease in demand as consumer income rises, reflecting different consumer preferences.

Chapter Concept :

Normal and Inferior Goods

Correct Answer: True

Solution:

Cardinal Utility Analysis involves quantifying utility in numerical units, allowing for statements like 'this shirt gives me 50 units of utility.'

Chapter Concept :

Cardinal Utility Analysis

Correct Answer: False

Solution:

Market demand for a good is derived by horizontally summing individual demand curves, not vertically.

Chapter Concept :

Market Demand

Correct Answer: False

Solution:

The Law of Demand states that, ceteris paribus, an increase in the price of a good leads to a decrease in quantity demanded, not an increase.

Chapter Concept :

Law of Demand

Correct Answer: True

Solution:

Cardinal utility analysis quantifies utility in numerical terms, allowing for the measurement of total and marginal utility.

Chapter Concept :

Cardinal Utility Analysis

Correct Answer: True

Solution:

The substitution effect describes changes in consumption due to relative price changes, and the income effect describes changes due to changes in purchasing power.

Chapter Concept :

Income and Substitution Effects

Correct Answer: False

Solution:

Inferior goods see a decrease in demand as consumer income rises, unlike normal goods which see an increase.

Chapter Concept :

Normal and Inferior Goods

Correct Answer: True

Solution:

Substitute goods can replace each other in consumption. Therefore, if the price of a substitute good increases, consumers may switch to the related good, increasing its demand.

Chapter Concept :

Substitutes and Complements

Correct Answer: True

Solution:

Price elasticity of demand is defined as the percentage change in demand for the good divided by the percentage change in its price.

Chapter Concept :

Price Elasticity of Demand

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