CONSUMER BEHAVIOUR A. UTILITY Utility is a subjective satisfaction derived from consumption of commodities.

. UTILITY FUNCTION- It is a real valued (numerical) representation of individual satisfaction or preferences. MARGINAL UTILITY- MU of a commodity is change in utility due to change in consumption by one additional unit. B. CARDINAL THEORY: Assumptions: 1) Utility is numerically measurable. 2) Marginal Utility of Money is the unit of measurement of utility which is constant. 3) Law of Diminishing Marginal Utility holds: As a consumer keeps on consuming successive units of the same commodity, consumption of other commodities remaining constant, MU diminishes. In other words total utility increases at a decreasing rate for successive units of consumption of any commodity. Units consumed Total Utility Marginal Utility 1 10 2 24 14 3 39 15 4 52 13 5 61 9 6 66 5 7 66 0 4) Independence Axiom holds, TU can be expressed as sum of utilities pertaining to each commodity separately. ORDINAL THEORY: According to the ordinal theory utility is no longer a measurable concept. What is required is the existence of a preference field such that an individual can rank consumption bundles according to his preference ordering.

C. INDIFFERENCE CURVES: An Indifference Curve is a locus of points or commodity bundles which yield the same level of total utility. Properties: 1) ICs are downward sloping. 2) ICs are non intersecting 3) Higher the ICs, higher the level of utility. 4) ICs are always convex to the origin. Special Cases: a) In case of substitute goods, the indifference curves are linear with a slope of -1. b) In case of complementary goods, the indifference curves are L shaped thereby depicting the consumption of 2 goods in fixed proportion. Marginal Rate of Substitution (MRS): The Marginal Rate of Substitution of x for y measures the number of units of y that must be sacrificed per unit of x gained so as to maintain a constant level of satisfaction. In a standard case, the marginal rate of substitution of x for y diminishes as x is substituted for y.

D. BUDGET LINE A consumer has the following objective function: Maximize U=u (x,y) Subject to M= x.Px + y.Py A Budget line is a graphical representation of an individuals budget constraint which gives equality between expenditure and money income. The Budget Line equation can be written as M/Py (Px/Py).x = y, where Px/Py is the slope of the Budget Line. Note: As price increases budget line becomes steeper and as price falls budget line becomes flatter

E. CONSUMER EQUILIBRIUM: An individual reaches equilibrium when his objective function is optimized and that happens where the Budget Line of the consumer is tangent to an indifference curve. The point of tangency is where the consumers equilibrium is achieved. At the point of tangency, Slope of the Budget Line = Slope of the Indifference Curve Or, - Px/Py = - Ux/Uy [where Ux = Utility from x commodity & Uy = Utility from y commodity] Special Case: In case of substitute goods, there can be two cases: MUx/Px > MUy/Py => means the utility derived from x is greater than the utility derived from y. MUy/Py > MUx/Px =>means the utility derived from x is greater than the utility derived from y. F. Income Offer Curves or Income Expansion Path or Income Consumption Curve: The ICC is a locus of points showing the equilibrium commodity bundles associated with different levels of money income for constant money prices. Engel Curves: When we plot the optimal choice of x commodity against income M, we get an Engel Curve. G. REVEALED PREFERENCE: The principle of Revealed Preference: Let (X1,X2) be the chosen bundle when prices are ( P1,P2) and let (Y1,Y2) be some other bundle such that P1X1 + P2X2 >= P1Y1 + P2Y2 ------------------------------ (1) Then if the consumer is choosing the most preferred bundle she can afford, we must have (X1,X2) > (Y1,Y2). In eq. (1), (X1,X2) is directly revealed preferred to (Y1,Y2). However if (X1,X2)>(Y1,Y2)>(Z1,Z2), then (X1,X2) is indirectly revealed preferred to (Y1,Y2)

AXIOMS OF REVEALED PREFERENCE: Weak Axiom of Revealed Preference (WARP): If (X1, X2) is directly revealed preferred to (Y1, Y2) and the two bundles are not the same, then it cannot happen that (Y1, Y2) is directly revealed preferred to (X1, X2). In other words, if a bundle (X1,X2 ) is purchased at prices (P1,P2) and a different bundle (Y1,Y2) is purchased at prices (Q1,Q2), then if P1X1 + P2X2 >P1Y1 + P2Y2 Then it cannot be that, Q1Y1 + Q2Y2 > Q1X1 + Q2X2. Strong Axiom of Revealed Preference (SARP): If (X1, X2) is revealed preferred to (Y1, Y2) [either directly or indirectly] and (Y1, Y2) is different from (X1, X2), then (Y1, Y2) cannot be directly or indirectly revealed preferred to (X1, X2).