Theory Of Consumer Behaviour

Budget set is a set of all possible combinations of the two goods the consumer can buy from his income at given prices; the cost of these combinations is exactly equal to the income of the consumer or less than it .

Now, let’s say the income of a consumer is Rs 1000 and he has to buy apples and oranges. The price per kg apple is Rs 50 and apple is Rs 20. The possible outcomes could be

These set of combinations will be called budget set.

The right angle triangle AOB as shown in the following figure is called budget set, it is formed between the budget line and the two axis

Budget line represents the different possible combinations of two goods which can be purchased by consumer with the given income and at prevailing prices and the cost of each of these combinations is equal to the income of consumer.

Now, let’s say the income of a consumer is Rs 1000 and he has to buy apples and oranges. The price per kg apple is Rs 50 and apple is Rs 20. The possible outcomes could be –

The combinations A, B, C, D, E will be called budgets lines.

Let the units purchased two goods be

Goods 1 X and

Goods 2 Y

(i) Equation of the budget line – P₁X + P₂Y = M

Where

P₁ – Price of Good 1 = 4

P₂ – Price of Good 2 = 5

M – Income of consumer = 20

X – Units of Good 1

Y - Units of Good 2

Therefore, here the budget line will be expressed as

4X + 5Y = 20

(ii) How much of good 1 can the consumer consume if she spends her entire income on that good?

4X + 5(0) = 20

X = 5

(iii) How much of good 2 can she consume if she spends her entire income on that good?

4(0) + 5(Y) = 20

Y = 4

(iv) What is the slope of the budget line?

The slope of budget line is

- 4/5 = X/Y

X/Y = - 0.8

The budget line will be expressed as

4X + 5Y = 40

As income has increased so the consumer can purchase more of both the commodities and the budget line will shift parallelly outwards to A’B’ from AB

The slope of new budget line will be

- 4/5 = X/Y

X/Y = - 0.8

The budget line will be expressed as

4X + 4Y = 20

The slope of new budget line will be

- 4/4 = X/Y

X/Y = - 1

The new budget line will also pivot outwards around the same horizontal intercept –

The budget line will be expressed as

8X + 10Y = 40

The new budget line will be same as old one with same slope.

Budget line – P₁X + P₂Y = M

Where,

P₁ – Price of Good 1 = 6

P₂ – Price of Good 1 = 8

M – Income of consumer = ?

X – Units of Good 1 = 6

Y - Units of Good 2 = 8

M = (6 × 6) + (8 × 8) = 36 + 64 = 100

Therefore, the income of consumer is Rs 100

(i) Here, M = 40

P₁ = 10

P₂ = 10

The bundles available to the consumer are –

(0,0) (0,1) (0,2) (0,3) (0,4)

(1,0) (1,1) (1,2) (1,3) (2,0)

(2,1) (2,2) (3,0) (3,1) (4,0)

(ii) The bundles available in this case are

Monotonic preference means that rational consumer always prefers to have more of a commodity because it will give him a higher level of satisfaction.

More is preferred to less. When preferences are monotone, the consumer prefers more of both the goods. When preferences are strictly monotone the consumer preferes more of one good but not less of the other.

Therefore, a consumer will prefer a particular bundle if it will have at least more of one good but not less of the other good

If we say that bundle A has 3 units of community X and 5 units of commodity Y, where bundle B has 3 units of community X but only 2 units of commodity Y, then the consumer will prefer bundle A, because he is getting the same quantity of commodity B in both bundles but more of commodity Y in bundle A.

A consumer having monotonic preference cannot be indifferent between two given bundle because bundle 1 contains more of goods as compared to bundle 2.

So she should prefer bundle 1.

As per monotonic preference, the bundles should be ranked as below –

In the given case it shows that the preference of my friend is not monotonic. As he is indifferent towards both the bundles means both the bundles give him same level of satisfaction and so he has assigned them the same rank.

According to the monotonic preference second bundle would have been preferred as it contains more of both the goods.

d₁(p) = 20 – p for any price less than or equal to 20, and d1(p) = 0 at any price greater than 20.

For Price ≤ 20

Market Demand = 2 (20 – p)

= 40 – 2p

For Price > 20

Market Demand = 2 (0)

= 0

Therefore, market demand function is

40 – 2p if Price ≤ 20

0 if Price > 20

d₂(p) = 30 – 2p for any price less than or equal to 15 and d1(p) = 0 at any price greater than 15.

For Price ≤ 15

Market Demand = 2 (30 – 2p)

= 60 – 4p

For Price > 15

Market Demand = 2 (0)

= 0

Therefore, market demand function is

60 – 4p if Price ≤ 15

0 if Price > 15

d(p) = 10 – 3p if Price ≤ 10/3

d₁(p) = 0 if Price > 10/3

Market Demand is total demand of all consumers

For Price ≤ 10/3

Market Demand = 20 (10 – 3p)

= 200 – 60p

For Price > 10/3

Market Demand = 20 (0)

= 0

Therefore, market demand function is

200 – 60p if Price ≤ 10/3

0 if Price > 10/3

Market Demand is total demand i.e d₁ + d₂

A good having inverse relationship with price but direct relationship with income is called Normal goods. The demand for normal good increases with increase in income and decreases with rise in price.

A good having direct relationship with price but inverse relationship with income is called inferior goods. The demand for inferior good increases with increase in price and decreases with rise in income.

Substitute goods means the goods that can replace the other like tea and coffee. If the price for tea will increase (no change in price of coffee), the demand for tea will decrease and people will substitute coffee for tea. Therefore we can say that demand for substitute goods move in the same direction with price. If the price of a commodity increases the demand for it substitute will also increase.

The goods that are consumed together are called complementary goods like pen and refill, car and petrol etc. In case of complementary goods the rise in price of one commodity affects the demand of another.

Like if the price of petrol will increase the demand for cars will decrease Therefore the demand for complementary goods move in opposite direction to the price so they are inversely related.

Price elasticity of demand is the measure of the degree of responsiveness of the demand for a good to the change in its price. The price elasticity of demand can be defined as the change in the demand of a particular commodity due to the change in its price.

According to Lipsey - "Price elasticity of demand is defined as the percentage of change in quantity demanded divided by the percentage change in price."

Where

E_d – Elasticity of demand

Proportionate change in quantity demanded = (q₁-q₀)/q₀

Proportionate change in price = (p₁-p₀)/p₀

= - 0.20/0.25

= - 0.8

Therefore, E_d <1

Proportionate change in quantity demanded = (q₁-q₀)/q₀ = -0.20

Proportionate change in price = (p₁-p₀)/p₀ = 0.25

q₀ = 25

q₁ = 20

p₀ = 4

p₁ = 5

D(p) = 10 – 3p

This implies Δq/Δp = -3

At p = 5/3

q will be = 10 – (3x5/3) = 5

Ed = Δq/Δp X p/q

= -1

Price elasticity of demand = -0.2

Increase in price – 5%

% Change in Quantity demanded = -0.2 X 5 = -1%

Price elasticity of demand = -0.2

Increase in price – 10%

The price elasticity is less than 1 so demand is inelastic. In this case the increase in price will result in increase in expenditure. In case on inelastic demand the price and expenditure are positively related.

Decrease in price is 4% whereas increase in expenditure is 2%

The percentage change in price is more than the percentage change in expenditure, which means the percentage change in demand is more than the percentage change in price.

This means the elasticity is more than 1, thus demand is elastic.