Module-B Consumer Behaviour

 

1.What is an indifference map? What an indifference map indicates?

An indifference map is the collection of indifference curves possessed by an individual. To describe a person’s preferences for all combinations of two goods i.e food and clothing, we can graph a set of indifference curves called an indifference map (Figure B12). Each indifference curve in the map shows the market baskets among which the person is indifferent. The graph below shows three indifference curves that form part of an indifference map (the entire map includes an infinite number of such curves). Indifference curve U3 generates the highest level of satisfaction, followed by indifference curves U2 and U1.

indifference map

2. What are the four basic assumptions about individual preferences? Explain the significance or meaning of each.

(1) Preferences are complete: this means that the consumer is able to compare and rank all possible baskets of goods and services.

(2) Preferences are transitive: this means that preferences are consistent, in the sense that if bundle A is preferred to bundle B and bundle B is preferred to bundle C, then bundle A is preferred to bundle C.

(3) More is preferred to less: this means that all goods are desirable, and that the consumer always prefers to have more of each good.

(4) Diminishing marginal rate of substitution: this means that indifference curves are convex, and that the slope of the indifference curve increases (becomes less negative) as we move down along the curve. As a consumer moves down along her indifference curve she is willing to give up fewer units of the good on the vertical axis in exchange for one more unit of the good on the horizontal axis. This assumption also means that balanced market baskets are generally preferred to baskets that have a lot of one good and very little of the other good.

3. Can a set of indifference curves be upward sloping? If so, what would this tell about the two goods?

A set of indifference curves can be upward sloping if we violate assumption number three; more is preferred to less. When a set of indifference curves is upward sloping, it means one of the goods is a “bad” so that the consumer prefers less of that good rather than more. The positive slope means that the consumer will accept more of the bad only if he also receives more of the other good in return. As we move up along the indifference curve the consumer has more of the good he likes, and also more of the good he does not like.

4. Why is the indifference curve downward slopping? Explain why two indifference curves cannot intersect.

Reasons for indifference curve downward slopping:

Indifference curves are downward sloping (Figure B14). In the example of food and clothing, when the amount of food increases along an indifference curve, the amount of clothing decreases. The fact that indifference curves slope downward follows directly from our assumption that more of a good is better than less. If an indifference curve sloped upward, a consumer would be indifferent between two market baskets even though one of them had more of both food and clothing. The magnitude of the slope of an indifference curve measures the consumer’s marginal rate of substitution (MRS) between two goods.

indifference curves

In this graph (Figure B14), the MRS between clothing (C) and food (F) falls from 6 (between A and B) to 4 (between B and D) to 2 (between D and E) to 1 (between E and G). When the MRS diminishes along an indifference curve, the curve is convex. To quantify the amount of one good that a consumer will give up to obtain more of another, we use a measure called the marginal rate of substitution (MRS). The MRS of food F for clothing C is the maximum amount of clothing that a person is willing to give up to obtain one additional unit of food.

Indifference curves cannot intersect: The figure below shows two indifference curves intersecting at point A. We know from the definition of an indifference curve that the consumer has the same level of utility for every bundle of goods that lies on the given curve. In this case, the consumer is indifferent between bundles A and B because they both lie on indifference curve U1. Similarly, the consumer is indifferent between bundles A and C because they both lie on indifference curve U2. By the transitivity of preferences this consumer should also be indifferent between C and B. However, we see from the graph that C lies above B, so C must be preferred to B because C contains more of Good Y and the same amount of Good X as does B, and more is preferred to less. But this violates transitivity, so indifference curves must not intersect.

5. Draw a budget line that identifies the satisfaction-maximizing choice using indifference curve analysis. What conclusion does it say?

The budget constraints the consumers face as a result of their limited incomes. This show using Budget Line. To see how a budget constraint limits a consumer’s choices, let’s consider a situation in which a woman has a fixed amount of income, I, that can be spent on food and clothing. Let F be the amount of food purchased and C be the amount of clothing. The budget line indicates all combinations of F and C for which the total amount of money spent is equal to income.

As shown in the above graph (Figure B15), a consumer maximizes satisfaction by choosing market basket A. At this point, the budget line and indifference curve U2 are tangent, and no higher level of satisfaction (e.g., market basket D) can be attained. At A, the point of maximization, the MRS between the two goods equals the price ratio. At B, however, because the MRS [−(−10/10) = 1] is greater than the price ratio (1/2), satisfaction is not maximized.

6. What happens to the marginal rate of substitution as you move along a convex indifference curve?

The MRS measures how much of a good you are willing to give up in exchange for one more unit of the other good, keeping utility constant. The MRS diminishes along a convex indifference curve. This occurs because as you move down along the indifference curve, you are willing to give up less and less of the good on the vertical axis in exchange for one more unit of the good on the horizontal axis. The MRS is also the negative of the slope of the indifference curve, which decreases (becomes closer to zero) as you move down along the indifference curve. The MRS is constant along a linear indifference curve because the slope does not change. The consumer is always willing to trade the same number of units of one good in exchange for the other.

7. ‘Shape of an indifference curve shows the law of marginal rate of substitution’- How?

The indifference curves show those combinations of two goods on which the utility of consumer remains the same. The slope of the indifference curve is the marginal rate of substitution. MRS shows the rate at which consumer substitutes the consumption of good Y for an additional unit of good X. The MRS determines the shape of the indifference curve. If the MRS is diminishing, then the consumer willing to substitute only smaller and smaller units of good Y for additional units of good X. The shape of the IC in case of diminishing MRS will be convex to the origin.

8. What is the difference between ordinal utility and cardinal utility? ‘Indifference curve is ordinal utility approach’- Do you agree? Explain your answer.

Ordinal utility implies an ordering among alternatives without regard for intensity of preference. For example, if the consumer’s first choice is preferred to his second choice, then utility from the first choice will be higher than utility from the second choice. How much higher is not important. An ordinal utility function generates a ranking of bundles and no meaning is given to the magnitude of the utility number itself. Cardinal utility implies that the intensity of preferences may be quantified, and that the utility number itself has meaning. An ordinal ranking is all that is needed to rank consumer choices. It is not necessary to know how intensely a consumer prefers basket A over basket B; it is enough to know that A is preferred to B.

 

Indifference curve is ordinal utility approach. A consumer’s preferences can be graphically presented with the use of indifference curves. An indifference curve represents all combinations of market baskets that provide a consumer with the same level of satisfaction. That person is therefore indifferent among the market baskets represented by the points graphed on the curve.

 

9. How is total satisfaction measured in utility analysis?

In utility analysis, total satisfaction, also known as total utility, refers to the overall level of satisfaction or happiness derived from consuming a certain quantity of a good or service. Utility analysis is a framework used in economics to understand and quantify the preferences and choices of individuals.Measuring total satisfaction or utility is a challenging task because it involves subjective experiences and individual preferences. However, economists use several methods to estimate and compare utility levels. Here are a few commonly used approaches:

1. Cardinal Utility Measurement: This approach assigns numerical values to utility, allowing for direct comparison between different levels of satisfaction. However, measuring cardinal utility is highly subjective and varies from person to person.

2. Ordinal Utility Measurement: In this approach, utility is ranked or ordered rather than assigned precise numerical values. Individuals provide preferences or rankings for different goods or services, which allow for comparison and analysis. This method avoids the subjectivity of assigning specific numbers to utility levels.

3. Indifference Curve Analysis: Indifference curves represent combinations of goods or services that provide the same level of utility or satisfaction to an individual. By comparing different indifference curves, economists can assess changes in satisfaction or utility when the quantities of goods consumed change.

4. Revealed Preference: This method infers an individual's utility or preference by observing their actual choices and behavior in the market. By analyzing the goods or services individuals select and the prices they are willing to pay, economists can infer their underlying utility functions.

5. Hedonic Methods: Hedonic analysis is used to measure utility or satisfaction by considering the characteristics or attributes of a product or service. This approach quantifies the value individuals derive from specific features and attributes and incorporates them into utility calculations.

It's important to note that measuring total satisfaction or utility precisely is challenging, as it involves subjective experiences and individual preferences that can vary greatly. Economists use these methods as approximations to better understand and analyze consumer behavior and choices.

10. ‘Marginal utility decreases as a consumer consumes more of a good’-Explain.

 Marginal Utility: The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important economic concept because economists use it to determine how much of an item a consumer will buy. Positive marginal utility is when the consumption of an additional item increases the total utility. Negative marginal utility is when the consumption of an additional item decreases the total utility

The law of diminishing the marginal utility:

According to this principle, the marginal utility of a commodity reduces when the quantity of goods is more. Consequently, when the quantity is more, the prices will fall and demand will increase. Hence, consumers will demand more goods when prices are less. This is why the demand curve slopes downwards.

Graphical Explanation:

The above graph shows the total utility in increasing gradually and after zenith point it is down moving. The margin utility curve is down sloping, after sometimes it may be zero or negative.

11. ‘Consumer consumes up to the point where marginal utility equal to price’- Explain.

The law of diminishing marginal utility states that all else equal, as consumption increases, the marginal utility derived from each additional unit declines. Marginal utility is the incremental increase in utility that results from the consumption of one additional unit.

In figure (B16), if a piece of mango costs Tk90, it would make sense to consume two pieces. The first piece gives 120 utility, which is greater than the price of 90. The second piece gives a utility equal to the price. The third piece would give marginal utility of only 60, which is less than the price of 90. A rational consumer would not consume more than two.

12. ‘Marginal utility curve slopes downward’-Why?

The marginal utility curve slopes downward because of the principle of diminishing marginal utility. According to this principle, as an individual consumes more units of a good or service, the additional satisfaction or utility derived from each additional unit decreases.

To understand why the marginal utility curve slopes downward, consider the following example: Suppose you are hungry, and you eat a slice of pizza. The first slice of pizza provides a significant level of satisfaction or utility because it fulfills your hunger. As you continue to eat more slices, your hunger diminishes, and the additional satisfaction you derive from each subsequent slice decreases.

This diminishing marginal utility occurs due to various factors, such as:

 

1. Satiation: As you consume more of a good or service, your desire or need for it decreases. For example, the first few slices of pizza may satisfy your hunger, but as you consume more, you become less hungry, and the additional satisfaction you gain from each slice decreases.

 

2. Substitution effect: As you consume more of a good, you may start to seek alternatives or substitutes that provide different sources of satisfaction. For example, after eating several slices of pizza, you may start craving dessert instead of more pizza.

 

3. Satiety: The more you consume of a particular good or service, the more likely you are to experience diminishing returns in terms of satisfaction. For instance, the first few bites of a delicious dessert may be very enjoyable, but as you continue eating, the enjoyment may diminish.

 

4. Time constraints: With limited time and attention, the utility you derive from each additional unit of a good or service decreases. For example, if you are given a large amount of time to consume a good, such as watching a movie, the utility from each additional minute may diminish as you become less engaged or interested.

 

These factors collectively contribute to the diminishing marginal utility and explain why the marginal utility curve slopes downward. The curve visually represents the decreasing rate at which additional units of a good or service contribute to total utility or satisfaction.