Theory of Consumer Behaviour

This is Chapter 2 of Introductory Microeconomics, and the longest and most technical in the book: 27 pages (8–35) in six sections — 2.1 utility (cardinal and ordinal); 2.2 the consumer's budget; 2.3 the optimal choice; 2.4 demand; 2.5 market demand; 2.6 elasticity of demand — with five tables, about twenty figures, boxes on the slope of the budget line, functions, linear demand, the rectangular hyperbola and elasticity and expenditure, and 26 exercise questions, about a third of them numerical. Every number below is recomputed, every graph drawn from computed points; where NCERT slips, we say so with a safe exam line.

• Builds on Chapter 1 (leec201 — scarcity and opportunity cost; the budget line is the consumer's own frontier). Leads into Chapter 3 (production and costs), Chapter 4 (the firm's supply) and Chapter 5 (market equilibrium, where demand meets supply, and price ceilings and floors).
• Macro links (live): Introductory Macroeconomics — leec104 (consumption and aggregate demand) and leec102 (price indices); Indian Economic Development keec102 and keec105 (food demand, MSP and public distribution).
• UPSC, honestly: micro theory is a small part of UPSC. Prelims has asked directly about what shifts market demand (2021) and consumer equilibrium (1998); elasticity and demand ideas then appear inside questions on taxes, subsidies, MSP and inflation. GS3 answers on food security, taxation of ‘sin goods’ or fuel pricing use elasticity — the vocabulary here — without asking for diagrams.

• Cardinal: MUₙ = TUₙ − TUₙ₋₁; Table 2.1 MU 12, 6, 4, 2, 0, −2 → diminishing marginal utility; TU is maximum where MU = 0. DMU explains the downward-sloping demand curve.
• Ordinal: indifference curve (equal utility); MRS = |ΔY/ΔX| falls 3 → 2 → 1 → convex curve; perfect substitutes → straight line. Monotonic preferences: higher IC better; ICs never intersect.
• Budget set p₁x₁ + p₂x₂ ≤ M; budget line intercepts M/p₁, M/p₂, slope −p₁/p₂. Income change → parallel shift; one price change → pivot.
• Optimum: budget line tangent to the highest IC → MRS = p₁/p₂. Changing p₁ traces the demand curve; substitution + income effects; Giffen = inferior good whose income effect outweighs.
• Normal vs inferior goods (income); substitutes (tea, coffee) vs complements (tea, sugar). Price change = movement along; other factors = shift. Market demand = horizontal sum.
• Price elasticity = %ΔQ ÷ %ΔP (Example 2.2: 20 ÷ 40 = 0.5). Linear demand: 0 → ∞, 1 at midpoint. Vertical 0, horizontal ∞, pq = constant 1. Elastic → spending moves opposite to price.

The consumer's choice depends on her preferences (likes) and on what she can afford (prices and income). With two goods — bananas (x₁) and mangoes (x₂) — a combination such as (5, 10) is a bundle. Utility is a commodity's want-satisfying capacity; it is subjective and varies with place and time — a room heater in Ladakh or Chennai, in winter or summer. Cardinal analysis assumes utility can be expressed in numbers. Total utility TUₙ is the satisfaction from n units; marginal utility MUₙ = TUₙ − TUₙ₋₁ is the change from one more unit (NCERT: 4 bananas give 28, 5 give 30, so MU₅ = 2); and TUₙ = MU₁ + MU₂ + … + MUₙ.

Table 2.1 is consistent. Marginal utility falls — 12, 6, 4, 2 — the law of diminishing marginal utility: MU from each additional unit declines as consumption rises, holding other consumption constant. Total utility rises at a diminishing rate, is maximum (24) when MU = 0 at the 5th unit, and falls once MU turns negative (−2 at the 6th).

Demand from diminishing MU. Demand is the quantity a consumer is willing and able to buy at given prices and income. Besides its own price, it depends on prices of other goods, income, and tastes. The demand curve shows quantities demanded at different prices of the good, holding other prices and income constant; its downward slope is the law of demand. Diminishing MU explains it: each extra unit is worth less, so the consumer pays less for it. NCERT's example: at ₹40 she buys 5 units; the 6th is worth less than the 5th, so she buys it only if the price falls below ₹40.

Cardinal analysis is simple but assumes utility can be counted; in real life we only rank bundles. Ordinal analysis starts there. Bundles giving equal utility lie on an indifference curve. To stay on it, a consumer who gets one more banana must give up some mangoes, so the curve slopes down. The mangoes given up per extra banana is the marginal rate of substitution, MRS = |ΔY/ΔX| (the magnitude: if ΔY/ΔX = −3/1, MRS = 3).

MRS falls as bananas increase — the law of diminishing MRS: with more bananas, each extra banana adds less utility, and with fewer mangoes each mango is worth more, so she gives up smaller and smaller amounts. This makes the indifference curve convex to the origin. For perfect substitutes — goods that can replace each other giving exactly the same utility, like ₹5 notes and ₹5 coins (Table 2.3: (1, 8), (2, 7), (3, 6), (4, 5)) — the MRS stays at 1 and the curve is a straight line.

Preferences are assumed monotonic: between two bundles, the one with more of at least one good and no less of the other is preferred. The family of curves is an indifference map, and monotonicity means higher curves are preferred. NCERT's three features: (1) curves slope down — more bananas with no fewer mangoes would put her on a higher curve; (2) a higher curve gives more utility (Table 2.4: A (1, 10), B (2, 10), C (3, 10) lie on successively higher curves, as long as MU is positive); (3) two curves never intersect.

With income M and prices p₁ (bananas) and p₂ (mangoes), the consumer can buy any bundle with p₁x₁ + p₂x₂ ≤ M — the budget constraint; the affordable bundles form the budget set. Example 2.1: income ₹20, both goods ₹5, integer units only: 15 bundles are affordable; (0, 4), (1, 3), (2, 2), (3, 1) and (4, 0) cost exactly ₹20; (3, 3) and (4, 5) cost too much.

If goods are divisible, the budget set is every point on or below the budget line p₁x₁ + p₂x₂ = M, rewritten as x₂ = M/p₂ − (p₁/p₂)x₁: intercepts M/p₁ (all income on bananas) and M/p₂ (all on mangoes), slope −p₁/p₂. Its absolute value is the rate at which the market lets her substitute bananas for mangoes: one more banana costs p₁, which would have bought p₁/p₂ mangoes. Changes: if income changes, the slope is unchanged and both intercepts change — a parallel shift out (M′ > M) or in. If p₁ changes, the vertical intercept stays and the line pivots — steeper if p₁ rises, flatter if it falls; a change in p₂ is symmetric.

The consumer has well-defined preferences — she can compare any two bundles — and is rational: she knows what is good for her and chooses the bundle with maximum satisfaction. Her problem: reach the highest indifference curve within her budget set. The optimum lies on the budget line (with monotonic preferences, any point below it is beaten by a point on it with more of something), at the point where the budget line is tangent to an indifference curve; every other point on the line is on a lower curve. At tangency the slopes match: MRS = p₁/p₂ — the rate at which she is willing to substitute equals the rate at which she is able to substitute in the market.

The optimum depends on the good's price, other prices, income and tastes. Holding the others fixed, the relation between the chosen quantity and the price is the demand function X = f(P); its graph, with price on the vertical axis, is the demand curve. Lowering the banana price pivots the budget line outward; the new optimum is on a higher curve with more bananas; plotting each price against its optimal quantity traces a downward-sloping demand curve. Two effects explain it: the substitution effect (bananas are now relatively cheaper, so she substitutes them for mangoes) and the income effect (her purchasing power rises, raising demand for bananas further if they are normal). Law of demand: other things equal, quantity demanded and price move in opposite directions. A linear demand curve d(p) = a − bp for 0 ≤ p ≤ a/b (and 0 above): demand a at price 0, zero at price a/b, falling by b units per ₹1 rise.

A good can be normal at some incomes and inferior at others: at very low incomes demand for low-quality cereals rises with income; beyond a point people switch to better cereals. Demand for a good moves with the price of its substitutes and against the price of its complements.

Market demand at a price is the total of all consumers' demands at that price: if at p′ consumer 1 wants q′₁ and consumer 2 wants q′₂, market demand is q′₁ + q′₂. Graphically, individual curves are added horizontally (horizontal summation). NCERT's example: d₁(p) = 10 − p (0 above ₹10) and d₂(p) = 15 − p (0 above ₹15) give market demand 25 − 2p for p ≤ 10, 15 − p for 10 < p ≤ 15, and 0 above 15 — we checked each piece.

Price elasticity of demand e_D = (% change in quantity demanded) ÷ (% change in price) = (ΔQ/Q) ÷ (ΔP/P) = (ΔQ/ΔP) × (P/Q). It is negative, but quoted in absolute value. Example 2.2: at ₹5 she buys 15 bananas; at ₹7, 12. Quantity changes by (12 − 15)/15 = −20%; price by (7 − 5)/5 = +40%; so |e_D| = 20/40 = 0.5 — inelastic. Demand is inelastic if |e| < 1 (often essentials), elastic if |e| > 1 (often luxuries), unit elastic if |e| = 1; the same good can be each at different prices.

Along a straight line q = a − bp, Δq/Δp = −b, so e_D = −bp/(a − bp): 0 at p = 0, 1 at the midpoint p = a/2b, less than 1 below it, more than 1 above it, and infinite where q = 0. Geometrically, elasticity at a point = lower segment ÷ upper segment of the line. Constant-elasticity curves: vertical (|e| = 0, perfectly inelastic), horizontal (|e| = ∞, perfectly elastic), and the rectangular hyperbola pq = constant (|e| = 1, spending always the same). Determinants: necessities are inelastic, luxuries elastic; close substitutes make demand elastic — food in general is inelastic, a particular variety of pulse is elastic.

Elasticity and expenditure (price × quantity): spending moves opposite to price if demand is elastic, with price if inelastic, and is unchanged if unit elastic. NCERT's box derives ΔE ≈ Δp·q(1 + e_D) (with e_D negative), ignoring the small term ΔpΔq. Table 2.5 illustrates; we add the exact change in spending.

The chapter has no activities; its 26 exercise questions follow. Numerical answers are recomputed. Try first, then open.

Numbers

One-liners

• MU falls, so willingness to pay falls: the demand curve slopes down.
• TU is greatest where MU is zero.
• MRS is what you are willing to swap; the price ratio is what the market lets you swap.
• Diminishing MRS makes indifference curves convex; perfect substitutes make them straight.
• Higher curves are better and curves never cross — thanks to monotonic preferences.
• Income shifts the budget line; a price tilts it.
• Optimum: tangency, MRS = p₁/p₂.
• Own price moves you along the demand curve; everything else shifts it.
• Giffen goods are inferior goods with a dominant income effect.
• Market demand is the horizontal sum.
• Elastic demand: spending moves opposite to price.
• A straight demand line runs from elasticity 0 to infinity.

Traps to avoid

• MU = 0 means TU is at its maximum, not zero.
• The budget line's slope is −p₁/p₂, the indifference curve's slope is MRS.
• If prices and income all double, the budget set is unchanged.
• NCERT calls ‘a’ in q = a − bp the vertical intercept; it is the quantity intercept (price intercept a/b).
• Functions box: f(5) = 90 and f(10) = 70 (the text misprints f(10) and f(15)).
• Table 2.5's ‘no change’ for ±10% is approximate — exactly, spending falls 1%.
• A straight demand line does not have constant elasticity.
• Every Giffen good is inferior; not every inferior good is Giffen.
• A price change is a movement along, not a shift of, the demand curve.
• Exercise 14 misprints d₁ for d₂ above ₹15.

Prelims — what UPSC asks

• Shifts of demand: market demand rises if the price of a substitute rises; it falls if a complement becomes dearer or if income rises for an inferior good (2021; the key also counts ‘its own price falls’, strictly a movement along the curve).
• Consumer equilibrium: the best bundle within the budget (1998, loosely worded). Learn MRS = p₁/p₂ and MU per rupee equal across goods.
• Expect statement questions on elasticity (spending rule; vertical, horizontal, hyperbola; midpoint of a straight line), Giffen vs Veblen vs inferior goods, and movement vs shift.

Mains — where it appears and how to answer

• Rarely asked directly. Use the tools in GS3: inelastic food demand and farm-price crashes (case for MSP and procurement, Chapter 5); taxing goods with inelastic demand (tobacco, fuel) for revenue; inferior and Giffen goods in discussions of food subsidies for the poor; substitution and income effects in subsidy design.
• Present policy positions as attributed economists' views side by side (e.g. on whether price support distorts markets), without present-day political commentary.

Tap an option. NCERT's own exercise questions come first; the rest test the figures and common confusions.

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