1. Introduction

The Theory of Consumer Behaviour deals with how consumers allocate their limited income among various goods and services to maximize satisfaction (utility). It forms the foundation of microeconomic analysis and demand theory.

The central question it addresses is:

“Given income and prices, what combination of goods will a rational consumer choose to maximize satisfaction?”

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2. Approaches to the Theory of Consumer Behaviour

A. Cardinal Utility Approach (Marshallian Approach)

Assumptions

1. Measurable Utility: Utility can be measured in cardinal numbers like 1, 2, 3… (Utils).

2. Rational Consumer: The consumer aims to maximize total utility.

3. Diminishing Marginal Utility: As more of a good is consumed, the additional utility derived from each extra unit declines.

4. Independent Utilities: The utility of one commodity is independent of others.

5. Constant Marginal Utility of Money: The marginal utility of money remains unchanged.

Law of Diminishing Marginal Utility (DMU)

“As more units of a good are consumed, the additional satisfaction from each successive unit decreases.”

Mathematically:

$$M{U}_x=\frac{\mathrm{\Delta }TU}{\mathrm{\Delta }{Q}_x}$$

where $M{U}_x$ = Marginal Utility of good X, $\mathrm{\Delta }TU$ = change in total utility, $\mathrm{\Delta }{Q}_x$ = change in quantity consumed.

Consumer’s Equilibrium under Cardinal Utility

A consumer attains equilibrium when:

$$\frac{M{U}_x}{P_x}=\frac{M{U}_y}{P_y}=M{U}_m$$

where $M{U}_m$ is the marginal utility of money.

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B. Ordinal Utility Approach (Indifference Curve Analysis)

Key Contributors

Vilfredo Pareto (1906), further developed by Hicks and Allen (1934) in Value and Capital.

Core Concept

Utility cannot be measured; it can only be ranked (ordered). Consumers can indicate preferences between bundles, not the exact level of satisfaction.

Assumptions

1. Rationality: Consumer seeks to maximize satisfaction.

2. Ordinal Utility: Preferences can be ordered (A preferred to B, etc.).

3. Transitivity: If A > B and B > C, then A > C.

4. Non-satiation: More of a good gives higher satisfaction.

5. Diminishing Marginal Rate of Substitution (DMRS): As a consumer substitutes X for Y, the amount of Y he gives up for one more unit of X decreases.

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3. Indifference Curve Analysis

Indifference Curve (IC)

An IC shows combinations of two goods that provide equal satisfaction to the consumer.
Thus, the consumer is indifferent among all combinations on the same IC.

Properties of Indifference Curves

1. Negatively Sloped: More of one good means less of the other to maintain same utility.

2. Convex to the Origin: Due to the law of diminishing MRS.

3. Non-Intersecting: Two ICs cannot cross each other.

4. Higher ICs Indicate Higher Utility: IC3 > IC2 > IC1.

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Marginal Rate of Substitution (MRS)

The rate at which the consumer is willing to give up Y for one more unit of X, keeping satisfaction constant.

$$MR{S}_{xy}=-\frac{\mathrm{\Delta }Y}{\mathrm{\Delta }X}$$

Diminishing MRS: As more of X is consumed, less of Y is sacrificed — hence IC is convex.

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Budget Line

Represents all possible combinations of two goods that a consumer can buy with given income (M) and prices $P_x,P_y$.

$$P_{x}X+P_{y}Y=M$$

Slope of the budget line: $-\frac{P_x}{P_y}$

Shifts:

• Increase in income → Parallel outward shift.

• Increase in price of one good → Rotation of line.

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Consumer’s Equilibrium (Hicksian Equilibrium)

Occurs where Indifference Curve is tangent to the Budget Line:

$$\frac{M{U}_x}{M{U}_y}=\frac{P_x}{P_y}$$

At this point, MRS = Price Ratio. The consumer maximizes satisfaction given constraints.

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4. Revealed Preference Theory (Samuelson, 1947)

This theory avoids the unobservable concept of utility. Instead, it relies on observed choices.

Assumptions

1. Rationality: Consumer prefers more to less.

2. Consistency: If A is preferred to B, B cannot be preferred to A.

3. Transitivity: If A > B and B > C, then A > C.

4. Stable Preferences: Preferences remain unchanged during analysis.

Axiom of Revealed Preference

If a consumer chooses bundle A over B when both are affordable, A is revealed preferred to B.

Implications

• Law of Demand can be derived without measuring utility.

• Indifference curves can be deduced from observed behaviour.

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5. Theory of Consumer Surplus

Origin:

Introduced by A.J. Dupuit (1844) and later formalized by Alfred Marshall.

Meaning:

The difference between what a consumer is willing to pay and what he actually pays.

Mathematically:

$$CS=TU-(P\times Q)$$

Hicksian Measurement (Indifference Curve Method):

Hicks redefined consumer surplus in ordinal terms using indifference curves and budget constraints — a superior alternative to Marshall’s cardinal concept.

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6. Criticisms and Limitations

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7. Modern Developments in Consumer Behaviour

1. Behavioral Economics: Challenges the assumption of rationality (bounded rationality, heuristics, biases).

2. Expected Utility and Risk: Consumers make choices under uncertainty using probability-weighted utilities.

3. Intertemporal Choice: Examines consumption decisions over time (Fisher model).

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8. Key Diagrams for UGC NET

• Indifference Curve and Budget Line (Consumer Equilibrium)

• Diminishing Marginal Rate of Substitution

• Revealed Preference and Budget Constraint

• Hicksian Consumer Surplus Measurement

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9. Summary Points

• The theory of consumer behaviour explains how consumers make choices under constraints.

• Ordinal utility replaces cardinal measurement for realistic analysis.

• Indifference curve analysis is central to modern microeconomics.

• Revealed preference theory provides a scientific basis using observed choices.

• Consumer surplus measures welfare from consumption.

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10. Suggested Readings

• Hicks, J.R. Value and Capital

• Samuelson, P.A. Foundations of Economic Analysis

• Dwivedi, D.N. Principles of Economics

• Mankiw, G.N. Principles of Microeconomics

• Koutsoyiannis, A. Modern Microeconomics