2. consumer behaviour
TRANSCRIPT
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Consumer
Behaviour
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Learning Objectives
Introduction to Consumer Behaviour Utility Approach
Law of Diminishing Marginal Utility
Law of Equi-Marginal Utility
Indifference Curve Approach
Marginal Rate of Substitution
Price Line
Consumer Equilibrium Income Effect
Substitution Effect
Consumer Surplus
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Law of Demand
Quantity of Ice-Cream Cones21 3 4 5 6 7 8 9 10 1211
3.00
2.50
2.00
1.50
1.00
0.50Priceo
fIce-CreamC
one
0
Demand of a commodityincreases with a fall in its
price
when other thingsremains constant
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What are the other things!?
1. Income of the consumer
2. Prices of Related goods
3. Tastes of consumer
4. Consumer expectations about thefuture
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Assumptions of Law of Demand
Income level should remain same
Tastes of the buyer should not change
Prices of other goods should remain same
No new substitutes for the commodity
Price raise in future should not be expected
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School of Thoughts
Law of demand can be explained with the help ofvarious theories of consumer behavior
Cardinal Utility Approach
Alfred Marshall
Ordinal Utility Approach (Indifference CurveAnalysis)
J.R. Hicks and RGD Allen
Revealed Preference Theory Paul A Samuelson
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Concept of utility
Utility = Value or Usefulness
Measure of Satisfaction that a consumerreceives from consuming a commodity
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The Cardinal Utility Approach
1. The cardinal measurement of utility1. Utility Quantifiable and measurable in terms of
money
2. Additivity of utility1. Utility derived from consuming different
commodities can be added it impliesindependence of utilities of different goods
U = U1(X1) + U2(X2) + . + Un(Xn)
Constancy of marginal utility of money Since money is the measuring rod it must be
constant
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Marginal Utility and Total Utility
Marginal Utility is the increase in totalutility as a result of the consumption ofan additional unit
Glass ofwater
TUin utils
0
1
23
4
5
6
0
7
1113
14
14
13
MUin utils
-
7
4
2
1
0
-1
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Diminishing Marginal utility
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-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Glass of
water
TU
in utils
0
1
23
4
5
6
0
7
1113
14
14
13
Utility
(utils)
Glass of water consumed
Gopals utility from consuming water
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-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Utility
(utils)
Glass of water consumed
TU
Glass of
water
TU
in utils
0
1
2
3
4
5
6
0
7
11
13
14
14
13
Gopals utility from consuming water
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-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Glass of
water
TU
in utils
0
1
23
4
5
6
0
7
1113
14
14
13
MU
in utils
-
7
42
1
0
-1
Utility
(utils)
Glass of water consumed
TU
MU
Gopals utility from consuming water
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-2
0
2
4
6
8
10
12
14
16
0 1 2 3 4 5 6
Utility
(utils)
Glass of water consumed
TU
MU
Gopals utility from consuming water
Point of Satiety
MU=0 but +veTU-increasingbut @decliningrate
MU = -ve,TU declines @increasing rate
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Law of diminishing Marginal Utility
The additional benefit which a personderives from a given increase of his
stock of a thing, diminishes with everyincrease in the stock that he alreadyhas
- Alfred Marshall
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Deriving Demand Curve fromLaw of Diminishing Marginal Utility
Quantity of Ice-Cream Cones
21 3 4 5 6 7 8 9 10 1211
MU1
MU2
MU3
MU4
MU5
MU6MarginalUtility
0
Quantity
21 3 4 5 6 7 8 9 10 1211
P1
P2
P3
P4
P5
P6
Price
0
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Exceptions to Law of Diminishing Marginal Utility
Alcoholics More alcohol-more intoxication-more consumption
Money More money greater desire to acquire more
Reading More knowledge by reading different books-not
the same one again and again Hobbies and rare collections
More the collection greater the desire to havemore
Arts Music, arts, drama, more the merrier !
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Equi-Marginal Utility
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Law of Equi-Marginal Utility
A consumer does not spend his incomeonly on one good but on number ofgoods.
Hence law of demand should involvesuch an analysis of choice amonggoods.
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The law of Equi-Marginal Utility statesthat the consumer would distribute hismoney income between the goods insuch a way that the utility from the last
rupee spent on each good is equal
Law of Equi-Marginal Utility
MU of commodity X
Price of X
MU of commodity Y
Price of Y=
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Illustration
Units MU ofX MU ofY
1
2
3
4
5
6
20
18
16
14
12
10
24
21
18
15
9
3
Units MU of X
Price of X
MU of Y
Price of Y
1
23
4
5
6
10
98
7
6
5
8
76
5
3
1
Let Price of X = Rs. 2
and Price of Y = Rs. 3
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Illustration
Units MU ofX MU ofY
1
2
3
4
5
6
20
18
16
14
12
10
24
21
18
15
9
3
Units MU of X
Price of X
MU of Y
Price of Y
1
23
4
5
6
10
98
7
6
5
8
76
5
3
1
Let Price of X = Rs. 2
and Price of Y = Rs. 3
MU of two commodities
are EQUAL
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Limitation of Cardinal Approach
Utility is a mental concept hencemeasurement is subjective.
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Indifference Curve Approach
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Indifference Curve Approach
In Indifference Curve analysis, consumer comparessatisfaction obtained from different combination of goods.
It is difficult to assign numbers to utility, however, one can rank(good, better, best or bad, worse, worst) the goods in theorder of utility.
Consumer is able to arrange various combinations of goodsand services on a scale ofpreference
Consumer is able to indicate;
- Whether he prefers one commodity bundle to other
- Whether he is indifferent between two commodity bundles.
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Illustration
Combinations
of 2 goods
(Apples andMangos)
Level ofSatisfaction
Order ofPreference
5 apples & 15Mangos
4 apples & 12
mangos
3 apples & 9mangos
Highest
Less than theprevious
Less than theprevious
I
II
III
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Indifference Schedule
It is a list of different combinations of two goodswhich will give equal level of satisfaction to theconsumer
Combination Apples Mangos Level ofSatisfaction
A
BC
D
E
20
1613
11
10
1
23
4
5
I
II
I
I
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0
2
4
6
8
10
12
14
16
18
20
22
24
26
28
30
0 2 4 6 8 10 12 14 16 18 20 22
Pears
Oranges
Pears
3024
20
14
10
8
6
Oranges
67
8
10
13
15
20
Point
ab
c
d
e
f
g
Constructing an indifference curve
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a
Pears
Oranges
Pears
3024
20
14
10
8
6
Oranges
67
8
10
13
15
20
Point
ab
c
d
e
f
g
Constructing an indifference curve
0
2
4
6
8
10
12
14
16
18
20
22
24
26
28
30
0 2 4 6 8 10 12 14 16 18 20 22
Constructing an indifference curve
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a
b
Pears
Oranges
Pears
3024
20
14
10
8
6
Oranges
67
8
10
13
15
20
Point
ab
c
d
e
f
g
Constructing an indifference curve
0
2
4
6
8
10
12
14
16
18
20
22
24
26
28
30
0 2 4 6 8 10 12 14 16 18 20 22
Constructing an indifference curve
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a
b
c
d
ef
g
Pears
Oranges
Pears
3024
20
14
10
8
6
Oranges
67
8
10
13
15
20
Point
ab
c
d
e
f
g
Constructing an indifference curve
0
2
4
6
8
10
12
14
16
18
20
22
24
26
28
30
0 2 4 6 8 10 12 14 16 18 20 22
Indifference curve
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0
2
4
6
8
10
12
14
16
18
20
22
24
26
28
30
0 2 4 6 8 10 12 14 16 18 20 22
a
b
c
d
ef
g
Pears
Oranges
Indifference curve
IC
An indifference map
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0
10
20
30
0 10 20
Unitso
fgoodY
Units of goodX
I1I2
I3
I4
I5
An indifference map
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Marginal Rate of Substitution
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Marginal Rate of Substitution
The Marginal Rate of Substitution of X forY (MRS XY) is defined as the amount ofY that a consumer is willing to give upin order to gain one additional unit of X
and still remain on the sameindifference curve (i.e., at the samelevel ofsatisfaction)
MRSXY= Y/X
Deriving the marginal rate of substitution (MRS)
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0
10
20
30
0 10 206
26
7
Unitso
fgoodY
Units of goodX
a
bY= 4
X= 1
MRS= 4
MRS= Y/X
Deriving the marginal rate of substitution (MRS)
Deriving the marginal rate of substitution (MRS)
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0
10
20
30
0 10 20
a
b
Unitso
fgoodY
Units of goodX
26
6 7
d
Y= 4
X= 1
Y = 1
X= 1
MRS= 1
MRS= 4
13 14
9
c
MRS= Y/X
Deriving the marginal rate of substitution (MRS)
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Properties of Indifference Curve
Indifference curves slope downwards fromleft to right
Indifference curves are convex to origin
Indifference curves do not intersect eachother
Distances of indifference curves from thepoint of origin determine their preferentialorder
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Budget Line (Price Line)
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Mangos
M M1 B
A
N
N1
Ap
ples
Budget Line (Price Line)
A Budget Line shows allpossible combination of 2
goods that the consumer
can buy at a given level of
income and prices of two
goods
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Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Assumptions
PX= Rs. 2
PY= Rs.1Budget = Rs. 30
A budget line
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Unitso
fgoodY
Units of goodX
a
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Assumptions
PX= Rs.2
PY= Rs. 1Budget = Rs. 30
Point on
budget line
a
A budget line
0
10
20
30
0 5 10 15 20
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Unitso
fgoodY
Units of goodX
a
b
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Point on
budget line
a
b
Assumptions
PX= Rs. 2
PY= Rs.1Budget = Rs. 30
A budget line
0
10
20
30
0 5 10 15 20
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Unitso
fgoodY
Units of goodX
a
b
c
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Point on
budget line
a
b
c
Assumptions
PX= Rs. 2
PY= Rs. 1Budget = Rs. 30
A budget line
0
10
20
30
0 5 10 15 20
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Unitso
fgoodY
Units of goodX
a
b
c
d
Units of
good X
0
5
10
15
Units of
good Y
30
20
10
0
Point on
budget line
a
b
c
d
Assumptions
PX= Rs.2
PY= Rs. 1Budget = Rs. 30
A budget line
0
10
20
30
0 5 10 15 20
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Consumer Equilibrium
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Consumer Equilibrium
The point of consumer equilibrium is the point
where the budget line just touches a particular
indifference curve. This is the point of maximumsatisfaction
Finding the optimum consumption
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Finding the optimum consumption
Unitsof
goodY
Units of good X
O
Finding the optimum consumption
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I1I2
I3
I4
I5
Unitsof
goodY
Units of good X
O
Finding the optimum consumption
Finding the optimum consumption
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I1I2
I3
I4I5
Unitsof
goodY
O
Units of good X
Budget line
Finding the optimum consumption
Finding the optimum consumption
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I1I2
I3
I4I5
Unitsof
goodY
O
Units of good X
r
v
s
u
Y1
X1
t
Finding the optimum consumption
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Increased Income and Budget Line
Effect of an increase
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UnitsofgoodY
Units of goodX
Assumptions
PX= Rs. 2
PY= Rs. 1Budget = Rs. 30
Effect of an increase
in income on the budget line
0
10
20
30
40
0 5 10 15 20
Effect of an increase in income on the budget line
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UnitsofgoodY
Units of goodX
Assumptions
PX= Rs. 2PY= Rs. 1
Budget = Rs. 40
Budget
= Rs. 40
Budget
= Rs. 30
16
7
0
10
20
30
40
0 5 10 15 20
m
n
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Income Effect (Income Consumption Curve)
Effect on consumption of a change in income
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UnitsofgoodY
O
Units of good X
B1
p g
I1
a
Effect on consumption of a change in income
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I2
UnitsofgoodY
O
Units of good X
B1 B2 I1
p g
Effect on consumption of a change in income
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I2
UnitsofgoodY
O
Units of good X
B1 B2 B3 B4 I1
I3
I4
g
Effect on consumption of a change in income
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I2
UnitsofgoodY
O
Units of good X
B1 B2 B3 B4 I1
I3
I4
Income-consumption curve
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Price Effect
Effect on the budget line of a fall in the price of good X
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0
10
20
30
0 5 10 15 20 25 30
UnitsofgoodY
Units of goodX
Assumptions
PX= Rs. 2PY= Rs. 1
Budget = Rs. 30
Effect on the budget line of a fall in the price of good X
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0
10
20
30
0 5 10 15 20 25 30
UnitsofgoodY
Units of goodX
Assumptions
PX= Rs. 2PY= Rs. 1
Budget = Rs. 30
Effect on the budget line of a fall in the price of good X
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0
10
20
30
0 5 10 15 20 25 30
UnitsofgoodY
Units of goodX
Assumptions
PX=Rs. 1PY= Rs. 1
Budget = Rs. 30
Effect on the budget line of a fall in the price of good X
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UnitsofgoodY
Units of goodX
Assumptions
PX=Rs. 1PY= Rs. 1
Budget = Rs. 30
B1 B2
a
b0
10
20
30
0 5 10 15 20 25 30
c
Effect of a fall in the price of good X
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0
10
20
30
0 5 10 15 20 25 30
Assumptions
PX= Rs. 2PY= Rs. 1
Budget = Rs. 30
UnitsofgoodY
Units of goodX
Effect of a fall in the price of good X
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UnitsofgoodY
Units of goodX
Assumptions
PX= Rs. 2PY= Rs. 1
Budget = Rs. 30
B1 I10
10
20
30
0 5 10 15 20 25 30
j
Effect of a fall in the price of good X
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UnitsofgoodY
Units of goodX
B1 I1
j
Assumptions
PX=
Rs. 1PY= Rs. 1
Budget = Rs. 30
0
10
20
30
0 5 10 15 20 25 30
30
Effect of a fall in the price of good X
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UnitsofgoodY
Units of goodX
Assumptions
PX=
Rs. 1PY= Rs. 1
Budget = Rs. 30
B1 I1 B2
a
j
0
10
20
30
0 5 10 15 20 25 30
I2
k
30
Effect of a fall in the price of good X
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0
10
20
30
0 5 10 15 20 25 30
UnitsofgoodY
Units of goodX
B1 I1 B2
a
j
I2
Price-consumption curve
k
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Income Effect and
Substitution Effect
of Normal Good
Income and substitution effects: normal good
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Units
ofgoodY
I3
I5
B1
f
QX1
Units of GoodX
Income and substitution effects: normal good
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Units
ofgoodY
I1
I2B2
h
B1
QX1
f
Rise in the priceof good X
Units of GoodX
QX3
Income Effect
Income and substitution effects: normal good
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Units
ofgoodY
Substitutioneffect
B1
QX1
f
I1
QX
2
B1a
Substitution effectof the price rise
g
Units of GoodX
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Effect of a rise in income on the
Demand for an Inferior Good
Effect of a rise in income on the demand for an inferior good
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UnitsofgoodY
(norm
algood)
Units of goodX
(inferior good)
O
I1B
1
a
Effect of a rise in income on the demand for an inferior good
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UnitsofgoodY
(norm
algood)
O
I2
I1B
1
B
2
a
b
Units of goodX
(inferior good)
Effect of a rise in income on the demand for an inferior good
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UnitsofgoodY
(norm
algood)
O
Income-consumption curve
I2
I1B
1
B
2
a
b
Units of goodX
(inferior good)
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Deriving a demand curve from
a price-consumption curve
Deriving a demand curve from a price-consumption curve
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B1I1
Expenditureon
allo
thergo
ods
Units of goodX
a
Deriving a demand curve from a price-consumption curve
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I2
B1 B2I1
Expenditureon
allo
thergo
ods
Units of goodX
a b
Fall in the
price ofX
Deriving a demand curve from a price-consumption curve
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I2
B1 B2I1
Expenditureon
allo
thergo
ods
Units of goodX
a b
Further falls in
the price ofX
Deriving a demand curve from a price-consumption curve
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B1 B2 B3
I3I2
I1
I4
B4
Expenditureon
allo
thergo
ods
Units of goodX
a b c d
Further falls in
the price ofX
Deriving a demand curve from a price-consumption curve
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B1 B2 B3
I3I2
I1
I4
B4
Expenditureon
allo
thergo
ods
Units of goodX
Price-consumptioncurve
a b c d
Deriving a demand curve from a price-consumption curve
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B1 B2 B3
I3I2
I1
I4
B4
Expenditureon
allo
thergo
ods
Units of goodX
a Price-consumptioncurve
b c d
Priceofg
oodX
Units of oodX
P1
Q1
a
Deriving a demand curve from a price-consumption curve
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B1 B2 B3
I3I2
I1
I4
B4
Expenditureon
allo
thergo
ods
Units of goodX
a Price-consumptioncurve
b c d
Priceofg
oodX
Units of oodX
a
Demand
P1
P2
P3P4
Q1 Q2 Q3 Q4
b
cd
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Consumer Surplus
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When a consumer buys a commodity he pay aprice to the commodity and derivessatisfaction from the commodity.
If the satisfaction he derives from thecommodity is greater than the money hepays for it, then this excess satisfaction iscalled Consumer surplus (Ex: Newspapers,Salt,)
Consumer Surplus = Price Prepared to Pay Actual Price Paid
MU P
Consumer surplus
-
7/28/2019 2. Consumer Behaviour
89/91
MU
P1
Q1O
MU, P
Q
MU P
Consumer surplus
-
7/28/2019 2. Consumer Behaviour
90/91
Total
consumer
expenditureMU
P1
Q1O
MU, P
Q
MU P
Consumer surplus
-
7/28/2019 2. Consumer Behaviour
91/91
Total
consumer
expenditureMU
Total
consumer
surplusP1
MU, P
Actual MoneyPaid
Amount of Money
which consumer is
prepared to pay