1. THEORY OF CONSUMER
DEMAND

2.  Its a want backed by willingness to pay

3. • The branch of economics devoted to the study of consumer
behavior
• Applies to decisions related to purchasing goods and services
through markets.
• Largely centered on the study
• Analysis of the utility generated from the satisfaction of wants
and needs.
• The key principle is the law of diminishing marginal utility
• Explanation for the law of demand and the negative slope of
the demand curve.

4. DEMAND ANALYSIS
Study of sales generated by a good or service to determine the
reasons for its success or failure, and how it sales performance can
be improved.
o Firms sell goods/services to buyers
 Consumers (individuals) : utility
 Firms : make profits
o Willingness to pay: maximum price buyer will pay
for a good
 Point of indifference between buying and not buying
 Lower price always preferred by buyer

5.  Willingness to pay is determined by
 Buyer’s tastes or needs
 Income and wealth
 Normal/inferior goods
 Cyclical/acyclical demand
 Substitutes
 Complementary goods

6. CARDINAL : Utility is measurable numerically.
INDEPENDENT: Utility of each commodity is experienced independently.
ADDITIVE : Goods can be measured by adding their independent utilities
together.
CONSTANT :MU of money to be constant at all levels of income of the
consumer.
RATIONALITY :consumer is rational maximization of tu he buys

7.  ADDITIVE UTILITY :utility cannot be measured quantitatively.
 HOMOGENITY :utility or satisfaction derived from different goods is
qualitatively homogenous.
 CONSTANCY : MU of money remains constant.
 INAPPLICABLITY :utility analysis is inapplicable for bulky goods.
Eg.tv, fridge etc.
 GIFFEN GOODS :there is paradox situation in which the consumer tends
to buy less of such goods when their price falls.

8.  According to law of diminishing marginal utility a consumer
tries to equalize marginal utility of a commodity with its
price, so that his satisfaction is maximized.
 Consumer is a rational and always tries to seek Maximum
total utility when he buys goods.
• The law of diminishing marginal utility implies that by
increasing the stock of commodity its marginal utility is
diminished.

9.  A more advanced form of
consumer demand theory
involves the analysis of
indifference curves.
 An indifference curve, such as the
one labelled U in the exhibit to the
right, presents all combinations of
two goods that provide the same
amount of utility.
 Indifference curve analysis relies
on a relative ranking of
preferences between two goods
rather than the absolute
measurement of utility (utils)
derived from the consumption of
a particular good.

10.  Utility is viewed as the level of satisfaction rather than an amount of
satisfaction.
 The level of satisfaction is relatively comparable but not quantifiable.

11.  Based on the subjective valuation
 Differs from person to person
 Significance of commodities
 Drawn by a consumer mind
 Independent of the price of the goods

12.  Generally, negatively sloped, reflecting marginal rate of
substitution
 Convex to the origin, reflecting diminishing marginal utility
 Two indifference curves cannot cross
 Special case: a positively sloped indifference curve

13.  Also know as Price Line, Consumption Possibility Line, Line of
attainable combinations
 A collection of commodity that are affordable forms the consumer’s
budget constraint.
 A commodity X satisfies your budget constraint if P (your price is
greater than equal to M (income)
 A budget line is a collection of commodity X that are just
affordable, i.e., P is equal to M (income).
 INCOME and PRICES are two objectives factors in budgetary constraints.

14. Definition-
The state of balance achieved by an end user of products that refers
to the amount of goods and services they can purchase given their
present level of income and the current level of prices.
 Based on ORDINAL PREFERENCE or INDIFFERENCE CURVE.
 ASSUMPTIONS
 Fixed amount of money
 Combinations of two goods
 Each of the goods is HOMOGENEOUS.
 Tastes and Preferences.
 Consumer is rational.

15. •When the commodity consumed by
the consumer is available free of
cost, he will carry on the consumption
of the commodity up to the
point, where his total utility from that
commodity is maximum.
•So, he goes on consuming the
commodity till extra units of the
commodity give him some satisfaction.
• He stops the consumption of the
commodity at the point of
satiety, i.e., where marginal utility is Fig: Consumer Equilibrium
equal to zero. (One commodity)

16.  When the price of commodity falls the consumer is prefer
substitute more of the relatively cheaper commodity.
 The larger quantity of commodity will be purchased at a
lower price because the attitude of consumer.
 For example, if private universities increase their tuition by
10% and public universities increase their tuition by only
2%, then it is very likely that we would see a shift in
attendance from private to public universities (at least
amongst students accepted to both

17.  This refer to the changes in the real income of the
consumer due to changes in price, when the price of
commodity falls the purchasing power of real income of
the consumer will rise.
 Income effect may be positive, negative or zero.
 For example, a decrease in the price of all cars allows
you to buy either a cheaper car or a better car for the
same price, thus increasing your utility.

18.  Giffen paradox states that demand for a commodity increases as its price
rises.
 Giffen paradox is explained by the fact that if the poor rely heavily on
basic commodities like bread or potatoes, when prices are low they might
still have some disposable income for purchases of other items.
 In economics and consumer theory, a Giffen good is one which people
paradoxically consume more of as the price rises, violating the law of
demand.
 In normal situations, as the price of a good rises, the substitution
effect causes consumers to purchase less of it and more of substitute goods.
 In the Giffen good situation, the income effect dominates, leading people
to buy more of the good, even as its price rises.

19. Indifference curve analysis is superior in respect of the
following:
 Indifference Curve analysis is more realistic
 Free from the Defect of Independent Commodity
 Free from unrealistic assumption of Constant Marginal Utility
of money
 Based on Less Assumption
 Explanation of Income and Substitution Effects
 Explanation of Giffen's Paradox
 Helpful in the estimation of welfare
 More Realistic Foundation
 More Realistic Theory of Consumer's Equilibrium
 In short, it is clear that Indifference curve analysis is more
realistic and improved analysis

20. Indifference curve analysis criticized on account of the following:
 Unrealistic assumption
 Complex Analysis
 Imaginary
 Ignores combination involving risk
 Introspective
 Criticism on the basis of Indifference
 Assumption of Convexity
 Old wine in New bottles
 Impossible to explain Diminishing MRS without Diminishing
Marginal Utility
 Laughable Combinations
 Unrealistic Assumption of Maximum Utility
 Impractical