Theory of Consumer Behaviour | CBSE Class 11 Economics Notes

This note covers consumer choice, utility, indifference curves, the consumer’s budget, optimal consumption, individual and market demand, changes in demand, price elasticity and the relationship between elasticity and expenditure.

How do preferences and income shape consumer choice?

A consumer chooses how to spend income on different goods. Here, goods includes services. This problem of choice involves finding a combination that gives maximum satisfaction, subject to what the consumer can afford. The consumer’s likes are called preferences.

Affordability depends on the prices of goods and the consumer’s income. Preferences and affordability therefore answer different questions: which combination the consumer likes, and which combinations are available to buy. Both are needed to explain the final choice.

What is a consumption bundle?

A consumption bundle is a combination of quantities of goods. To simplify the analysis, consider two goods: bananas and mangoes. Let x₁ denote the quantity of bananas and x₂ the quantity of mangoes. Both quantities can be positive or zero.

The notation (x₁, x₂) represents the bundle containing these quantities. Thus, (5, 10) means 5 bananas and 10 mangoes, whereas (10, 5) means 10 bananas and 5 mangoes. The order identifies which quantity belongs to which good.

Definition: Utility is the want-satisfying capacity of a commodity. A consumer usually decides demand for a commodity on the basis of the utility, or satisfaction, derived from it.

Utility is subjective: different people can obtain different satisfaction from the same commodity. Someone fond of chocolates receives greater utility from chocolate than someone who is not. Utility can also change with place and time.

A room heater’s utility depends on whether the person is in Ladakh or Chennai, and whether it is summer or winter. Consumer behaviour can be studied through cardinal utility analysis, which uses numbers, or ordinal utility analysis, which ranks alternatives.

How are total utility and marginal utility related?

Cardinal utility analysis assumes that utility can be expressed numerically. Total utility, abbreviated TU, is the total satisfaction from consuming a given quantity. Marginal utility, abbreviated MU, is the change in total utility from consuming one additional unit.

Let n denote the number of units consumed. TUₙ means total utility from n units; TUₙ₋₁ means total utility from one fewer unit; MUₙ means marginal utility of the nth unit. The subscript identifies the relevant quantity or unit.

MUₙ = TUₙ − TUₙ₋₁

TUₙ = MU₁ + MU₂ + … + MUₙ

The second equation adds the marginal utilities of successive units to obtain total utility. The following schedule shows how total and marginal utility can change together.

What does diminishing marginal utility mean?

Usually, marginal utility diminishes as consumption increases because the desire for still more of the commodity becomes weaker. The law of diminishing marginal utility states that each additional unit provides less marginal utility as consumption increases, while consumption of other commodities remains constant.

Falling marginal utility does not immediately mean falling total utility. In the schedule, total utility rises while marginal utility is positive. Total utility is unchanged at the fifth unit, where marginal utility is zero, and falls at the sixth unit, where marginal utility is negative.

Quantity is on the horizontal axis and utility on the vertical axis. The total utility line rises, levels between the fourth and fifth units, then falls. The marginal utility line reaches zero at the fifth unit and becomes negative.

See Fig. 2.1 in your NCERT textbook

Worked example 1. In a separate banana example, 4 bananas provide total utility of 28 units and 5 bananas provide 30 units. Find the marginal utility of the fifth banana.

Answer: MU₅ = TU₅ − TU₄ = 30 − 28 = 2 units of utility. The additional banana contributes the difference between the two totals.

How do indifference curves represent ordinal utility?

Ordinal utility analysis starts from ranking consumption bundles. Numerical measurement is a major drawback of cardinal analysis: in real life, consumers do not express satisfaction in numbers, though they often rank alternative bundles as providing more or less utility.

An indifference curve joins points representing bundles that give the consumer equal satisfaction. The consumer is indifferent between such bundles. Preferences can often be represented diagrammatically, and points giving equal utility can generally be joined to form such a curve.

What is the marginal rate of substitution?

The marginal rate of substitution, abbreviated MRS, is the amount of mangoes the consumer gives up for an additional banana while total utility remains unchanged. Let Δ mean “change in”. Thus, Δx₁ is the change in bananas and Δx₂ the change in mangoes.

MRS = |Δx₂/Δx₁|

The vertical bars mean absolute value, or magnitude without the negative sign. Moving along a downward-sloping indifference curve, more bananas require fewer mangoes. MRS expresses the magnitude of this sacrifice.

The dash in the first row indicates that no preceding change is shown. From A to B, the consumer sacrifices 3 mangoes; from B to C, 2 mangoes; and from C to D, 1 mango, each time for one additional banana.

This diminishing MRS makes the curve convex to the origin, meaning that it becomes flatter as consumption of bananas increases. This is the most common shape. As bananas become more plentiful and mangoes scarcer, the consumer is willing to sacrifice smaller amounts of mangoes.

Bananas are on the horizontal axis and mangoes on the vertical axis. Points A, B, C and D lie on a downward-sloping curve, with guide lines marking the combinations in the table.

See Fig. 2.3 in your NCERT textbook

Perfect substitutes can replace one another while providing exactly the same utility. Five-rupee notes and five-rupee coins illustrate this case: the consumer sacrifices one coin for one note regardless of how many notes she has. MRS remains constant and the indifference curve is straight.

What properties do indifference curves and maps have?

Monotonic preferences mean that a consumer prefers a bundle with more of at least one good and no less of the other. This assumption does not rank bundles merely by adding their quantities; it compares the amount of each good separately.

An indifference map is a family of indifference curves representing preferences over bundles. Under monotonic preferences, bundles on a higher curve are preferred to those on a lower curve. Bundles on the same curve provide equal satisfaction.

Why do the curves slope downwards and remain separate?

1. Downward slope: To remain on the same curve while obtaining more bananas, the consumer must give up mangoes. More bananas with unchanged mangoes would be preferred under monotonic preferences.
2. Higher satisfaction: As long as marginal utility is positive, more of a commodity increases satisfaction. Holding mangoes unchanged while increasing bananas therefore places the bundle on a higher curve.
3. No intersection: Intersecting curves would imply inconsistent rankings. Bundles could appear equally satisfactory even though one contains more of a good and no less of the other.

For the non-intersection argument, consider bundles A = (7, 10), B = (9, 7) and C = (9, 5), with bananas written first. If A and B were on one curve, and A and C on another, all three would provide equal utility.

Yet B has the same bananas as C and more mangoes, so B is preferred under monotonic preferences. The contradiction shows why two indifference curves cannot intersect. The reasoning depends on the stated preference assumptions.

Keep diminishing MRS distinct from equal utility. Equal utility defines movement along one curve; diminishing MRS describes how the willingness to exchange the goods changes along the commonly convex curve. Perfect substitutes retain equal utility along a straight curve with constant MRS.

How do the budget set and budget line describe affordability?

Let M be the consumer’s money income available for the two goods. Let p₁ and p₂ be their prices per unit: bananas and mangoes respectively. Buying x₁ bananas costs p₁x₁, while buying x₂ mangoes costs p₂x₂.

The budget constraint requires spending to be no greater than income: p₁x₁ + p₂x₂ ≤ M. The budget set contains every bundle satisfying this condition. The symbol ≤ means “less than or equal to”.

The budget line contains bundles that cost exactly the entire income:

p₁x₁ + p₂x₂ = M

x₂ = M/p₂ − (p₁/p₂)x₁

How are intercepts and slope interpreted?

An intercept is where a line meets an axis. The horizontal intercept M/p₁ is the maximum bananas affordable if all income is spent on bananas. The vertical intercept M/p₂ is the maximum mangoes affordable if all income is spent on mangoes.

The slope is −p₁/p₂. Its absolute value, p₁/p₂, is the price ratio: the amount of mangoes the consumer must give up to obtain one more banana while spending the whole budget. It describes the exchange permitted by market prices.

Bananas are on the horizontal axis and mangoes on the vertical axis. A descending straight line joins M/p₂ on the vertical axis to M/p₁ on the horizontal axis. The region on or below it represents affordable non-negative bundles.

See Fig. 2.9 in your NCERT textbook

If the goods are perfectly divisible, quantities need not be whole numbers. Bundles below the line cost less than income, bundles on it exhaust income, and bundles above it are unaffordable. Whole-unit goods instead restrict the available combinations to integer quantities.

Worked example 2. A consumer has ₹20. Both goods cost ₹5 per unit and are available only in whole units. Identify all affordable bundles and those exhausting income.

Answer: Affordable bundles are (0, 0), (0, 1), (0, 2), (0, 3), (0, 4), (1, 0), (1, 1), (1, 2), (1, 3), (2, 0), (2, 1), (2, 2), (3, 0), (3, 1) and (4, 0).

Answer: The bundles (0, 4), (1, 3), (2, 2), (3, 1) and (4, 0) each cost exactly ₹20. All the other listed bundles cost less. The bundles (3, 3) and (4, 5) are unaffordable.

How do income and price changes alter the budget line?

The available bundles depend on income and both prices. When one changes, the budget set is also likely to change. To identify the effect, first specify what is held constant. Income changes and changes in one price affect the line differently.

What happens when income changes?

With both prices unchanged, an increase in income raises both intercepts. The budget line shifts parallel outwards, allowing more of the goods to be bought at prevailing prices. A decrease in income reduces both intercepts and shifts the line parallel inwards.

The slope remains −p₁/p₂ because the price ratio has not changed. A larger budget therefore changes affordability without changing the market rate of substitution between the two goods.

What happens when one price changes?

If the price of bananas rises while income and the mango price remain unchanged, the horizontal intercept falls and the vertical intercept stays fixed. The budget line becomes steeper, pivoting inwards around the vertical intercept.

If the banana price falls under the same conditions, the horizontal intercept increases. The line becomes flatter and pivots outwards. A change in the mango price, with banana price and income unchanged, similarly changes the vertical intercept while leaving the horizontal intercept fixed.

Worked example 3. Goods 1 and 2 cost ₹4 and ₹5 per unit. Income is ₹20. Let x₁ and x₂ now denote their respective quantities. Find the budget equation, intercepts and slope.

Answer: The budget line is 4x₁ + 5x₂ = 20. Spending everything on good 1 buys 20/4 = 5 units; spending everything on good 2 buys 20/5 = 4 units. Its slope is −4/5.

If income and both prices double together, affordability is unchanged: multiplying both sides of the budget constraint by the same positive number preserves the original set of affordable bundles. A change in money income must therefore be considered alongside price changes.

How does a rational consumer choose the optimum bundle?

A consumer is generally assumed to have well-defined preferences and to act rationally, choosing the available bundle that provides maximum satisfaction. The optimum bundle, or consumer’s equilibrium, is the most preferred affordable combination.

The choice problem combines the budget set with the indifference map. The consumer seeks the highest attainable indifference curve. A higher curve is attractive only if some bundle on it is affordable; preference alone cannot overcome the budget constraint.

Why is the optimum on the budget line?

Under monotonic preferences, a bundle below the line cannot be optimal. There is a bundle on the line with more of at least one good and no less of the other. Bundles above the line are unavailable, so the optimum lies on the line.

In the usual convex-curve situation, the budget line is tangent to the highest attainable indifference curve: it just touches that curve at the optimum. At this point, the willingness to substitute matches the exchange rate available in the market.

MRS = p₁/p₂

The descending budget line touches the black indifference curve. A grey curve lies beyond the budget, while a blue curve lies below the attainable optimum. The touching point represents the chosen quantities of bananas and mangoes.

See Fig. 2.12 in your NCERT textbook

If MRS is 2 while the goods have equal prices, the consumer is willing to surrender 2 mangoes for an extra banana, but the market requires surrendering just 1 mango. The difference allows movement to a preferred bundle, so that position is not optimal.

Note: Tangency describes the situation with the usual curved preferences shown here. There are other situations in which the optimum involves spending the entire income on one good only. Tangency is therefore not a universal requirement for every possible optimum.

How is the demand curve derived from consumer choice?

Demand is the quantity of a commodity a consumer is willing to buy and able to afford. It depends on the commodity’s own price, other goods’ prices, the consumer’s income, and tastes and preferences.

A demand function relates the consumer’s chosen quantity to price while the other influences remain unchanged. Let X denote quantity demanded and P the good’s price. The notation f means the rule assigning a chosen quantity to each price.

X = f(P)

The demand curve is the graphical representation of this function. Price is the independent variable, meaning the variable being changed; quantity is the dependent variable, whose value responds. In this graph, price is on the vertical axis and quantity on the horizontal axis.

Why is demand generally downward sloping?

The relationship between price and quantity demanded is likely to be negative in general. The law of demand states that, other things being equal, demand falls when price rises and rises when price falls. Its constant-other-factors condition is essential.

Diminishing marginal utility helps explain this relation: successive units provide less additional satisfaction, so a consumer is unwilling to pay as much for each additional unit. A lower price can therefore make a larger quantity worth buying.

In indifference-curve analysis, a fall in the banana price, with income and mango price unchanged, expands the budget set. In the illustrated case, the new optimum includes more bananas. Repeating this process and plotting each price against its chosen quantity produces the demand curve.

The substitution effect is the increase in banana consumption as cheaper bananas replace mangoes while maintaining the same satisfaction. The income effect arises because the price fall increases purchasing power, which further increases demand in the illustrated case.

A rise in purchasing power can sometimes reduce consumption of a good. Then the two effects oppose each other. If the income effect outweighs the substitution effect, quantity demanded moves positively with price. Such a commodity is a Giffen good.

Why does a demand curve shift rather than show movement along it?

A change in a good’s own price, with other influences unchanged, produces a movement along its demand curve. A change in income, another good’s price, or preferences changes demand at each own-price level and therefore shifts the curve.

How do income and related goods matter?

For most goods, demand rises with income and falls when income falls. These are normal goods. Demand for inferior goods moves in the opposite direction to income. Coarse cereals are an example of low-quality food items that can be inferior goods.

The classification can change with income level. Demand for low-quality cereals can increase with income at very low incomes. Beyond a level, further income increases are likely to reduce their consumption as the consumer switches to better-quality cereals.

Complementary goods are consumed together, such as tea and sugar, shoes and socks, or pen and ink. An increase in sugar’s price is likely to decrease demand for tea; a decrease is likely to increase it.

Substitute goods can be used in place of one another, such as tea and coffee. When coffee becomes dearer, consumers can switch to tea, whose demand is likely to rise. Demand usually moves in the same direction as a substitute’s price.

Preferences can also change with circumstances. The demand curve for ice-creams is likely to shift rightward in summer as preference for them increases. This concerns a change in demand at each price, rather than a response to a change in ice-cream’s own price.

Both panels place price vertically and quantity horizontally. Panel (a) shows an arrow along one downward-sloping curve. Panel (b) shows an arrow from a demand curve towards a second curve to its right.

See Fig. 2.17 in your NCERT textbook

How is market demand obtained from individual demands?

Market demand at a particular price is the total quantity demanded by all consumers together. The quantities must be added at the same price. Individual demand describes one consumer’s choice; market demand combines those choices across the market.

Graphically, this is horizontal summation: add quantities along the horizontal axis while keeping the vertical price level fixed. Repeat at different prices to obtain the market demand curve.

How are linear demands added?

Let p denote the common market price, d₁(p) consumer 1’s quantity demanded at that price, and d₂(p) consumer 2’s quantity demanded. A linear demand has a straight-line relationship within the price range for which demand is positive.

Worked example 4. A market has only two consumers. Their demands are d₁(p) = 10 − p for prices up to 10 and zero above 10; d₂(p) = 15 − p for prices up to 15 and zero above 15. Find market demand at non-negative prices.

Answer: At prices up to 10, both consumers’ demands contribute, giving (10 − p) + (15 − p) = 25 − 2p. Above 10 and up to 15, only consumer 2 contributes, giving 15 − p. Above 15, market demand is zero.

The price ranges matter because a consumer’s demand is zero beyond the specified limit. Continuing a linear expression into negative quantities would incorrectly reduce the market total. Add the relevant non-negative demands in each range.

The procedure extends to markets with more than two consumers: choose a price, find each consumer’s demand at that price, add the quantities, and repeat. The market curve therefore summarises the quantities consumers collectively choose at each price.

How is price elasticity of demand calculated and interpreted?

Price elasticity of demand measures how responsive quantity demanded is to a price change. Let eᴅ denote signed price elasticity, Q the original quantity and P the original price. ΔQ and ΔP denote changes in quantity and price respectively.

eᴅ = (ΔQ/Q)/(ΔP/P) = (ΔQ/ΔP) × (P/Q)

Multiplying each proportional change by 100 gives percentage changes. Elasticity is a pure number. For a downward-sloping demand curve, price and quantity change in opposite directions, making signed elasticity negative. Classification uses its absolute value, |eᴅ|.

Worked example 5. A consumer buys 15 bananas at ₹5 per banana and 12 bananas when price rises to ₹7. Calculate price elasticity using the original price and quantity as bases.

Answer: Percentage quantity change = [(12 − 15)/15] × 100 = −20%. Percentage price change = [(7 − 5)/5] × 100 = 40%. Signed elasticity is −20/40 = −0.5; its absolute value is 0.5. Demand is inelastic at that price.

What influences responsiveness?

Demand for essential goods is often found to be inelastic. In general, demand for a necessity is likely to be price inelastic, whereas demand for a luxury is likely to be price elastic. These are tendencies, not universal classifications.

The availability of close substitutes also matters. Demand is likely to be elastic when close substitutes are easily available, and likely to be inelastic when they are not. If one variety of pulses becomes dearer, consumers can shift to another variety.

Consequently, although demand for food is inelastic, demand for specific food items is likely to be more elastic. Elasticity can also differ at different prices for the same good; it is not necessarily a fixed characteristic of that good.

How do elasticity, curve shape and expenditure fit together?

Let q be quantity demanded and p price in a linear demand equation. Let a be demand at zero price and b the amount by which demand falls for a unit rise in price. For non-negative demand, q = a − bp, with a and b positive.

The magnitude of elasticity is |eᴅ| = bp/(a − bp). Although the quantity change per unit price change is constant, the price-to-quantity ratio varies. Thus, a straight demand curve does not have constant elasticity.

How does elasticity vary along the curve?

Elasticity is zero where the curve meets the quantity axis and infinite, denoted ∞, where it meets the price axis. It equals 1 at the midpoint, exceeds 1 above the midpoint, and is below 1 beneath it.

The geometric measure at a point on a straight demand curve is the length of its lower segment divided by the length of its upper segment. The lower segment runs to the quantity-axis intercept; the upper segment runs to the price-axis intercept.

A vertical demand curve is perfectly inelastic, with elasticity zero. A horizontal demand curve is perfectly elastic, with infinite elasticity. A rectangular hyperbola is a downward-sloping curve with a constant product of its two variables; as a demand curve, it has unitary elasticity throughout.

What is the expenditure relationship?

Let E denote expenditure on the good. Since expenditure equals price multiplied by quantity, E = pq. Along a rectangular-hyperbola demand curve, pq is constant, so expenditure remains unchanged at every point.

For the small-change derivation, let ΔE be the change in expenditure, and Δp and Δq the changes in price and quantity. Expanding the new expenditure gives:

ΔE = (p + Δp)(q + Δq) − pq = qΔp + pΔq + ΔpΔq

For small changes, ΔpΔq is negligible. The approximate expenditure change is qΔp + pΔq, or Δp × q × (1 + eᴅ), using signed elasticity. This explains the opposing expenditure responses for elastic and inelastic demand.

Note: The small-change derivation is an approximation. For finite changes with actual prices and quantities supplied, calculate old and new expenditure directly. Do not silently drop the product of the two changes from the exact expression.

Glossary

• Consumption bundle — A combination specifying the quantities of the goods a consumer consumes.
• Utility — The want-satisfying capacity of a commodity, experienced subjectively by its consumer.
• Total utility — Total satisfaction derived from consuming a given quantity of a commodity.
• Marginal utility — The change in total utility caused by consuming one additional unit.
• Indifference curve — A curve joining consumption bundles that provide the consumer with equal satisfaction.
• Marginal rate of substitution — The amount of one good sacrificed for another while satisfaction remains unchanged.
• Monotonic preferences — Preferences favouring more of at least one good and no less of the other.
• Indifference map — A family of indifference curves representing a consumer’s preferences over consumption bundles.
• Budget set — All bundles affordable at the consumer’s income and prevailing prices of goods.
• Budget line — The line representing bundles that cost exactly the consumer’s entire available income.
• Consumer’s optimum — The most preferred bundle among those available within the consumer’s budget set.
• Normal good — A good whose demand moves in the same direction as consumer income.
• Inferior good — A good whose demand moves in the opposite direction to consumer income.
• Market demand — The total quantity demanded by all consumers at a particular market price.
• Price elasticity of demand — Percentage change in quantity demanded divided by the percentage change in price.

Common errors and misconceptions

• Misconception: Falling marginal utility means total utility must fall. Correct: Total utility can rise while marginal utility falls, provided marginal utility remains positive.
• Misconception: Every indifference curve is convex. Correct: Convexity is the most common shape associated with diminishing marginal rate of substitution. Perfect substitutes have straight indifference curves.
• Misconception: The budget set consists only of bundles that exhaust income. Correct: It also includes affordable bundles costing less than income; the budget line represents exact expenditure of income.
• Misconception: Every optimum must be a tangency. Correct: Tangency applies to the usual illustrated situation. Other situations have an optimum involving expenditure on one good only.
• Misconception: A change in a good’s own price shifts its demand curve. Correct: With other influences unchanged, it causes movement along the existing curve. Other determinants cause shifts.
• Misconception: A good must be normal or inferior at every income level. Correct: The same good can be normal at some income levels and inferior at others.
• Misconception: A straight demand curve has the same elasticity everywhere. Correct: Its elasticity varies with the price-to-quantity ratio and equals one at the midpoint.

Exam-style questions with model answers

Q1. Distinguish between total utility and marginal utility. [2 marks]

1. Total utility is the total satisfaction obtained from consuming a given quantity of a commodity.
2. Marginal utility is the change in total utility resulting from consumption of one additional unit of that commodity.

Q2. Explain the law of diminishing marginal utility. If total utility is 24 units after both the fourth and fifth units consumed, and 22 units after the sixth, calculate marginal utility of the fifth and sixth units. [3 marks]

1. The law states that marginal utility from each additional unit declines as consumption increases, keeping consumption of other commodities constant.
2. Marginal utility of the fifth unit equals total utility after five units minus that after four: 24 − 24 = 0 units.
3. Marginal utility of the sixth unit is 22 − 24 = −2 units. This negative marginal utility corresponds to the decline in total utility.

Q3. A consumer has ₹20 and buys goods 1 and 2 priced at ₹4 and ₹5 per unit respectively. Write the budget-line equation, calculate both intercepts, and explain its slope. Put good 1 on the horizontal axis. [4 marks]

1. Let x₁ and x₂ denote quantities of goods 1 and 2. The budget line is 4x₁ + 5x₂ = 20, representing bundles that exhaust income.
2. The horizontal intercept is 20/4 = 5 units of good 1, bought when all income is spent on that good.
3. The vertical intercept is 20/5 = 4 units of good 2, bought when all income is spent on that good.
4. The slope is −4/5. Along the budget line, obtaining one extra unit of good 1 requires giving up 4/5 unit of good 2.

Q4. Explain a rational consumer’s optimum using a budget line and an indifference map. Assume monotonic preferences and the usual convex indifference curves with a tangency at which both goods are consumed. [5 marks]

1. A rational consumer chooses the most preferred affordable bundle. The objective is to reach the highest indifference curve available within the budget set.
2. Under monotonic preferences, a point below the budget line cannot be optimal because some affordable bundle offers more of a good without less of the other.
3. Points above the budget line cannot be chosen because their cost exceeds available income. The optimum must therefore be on the budget line.
4. For the stated situation, the highest attainable indifference curve just touches the budget line. This tangency identifies the optimum bundle.
5. At tangency, the marginal rate of substitution equals the price ratio. The rate at which the consumer is willing to exchange goods matches the market rate.

Q5. Distinguish movement along a demand curve from a shift. Explain the effect of an income rise for normal and inferior goods, a rise in a substitute’s price, and a rise in a complement’s price. Hold other relevant influences constant in each case. [6 marks]

1. A change in the good’s own price causes movement along the existing demand curve, with the other demand determinants held unchanged.
2. A shift occurs when a determinant other than own price changes, altering the quantity demanded at each price of the good.
3. For a normal good, an income rise increases demand and shifts the demand curve rightward, holding prices and preferences unchanged.
4. For an inferior good, an income rise reduces demand and shifts the demand curve leftward, holding prices and preferences unchanged.
5. A rise in a substitute’s price shifts demand rightward. For example, dearer coffee is likely to increase demand for tea.
6. A rise in a complement’s price shifts demand leftward. For example, dearer sugar is likely to reduce demand for tea.

Q6. A consumer buys 15 bananas when the price is ₹5 each and 12 bananas when it rises to ₹7 each. Calculate the percentage quantity change, percentage price change and signed elasticity using the original values as bases. Classify demand. [4 marks]

1. Quantity falls from 15 to 12 bananas. Its percentage change is [(12 − 15)/15] × 100 = −20%.
2. Price rises from ₹5 to ₹7. Its percentage change is [(7 − 5)/5] × 100 = 40%.
3. Signed price elasticity is percentage quantity change divided by percentage price change: −20/40 = −0.5.
4. The absolute elasticity is 0.5, which is below one. Demand is inelastic because quantity changes proportionately less than price in this example.

Q7. A market has exactly two consumers. At non-negative price p, consumer 1 demands 10 − p units up to price 10 and zero above 10. Consumer 2 demands 15 − p units up to price 15 and zero above 15. Find market demand in the three price ranges. [3 marks]

1. For prices from zero to 10, add the two individual demands at the same price. Market demand is (10 − p) + (15 − p) = 25 − 2p.
2. For prices above 10 and up to 15, consumer 1 demands zero. Market demand therefore equals consumer 2’s demand, 15 − p.
3. For prices above 15, both consumers demand zero, so their combined market demand is also zero.

Q8. Explain how the nature of a good and the availability of close substitutes influence price elasticity of demand. [2 marks]

1. In general, demand for necessities is likely to be price inelastic, while demand for luxuries is likely to be price elastic.
2. Demand is likely to be elastic when close substitutes are easily available, and likely to be inelastic when they are not easily available.

Key takeaways

• Consumer choice combines preferences over bundles with affordability determined by income and the prices of goods.
• Marginal utility measures additional satisfaction, while total utility sums satisfaction from the entire quantity consumed.
• Indifference curves represent equal satisfaction; diminishing marginal rate of substitution gives the most common convex shape.
• The budget set includes every affordable bundle, whereas the budget line contains bundles that exhaust income.
• With monotonic preferences, the optimum lies on the budget line; tangency describes the usual convex-curve situation.
• Own-price changes cause movement along demand curves; income, related prices and preferences can shift them.
• Market demand adds every consumer’s quantity demanded at the same price through horizontal summation.
• Price elasticity measures proportional responsiveness and helps explain how expenditure responds to changes in price.

Test yourself

Why can the same heater provide different utility in different situations?

Utility is subjective and can change with place and time, such as location and season.

What happens to total utility when an additional unit has zero marginal utility?

Total utility remains unchanged because the additional unit contributes no further satisfaction.

Why are indifference curves straight for perfect substitutes?

The consumer substitutes the goods at a constant rate, so marginal rate of substitution does not diminish.

What does the absolute slope of the budget line measure?

It measures the market rate at which the consumer can substitute one good for the other while spending the whole budget.

How does an income increase affect the budget line if prices remain unchanged?

Both intercepts increase and the line shifts parallel outwards; its slope stays unchanged.

Can the same good be normal and inferior at different income levels?

Yes. A good can be normal at some income levels and inferior at others.

Where is elasticity equal to one on a straight downward-sloping demand curve?

Elasticity is one at the midpoint, greater above it and smaller below it.

What happens to expenditure along a rectangular-hyperbola demand curve?

Expenditure remains constant because price multiplied by quantity is constant at every point.