THE THEORY OF CONSUMERS’ BEHAVIOURS

A consumer is an individual who buys products or services for personal use and not for manufacture or resale.

A consumer is always faced with a problem of allocating a fixed income among a variety of available options.

A consumer is assumed to be rational i.e. given his income and the market prices of the various commodities; he plans the spending of his income so as to attain the highest possible utility.

DEFINITION OF CONCEPTS

1.     Utility

This is the satisfaction derived from consuming a certain amount of a good or service.

OR

Utility is the ability of a commodity to give satisfaction for example water has utility because it can quench your thirst.

Utility can be measured in monetary units by the amount of money a consumer is willing to sacrifice for a given amount of a commodity.

2.     Total utility

This refers to the total satisfaction obtained from the consumption of all possible units of a commodity.

3.     Marginal utility

This is the additional satisfaction derived from consuming an extra unit of a commodity.

Marginal utility is calculated as follows.

The concepts of total utility and marginal utility can be better understood from the following schedule and diagram.

From the schedule and the diagram above, we note the following;

     As total utility is increasing, marginal utility is falling but positive.

     When total utility is at its maximum (point of satiety), marginal utility is zero.

     When total utility is decreasing, marginal utility becomes negative and this shows disutility.

1.     Disutility

This is the loss of satisfaction due to consumption of so many units of a commodity.

THE LAW OF DIMINISHING MARGINAL UTILITY

It is states that as more and more units of a commodity are consumed in succession, the satisfaction derived from each additional unit consumed reduces.

ASSUMPTIONS UNDERLYING THE LAW OF DIMINISHING MARGINAL UTILTIY

     It assumes that the consumer aims at utility maximization.

     The consumer has a fixed level of income.

     The commodity prices are fixed and constant.

     The consumer has perfect knowledge about the prevailing market conditions.

     The consumer’s tastes and preferences and preferences are constant.

     It assumes consumption of only one commodity whose units are homogeneous.

     It assumes that the commodity has uniform sizes i.e. the commodity is divisible into similar portions.

     It assumes continuity in consumption i.e. the units of the commodity should be consumed in succession one after the other.

     It assumes that the consumer does not develop addiction to the commodity.

     It assumes that utility is measurable in monetary units (utils).

     It assumes that the commodity consumed is a normal good.

RELATIONSHIP BETWEEN MARGINAL UTILITY AND THE DEMAND CURVE

The derivation of the demand curve is based on the law diminishing marginal utility. Marginal utility is the slope of the total utility curve.

As marginal utility declines, the consumer is willing to pay less for the commodity. The consumer can buy more if the price is reduced since marginal utility is low.

When  fewer units of the commodity are available, marginal utility is high and the consumer is willing to pay high prices for the commodity. This implies that demand is more at lower prices and less at high prices.

If marginal utility is measured in monetary units, then the demand curve for the commodity is identical to the positive segment of the marginal utility curve.

Sample questions

a)     Distinguish between price and marginal utility.                                    (02 marks)

b)     What is the relationship between marginal utility and price?                 (02 marks)

c)     With the help of illustrations, show the relationship between marginal utility and demand.

Solution

a)     Refer to your notes

b)     As marginal utility declines, the consumer is willing to pay less for the commodity. The consumer can buy more if the price is reduced since marginal utility is low.

c)     Both are high for the first unit of output consumed and they tend to fall as more and more of a product is consumed.

Both are illustrated by a downward sloping curve.                                (2 marks)

APPLICABILITY OF THE LAW OF DIMINISHING MARGINAL UTILITY

1.     It helps to explain the law of demand.

2.     It is applied under the principle of progressive taxation.

3.     The law is used to explain the water – diamond paradox.

4.     It explains why discounts are offered on extra units purchased.

5.     Guides consumers when making consumption decisions.

6.     It guides in pricing of goods and services.

LIMITATIONS/ CRICISIMS/ DEFECTS OF THE LAW OF DIMINISHING MARGINAL UTILITY

1.     It assumes that consumers are rational which is not always the case. Many consumers do not attach cardinal values on commodities being consumed.

2.     It assumes that the units of the commodity consumed are homogeneous which is unrealistic. Units of the same commodity may be different e.g. when consuming a sugarcane.

3.     It assumes constant tastes and preferences yet for the same individual; tastes and preferences keep on changing from time to time depending on the environment, age, fashion, etc.

4.     Consumption is not always continuous i.e. the consumers take breaks when consuming commodities.

5.     It assumes that commodities are divisible into standard sizes but this does not apply to all commodities e.g. furniture, vehicles, etc.

6.     The law is not applicable to money because the more money one gets, the more marginal utility he/she gets.

7.     It is not applicable under habitual consumption where marginal utility increases as the consumer consumes more of the commodity.

8.     It is not applicable in situations where the commodity prices keep on changing due to inflation.

9.     The assumption that the consumer’s income is fixed is unrealistic.

10. Utility cannot be measured as the law assumes i.e. there is no instrument which can be used to measure utility.

11. The law is not applicable in situations of joint demand where two commodities are consumed at the same time. This is because it assumes consumption of only one commodity at a time.

12. In most cases, the consumers are ignorant about the market prices of commodities. This violates the assumption of perfect knowledge of the consumer about the market price.

CONSUMER’S SURPLUS

This is the difference in monetary units between what the consumer is willing to pay for a commodity and what he actually pays.

OR

It is the additional utility which the consumer enjoys without paying for it.

Illustration

Consumer’s surplus is represented by the shaded region (Area under the demand curve but above the equilibrium price) i.e. Area PeABE.

It can be computed using the formula;

Example

Study the table below showing the price and quantity purchased of commodity X and answer the questions that follow.

Calculate the consumer’s surplus if 4 units of the commodity were purchased at shs 150.

Solution

Exercise

a)     What is consumer’s surplus?                                                                         (01 mark)

b)     Given the table below;

Calculate the consumer’s surplus for the first five units of the commodity purchased.

                                                                                                                             (03 marks)

PRODUCER’S SURPLUS

This is the difference between the actual revenue a seller gets and the revenue he expected.

Illustration

The producer’s surplus is represented by the shaded area (Area above the supply curve but below the equilibrium price) i.e. Area. APeEB.

It can be computed using the formula;

Example

Given the supply schedule below;

Taking 100 to be the equilibrium price, calculate the producer’s surplus.

Solution

Exercise

a)     Distinguish between producer’s surplus and consumer’s surplus.                (02 marks)

b)     Given that the market price of the commodity is Uganda shs 65,000; calculate the producer’s surplus in the table below.