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ECON 212 EU Consumer Demand Theory & Consumer Behavior Notes

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Economics
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Egerton University
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EGERTON UNIVERSITY
ECONOMICS 212
1.0 CONSUMER DEMAND THEORY/ CONSUMER BEHAVIOR
Consumer behavior theory is concerned with how consumers make decisions about consumption of
commodities given their prices and consumer’s limited income so as to maximize utility.
WHO IS A CONSUMER?
A consumer is a decision making unit about consumption.
PRINCIPALS OF CONSUMERS DEMAND THEORY
(a) Limited income (scarcity) necessitates choice.
(b) Consumers make decisions purposely. That is consumers are careful shoppers
(c) One good or service can be substituted for another.
(d) Consumers make decisions without perfect information.
(e) The law of diminishing marginal utility applies to consumer behavior.
THEORIES OF CONSUMER BEHAVIOR
a) Cardinal/Neo-classical utility theory
The theory holds that utility derived from consumption of a good or service is measurable subjectively
using cardinal numbers (e.g. 1, 2, 3 …) by units of measurements called utils.
Consumer equilibrium
Analyses of consumer equilibrium entails answering the question ‘‘how does a consumer allocates his
money income among the various goods and services he/she consumes to maximize utility?’’.
The cardinal utility approach to consumer’s equilibrium is based on the following assumption,
Consumer is assumed to be rational
Consumer possesses perfect knowledge of obtainable utilities
Marginal utility of money is constant at whatever the level of income and each unit of money has
utility equal to one.
Units of commodities are homogeneous
Commodities are divisible
Utility is additive- If a basket of goods and services consumed by a consumer contains n items and
their quantities are,
n
XXXX ,.........,,
321
, the utility function of the consumer may be expressed as,
),.........,,(
321 n
XXXXfU =
.
Given the utility function, the TU obtained from n items may be expressed as,
)()........()()(
332211 nnn
XUXUXUXUTU ++=
.
Consumer Equilibrium-The General Case (Several Commodity Case)
Suppose a consumer consumes only two commodities one and two with quantities X
1
and X
2
The corresponding utility function is,

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