What is the Consumer Theory of Demand?
The consumer theory of demand deals with the consumer behaviour theory. This means that how does a consumer decide that how much of good he or she should purchase at the given cost and why does he or she buy more of a good when its cost falls and vice versa. The answer to all these kinds of questions lies in the consumer behaviour theory which is also known as the consumer theory of demand.
In microeconomics, the consumer is deriving or always tries to derive some kind of demand that will lead to maximization of usage and minimization of cost. This is the basic assumption based on which the consumer purity of demand is formulated.
Now various kinds of consumer behaviour theory have been developed in the past to explain that how the consumer will behave with the changing costs of the commodity from time to time. Two such theories are Cardinal utility analysis (marginal utility analysis) and ordinal utility analysis (indifference curve analysis).
To have a very simple idea about the approaches of Cardinal Utility and ordinal utility, it is examined that: Cardinal utility is the approach when the satisfaction gained from any quantity of the commodity is expressed in terms of units of satisfaction. For example, suppose our consumer prefers coffee over tea then if he wants to express his predilection in terms of Cardinal utility, he will say that one mug of coffee gives 5 utils or satisfaction and one mug of tea gives 3 utils or satisfaction. Therefore, in this case, the individual or the consumer is keeping coffee on top of tea which means he is numbering his predilection according to the usage deriving feature of that commodity.
Now in the case of ordinal utility, the consumer will rank his or her predilection according to the usage deriving feature of a commodity. For example: suppose a consumer prefers bikes over cars therefore to have an ordinal utility approach that individual will say that riding bikes gives him more usage than driving a car. This means that the consumer is ranking his predilection of riding bikes on top of driving cars. This means a bike is of more usage to him than a car. This is known as the ordinal utility approach.
Cardinal Utility Analysis- Marginal Utility Analysis
It is quite common that every individual has to buy a certain number of assets and economic goods with his limited income. One of the basic assumptions of the economic theory of household behaviour is that the consumer is rational which means that he or she tries to maximise his total utility from his or her economic consumption or purchase. Now the questions that arise in this context is that how does the consumer or the individual allocate heels or a herd limited income among different kinds of assets and economic goods for maximisation of total utility. The general rule is that the consumer will maximise his total utility when he or she allocate his or her income among various commodities in such a way that the marginal utility of the last rupee or any other unit of money spent on each commodity is equal.
For example: suppose the consumer consumes two commodities. One is food and the other is clothing. In this case, we will presume that the consumer usually consumes 5 units of food and 6 units of clothing. Now if the consumer wants to consume one more unit of food, he derives the usage of two units from the economic consumption of one more extra unit of food. Now to maximise his or her total utility the rule that should be applied here is that if the consumer now consumes one more extra unit of clothing, then also, he will derive units of usage from that extra economic consumption of clothing. If this condition is satisfied then the consumer is said to be rational and also the total utility maximisation is done.
The concept of utility is important to understand the above phenomena. The utility is defined as the amount of satisfaction that the individual or the consumer derives from the economic consumption of a commodity or good. Under utility there are further subdivisions: one is called the total utility and the other is called the marginal utility.
Total utility is that concept which explains the total satisfaction that is gained by the consumer by consuming a specific quantity of a commodity.
On the other hand, marginal utility referrers to the additional utility that is being gained from the economic consumption of an additional unit of a quantity by the consumer or the individual. It is an addition that is being made to the total utility by consuming one more unit of that commodity.
Ordinal Utility Analysis
Ordinal utility means ranking the predilection of the consumer according to his or her level of gained usage from a specific kind of commodity. Therefore, the concept of indifference curve analysis is used to explain such a concept. The indifference curve analysis is based on the idea of a given scale of predilection on the part of the consumer or an individual as between different bundles of two goods. A quantity of two goods consumed by an individual or a consumer is called a combination of goods or bundles of goods.
An indifference curve refers or shows the various combination of two commodities which give equal amount of satisfaction to the consumer or an individual. This makes the individual or the consumer indifferent between the combination of goods. Consumers consume any bundle of the two commodities that individual will get equal satisfaction. Therefore, the consumer or the individual is indifferent between the combination of assets and economic goods that he or she is willing to consume within that limited income.
When a set of indifference curves is shown that represents a given level of satisfaction, we call it an indifference map.
Marginal Rate of Substitution
This concept gives the notion or referrers to the rate at which the consumer is willing to or wish to replace one good for consuming another good but without changing the level of satisfaction. In other words, the marginal rate of substitution tells us about the trade-off between two boats that a consumer wishes to do to maximise his satisfaction.
There are some of the assumptions that are important to be kept in mind while doing indifference curve analysis for demand theory.
- The consumer is supposed to be rational which means that he or she aims at attaining the highest possible indifference curve to maximize his or her usage with a given budget constraint or with the given income.
- The indifference curve analysis always presumes that the user is being measured in terms of quantity. The consumer ranks his or her usage according to the predilections.
- Diminishing marginal rate of substitution: Indifference curve analysis is mainly based on the assumption of diminishing marginal rate of substitution which means that the consumer replaces or trades more of 1 commodity to consume another commodity. This means that the consumer is always prepared to give up lesser units of the latter for each additional unit of the former commodity.
Now some properties of the indifference curve make it worth the concept of indifference curve:
- An indifferent curve slopes downward from left to right: This is because of the fact of diminishing marginal rate of substitution.
- An indifference curve is convex to the origin: This assumption implies that lower is the amount of 1 commodity consumed by a consumer or an individual, the lesser willing of the household will be to give up a unit of that commodity to obtain an additional unit of another commodity. This means that he or she gives more importance to a unit of commodity the amount of which is decreasing.
- Hire in different car use elevated satisfaction and vice versa: An indifference curve that lies above and is right to another indifferent curve means that the higher indifference curve gives an elevated level of satisfaction than the lower one. This is because the elevated indifference curve represents such a combination that yields more satisfaction than the combination of the lower indifference curve.
- Indifferent curves never cross or cut each other: One of the most important properties of indifferent curves is that they may lie very close to each other, but they never cross or cut each other this is for the fact that each indifference curve represents a different level of satisfaction. Therefore, two indifference curves should not cross or cut each other or would give two different levels of satisfaction, which is absurd.
Why do we study the Theory of Consumer Demand?
The theory of consumer demand is very important to understand consumer behaviour with changing costs of the commodity within a given period. This purity in economics is important because it helps the producers to examine that how the consumer will react if there are some changes in the cost of the commodity. Also, how the choice is off purchasing various kinds of assets and economic goods are made to maximise the satisfaction level or in other words, for the matter of maximization of satisfaction level within the given amount of income that the consumer or an individual owns in a certain time.
How does consumer demand work?
Quantity demanded is the function of the price of a commodity, consumers income, price of related goods and taste and preferences of the consumer.
What does the demand curve explain?
The demand curve examines that consumers’ demand is generally based on the price. It shows the inverse relationship between price and quantity demanded. As the price of a commodity rise, consumers’ quantity demanded falls and vice versa.
Context and Applications
This topic is important for the students pursuing the below-mentioned disciplines.
- Masters in Economics
- Master in Business Administration
- Masters in Commerce
- Bachelor of Economics
- Bachelor of Commerce
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