Understanding the Theory of Consumer Behavior
The Theory of Consumer Behavior analyses how a consumer allocates his income to different uses so that he maximizes his satisfaction. Demand for goods and services and consumer’s choice on the allocation of his income to different uses are the principal issues that are studied in this concept.
Demand refers to various amounts of a commodity that a consumer is ready to buy at different possible prices of the commodity at a point in time. Thus, demand for a commodity is the desire to buy a commodity backed with sufficient purchasing power and the willingness to spend.
Quantity Demanded refers to a specific quantity of a commodity to be purchased against a specific price of that commodity at a point of time.
Illustration – Demand for a commodity – X refers to 10 units of X if Px ( price of X) = ₹ 5 per unit, 8 units of X if Px = ₹ 6 per unit, 6 units of X if Px = ₹ 7 per unit, and so on. Quantity Demanded of commodity – X refers to 8 units of X if Px happens to be ₹ 6 per unit.
A table that shows the relationship between price and quantity demanded of a commodity is known as demand schedule. According to Samuelson, the table relating to price and quantity demanded is called the demand schedule. The concept of demand schedule includes:
(a) Individual Demand Schedule
(b) Market Demand Schedule
Demand curve is simply a graphic representation of the demand schedule that shows how the quantity demanded of a commodity is related to its own price. It slopes downward from left to right, showing an inverse relationship between price and quantity demanded of a commodity. Like demand schedule, the concept of demand curve includes:
(a) Individual Demand Curve
(b) Market Demand Curve
Law of Demand
The Law of Demand indicates an inverse relationship between its own price of a commodity and its quantity demanded. It means that other things being equal, quantity demanded decreases with a rise in its own price of the commodity and vice-versa. It is represented by a downward sloping demand curve.
Why Does a Demand Curve Slope Downward?
Downward slope of demand curve shows that more is purchased in response to a fall in price. Hence, there is an inverse relationship between its own price of a commodity and its quantity demanded. This can be explained in terms of the following factors :
(1) Law of Diminishing Marginal Utility – According to this law, as the consumption of a commodity increases, the marginal utility of each successive unit goes on diminishing to a consumer.
(2) Income Effect – Income effect means that a change in the quantity demanded when the real income of the buyer changes due to a change in the price of the commodity.
(3) Substitution Effect – Substitution effect refers to the substitution of one commodity from the other when it becomes relatively cheaper.
(4) Size of Consumer Group – When the price of a commodity falls, many more buyers can afford to buy it. Accordingly, demand expands.
(5) Different Uses – A good may have different uses.
Exceptions to the Law of Demand
Following are some of the exceptions to the law of demand:
(1) Giffen Goods – Giffen goods are highly inferior goods that show a high negative income effect.
(2) Articles of Distinction – There are certain goods that command social distinction. These articles are demanded only because their prices are very high.
(3) When the consumers judge the quality of a commodity by its price – Law of Demand is violated when consumers judge the quality of a commodity by its price.
Shifts in the Demand Curve
There are two shifts in the demand curve: (i) Forward Shift – Forward Shift in demand curve refers to the increase in demand.
(ii) Backward Shift – Backward shift in demand curve refers to the decrease in demand.
1. Forward Shift in Demand Curve – Increase in Demand: Increase in demand is indicated by a shift in demand curve to the right and is also called forward shift in the demand curve.
Causes of Increase in Demand (Situations when the Demand Curve Shifts Forward): Following are some of the important causes of the increase in demand:
(i) When the price of substitute goods increases.
(ii) When the price of complementary good falls.
iii) When the income of the consumer increases.
(iv) When the availability of the commodity is expected to reduce in the near future.
2. Backward Shift in Demand Curve – Decrease in Demand: Decrease in demand is indicated by a shift in demand curve to the left, also called backward shift in demand curve.
Causes of Decrease in Demand (Situations when the Demand Curve Shifts Backward): Following are some of the important causes of an increase in demand-
(i) When the price of the substitute good decreases.
(ii) When the income of the consumer falls.
(iii) When the price of complementary good increases.
(iv) When the availability of the commodity is expected to rise in the near future.
Price Elasticity of Demand
Price elasticity of demand is a measurement of the percentage change in demand in response to a given percentage change in its own price of the commodity.
Methods of Measuring Price Elasticity of Demand
There are two important methods of measuring price elasticity of demand: (1) Proportionate or Percentage Method (2) Geometric Method
(1) Proportionate or Percentage Method –
Ed = (-) Percentage change in Quantity Demanded/ Percentage Change in Price = △Q / △P x P/Q
Ed = Price elasticity of demand
Q= Initial Demand
P= Initial Price
△Q = Change in demand
△P = Change in Price
(2) Geometric or Print Method – Ed = Lower segment of the Demand Curve/ Upper segment of the Demand Curve = PN/PM
Factors Affecting the Price Elasticity of Demand
Price elasticity of demand is high or low depending upon various factors. Some of the important factors are as under – (1) Nature of commodity – Necessities like salt, textbooks have less than unitary elastic demand. However, luxuries like air-conditioner have a greater than unitary elastic demand.
(2) Availability of Substitutes – Demand for goods that have close substitutes (like tea and coffee) is relatively more elastic.
(3) Time period – Demand is inelastic in a short period but elastic for a long period.
(4) Diversity of uses – Commodities that can be put to a variety of uses have an elastic demand.
(5) Postponement of Use – Demand will be elastic for goods, the consumption of which can be postponed.
(6)The Habit of Consumers – Goods that consumers have become habitual to will have an inelastic demand such as cigarettes.
(7)Price level – Elasticity of demand will be high at a higher level of the price of the commodity and low at the lower level of the price.
(8) The Proportion of Income Spent on a Commodity – When consumers spend a small proportion of their income (toothpaste, needles etc.) on a certain type of goods, then it will have an inelastic demand.