Theory of Consumer Behaviour: Business Economics Chapter 2 Notes

Chapter 2 of Business Economics covers the Theory of Consumer Behaviour. This topic explains how consumers allocate their limited income to purchase goods and achieve maximum satisfaction. Let's review the key concepts for your revision.

1. Cardinal Utility Approach (Marshall) 📏

Developed by Alfred Marshall, this approach assumes utility can be measured in cardinal numbers (utils):

• Law of Diminishing Marginal Utility: As a consumer consumes more units of a commodity, the marginal utility (additional satisfaction) derived from each successive unit decreases.
• Consumer's Equilibrium: Achieved when the marginal utility of a good equals its market price: $MU_x = P_x$.

2. Ordinal Utility Approach (Hicks & Allen) 📈

This approach assumes utility cannot be measured in exact numbers, but can be ranked or ordered using Indifference Curves (IC):

• Indifference Curve: A curve showing different combinations of two goods that give the consumer equal satisfaction. It is convex to the origin due to the Diminishing Marginal Rate of Substitution (MRS).
• Budget Line: Shows the combinations of two goods a consumer can buy with their given budget and prices.
• Consumer's Equilibrium: Achieved at the point where the Budget Line is tangent to the highest possible Indifference Curve: $MRS_{xy} = rac{P_x}{P_y}$.