Theory of Consumer Behaviour assumes that you can only order or arrange your preference in order of priority, you cannot quantify the level of your satisfaction. After reading this summary, you’ll have a clear understanding on the theory of consumer behavior, I will also introduce you to the concept of the indifference curve, budget lines, and consumer equilibrium. This will help you appreciate the rationality behind your consumption decisions.
The Ordinal Utility Theory
While the cardinal school of thought assumes that numerical values could be assigned to utility derivable from consumption and that utility of one commodity is independent of other commodities, the ordinal utility school believes that cardinal utility measurement of utility is neither feasible nor necessary to analyze consumer behavior.
According to the ordinal analysts, all that is needed to study consumer behaviors is that the consumer should be able to arrange his/her preferences in order of importance. He/she should be able to identify which of the commodity he/she would prefer to another.
The early contributors include Vilfred Pareto, who introduced in 1906, the ordinal utility hypothesis, to the indifference curve analysis. Other contributors include E.E. Slutsky, W.E. Johnson, and A.L. Bowley.
Indifference curve analysis became prominent in the 1930s through the work of John R. Hicks and R.G.D. Allen who systematically developed the ordinal utility theory as a powerful analytical tool of consumer analysis. According to Dwivedi (1997) indifference analysis is regarded as the most powerful tool of consumer analysis.
Still in view considering the theory of consumer behavior, let’s also consider the assumptions of ordinal utility theory.
Assumptions of the Ordinal Utility Theory
The analysis of consumer behavior through the ordinal approach makes use of the indifference curve. Hence, it is sometimes called the indifference curve analysis. The ordinal approach is based on some fundamental assumptions which include the following:
- Optimality / Rationality: The consumer is assumed to behave rationally, such that he wants to maximize his benefit given the level of his income. He is also assumed to have full knowledge of situations of the markets and the environment
- Ordinality of Utility: It is believed that the consumer can rank or arrange their preferences according to the benefits of each basket of commodities. He does not need to attach a numerical value to determine the level of his satisfaction. It is sufficient to be able to know his preferences among various baskets or bundles of commodities available.
Total utility of consumers depend on the quantities of the various commodities consumed
U = f(q1, q2, q3 ……………. qn )
U = Utility
q1 q2 q3 …….. qn are quantities of commodities 1,2, 3,……….n
- Transitivity and Consistency of choice: It is assumed that the consumer is consistent in his choice, that is, if in one period he chooses A over B, at another period, he might not choose B over A. While transitivity implies that if a consumer prefers A to B and B to C, he must prefer A to C or he treats A = B and B = C, he must treat A = C.
In summary, consistency implies symbolically if A≥ B then B≤ A
If A ≥ B and B ≥ C, then A ≥ C
- Nonsatiety (i.e. more is preferred to less) The assumption states that consumers would always prefer more commodities to fewer ones within the normal range of consumption. Rational consumers will prefer to operate at a higher level of an indifference curve than at lower ones because higher indifference curves give more of all commodities.
- There must be a minimum of two commodities: For consumers to be able to make a choice there must be a minimum of two products. If there is only one product, there is no opportunity to make a choice.
- The diminishing marginal rate of substitution: It is assumed that commodities are continuously and infinitesimally divisible into sub-units. Thus, given an X, Y plane, this assumption maintains that it is possible for the consumer to vary the quantity of the two commodities consumed by infinitesimal amounts. This implies continual substitutability between commodities x and y in two commodity spaces. It also implies that both commodities cannot be increased at the same time given the same indifference curve, one product must be given up in order to have more of the other. However, as the consumer continues to substitute more of the quantity of one commodity for the other, he will require increasing amounts to substitute for one unit of the decreasing commodity. This implies a diminishing marginal rate of substitution.