Consumer Behaviour and Demand
This domain tests how a consumer with limited income chooses between goods, and how that choice generates a downward-sloping demand curve. Two approaches appear: utility (cardinal) analysis and indifference curve (ordinal) analysis, followed by elasticity of demand.
Core rules
- Law of diminishing marginal utility: as consumption of a good rises, MU of each extra unit falls; TU is maximum when MU = 0.
- One-good equilibrium: MUx = Px (taking MU of money as 1). Two-good equilibrium: MUx/Px = MUy/Py, with total outlay equal to income. If MUx/Px exceeds MUy/Py, buy more X and less Y.
- Indifference curves are downward sloping, convex to the origin (diminishing MRS) and never intersect. Higher curves mean higher satisfaction.
- Budget line slope = Px/Py; it shifts with income and rotates with a price change. Consumer equilibrium: MRS = Px/Py at the tangency point.
- Price elasticity Ed = % change in quantity / % change in price. Demand is elastic if |Ed| > 1, inelastic if < 1, unitary if = 1. Total outlay rises with price cuts when demand is elastic.
- A movement along the demand curve follows own-price change; a shift follows income, tastes, prices of related goods or expectations.
Worked example
Price falls from ₹10 to ₹8 and quantity rises from 100 to 140 units. % ΔQ = 40/100 = 40%; % ΔP = −2/10 = −20%; Ed = 40/20 = 2 (elastic). Total outlay rises from ₹1,000 to ₹1,120, which is exactly what elastic demand predicts for a price cut.
Traps that cost marks
- Reporting Ed as a negative number and then misreading it; use the absolute value for the elasticity category.
- Forgetting that Giffen goods and inferior goods violate the normal income–demand relation.
- Confusing expansion of demand (price change) with increase in demand (other determinants).
- Writing MRS as the slope of the budget line instead of the indifference curve.