Theory of Consumer Behaviour and Utility Analysis
Domain 4 covers cardinal utility, diminishing marginal utility, consumer surplus, and ordinal utility with indifference curves and budget lines. The exam tests the equi-marginal condition and the geometry of consumer equilibrium.
Core rules and concepts
- Total utility rises while marginal utility is positive; total utility is maximum when marginal utility is zero; negative marginal utility reduces total utility.
- Law of diminishing marginal utility: as consumption of a good increases, the extra satisfaction from each additional unit falls, other things equal.
- Cardinal utility equilibrium: MUx/Px = MUy/Py, with spending equal to income.
- Ordinal utility: an indifference curve shows combinations giving equal satisfaction; curves are downward sloping, convex, and cannot intersect.
- The budget line is PxX + PyY = M, with slope −Px/Py. Equilibrium is where MRSxy = Px/Py and the budget is exhausted.
Worked example
Suppose MUx = 20, Px = ₹4; MUy = 30, Py = ₹6. MU per rupee is 5 for X and 5 for Y, so the consumer is in equilibrium. If MUx rises to 28 while Px stays ₹4, MUx/Px = 7, above 5, so the consumer should buy more X and less Y. As X rises, its marginal utility falls until the ratios are equal again. This is the equi-marginal principle in action.
Traps that cost marks
Do not say total utility is maximised when marginal utility is maximised; it is maximised when MU = 0. Do not let indifference curves cross. Do not confuse MRS with the price ratio. Do not forget the budget constraint when stating equilibrium.