NCERT Class 12 Economics Theory of Consumer Behaviour

In this chapter, we will study the behaviour of an individual consumer in a market for final goods1. The consumer has to decide on how much of each of the different goods she would like to consume. Our objective here is to study this choice problem in some detail. As we see, the choice of the consumer depends on the alternatives that are available to her and on her tastes and preferences regarding those alternatives. To begin with, we will
try to figure out a precise and convenient way of describing the available alternatives and also the tastes and preferences of the consumer. We will then use these descriptions to find out the consumer’s choice in the market.

Preliminary Notations and Assumptions
A consumer, in general, consumes many goods; but for simplicity, we shall consider the consumer’s choice problem in a situation where there are only two goods.2 We will refer to the two goods as good 1 and good 2. Any combination of the amount of the two goods will be called a consumption bundle or, in short, a bundle. In general, we shall use the variable x1 to denote the amount of good 1 and x2 to denote the amount of good 2. x1 and x2 can be positive or zero. (x1, x2) would mean the bundle consisting of x1 amount of good 1 and x2 amount of good 2. For particular values of x1 and x2, (x1, x2), would give us a particular bundle. For example, the bundle (5,10) consists of 5 units of good 1 and 10 units of good 2; the bundle (10, 5) consists of 10 units of good 1 and 5 units of good 2.

THE CONSUMER’S BUDGET

Let us consider a consumer who has only a fixed amount of money (income) to spend on two goods the prices of which are given in the market. The consumer cannot buy any and every combination of the two goods that she may want to consume. The consumption bundles that are available to the consumer depend on the prices of the two goods and the income of the consumer. Given her fixed income and the prices of the two goods, the consumer can afford to buy only those bundles which cost her less than or equal to her income.

Budget Set

Suppose the income of the consumer is M and the prices of the two goods are p1 and p2 respectively.3 If the consumer wants to buy x1 units of good 1, she will have to spend p1x1 amount of money. Similarly, if the consumer wants to buy x2 units of good 2, she will have to spend p2x2 amount of money. Therefore, if the consumer wants to buy the bundle consisting of x1 units of good 1 and x2 units of good 2, she will have to spend p1x1 + p2x2 amount of money. She can buy this bundle only if she has at least p1x1 + p2x2 amount of money. Given the prices of the goods and the income of a consumer, she can choose any bundle as long as
it costs less than or equal to the income she has. In other words, the consumer can buy any bundle (x1, x2) such that

p1x1 + p2x2 ≤ M (2.1)
The inequality (2.1) is called the consumer’s budget constraint. The set of bundles available to the consumer is called the budget set. The budget set is thus the collection of all bundles that the consumer can buy with her income at the prevailing market prices.

1. What do you mean by the budget set of a consumer?
2. What is budget line?
3. Explain why the budget line is downward sloping.
4. A consumer wants to consume two goods. The prices of the two goods are Rs 4 and Rs 5 respectively. The consumer’s income is Rs 20.
(i) Write down the equation of the budget line.
(ii) How much of good 1 can the consumer consume if she spends her entire income on that good?
(iii) How much of good 2 can she consume if she spends her entire income on that good?
(iv) What is the slope of the budget line?
Questions 5, 6 and 7 are related to question 4.
5. How does the budget line change if the consumer’s income increases to Rs 40 but the prices remain unchanged?
6. How does the budget line change if the price of good 2 decreases by a rupee but the price of good 1 and the consumer’s income remain unchanged?
7. What happens to the budget set if both the prices as well as the income double?
8. Suppose a consumer can afford to buy 6 units of good 1 and 8 units of good 2 if she spends her entire income. The prices of the two goods are Rs 6 and Rs 8 respectively. How much is the consumer’s income?
9. Suppose a consumer wants to consume two goods which are available only in integer units. The two goods are equally priced at Rs 10 and the consumer’s income is Rs 40.
(i) Write down all the bundles that are available to the consumer.
(ii) Among the bundles that are available to the consumer, identify those which cost her exactly Rs 40.
10. What do you mean by ‘monotonic preferences’?
11. If a consumer has monotonic preferences, can she be indifferent between the bundles (10, 8) and (8, 6)?

Please refer to attached file for NCERT Class 12 Economics Theory of Consumer Behaviour