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Theory of Consumer Behaviour – Class 12 Economics notes, important questions and MCQs

NCERT Class 12 Economics, chapter 2. Notes, key terms, important questions with answers and MCQs.

Chapter overview

A consumer tries to get maximum satisfaction from a limited income. Satisfaction can be studied through utility analysis (total and marginal utility) or through indifference curves and the budget line. The consumer is in equilibrium where the marginal rate of substitution equals the price ratio. Demand for a good depends on its price, income, prices of related goods and tastes; price elasticity measures how strongly demand responds to price.

Utility analysis

Total utility is the total satisfaction from consuming a good; marginal utility is the change in total utility from one more unit.
Law of diminishing marginal utility: as more units are consumed, marginal utility falls.
With one good, the consumer is in equilibrium when marginal utility in money terms equals the price (MUx ÷ MUm = Px).

Indifference curve analysis

The budget line shows combinations a consumer can buy with income M: P1x1 + P2x2 = M; its slope is −P1 ÷ P2.
An indifference curve shows combinations giving equal satisfaction; it slopes downward and is convex to the origin because of diminishing marginal rate of substitution (MRS).
Higher indifference curves show higher satisfaction; indifference curves never intersect.
Consumer's equilibrium: where the budget line is tangent to the highest indifference curve, so MRS = P1 ÷ P2.

Demand and elasticity

Law of demand: other things equal, quantity demanded falls when price rises.
Normal goods: demand rises with income; inferior goods: demand falls as income rises. Substitutes (tea and coffee) and complements (car and petrol) affect each other's demand.
A movement along the demand curve is due to the good's own price; a shift is due to other factors.
Price elasticity of demand = percentage change in quantity demanded ÷ percentage change in price; demand is elastic if it is greater than 1 and inelastic if less than 1.

Key terms

Marginal utility: the additional satisfaction from consuming one more unit of a good
Budget line: the line showing all combinations of two goods a consumer can buy with given income and prices
Indifference curve: a curve showing combinations of two goods that give equal satisfaction
Marginal rate of substitution: the rate at which a consumer is willing to give up one good to get one more unit of another
Price elasticity of demand: the responsiveness of quantity demanded to a change in price

Important questions with answers

State the law of diminishing marginal utility.2 marks

The law of diminishing marginal utility states that as a consumer consumes more and more units of a good, the additional satisfaction (marginal utility) from each successive unit goes on decreasing, other things remaining the same.

Distinguish between a movement along and a shift of the demand curve.3 marks

A movement along the demand curve occurs when the quantity demanded changes because of a change in the good's own price, other factors remaining constant; it is called expansion or contraction of demand. A shift of the demand curve occurs when demand changes at the same price because of other factors such as income, prices of related goods or tastes; it is called increase or decrease in demand.

Explain consumer's equilibrium using indifference curve analysis.5 marks

Indifference curve analysis explains how a consumer chooses the combination of two goods that gives maximum satisfaction. The budget line shows all combinations of goods 1 and 2 that the consumer can buy with income M at prices P1 and P2, given by P1x1 + P2x2 = M; its slope is −P1 ÷ P2. An indifference curve shows combinations of the two goods that give the same satisfaction. Indifference curves slope downward, are convex to the origin because the marginal rate of substitution diminishes, never intersect, and higher curves represent higher satisfaction. The consumer wants to reach the highest possible indifference curve but is limited by the budget line. Equilibrium occurs at the point where the budget line is tangent to the highest attainable indifference curve. At this point, the slope of the indifference curve (MRS) equals the slope of the budget line (P1 ÷ P2), and the MRS is diminishing. If MRS is greater than P1 ÷ P2, the consumer values good 1 more than its market price and will buy more of it, moving towards equilibrium; if MRS is less, he will buy less of good 1. Thus equilibrium is reached where MRS = P1 ÷ P2.

Quick revision

Diminishing marginal utility.
Budget line slope = −P1 ÷ P2.
IC convex; equilibrium MRS = P1 ÷ P2.
Normal, inferior, substitutes, complements; elasticity.

Exam tips

Draw the equilibrium diagram with the budget line touching the highest indifference curve.
Remember: change in own price = movement; change in other factors = shift.

Practice MCQs

The additional satisfaction from one more unit of a good is
1. total utility
2. average utility
3. marginal utility
4. zero utility
Show answer
Answer: (c) marginal utility. It usually falls as consumption rises.
A curve showing combinations of two goods giving equal satisfaction is a
1. indifference curve
2. budget line
3. demand curve
4. supply curve
Show answer
Answer: (a) indifference curve. All points are equally preferred.
According to the law of demand, when price rises quantity demanded
1. rises
2. falls
3. stays the same
4. doubles
Show answer
Answer: (b) falls. Other things remaining equal.
The slope of the budget line is
1. −P1 ÷ P2
2. P1 × P2
3. M ÷ P1
4. zero
Show answer
Answer: (a) −P1 ÷ P2. It equals the price ratio.
A good whose demand falls when income rises is
1. a normal good
2. an inferior good
3. a luxury good
4. a complement
Show answer
Answer: (b) an inferior good. Example: coarse grains for some consumers.
Tea and coffee are
1. complements
2. unrelated
3. inferior goods
4. substitutes
Show answer
Answer: (d) substitutes. One can replace the other.
Indifference curves are convex to the origin because of
1. increasing MRS
2. rising income
3. constant prices
4. diminishing MRS
Show answer
Answer: (d) diminishing MRS. The consumer gives up less of one good for each extra unit of the other.
If price rises by 10 per cent and quantity demanded falls by 20 per cent, price elasticity of demand is
1. 0.5
2. 1
3. 2
4. 20
Show answer
Answer: (c) 2. 20 ÷ 10 = 2, elastic.

All chapters of Class 12 Economics

Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.