Micro Economics for BusinessUnit 212 min read

Consumer Behavior: Utility, Demand & Elasticity (Theory & Math)

Unit 2 of Micro Economics for Business covers how consumers make choices (utility theory), how demand curves work (law of demand, shifts), and how elasticity measures sensitivity to price/income—with real-world applications to Nepalese markets like eSewa, Daraz, and Ncell.

Padhai · Based on the official syllabus and past papers
Updated 1 Oct 2026

TAKEAWAYS:

Utility maximization is the core of consumer choice: people buy until marginal utility per rupee equals the price (MUₚ/P).
Demand curves slope downward because of diminishing marginal utility and substitution effects.
Elasticity (price, income, cross) quantifies how much demand responds to changes—critical for pricing strategies (e.g., Ncell’s data plans).
Shifts in demand (not movements along the curve) happen due to income, tastes, or prices of substitutes/complements (e.g., Kathmandu traffic congestion → higher demand for Pathao rides).
Consumer surplus = willingness to pay minus actual price (e.g., eSewa users pay less than their max bid for online payments).
Demand functions (single/multi-variable) let firms predict sales (e.g., Daraz’s Qd = f(price, income, ads)).

1. Consumer Behavior: Utility Theory

Diminishing marginal utility for Anisha’s data (Rs. 200/GB) and pencils (Rs. 20/pencil). MU declines but never reaches negative values.

1.1 Utility and Marginal Utility

Definition:

Utility: The satisfaction or benefit a consumer gets from consuming a good/service.
Marginal Utility (MU): The additional satisfaction from consuming one more unit.
- Law of Diminishing Marginal Utility: As you consume more of a good, MU falls (e.g., your 1st cup of tea gives more joy than the 5th).

Real-World Example:

eSewa: When you first use eSewa, the convenience (utility) is high. After 10 transactions, the marginal utility drops—you’re less thrilled by each new payment.

1.2 Utility Maximization Rule

Consumers allocate their budget to maximize total utility under two constraints:

Budget constraint: $P_{x} Q_{x} + P_{y} Q_{y} = M$ (where $M = Rs. 500$ in Anisha’s case).
Equilibrium condition: $\frac{M U _{x}}{P _{x}} = \frac{M U _{y}}{P _{y}}$ .

Worked Example: Anisha’s Data and Pencils

Given:
- Budget ( $M$ ) = Rs. 500
- Price of data ( $P_{x}$ ) = Rs. 200/GB
- Price of pencils ( $P_{y}$ ) = Rs. 20/pencil
- Assume MU of data falls by 50 utils per GB, MU of pencils falls by 10 utils per pencil.

Step-by-Step:

Write the budget constraint: $200 Q_{x} + 20 Q_{y} = 500$ .
Assume Anisha buys 1 GB of data ( $Q_{x} = 1$ ):
- Remaining budget for pencils: $500 - 200 = 300$ .
- Pencils bought: $Q_{y} = 300/20 = 15$ .
Check MU/P ratios:
- MU of 1st GB data = 100 utils → $\frac{100}{200} = 0.5$ .
- MU of 15th pencil = $150 - (14 \times 10) = 10$ utils → $\frac{10}{20} = 0.5$ .
- Equilibrium achieved at $Q_{x} = 1$ GB, $Q_{y} = 15$ pencils.

2. Demand Analysis

Ncell’s market growth (2015–2019) driven by income elasticity (Ey > 1).

Cigarette market equilibrium before/after Rs. 10 tax per unit. Tax shifts supply left, raising price from Rs. 46.15 to Rs. 56.15 and reducing quantity from 120,

2.1 Law of Demand

Definition:

Downward-sloping demand curve: As price falls, quantity demanded rises (ceteris paribus).
Reasons:
- Substitution effect: Cheaper goods replace pricier ones (e.g., Daraz vs. local shops).
- Income effect: Lower prices increase purchasing power (e.g., Ncell’s Rs. 100 data plan).

Worked Example: Cigarette Market

Demand: $Q_{d} = 350, 000 - 5, 000 P$ .
Supply: $Q_{s} = 50, 000 + 1, 500 P$ .
Equilibrium: Set $Q_{d} = Q_{s}$ : $350, 000 - 5, 000 P = 50, 000 + 1, 500 P$ . $300, 000 = 6, 500 P$ → $P = 46.15$ , $Q = 120, 000$ . (Note: The past exam had a typo; corrected here.)

Tax Impact:

Government imposes Rs. 10 tax → supply shifts up by Rs. 10.
New supply: $Q_{s} = 50, 000 + 1, 500 (P - 10)$ .
New equilibrium: $P = 47.15$ , $Q = 118, 000$ .

2.2 Types of Demand Functions

Type	Formula	Example	When Used
Single-variable	$Q_{d} = f (P)$	$Q_{d} = 100 - 2 P$	Simple markets (e.g., NTC’s electricity).
Multi-variable	$Q_{d} = f (P, Y, P_{s}, P_{c}, T)$	$Q_{d} = 500 - 3 P + 0.5 Y + 2 P_{s}$	Complex markets (e.g., Daraz’s demand depends on income $Y$ , substitute prices $P_{s}$ , and trends $T$ ).

Real-World Tie-In:

Daraz’s Demand: $Q_{d} = f (price, income, advertising, seasonality)$ .
- If income rises (remittances increase), demand for electronics shifts right.
- If Pathao (complement) reduces fares, Daraz’s demand for delivery services rises.

2.3 Elasticity of Demand

Measures how much quantity demanded responds to price/income changes.

Type	Formula	Interpretation	Example (Nepal)
Price Elasticity	$E_{d} = \frac{%Δ Q _{d}}{%Δ P}$	$∣ E_{d} ∣ > 1$ : Elastic (luxury goods)	Ncell’s 4G data: $E_{d} = 1.5$ → price cut increases revenue.
Income Elasticity	$E_{y} = \frac{%Δ Q _{d}}{%Δ Y}$	$E_{y} > 1$ : Normal good (income rises, demand rises)	Rice ( $E_{y} = - 0.75$ ): Inferior good—demand falls as income rises.
Cross Elasticity	$E_{c} = \frac{%Δ Q _{d}}{%Δ P _{s}}$	$E_{c} > 0$ : Substitutes (e.g., Daraz vs. local shops)	$E_{c} = 2.0$ for tea vs. coffee.

Worked Example: Ncell’s Data Plan

Given: $E_{d} = 1.5$ , Average Revenue (AR) = Rs. 300.
Find Marginal Revenue (MR): $M R = A R \times (1 + \frac{1}{E _{d}}) = 300 \times (1 + \frac{1}{1.5}) = 300 \times 1.67 = 500$ . (Ncell can increase revenue by lowering prices if $E_{d} > 1$ .)

Elasticity regions: Ncell’s data plans (E=1.5) lie in the elastic region, meaning revenue increases when prices fall.

3. Consumer and Producer Surplus

eSewa’s consumer surplus: Rs. 20 million/month from 1M transactions at Rs. 30 (vs. max Rs. 50). Area = ½ × (50-30) × 1,000,000.

3.1 Consumer Surplus (CS)

Definition: The difference between what consumers are willing to pay and what they actually pay. $C S = \frac{1}{2} \times (P_{max} - P) \times Q$ .

Example: eSewa

Suppose a user is willing to pay Rs. 50 for an online bill payment but pays Rs. 30.
CS per transaction = Rs. 20.
If 1 million transactions occur monthly, total CS = Rs. 20 million.

3.2 Producer Surplus (PS)

Definition: The difference between what producers are willing to sell for and the market price. $P S = \frac{1}{2} \times (P - P_{min}) \times Q$ .

Example: NTC’s Electricity

NTC sells at Rs. 6/kWh but would accept Rs. 4/kWh.
PS per unit = Rs. 2.
At 100 million units sold, total PS = Rs. 200 million.

4. Government Intervention: Subsidies and Taxes

Subsidy impact: Rs. 20 subsidy per unit shifts demand right, increasing quantity from 50 to 70 units.

4.1 Subsidy Impact

Effect: Shifts demand curve right (or supply curve down).
Example: Government subsidizes solar energy.
- Before: $Q_{d} = 10, 000 - 50 P$ , $Q_{s} = 2, 000 + 20 P$ .
- After Rs. 20 subsidy: New demand = $Q_{d} = 12, 000 - 50 P$ .
- New equilibrium: $P = 80$ , $Q = 8, 000$ (vs. original $P = 100$ , $Q = 5, 000$ ).

4.2 Tax Impact

Effect: Shifts supply curve up (or demand curve left).
Example: Rs. 10 tax on cigarettes (from earlier).
- Tax burden: Consumers pay Rs. 5 more, producers receive Rs. 5 less.

## In the Real World

eSewa and Kathmandu Traffic:
- Idea Used: Substitution effect (consumers switch from cash to digital payments).
- How: During Kathmandu’s traffic jams, demand for eSewa rises because people value time savings (higher marginal utility of digital payments).
Ncell’s Data Plans:
- Idea Used: Price elasticity of demand.
- How: Ncell’s Rs. 100 data plan has $E_{d} = 1.5$ . A 10% price cut (to Rs. 90) increases quantity demanded by 15%, boosting total revenue.
Daraz’s Demand Forecasting:
- Idea Used: Multi-variable demand function.
- How: Daraz’s algorithm predicts demand using:
  - Price ( $P$ )
  - Income ( $Y$ ): Higher remittances → more electronics sales.
  - Substitute prices ( $P_{local shops}$ ): If local shops raise prices, Daraz’s demand rises.

## Exam Tip

Utility Problems:
- Always check if the consumer is at equilibrium ( $\frac{M U _{x}}{P _{x}} = \frac{M U _{y}}{P _{y}}$ ).
- For Anisha’s problem, show the budget constraint equation and solve step-by-step.
Elasticity Questions:
- Memorize the formulas and interpret signs:
  - $E_{d} > 1$ : Elastic (price cut increases revenue).
  - $E_{y} > 0$ : Normal good.
  - $E_{c} > 0$ : Substitutes.
- Example: If $E_{y} = - 0.75$ for rice, say: “Rice is an inferior good—demand falls as income rises.”
Equilibrium and Policy:
- For subsidies/taxes, draw the before/after graph and state:
  - Who bears the burden (consumers/producers)?
  - Change in quantity and price.
- Shortcut: Tax shifts supply up; subsidy shifts demand right.
Demand Functions:
- Single-variable: Only price matters (e.g., $Q_{d} = a - b P$ ).
- Multi-variable: Include income, substitutes, etc. (e.g., $Q_{d} = a - b P + c Y + d P_{s}$ ).
- Always derive equilibrium by setting $Q_{d} = Q_{s}$ .
Surplus Questions:
- Consumer surplus = area under demand curve, above price.
- Producer surplus = area above supply curve, below price.
- Total surplus = CS + PS (maximized at equilibrium).
Case Studies:
- For solar energy or vegetable prices, identify:
  - Why prices aren’t adjusting (e.g., supply constraints, black markets).
  - Policy solutions (subsidies, price controls).

Final Visual Summary:

Based on the TU BBM syllabus for Micro Economics for Business (ECO203), unit 2.

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