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Chapter -2

Consumer Equilibrium

Demand -

Demand is a desire for a commodity which is supported by sufficient resources which are willing to spend at various prices and at a particular point of time.

Demand shows an inverse relationship between price and quantity.

Elements of Demand-

- Desire

- Sufficient Resources

- willingness to spend

- Price

- Time

Types of Demand-

1. Individual Demand-

Individual Demand is a desire for a commodity which is supported by sufficient resources which are willing to spend at various prices and at a particular point of time by a consumer.

2. Market Demand-

Market Demand is a desire for a commodity which is supported by sufficient resources which are willing to spend at various prices and at a particular point of time by all consumers.

Determinants of Individual Demand / Factors affecting Demand / Demand Functions

1. Price of a Commodity (Px)-

When the price of a commodity increases then the quantity demanded of that Commodity decreases and When a price of a commodity decreases then the quantity demanded of that Commodity increases.

2. Price of a related goods (Pr)-

There are two types of related goods-

a. Substitute Goods - Those goods which are used in place of another.

For example - Tea and coffee

When the price of tea increases then the quantity demanded of coffee also increases and When the price of tea decreases then the quantity demanded of coffee also decreases.

It is a direct relationship between price and quantity demanded.

B. Complementary Goods - Those goods which are used together, there is no single use of goods.

For example - Car and Petrol

When the price of a car increases then the quantity demanded of petrol decreases and When the price of a car decreases then the quantity demanded of petrol increases.

It is an inverse relationship between price and quantity demanded.

3. Income of a Consumer (Y)-

In the case of normal goods, when the income of a consumer increases then the demand of this goods also increases and when the income of a consumer decreases then the demand of this goods also decreases.

It is a direct relationship.

Exception - Inferior Goods

When the income of a consumer increases then the demand of this goods also decreases and when the income of a consumer decreases then the demand of this goods increases.

It is an inverse relationship.

4. Taste/ Preference/ Fashion etc (T)-

When taste or preference positively changed then demand of commodity positively changed and when taste or preference negatively changed the demand of commodity negatively changed.

It is a direct relationship.

5. Distribution of Income (yd)-

If in the economy the distribution of income of wealth is equal than demand for necessities goods increase and if there is unequal distribution than the demand for luxury goods increases.

6. Future Expectations (E)-

If the prices of any commodity will increase in future then the quantity demanded of that commodity is increase in present and when the prices of any commodity will decrease in future then the quantity demanded of that commodity is decrease in present.

Determinants of Market Demand-

All the determinants of individual demand are also determinants of market demand as well as. But following are other determinants which also determine market demand.

7. Size and Composition of population(P)-

a. Size of population-

B. Composition of population -

Male- Demand of items which preferred by male

Female- Demand of items which preferred by female

Children- Toys

Old age persons- Medicines, sticks, Specks

8. Weather Conditions / Occasions(W)-

Summer- AC, Cooler

Winter- Hot Clothes

Rainy- Raincoat

Demand Functions-

Functional relationship between demand and factors affecting demand is known as demand function.

It can be represented mathematically as-

Dx = F (Px, Pr, Y, T, Yd, P W, E)

Law of Demand-

Proupended by Alfred Marshall.

If other things remain constant , when the price of any commodity increases then the quantity demanded of that commodity decreases and when price of any commodity decreases then the quantity demanded of that commodity increases.

It shows the inverse relationship between price and quantity demanded.

Demand Schedule -

Tabular representation of the inverse relationship between price and quantity demanded is known as demand schedule.

There are two types-

1. Individual Demand Schedule-

Tabular representation of the inverse relationship between price and quantity demanded of a single consumer is known as individual demand schedule.

2. Market Demand Schedule-

Tabular representation of the inverse relationship between price and quantity demanded of an all consumer is known as market demand schedule.

Demand Curve-

Graphical representation of the inverse relationship between price and quantity demanded is known as Demand Curve.

There are two types-

1. Individual Demand Curve-

Graphical representation of the inverse relationship between price and quantity demanded of a single consumer is known as individual demand curve.

2. Market Demand Curve-

Tabular representation of the inverse relationship between price and quantity demanded of an all consumer is known as market demand curve.

Assumptions of Law of Demand-

1. Price of relatable goods remains constant,

2. Price of substitute goods remains constant.

3. Price of complementary goods remains constant.

4. Income of consumers does not change.

5. Taste/ Preference does not change.

6. Distribution of income remains constant.

7. Size and composition of the population remains constant.

8. Weathers/ Occasions do not change.

Why Law of Demand Applicable/ Why Demand Curve Downward Sloping/ Origin of demand

1. Law of Diminishing Marginal Utility-

When a consumer consumes more and more standard unit of a commodity, then from each additional unit additional utility must be declined.

2. Substitution Effect-

When the prices of a substitute goods increases, consumers shift to another commodity and then demand for the previous commodity decreases and vice versa.

3. Income Effect

Income means real income or purchasing power of a commodity.

If the price of a commodity increases then purchasing power of a consumer decreases hence quantity demanded also decreases and If the price of a commodity decreases then purchasing power of a consumer increases hence quantity demanded also increases.

4. NUmber of Buyers-

When the price of a commodity increases then existing buyers exist from the market, Hence, Quantity demanded decreases and When the price of a commodity decreases then existing and new buyer enter in the market, Hence, Quantity demanded increase.

5. Number of uses-

If a commodity has alternative uses and the price of that commodity increases then the number of uses should decrease. Hence, the quantity of that commodity also decreases.

For Example - Milk

Change in Quantity Demanded / Change in Demad OR Movement along same Demand Curve and Shift of Demand Curve

1. Change in Quantity Demanded / Movement along same Demand Curve

a. Expansion of Demand / Increase in quantity Demanded / Downward movement along same demand curve

When the price of a commodity decreases the quantity demand increases is known as expansion of demand.

B. Contraction of Demand/ Decreases in Quantity Demanded / Upward movement along same demand curve

When the price of a commodity increases then quantity demanded decreases it is known as contraction of demand.

2. Downward movement along same demand curve/ Shift of demand curve

If there is change in demand due to a change in factor other than price then it is known as change in demand.

There are two types of change in demand

a. Increase in Demand / Rightward shift in demand curve -

If demand of a consumer increases due to change in factor other than price then it is known as increase in demand or rightward shift in demand curve,

Reasons for increase in demand

1. Increase in income of the consumer.

2. Increase in price of substitute goods.

3. Decreases in prices of complementary goods.

4. Increase in future price.

5. Tate, preference or priorities positively change.

6. Increase in size of population.

B. Decrease in Demand/ Leftward shift in Demand Curve

If demand of a consumer decreases due to change in factor other than price then it is known as decrease in demand or leftward shift in demand curve.

Reasons for decrease in demand

1. Decrease in income of the consumer.

2. Decrease in price of substitute goods.

3. Increases in prices of complementary goods.

4. Decrease in future price.

5. Taste, preference or priorities negatively change.

6. Decrease in size of population

Exception of Law of Demand-

Giffen Goods / Giffin’s Paradox-

Giffen goods are those goods in which there is a positive relation between price and quantity demanded and there is no close substitute to these goods.

British economist Robert opposes Alfred Marshall because in every situation the law of demand is not applicable. In case of giffen goods when price of a commodity increase then quantity demanded is also increase and when price of a commodity increase then quantity demanded is also increase and when price of a commodity decrease then quantity demanded is also decrease

Prestigious Goods-

Prestigious goods are those goods which are quite expensive and more available . By thos goods prestigious of the person increase so this goods only demanded when this are expensive

If the price of these goods decreases then demand for these goods also decreases.

So there is a positive relationship between price and quantity demanded.

Hence, it is a exception of law of demand

Ignorance of a Consumer

Ignorance of a consumer means a consumer thinks that high price of goods means better quality of the product and low prices means low quality of the product. So, a consumer buys those goods which prices are high and bot buy those goods which prices are low.

Change in Future Prices-

If a consumer accepts that in the near future any change in prices than present demand also changes. If in near future prices are expected to rise then in present time consumers also increase quantity demanded.

There is a positive relationship between price and quantity demand.

Elasticity of Demand (Ed)-

Ed refers to responsiveness of change in quantity demanded to change in price.

For example- Price 100, Quantity demanded- 100

Price 90, Quantity Demanded - ?

Formula - % change in Quantity Demanded

% change in price

Expansion of Formula-

Ed-

Note- Elasticity of demand is always negative.

Que. for example-

A consumer buys 10 ice cream when its price is 25. When price of ice cream increases by Rs 15 then Quantity demanded of ice cream decreases upto 5 units? Calculate elasticity of demand of ice cream.

Ans- -0.83

Degrees of Elasticity of Demand / Types of Elasticity of Demand -

1. Perfectly Inelastic Demand-
When there is no change in quantity demand then it is known as perfectly elastic demand. Its value is always zero.

Ed = 0

2. Relatively Elastic Demand / Inelastic Demand-

When percentage change in quantity demanded is less than percentage change in price it is known as relatively inelastic demand. Its value is always less than 1.

Ed < 1

3. Unitary Elastic Demand -

When proportion change in price becomes equal to the proportion change in quantity demanded then it is known as Unitary Elastic Demand.

Ed = 1

4. Relatively Elastic Demand / Elastic Demand-

When proportion change in quantity demanded is more than proportion change in price then it is known as relatively elastic demand . its value is more than 1.

Ed > 1

5. Perfectly Elastic Demand-

If the price of the commodity remains constant but change in quantity demanded then it is known as Perfectly elastic demand. Its value is infinity.

Ed = Infinity

Methods of Elasticity of Demand

1. Percentage Method/ Flux Method

Formula- Percentage change in QD / Percentage change in price

Percentage change in QD = Q1 - Q * 100

Percentage change in price = P1 - P * 100

For Example- Ram purchased 20 apples when its price Rupees 50 per apple and he purchased 25 apples when its price reduced by rupees 10. Calculate price elasticity of Demand by percentage Method.

Ans- -1.25

2. Geometric Method / Point Method

Ed- Lower Segment

Upper Segment

3. Expenditure Method

Under this method, Elasticity of demand can be calculated with the help of consumer total expenditure and price of a commodity

Formula - Price * Q.D.

In this Method. Three types of elasticity of demand can be calculated-

Relatively Elastic Demand
Relatively Inelastic Demand
Unitary Elastic Demand

1. Relatively Elastic Demand

When the price of a commodity increases so total expenditure of the consumer decreases and When the price of a commodity decreases so total expenditure of the consumer increases then it is known as Relatively Elastic Demand.

2. Relatively Inelastic Demand

If the price of a commodity increases and total expenditure also increases and when the price of a commodity decreases and total expenditure also decreases.

It is a positive relation between price and total expenditure then it is known as relatively inelastic demand.

3. Unitary Elastic Demand

When there is any change in price of the commodity but there is no changes in the Total Expenditure of the Demand means expenditure remains constant irrespective of change in price. The demand is unitary elastic. Its value is always 1.

Factors affecting Elasticity of Demand

1. Nature of a commodity- Nature of the commodity also effect elasticity of demand necessities have inelastic demand where as comfortable and luxurious goods have elastic demand.

2. Income level of the consumer- Income level of the consumer also affects elasticity of demand. Rich people have Inelastic demand whereas poor people have elastic demand.

3. Price Level of the consumer- Commodities having higher prices have elastic demand and lower price range have inelastic demand.

4. Time Period- In a short term period demand is inelastic and in long term period demand is elastic.

5. Addiction- If any commodity having addicted for someone then demand for that commodity is inelastic

6. Alternative uses - Those commodities having a lot of alternatives then its demand is elastic and if any commodity has no alternative uses then its demand is inelastic.

7. Availability of substitute goods- Those commodities having various substitutes then their demand is elastic and if there is no substitute then demand is inelastic.

8. Postponement of consumption - Those goods which consumption can be postponed

Then their demand is elastic and those goods which consumption can’t be postponed their demand is inelastic.

9. Proportion of expenditure in income- If proportion of expenditure in income is more. then demand is elastic and if the proportion of expenditure in income is less than demand is inelastic.