Sponsor Area
Demand Function. It explains the relationship between the demand for a commodity and the factors determining demand. In a way it gives functional relationship (i.e., cause and effect relationship) between demand and its determinants. The above analysis is presented as demand function in the form of the following equation.
Dx = f(Px, PR, Y, T)
The equation shows that demand for commodity x (Dx) is the function (f) of Price of commodity x (Px); Price of Related goods (PR); Income of consumer (Y) and Tastes of consumer (T).
A consumer's demand function for a good gives the amount of the good that the consumer chooses at different levels of its price when the other things remain unchanged.
Let us first discuss the relationship between the price and demand which is expressed in the form of 'law of demand' and take up the relationship with other determinants afterwards.
To simplify let us divide all the determinants of demand in two categories, namely, 'price of commodity itself' in first category and 'factors other than the price' of the commodity, (such as price of related goods, income of consumer and taste of consumer) in the second category.
(i) Change in quantity demanded. When change (rise or fall) in demand for a commodity is caused by change in its own price, it is called change in quantity demanded. It shows specific quantity of a commodity purchased against its specific price. It is expressed in the form of either extension or contraction of demand. A change in quantity demanded is graphically represented in the form of movement along a given demand curve.
(ii) Change in demand. When change (rise or fall) in demand is caused by factors other than the own price of the commodity, it is merely called change in demand. It is expressed in the form of either increase or decrease in demand. In fact, change (increase or decrease) in demand is graphically represented by shift of a demand curve upward or downward.
Comparison. 1. Change in 'quantity demanded' is caused by change in price of commodity (i.e., demand curve does not shift) whereas 'change in demand' is caused by factors other than the price i.e., demand curve shifts rightward or leftward.
Sponsor Area
When rise in income leads to rise in demand for a good, that good is called a normal good. (Positive relationship). When rise in income leads to fall in demand for a good, that good is called an inferior good. (Negative relationship)
Sponsor Area
(i) Wheat and Scooter are examples of normal goods.
(ii) Jawar and toned milk are examples of inferior goods.
(i) Prices of related goods (substitute and complementary goods).
(ii) Distribution of income.
(iii) Tastes of consumers.
(iv) Size of the market (i.e. number of consumers in the market).
Meaning of Consumer's Equilibrium. The term equilibrium literally means a state of balance or stability but in economics it stands for 'best position', 'a position of no change'. It is a state of rest which once reacted has no tendency to change the present position. A consumer is one who buys goods and services for satisfaction of his wants. His aim is to obtain maximum possible satisfaction (utility) from spending his limited income. When he achieves the state of maximum satisfaction, he is said to be in equilibrium. Simply put, consumer's equilibrium means consumers's maximum satisfaction.
Meaning. Consumer's equilibrium refers to a situation under which he spends his given income on purchase of a commodity (or combination of two goods) in such a way that gives him maximum satisfaction and he feels no urge to change. It is a position of rest because he does not want to consume (buy) less or more than that. (Mind, in economics the term 'equilibrium' is used quite frequently such as consumer's equilibrium, producer's equilibrium, equilibrium price, equilibrium level of national income etc.)
There are two alternative approaches — Utility approach and Indifference curve approach — to attain the state of consumer's equilibrium. Again under utility approach consumer's equilibrium is studied in case of one commodity and two commodities. These are discussed in questions that follow.
A consumer wants to consume two goods. The prices of two goods are र 4 and र 5
respectively. The consumer's income is र 20.
Write down the equation of budget line.
The budget line equation is 'P1x1 + P2x2 = M' presuming two goods are x1and x2 and prices, P1 and P2 respectively. M represents money income. Thus budget line equation under given information is 4x1 + 5x2 = 20.
A consumer wants to consume two goods. The prices of two goods are र 4 and र 5
respectively. The consumer's income is र 20.
How much of good 1 the consumer can consume if she spends her entire income on that good?
The consumer can consume 5 (= 20 ÷ 4) units if she spends her entire income on purchase of good 1 (here x1).
A consumer wants to consume two goods. The prices of two goods are र 4 and र 5
respectively. The consumer's income is र 20.
How much of good 1 the consumer can consume if she spends her entire income on that good?
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 two goods are र 6 and र 8 respectively.
How much is the consumer's income?
M (Income) = P1 × good 1 + P2 × good 2.
By substituting values, we get:
M = (6 × 6) + (8 × 8) = 36 + 64 = र 100
Suppose a consumer wants to consume two goods which are available only in integer units. The two goods are equally priced and the consumer income is र 40.
Write down all the bundles that are available to the consumer.
Among the available bundles, identify those which cost her exactly र 40.
Let the price be र 10 each of good 1 and good 2. The bundles available to consumer are:
(i) (0, 0), (0, 1), (0, 2), (0, 3), (0, 4); (1, 0), (1, 1), (1, 2), (1, 3); (2, 0), (2, 1), (2, 2); (3, 0), (3, 1), (4, 0).
These bundles are available because all the above bundles cost her र 40 or less.
(ii) (0, 4), (1, 3), (2, 2), (3, 1), (4, 0) because all these bundles cost her exactly र 40.
(i) The consumer will prefer bundle (10, 10) to the other two bundles (10, 9) and (9, 9).
(ii) Between the other two bundles, he will prefer bundle (10, 9) to bundle (9, 9).
onsider a market where there are just two consumers and suppose their demand for the good are given as follows. Calculate market demand for the good.
|
p |
1 |
2 |
3 |
4 |
5 |
6 |
|
d1 |
9 |
8 |
7 |
6 |
5 |
4 |
|
d2 |
24 |
20 |
18 |
16 |
14 |
12 |
|
P |
d1
|
d2 |
Market demand (= d1 + d2) |
|
1 |
9 |
24 |
33(= 9 + 24) |
|
2 |
8 |
20 |
28 |
|
3 |
7 |
18 |
25 |
|
4 |
6 |
16 |
22 |
|
5 |
5 |
14 |
19 |
|
6 |
4 |
12 |
16 |
What do you mean by substitutes? Give examples of two goods which are substitutes of each other.
Explain price elasticity of demand.
Hint, (i) They are complementary goods since fall in price of good x has caused a rise in demand for good y.
(ii) They are substitute goods because fall in price of good x has caused fall in demand for good y.
Hint. (i) When consumer's income increases but prices remain same.
(ii) When price of either of the two goods changes but income remains same.
Condition of Consumer's Equilibrium (in case of a single commodity).
Consumer's equilibrium is attained when marginal utility of commodity in money terms is equal to its price. Symbolically :
MUx = Px
Marginal utility of commodity x is equal to price of x.
A consumer compares price with marginal utility of commodity in terms of money. Since it is difficult to compare MU of a good (expressed in utils) with its price (expressed in र), therefore, MU of a good is first converted in terms of money by dividing MU of a good with MU of a rupee 
and then compared, (Mind, MU of a rupee is the extra utility when an extra rupee is spent on other available good, )
The above condition of consumer's equilibrium can be explained with the help of following utility schedule.
Utility Schedule. We know that according to law of diminishing marginal utility, the utility which we draw from each additional unit goes on falling. Let us suppose that a consumer gets marginal utility from consumption of successive oranges as shown in the following utility schedule. Further suppose that price of an orange is र 1 and MU of a rupee is 2 utils. How many oranges will he consume to attain the level of equilibrium (i.e., maximum satisfaction)?
|
UTILITY SCHEDULE OF A CONSUMER |
||||
|
Units of oranges consumed |
Marginal utility (utils) |
MU in terms of money (र) (MU of orange ÷ MU of र) |
Price of orange (र) |
Gain (र) |
|
1 |
10 |
5(= 10 ÷ 2) |
1 |
4 |
|
2 |
8 |
4 |
1 |
3 |
|
3 |
5 |
2.5 |
1 |
1.5 |
|
4 |
2 |
1 |
1 |
0 |
|
5 |
1 |
0.5 |
1 |
-0.5 |
It is clear from the above schedule that initially MU in terms of money is greater than the price of orange. For example from consumption of first orange, the consumer gets utility equal to 10 utils or utility worth र 5 (= 10 ÷ 2) whereas he sacrifices utility of र 1 in the form of price. Thus he gets benefit of र 4(= 5 - 1) from the first orange. So he will buy it. Making such comparisons for successive units he will go on buying additional units till the consumption level of 4th units at which MU in terms of money (i.e., 1) becomes equal to its price (i.e., र 1). Thus at the level of 4 oranges, the consumer reaches the state of equilibrium because the above mentioned condition of equilibrium MUx = Px is met here. This condition is sometimes usually described as "marginal utility is equal to price".
The above phenomenon of consumer's equilibrium is graphically shown in the above Fig. 2.2 presuming MU of र (money) to be constant.
Note. Equilibrium equation MUx = Px can also be written as 
Clearly a consumer's equilibrium depends upon three factors : (i) MU of a product, (ii) MU of a rupee (money), and (iii) Price of the product.
i.e., ratio of MU of commodity x to its price 
s equal to ratio of MU of commodity y to its price 
The equation also implies if price of commodity x is equal to price of commodity y (if Px = Py), the consumer will attain equilibrium when MUx = MUy.It also means that satisfaction is maximum when a rupee worth of MU is same in both the goods x and y. This is proved in the following utility schedule of a consumer who has र 20 with him to spend on two goods x and y. Further suppose price of each unit of x (say tea) is र 5 and that of y (say biscuits) is र 2. How will consumer attain his equilibrium?
|
UTILITY SCHEDULE IN CASE OF TWO GOODS |
||||
|
Units of goods |
MUx |
MUx / Px (A rupee worth of MU) |
MUy |
MUy / Py (A rupee worth of MU) |
|
1 |
50 |
50 ÷ 5 = 10 |
24 |
24 ÷ 2 = 12 |
|
2 |
40 |
40 ÷ 5 = 8 |
22 |
22 ÷ 2 = 11 |
|
3 |
30 |
30 ÷ 5 = 6 |
20 |
20 ÷ 2 = 10 |
|
4 |
20 |
20 ÷ 5 = 4 |
18 |
18 ÷ 2 = 9 |
|
5 |
10 |
10 ÷ 5 = 2 |
16 |
16 ÷ 2 = 8 |
|
6 |
0 |
— |
14 |
14 ÷ 2 = 7 |
For obtaining maximum satisfaction from spending his given income of र 20 the consumer will buy 2 units of x (say, tea) by spending र 10(= 2 × 5) and 5 units of y (say, biscuits) by spending र 10(= 5 × 2). This combination of goods brings him maximum satisfaction (or state of equilibrium) because a rupee worth of MU in case of good x is 
and in case of good y is also 
= MU of a rupee or money). Remember, a consumer's maximum satisfaction is subject to budget constraints, i.e., the amount of money to be spent by a consumer.
One major limitation of Utility Approach is that it is measured in cardinal number (i.e., in exact numbers like 1, 2, 3 ....) and also utility being a subjective thing is incapable of being measured in exact numbers.
Briefly explain the following concepts.
(a) Indifference curve and its properties.
(b) Indifference map.
Fig. 2.4
Properties of indifference curves are :
1. Indifference curves always slope down from left to the right. It is negatively sloped because when consumer increases consumption of good-1, he must reduce consumption of good-2 so as to keep utility level unchanged.
2. Higher indifference curves represent higher level of satisfaction. It is so because higher indifference curve represents more quantity of both the goods.
3. Indifference curves are always convex to the origin O because MRS of two goods continuously fall.
4. Indifference curves cannot touch or intersect each other.
Assumptions. Indifference curve analysis is based on the following assumptions.
(i) A consumer is rational, i.e., he would like to get maximum satisfaction.
(ii) A consumer can rank bundles on the basis of satisfaction.
(iii) Prices of goods and income of consumer are given.
(iv) A consumer's preferences are monotonic.
(b) Indifference Map. "An indifference map is a collection of indifference curves that represent different levels of satisfaction." Simply put a set of indifference curves shown on a single diagram is called indifference map. Remember one indifference curve has one utility level throughout and so different curves show different utility levels. An indifference map gives a complete picture of a consumer's scale of preferences for two goods as it represents different levels of satisfaction. Such a map has been drawn in the adjoining Fig. 2.5 containing different indifference curves. They are numbered in ascending order like IC1, IC2, IC3 and IC4. A higher indifference curve indicates higher level of satisfaction as compared to lower indifference curve. Its reason is that any point on a higher indifference curve means more of both goods or the same quantity of one good and more quantity of other good. Thus IC2 is superior to IC1 IC2 to IC3 and IC4 is superior to IC3. In short higher the position of a curve, the better for the consumer because the higher curve represents greater quantities of both the goods. Briefly put, all the indifference curves taken together constitute the Indifference Map of the consumer. Thus the map describes preferences of a consumer.
Fig. 2.5
Remember, indifference curve analysis is based on the assumption that preference are monotonic.
Sponsor Area
Briefly explain the following concepts.
(a) What are monotonic preferences?
(b) Marginal Rate of substitution.
(c) Consumer's Preferences. It is assumed that a consumer is rational and has well defined preferences to the set of bundles available to him. He can compare any two bundles and either prefers one to the other or is indifferent (neutral) to the two. He can rank the bundles in order of his preferences over them and chooses his most preferred bundle. A consumer's preferences are monotonic.
Monotonic preferences. Consumer's preferences are monotonic if and only if between two bundles, consumer prefers the bundle which has more of atleast one of the good and not less of other good as compared to other bundles. In other words consumer's preferences are called monotonic when between any two bundles (x1, x2) and (y1, y2), if (x1, x2) has more of at least one of the goods and no less of the other good as compared to (y1, y2), the consumer prefers (x1, x2) to (y1, y1). For example, between two bundles (10, 9) and (9, 9), consumer's preference of bundle (10, 9) to (9, 9) will be called monotonic preference.
(d) Marginal Rate of Substitution (MRS). The rate of substitution of one commodity for another is known as marginal rate of substitution. Let the two goods be x and y. MRS is the rate at which a consumer is willing to give up the amount of y for getting an extra unit of x without affecting his total utility. This is expressed as MRSxy which is read as marginal rate of substitution of good x for good y. Thus, the MRS of good x for good y is the amount of good y which will be sacrificed for obtaining an additional unit of good x. Symbolically:
This is illustrated in the adjoining Fig. 2.6.
Fig. 2.6
We take two points A and B on the adjoining indifference curve. At point A, a consumer gets combination of OR (= MA) of good y and OM (= RA) of good x. Suppose he shifts to point B where he gets combination of OS (= MC) of good y and ON (= SB) of good x. By this change he loses AC (= MA - MC) amount of good y and gains CB (= ON - OM) amount of good x which means he is willing to substitute goods x for goods y at the rate of 
Thus MRS can be defined as the rate at which a consumer is willing to sacrifice a unit of one good for getting an extra unit of another good without affecting his total utility. It needs to be noted that 
is the slope of indifference curve and this is called MRS of good x for good y. Diminishing Marginal Rate of Substitution. Since marginal utility of good x goes on falling with every increase in units of x, therefore, consumer will be willing to sacrifice lesser quantity of good y for obtaining additional units of x. Hence we can say that marginal rate of substitution (MRS) is always diminishing. (Let it be noted that for consumer's equilibrium, MRS must be equal to ratio of prices of two goods, i.e., Px/Py).
Explain the condition of consumer's equilibrium using indifference curve analysis. Use Diagram.
OR
Why is the consumer in equilibrium when he buys only that combination of two goods that is shown at the point of tangency of the budget line with an indifference curve? Explain.
Consumer's Equilibrium through Indifference Curve: According to indifference curve approach, a consumer attains equilibrium under two conditions:
Let the two goods be x and y as shown in the following Fig. E is the tangency point of budget line on indifference curve IC2. For this two basic tools — Indifference Map (i.e., set of indifference curves representing scale of preferences) and Budget Line (representing money income and prices of two goods) are required.
In Fig, we superimpose budget (price) line M on consumer's indifference map. Mind, indifference curves to the right represent progressively higher satisfaction. The aim of the consumer is to obtain the highest combination on his indifference map and, therefore, he tries to go to the highest indifference curve with his given budget line. He would be in equilibrium only on such point which is common to both the budget line and the highest attainable indifference curve. Here budget line M is tangent to indifference curve IC2 at point E.
In the Fig., E is the equilibrium point where both the conditions are fulfilled simultaneously. Mind, bundles on the higher indifference curve IC3 are not affordable because his income does not permit whereas bundles on the lower indifference curve IC1 give lower satisfaction. Hence the equilibrium choice is only at the tangency point E where consumer attains a state of equilibrium., i.e., maximum satisfaction. The equilibrium purchase is ox of good x and oy of good y on indifference curve IC2.
(i) Price of commodity itself. It is generally observed when price of the commodity falls, its demand rises and when price rises, its demand falls, other things being equal. Thus there is an inverse relationship between the price and the demand for commodity. It is discussed in detail in next question titled 'law of demand'.
(ii) Price of related goods. Goods are said to be related when price of one good (say, x) causes change in demand for other good (say, y). A consumer's demand for a particular good (say coffee) depends upon the price of its related good (say, tea). Related goods are of two types — substitute goods and complementary goods.
(a) Substitute goods. Substitute goods are a pair of goods which can be used (substituted) in place of each other to satisfy a given want. For example coffee, is substitute of tea. If price of coffee rises, demand for its substitute tea will rise because consumers will substitute tea for coffee. Thus demand for a good (here tea) rises with a rise in price of its substitute good (here coffee), i.e., there is direct relationship.
(b) Complementary goods. These are a pair of goods which are used jointly to satisfy a given want. For example car and petrol. If price of complementary good petrol rises, demand for car will fall. Thus in case of complementary goods, if price of one good falls, demand for the other good rises, i.e., there is Inverse Relationship.
(iii) Income of the consumer. Higher the income, larger will be the demand generally. The effect of change in income on demand depends upon the nature of the good whether the good is normal or inferior. A good whose demand rises with rise in income is called a normal good whereas a good whose demand falls with rise in income is called an inferior good. If income of a consumer goes up, demand for a normal good (like full cream milk, wheat, fine cloth) will rise but for an inferior good (like toned milk, jowar, coarse cloth) will fall. On the contrary with a fall in income, demand for a normal good will fall but for an inferior good will rise. (For detail see Q. 2.23).
(iv) Taste and preference of consumer. A favourable change in taste for a good (say, salty eatable) increases its demand whereas an unfavourable change in taste (say, for sweets) decreases its demand at the same price. Similarly, a change in preference also affects demand. For instance a student may demand more of books and pens than utensils.
Demand Function. It explains the relationship between the demand for a commodity and the factors determining demand. In a way it gives functional relationship (i.e., cause and effect relationship) between demand and its determinants. The above analysis is presented as demand function in the form of the following equation.
Dx = f(Px, PR, Y, T)
The equation shows that demand for commodity x (Dx) is the function (f) of Price of commodity x (Px); Price of Related goods (PR); Income of consumer (Y) and Tastes of consumer (T).
A consumer's demand function for a good gives the amount of the good that the consumer chooses at different levels of its price when the other things remain unchanged.
Let us first discuss the relationship between the price and demand which is expressed in the form of 'law of demand' and take up the relationship with other determinants afterwards.
According to Classical approach, the most important reason behind law of demand is 'law of diminishing marginal utility' but the modem economists believe income effect and substitution effect as the main causes. These are explained below:
1. Law of diminishing marginal utility. Briefly, this law states that when a consumer consumes more and more units of a commodity, marginal utility derived from successive units goes on decreasing. As for example, a hungry man gets maximum utility from first chapati, lesser utility from second chapati, still lesser from third chapati and so on. Demand depends on utility or usefulness of a commodity to the consumer, i.e., if he gets more satisfaction, he will pay more and if he gets less utility, he will buy at a lower price. Since additional (or successive) units give him lesser utility, he will buy additional units only at lower price. And this is Law of Demand which states that demand for a commodity is more at a lower price and less at a higher price. Thus law of diminishing marginal utility explains the downward slope of demand curve. Indeed demand curve is essentially the downward sloping portion of the marginal utility curve.
2. Income effect. A change in quantity demanded as a result of change in real income caused by change in price of a commodity is called income effect. Any change in the price of a commodity affects the purchasing power or real income of the consumer although his money income remains the same. When price of a commodity falls, less has to be spent on purchase of same quantity of that commodity or same quantity can be purchased with less money. With money thus saved, a consumer can purchase more quantity of the commodity whose price has fallen. This is called income effect of change in price of the commodity.
In short, a fall in price increases the real income (purchasing power) of a consumer with the result that he buys more quantity with the same money income. Similarly, a rise in price virtually amounts to fall in real income of the consumer leading to contraction of his demand. This part of increase in demand is called income effect. Mind, income effect is related to change in income caused due to change in price and not due to change in money income.
3. Substitution effect. Substituting a cheaper commodity for the relatively expensive commodity is called substitution effect., Alternatively, it refers to substitution of one commodity in place of other commodity when it becomes relatively cheaper. How? A rise in the price of a commodity, say coffee, also means that price of its substitute, say tea, has fallen in relation to that of coffee even though price of tea remains unchanged. So people are induced to buy more of tea and less of coffee when price of coffee rises. In other words, consumers will substitute tea for coffee. This part of increase in demand is called substitution effect.
The effect operates reverse when the price of the commodity falls. A fall in the price of a commodity induces the consumer to substitute other commodities with this commodity whose price has fallen. This leads to rise in demand. Clearly substitution effect is based on concept of relative prices of substitute goods.
Thus, according to modern economists, the combined operation of income effect and substitution effect causes increase in demand with a fall in price.
It may be noted that the combined effect of income effect and substitution effect is called price effect.
Why inverse relationship between price and demand? We have read in Utility Approach of consumer's equilibrium that a consumer buys only that much of a commodity at which its marginal utility in money terms is equal to its price. Under such a situation suppose price falls, it makes marginal utility greater than price. This induces the consumer to buy more of the commodity. Clearly it shows inverse relationship between price and demand.
To simplify let us divide all the determinants of demand in two categories, namely, 'price of commodity itself' in first category and 'factors other than the price' of the commodity, (such as price of related goods, income of consumer and taste of consumer) in the second category.
(i) Change in quantity demanded. When change (rise or fall) in demand for a commodity is caused by change in its own price, it is called change in quantity demanded. It shows specific quantity of a commodity purchased against its specific price. It is expressed in the form of either extension or contraction of demand. A change in quantity demanded is graphically represented in the form of movement along a given demand curve.
(ii) Change in demand. When change (rise or fall) in demand is caused by factors other than the own price of the commodity, it is merely called change in demand. It is expressed in the form of either increase or decrease in demand. In fact, change (increase or decrease) in demand is graphically represented by shift of a demand curve upward or downward.
Comparison. 1. Change in 'quantity demanded' is caused by change in price of commodity (i.e., demand curve does not shift) whereas 'change in demand' is caused by factors other than the price i.e., demand curve shifts rightward or leftward.
Distinguish between extension of demand and contraction of demand with the help of a diagram.
(b) What is 'movement along a demand curve'? Show it with the help of a diagram.
(c) What causes an upward movement along a demand curve of a commodity?
(a) Extension and contraction of demand. Rise in demand due to fall in price of a commodity itself, other things remaining the same, is called extension of demand. It results in downward movement along a demand curve. On the other hand, fall in demand due to rise in price of a commodity itself, other things remaining the same, is called contraction of demand. It results in upward movement along a demand curve. The following demand schedules and curve further clarify it.
|
EXTENSION OF DEMAND |
CONTRACTION OF DEMAND |
||
|
Price per unit (र) |
Demand (units) |
Price per unit (र) |
Demand (units) |
|
5 |
10 |
1 |
20 |
|
3 |
15 |
3 |
15 |
|
1 |
20 |
5 |
10 |
(b) Movement along a demand curve. A demand curve showing change in demand due to change in price (i.e., extension and contraction of demand) is graphically called movement along a demand curve. In Fig. 2.9 when price is OP, demand is OQ. But when price falls from OP to OP2, demand expands from OQ to OQ2 and we move downward along the demand curve. When price rises from OP to OP1, demand falls from OQ to OQ1 and we move upward the demand curve. Thus a change in demand due to change in price of the commodity graphically means movement along the demand curve.
(c) Rise in price or fall in demand causes an upward movement along a demand curve.
Fig. 2.9
An individual (household) demand schedule is a tabular statement which shows different quantities of a commodity that a consumer would demand at different prices. Market (or composite) demand for a commodity is the total demand at each price by all the consumers of that commodity in the market. Therefore, market demand schedule is the aggregate of individual demand schedules. By summing up individual demand schedules we get market demand schedule as shown in the following demand schedules. Let us suppose there are three households, namely, A, B and C in the potatoes market. Individual demand schedules and the resultant market demand schedule for potatoes are given in the table below.
|
INDIVIDUAL DEMAND SCHEDULES |
MARKET DEMAND SCHEDULE |
|||
|
Price Per kg (र) |
Demand by Individual Households (kg) |
Aggregate (Market) Demand (kg) |
||
|
A |
B |
C |
(A + B + C) |
|
|
1 |
6 |
11 |
13 |
30 |
|
2 |
5 |
9 |
12 |
26 |
|
3 |
4 |
7 |
11 |
22 |
|
4 |
3 |
5 |
10 |
18 |
|
5 |
2 |
3 |
9 |
14 |
|
6 |
1 |
1 |
8 |
10 |
Change in demand is 4% in response to 10% change in price, meaning thereby that the demand for wheat is less elastic or less responsive.
Price elasticity of demand is also defined as percent change in demand for the good divided by percent change in its price. Symbolically:
The following are the main factors which determine the price elasticity of demand for a commodity.
1. Number of close substitutes of a good. Demand for a commodity which has a large number of its substitutes is usually elastic. Pepsi, Limca, Coca-Cola, Rooh Afza are good substitutes for each other. Demand for any of them, say, Pepsi, is likely to be highly elastic due to availability of its close substitutes. If a good has less number of close substitutes, its demand will be less elastic, e.g., electricity. Similarly demand for salt is inelastic since it has no close substitutes. In short more the number of close substitutes of a good, higher is elasticity of demand of that good.
2. Number of uses of a commodity. More the number of uses of a commodity, more is eD of that good. Thus demand for a commodity which has many uses is generally elastic, e.g., demand for electricity, milk, petrol etc. On the other hand if commodity has a few uses (like butter), its demand is likely to be inelastic.
3. Proportion of income spent on a good. More the proportion of income spent on a good, more is eD of that good. Demand for a commodity is inelastic if proportion of income spent on that commodity is very small, e.g., demand for needles, matchboxes etc. On the other hand, if expenditure on a commodity forms a large proportion of consumer's income, its elasticity is likely to be high, e.g., demand for clothes, Scooters etc.
4. Level of prices. Demand for a good at higher level of price is generally more elastic than for good at lower level of price. For example, demand for inexpensive or Iow priced articles like matchboxes, pencils, combs etc. is inelastic. On the contrary, demand for high priced goods like cars, TVs, ACs etc. is usually elastic because change in price affects the consumer's budget greately.
5. Level of income. If income level of consumer is high, change in price will not affect the quantity demanded of most of the commodities, i.e. elasticity of demand will be low for most of the goods. But if income level is low, elasticity of demand for most of the commodities will be very high. For instance if price of a good rises, a rich consumer is not likely to reduce the demand than a poor consumer.
6. Tastes, preferences and habits of consumers also determine change in their demand for commodities. For example, a chain-smoker will not restrict his smoking even at a higher price.
7. Nature of goods. A good for a person may be a necessity or a comfort or a luxury. (i) Necessities of life have inelastic demand, since they are to be purchased even though their prices go up, e.g. demand for food, textbooks etc. Thus more necessary the good for a consumer, less elastic is the demand. (ii) As against this, demand for luxuries is generally more elastic, as they are high price goods, e.g. demand for T.V. sets, Air-conditioners, cars etc. (iii) However demand for comforts like fan, cooler, radio etc. is generally elastic as a consumer can postpone its consumption.
8. Miscellaneous. Nature of use of a commodity (coal for cooking or heating of room), jointly demanded goods, possibility of postponement, short or long period etc. are some of the other factors that affect elasticity of demand.
False because with fall in income, demand for a normal good generally falls and that for an inferior good rises,
Define Marginal Utility. State law of diminishing marginal utility.
Marginal Utility: It is an addition to the total utility as consumption is increased by one more unit of the commodity.
Law of Diminishing Marginal Utility: The law states that 'as a consumer consumes more and more units of a commodity (say chapati), the additional utility derived from each successive unit goes on diminishing (falling).'
In case of a single commodity, consumer's equilibrium is attained when :
(i) Marginal utility in terms of money = Price (MUx = Px)
(ii) In case of two commodities, it is attained when :
Sponsor Area
When rise in income leads to rise in demand for a good, that good is called a normal good. (Positive relationship).
When rise in income leads to fall in demand for a good, that good is called an inferior good. (Negative relationship)
What are increase in demand and decrease in demand?
Rise in demand due to change in factors other than the price (i.e., at the same price) is called increase in demand whereas fall in demand due to change in factors other than the price (i.e., at the same price) is called decrease in demand.
What causes upward movement along a demand curve?
Rise in price of the commodity itself causes upward movement along a demand curve.
(i) Wheat and Scooter are examples of normal goods.
(ii) Jawar and toned milk are examples of inferior goods.
(i) Prices of related goods (substitute and complementary goods).
(ii) Distribution of income.
(iii) Tastes of consumers.
(iv) Size of the market (i.e. number of consumers in the market).
Which of the following commodities have inelastic demand?
(i) Salt, (ii) Particular brand of lipstick, (iii) Medicine, (iv) Mobile phone, and (v) School uniform.
|
Price (र) |
10 |
|
|
Demand (units) |
80 |
100 |
|
Total expenditure (र) |
800 |
800 |
It is a case of unit elastic demand because total expenditure before and after the change in price is the same, i.e., र 800.
Since demand for the product is elastic it implies that % rise in demand is more than % fall in price, therefore, total expenditure will change in the opposite direction of price change (see above part 'b'). Thus total expenditure will rise with fall in price as shown in the following example.
|
Price per unit (र) |
Demand (Units) |
Total Expenditure (र) |
|
6 |
10 |
60 |
|
5 |
15 |
75 |
|
4 |
20 |
80 |
% change in demand = -0.2 × 10 = -2
According to the expenditure method if % change in demand (here 2%) is less than % change in price (10%) (i.e., if good is price inelastic) expenditure on good will change in the direction of price change. As price has increased, so expenditure in good will increase.
Percent rise in quantity demanded
Demand is not elastic because elasticity is less than unity (i.e. 1).
% change in demand = -0.2 × 10 = -2
According to the expenditure method if % change in demand (here 2%) is less than % change in price (10%) (i.e., if good is price inelastic) expenditure on good will change in the direction of price change. As price has increased, so expenditure in good will increase.
Percent rise in quantity demanded
Draw a downward sloping straight line demand curve touching both the axes. Mark price elasticity at different points of this demand curve.
What is elasticity of demand on the mid-point of a straight line moving down from left to right?
Elasticity on a straight line (linear) demand curve. Another method of measuring price elasticity of demand is geometric method which is used when elasticity is to be measured at different points on the straight line demand curve. This method involves the following steps as shown in the following Fig. 2.29.
(i) Straight line demand curve is first extended to both sides to join Y-axis at E and X-axis at D in Fig. 2.29.
Fig. 2.29
(ii) Take mid-point of straight line demand curve (say, point B) which divides the demand curve into two equal portions — upper portion (say, BE) and lower portion (say, BD). Point A is located in the upper portion and point C in the lower portion.
(iii) Elasticity at any point on straight line demand curve is worked out by dividing lower portion of the demand curve with upper portion of the demand curve. Thus:
because B is the mid-point.
(Alternatively elasticity of demand on the mid-point of a straight line moving from left to right is 1 or unit elastic.)
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
If price of good X rises and this leads to decrease in demand for good Y, how are the two goods related?
Solution not provided.
Solution not provided.
Tips: -
Hint. Individual demand for a commodity means quantity of the commodity that an individual household is willing to buy at a particular price in a given period of time. On the contrary market demand for a commodity is the collective demand of all individuals for the commodity at a given price at a given time period.Solution not provided.
Tips: -
Hint, (i) Law of diminishing marginal utility, (ii) Substitution effect, and (iii) Income effect.Solution not provided.
Tips: -
Hint, (i) Availability of close substitute goods (ii) Proportion of income spent on product, (iii) Level of income of consumer.Solution not provided.
Tips: -
Hint, (i) Total expenditure will change in the opposite direction of price change if % change in quantity > % change in price and (ii) in the same direction of price change if % change in quantity < % change in price.Solution not provided.
Tips: -
Hint. (i) Increase in income increases the demand for normal good and reduces demand for inferior good, (ii) Decrease in income increases demand for inferior good but reduces demand for normal good.Solution not provided.
Tips: -
Hint. As more and more units of a commodity are consumed, marginal utility derived from each successive unit goes on falling.
Tips: -
Hint, (i) Good X is complementary to good Y. (ii) Good Y is substitute of good X.Solution not provided.
Tips: -
Hint, (i) In case of substitute goods, there is direct relationship between demand for a given good (say coffee) and price of its substitute (say tea), (ii) In case of complementary good there is inverse relationship between demand for a given good (say scooter) and price of its complementary good (say petrol).Complete the following table:
|
Units consumed |
Total Utility (TU) |
Marginal Utility (MU) |
|
1 |
9 |
— |
|
2 |
— |
7 |
|
3 |
— |
6 |
|
4 |
27 |
— |
|
5 |
— |
2 |
|
6 |
27 |
— |
Solution not provided.
Tips: -
Hint. TU = 9, 16, 22, 27, 29, 27 MU = 9, 7, 6, 5, 2, -2Solution not provided.
Tips: -
Hint, (i) Increase in income of buyers of normal good, (ii) Fall in price of complementary good, and (iii) Favourable change in taste of commodity.Solution not provided.
Tips: -
Hint. When between any two bundles (x1, x2) and (y1, y2), if (x1, x2) has more of at least one of the goods and no less of the other good as compared to (y1, y2), the consumer prefers (x1, y2) to (y1, y2), it is called monotonic preference.
Solution not provided.
Tips: -
Hint. A budget constraint indicates what different bundles of goods a consumer can afford to buy within his given (limited) income.Solution not provided.
Tips: -
Hint. Total expenditure before price change = 30 × 7 = 210
Total expenditure after price change = 20 × 8 = 160
Since rise in price reduces total expenditure, therefore, eD is more than 1.
Solution not provided.
Tips: -
Hint, (i) They are complementary goods since fall in price of good x has caused a rise in demand for good y.
(ii) They are substitute goods because fall in price of good x has caused fall in demand for good y.
Solution not provided.
Tips: -
Hint. Slope of IC shows the rate at which consumer is willing to substitute one good for the other good whereas slope of budget line shows ratio between Px and Py (i.e., Px/Py).Solution not provided.
Tips: -
Hint. (i) When consumer's income increases but prices remain same.
(ii) When price of either of the two goods changes but income remains same.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Solution not provided.
Give equation of Budget Line.
The budget line can be expressed as an equation:
M = (PA x QA) + (PB x QB)
Where:
M = Money income;
QA = Quantity of good 1
QB = Quantity of good 2
PA = Price of good 1
PB = Price of good 2
When income of the consumer falls, the impact on price-demand curve of an inferior
good is: (choose the correct alternative)
Shifts to the right.
Shifts of the left.
There is upward movement along the curve.
There is downward movement along the curve.
A.
Shifts to the right.
Reason: Demand for inferior goods share a negative relationship with consumer's income.
Hence, when the income of the consumer falls, the demand for inferior good
increases leading to the rightward shift of the demand curve.
If Marginal Rate of Substitution is constant throughout, the Indifference curve will
be
Parallel to the x-axis.
Downward sloping concave.
Downward sloping convex.
Downward sloping straight line.
D.
Downward sloping straight line.
Reason: If Marginal Rate of Substitution is constant throughout, the Indifference curve will
be downward sloping straight line.
The measure of price elasticity of demand of a normal good carries minus sign while
price elasticity of supply carries plus sign. Explain why?
The first law of demand states that as price increases, less quantity is demanded. This is
why the demand curve slopes down to the right. Because price and quantity move in
opposite directions on the demand curve, the price elasticity of demand is always negative.
Hence the measure of price elasticity of demand of a normal good carries minus sign as
there exists an inverse relationship between demand and price of the good.
On the other hand, a supply curve is characterized by a line that slopes up to the right.
Thus, as the price increases, more quantity is supplied. Because price and quantity move
in the same directions on the supply curve, the price elasticity of supply is usually positive.
Thus the price elasticity of supply always carries a plus sign.
A consumer spends Rs. 1000 on a good priced at Rs. 8 per unit. When price rises by 25 per cent, the consumer continues to spend Rs. 1000 on the good. Calculate price elasticity of demand by percentage method.
Elasticity of Demand by Percentage method:
E = % change in quantity demanded / % change in price.
| Price (Rs) |
Quantity |
Total Expenditure |
| 8 | 125 | 1000 |
| 10 | 100 | 1000 |
% change in quantity demanded = (New quantity demanded - old quantity demanded)/
initial quantity * 100
(100-125)/125 = -0.2*100 = -20
% in price = (New price – old price)/ Initial price*100
(10-8)/8 = 0.25 *100 = 25
Price elasticity of demand Rs = -20/25 = -0.8
A consumer consumes only two goods X and Y both priced at Rs. 3 per unit. If the consumer chooses a combination of these two goods with Marginal Rate of Substitution equal to 3, is the consumer in equilibrium? Give reasons. What will a rational consumer do in this situation? Explain.
Or
A consumer consumes only two goods X and Y whose prices are Rs. 4 and Rs. 5 per unit respectively. If the consumer chooses a combination of the two goods with marginal utility of X equal to 5 and that of Y equal to 4, is the consumer in equilibrium? Give reason. What will a rational consumer do in this situation? Use utility analysis.
At the point of consumer equilibrium, the following equality should be met:
MRS = Px/Py
MRS = 3 (given)
Px/Py= 3/3 = 1
Thus, MRS is greater than the price ratio.
In order to reach the equilibrium point, a rational consumer would increase the consumption of good X and decrease that of good Y.
Or
According to the utility approach, a consumer reaches an equilibrium where the following equality is met.
MUx/Px = MUY/Py
MUx/Px =5/4 (given)
MUY/Py = 4/5
So MUx/Px is greater than MUY/Py . Thus a rational consumer has to increase the consumption of good X and decrease that of good Y in order to reach equilibrium.
Define budget set.
The set of bundles available to the consumer is called the budget set. The budget set is the collection of all bundles that the consumer can buy with her income at the prevailing market prices. It is represented by the following condition of inequality: P1x1 + P2x2≤M.
A consumer buys 18 units of a good at a price of Rs. 9 per unit. The price elasticity of demand for the good is (−) 1. How many units the consumer will buy at a price of Rs. 10 per unit? Calculate.
Initial quantity demanded = 18
Initial price =Rs 9 per unit
New price = Rs 10 per unit
Price elasticity of demand (-)1
Price elasticity of demand (ed) = Percentage change in quantity demanded/ Percentage change in price.
ed = (△Q/Q)÷(△P/P)
-1 = (Q2-18)/18 * 9/(10-9)
-1 = (Q2-18)/18 *9/1
(-1/9)*18 = (Q2-18)
-2= (Q2-18)
-2+18 = Q2
Q2 = 16
Therefore, at a price of Rs 10, the consumer will buy 16 units of the goods.
A consumer consumes only two goods. Explain consumer's equilibrium with the help of utility analysis.
The consumer’s equilibrium in case of consumption of two goods is explained by the Law of Equi-Marginal Utility. As per this law, a consumer allocates his expenditure between two commodities in such a manner that the utility derived from each additional unit of the rupee spent on each of the commodities is equal to the marginal utility of money.
In case the price of one commodity rises, less of this commodity and more of the other commodities will be purchased so that the proportion will be restored. In the case of durable goods, it may not be possible to maintain proportionality.
What happens to the demand of a good when consumer's income changes? Explain.
Income of consumer is an important determinant of demand. The rise and fall of the demand for a good as per the rise in income of consumers depends upon the nature of good. Normal goods have a positive income elasticity of demand, so as consumers' income rises, more will be the demand. A rise in the income of the consumer will increase the demand for the good. In the case of Luxury goods and services, demand rises more than proportionate to a change in income. Inferior goods have a negative income elasticity of demand meaning that demand falls as income rises.
Explain the conditions of consumer's equilibrium with the help of the indifference curve analysis.
Consumer equilibrium refers to a situation, in which a consumer derives maximum satisfaction, with no intention to change it and subject to given prices and his given income. The point of maximum satisfaction is achieved by studying indifference map and budget line together. On an indifference map, higher indifference curve represents a higher level of satisfaction than any lower indifference curve. So, a consumer always tries to remain at the highest possible indifference curve, subject to his budget constraint.
Conditions of Consumer’s Equilibrium:
The consumer’s equilibrium under the indifference curve theory must meet the following two conditions:
(i) MRSXY = Ratio of prices or PX/PY:
Let the two goods be X and Y. The first condition for consumer’s equilibrium is that
MRSXY = PX/PY
a) If MRSXY > PX/PY, it means that the consumer is willing to pay more for X than the price prevailing in the market. As a result, the consumer buys more of X. As a result, MRS falls till it becomes equal to the ratio of prices and the equilibrium is established.
b) If MRSXY < PX/PY, it means that the consumer is willing to pay less for X than the price prevailing in the market. It induces the consumer to buys less of X and more of Y. As a result, MRS rises till it becomes equal to the ratio of prices and the equilibrium is established.
(ii) MRS continuously falls:
The second condition for consumer’s equilibrium is that MRS must be diminishing at the point of equilibrium, i.e. the indifference curve must be convex to the origin at the point of equilibrium. Unless MRS continuously falls, the equilibrium cannot be established.
Thus, both the conditions need to be fulfilled for a consumer to be in equilibrium.
In Fig, IC1, IC2 and IC3 are the three indifference curves and AB is the budget line. With the constraint of budget line, the highest indifference curve, which a consumer can reach, is IC2. The budget line is tangent to indifference curve IC2 at point ‘E’. This is the point of consumer equilibrium, where the consumer purchases OM quantity of commodity ‘X’ and ON quantity of commodity ‘Y. All other points on the budget line to the left or right of point ‘E’ will lie on lower indifference curves and thus indicate a lower level of satisfaction.
Thus, we can conclude that if the consumer is consuming any bundle other than the optimum one, then he would rearrange his consumption bundle in such a manner that the equality between the MRS and the price ratio is established and he attains the state of equilibrium.
Explain the three properties of the indifference curves.
1) Indifference curves slope downward to the right:
This property implies that an indifference curve has a negative slope If the preferences are monotonic, an increase in the amount of good: 1. along the indifference curve is associated with a decrease in the amount of good 2. This implies that the slope of the indifference curve is negative. Thus, monotonicity of preferences implies that the indifference curves are downward sloping to the right.
2) Indifference curves are convex to the origin:
Another important property of indifference curves is that they are usually convex to the origin.
In other words, the indifference curve is relatively flatter in its right hand portion and relatively steeper in its left-hand portion. This is because as the consumers consume more and more of one good, the marginal utility good fall. In other words, the consumer is willing to sacrifice less and less for each additional unit of the other good consumed. Thus, as we move down the IC, MRS diminishes. This suggests the convex shape of indifference curve.
3) Slope of IC: The Slope of an IC is given by the Marginal Rate of Substitution (MRS). Marginal rate of substitution refers to the rate at which a consumer is willing to substitute one good for each additional unit of the other good.
When is the demand for a good said to be inelastic?
Inelastic demand is a situation in which the demand for a product does not increase or decrease correspondingly with a fall or rise in its price.
Given the meaning of market demand.
The market demand for a good at a particular price is the total demand of all consumers taken together.
Explain the difference between an inferior good and a normal good.
Normal Goods: The quantity of a good that the consumer demands can increase or decrease with the rise in income depending on the nature of the good. For most goods, the quantity that a consumer chooses increases as the consumer’s income increases and decreases as the consumer’s income decreases. Such goods are called normal goods. Thus, a consumer’s demand for a normal good moves in the same direction as the income of the consumer. For example, clothing is a normal good. As income increases, the demand for clothing increases.
Inferior Goods: The goods for which the demand moves in the opposite direction of the income of the consumer are called inferior goods. As the income of the consumer increases, the demand for an inferior good falls, and as the income decreases, the demand for an inferior good rises. Examples of inferior goods include low quality food items like coarse cereals. As the income increases, the consumer reduces its demand for coarse cereals and instead shifts its demand towards superior quality cereals.
Explain the condition of consumer’s equilibrium with the help of utility analysis.
Consumer’s Equilibrium in case of Single Commodity:
The Law of Diminishing marginal utility can be used to explain consumer’s equilibrium in case of a single commodity.
A consumer purchasing a single commodity will be at equilibrium, when he is buying such a quantity of that commodity, which gives him maximum satisfaction. The number of units to be consumed of the given commodity by a consumer depends on 2 factors:
1. Price of the given commodity;
2. Expected utility (Marginal utility) from each successive unit.
To determine the equilibrium point, consumer compares the price (or cost) of the given commodity with its utility (satisfaction or benefit). Being a rational consumer, he will be at equilibrium when marginal utility is equal to price paid for the commodity.
Hence the consumer attains equilibrium when, Marginal Utility of a Rupee spent on the commodity = Marginal Utility of Money
The price elasticity of demand for a good is − 0.4. If its price increases by 5 percentage, by what percentage will its demand fall? Calculate.
Ed = percentage change in quantity demanded / Percentage change in price
Ed = -0.4
% change in price = 5
Hence, -0.4 = percentage change in quantity demanded / 5
Percentage change in quantity demanded = -0.4 * 5 = -2
Thus, when the price of good increase by 5%, the quantity demanded falls by 2%.
Explain any two factors that affect the price elasticity of demand. Give suitable examples.
The following are the two factors that affect the price elasticity of demand.
1. Availability of substitutes:
Demand for a commodity with large number of substitutes will be more elastic. The reason is that even a small rise in its prices will induce the buyers to go for its substitutes. For example, a rise in the price of Pepsi encourages buyers to buy Coke and vice-versa.
Thus, availability of close substitutes makes the demand sensitive to change in the prices. On the other hand, commodities with few or no substitutes like wheat and salt have less price elasticity of demand.
2. Number of Uses:
If the commodity under consideration has several uses, then its demand will be elastic. When price of such a commodity increases, then it is generally put to only more urgent uses and, as a result, its demand falls. When the prices fall, then it is used for satisfying even less urgent needs and demand rises.
For example, electricity is a multiple-use commodity. Fall in its price will result in substantial increase in its demand, particularly in those uses (like AC, Heat convector, etc.), where it was not employed formerly due to its high price. On the other hand, a commodity with no or few alternative uses has less elastic demand.
Explain consumer’s equilibrium with the help of Indifference Curve Analysis.
Consumer equilibrium refers to a situation, in which a consumer derives maximum satisfaction, with no intention to change it and subject to given prices and his given income. The point of maximum satisfaction is achieved by studying indifference map and budget line together. On an indifference map, higher indifference curve represents a higher level of satisfaction than any lower indifference curve. So, a consumer always tries to remain at the highest possible indifference curve, subject to his budget constraint.
Conditions of Consumer’s Equilibrium:
The consumer’s equilibrium under the indifference curve theory must meet the following two conditions:
(i) MRSXY = Ratio of prices or PX/PY:
Let the two goods be X and Y. The first condition for consumer’s equilibrium is that
MRSXY = PX/PY
(a) If MRSXY > PX/PY, it means that the consumer is willing to pay more for X than the price prevailing in the market. As a result, the consumer buys more of X. As a result, MRS falls till it becomes equal to the ratio of prices and the equilibrium is established.
(b). If MRSXY < PX/PY, it means that the consumer is willing to pay less for X than the price prevailing in the market. It induces the consumer to buys less of X and more of Y. As a result, MRS rises till it becomes equal to the ratio of prices and the equilibrium is established.
(ii) MRS continuously falls:
The second condition for consumer’s equilibrium is that MRS must be diminishing at the point of equilibrium, i.e. the indifference curve must be convex to the origin at the point of equilibrium. Unless MRS continuously falls, the equilibrium cannot be established.
Thus, both the conditions need to be fulfilled for a consumer to be in equilibrium.
In Fig, IC1, IC2 and IC3 are the three indifference curves and AB is the budget line. With the constraint of budget line, the highest indifference curve, which a consumer can reach, is IC2. The budget line is tangent to indifference curve IC2 at point ‘E’. This is the point of consumer equilibrium, where the consumer purchases OM quantity of commodity ‘X’ and ON quantity of commodity ‘Y. All other points on the budget line to the left or right of point ‘E’ will lie on lower indifference curves and thus indicate a lower level of satisfaction.
Thus, we can conclude that if the consumer is consuming any bundle other than the optimum one, then he would rearrange his consumption bundle in such a manner that the equality between the MRS and the price ratio is established and he attains the state of equilibrium.
Explain the relationship between prices of other goods and demand for the given period.
Price of Other Goods and Demand for the given Good:
Quantity demanded of a good depends on the price of other goods (i.e. related goods). Any two goods are considered to be related to each other, when the demand for one good changes in response to the change in the price of the other good. The related goods can be classified into following two categories.
A. Substitute Goods:
Substitute goods refer to those goods that can be consumed in place of each other. In other words, they can be substituted for each other. For example, tea and coffee, Colgate and CLOSE UP, Cello pens and Reynolds pen, etc. In case of substitute goods, if the price of one good increase, the consumer shifts his demand to the other (substitute) good i.e. rise in the price of one good result in a rise in the demand of the other good and vice-versa.
For example, if price of tea increases, then the demand for tea will decrease. As a result, consumers will shift their consumption towards coffee and the demand for coffee will increase. It should be noted that the demand for a good moves in the same direction as that of the price of its substitute.
B. Complementary Goods:
Complementary goods refer to those goods that are consumed together. The joint consumption of these goods satisfies wants of the consumer. For example: Tea and sugar, ink pen and ink, printer and paper, etc.
In case of complementary goods, if the price of one good increases then a consumer reduces his demand for the complementary good as well, i.e. a rise in the price of one good results in a fall in demand of the other good and vice-versa.
For example, sugar and tea are complementary goods. Since, sugar and tea consumed together, so a rise in price of tea reduces the demand for sugar and vice-versa. It should be noted that demand for a good moves in the opposite direction of the price of its complementary goods.
Explain the relationship between income of the buyers and demand for a good.
Income of the Buyer and the Demand for a Good:
Income of consumer is an important determinant of demand. The rise and fall of the demand for a good as per the rise in income of consumers depends upon the nature of good. Normal goods have a positive income elasticity of demand, so as consumers' income rises, more will be the demand. A rise in the income of the consumer will increase the demand for the good. In the case of Luxury goods and services, demand rises more than proportionate to a change in income. Inferior goods have a negative income elasticity of demand meaning that demand falls as income rises.
What is market Demand?
The market demand for a good at a particular price is the total demand of all consumers taken together.
Given price of a goods, how does a consumer decide as to how much of the good to buy?
The marginal utility of a good or service is the gain from an increase, or loss from a decrease, in the consumption of that good or service. In order to decide, how much of a good to buy at a given price, a consumer compares Marginal Utility (MU) of the good with its price (P). The consumer will be at equilibrium, when the Marginal Utility of the good will be equal to the price of the good.
i.e. MUx = Px
If MUx > Px, that is, when price is lesser than the Marginal Utility, then the consumer will buy more of that good.
On the other hand, if MUx < Px, that is, when price is more than the Marginal Utility, then the consumer will buy less of good.
Define an indifference curve. Explain why an indifference curve is downward sloping from left to right.
An indifference curve is a graph showing different bundles of goods between which a consumer is indifferent. That is, at each point on the curve, the consumer has no preference for one bundle over another. 
In the above figure, IC is the Indifference Curve. Each bundle on the IC shows those combinations of two goods that yield the consumer the same level of satisfaction.
This property implies that an indifference curve has a negative slope. If the preferences are monotonic, an increase in the amount of good: 1 along the indifference curve is associated with a decrease in the amount of good 2. This implies that the slope of the indifference curve is negative. Thus, monotonicity of preferences implies that the indifference curves are downward sloping from left to right.
When price of good is Rs 7 per unit a consumer buys 12 units. When price falls to Rs6 per unit he spends Rs 72 on the good. Calculate price elasticity of demand by using the percentage method. Comment on the likely shape of demand curve based on this measure of elasticity.
| Price (Rs) | Quantity (Uts) | (Total Expenditure) (TE) |
| 7 | 12 | 84 |
| 6 | 12 | 72 |
Elasticity of Demand by Percentage method:
E = % change in quantity demanded / % change in price.
% change in quantity demanded = (New quantity demanded - old quantity demanded)/ initial quantity*100
= (12-12)/12 = 0
% in price = (New price – old price)/ Initial price*100
= (6-7)/7 = -14.28
Ed = 0/-14.28 = 0
Hence demand is perfectly inelastic
As the demand is perfectly inelastic, so the demand curve is a vertical straight line parallel to the price-axis.
Explain how changes in prices of other products influence the supply of a given product.
If other things remain the same, the price of a product and its supply is directly proportional. But the relationship between supplies of a product due to changes in the price of other products is different. In other words, the supply of the good depends on the price of its substitute goods and on the price of its complementary goods. The supply of a given good shares positive (negative) relationship with the price of its substitute goods (complementary goods).
In Case of Substitute Goods: Let “A” and “B” are substitutes. If the price of the good “A” falls, then the consumer will shift their preference towards that good “A”. As a result, the demand for the good “B” reduces. Consequently, it is not profitable to supply this good.
“B”, thereby the supply of the “B” reduces. For example, tea and coffee are substitute goods. If the price of tea falls, then the supply of coffee will fall.
In Case of Complementary Goods: Suppose “M” and “N” is complementary goods. If the price of the goods “M” falls, then the consumer will shift their preference towards its complementary good “N”. This will lead to increase in the demand of the good “N”. As a result, it becomes profitable to supply more of the good. Thereby, the supply of the “N” increases. For example, petrol and car are complementary goods. If the price of petrol falls, then the supply of cars will increase.
Explain how the following influence demand for a good:
Rise in income of the consumer.
Rise in income of the consumer:
Income of consumer is an important determinant of demand. The rise and fall of the demand for a good as per the rise in income of consumers depends upon the nature of good. Normal goods have a positive income elasticity of demand, so as consumers' income rises, more will be the demand. A rise in the income of the consumer will increase the demand for the good. In the case of Luxury goods and services, demand rises more than proportionate to a change in income. Inferior goods have a negative income elasticity of demand meaning that demand falls as income rises.
Fall in Prices of the Related Goods: Related goods may be complementary or supplementary.
In Case of Substitute Goods: Let “A” and “B” are substitutes. If the price of the good “A” falls, then the consumer will shift their preference towards that good “A”. As a result, the demand for the good “B” decreases. Ex. If the price of tea falls, then the supply of coffee will fall.
In Case of Complementary Goods: Suppose “M” and “N” is complementary goods. If the price of the goods “M” falls, then the consumer will shift their preference towards its complementary good “N”. This will lead to increase in the demand of the good “N.
Define budget set
The set of bundles available to the consumer is called the budget set. The budget set is the collection of all bundles that the consumer can buy with her income at the prevailing market prices. It is represented by the following condition of inequality: P1x1 + P2x2≤M
8 units of a good are demanded at a price of Rs. 7 per unit. Price elasticity of demand is (-)1. How many units will be demanded if the price rises to Rs. 8 per unit? Use expenditure approach of price elasticity of demand to answer this question.
Here the price elasticity of demand is (-1). In unitary elastic, quantity demanded changes by exactly the same percentage as price does.
Here number of units initially demanded is 8 @ Rs 7 per unit.
Total price =8*7 = 56 Rs
If the price rise to Rs 8 per unit with a price elasticity of -1, the quantity demanded will be 56/8 = 7 units.
A consumer consumes only two goods X and Y. State and explain the conditions of consumer's equilibrium with the help of utility analysis.
In case of two commodities, the consumer’s equilibrium is attained in accordance with the Law of Equi-Marginal Utility. It states that a consumer allocates his expenditure on two goods in such a manner that the utility derived from each additional unit of the rupee spent on each of the commodities is equal.
i.e. Marginal utility of a rupee spent on commodity x = Marginal Utility of a rupee spent on commodity Y = Marginal Utility of Money.
Or
MUx/Px=MUy/Py = MUm
In the diagram, OO1 represents the total income of a consumer. Mux and MUy represents the Marginal Utility curves of commodity X and commodity Y, respectively. Equillibrium is established at point E, where, Mux and MUy intersect each other and with MUy.
At this point, OM amount of income is spent on commodity X and the remaining amount of income MO1 is spent on commodity Y.
Explain how the demand for a good is affected by the prices of its related goods. Give examples.
How much the consumer would like to buy a given commodity depends on the relative price of other related goods such as substitutes or complementary goods to a commodity.
The demand for a commodity depends on the relative prices of its substitutes. If the substitutes are relatively costly, then there will be more demand for that commodity at a given price and vice versa. Example Tea and Coffee
Similarly, the demand for a commodity is also affected by its complementary products. When in order to satisfy a given want, two or more goods are needed in combination, these goods are referred to as complementary goods. Example pen and ink
Explain the three properties of indifference curves.
The properties of indifference curves are as follows:
(1) Indifference curves slope downward to the right:
This property implies that an indifference curve has a negative slope. If the preferences are monotonic, an increase in the amount of good 1. along the indifference curve is associated with a decrease in the amount of good 2. This implies that the slope of the indifference curve is negative. Thus, monotonicity of preferences implies that the indifference curves are downward sloping to the right.
(2) Indifference curves are convex to the origin:
Another important property of indifference curves is that they are usually convex to the origin.
In other words, the indifference curve is relatively flatter in its right hand portion and relatively steeper in its left hand portion. This is because as the consumers consumes more and more of one good, the marginal utility good fall. In other words, the consumer is willing to sacrifice less and less for each additional unit of the other good consumed. Thus, as we move down the IC, MRS diminishes. This suggests the convex shape of indifference curve.
(3) Slope of IC: The Slope of an IC is given by the Marginal Rate of Substitution (MRS). Marginal rate of substitution refers to the rate at which a consumer is willing to substitute one good for each additional unit of the other good.
When does 'change in demand' take place?
Change in demand describes a change or shift in demand due to changes in other determinants of demand in addition to own price of a commodity such as:- Income of consumer, Tastes & Preferences of consumer, Price of substitute goods.
A consumer consumes only two goods X and Y. Marginal utilities of X and Y is 3 and 4 respectively. Prices of X and Y are Rs 4 per unit each. Is consumer in equilibrium? What will be further reaction of the consumer? Give reasons.
Consumer will attain its equilibrium (maximum satisfaction) at the point, where marginal utility of a product divided by the marginal utility of a rupee, is equal to the price.
Consumer’s equilibrium = 
In case of two goods, a consumer equilibrium attain where:
For goods X,
For goods Y,
Here, 
Hence consumer is not in equilibrium, Thus, in order to attain equilibrium consumer will increase the consumption of good Y and decrease the consumption of good X.
What will be the effect of 10 percent rise in price of a good on its demand if price elasticity of demand is (a) Zero, (b)-1, (c)-2.
(a) When Ed(Elasticity of demand) is zero
Therefore, Percentage change in quantity demand = 0, so it has no effect on demand
(b) Ed = -1, Percentage change in price = 10
Therefore, Percentage change in quantity demand = -10.
(c) Ed = -2, Percentage change in price = 10
Therefore, Percentage change in quantity demanded= -20
Define demand. Name the factors affecting market demand.
Demand of a commodity is ability and desire to purchase a certain quantity of goods at a given price.
(i) Income of consumers: When the income of a consumer rises, the demand of normal good also rises while the demand for inferior goods decrease with an increase in income.
(ii) Tastes and Preferences: Other factors being constant, if any change prevails in the tastes and Preferences of a consumer, then the demand for such goods will increase leading to shift in demand curve for those goods as compared to goods have no preference.
(iii) Substitute Goods: When there is an increase in the price of a good like - coffee, then demand curve for its substitute tea shifts to the right as people will start consuming more tea than coffee.
(iv) Complementary goods: Those goods which are together used to satisfy the demand are called complementary goods such as Pen & Refill, Petrol and Scooter, An increase in the price of petrol leads to fall in the demand of scooter.
Explain three properties of indifference curves.
Examine the effect of (a) fall in the own price of good X and (b) rise in tax rate on good X, on the supply curve. Use diagrams.
1. A decline in the own price of Good X shows a positive relationship with the supply of good. When the price declines from P1 to P2, there will be contraction of supply from Q1 to Q2. Hence, the supply curve will move downwards. 
2. Assuming other things remain constant, the levy of a tax on Good X shows a negative relationship with the supply of a good. When there is a tax on a good, the cost of production increases and decreases the profit of the producer. Hence, it leads to a decrease in the supply of a good which shifts the supply curve towards the left, i.e. S2S2 to S1S1.
Explain the conditions of consumer’s equilibrium under indifference curve approach.
Conditions of consumer’s equilibrium using indifference curve analysis:
A consumer will strike his equilibrium at the point where the budget line is tangent to an indifference curve. the optimum point is characterised by the following equality :
Slope of IC = Slope of price line
| -dy | = MRS = | -P1 |
| dx | | P2 |
Equality of marginal rate of substitution and ratio of prices: When the budget lines is tangent to an indifference curve at a point, the absolute value of the slope of the indifference curve and of the budget line are equal at that point, i.e. MRS is equal to the price ratio. The slope of the budget line is the rate at which the consumer can substitute one good for the other in the market. At the optimum, the two rates should be the same.
Thus, a point at which the MRS is greater, the price ratio cannot be optimum, and when the MRS is less than the price, the ratio cannot be optimum.
In the diagram, Point E shows the consumer’s equilibrium where the budget line is tangent to the indifference curve. Consumers’ desire to purchase correspond to the consumer originally purchase, i.e. x1*, x2* shows the optimum bundle.
Marginal Utility of a commodity
Always decreases with increase in quantity.
Decreases only when total utility decreases.
Decrease but always remain positive.
First increase and start decreasing after reaching maximum point.
A.
Always decreases with increase in quantity.
A consumer gets maximum satisfaction, when?
The price of commodity is minimum
Total Utility is maximum
Total utility he gets is equal to total utility he give up in terms of money.
Utility he gets from last unit is equal to utility he give up in terms of money.
D.
Utility he gets from last unit is equal to utility he give up in terms of money.
If price of commodity is zero. The consumer will consume
Unlimited units of commodity
Till total utility reaches maximum
Till Marginal utility becomes zero
Till total utility becomes zero
C.
Till Marginal utility becomes zero
Number of Budget sets of a consumer are
Unlimited, but within budget line.
Limited, depends upon the Income of consumer.
Limited, depends upon price of commodities.
Limited, depends upon price and income of consumer.
D.
Limited, depends upon price and income of consumer.
Which of the following is not a characteristic of an indifference curve:
Indifference Curve is convex to the origin.
Higher Indifference Curve indicates higher level of satisfaction.
Indifference Curve do not intersect each other.
Indifference Curve is concave to the origin.
A.
Indifference Curve is convex to the origin.
A consumer demands more quantity of a commodity when price decreases because
Total utility increases and become more than the price.
Marginal utility becomes more than price.
Marginal utility of money increases with decrease in the price.
Marginal utility decreases with decrease in price.
B.
Marginal utility becomes more than price.
Price elasticity of demand of a commodity is - 2.5. Price of commodity increased by 20 percent. What will be the change in quantity demanded?
Decrease by 50 units
Increase by 50 units
Decrease by 8 percent
Decrease by 50 percent
A.
Decrease by 50 units
Change in quantity demanded = - (2.5 x 20) = -50.
What is the maximum number of Indifference curves of a consumer?
Unlimited numbers of Indifference curves
Upto his maximum satisfaction level
Depends upon his Budget line
Equal to various bundles of budget sets
A.
Unlimited numbers of Indifference curves
Which of these is not a factor affecting the elasticity of demand:
Nature of Goods
Number of users of the commodity
Availability of substitute goods
Quantity of the commodity demanded
D.
Quantity of the commodity demanded
When does a good is called 'Normal Good'?
If the income effect of a commodity is positive and price effect is negative, it is called 'Normal Good'.
When does a good is called 'Inferior Good'?
If the income effect of a commodity is negative, it is called 'Inferior Good'.
Explain relationship between total utility and marginal utility with help of a schedule.
| Quantity (in units) | Total Utility | Marginal Utility |
| 0 | 0 | - |
| 1 | 8 | 8 |
| 2 | 14 | 6 |
| 3 | 18 | 4 |
| 4 | 20 | 2 |
| 5 | 20 | 0 |
| 6 | 18 | -2 |
Explain the effect of change in income on demand for a good with the help of diagram.
(i) In case of Normal Goods:
(ii) In case of Inferior Goods:
Why does demand curve slope downwards?
Following are the causes why demand curve slope downward:
Sponsor Area
Sponsor Area
.
