THEORY OF DEMAND

DEMAND ANALYSISCONCEPT OF DEMANDMarshall/Hicks utility approaches LAW OF DEMAND

CONTENTS
Demand analysisMeaning of demand Individual demand-utility concepts Law of diminishing utility Indifference curves Budget line-income/substitution effect Theory of demand- Applications of LAW CONSUMER SURPLUS /MARKETABLE SURPLUS concept

WHY DEMAND ANALYSIS?

DEMAND IS THE MOTHER OF PRODUCTION BUSINESS MANAGER WANTS TO KNOW:WHAT ARE THE SOURCES OF DEMAND? WHAT ARE THE DETERMINANTS OF DEMAND? HOW DO BUYERS DECIDE THE QUANTITY OF A PRODUCT TO BE PURCHASED? HOW DO BUYERS RESPOND TO PRICE CHANGES? What is consumer behaviour?

MEANING OF DEMAND
EFFECTIVE DEMAND FOR A PRODUCT-SAY MARUTI CAR CONSISTS OF DESIRE TO BUY,WILLINGNESS TO PAY,ABILITY TO PAY FOR THE CAR WHAT IS A MEANINGFUL STATEMENT OF DEMAND? QUANTITY DEMANDED THE PRICE AT WHICH THE COMMODITY IS DEMANDED THE TIME PERIOD(ANNUAL,MONTHLY ETC THE MARKET AREA OR PLACE E.g1000 cars at Rs 2lakhs each monthly at New Delhi

BASIS OF CONSUMER DEMAND

BASIS OF CONSUMER DEMAND IS THE PRODUCTS UTILITYTWO ANGLES COMMODITY ANGLE WANT SATISFYING PROPERTY OF THE COMMODITY ABSOLUTE CONCEPT(PEN)-ONE NEEDS OR NOT EHITHICALLY NEUTRAL CONCEPT (DRUG/ALCHOHOL/MORAL/IMMORAL NEED PRE-CONSUMPTION PHENOMENON CONSUMER ANGLE FEELING OF SATISFACTION/PLEASURE POST CONSUMPTION PHENOMENA RELATIVE OR SUBJECTIVE CONCEPT

CONCEPTS OF UTILITY
TOTAL UTILITY SUM OF THE UTILITIES DERIVED BY A CONSUMER FROM THE VARIOUS UNITS OF GOODS AND SERVICES HE CONSUMES i.e (u1+u2+u3+u4 ) MARGINAL UTILITY UTILITY DERIVED FROM THE MARGINAL UNIT CONSUMED ADDITION TO TOTAL UTILITY BY CONSUMING ONE MORE UNIT i.e TU(n)-TU(n-1)

LAW OF DIMINISHING MARGINAL UTILITY

AS THE QUANTITY CONSUMED OF A COMMODITY INCREASES,THE UTILITY DERIVED FROM EACH SUCCESSIVE UNITS DECREASES,CONSUMPTION OF ALL OTHER COMMODITIES REMAINING THE SAME THIS LAW APPLIES TO ALL KINDS OF CONSUMER GOODS-DURABLE AND NON-DURABLE SOONER OR LATER

DIMINISHING MARGINAL UTILITY?

ASSUMPTIONS OF THE LAW 1)THE UNIT OF THE CONSUMER GOOD (CUP/BOTTLE/SHIRTS ETC)MUST BE A STANDARD ONE-IF THE UNIT IS SMALL OR BIG THEN THE LAW WILL NOT APPLY 2)THE CONSUMERS TASTE OR PREFERENCE MUST REMAIN THE SAME DURING THE PERIOD OF CONSUMPTION 3)CONTINUITY IN CONSUMPTION-SHORT BREAK ALLOWED 4)MENTAL CONDITION OF THE CONSUMER MUST BE NORMAL

CARDINAL /ORDINAL CONCEPTS OF UTILITY

CARDINAL UTILITY UTILITY IS QUANTITATIVELY MEASURABLE LIKE HEIGHT,WEIGHT ETC-UTILS ALFRED MARSHALL(CLASSICAL ECONOMISTS)ADVOCATES ORDINAL UTILITY NOT MEASURABLE QUANTITATIVELY OR ABSOLUTELY CAN BE MEASURED RELATIVELY OR IN TERMS OF MORE THAN OR LESS THAN-LIST IN ORDER OF PREFERENCE J.R.HICKS(MODERN ECONOMISTS)

CARDINAL UTILITYAPPROACHCONSUMER BEHAVIOUR ANALYSIS

ASSUMPTIONS:1)RATIONALITY 2)LIMITED MONEY INCOME 3) DIMINISHING MARGINAL UTILITY 4)MAXIMISATION OF SATISFACTION 5)UTILITY IS MEASURABLE-UTIL 6)CONSTANT MARGINAL UTILITY OF MONEY 7)UTILITY IS ADDITIVE 2AND3 LEAD TO CONSUMERS EQUILIBRIUM(I.E)POINT AT WHICH THE CONSUMER HAS MAXIMISED THE LEVEL OF SATISFACTION

LAW OF DEMAND
THE DEMAND FOR A COMMODITY INCREASES WHEN ITS PRICE DECREASES,OTHER THINGS REMAINING CONSTANT EMPIRICAL LAW-INVERSE RELATIONSHIP-PRICE/QUANTITY OTHER THINGS INCLUDE OTHER DETERMINANTS OF DEMANDINCOME,PRICE OF SUBSTITUTESETC

DEMAND SCHEDULE&DEMAND CURVE

DEMAND SCHEDULE NO OF CUPS CONSUMED 6-1-X AXIS PRICE PER CUP-RS 6-1-Y AXIS CURVE DD IS THE DEMAND CURVE DD SLOPES DOWNWARD TO THE RIGHT DEPICTING THE LAW OF DEMAND CONSUMER SURPLUS

CONSUMER SURPLUS
DEMAND CURVE IS USEFUL TO ESTIMATE THE AMOUNT THE CONSUMER IS WILLING TO SPEND ON COMMODITY X CONSUMER WOULD PREFER THAT COMMODITY RATHER THAN GO WITHOUT IT AMOUNT SPENT FOR A GIVEN LEVEL OF CONSUMPTION OF THAT COMMODITY THE EXCESS OF SUCH AN AMOUNTOVER WHAT HE ACTUALLY PAYS FOR THE COMMODITY IS SURPLUS THAT ACCRUES THIS NOTIONAL SURPLUS IS CALLED CONSUMER SURPLUS

CONSUMER SURPLUS OBSERVATIONS

CONSUMERS SURPLUS INCREASES AS THE PRICE OF THE GOOD FALLS CONSUMERS TOTAL SATISFACTION INCREASES AS THE PRICE FALLS CONSUMERS WOULD PREFER A LOWER THAN A HIGHER PRICE FOR A GOOD GIVES AN ESTIMATE OF THE POTENTIAL BENEFITS ACCRUING TO CONSUMERS SHOWS THE POTENTIAL REVENUE A SELLER(GOVT/PRIVATE) CAN RAISE FROM THE CONSUMERS

EXCEPTIONS TO LAW OF DEMAND

EXPECTATIONS REGARDING RISE IN PRICE STATUS SYMBOL GOODS-GOLD AND ORNAMENTS ETC GIFFIN GOODS-INFERIOR COMMODITY (BAJRA) MUCH CHEAPER THAN SUPERIOR GOODS(ATTA) IF BAJRA PRICE INCREASES THE HOUSE HOLDS REDUCE THE CONSUMPTION OF ATTA,INCOME REMAINING THE SAME

ORDINAL UTILTYINDIFFERENCE CURVES

INDIFFERENCE CUVE IS THE LOCUS OF POINTS ,EACH REPRESENTING A DIFFERENT COMBINATION OF TWO SUBSTITUTE GOODS WHICH YIELD SAME LEVEL OF SATISFACTION TO THE CONSUMER THEREFORE HE IS INDIFFERENT BETWEEN ANY TWO COMBINATION OF GOODS WHEN IT COMES TO MAKING A CHOICE

PROPERTIES OF IC
HAVE NEGATIVE SLOPE CONVEX TO ORIGIN DONOT INTERSECT UPPER IC INDICATE HIGHER LEVEL OF SATISFACTION FEASIBILITY/NON FEASIBILITY AREA

CONSUMER BUDGET LINE

BUDGET CONSTRAINT FOR THE CONSUMER-MONEY INCOME CONSUMER CANNOT OVERSPEND HE CAN SPEND LESS BUT NOT MORE ON THE AVAILABLE GOODS Budget line for X and Y M/PY and M/PX AB budget line

EQUILIBRIUM
INDIFFERENCE MAP-QTY X &QTY Y(X-Y AXIS) BUDGET LINE SLOPE AB AND IC2 SLOPE ARE EQUAL AS BOTH PASS THRO POINT E THE LEVEL OF SATISFACTION AT POINT E IS >THAN ANY OTHER POINT ON IC1 DUE TO BUDGET CONSTRAINT HE CANNOT MOVE TO IC3 COMMODITY SPACE FEASIBILITY/NON FEASIBILITY AREA

FACTORS BEHIND LAW OF DEMAND

INCOME EFFECT AND SUBSTITUTION EFFECT INCOME EFFECT-WHEN THE PRICE OF A COMMODITY FALLS,THE REAL INCOME OF THE CONSUMER INCREASES HIS PURCHASING POWER INCREASESDEMANDS MORE GOODS AND SERVICES INCOME EFFECT ON INFERIOR GOODS IS NEGATIVE AND SUPERIOR GOODS IS POSITIVE

SUBSTITUTION EFFECT-WHEN?
SUBSTITUTION EFFECT-WHEN PRICE OF A COMMODITY FALLS,ITS SUBSTITUTE BECOMES COSTILIER,IF ITS PRICE IS CONSTANT-NOT CHANGED UTILITY MAXIMISING BEHAVIOUR UNDER DIMINISHING MARGINAL RATE OF SUBSTITUTION CONSUMER SUBSTITUTES CHEAPER GOODS FOR COSTLIER GOODS DEMAND FOR CHEAPER GOODS INCREASE

Demand theory some applications

Subsidies in cash and kind-poverty alleviation programs by govts Direct income subsidy-tax concessions unemployment allowances welfare payments etc Direct medcines, food ,clothing ,shelter subsidyfood for work (antyodaya schemes) ,free sarees /dhoties /free shelter for poor Direct or indirect taxation-income tax vs excise duty concessions Which is more efficient?

Marketable surplus
Marketable surplus Analysing the behaviour of Producers who also consume their goods-e.g farmers , House wives who go for outside work-time is marketable surplus House wife allocation of time to outside work is her marketable surplus

REVEALED PREFERENCE THEORY-SAMUELSON

A&B ARE TWO ALTERNATIVE BASKETS OF GOODS X&Y BOTH ARE EQUALLY EXPENSIVE BY CHOOSING ONE HE REVEALS HIS PREFERENCE OR LIKINGTO THATBASKET THIRD ROOT OF THE LOGICAL THEORY OF DEMAND-DUE TO ITS MERITS OVER UTILITY THEORY

DEMAND FUNCTION
LINEAR DEMAND FUNCTION NONLINEAR DEMAND FUNCTION DYNAMIC DEMAND FUNCTION

LINEAR/NON LINEAR DEMAND FUNCTION

DEMAND LINE AND DEMAND CURVE-linear/non-linear relationships-SHORT RUN PRICE AS THE SINGLE VARIABLE DEMAND SCHEDULE-DRAW THE DEMAND LINE GIVEN THE FOLLOWING FOR COMMODITY X:Dx=f(Px) PRICE QUANTITY DEMANDED 1 100 5 75 10 50 15 25 20 0

NON-LINEAR DEMAND FUNCTION

NON LINEAR OR CURVILINEAR SLOPE OF THE DEMAND CURVE CHANGES ALL ALONG THE CURVE DRAW A POWER FUNCTION -b Dx=aPx

DYNAMIC DEMAND FUNCTION

LONG RUN DEMAND-DEPENDS ON THE COMPOSITE IMPACT OF DETERMINANTS OPERATING SIMULTANEOUSLY-multi variate demand Dx=f(Px,M,Py,Pc,T,A) WHERE Dx-demand for commodity x Px-Price of X M-Consumers income Py-price of its substitute Pc-Price of its compliment T-Taste of the consumer A-Advertisement expenditure