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Consumer Behavior & DEMAND Ms S Chattopadhyay PGT Economics KV BallygungE Slide 2 Content Consumers Equilibrium Theory of Demand Price Elasticity of Demand Slide 3 CONSUMERs EQUILIBRIUM Slide 4 BASIC CONCEPTS Consumers Equilibrium Using Marginal Utility Analysis Consumers Equilibrium by Indifference Curve Approach Slide 5 Basic concepts I Utility - Want satisfying power of a commodity. Total Utility - Total satisfaction obtained by a consumer from consuming given amount of a commodity. Marginal Utility - Change in total utility resulting from the change in consumption by one unit. MU n = TUn TUn-1. Slide 6 Basic concepts II Law of Diminishing MU As we consume more and more units of a commodity, the utility derived from each successive unit goes on diminishing. Assumption LDMU is based on certain basic assumptions like Rationality of the consumer, Continuous consumption, Uniform quality of the commodity consumed. Slide 7 Basic concepts III Relation : TU & MU When TU increases at a diminishing rate, MU falls. ( Upto 4 th Unit ) When TU reaches its maximum & constant, MU = 0 ( At 5 th Unit ) When TU falls, MU < 0 ( Above 5 th Unit ) Unit of consumptionTUMU 0120 023616 034610 045004 055000 064406 Slide 8 Consumers Equilibrium by marginal utility analysis ( Cardinal Approach ) Consumer Equilibrium : Meaning The situation when a consumer is having maximum satisfaction with given income and has no tendency to change his way of existing expenditure. Condition of consumer equilibrium In case of single commodity : MU x in terms of money = P x ( x : commodity ) i.e MU x / MU m = P X ( MU m : MU of money ) Slide 9 Consumer Equilibrium ( in case of single commodity ) Unit of X Price of XMU xMUx / Mum MUm = 1 Mux/MUm - Px Remarks 1212 10 20 16 20 / 1 = 20 16/1 = 16 20 10 = 10 16 10 = 6 MUx/MUm > Px Increase in consumption 310 10/1 = 10 10-10 = 0 MUx/MUm = Px Consumers Equilibrium 4545 10 4040 4/1 = 4 0 / 1 = 0 4 10 = -6 0 10 = -10 MUx/MUm < Px Decrease in consumption Slide 10 Conditions of Consumer Equilibrium In case of Two commodities ( X & Y ) : MU of last rupee spent on each commodity spent is same i.e. MU X / P X = MU Y / P Y Subject to Px. X + Py. Y = M M : Money income. Slide 11 Consumer Equilibrium ( In case of Two comm) Commodity XCommodity Y Unit XMUxPxMux / Px Unit YMUyPyMUy / Py 1 1001010 124212 2 8010 8 222211 3601063 20210 44010441829 520102 5 162 8 6010061427 * Money Income (M) of the consumer is Rs 30. 1. At X=1 & Y= 3, MUx / Px = MUy / Py but (Exp on X + Exp on Y ) M 2. At X= 2 & Y= 5, MUx / Px = MUy / Py and (Exp on X + Exp on Y ) = M (Equilibrium ) 3.If MUx/Px > MUy/Py, the consumer gets more MU from last rupee spent on X as compared to Y. He will buy more of X and less of Y till MUx/Px = MUy/Py. 4.If MUx/Px < MUy/Py, the consumer gets more MU from the last rupee spent on Y as compared to X. He will buy more of X and less of Y till MUx/Px = MUy/Py. Slide 12 Consumers Equilibrium by Indifference Curve Approach ( Ordinal Approach ) Indifference Curve : Meaning A curve showing different combinations of two goods which give equal satisfaction to the consumer. Indifference Map : Meaning A family of indifference curves is called an Indifference Map. Higher IC represents higher level of satisfaction. Slide 13 Monotonic Preference : Meaning A consumers preferences are monotonic if and only if between any two bundles, he prefers the bundle which has more of at least one of the goods and no less of the other good as compared in the other bundle. Example : Consumer prefers bundle (2,3) to bundles (2,2), (1,3) & (1,2). Monotonicity of preferences implies that a point above IC represents a bundle which is preferred to the bundle on IC Slide 14 Slope of Indifference Curve / Marginal Rate of Substitution (MRSxy) (i) MRSxy The amount of one good (Y) which a consumer is willing to sacrifice for an additional unit of the other good (X). The rate at which the consumer trades off Y for X. (ii) The slope measures the substitution ratio between the two goods. (iii) Slope of IC = Y / X = MRSxy Slide 15 Properties Of Indifference Curve (i) An IC slopes downward If the consumer wants to have more units of one good, he will have to reduce the consumption of other good in order to maintain the same level of satisfaction. (ii) An IC is convex to the origin i.e. MRS is Diminishing The consumer is willing to give up less and less unit of one good for an increment in the other ( MU of the other falls with increase in consumption ). (iii) Two ICs do not intersect each other. ( Explanation may be given with diagram ) Slide 16 Budget Line It shows all possible combinations of two goods that a consumer can buy with given income & prices of the commodities. Budget Line : Px. X + Py. Y = M ( M : total income) Slope of Budget Line = Px / Py i.e. the consumer can substitute good X for Y at the rate of Px / Py. Qy A (0, M/Py) Budget Line (AB) B (M/Px, 0) Qx Slide 17 Why is the slope of Budget Line represented by Price Ratio A point on budget line indicates a bundle which the consumer can purchase by spending his entire income. So, if he wants to have one more unit of one good ( say X), he will have to give up some amount of the other good (say Y). Suppose price of good X is Rs 4 per unit (Px=4) & that of good Y is Rs 2 per unit (Py= 2). So to get one extra unit of X, he has to sacrifice 2 units of good Y. Slope of Budget Line = Unit sacrificed / Unit gained = 2 / 1 Price Ratio = Px / Py = 4 / 2 = 2/1 Thus, slope of Budget Line = Price ratio Slide 18 Shift in Budget Line (i) Change in Income when income rises consumer can buy more of both the goods, the budget line shifts rightward (parallel shift - slope remains same as no change in price ) & vice versa. (ii) Change in Price ( change in slope) Px falls / Px rises Py falls / Py rises Qy A Qy A1 A Py falls Px falls A2 Qx Py rises Qx B2 B B1 B Slide 19 Conditions of ConsumerEquilibrium ( IC ) (i) Slope of IC = Slope of Budget Line i.e. MRSxy = Px / Py (ii) Diminishing MRS Slide 20 Consumer Equilibrium with IC E : equilibrium point which shows the combination at which Slope of Budget Line = Slope of IC i.e. Px / Py = MRSxy Slide 21 Consumer equilibrium with IC (contd) (i) if MRSxy > Px/Py, to obtain one more unit of X, the consumer is willing to sacrifice more unit of Y than what the market requires i.e. he is willing to pay more for X than the price prevailing in the market. As a result, he buys more of X & MRS falls till it becomes equal to the ratio of prices. (ii) If MRSxy < Px/Py, to obtain one more unit of X, the consumer is willing to sacrifice lesser units of Y i.e. he is willing to pay less for X than the price prevailing in the market. As a result he buys less of X & more of Y & MRS rises till it becomes equal to the ratio of prices. Slide 22 THEORY OF DEMAND Slide 23 THEORY OF DEMAND Basic Concepts Determinants of Demand Law of demand Change in quantity demanded Change in demand Slide 24 Basic Concepts Demand The quantity of a commodity the consumer is willing to buy at a particular price during a particular period of time. Demand Schedule A tabular presentation of various quantities of a good that consumers are willing to buy at different prices Individual & Market Demand Schedule. Demand Curve A graphical presentation of various quantities of a good that consumers are willing to buy at different prices Individual & Market Demand Curve. Slide 25 Determinants of Demand I Price of the commodity Inverse relationship between price of the commodity & its quantity demanded. Prices of Related commodities Two cases (i) Substitute Goods ( eg. Tea& Coffee ) Direct relation between price of a commodity & demand for its substitute. (ii) Complementary Goods ( eg. Ink & Pen ) Inverse relation between price of a commodity & demand for its complementary good. Slide 26 Determinants of Demand II Income of the consumer ( Two cases ) (i) Normal Good Demand for the good increases with increase in income of the consumer. Direct relation. (ii) Inferior Good Demand for the good decreases with increase in income of the consumer. Inverse relation.. Taste & preferences of the consumer Favourable changes in taste & preferences of the consumer increases demand for a commodity. Direct relation.. Expectation of consumer about future change in price of the commodity Direct relation. Size of population Direct relation. Slide 27 Law of Demand Statement Other factors remaining same the demand for a good is inversely related to its price. Example Px 10 20 30 Qx 35 25 15 Diagram Inverse relation is represented by downward sloping demand curve. Px d Qx Slide 28 Change in Quantity Demanded Expansion of Demand Other things remaining same, demand for a commodity rises with fall in its price. Represented by downward movement along the demand curve. Eg. Px : 10 05 Qx : 15 20 Contraction of Demand Other things remaining same, demand for a commodity falls with rise in its price. Represented by upward movement along the demand curve. Eg. Px : 05 10 Qx : 20 15 Diagram : Represented by the movement along the demand curve. Students should draw the diagram Slide 29 Change In Demand (i) Increase in demand . Meaning : When higher quantity of a commodity is demanded at the same price due to change in other determinants of demand.. Example : Px 10 10 Qx 20 30. Specific reasons : Change in determinants other than the price of the commodity eg. Increase in Income, Rise in price of substitute good, Fall in price of complementary good, Favourable change in taste & preference of the consumer etc.. Diagram : Represented by rightward shift of demand curve. (Students should draw the diagram.) Slide 30 (ii) Decrease in demand . Meaning : When lower quantity of a commodity is demanded at the same price due to change in other determinants of demand.. Example : Px 10 10 Qx 30 20. Specific reasons : Change in determinants other than the price of the commodity eg. Decrease in Income, Fall in price of substitute good, Rise in price of complementary good, Unfavourable change in taste & preference of the consumer etc.. Diagram : Represented by leftward shift of demand curve. Students should draw the diagram. Slide 31 Price Elasticity of demand Slide 32 Price Elasticity of demand Meaning Measurement of Price Elasticity of Demand - Total Expenditure Method, Point Method & Percentage Method. Degrees of Elasticity of Demand Factors affecting Price Elasticity of Demand. Slide 33 Price Elasticity of Demand Meaning : It is a measure of degree of responsiveness of demand for a commodity to change in its price. Slide 34 Measurement of Price Elasticity of Demand I Total Expenditure Method Elasticity is measured on the basis of nature of change in total expenditure on the commodity due to change in its price. SL If Price fallsDescriptionEdTerm Used 1Expenditure IncreasesQty demanded rises in greater proportion Ed > 1Elastic Demand 2Expenditure remains constant Qty demanded rises in the same proportion Ed = 1Unitary elastic demand 3Expenditure fallsQty demanded rises in a lesser proportion Ed < 1Inelastic Demand Slide 35 Measurement of Price Elasticity of Demand II Point Method Elasticity of Demand = (Lower seg. / Upper seg.) of demand curve Price A (Ed = ) E (Ed >1) C (Ed = 1 : C - Mid-point) D (Ed < 1) B (Ed=0) Qty Slide 36 Measurement of Price Elasticity of Demand III Percentage Method Ed = ( % change in Qty demanded / % change in Price) = ( change in Q / change in P ) X P/Q The absolute value of the coefficient of elasticity of demand ranges from Zero to Infinity. Slide 37 Degrees of Elasticity of Demand EdType of Ed DescriptionType of Good Shape of Demand Curve Ed = 0Perfectly Inelastic No change in Qty demanded due to change in price Essentials of life Vertical St Line 0 < Ed < 1Inelastic% change in demand < % change in price Necessities of life Downward sloping steeper Ed = 1Unitary Elastic % change in demand = % change in price Normal goods Rectangular hyperbola 1 < Ed < Elastic% change in demand > % change in price LuxuriesDownward sloping flatter Ed = Perfectly Elastic Infinite change in demand without any change in price Imaginary (under PC) Horizontal Slide 38 Factors affecting Price Elasticity of Demand Availability of close substitutes in market Nature of commodity necessary / luxury Income level of the consumers. Proportion of total expenditure spent on the product. Time period needed to find substitute Slide 39 THANKS