unit-2 dr. a. mohamed riyazh khan doms, sns. college of engg

UNIT-2

Dr. A. Mohamed Riyazh Khan

DoMS,

SNS. College of Engg.

Dr. Mohamed Riyazh Khan - SNS, DoMS

Law of Demand

Meaning:

Law of demand the relationship between change in quantity demanded and change in price.

it states that higher the price, the lower would be the quantity demanded and vice versa.

According to Benham:

“The demand for anything, at a given price, is the amount of it, which will be bought per unit of time, at that price.”


Assumption

1. Income level should remain constant 2. Taste of the buyer should not change 3. Prices of other goods should remain

constant 4. No new substitutes for the commodity 5. price rise in future should not be

expected

Demand Curve

The demand curve has a negative slope, consistent with the law of demand.



Why does Demand curve slope downwards?

It implies inverse relationship between demand and price of a commodity.

Causes: 1. Substitution Effect:2. Income Effect3. New consumer creating demand4. Based on the law of diminishing marginal

utility5. Price effect


Determinants of demand/factors affecting demand

Income of consumers- As income increases, people increases car purchases.

Population/Size of the market – A growth in population increases car purchases.

Price & availability of related goods- Lower LPG prices raise the demand for cars.

Taste & preference of consumers – Having a new car becomes the status symbol

Special influences – Availability of alternative forms of transportation, safety of mobility, expectation of future price increases…etc…


Elasticity of Demand

An elasticity demand is one in which the change in quantity demanded due to change in price is large.

Types of Elasticity of Demand1. Price elasticity of demand2. Income elasticity of demand3. Cross elasticity of demand4. Advertising @ promotional elasticity of

demand.


Price elasticity of demand

Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.

Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price. (Ep)


Price elasticity of demand=Percentage change in quantity demanded

Percentage change in price


Types

Perfectly Elastic Perfectly inelastic Unitary elastic Elastic demand Inelastic demand


Perfectly elastic demand

Perfectly Elastic (Ep=∞) Quantity demanded changes infinitely with any

change in price. Very small change in price will result in

infinitely large response in demand A small rise in price may result in contraction

of demand even to zero and a small fall in rise may result in extension of demand to infinity

Demand curve D1D1 is a horizontal straight line showing that at price OP the amount demanded is infinity


Perfectly elastic


Perfectly Inelastic demand

Perfectly Inelastic (Ep=0) Quantity demanded does not respond to

price changes. A large fall in price or rise in price will

not induce the consumer to change in the quantity demanded

Demand curve D2D2 shows a fixed quantity will be purchased whatever changes takes place in price


Perfectly inelastic


Relatively elastic demand

Elastic Demand (Ep>1)

Quantity demanded responds strongly to changes in price.

Where a small change in price will lead to a very big change in the quantity demanded

Price elasticity of demand is greater than one. The curve D3D3 is flatter showing that quantities demanded are

larger than change in price When the price falls from P to P1 the demand increased form Q

to Q1 which is comparatively larger than fall in price. So the demand is relatively elastic.


Relatively elastic


Relatively inelastic

Inelastic Demand (Ep<1) Quantity demanded does not respond strongly to

price changes. Price elasticity of demand is less than one. It refers to a condition where a large change in

price will result in smaller change in quantity demanded

D4D4 is a steeper curve showing a steep fall in price leads to a little change in qty demanded

When price falls from P to P1 the qty demanded is increased from Q to Q1 which is comparatively lower than fall in price


Relatively inelastic


Unitary elastic

Unit Elastic (Ep=1) Quantity demanded changes by the same

percentage as the price. The demand curve D5D5 slopes

uniformly shows that PP1+QQ1. i.e. change in price has created an equal change in quantity demanded


Unitary elastic


Income Elasticity

Income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income.

It is computed as the percentage change in the quantity demanded divided by the percentage change in income.

The relationship between changes in income of the consumer and the consequent changes in the quantity demanded is expressed through the concept of income elasticity of demand


In co m e e la stic ity o f d em an d =

P ercen tag e ch an g e in q u an tity d em an d ed

P ercen tag e ch an g e in in co m e


Types

1. High-income Elasticity: When the quantity demanded of good increased by a larger percentage as compared with the income of the consumer.

2. Unitary Income Elasticity: When the percentage change in quantity demanded is equal to the percentage change in income.

3. Low-income Elasticity: When the quantity demanded of good increased by a smaller percentage as compared with the income of consumer.

4. Zero income Elasticity: When the quantity demanded of a good remains unchanged upon the change of income, income elasticity of demand is zero.

5. Negative income Elasticity: When the quantity demanded of a good falls in response to an increase in income, the income elasticity of demand is negative.


Cross Elasticity of Demand

It tells us the extent of change in the quantity demanded of a commodity A due to change in the price of another commodity B which may either be substitute of A or complimentary of A

Ec= % change in demand for commodity A

% change in price of commodity B


The Law of Supply

The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa.

Why do producers produce more output when prices rise? They seek higher profits They can cover higher marginal costs of

production

Supply Curve

The supply curve has a positive slope, consistent with the law of supply.



Determinants of supply

1. Price of the good.2. Prices of related goods.3. Prices of factors of production.4. Producers objectives.5. Technological know how’s.6. Cartels (group of business controlling mkt)7. To raise price – supply may be destroyed.8. Taxation on output.9. Political disturbances.10. Time period.

Equilibrium

Equilibrium occurs at a price of $3 and a quantity of 30 units.



Consumer behaviour

CB is the study of When, Why, How and Where people do or do not buy product.

It attempts to understand the buyer decision-making process both individually and in groups.


Consumer Equilibrium

It is a situation in which a costumer is getting maximum satisfaction and he has no tendency to change his pattern of consumption.

The term consumer’s equilibrium refers to the amount of goods and services which the consumer may buy in the market given his income and given prices of goods in the market.


The aim of the consumers to get maximum satisfaction from his money income.

Given the price line (budget line) and the indifference map, a consumer is said to be in equilibrium at a point where the price line is touching the highest attainable indifference curve from below.


Assumption

1.There are two goods i.e commodity X and commodity Y .

2.The consumer’s preference scale for combination of two goods is exhibited by indifference map.

3.The prices of goods are given and remain constant.

4.The consumer has a given income which sets to limits to his maximizing behavior.


Above diagram explain the process of consumer’s equilibrium.

The consumer’s preference scale is described by means of indifference mapping .

Then we impose a budget line that reflects our income. In this case we have r 50 and the price of good X and good Y is r 10 and r 5 respectively. Therefore, we can afford only those combinations that are on or inside the price line GH.

In this diagram every combination on the price line GH cost you the same amount of money. In order to maximize the utility , we will try to reach the highest indifference curve which you could get with a given expenditure of money and given prices of two goods.


The budget line touches IC2 at point E represents the most utility.

This is the highest attainable indifference curve with which you can get OQ1 units of good X and OQ2 units of good Y for r 50.

Any other affordable combinations on the price line GH gives you less satisfaction, because that will be on a lower indifference curve IC1.

With this we conclude that the point of tangency between the budget line and an indifference curve represents optimal consumption. It is the affordable combination that maximize our utility.


the marginal rate of substitution is the rate at which a consumer is ready to give up one good in exchange for another good while maintaining the same level of utility.

At the tangency point E the slope of the price line GH and indifference curve are equal. Slope of the indifference curve shows the marginal rate of substitution of X for Y.

The price line indicates the ratio between the prices of two goods (PX/PY). Thus at the equilibrium point E,MRSXY=Price of good x/Price of good y= PX/PY


1.A given budget line must be tangent to an indifference curve , or the marginal rate of substitution between commodity X and commodity Y (MRSx,y) must be equal to the price ratio between the two goods .

2.At the point of equilibrium, indifference curve must be convex to the origin.


Indifferent Curves

An indifference curve which represent different combination of two goods which give a consumer equal level of satisfaction.


Marginal Rate of Substitution

It is the quantity of one good that must be given up as the consumption of the other good increase by one unit and total utility remains constant.

The consumer can substitute one good another without changing the level of satisfaction. It determines the slope of indifferent curves.

Change in the consumption of one good

MRS= ——————————————— Change in the consumption of another good


Return to Scale

In long-run all inputs are variable. Production can increased by changing one or more of the inputs. In long-run, it is possible for to change all inputs up or down.

This is known as return to scale. Assumption: 1. All factors are variable but industry is

static (fixed). 2. there is perfect competition. 3. the production is measured by quantity.


Types: 1. Increasing 2. Constant 3. Diminishing


Factor Combinations(Quintals)

Total product Marginal Product

12

26

24 Increasing return

345

121824

666 Constant Return

67

2830

42 Diminishing return


Increasing:

The factor of production fixed and the scale is expanded. The output increases in a greater proportion than the increase in the factor of production.

Constant:

the increase in the total output is in exact proportion to the increase in inputs. The total return will increase in such a way that the marginal returns become constant.

Diminishing:

the proportion of the factor remains unchanged, output increase in a smaller proportion as compared to increases in the amounts of the factor of production.


Short-run production function

In the short-run, the technical conditions of production are inflexible. The variables are fixed position.

Assumption: 1. only one factor is variable while others are held constant. 2. variable factors are homogeneous. 3. it assume to short-run situation. No change in technology factor.


Relationship between Average product/ Marginal product

Total Product: it is the total output resulting from the efforts of all the factors of production combined together.

Average Product: it is the total product per unit of the variable factor. When one unit of labour is employed, average product, are 100, when two units of labour are employed, average product rises to 105.

Marginal Product: MR is the change in total product per unit in the quantity of variable factor. In addition made to the total production by an additional unit of input.


Quantity of labour

Total Product (TP)

Average Product (AP)

Marginal Product (MP)

1 100 100 100

2 210 105 110

3 330 110 120

4 430 107.5 +100

5 520 104 90

6 600 100 80

7 670 95.7 70

8 720 90 50

9 750 83.3 30

10 760 76 10

11 740 67.2 -20


Economies and Diseconomies

Economies of scale are advantage that arise due to large-scale production. It refer to the concept of increasing efficiency of the production of goods as the number of good being produced increased.

Economies of scale is a long-run concept and refers to reductions in unit cost (Average cost)as the size of a facility and the usage levels of other inputs increase.


According to Porter, Economies of scale is the “decline in the unit’s cost of production”.

……………………………………………….. Diseconomies: When a firm to expand its size, a stage

comes when diminishing return to scale set in. as a firm expand beyond a level, it shows diseconomies.


Cost Function

In cost function the dependent variable is unit cost or total cost and the independent variables are the prices of a factor, the size of the output.

C= f(O,S,T,U,P….) C-COST, O- Level of output, S-size of plant,T-Time, P-Prices of factor of production

unit-2 dr. a. mohamed riyazh khan doms, sns. college of engg

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