Theory of Demand I supply

Unit 1 Law of Demand and Elasticity

of Demand
Demand

Desire ability to willingness to

pay pay

To constitute effective demand at the

above 3 essentials should be present

e A beggar sitting beside the temple wants

g
to buy sports car worth 21 crores
Here beggar cannot create demand
forsports car
in market because
Desire Ability to pay Willingness to pay
x x
The demanded is always expressed
qty
at a
given price
 Qty demanded is a flow concept

e.g demand for apples will be soo dozens

per day if price of apples is 2100 dozen
time period
flow concept
Determinants of Demand

i Price of a commodity PT Add

Pt Id 9
demand for commodity is inversely related
a

to it's price provided other things remains

Constant celesisparibus

Iii Price of related commodity

Complementary substitutes
Goods
competing goods

goods that are bought goods that can replaced

or consumed
together othergoods with ease
 e
g card fuel ink pen e.g coke or pepsi
and ink bottles ink pen or ball pen
tea andsugar Lays or Balaji wafers
indirect relationship btw a
direct relationship
btw
qty demanded of a demanded
qty of
commodity and price of
a
commodity and
it's complementary price of it's substitute
Ipad Pt e Coke PT
e
g g
t t
ApplePencil Adt Pepsi ddt

Iii Disposable Income of the consumer

IT dd't
It dd t
demand for is
a commodity
directly reated
to the disposable income level of the consumer

Exceptions
Inferior goods IT ddt
e
g As income level increases demand for
street food decreases person can now

afford to visit fancy restaurants

 I

Necessity It Od const
e
g salt water etc

Iv Other factors

size
of population
Demographics
age distribution of
y population
level of national income
and it's distribution
a Size of population

For normal goods

population 4 dd t
population t da t
Direct relationship btw size
of population
and qty demanded

b Age distribution of population

Old age persons 4 Demand

for hospitals
walkingsticks medical y
shops etc
 Yount gadgets shopping malls

children 4 Demand for tops

chocolates etc
f

C level of national income and it's distribution

MPC MPC rich

poor
e.g
Income Expenditure
Poor 1000 t 9004
Rich 10004 200 t

majority t
ofnational Uneven distribution
income comes dd t
of national income
from small
no
of households
like in India

even distribution of ddt

national income
 d Consumer credit and interest rates
facility

Consumer credit facility

available
Adt
easily

Interest rate 4 Add

Interest rate d dd t

e Gout policies and regulations

Gout provide incentives Id M

subsidies
e.g subsidies on installation
of Solarpanel etc

Govt
introducing policy Adt
unfavourable for product
e
g T in tax rates on
cigarette etc
V Tastes and preferences of buyers
if Demonstration effect Dekha Dekhi kina
 o
term coined by James Dusenberry

Mr X mu X's
Mr friend
I phone 13
already
y
Purchased latest
hai uske paas I phone 14 max
pro

Here Mr X also purchased the same smartphone

model which his friend bought even though he
has smartphone which he purchased
just 5
months back

ily Bandwagon effect it quantifies the

demonstration
effect

tf Mr purchased a smartphone
Raj
and because of this 3 of his friends
out of to also purchased the same
Smartphone
Here Conversion rate 30
X 100

30

Iii Snob effect Sab me sabsealag dikhne

ki iccha tkhna
 Oneplus will manufacture But will manufacture
100,000 units 5000 units

of one plus 10 of MARVEL edition

250,000 unit 55,000 unit

in Veblen effect show off kina

named after the American economist

Thorstein Veblen

tf rich person will buy mon of prestige

goods like luxury cars precious
stones gold etc because these goods
have attached to it's value
utility
 Law of Demand

Prof Alfred Marshall defined the law

The
qty demanded increases with
a fall in price and diminishes with a
rise in price

It is a qualitative statement

Rationale of the law of demand

i Price effect of a fall in
price
a Substitution effect

Coke Pepsi
100 persons n
Initially 20 persons
were
consuming coke
shift to Pepsi
Now price increases

80 persons are consuming

coke and
 b Income effect

Income month 4 240.000

allocated for Rice
monthly ant 300

April month Price of Rice kg 2251kg

Qty demanded 12kg
339

Price of Rice
May month hg 2301kg

Qty demanded
3310 10kg

Because of increase in price of Rice

demanded falls
qty
Note At the time of inflation purchasing
power of money decreases

Actual income const Nominal terms

Real income decreases Real terms
ily Arrival of new consumer

Earlier when price was high some people

were not able to purchase that commodity

But now as price those people who

falls
were not able to purchase it earlier can now

purchase it
Priced Qty demanded I

iiiy Different uses

e
g Electricity
Geyser
Wen
Refrigerator
Fang light
unit decreases
Electricity charges
consumption of electricity increases

electricity for
Earlier we were using
fan light refrigerator only but now
as charges unit decreases we start
using it for geyser Acf owen also
 ing Utility maximising behaviour of consumers

No of units total'itility margiaputility

I 10 utils to utils
2 18 utils 8 utils
3 25 utils 7 utils
4 30 utils 5 utils

Consumption P MU I
law of diminishing marginal
utility
Amt ready Consumer Total
No of units Price unit to surplus
pay
1 10 12 2 2

2 10 11.75 1.75 3.75

3 10 11.25 1.25 5
4 10 10.75 0.75 5.75
5 10 10 0 5.75
6 10 9.75 0.25 5.50

Consumer surplus Amt ready Amt actually

to paid
pay
 A consumer is in equilibrium when marginal
to it's i.e when total
utility is equal price
Consumer surplus is maximum

Exceptions to the law of Demand

Ii Demand for necessaries

Salt water cooking oil etc

PM'd dd const

Iii Giffen Goods

Sat
Before
price
f Mon Bread
meat
increase 2 Sunday
Price of bread T
Mon Sat Bread
Sunday Bread
Price
of bread 4 Ad of bread A

NOTE All Giffen goods are inferior goods but

all inferior goods are not Giffen goods
 Giffengoods goods having direct relationship
btw price and demanded
qty

iii Speculative Goods

e
Stock market

Reliance Industries Limited RIL

Stock price 4 Demand

for RIL Stocks
Stock price I Demand for f
RIL Stocks

Iv Future expectations about price

mix
4 in
future Essig Essig
price
Demand T
pre poned

current future

Mr Y infuture 3013
Demand I
2271kg
prat post pored
 Iu Incomplete information and irrational
behaviour

Mr prevailing price
25 hg
no knowledge of
price prevailing in But he purchased goods
market at price of 2301kg

Vi Conspicuous Goods Veblen effect

Prestige goods like Diamond expensive cars

precious stones etc

Price 4 Demand T
since here utility is attached to it's value

Hii Conspicuous necessities have become necessaries

bcuz of it's constant
usage
The demand for goods is affected by the
demonstration effect the consumption pattern
of
of a social groups to which an individual
belongs
 e
Refrigerator two wheeler television
smartphones etc

Demand function

In f Pr Pr M
dependent
where In X
Qty demanded of commodity variable
Poe Price
of commodity independent
Pr Price
of related goods variable
M Income level f
F On 100 2 Pre
assuming otherfactors
Here In depends only on Pa remains const

slope is negative beoz of inverse relationship

btw
price and demanded
qty
 Demand Schedule Individual
Commodity Apple Individual Raj
Price Demand in kgs
kg
150 O
120 3
100 5
90 6

Demand Curve Individual

Price.fi te downward
Slope
sloping
of demand curve is
a

negative
100145demanded
Od
NOTE Demand curve can be linear straight line
or it can be curvilinear
Demand curve for necessaries

Slope es
is s
Otg demanded
 Market Demand Schedule
Commodity Apple Market consistof only two
persons
Raj Simran
Simran
Price Raj Mkt
kg Demond Demond Demand
150 0 T O 0

120 3 4 7
100 5 T 6 11
90 6 7 13

Market Demand Curve

market demand curve

Price downward
sloping
slope ve
Qty demanded

NOTE For preparing mkt demand curve we

will have to horizontally add all the
individual demand curve
Expansion Contraction
of Demand

Price
of commodity t change
other factors remains constant

Price Qty demandedlinks

kg
30 100
25 125

Pt Idt
It is an example
of Expansion of Demand

Price demanded in kgs

kg Qty
30 100
35 80
Pt Odd
It is an example of contraction of demand

Expansion of demand
Price 25
1
downward movement
Qty demanded along the demand curve
 Contraction
of demand
Price
It
30
do 00
upward
t
movement along
the demand curve
aty demanded

Increase Decrease in Demand

Price
of commodity const
other factors t change

Increase in Demand Demand cure will

shift to the right
Decrease in Demand Demand curve will
shift to the left

G
It Od A
P D Here demand curve will
shift to the tight baz
Id of increase in incomelevel
Do t demand curve before increase in incomelevel
D demand curve after increase in income level
f Commodity
Coke
substitute t Pepsi

Do Pepsi Pt Coke ddt

p
demand curve
of coke
will shift to left bcuz
ad of decrease in price of
Pepsi
Do initial demand curve
D demand curve after decrease in pace of substitute

Elasticity of demand ed

change in qty demanded

1 change in determinant

14 Price
elasticity of demand

change in qty demanded of commodity

change in price of commodity
EI Price bottle Demand
Fanta 600
5 81 201 360 17
 ed 0.5
14
Here ve denotes inverse relationship
sign
btw price and
qty demanded
And 0.5 denotes t change in qty demanded

is 0.5 time the f change in price

For normal goods

price elasticity of demand ve

For necessaries
closeto
price elasticity of demand is
very
Zero

For Giffen goods

price elasticity of demand tve

Ignoring sign of ed
ve

ed o perfectly inelastic e.g salt water etc

o c ed c I inelastic e.g essentialgoods
ed I unitary elastic
 o
ed 71 I elastic leg electronicgadgets

ed f perfectly elastic whose

as

e.g goods mkt

is
perfectly competitive

Price elasticity of demand X

If q
where a d change in qty demanded
AP change in price
P initial price
I initial qty demanded

2 Cross demand
price elasticity of

change in qty demanded of commodity

change in price of related commodity

NOTE cross price elasticity of demand of

complementary goods
is negative and
that for substitutes is positive

NOTE cross price elasticity of demand of

uncorrelated goods is zero o
 Ink Pen P 50 760
Ink bottles ad 100
70
Cross price elasticity of demand
for ink bottles

1 5

cross price
elasticity of demand x
Pg
ILY
where a du change in qty demanded
of se

A
Py change in price of related commodity
y
Py initial price of related commodity
y
On initial qty demanded of se

Income
3
elasticity of demand

I change in
qty demanded of commodity
change in income level of consumer
 Type of Goods
Income
elasticity
demand
of

it Normal Goods tve

ily Inferior Goods ve

ing Luxuries highly tue 1

iy normal essentialgoods low L1

V necessaries close to zero

Income elasticity of demand

E
where all change in qty demanded
A I change in income level
I initial incomelevel
of initial qty demanded
 Arc elasticity

Price elasticity
of demand Ffp
x

here P aug price

I aug qty
Cross
price elasticity of demand x

Ipf Pt
here Pp aug price of commodity
demanded
Y
On avg qty of commodity X

Income elasticity of demand

It
x
q
here avg income level
I
demanded
Q avg qty
Promotional elasticity of demand Advt expenditure

demanded
Ychangeingty
change in advt expenditure
 If
here a 4 change in qty demanded
A A change in advt expenditure
A initial advt expenditure
Q initial qty demanded

Promotional of demand
elasticity
Arc Elasticity method
x
If Aq
here A avg advt expenditure
9 avg qty demanded

Measurement
of elasticity on a linear demand
curve
ed at
Afed
O
any point
lowersigment
Price
weded 17 uppersegment

Medal
Bled o

Qty
 7

Point elasticity

used when change in price is infinitesimally

small veryvery small

Price
elasticity of demand
dgp
x
Pq

et q 80 3p
Find price elasticity of demand at p is

80 3p 3
I
At p 15

9 80 3115 35

ed dgp
f
3
3153

1 285
 Total
outlay method for calculating
price
elasticity

ed s inelastic
P H Total outlay I relation
P t Total outlay T direct

ed t elastic relation
Total outlay A inverse

If Total outlay I

ed unitary elastic
PRI Total
outlay remains same

The above
summary applies in case
of Total
Revenue also
Total Revenue

Total Revenue Paul unit X No of units sold

Price effect no of units sold const

P T TR T
P I TR I
 Qty effect Price const
No of wits sold T TR T
No of wits sold I TR 1

Important points

if Mose the no of substitutes greater will be

the price
elasticity of demand

2 more the no
of substitutes lower will be
the cross
price elasticity of demand

3 more the no of uses of commodify

greater will be the price elasticity of demand

6 If the product has major portion in household's

budget then the price elasticity of demand
for that product is greater
5 perfect substitutes t cross price elasticity btw
them is infinite
 close substitutes I Cross price elasticity will
be positive and large

not close substitutes I Crossprice elasticity will

be positive and small

6 habitual consumer of
commodity then
a demand

for the commodity will be inelastic

7 Demand for cheap complementary items to be

used together with a costlier product generally
have an inelastic demand

Demand curve
8 fornecessaries
Price
ed 0 perfectly inelash
Slope as

Qty demanded
 psia ed P
perfectly elastic
o
Slope O

Qty demanded

Demand curve for Giffen

goods
Price
upward sloping
Slope tve
Qty demanded

k.fi fp.P.d1
Pzdz
then ed I
unitary
elastic

shape of demand curve is

In rectangular hyperbola

ed 1 Sox 1700
It final
Pm
Eto 1200
24
30
Final so 1200
 Units Law of Supply Elasticity
of Supply

Meaning of Supply

Supply refers to quantity that supplier wishes

to supply at a particular price over a period
of time
ex ante planned
supply Demand

ex post Actual X

Supply is a flow variable

Supply
1
Willingness Ability to supply

Price T Supply A Didnt relationship btw

Price I 1 Price and qty supplied
Supply
 Determinants
of Supply
iy Price of the commodity PT Ost
Pt As I

iiy Price of related goods

tf Farmer can cultivate both rice wheat

Wheat Fff Rice

supply ofwheat I P t

iity Price of factors of production

II
Print
labour
cost t supply f

labour
p a Pitt supply t
 Price of land T then it will affect more

the production
on
of pulses like wheat and
less effect on the production of smartphones

in State of technology

Technology t supply T

Y Gout policy

Raw material
g firm
Tax rate 5 f
Tax rate 8 f cost of raw materials 4
Irrecoverable fax supply I

tax rate on raw materials T supply t

subsidies t supply A

Vil No
of sellers No of sellers t supply t
no
of sellers f supply I
Vii Nature of competition size
of industry
2 market structures

EI monopity I oligopoly

supply will be more in

oligopoly as
these will be more no
of sellers in
oligopoly mkt Structure as compared
to monopoly mkt structure

Viii Expectations

pity site't
Price I supply

Other factorsix
labour strikes T supply I
Communiol riots T supply I
Infrastructional development t supply A
 Law of Supply
If price of the commodity increases then qty
supplied of the commodity also increases and vice
versa

Price A Supply T
Price t supply 1
ie direct relationship btw price and qty supplied

Supply Schedule Individualfirm

Price Qty supplied in kgs

1kg
30 600
32 630
35 670
60 700

Supply Curve

F
upward sloping
Price
slope of supply curve tve

Ofy supplied
 Supply curve can be linear or curvilinear

Market Supply Schedule

Commodity wheat Market Individualfirms
A B
Film A MB Market
Price
kg qty supplied Qty supplied supply
30 600 t 700 1300
32 630 720 1350
670 750 1620
700 t 770 1670

t
pace
Market supply curve

upwardsloping
slopeof curve tue
Qty Supplied

For market supply curve we have to

preparing
horizontally add all the individual firm's supply curve
Expansion Contraction of Supply

Price of commodity t change

other factors remains constant

Price supplied
1kg Qty
30 500
32 530
PT Is t
It is an example of expansion of supply

Expansion of supply
upward movement along the
price
supply curve

Qty supplied

Price Oty supplied in kgs

kg
30 500
28 650
Pt Is t
It is an example of contraction of supply
 y

Contraction
of supply
2
Downward movement
along the
Price

supply curve
g g
Qty supplied
5 45 to 6 45

Increase Decrease in
Supply

Price of the commodity const

other factors change

Increase in Rightward shift Sn

supply 4
Decrease in supply 4 Leftward shift S2

S
Price

Qty Supplied
 Elasticity of Supply Price elasticity of supply

change inqty supplied of commodity

I change in price of commodity

Is Is
where all change in qty supplied
A P change in price
P initial price
As initial qty supplied

es o perfectly inelastic
Price Td As Const

Supply curveO
Price 5 so
when es
10 slope ofsupplycurve as
soo
vertical straightline parallel
Qty supplied to Y axis Price axis
 es e es perfectly elastic
Prices negligible change Is high change

When es es
Price
slope 0
horizontalstraight line parallel
qty supplied to X axis Qty supplied axis

Are elasticity

es
IF Is
where P Aug price
Is aug qty Supplied

Relative price

of Commodity A 20
hg
commodity B E
101kg

Relative price
of B as compared to A
10 20 1 2
 Relative price of A as compared to B
20 10 2 1

Important Points

Time period t est

large no of producers s est
raw materials and inputs easily and cheaply available

Supply will be elastic

adequate stock available of RM Fa eti s est
o

capital and labour can be easily switched s est

labour employed s scarce or sequins longer training

period s est
production process more complicated t est
Flatter supply curve is more elastic as compared

to steepen curve
 Unit 2
Theory of Consumer Behaviour
Human warts are unlimited but the resources
available to
satisfy these human warts are
limited
Goods

Necessaries Comforts Luxuries

e salt water two wheelers Cat Air conditioner
g
clothing etc fan look etc diamond etc

Comforts lies btw necessaries and luxuries

Utility

want
satisfying power of a commodity

utility can be measured as stated by Prof

Alfred
Marshall and it's unit of measurement is utils

even harmful things like liquor tobacco etc

may
be said to have utility because people want them
is ethically neutral
Concept of utility
 utility is a subjective and native entity and

vary from person to person

MarginalUtility Analysis propounded
Marginal Utility
by Alfred Marshall
Units Total Utility TU Marginal Utility MU
O O O

I 75 75
2 140 65
3 1 90 50
6 230 40
5 265 35
6 280 15
7 280 0
8 270 10

Observations
as we consume more and more of a commodity
total utility Tu rises but at a diminishing rate

Marginal utility Mu falls as additional units

are consumed
 TU starts falling after Mu becomes zero

Mu is either negative
O
zero or positive

TU is maximum when MU is zero

Assumptions for MU
Analysis

in utility is quantifiable and is measured in utils

ily consumer is rational he has all the available

i.e
market information and his objective is to
maximise his utility

iity Marginal utility of money

is constant

ing money is the measuring tod of utility

y Goods are unrelated

Vip continuous consumption

Viiy goods to be consumed should be homogenous
or identical in nature

Viii standard units

Marginal Utility Curve

diwniaidescoping Area under the

Mu straight line marginal utility curve
gives total utility

Qty

MU curve can be either straight line or curvilinear

Total Utility Curve

Imax utility
At any point
sloping slopeof tu curve
marginalutility

Qty

NOTE For conspicuous goods TU curve is upward

sloping only
 Limitations of law of diminishing marginal utility

if Mu of money is constant
in fact Mu of is increasing
money

are unrelated
ily goods
infact goods can be related

iii Prestige goods Veblengood do not follow law

of DMV because here utility is attached to its
value

Consumer Surplus

Consumer surplus Amt ready Amt actually

to paid
pay
Amt ready Consumer Total
No of units Price unit to
pay surplus
1 10 12 2 2

2 10 11.75 1.75 3.75

3 10 11.25 1.25 5
4 10 10.75 0.75 5.75
5 10 10 0 5.75
6 10 9.75 0.25 5.50

Total consumer surplus is maximised when

marginal utility ant ready to payfor additionalunit
is equal to price unit

decrease in consumer surplus increase in revenue

increase in consumer surplus decrease in revenue

i.e indirect relationship btw consumer

surplus and revenue
 Ordinal Concept of Utility

utility cannot be quantified but utility derived

from consumption of different products can
be compared

F Bitter gourd Ice cream

Curve Indifference curve analysis

Indifference propounded
byHicks Allen

locus of all the points having the same

amount of utility

20160
at all points A BandC
c
same
product utility is derived

Ipo Indifference Curve

duct
VA UB VC
 Product X Product
20 40 y
I
a
4
36 362 5
i 22 3 33 3
3 3,6
1 23 2 31

marginal rate of substitution of product y

over product X
for 1 unit increase in
product X how much units of product
you are ready to Sacrifice
y

Indifference Curve
Product
y slope of IC
Mrs of over X
y
Product X

Mrs
of y our X
It
or
Mffy
NOTE When we upward
are or
moving
downward along the IC
utility
remains constant

Product X Product Ars of your X

Y
915 302 5
2
2.5
2217 2555
310
5 167
3
so

212 1931 42 0.5

NOTE When we are downward

moving
along the IC then both MRS
ARS of over X decreases
y
NOTE IC is also called Iso
utility
curve Equal Utility Curve
Characteristics
of IC

IC is downward sloping

Both MRS ARS of y over X falls

as we move downward along the LC

IC curve is convex to the origin

Higher the be the

IC more will
utility

Two IC's cannot intersect each other

Slope of IC Mrs
of y over X
or
EY Mitty
 Exceptions to Indifference Curve

If Stock A Stock B
Risk 15 121
Expected Rehm 247 201
ActualReturn 181 181

Rett
INA
IC is upward
Exp sloping in case of
speculative goods
Risk

ily
x
Product
y
y
substitutes
are
perfect

Ic is downward sloping
Product X
straight line
Product X Product
20 30
Y 3

21 2,33
1 22 2473
I 23 2133
In case
of perfect substitutes MRS
of Y over X
is constant
 In
ing case
of perfect complementary goods
IC is L shaped

L shaped IC
for perfect
complementary goods

Budget line
Product X Product
Y
Price

Qty On se
y
Money Income level of consumer
MO
M se Pat
y Py
se put M
YPy
y KAFI
 y Py
set
By

it with mate
Comparing
y
Slope
Ppg
slope of budget line
is ve

intercept
Y Mpg

If y o Ff n o
then M se Pu then M YPy
in
Mp Y My

O Slope Pyp
My
downward
sloping
Straight line
Y
Int
Consumer equilibrium will occur at the point
when the I C is tangent to the budget line

point of equilibrium
I I
Is
re equilibrium qty of
y act product X

Y equilibrium qty of
productY

At point of equilibrium point P

slope of budget line slope of IC

Mun
Bep
Fu
law of equi marginal
My My utility
Important Points

Demand curve shift to the right and supply

curve is unchanged then
eq qty eq price increases

Demand curve shift to the left and

supply curve is unchanged then

eq qty I eq price decreases

Supply curve shift to the

right and
demand curve is unchanged ther
eq qty T and eq price I

Supply curve shift to the left and demand

curve is unchanged then
eq qty I and eq price t