ANALYSIS OF INDIVIDUAL DEMAND

ANALYSIS OF INDIVIDUAL DEMAND

Demand

Demand implies a ‘desire’ for a commodity backed by willingness, and obviously ability to pay for it.

BASIS OF CONSUMER DEMAND The Utility is the sense of pleasure, or satisfaction, that comes

from consumption, possession or the use of a cammodity.

The utility that a person derives from consuming a particular good depends on that person’s tastes or preferences for different goods and services likes and dislikes

We generally assume simply that tastes are given and are relatively stable different people may have different tastes but a given individual’s tastes are not constantly in flux

The commodities for which are ready to pay higher price, the utility of them is supposed to be higher.

Two approaches to understand Utility Cardinal utility approach

Ordinal utility approach

Assumptions in Cardinal theory The consumer is rational.

Limited money income.

Maximization of satisfaction

Utility is cardinally measurable, and it is additive, and diminishing.

Total and Marginal Utility We have to distinguish between total

utility and marginal utility

Total utility is the total satisfaction a person derives from consumption

Marginal utility is the change in total utility resulting from a one-unit change in consumption of a good

Law of Diminishing Marginal Utility The more of a good an individual

consumes per time period, other things constant, the smaller the increase in total utility from additional consumption

That is, the smaller the marginal utility of each additional unit consumed

This applies to all consumption

Some Assumptions of this Law The successive units being consumed should be

identical and homogeneous in all respects e.g. taste, flavour etc.

The unit consumed should be of standard unit. The income of the consumer remains constant. Preference of the consumer should not be changed

during the time of intake. The units are consumed without any interval of time.

Criticism of this law

In practical life nobody consumes in succession.

This law does not hold good when there is scarcity of resources.

This law holds good for individuals only, the same marginal utility can not be generalized on others.

Consumer’s Equilibrium one Commodity Model

Derivation of Individual Demand for a Commodity.

Law of Demand

It states that when the demand of a particular commodity rises, its price decreases, and the price of a commodity rises, the demand for it decreases, provided other things remain constant.

Factors behind law of Demand Substitution Effect- When the price of a commodity

falls keeping its substitute’s price constant, a utility maximizing customer will go for the commodity whose price has fallen.

Income Effect- when the price of commodity falls the real income of the consumer increases, the increase in the demand of that product on account of increase in his income is known as the income effect.

Utility Maximizing Behavior

Exceptions in Law of Demand Expectation regarding further increase in

Prices. Status Goods Giffen Goods

Shift in Demand Curve

Reasons for Shift

Increase in consumer’s income. Price of Substitute rises. Advertisement Price of complement falls.

Assumptions in Ordinal Utility Approach Rationality Ordinal Utility Transitivity and consistency of choice Diminishing Marginal rate of Substitution

Indifference Curve Approach

It can be said that locus of combination of those two substitute goods, which yield same utility to the consumer, therefore he is indifferent between any two combinations, these curves are also called Isoutility or Equal Utility curve.

Indifference Chart

commodity Units of Commodity Y

+

Units of Commodity X

Total Utility

a 25 + 3 U

b 15 + 6 U

c 8 + 9 U

d 4 + 17

e 2 + 30 U

Marginal Rate of Substitution Marginal Rate of substitution is that rate for

which one commodity can be substituted for another, the level of satisfaction remaining the same.

Indifference Map

Properties of Indifference Curves The curves have a negative slope.

They are convex to origin.

They never intersect

Upper curves represent higher level of satisfaction.

Budget Line

Consumer Equilibrium under Ordinal Utility Approach

Price Effect

Income Effect and Substitution Effect under Hicksian Approach

Income Effect and Substitution Effect under Slutskian Approach

Derivation of Individual Demand Through Price Consumption Curve

Revealed Preference Theory

Assumptions Rationality Transitivity Consistency Effective Price Inducement

Revealed Preference

Derivation Of Demand Curve in Revealed Preference Theory

Determinants of Demand

Price of a Product Price of related goods Consumer’s Income Consumer’s Taste and Preference Advertising Expenditure Consumer’s Expectations Credit Facility Population Distribution of Nation Income

Elasticity Of Demand

The degree of responsiveness of demand to changes in its determinants is called elasticity of demand.

Price Elasticity Income Elasticity Cross Elasticity Promotional Elasticity

Price Elasticity

Price elasticity of the demand is generally defined as the degree of responsiveness of demand to the changes in its price.

EP = %age change in quantity demanded

Percentage change in price

Price Elasticity

Factors Affecting Price Elasticity Availability of substitutes Nature of commodity Weightage in total consumption Time factor in adjustment of consumption

pattern Range of commodity use Proportion of market supplied

Income Elasticity

Income elasticity of the demand is generally defined as the degree of responsiveness of demand to the changes in the income of consumer.

Ei = %age change in quantity demanded

Percentage change in income

Income Elasticity

Cross Elasticity

Cross elasticity is the measure of degree of responsiveness of demand for a commodity to changes in price of its substitutes and complementary goods.

E = %age change in demand of petrol

% change in price of car

Uses of Cross Elasticity

If cross elasticity is positive then both goods have positive coefficient then they are substitutes and higher the coefficient higher are they close substitutes and similarly if coefficient is negative they will be complements.

Advertisement Elasticity

Advertising is the sales promotional activity that helps us in increasing sales.

So advertisement elasticity will be responsiveness of sales on the advertising expenditure

Determinants of Advertising Elasticity The level of total sales Advertisements of rival firms Cumulative impact of past advertisements