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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