Theory Of Demand

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Theory Of Demand

  1. 1. THEORY OF DEMAND DEMAND ANALYSIS- CONCEPT OF DEMAND- Marshall/Hicks utility approaches LAW OF DEMAND I
  2. 2. CONTENTS <ul><li>Demand analysis- </li></ul><ul><li>Meaning of demand </li></ul><ul><li>Individual demand-utility concepts </li></ul><ul><li>Law of diminishing utility </li></ul><ul><li>Indifference curves </li></ul><ul><li>Budget line-income/substitution effect </li></ul><ul><li>Theory of demand- Applications of LAW </li></ul><ul><li>CONSUMER SURPLUS /MARKETABLE SURPLUS concept </li></ul>
  3. 3. WHY DEMAND ANALYSIS? <ul><li>DEMAND IS THE MOTHER OF PRODUCTION </li></ul><ul><li>BUSINESS MANAGER WANTS TO KNOW:- </li></ul><ul><li>WHAT ARE THE SOURCES OF DEMAND? </li></ul><ul><li>WHAT ARE THE DETERMINANTS OF DEMAND? </li></ul><ul><li>HOW DO BUYERS DECIDE THE QUANTITY OF A PRODUCT TO BE PURCHASED? </li></ul><ul><li>HOW DO BUYERS RESPOND TO PRICE CHANGES? </li></ul><ul><li>What is consumer behaviour? </li></ul>
  4. 4. MEANING OF DEMAND <ul><li>EFFECTIVE DEMAND FOR A PRODUCT-SAY MARUTI CAR CONSISTS OF </li></ul><ul><li>DESIRE TO BUY,WILLINGNESS TO PAY,ABILITY TO PAY FOR THE CAR </li></ul><ul><li>WHAT IS A MEANINGFUL STATEMENT OF DEMAND? </li></ul><ul><li>QUANTITY DEMANDED </li></ul><ul><li>THE PRICE AT WHICH THE COMMODITY IS DEMANDED </li></ul><ul><li>THE TIME PERIOD(ANNUAL,MONTHLY ETC </li></ul><ul><li>THE MARKET AREA OR PLACE </li></ul><ul><li>E.g1000 cars at Rs 2lakhs each monthly at New Delhi </li></ul>
  5. 5. BASIS OF CONSUMER DEMAND <ul><li>BASIS OF CONSUMER DEMAND IS THE PRODUCT’S UTILITY-TWO ANGLES </li></ul><ul><li>COMMODITY ANGLE – </li></ul><ul><li>WANT SATISFYING PROPERTY OF THE COMMODITY- </li></ul><ul><li>ABSOLUTE CONCEPT(PEN)-ONE NEEDS OR NOT- </li></ul><ul><li>EHITHICALLY NEUTRAL CONCEPT (DRUG/ALCHOHOL/-MORAL/IMMORAL NEED- </li></ul><ul><li>PRE-CONSUMPTION PHENOMENON </li></ul><ul><li>CONSUMER ANGLE- </li></ul><ul><li>FEELING OF SATISFACTION/PLEASURE- </li></ul><ul><li>POST CONSUMPTION PHENOMENA </li></ul><ul><li>RELATIVE OR SUBJECTIVE CONCEPT </li></ul>
  6. 6. CONCEPTS OF UTILITY <ul><li>TOTAL UTILITY – </li></ul><ul><li>SUM OF THE UTILITIES DERIVED BY A CONSUMER FROM THE VARIOUS UNITS OF GOODS AND SERVICES HE CONSUMES i.e </li></ul><ul><li>(u1+u2+u3+u4 ) </li></ul><ul><li>MARGINAL UTILITY- </li></ul><ul><li>UTILITY DERIVED FROM THE MARGINAL UNIT CONSUMED </li></ul><ul><li>ADDITION TO TOTAL UTILITY BY CONSUMING ONE MORE UNIT i.e </li></ul><ul><li>TU(n)-TU(n-1) </li></ul>
  7. 7. LAW OF DIMINISHING MARGINAL UTILITY <ul><li>AS THE QUANTITY CONSUMED OF A COMMODITY INCREASES,THE UTILITY DERIVED FROM EACH SUCCESSIVE UNITS DECREASES,CONSUMPTION OF ALL OTHER COMMODITIES REMAINING THE SAME </li></ul><ul><li>THIS LAW APPLIES TO ALL KINDS OF CONSUMER GOODS-DURABLE AND NON-DURABLE SOONER OR LATER </li></ul>
  8. 8. DIMINISHING MARGINAL UTILITY? <ul><li>ASSUMPTIONS OF THE LAW </li></ul><ul><li>1)THE UNIT OF THE CONSUMER GOOD (CUP/BOTTLE/SHIRTS ETC)MUST BE A STANDARD ONE-IF THE UNIT IS SMALL OR BIG THEN THE LAW WILL NOT APPLY </li></ul><ul><li>2)THE CONSUMER’S TASTE OR PREFERENCE MUST REMAIN THE SAME DURING THE PERIOD OF CONSUMPTION </li></ul><ul><li>3)CONTINUITY IN CONSUMPTION-SHORT BREAK ALLOWED </li></ul><ul><li>4)MENTAL CONDITION OF THE CONSUMER MUST BE NORMAL </li></ul>
  9. 9. CARDINAL /ORDINAL CONCEPTS OF UTILITY <ul><li>CARDINAL UTILITY- </li></ul><ul><li>UTILITY IS QUANTITATIVELY MEASURABLE LIKE HEIGHT,WEIGHT ETC-UTILS </li></ul><ul><li>ALFRED MARSHALL(CLASSICAL ECONOMISTS)-ADVOCATES </li></ul><ul><li>ORDINAL UTILITY- </li></ul><ul><li>NOT MEASURABLE QUANTITATIVELY OR ABSOLUTELY- </li></ul><ul><li>CAN BE MEASURED RELATIVELY OR IN TERMS OF ‘MORE THAN’ OR LESS THAN’-LIST IN ORDER OF PREFERENCE- </li></ul><ul><li>J.R.HICKS(MODERN ECONOMISTS) </li></ul>
  10. 10. CARDINAL UTILITYAPPROACH-CONSUMER BEHAVIOUR ANALYSIS <ul><li>ASSUMPTIONS:- </li></ul><ul><li>1)RATIONALITY </li></ul><ul><li>2)LIMITED MONEY INCOME </li></ul><ul><li>3) DIMINISHING MARGINAL UTILITY </li></ul><ul><li>4)MAXIMISATION OF SATISFACTION </li></ul><ul><li>5)UTILITY IS MEASURABLE-UTIL </li></ul><ul><li>6)CONSTANT MARGINAL UTILITY OF MONEY </li></ul><ul><li>7)UTILITY IS ADDITIVE </li></ul><ul><li>2AND3 LEAD TO CONSUMER’S EQUILIBRIUM-(I.E)POINT AT WHICH THE CONSUMER HAS MAXIMISED THE LEVEL OF SATISFACTION </li></ul>
  11. 11. LAW OF DEMAND <ul><li>THE DEMAND FOR A COMMODITY INCREASES WHEN ITS PRICE DECREASES,OTHER THINGS REMAINING CONSTANT </li></ul><ul><li>EMPIRICAL LAW-INVERSE RELATIONSHIP-PRICE/QUANTITY </li></ul><ul><li>OTHER THINGS INCLUDE OTHER DETERMINANTS OF DEMAND-INCOME,PRICE OF SUBSTITUTESETC </li></ul>
  12. 12. DEMAND SCHEDULE&DEMAND CURVE <ul><li>DEMAND SCHEDULE </li></ul><ul><li>NO OF CUPS CONSUMED 6-1-X AXIS </li></ul><ul><li>PRICE PER CUP-RS 6-1-Y AXIS </li></ul><ul><li>CURVE DD’ IS THE DEMAND CURVE </li></ul><ul><li>DD’ SLOPES DOWNWARD TO THE RIGHT DEPICTING THE LAW OF DEMAND </li></ul><ul><li>CONSUMER SURPLUS </li></ul>
  13. 13. CONSUMER SURPLUS <ul><li>DEMAND CURVE IS USEFUL TO ESTIMATE THE AMOUNT THE CONSUMER IS WILLING TO SPEND ON COMMODITY X </li></ul><ul><li>CONSUMER WOULD PREFER THAT COMMODITY RATHER THAN GO WITHOUT IT </li></ul><ul><li>AMOUNT SPENT FOR A GIVEN LEVEL OF CONSUMPTION OF THAT COMMODITY </li></ul><ul><li>THE EXCESS OF SUCH AN AMOUNTOVER WHAT HE ACTUALLY PAYS FOR THE COMMODITY IS SURPLUS THAT ACCRUES </li></ul><ul><li>THIS NOTIONAL SURPLUS IS CALLED CONSUMER SURPLUS </li></ul>
  14. 14. CONSUMER SURPLUS OBSERVATIONS <ul><li>CONSUMER’S SURPLUS INCREASES AS THE PRICE OF THE GOOD FALLS </li></ul><ul><li>CONSUMER’S TOTAL SATISFACTION INCREASES AS THE PRICE FALLS </li></ul><ul><li>CONSUMERS WOULD PREFER A LOWER THAN A HIGHER PRICE FOR A GOOD </li></ul><ul><li>GIVES AN ESTIMATE OF THE POTENTIAL BENEFITS ACCRUING TO CONSUMERS </li></ul><ul><li>SHOWS THE POTENTIAL REVENUE A SELLER(GOVT/PRIVATE) CAN RAISE FROM THE CONSUMERS </li></ul>
  15. 15. EXCEPTIONS TO LAW OF DEMAND <ul><li>EXPECTATIONS REGARDING RISE IN PRICE </li></ul><ul><li>STATUS SYMBOL GOODS-GOLD AND ORNAMENTS ETC </li></ul><ul><li>GIFFIN GOODS-INFERIOR COMMODITY (BAJRA) MUCH CHEAPER THAN SUPERIOR GOODS(ATTA) </li></ul><ul><li>IF BAJRA PRICE INCREASES THE HOUSE HOLDS REDUCE THE CONSUMPTION OF ATTA,INCOME REMAINING THE SAME </li></ul>
  16. 16. ORDINAL UTILTY-INDIFFERENCE CURVES <ul><li>INDIFFERENCE CUVE IS THE LOCUS OF POINTS ,EACH REPRESENTING A DIFFERENT COMBINATION OF TWO SUBSTITUTE GOODS WHICH YIELD SAME LEVEL OF SATISFACTION TO THE CONSUMER </li></ul><ul><li>THEREFORE HE IS INDIFFERENT BETWEEN ANY TWO COMBINATION OF GOODS WHEN IT COMES TO MAKING A CHOICE </li></ul>
  17. 17. PROPERTIES OF IC <ul><li>HAVE NEGATIVE SLOPE </li></ul><ul><li>CONVEX TO ORIGIN </li></ul><ul><li>DONOT INTERSECT </li></ul><ul><li>UPPER IC INDICATE HIGHER LEVEL OF SATISFACTION </li></ul><ul><li>FEASIBILITY/NON FEASIBILITY AREA </li></ul>
  18. 18. CONSUMER BUDGET LINE <ul><li>BUDGET CONSTRAINT FOR THE CONSUMER-MONEY INCOME </li></ul><ul><li>CONSUMER CANNOT OVERSPEND </li></ul><ul><li>HE CAN SPEND LESS BUT NOT MORE ON THE AVAILABLE GOODS </li></ul><ul><li>Budget line for X and Y </li></ul><ul><li>M/PY and M/PX </li></ul><ul><li>AB budget line </li></ul>
  19. 19. EQUILIBRIUM <ul><li>INDIFFERENCE MAP-QTY X &QTY Y(X-Y AXIS) </li></ul><ul><li>BUDGET LINE SLOPE AB AND IC2 SLOPE ARE EQUAL AS BOTH PASS THRO POINT ‘E’ </li></ul><ul><li>THE LEVEL OF SATISFACTION AT POINT E IS >THAN ANY OTHER POINT ON IC1 </li></ul><ul><li>DUE TO BUDGET CONSTRAINT HE CANNOT MOVE TO IC3 </li></ul><ul><li>COMMODITY SPACE –FEASIBILITY/NON FEASIBILITY AREA </li></ul>
  20. 20. FACTORS BEHIND LAW OF DEMAND <ul><li>INCOME EFFECT AND SUBSTITUTION EFFECT </li></ul><ul><li>INCOME EFFECT-WHEN THE PRICE OF A COMMODITY FALLS,THE REAL INCOME OF THE CONSUMER INCREASES- </li></ul><ul><li>HIS PURCHASING POWER INCREASES-DEMANDS MORE GOODS AND SERVICES </li></ul><ul><li>INCOME EFFECT ON INFERIOR GOODS IS NEGATIVE AND SUPERIOR GOODS IS POSITIVE </li></ul>
  21. 21. SUBSTITUTION EFFECT-WHEN? <ul><li>SUBSTITUTION EFFECT-WHEN PRICE OF A COMMODITY FALLS,ITS SUBSTITUTE BECOMES COSTILIER,IF ITS PRICE IS CONSTANT-NOT CHANGED </li></ul><ul><li>UTILITY MAXIMISING BEHAVIOUR UNDER DIMINISHING MARGINAL RATE OF SUBSTITUTION- </li></ul><ul><li>CONSUMER SUBSTITUTES CHEAPER GOODS FOR COSTLIER GOODS </li></ul><ul><li>DEMAND FOR CHEAPER GOODS INCREASE </li></ul>
  22. 22. Demand theory –some applications <ul><li>Subsidies in cash and kind-poverty alleviation programs by govts </li></ul><ul><li>Direct income subsidy-tax concessions unemployment allowances welfare payments etc </li></ul><ul><li>Direct medcines, food ,clothing ,shelter subsidy-food for work (antyodaya schemes) ,free sarees /dhoties /free shelter for poor </li></ul><ul><li>Direct or indirect taxation-income tax vs excise duty concessions </li></ul><ul><li>Which is more efficient? </li></ul>
  23. 23. Marketable surplus <ul><li>Marketable surplus </li></ul><ul><li>Analysing the behaviour of Producers who also consume their goods-e.g farmers , </li></ul><ul><li>House wives who go for outside work-time is marketable surplus </li></ul><ul><li>House wife’ allocation of time to outside work is her marketable surplus </li></ul>
  24. 24. REVEALED PREFERENCE THEORY-SAMUELSON <ul><li>A&B ARE TWO ALTERNATIVE BASKETS OF GOODS X&Y </li></ul><ul><li>BOTH ARE EQUALLY EXPENSIVE </li></ul><ul><li>BY CHOOSING ONE HE REVEALS HIS PREFERENCE OR LIKINGTO THATBASKET </li></ul><ul><li>‘THIRD ROOT OF THE LOGICAL THEORY OF DEMAND’-DUE TO ITS MERITS OVER UTILITY THEORY </li></ul>
  25. 25. DEMAND FUNCTION LINEAR DEMAND FUNCTION NONLINEAR DEMAND FUNCTION DYNAMIC DEMAND FUNCTION
  26. 26. LINEAR/NON LINEAR DEMAND FUNCTION <ul><li>DEMAND LINE AND DEMAND CURVE-linear/non-linear relationships-SHORT RUN- </li></ul><ul><li>PRICE AS THE SINGLE VARIABLE </li></ul><ul><li>DEMAND SCHEDULE-DRAW THE DEMAND LINE GIVEN THE FOLLOWING FOR COMMODITY X:-Dx=f(Px) </li></ul><ul><li>PRICE QUANTITY DEMANDED </li></ul><ul><li>1 100 </li></ul><ul><li>5 75 </li></ul><ul><li>10 50 </li></ul><ul><li>15 25 </li></ul><ul><li>20 0 </li></ul>
  27. 27. NON-LINEAR DEMAND FUNCTION <ul><li>NON LINEAR OR CURVILINEAR </li></ul><ul><li>SLOPE OF THE DEMAND CURVE CHANGES ALL ALONG THE CURVE </li></ul><ul><li>DRAW A POWER FUNCTION </li></ul><ul><li>-b </li></ul><ul><li>Dx=aPx </li></ul>
  28. 28. DYNAMIC DEMAND FUNCTION <ul><li>LONG RUN DEMAND-DEPENDS ON THE COMPOSITE IMPACT OF DETERMINANTS OPERATING SIMULTANEOUSLY-multi variate demand </li></ul><ul><li>Dx=f(Px,M,Py,Pc,T,A) WHERE </li></ul><ul><li>Dx-demand for commodity x </li></ul><ul><li>Px-Price of X </li></ul><ul><li>M-Consumer’s income </li></ul><ul><li>Py-price of its substitute </li></ul><ul><li>Pc-Price of its compliment </li></ul><ul><li>T-Taste of the consumer </li></ul><ul><li>A-Advertisement expenditure </li></ul>

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