Eco

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Eco

  1. 1. THEORY OF CONSUMER DEMAND
  2. 2.  Its a want backed by willingness to pay
  3. 3. • The branch of economics devoted to the study of consumerbehavior• Applies to decisions related to purchasing goods and servicesthrough markets.• Largely centered on the study• Analysis of the utility generated from the satisfaction of wantsand needs.• The key principle is the law of diminishing marginal utility• Explanation for the law of demand and the negative slope ofthe demand curve.
  4. 4. DEMAND ANALYSIS Study of sales generated by a good or service to determine thereasons for its success or failure, and how it sales performance canbe improved. o Firms sell goods/services to buyers  Consumers (individuals) : utility  Firms : make profits o Willingness to pay: maximum price buyer will pay for a good  Point of indifference between buying and not buying  Lower price always preferred by buyer
  5. 5.  Willingness to pay is determined by  Buyer’s tastes or needs  Income and wealth  Normal/inferior goods  Cyclical/acyclical demand  Substitutes  Complementary goods
  6. 6. CARDINAL : Utility is measurable numerically.INDEPENDENT: Utility of each commodity is experienced independently.ADDITIVE : Goods can be measured by adding their independent utilitiestogether.CONSTANT :MU of money to be constant at all levels of income of theconsumer.RATIONALITY :consumer is rational maximization of tu he buys
  7. 7.  ADDITIVE UTILITY :utility cannot be measured quantitatively. HOMOGENITY :utility or satisfaction derived from different goods is qualitatively homogenous. CONSTANCY : MU of money remains constant. INAPPLICABLITY :utility analysis is inapplicable for bulky goods. Eg.tv, fridge etc. GIFFEN GOODS :there is paradox situation in which the consumer tends to buy less of such goods when their price falls.
  8. 8.  According to law of diminishing marginal utility a consumer tries to equalize marginal utility of a commodity with its price, so that his satisfaction is maximized. Consumer is a rational and always tries to seek Maximum total utility when he buys goods.• The law of diminishing marginal utility implies that by increasing the stock of commodity its marginal utility is diminished.
  9. 9.  A more advanced form of consumer demand theory involves the analysis of indifference curves. An indifference curve, such as the one labelled U in the exhibit to the right, presents all combinations of two goods that provide the same amount of utility. Indifference curve analysis relies on a relative ranking of preferences between two goods rather than the absolute measurement of utility (utils) derived from the consumption of a particular good.
  10. 10.  Utility is viewed as the level of satisfaction rather than an amount of satisfaction. The level of satisfaction is relatively comparable but not quantifiable.
  11. 11.  Based on the subjective valuation Differs from person to person Significance of commodities Drawn by a consumer mind Independent of the price of the goods
  12. 12.  Generally, negatively sloped, reflecting marginal rate of substitution Convex to the origin, reflecting diminishing marginal utility Two indifference curves cannot cross Special case: a positively sloped indifference curve
  13. 13.  Also know as Price Line, Consumption Possibility Line, Line of attainable combinations A collection of commodity that are affordable forms the consumer’s budget constraint. A commodity X satisfies your budget constraint if P (your price is greater than equal to M (income) A budget line is a collection of commodity X that are just affordable, i.e., P is equal to M (income). INCOME and PRICES are two objectives factors in budgetary constraints.
  14. 14. Definition- The state of balance achieved by an end user of products that refers to the amount of goods and services they can purchase given their present level of income and the current level of prices. Based on ORDINAL PREFERENCE or INDIFFERENCE CURVE. ASSUMPTIONS Fixed amount of money Combinations of two goods Each of the goods is HOMOGENEOUS. Tastes and Preferences. Consumer is rational.
  15. 15. •When the commodity consumed bythe consumer is available free ofcost, he will carry on the consumptionof the commodity up to thepoint, where his total utility from thatcommodity is maximum.•So, he goes on consuming thecommodity till extra units of thecommodity give him some satisfaction.• He stops the consumption of thecommodity at the point ofsatiety, i.e., where marginal utility is Fig: Consumer Equilibriumequal to zero. (One commodity)
  16. 16.  When the price of commodity falls the consumer is prefersubstitute more of the relatively cheaper commodity. The larger quantity of commodity will be purchased at a lower price because the attitude of consumer. For example, if private universities increase their tuition by 10% and public universities increase their tuition by only 2%, then it is very likely that we would see a shift in attendance from private to public universities (at least amongst students accepted to both
  17. 17.  This refer to the changes in the real income of the consumer due to changes in price, when the price of commodity falls the purchasing power of real income of the consumer will rise. Income effect may be positive, negative or zero. For example, a decrease in the price of all cars allows you to buy either a cheaper car or a better car for the same price, thus increasing your utility.
  18. 18.  Giffen paradox states that demand for a commodity increases as its price rises. Giffen paradox is explained by the fact that if the poor rely heavily on basic commodities like bread or potatoes, when prices are low they might still have some disposable income for purchases of other items. In economics and consumer theory, a Giffen good is one which people paradoxically consume more of as the price rises, violating the law of demand. In normal situations, as the price of a good rises, the substitution effect causes consumers to purchase less of it and more of substitute goods. In the Giffen good situation, the income effect dominates, leading people to buy more of the good, even as its price rises.
  19. 19. Indifference curve analysis is superior in respect of the following: Indifference Curve analysis is more realistic Free from the Defect of Independent Commodity Free from unrealistic assumption of Constant Marginal Utility of money Based on Less Assumption Explanation of Income and Substitution Effects Explanation of Giffens Paradox Helpful in the estimation of welfare More Realistic Foundation More Realistic Theory of Consumers Equilibrium In short, it is clear that Indifference curve analysis is more realistic and improved analysis
  20. 20. Indifference curve analysis criticized on account of the following: Unrealistic assumption Complex Analysis Imaginary Ignores combination involving risk Introspective Criticism on the basis of Indifference Assumption of Convexity Old wine in New bottles Impossible to explain Diminishing MRS without Diminishing Marginal Utility Laughable Combinations Unrealistic Assumption of Maximum Utility Impractical

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