This document covers key concepts in demand theory, indifference curves, utility analysis, and the laws of demand. It discusses consumer demand, the law of demand, factors that shift demand, and exceptions to the law of demand. It also explains properties and applications of indifference curves, different shapes of indifference curves, budget lines, and how prices impact consumer choice. Finally, it introduces utility analysis, marginal utility, and the laws of diminishing marginal utility and equi-marginal utility.
3. Basics of Demand Theory
■ Consumer’s desire and the
willingness to pay
■ Market demand
■ Law of Demand
■ Reasons for inverse relation
■ Shape of demand curve
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4. Shift in Demand Curve
■ Temporary shift vs Permanent Shift
■ Income of the buyer
■ Consumer trends and tastes.
■ Expectations of future prices,
supply, needs, etc.
■ The price of substitute goods
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5. Exceptions to Law of Demand
■ Inferior goods/ Giffen goods
■ Goods having prestige value
■ Price expectation
■ Fear of shortage
■ Change in income, fashion
■ Basic necessities of life
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8. APPLICATIONS
■ The Problem of Exchange
■ Effects of Subsidy on Consumers
■ The Problem of Rationing
■ Index Numbers: Measuring Cost of Living
■ The Supply of Labour
■ The Effect of Income Tax vs. Excise Duty
■ The Saving Plan of an Individual
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10. PERFECT SUBSTITUTES
■
•Interchangeable goods
•Utility for both the goods is
same
•Consumer does not mind
having either
•Consumer would not trade
less quantity of one good for
more quantity of another
good
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11. PERFECT COMPLIMENTS
■
•Demand for complementary
goods is not independent but
directly related.
•E.g. – Gloves
•Virtually no difference in
happiness whether you have one
right glove or one left glove.
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12. BADS
■
•When for a consumer a
commodity is a bad’ that is
undesirable object, the more of it
will lower his satisfaction.
•E.g. Portfolio Analysis
Average return – Good
Risk - Bad
•Investor prefers high average
return and low risk.
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13. NEUTRAL GOODS
■
•Consumer doesn't care about
one of the goods, meaning that
getting more of that good or less
of that good doesn't make them
happier or sad
•E.g. Getting CDs vs getting
expired movie tickets
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17. Impact of Higher Price
Income effect
• Increase in the price of goods affects on
person’s disposable income.
• If the price of a good increases, then
consumers will have relatively lower
available income to use.
• As an example, suppose the price of
petrol rises, consumers may not be able
to afford to drive/use as much as earlier,
leading to lower demand.
Substitution effect:
• See the effect of price increase in the
goods compared to alternatives on
increase of demand of substitute.
• If the price of petrol rises, then it is
relatively cheaper to go by bus.
• So, it will increase the demand of
substitute.
21. Consumer’s Equilibrium
■ Given the price line and
the indifference map:
"A consumer is said to
be in an equilibrium at a
point where the budget line
is touching the highest
achievable indifference
curve from below".
C
E
F
H B I
Bananas
A
P
P
L
E
S
IC2
IC3
IC1
P R
S
U
23. Utility Analysis
■ Total satisfaction received from
consuming a good or service
■ Directly influence the demand
■ Consumers will strive to maximize their
utility
■ Cardinal utility vs ordinal utility
■ Types of Utility
– Total utility
– Marginal utility
– Zero utility
– Negative utility
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24. Utility Function
■ Cobb-Douglas utility function
– u(x, y) = x a y 1 - a.
■ Perfect Substitutes Utility Function
– U(X,Y) = aX + bY
■ Perfect Complements Utility Function
– U(X,Y) = MIN(aX,bY)
■ Marginal Utility
– MU(x) = dU/dx
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27. LAW OF DIMINISHING MARGINAL
UTILITY
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■ As Consumption increases
utility decreases
■ Assumptions
– All units of given commodity are
homogenous
– Consumption is continuous
– Only one type of commodity
– Utility can be measured
cardinally
– Consumer is rational human
being and aims at maximum of
satisfaction
28. Exceptions and Limitations
Exceptions
■ Rare collections
■ Not fully applicable to
money
■ Unreasonable quantity
■ Habitual goods
■ Durable and valuable goods
Limitations
■ Unrealistic assumptions -
homogeneity, continuity, and
constancy
■ Inapplicability to certain
goods
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29. Applications and Importance
■ Basic law of consumption
■ Reason for bringing variety in consumption and production
■ Diamond-water paradox
■ Progression in taxation
■ Socialist plea for an equitable distribution of wealth.
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31. LAW OF EQUI MARGINAL UTILITY
■ Consumer is in equilibrium
position
■ Marginal utility of money
expenditure on each goods is
same.
■ Given by Australian economists
H. H. Gossen
■ Law of maximum satisfaction or
Law of substitution
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32. Assumption
■ No change in price of
goods.
■ Income of consumer is
fixed..
■ Marginal utility of money is
constant..
■ Consumer has perfect
knowledge of utility.
■ Consumer tries to seek
maximum satisfaction.
Applications
■ Helpful in the field of
production
■ Field of exchange
■ Public finance
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33. Summary
■ Demand Theory
■ Indifference Curve
– Properties
– Applications
– Different Shapes
■ Budget Line
■ Utility Analysis
■ Law of Diminishing Marginal Utility
■ Law of equi-marginal Utility
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