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Based on Latest Syllabus of MBA prescribed By
Maharshi Dayanand University, Rohtak (DDE)
M.B.A.
1st Semester
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CONTENTS
MANAGERIAL ECONOMICS
ACCOUNTING FOR MANAGERS
INDIAN ETHOS AND VALUES
UNIT –II....................................................................27-77
UNIT –III.................................................................78-121
UNIT –IV...............................................................122-134
Past Year Question Paper......................................135-139
Worksheet............................................................140-142
Syllabus...............................................................143-143
UNIT –I.................................................................144-175
UNIT –II................................................................176-202
UNIT –III...............................................................203-227
UNI –IV................................................................228-246
Worksheet............................................................254-256
Syllabus...............................................................257-257
UNIT –I.................................................................258-270
UNIT –II................................................................271-283
UNIT –III...............................................................284-298
UNI –IV................................................................299-304
Worksheet............................................................310-312
Syllabus......................................................................5-5
UNIT –I.......................................................................6-26
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UNIT-I
UNIT-II
UNIT-III
UNIT-IV
Nature of managerial economics; significance in managerial decision
making, role and responsibility of managerial economist; objectives of a
firm; basic concepts - short and long run, firm and industry,
classification of goods and markets, opportunity cost, risk and
uncertainty and profit; nature of marginal analysis.
Nature and types of demand; Law of demand; demand elasticity;
elasticity of substitution; consumer's equilibrium – utility and
indifference curve approaches; techniques of demand estimation.
Short-run and long-run production functions; optimal input
combination; short-run and long-run cost curves and their
interrelationship; engineering cost curves; economies of scale;
equilibrium of firm and industry under perfect competition, monopoly,
monopolistic competition and oligopoly; price discrimination.
Baumol's theory of sales revenue maximisation basic techniques of
average cost pricing; peak load pricing; limit pricing; multi-product
pricing; pricing strategies and tactics; transfer pricing.
5
MBA–1st SEMESTER, M.D.U., ROHTAK
SYLLABUS
External Marks : 70
Time : 3 hrs.
Internal Marks : 30
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Q. What do you mean by Managerial Economics. Explain its Nature and
Scope.
:–
:–
According to McNair and Meriam :–
According to Mansfield :–
:–
Managerial Economics is a Science :–
Ans. Managerial economics is the study
of economic theories, logic and tools of economic analysis that are used in the
process of business decision making. Economic theories and techniques of
economic analysis are applied to analyse business problems, evaluate
business options and opportunities with a view to arriving at an appropriate
business decision. Managerial economics is thus constituted of that part of
economic knowledge, logic, theories and analytical tools that are used for
rational business decision-making.
Managerial economics is that subject which describes how economic analysis
is used in taking business decisions. The purpose of Managerial Economics is
to show how economic analysis can be used in formulating business policies.
Managerial economics is that discipline which uses economic concepts,
principles and economic analysis in taking business decision and formulating
future plans. It integrates economic theory with business practice for choosing
business policies. Managerial economics lies on the borderline between
economics and business management and bridges the gap between the two.
“Managerial economics…… is the use of economic modes of thought to
analyse business situation”.
“Managerial economics is concerned with the application of economic
concepts and economics analysis to the problems of formulating rational
decision making”.
1. Managerial economics is a science
because it establishes relationship between causes and effects. It studies the
Meaning of Managerial Economics
Definition of Managerial Economics
Nature or Characteristics of Managerial Economics
MBA 1st Semester (DDE)
UNIT – I
6
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effects of a change in price of a commodity factors and forces on the demand of a
particular product. It also studies the effects and implications of the plans,
policies and programmes of a firm on its sales and profit.
2. Managerial economics may also be
called an art. Because it also develops the best way of doing things. It helps
management in the best and most efficient utilization of limited economic
resources of the firm.
3. Entire study of
economics may be divided into two segments- Macro economics and Micro
economics. Managerial economics is mainly micro-economics. Micro-
economics is the study of the behaviour and problems of individual economic
unit. In managerial economics unit of study is firm or business organization
and an individual industry. It is the problem of business firms such as problem
of forecasting demand, cost of production, pricing, profit planning, capital,
management etc.
4. Managerial
economics largely use that body of economic concepts and principles which is
known as ‘Theory of the Firm’ or ‘Economics of the Firm’.
5. Managerial
economics also uses macro-economics to analysis and understand the general
business environment in which the business firm must operate. Business
management must have the adequate knowledge of external forces that affect
the business of the firm. The important macro-factors that affect the firm are
trends in national income and expenditure, business cycles, economic policies
of the government, trends in foreign trade etc.
6. It is concerned with practical
problems and results. It has nothing to do with abstract economic theory which
has no practical application to solve the problems faced by business firms.
7. There are two types of
science-Normative Science and Positive Science. Positive science studies what
is being done. Normative science studies what should be done. From this point
of view, it can be concluded that managerial economics is normative science
because it suggests what should be done under particular circumstances.
Managerial economics is the application of
economic theories in the process of decision-making and formulation of future
plans. The management will have to analyse the business problems that are
faced by the firm. Thus, the principles relating to following topics constitute the
scope of subject matter of managerial economics:
1 A business firm is in an economic organization which
is engaged in transforming productive resources into goods that are to be sold
Managerial Economics is an Art :–
Managerial Economics is a Micro Economics :–
Managerial Economics is the Economics of firms :–
Managerial Economics uses Macro-economic Analysis :–
Managerial Economics is Progmatic :–
Managerial Economics is Normative Science :–
:–
Demand Analysis :–
Scope of Managerial Economics
7
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in the market. A major part of managerial decision-making depends on
accurate estimates of demand. A forecast of future sales serves as a guide to
management for preparing production schedules and employing resources. It
will help management to maintain or strengthen its market position and profit-
base. Demand analysis also identifies a number of other factors influencing the
demand for a product. Demand analysis and forecasting occupies a strategic
place in Managerial Economics.
2 Cost estimates are most useful for management
decisions. The different factors that cause variations in cost estimates should
be given due consideration for planning purpose. There is the element of
uncertainty of cost as other factor influencing cost are either uncontrollable or
not always known.
3 As price gives income to the firm, it
constitutes as the most important field of Managerial Economics. The success
of a business firm depends very much on the correctness of the price decision
taken by it. The various aspects that are deal under it cover the price
determination in various market forms, pricing policies, pricing method,
different pricing, productive pricing and price forecasting.
4 The chief purpose of a business firm is to earn the
maximum profit. There is always an element of uncertainty about profits
because of variation in cost and revenue. If knowledge about the future were
perfect, profit analysis would have been very easy task. But in this world of
uncertainty expectations are not always realized. Hence profit planning and its
measurement constitute the most difficult area of managerial economics.
Under profit management we study nature and management of profit, profit
policies and techniques of profit planning like Break Even Analysis.
5 The problems relating to firm’s capital
investments are perhaps the most complex and the troublesome. Capital
management implies planning and control of capital expenditure. The main
topics deal with under capital management are cost of capital, rate of return
and selection of projects.
6 The environmental factors
influence the working and performance of a business undertaking. Therefore,
the managers will have to consider the environmental factors in the process of
decision-making. The factors which constitute economic environment of a
country include the following factors:
Economic System of the Country
Business Cycles
Fluctuations in National Income and National Production
Cost Analysis :–
Pricing Practices and Policies :–
Profit Management :–
Capital Management :–
Analysis of Business Environment :–
Ø
Ø
Ø
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Industrial Policy of the Government
Trade and Fiscal Policy of the Government
Taxation Policy
Licensing Policy etc.
Political Environment
Social Factors
Trend in labour and capital markets.
Ans. Managerial economics is the study
of economic theories, logic and tools of economic analysis that are used in the
process of business decision making. Economic theories and techniques of
economic analysis are applied to analyse business problems, evaluate
business options and opportunities with a view to arriving at an appropriate
business decision. Managerial economics is thus constituted of that part of
economic knowledge, logic, theories and analytical tools that are used for
rational business decision-making.
Managerial economics is that subject which describes how economic analysis
is used in taking business decisions. The purpose of Managerial Economics is
to show how economic analysis can be used in formulating business policies.
Managerial economics is that discipline which uses economic concepts,
principles and economic analysis in taking business decision and formulating
future plans. It integrates economic theory with business practice for choosing
business policies. Managerial economics lies on the borderline between
economics and business management and bridges the gap between the two.
“Managerial economics…… is the use of economic modes of thought to
analyse business situation”.
“Managerial economics is concerned with the application of economic
concepts and economics analysis to the problems of formulating rational
decision making”.
The most important function of management of a business firms is decision
making and future planning. Business decision-making is essentially a
process of selecting the best out of alternative opportunities open to the firm.
The process of decision-making comprises following phases :–
(i) Determining and defining the objective to be achieved
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Q. What do you mean by Managerial Economics? Explain its
significance in Managerial Decision Making.
Meaning of Managerial Economics :–
:–
According to McNair and Meriam :–
According to Mansfield :–
:–
Definition of Managerial Economics
Significance of Managerial Economics in Managerial Decision Making
9
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(ii) Developing and analyzing possible course of action; and
(iii) Selecting a particular course of action.
(1)
Managerial economics attempts to
reconcile the tools, techniques, models and theories of economics with actual
business practices and with the environment in which a firm has to operate.
Analytical techniques of economic theory builds models by which we arrive at
certain assumptions and conclusions are reached thereon in relation to certain
firms. There is need to reconcile the theoretical principles based on simplified
assumptions with actual business practice and develop the economic theory, if
necessary.
(2) Managerial economics plays an
important role in business planning and decision making by estimating
economic relationship between different business factors- income, elasticity of
demand like price elasticity, income elasticity, cross elasticity and cost volume
profit analysis etc. The estimates of this economic relationship can be used for
purpose of business forecasts.
(3) Sound business plans and
policies for future can be formulated on the basis of economic quantities.
Managerial economics helps the management in predicting various economic
quantities such as:
Cost
Profit
Demand
Capital
Production
Price etc.
Since a business manager has to work in an environment of uncertainty,
future should be well predicted in the light of these quantities.
(4) The management has to
identify all the important factors that influence firm. These factors broadly
divided into two parts- Internal Factors and External Factors. External factors
are the factors over which a firm cannot have any control. Therefore, the plans,
policies and programmes of the firm should be adjusted in the light of these
factors. Important external factors affecting decision-making process of a firm
are:
Economic System of the Country
Business Cycles
Fluctuations in National Income and National Production
Industrial Policy of the Government
Economic analysis helps the management in following ways:-
Reconciling Theoretical Concepts of economics to the Actual
Business Behaviour and Conditions :–
Estimating Economic Relationship :–
Predicting Relevant Economic Quantities :–
Understanding Significant External Forces :–
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Ø
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Trade and Fiscal Policy of the Government
Taxation Policy
Licensing Policy etc.
Managerial economics plays an important role by assisting management
in understanding these factors.
(5) Managerial economics is the foundation of
all business policies. All the business policies are prepared on the basis of
studies and findings of managerial economics. It warns the management
against all the turning points in national as well as international economy.
(6) It gives clear
understanding of various economic concepts (i.e, cost, price, demand etc.) used
in business analysis. For example , the concept of cost includes ‘total’,
‘average’, ‘marginal’, ‘fixed’, ‘variable’, ‘actual cost’, and opportunity cost.
Economics clarifies which cost concepts are relevant and in what context.
(7) Managerial Economics provides
a number of tools and methods which increases the analytical capabilities of
the business analysis.
Ans. Managerial Economist is an expert who
counsels business management in economic matters and problems faced by a
business organization.
Taking business decision and formulating forward plans are two important
jobs of business management. Specialized skills are needed to perform these
jobs efficiently. The managerial economist can assist the management in using
the specialized skill to solve the problems of business to formulate business
policies.
One of the main functions of any
management is to determine the key factor which influences the business over
a period of time. This function is performed by a Managerial Economist. In
general, the factors which influence the business over a period to come fall
under two categories:
(A) The external factors are beyond the control of
management.
(B) The internal factors are well within the control of
management.
(A) The external factors operate outside the
firm and firm has no control over these. Such factors constitute business
Ø
Ø
Ø
Basis of Business Policies :–
Clear Understanding of Economic Concepts :–
Increases the Analytical Capabilities :–
Q. Who is Managerial Economist? Discuss the Role and Responsibility
of Managerial Economist.
:–
:–
External Factors :–
Internal Factors :–
Thus, the role of Managerial Economist are :–
Analysis of External Factors :–
Managerial Economist
Role of Managerial Economist
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environment and include prices, national income and output, business cycle,
government policies, international trends, etc. These factors are of great
importance to the firm. Managerial economists by studying and analyzing
these factors can contribute effectively in determining business policies.
Certain relevant question relating to these factors are:-
(i) What are the present trends in nations and international economics?
(ii) What phase of business cycle lies immediately ahead?
(iii) Where are the market and customer opportunities likely to expand or
contract most rapidly?
(iv) What are the possibilities of demand and prices of finished products?
(v) Is competition likely to increase or decrease?
(vi) What changes are expected in government policies and control?
(vii) What are the demand prospects in new and the established markets?
(B) Internal factors are known as business
operations. In other words internal activities of a firm are called business
operations. A managerial economists can also help the management to
solve problems relating the business operation such as price
determination, use of installed capacity, investment decision, expansion
and diversification of business etc. Relevant questions in this context are
as follows:-
(i) What will be the reasonable sales and profit targets for the next year?
(ii) What will be the most appropriate production schedules and the
inventory policy for the next five or six months?
(iii) What changes in wage and price policies should be made now?
(iv) How much cash will be available in the coming months and how it
should be invested?
(C) These Specific functions are as under :–
(i) Sales Forecasting
(ii) Market Research
(iii) Economic Analysis of competing firms.
(iv) Pricing problem of the industry
(v) Evaluation of Capital Projects.
(vi) Advice on foreign exchange.
(vii) Advice on trade and public relations
(viii) Environmental forecasting.
(ix) Investment analysis and forecasts
(x) Production and inventory schedule
(xi) Marketing function.
(xii) Analysis of underdeveloped economics
1. He must have
Analysis of Internal Factors :–
Specific Functions :–
:–
To make reasonable profits on capital employed :–
Responsibilities of a Managerial Economist
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strong conviction that profits are essential and his main obligation is to
assist the management in earning reasonable profits on capital invested
by the firm. He should always help the management to enhance the
capacity of the firm to earn profits. If he fails to discharge this
responsibility then his academic knowledge, experience and business
skill will be of no use to the firm.
2. It is necessary for the managerial economist to
make successful forecasts by making in depth study of internal and
external factors that may have influence over the profitability or the
working of the firm. A managerial economist is supposed to forecast the
trends in the activities of importance to the firm such as sales, profit,
demand, costs etc.
3. A managerial
economist should establish and maintain close contacts with specialists
and data sources in order to collect quickly the relevant and valuable
information in the field. For this purpose he should develop personal
relation with those having specialized knowledge of the field. He should
also join professional associations and take active part in their activities.
4. A managerial economist must earn full status in
the business ream because only then he can be really helpful to the
management in formulating successful business policies.
Ans. Conventional theory of firm assumes profit
maximization, as the sole objective of business firms. Recent researchers on
this issue reveal that the objectives that business firms pursue are more than
one. Some important objectives, other than profit maximization, are:-
(i) Maximization of Sales Revenue
(ii) Maximization of Firm’s growth rate
(iii) Maximization of manager’s utility function
(iv) Long-run survival of the firm
Therefore the objectives of the Business firms are
Main Objective Alternative Objectives
Profit Maximization Maximization of Sales Revenue
Maximization of Firm’s growth rate
Maximization of manager’s utility function
Long-run survival of the firm
Successful Forecasts :–
Knowledge of Sources of Economic Informations :–
His Status in the Firm :–
Q. What are the objectives of Business Firms?
:–
Objectives of Business Firms
Introduction
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(A)
1. According to traditional
economic theory profit maximization is the sole objective of business
firms. The traditional theory suggests a number of reasons as to why does
a firm want to maximize profits. All these reasons essentially fall into the
following categories:
(i) Traditional economic theory assumes that the firm is owner-
managed, and therefore maximizing profit would imply maximizing
the income of the owner; Owner would like to have adequate return
for his activity as n entrepreneur.
(ii) Firm may pursue goals other than profit-maximization, but they can
achieve these subsidiary goals much easier if they aim for profit
maximization.
Under perfect competition individual firms have to maximize their profits
at price determined by industry. Under imperfect competition firms search
their profit maximizing price output as they are price makers. The profit can be
defined as the difference between total revenue and total cost.
A firm will maximize its profit at that level of output at which the difference
between total revenue and total cost is maximum. Generally conventional price
theory determines profit maximizing price-output in terms of marginal cost
and marginal revenue.
Marginal revenue is the addition to total revenue from the
sale of an additional unit of a commodity.
Marginal Cost :– Marginal cost is the addition to total cost from the production
of an additional unit of a commodity.
The two profit maximizing conditions are :–
1. We take first condition
(i) If MC<MR total profits are not maximized because firm will earn more
profits by increasing output.
(ii) If MC>MR the level of total profit is being reduced and firm can
increase profit by decreasing production.
(iii) If MC = MR the profits could not increase either by increasing or
decreasing output and hence profits are maximized.
(b) MC cuts MR from below :– Now we take the second condition. The
second condition of profit maximization requires that MC be rising at
the point of its intersection with the MR curve
Main Objectives :–
Profit Maximization Goal of a Business Firm :–
Profit = Total Revenue - Total Cost.
Marginal Revenue :–
MC = MR :–
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At point E both the conditions are satisfied.
a) The real world business environment is more complex than what
convention theory of firm thought. The modern business firms face lot of
risk and uncertainty. Long-run survival is more important than short-run
profit.
b) The other objectives such as – sales maximization, growth rate
maximization etc. describe real business behavior more accurately.
c) Profit maximization objective cannot be realized without the exact
measurement of marginal cost and marginal revenue.
d) Profits are not only measure of firm’s efficiency.
e) Profit maximization assumption may require expansion of business which
means more risks. But firms may prefer less profit instead of bearing
additional uncertainties.
(B)
(1) Baumol’s
theory of sales maximization is an alternative theory of firm’s behaviour.
The basic premise of his theory is that sales maximization, rather than
profit maximization, is the plausible goal of the business firms. He argues
that there is no reason to believe that all firms seek to maximize their
profits. Business firms, in fact, pursue a number of objectives and it is not
easy to single out one as the most common objective pursued by the firms.
However, from his experience as a consultant to many big business
houses, Baumol finds that most managers seek to maximize sales revenue
rather than profits.
(2) According to Robin Marris
managers maximize firm’s balanced growth rate. He defines firm’s
balanced growth rate (G) as
Criticism of profit Maximization Approach :–
Alternative Objectives of Business Firms :– There are the following
objectives:
Baumol’s Hypothesis of Sales Revenue Maximization :–
Maximization of firm’s growth rate :–
Y
P
O
M
A
Cost/Revenue
Q X
E
MC
AR=MR
OUTPUT
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G = G = G
Maximization of Managerial Utility Function :–
Long-Run Survival of the firm :–
Q. Write a short note on the following :–
(A) Short-Run
(B) Long-Run
(C) Firm
(D) Industry
(E) Classification of Goods
(F) Classification of Markets
(G) Opportunity Cost
(H) Risk
(I) Uncertainty
(J) Profit
(K) Nature of Marginal Analysis.
(A) :–
D C
Where G = Growth rate of demand for firms product
G = Growth rate of capital supply to the firm
In simple words, a firm’s growth rate is balance when demand for its
product and supply of capital to the firm increase at the same rate.
(3) According to this
concept managers seek to maximize their own utility function subject to a
minimum level of profit.
(4) According to this concept, the primary
goal of the firm is long-run survival. The managers, therefore, seek to
secure their market share and long-run survival. The firms may seek to
maximize their profit in the long-run though it is not certain.
Ans.
Short-Run refers to that time period in which supply of a
commodity can be increased only up to its existing production capacity. If
demand has increased, there is not enough time for a firm to install new
machines nor for the new firms to enter the industry. The main features of
short-run are :–
(1) In the short-run there are two types of factors of production:-
Fixed Factors
Variable Factors
(2) In the short-run supply can be changed only by varying variable
factors.
(3) The fixed factors cannot be changed.
(4) In short-run demand plays greater role than supply in the
determination of price.
D
C
Short-Run
Ø
Ø
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(5) The price that is determined in the short period is called Sub-normal
price.
(6) There are two types of cost in the short-run:-
The costs of fixed inputs are called fixed costs.
Fixed costs are costs which do not change with changes in the
quantity of output.
Variable costs are those costs which are
incurred on the use of variable factors of production.
Supposing you have a carpet manufacturing factory. If you run
your factory for full 24 hours, you can produce 10 carpets at the most.
Supposing demand for carpets increases to 20 carpets per day for two days
only. You will be unable to meet this additional demand. Your maximum
production capacity is limited to 10 carpets only. You do not have time to install
new looms to increase your production.
Long-Run refers to that time period in which supply of a
commodity can be increased or decreased according to the changed
conditions of demand. The increased demand can be met with increasing
the supply by installing machines. Or new firms can enter the industry.
On the contrary, if demand has gone down, some firms will discontinue
their production. Price, in the long-run is therefore, more influence by
supply than demand. Price that comes to prevail in the long-run is called
Normal Price. The main features of long-run are:-
(1) In the long-run all factors are variable.
(2) In the long-run supply can be changed by varying all factors of
production.
(3) In long-run demand and supply both plays equal role in the
determination of price.
(4) The price that is determined in the long period is called Normal Price.
(5) In the long-run supply can be increased or decreased according to
the demand.
(6) In the long-run new firms can enter the industry and old firms can
leave it.
A firm is a unit engaged in the production for sale at a profit and
with the objective of maximizing the profit. A firm is in equilibrium when it
is satisfied with its existing amount of output. A firm is in equilibrium has
no tendency either to increase or to decrease its output. The objectives of a
firm are:-
Ø
Ø
Fixed Cost :–
Variable Cost :–
Example :–
(B) :–
(C) :–
Long-Run
Firm
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Objectives of Business Firms
Main Objective Alternative Objectives
Profit Maximization Maximization of Sales Revenue
Maximization of Firm’s growth rate
Maximization of manager’s utility function
Long-run survival of the firm
The group of firms producing homogenous products is called
industry. Homogeneous products are those products in which it is not possible
to make any distinction between the units of the commodity being sold by
different sellers. Such firms are found only under perfect competition. Perfect
competition is that situation of the market in which there are large number of
buyers and sellers of homogeneous product. Under perfect competition, price
of the commodity is determined by the industry. In perfect competition market
firm is a price-taker and not a price-maker.
An industry is in equilibrium when it has no
tendency to change its size. There are two conditions of an industry’s
equilibrium:
(1) An industry will be in equilibrium
when the number of its firms remains constant. In this situation, no
new firm will enter and no old firm will leave the industry.
(2) Another condition of an Industry’s
equilibrium is that all firms operating in it are in equilibrium and
have no tendency either to increase or to decrease their output.
Conditions of equilibrium of firm are:
(i) MC=MR
(ii) MC curve cuts MR curve from below
At point E both the conditions are satisfied.
(D) :–
Equilibrium of Industry :–
Constant Number of Firms :–
Equilibrium of Firms :–
Industry
Y
P
O
M
A
Cost/Revenue
Q X
E
MC
AR=MR
OUTPUT
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(E) There are basically three types of goods :–
1. Those goods which are directly put to use are called
consumer’s goods. These goods are used in our daily life. For example:-
Bread, Cloth, Medicines etc.
2. This classification includes durable or semi-durable
items. Shopping goods purchase are characterized by Pre-Planning,
information search & price comparisons. It is divided into:
(i) Homogeneous products are those goods in
which it is not possible to make any distinction between the units of
the commodity being sold by different sellers.
(ii) Heterogeneous goods mean that goods are
close substitutes but are not homogeneous. They differ in colour,
name, packing, shape, size, quality etc.
3. Those goods which are used in production
by other industries are capital goods. Huge amount is invested in these
goods. For Example:- Machinery, Plant, etc.
4. Some industries manufacture such goods as are
processed in some other industry to produce some need goods. Such
goods are called intermediate goods. For example :– Plastic, rubber,
aluminum etc.
5. The purchase of specialty goods is characterized by
extensive search to accept substitutes once the purchase choice has been
made. The market for such goods is small but price & profits are high.
6. Normal goods are those goods the demand for which
tends to increase following increase in consumer’s income, and tends to
decrease following decrease in his income. So, there is a positive
relationship between consumer’s income and quantity demanded.
7. Inferior goods are those goods the demand for which
tends to decline following a rise in consumer’s income, and tends to
increase following a fall in his income. So there is an inverse relationship
between income of the consumer and demand for a commodity.
8. In case of necessaries of
life and inexpensive goods, the demand remains almost constant
irrespective of the level of income.
9. A luxury good means an increase in income causes a
bigger % increase in demand.
(F) In economics the term market refers not
necessarily to a particular place but to the mechanism by which buyers
and sellers are brought together. The classification of markets are:-
Classification of Goods
Classification of Market
:–
Consumer’s Goods :–
Shopping Goods :–
Homogeneous Goods :–
Heterogeneous Goods :–
Producer’ or Capital Goods :–
Intermediate Goods :–
Specialty Goods :–
Normal Goods :–
Inferior Goods :–
Necessaries of Life and Inexpensive Goods :–
Luxury Good :–
:–
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Classification of Market
Perfect Competition :–
Imperfect Competition :–
Monopolistic Competition :–
Oligopoly :–
Perfect Competition Imperfect Competition Monopoly
Monopolistic Competition Oligopoly
1. Perfect competition refers to a market situation
where there is a large number of buyers and seller. The sellers sell
homogeneous product at a uniform price. The price is determined not by
the firm but by the industry. Features of Perfect Competition market are :–
(i) Large Number of Buyers and Sellers
(ii) Homogeneous Products
(iii) Free entry and exit of firms
(iv) Perfect Knowledge
(v) Absence of Selling costs
(vi) Price Taker.
2. There are two types of market under imperfect
competition :–
(a) Monopolistic competition is a market
structure in which there are many sellers of a commodity, but the
product of each seller differs from that of the other sellers on one
respect or the other. Thus product differentiation is the main feature
of monopolistic competition. The main feature of this market are :–
(i) Large Number of Buyers and Sellers
(ii) Product Differentiation.
(iii) Freedom of Entry and Exit of firms
(iv) Higher Selling Costs
(v) Price Control.
(vi) Imperfect Knowledge.
(vii) Non-Price Competition
(b) oligopoly is a market structure in which there are few
sellers selling a homogenous or differentiated products and large
number of buyers. The main features of oligopoly are :–
(i) Small number of sellers
(ii) Interdependence of decision-making.
(iii) Barriers to Entry
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3. Monopoly is a market situation in which there is a single
seller, there are no close substitutes for commodity it produces, there are
barriers to entry. The main features of this market are:-
(i) One Seller and Large Number of Buyers
(ii) Monopoly is also an Industry
(iii) Restriction on the entry of the new firms
(iv) Price Maker
(v) Price Discrimination
(G) The concept of opportunity cost is extremely
important in economic analysis. We know that the cost is the value of
inputs in the process of production. An input has got value because it is
scarce or limited. If we use the input to produce one good, it is not available
to produce something else. The cost of producing one thing is measured in
terms of what was given up in terms of next best alternative that is
sacrificed. If several opportunities are given up for producing a particular
commodity, it is the value of the next best foregone opportunity that
constitutes cost. Thus it is called opportunity cost. The opportunity cost is
the cost of next best alternative foregone. It is also called alternative cost.
Supposing a farmer can grow both wheat and gram on a farm.
If on a farm measuring one-hectare land he grows only wheat, he foregoes
the production of gram. If the price of quantity of gram that he foregoes is
Rs. 1,000, then the opportunity cost of growing wheat will be Rs. 1,000.
Thus, the price of gram which the farmer has to forgo in order to produce
wheat is called opportunity cost of wheat.
According to Leftwitch
“Opportunity cost of a particular product is the value of the foregone
alternative product that resources used in its production, could have produce
Monopoly :–
:–
Example :–
:–
Diagram of Opportunity Cost :–
Opportunity Cost
Definition of Opportunity Cost
X-Commodity
12
10
8
6
4
2
2 4 6 8 10 12
Y
P
P
X
O
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Explanation :–
OR
OR
Example :–
A priori approach :–
Posteriori approach :–
:–
In this figure the production line PP shows that if a given
quantity of resources is employed to produce both X and Y, it can produce
(a) 12 units of Y and nothing of X
(b) 6 units of X and nothing of Y
(c) Any combination of X and Y long the line.
This line shows that to produce X, we must forego the opportunity of
producing some of Y. This is called the opportunity cost of X in terms of Y. In
this figure the opportunity cost of one unit of X is 12Y/6 = 2Y. This means that
the same amount of factors of production that can produce 1 unit of X can
produce 2 units of Y. Likewise, the opportunity cost of producing one unit of Y
in term of X is 6X/12= 0.5 X. The same amount of factors of production
employed in the production of 1 unit of Y can produce 0.5 units of X. The
opportunity cost of Y interns of X is 0.5.
(H) :– In common practice, risk means a low profitability of an expected
outcome. From business decision-making point of view, risk refers to a
situation in which business decision is expected to yield more than one
outcome and the profitability of each outcome is known to the decision
makers or can be reliably estimated.
If a company doubles its advertisement expenditure, there are
three probable outcomes:-
(i) Its sales may more than double
(ii) It may just double
(iii) It may less than double.
The company has the knowledge of these probabilities of the three
outcomes on the basis of its past experience as
(i) more than double- 10%
(ii) almost double- 40%
(iii) Less than double-50%
It means that there is 90 % risk in more than doubling the sales and in
doubling the sale, the risk is 60% and so on.
There are two approaches to estimate probabilities of outcomes of a business
decision, viz.
(i) This approach based on intuition.
(ii) This approach is based on past data.
(I) Uncertainty refers to a situation in which there is more
than one outcome of a business decision and the probability of outcome is
not known or not meaningful. The unpredictability of outcome may be
due to :
Lack of Reliable market information
Risk
Uncertainty
Ø
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Inadequate past experience
(i) Life of new plant and future maintenance are unpredictable.
(ii) Technological changes are highly unpredictable.
(iii) The size of the market may not turn out to be as anticipated due to a
number of reasons like, changes in the pattern or fashions, tastes of
the people, etc.
(iv) It is not possible to base scientific judgments about the following
factors which affect the extent of prospective yields in the distant
future:
The extent of new competition
The prices which may fluctuate from year to year
The size of export market during the years to come.
Change in fiscal policies particularly in individual taxation and
corporate taxation, and policies with regard to labour and
wages.
Conditions in the labour market, changes in labour legislation,
level of wages, the possibilities of lockouts and strikes etc.
Political, climate etc.
The long term investment involves a great deal of uncertainty with
unpredictable outcome. But, in really investment decisions involving
uncertainty have to be taken on the basis of whatever information can be
collected, generated. For the purpose of decision-making, the uncertainty
is classified as :–
(i) In case of complete ignorance, investment
decisions are taken by the investors using their own judgment.
(ii) In case of partial ignorance, on the other hand,
there is some knowledge about the future market conditions, some
information can be obtained from the experts in the field and some
probability estimates can be made. The available information can be
incomplete and unreliable.
(J) Profit means different things to different people. “The word ‘profit’
has different meaning to businessmen, accountants, tax collectors,
workers and economists. In a general sense, ‘profit’ is regarded as income
accruing to the equity holders, in the same sense as wages accrue to the
labour, rent accrues to the owners of rentable assets and interest accrues
to the money lenders.
The two important concepts of profit in business
decisions are ‘economic profit’ and ‘accounting profit’. It will be useful to
understand the difference between the two concepts of profit.
Ø
Ø
Ø
Ø
Ø
Ø
Ø
Some Examples of Uncertainties :–
Complete Ignorance :–
Partial Ignorance :–
:–
Concepts of Profit :–
Profit
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(1) Accounting profit is surplus of revenue over and
above all paid-out costs, including both manufacturing and overhead
expenses. Accounting profit may be calculated as follows:
Where
TR= Total Revenue W= Wages and Salaries
R= Rent I=Interest
M=Cost of materials
Obvious, while calculating accounting profit, only explicit or book costs, i.e.,
the cost recorded in the books of accounts, are considered.
(2) The concept of economic profit differs
from that of accounting profit. Economic profit takes into account also the
implicit or imputed costs. The implicit cost is opportunity cost.
Opportunity cost is the income foregone which a businessman could
expect from the second best alternative use of his resources. There are the
following examples of opportunity cost:
(i) If an entrepreneur uses his capital in his own business, he foregoes
interest which he might earn by purchasing debentures of other
companies or by depositing his money with joint stock companies for
a period.
(ii) Furthermore, if an entrepreneur uses his labour in his own business,
he foregoes his income (Salary) which he might earn by working as a
manager in another firm.
(iii) Similarly, by using productive assets (land and building) in his own
business, he sacrifices his market rent.
These foregone incomes-interest, salary and rent are called opportunity
costs or transfer costs. Accounting profit does not take into account the
opportunity cost.
(K) The concept of marginal is widely used in
economic analysis. The nature of marginal analysis :
(1) Marginal analysis is related to a unit change in independent variable, say,
increase in cost as a result of a unit change in output, increase in product
as a result of a unit change in labour, increase in revenue as a result of a
unit change in sale, increase in utility as a result of a unit change in
consumption of units. These are explained in the following:
(a) The marginal utility can be defined as the
Accounting Profit :–
Accounting Profit = TR – (W +R + I + M)
Economic Profit or Pure Profit :–
Economic Profit = Total Revenue – (Explicit Costs –Implicit Costs)
:–
Marginal Utility (MU) :–
Nature of Margin Analysis
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change in total utility from the consumption of an additional or less
unit of a commodity.
MU= Marginal Utility TU = Change in Total Utility
Q = Change in Quantity
(b) Marginal cost can be defined as the change in
to total cost as result of producing one more or less unit of a
commodity.
MC= Marginal Cost TC = Change in Total Cost
(c) Marginal Product can be defined as the
change in total product as result of increasing or decreasing one more
unit of labour.
MP= Marginal Product TP = Change in Total Product
L = Change in Labour
(d) Marginal product can be defined as the
change in total revenue due to the sale of one additional unit of a
product.
MR= Marginal Revenue TR = Change in Total Revenue
(2) There are certain cases where marginal analysis is superior to any other
analysis. These include the selection of :–
(a) best product-mix, in cases where substitution between products
occurs at a decreasing rate.,
TU
MU= ————
Q
Marginal Cost (MC) :–
TC
MC= ————
Q
Marginal Product (MP) :–
TP
= ————
L
Marginal Revenue (MR) :–
TR
MR= ————
Q
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
MR
————
MP
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(b) least cost input-mix where inputs are substitutable at a decreasing
rate.
(c) Optimum input-level where input-output relationship faces
diminishing returns, and
(d) Optimum maturity of assets, having value decreasing over time.
(3) Whenever the cost and revenue functions are curvilinear, it is more
appropriate to use marginal analysis. Marginal analysis calls for unit-to-
unit comparison and would, therefore be able to capture the impact of all
points.
(4) In case of those functions which are linear, in such a case only the end
points of a range are to be compared, and marginal analysis would not give
any different results.
(5) In case of those alternatives, which are discrete, marginal analysis cannot
be used. If a producer wants to produce a particular level of output and
wants to make a choice between different technologies for the purpose, it
is not possible to compare these processes in terms of marginal cost of
moving from one process to another.
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MBA 1st Semester (DDE)
Q. Explain Demand and its various types. Also Explain the Determinants
of Demand.
:–
:–
According to Ferguson
:–
:–
1. Demand for Consumers’ Goods and Producers’ Goods :–
2. Demand for Perishable Goods and Durable Goods :–
Ans. Demand is defined as the quantities of a product
which a consumer is not only desiring to purchase and able to purchase but is
also ready to purchase at given prices at a given point of time.
“Demand refers to the quantities of a commodity that the consumers are
able and willing to but at each possible price during a given period of time, other
things being equal”.
(i) Desire for a thing.
(ii) Money to satisfy the desire.
(iii) Willingness to spend the money.
(iv) Relationship of the price and the quantity of the commodity demanded.
(v) Relationship of time and the quantity of the commodity demanded.
There are various types of demand:
i) Goods and services for final consumption are called consumers
goods. These include those consumed by human beings such as food
items, clothes, medicines etc. Demand for consumers goods is direct.
ii) Producers goods refer to the ones used for the production of other
goods such as plant and machines, factory buildings, raw materials
etc. Demand for producers goods is derived.
i) Perishable Goods are those goods which can be consumed only once.
For example:- bread, milk and vegetables etc.
Meaning of Demand
Definition of Demand
Constituents of Demand
Types of Demand
UNIT – II
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ii) Durable Goods are those goods the utility from which accrues over a
period of time. For example refrigerator, car, furniture etc.
(i) Goods that are demanded for their own sake have
direct demand.
(ii) Goods that are needed in order to obtain some
other goods possess indirect demand.
(i) Short-run demand represents the existing
demand which is based on immediate reaction to price changes,
income fluctuations and other explanatory variables.
(ii) Long-run demand on the other hand, is that
demand which emerges after the influence of price changes, product
improvement, promotional efforts and other factors over time is
allowed to adjust the market to the new situation. In the long run,
new customers may start purchasing the product. Some products
may not be demanded any more.
(i) When two goods are demanded in conjunction with
one another at the same time to satisfy a single want, they are said to
be joint demand. For Example:- Pens and ink, camera and film, Car
and petrol etc.
(ii) A commodity is said to be in composite
demand when it is wanted for several different uses.
(i) Individual demand schedule is defined as the
table which shows quantities of a given commodity which an
individual consumer will buy at all possible prices at a given time.
(ii) Market demand schedule is defined as the
quantities of a given commodity which all consumers will buy at all
possible prices at a given moment of time.
(i) Price demand refers to the various quantities of a
product purchased by the consumer at alternative prices.
3. Direct and Indirect Demand :–
Direct Demand :–
Indirect Demand :–
4. Short-Run Demand and Long-Run Demand :–
Short Run Demand :–
Long Run Demand :–
5. Joint Demand and Composite Demand :–
Joint Demand :–
Composite Demand :–
6. Individual Demand and Market Demand :–
Individual Demand :–
Market Demand :–
7. Price Demand, Income Demand and Cross Demand :–
Price Demand :–
D= f (P)
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(ii) Income demand refers to the various quantities
of a commodity demanded by the consumer at alternative levels of his
changing money income.
(iii) Cross demand refers to the various quantities of
commodity (say coffee) purchased by the consumer in relation to
change in the price of a related commodity (say tea) which may either
be a substitute or a complementary product.
Demand of a consumer for a particular
commodity is determined by the following factors:
(1) There is an inverse relationship between price and
demand for a commodity. When Price increases, then demand decreases
and when price decreases, then demand increases. It is also explained
with the help of following diagram :–
(2) Demand for a commodity depends not only on
its own price, but also upon the prices of related goods. Related goods are
broadly classified into two categories :–
(i) Substitutes goods are those goods which can be
substituted for each other, such as tea and coffee. Demand of tea is
related to the price of coffee. If price of coffee is raised people may shift
to tea, and vice-versa. In other words, in case of substitute the
demand of one good is positively related to the price of the other good.
Income Demand :–
D= f (Y)
Cross Demand :–
D = f (P )
:–
Price of Commodity :–
Price of Related Goods :–
Substitute Goods :–
a b
Determinants of Demand
Y
P1
P
O Q Q1
X
D
D
Price
of
Coffee
Quantity of Tea
Y
P1
P
O Q1 Q
X
D
D
Price
Quantity
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(ii) Complementary goods are those goods
which complete the demand for each other, such as car and petrol.
There is an inverse relationship between the demand for first good
and the price of the second good.
(3) There is a positive relation between income of
the consumer and his demand for a good in case of normal goods. But
there is a negative relation between income of the consumer and demand
for a good in case of inferior goods.
(i) There is a positive relation between income of the
consumer and his demand for a good in case of normal goods.
(ii) There is a negative relation between income of the
consumer and demand for a good in case of inferior goods.
(4) The demand for any goods and service
depends on individual’s tastes and preferences. Demand for those goods
increases for which consumers develop tastes and preferences.
Complementary Goods :–
Income of the Consumer :–
Normal Goods :–
Inferior Goods :–
Tastes and Preferences :–
Y
P1
P
O Q1 Q
X
D
D
Price
of
Car
Quantity of Petrol
Y
Y1
Y
O Q Q1
X
D
D
Income
of
Consumer
Quantity
Y1
Y
O Q1 Q
X
D
D
Income
of
Consumer
Quantity of Inferior Goods
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(5) If the consumer expects that price will rise in future, he
will buy more goods in the present even when price is high. In case, he
expects that prices will fall in future, he will either buy less in the present.
(6) Demand for certain products is
determined by climate or weather conditions. For example, in summer,
there is a greater demand for cold drinks, fans, coolers, etc.
(7) Market demand is influenced by change in size of
population. Increase in population leads to more demand and decrease in
population means less demand for them.
Ans Change in demand of two types :–
(A) Other things remaining the same,
when the quantity demanded changes consequent upon the change in
price only, then this change is shown by different points along the same
demand curve. Fall in price is followed by extension of demand and rise in
price is followed by contraction of demand.
Change in Quantity Demanded
Movement along the Demand Curve
(1) Extension of demand refers to a rise in quantity
demanded as a result of fall in price, other things remaining the same.
This can be explained with the help of following table and diagram:
5 1Kg Fall in Price
1 5 Kg Extension of
Demand
As shown in the above table, when price of apples is Rs.5 per Kg demand is for 1
Kg of apples, when it falls to Re. 1 per Kg demand extends to 5 Kg of apples.
Expectations :–
Climate and Weather Conditions :–
Size of Population :–
Q. Explain the difference between Increase in Demand and Extension of
Demand and Decrease in Demand and Contraction of demand.
OR
Q. Explain the Change in Demand.
. :–
:–
Change in Price alone
Extension of Demand :–
Extension of Demand
Price (Rs.) Quantity Demanded Description
Change in Demand
Movement Along Demand Curve
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Price
5
4
3
2
1
O 1 2 3 4 5
Quantity
Extension of
Demand
A
B
In this figure AB is the demand curve of apples. When price of apples is Rs.5 per
Kg demand is for 1 Kg of apples. The consumer is at point ‘A’ of the demand
curve. As the price of apples falls to Re. 1 per Kg demand extends to 5 Kg and
the consumer moves to point ‘B’ of the demand curve. Movement along the
demand curve from higher point (A) to lower point (B) is called extension of
demand.
(2) Contraction of Demand :– Contraction of demand refers to a fall in
quantity demanded as a result of rise in price, other things remaining the
same. This can be explained with the help of following table and diagram:
As shown in the above table, when price of apples is Rs.1 per Kg demand is
for 5 Kg of apples, when it rises to Re. 5 per Kg demand contracts to 1 Kg of
apples.
Extension of Demand
Price (Rs.) Quantity Demanded Description
1 5Kg Rise in Price
5 1 Kg Contraction
of Demand
Price
5
4
3
2
1
O 1 2 3 4 5
Quantity
Contraction of
Demand
A
B
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In this figure AB is the demand curve of apples. When price of apples is
Rs.1 per Kg demand is for 5 Kg of apples. The consumer is at point ‘B’ of the
demand curve. As the price of apples rises to Re. 5 per Kg demand contracts to 1
Kg and the consumer moves to point ‘A’ of the demand curve. Movement along
the demand curve from lower point (B) to higher point (A) is called contraction of
demand.
A change in any determinants of the demand
other than price will shift the entire demand curve to the right or to the left.
An increase in demand is shown as rightward shift. A decrease in demand
is a leftward shift of the entire demand curve.
Change in Demand
Shift of Demand Curve
(1) Increase in demand means rise in demand in
response to change in determinants of demand other than price of the
product. Increase in demand refers to rightward shift in demand curve.
Thus, demand may increase in two ways:
(i) When price of ice cream is Rs. 3 per
unit, demand is for 3 units. If price remains the same, i.e., Rs. 3 per
unit but demand goes up to 4 units, then it will be an instance of
increase in demand.
(ii) When price of ice cream is Rs. 3 per
unit, demand is for 3 units. If price rises to Rs. 4 per unit but demand
remains the same, that is, 3 units, then it will also be an instance of
increase in demand.
Same Price More Purchase
3 3
3 4
More Price Same Purchase
3 3
4 3
(B) :–
Change in Income, Tastes or Price of other goods
Increase in Demand :–
Same Price more Demand :–
More Price same Demand :–
This can be explained with the help of following Table and Diagram :–
Price of Ice Quantity
Cream (Rs.) Purchased
Shift in Demand Curve
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Causes of Increase in Demand :–
Decrease in Demand :–
Same Price Less Demand :–
Less Price same Demand :–
This can be explained with the help of following Table and Diagram :–
(i) Increase in Income
(ii) Rise in Price of Substitute Good
(iii) Fall in the price of complementary good
(iv) Favourable changes in tastes and preferences
(v) Expectation of rise in price
(vi) Increase in population.
(2) Decrease in demand means fall in demand in
response to change in determinants of demand other than price of the
product. Decrease in demand refers to leftward shift in demand curve.
Thus, demand may increase in two ways:
(i) When price of ice cream is Rs. 3 per
unit, demand is for 3 units. If price remains the same, i.e., Rs. 3 per
unit but demand goes down to 2 units, then it will be an instance of
decrease in demand.
(ii) When price of ice cream is Rs. 3 per unit,
demand is for 3 units. If price falls to Rs. 2 per unit but demand
remains the same, that is, 3 units, then it will also be an instance of
decrease in demand.
Same Price Less Purchase
3 3
3 2
Less Price Same Purchase
3 3
2 3
Price of Ice Quantity
Cream (Rs.) Purchased
Price
5
4
3
2
1
O 1 2 3 4 5
Quantity
Increase of
Demand
C
D
A
B
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Causes of Increase in Demand :–
:–
Extension of Demand :–
Increase in Demand :–
(i) Decrease in Income
(ii) Fall in Price of Substitute Good
(iii) Rise in the price of complementary good
(iv) UnFavourable changes in tastes and preferences
(v) Expectation of Fall in price
(vi) Decrease in population.
Extension of demand means rise in demand response
to fall in the price of a commodity, other things being equal. It is expressed by
the movement from a higher point to a lower point along the same demand
curve.
On the other hand, increase in demand refers to rise in
demand response to change in the determinants of demand other than the
price. It is expressed by the upward shift of the entire demand curve.
This difference can be explained with the help of following diagram :–
This figure shows the distinction between extension and increase in
demand. DD is the initial Demand Curve. This figure shows that from the point
A of the demand curve DD two quite different rise in demand are possible. One
Difference between Extension and Increase in Demand
Price
P
P1
O
Quantity
Increase of
Demand
D
D
D1
D1
Q Q1
Extension in
Demand
A
B
C
Price
5
4
3
2
1
O 1 2 3 4 5
Quantity
Decrease of
Demand
C
D
A
B
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is a rise in the quantity demanded from OQ to OQ , moving along the same
curve from point A to B. Such a rise in quantity demanded results from
consumer’s adjustment to a reduction in price from OP to OP . It is called
extension of demand.
The second is the shift in the entire demand curve from DD to D D . At the
initial price OP the consumer used to purchase OQ, as shown by point A but
now purchases OQ as shown by point C. This change in demand is the
response to change in any determinant of demand, other than the price. This
change is called increase in demand.
:–
Contraction of demand :– Contraction in demand means fall in demand in
response to a rise in the price of a commodity, other things being equal. It is
expressed by the movement from a lower point to a higher point on the same
demand curve.
Decrease in Demand :– On the other hand, decrease in demand refers to fall in
demand response to change in the determinants of demand other than the
price. It is expressed by the downward shift of the entire demand curve.
This difference can be explained with the help of following diagram :–
This figure shows the distinction between Contraction and decrease in
demand. DD is the initial Demand Curve. This figure shows that from the point
A of the demand curve DD two quite different reduction in demand are possible.
One is a fall in the quantity demanded from OQ to OQ , moving along the same
curve from point A to B. Such a fall in quantity demanded results from
consumer’s adjustment to a rise in price from OP to OP . It is called contraction
of demand.
The second is the shift in the entire demand curve from DD to D D . At the
initial price OP the consumer used to purchase OQ. But now purchases OQ .
This change in demand is the response to change in any determinant of
demand, other than the price. This change is called decrease in demand.
1
1
1 1
1
1
1
1 1
1
Difference between Contraction and Decrease in Demand
Price
P
P
1
O
Quantity
Contraction of
Demand
D1
D1
D
D
Q Q
1
Decrease
in
Demand
A
B
C
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Q. Explain the Law of Demand. OR
Q. Why does the demand curve slope downwards to the right?
:–
:–
Meaning :–
:–
According to Marshall
:–
:–
:–
Individual Demand Schedule :–
Ans. Demand is defined as the quantities of a product
which a consumer is not only desiring to purchase and able to purchase but is
also ready to purchase at given prices at a given point of time.
Law of demand states that, other things being equal, the demand
for a good extends with a fall in price and contracts with a rise in price.
According to law of demand there is an inverse relationship between price and
demand for a commodity.
“The law of demand states that amount demanded increases with a fall in
price and diminishes when price increases, other things being equal”.
Assumptions of the law of demand are that all the determinants
of demand other than the price of good remain unchanged. There are the
following assumptions:-
(1) There should be no change in the price of related goods
(2) There should be no change in the income of the consumer
(3) There should be no change in the tastes and preference of consumer
(4) The consumer does not expect any change in the price of the
commodity in the near future.
(5) There is no change in weather conditions.
Law of demand can be explained with the
help of schedule and diagram :
(A) Demand schedule is a table that shows different
prices of a good and the quantity of that good demanded at each of these
prices. It has two aspects:-
(1) Individual demand schedule is defined
as the table which shows quantities of a given commodity which an
individual consumer will buy at all possible prices at a given time. The
following table shows Individual demand schedule:
Meaning of Demand
Law of Demand
Definition
Assumption
Explanation of Law of Demand
Demand Schedule
Price Per Unit (in Rs.) Quantity Demanded (Units)
1 4
2 3
3 2
4 1
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Above schedule indicates that as the price of Ice cream increases, its
demand tends to contract.
(2) Market demand schedule is defined as the
possible prices at a given moment of time. The following table show market
demand schedule. The schedule is based on the assumption that there
are, in all two consumers ‘A’ and ‘B’.
1 4 5 4+5=9
2 3 4 3+4=7
3 2 3 2+3=5
4 1 2 1+2=3
Above schedule indicates that as the price of Ice Cream increases, its market
demand tends to contract.
(B) The demand curve is a graphic presentation of a
demand schedule. The curve which shows the relation between the price
of a commodity and the amount of the commodity that the consumer
wishes to purchase, is called demand curve. It has two aspects:-
(1) Individual demand curve is a curve which
shows quantities of a given commodity which an individual consumer will
buy at all possible prices at a given time. The following figure shows
Individual demand curve:
Quantity demanded is shown on OX-axis. And the price is shown on OY-axis.
DD is the demand curve. Each point on the demand curve expresses the
Market Demand Schedule :–
Price of Demand Demand Market
Commodity of A of B (A+B)
:–
Individual Demand Curve :–
Demand
Demand Curve
4
4
3
3
2
2
1
1
Quantity
Price
Individual
Demand
D
Y
O
D
X
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relation between price and demand. At a price of Rs. 1 per unit, demand is for 4
units and at a price of Rs. 4 per unit, demand is for 1 unit.
(2) Market demand curve is defined as the
possible prices at a given moment of time. The following curve shows
market demand. The curve is based on the assumption that there are, in
all two consumers ‘A’ and ‘B’.
Quantity demanded is shown on OX-axis. And the price is shown on OY-axis.
DD is the demand curve. Each point on the demand curve expresses the
relation between price and demand. At a price of Rs. 1 per unit, market demand
is for 9 units and at a price of Rs. 4 per unit, demand is for 3 units.
1. A consumer demands a
commodity because it has utility. As he consumes more and more units of
a commodity, in a given time, the utility derived from each successive unit
goes on diminishing. Obviously, a consumer will buy an additional unit of
a commodity only if he has to pay less price for it compared to the previous
unit.
2. Income effect is the effect that a change in a person’s real
income caused by change in the price of a commodity has on the quantity
of that commodity. When the relative price of a good decrease, less of a
person’s income would need to be spent to purchase exactly the same
amount of the good; therefore it is possible to purchase more because of
this rise in purchasing power.
Suppose your income is Rs. 15 per day. You want to buy
apples whose price is Rs. 5 per Kg. It means with your fixed income of Rs.
15 you can buy three Kg. In case, the price of apples comes down to Rs. 3
Market Demand Curve :–
Causes of Law of Demand OR Why does Demand Curve slope
downward :–
Law of Diminishing Marginal Utility :–
Income Effect :–
For Example :–
4
8 10
3
6
2
4
1
2
Price
Market
Demand
D
Y
O
D
X
Quantity
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per Kg then after buying 3Kg of apples you will be left with Rs.6. This
increased income may be spent on buying two more Kg of apples.
Thus fall in price causes increase in real income and so extension in
demand. On the contrary, rise in price causes decrease in real income and
so contraction in demand.
3. The substitution effect is the effect that a change in
relative prices of substitute goods has on the quantity demanded.
Substitutes are goods that can be used in place of each other. For
example, tea and coffee, coca cola and Pepsi cola are substitutes. In order
to get maximum satisfaction with a fixed income, a consumer will
substitute a lower priced goods for higher priced one.
Tea and coffee are substitutes of each other. If price of tea
goes down, the consumers may substitute tea for coffee, although price of
coffee remains the same.
4. Some goods have more than one use. Milk, for example,
may be used for drinking and for making curd and cheese. At its very high
price, an individual consumer may buy milk only for drinking; but at the
reduced price more milk may be bought for making curd and cheese as
well.
5. When the price of a commodity falls, then
many consumers, who are unable to buy that commodity at its previous
price, come forward to but it. Consequently, the total number of
consumers goes up. On the contrary, if the price of commodity rises many
consumers will withdraw from the market and in this way total demand
for apples will go down.
There are some exceptions of law of demand.
Demand curve of such commodities slopes upwards from left to right.
(1) Veblen goods are articles of distinction or
luxury goods like jewellery, original works of art by great artists. Articles of
distinction according to Veblen, command more demand when their
prices are high.
Substitution Effect :–
For Example :–
Different Uses :–
Size of Consumer Group :–
:–
Articles of Distinction :–
Exception of Law of Demand
Y
O X
D
D
Price
Quantity
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(2) Many a time, consumer out of poor judgment consider a
commodity to be of low quality of its price is low and of high quality if its
price is high.
(3) Giffen goods are those inferior goods whose demand falls
even when their price falls, so that the law of demand does not hold good.
Ans Law of demand tells us about the direction of
change in demand for a commodity as a result of change in its price. Thus this
law a qualitative statement. It simply states that when price falls demand
extends and when price rises demand contracts. It does not explain how much
the demand will change. It is the concept of price elasticity of demand which
measurers how much the quantity demanded of a good changes when its price
changes. Elasticity of demand is a ratio between a cause and an effect, always
in percentage terms. Elasticity of demand is a quantitative statement.
Demand for a good depends upon its price,
commodity of the consumer and price of related goods. Therefore, elasticity of
demand is of three types:-
(1) Price Elasticity of Demand
(2) Income Elasticity of Demand
(3) Cross Elasticity of Demand
The price elasticity of demand is equal to the
ratio of the percentage change in the quantity demanded to a percentage
change in the price, other things being equal. It measures how much the
quantity demanded of a good changes when its price changes. Price elasticity of
demand denotes the ratio at which the demand contracts with a rise in price
and extends with a fall in price. There is an inverse relationship between price
and quantity demanded of a good. Accordingly, elasticity of demand is
expressed by minus(-) sign.
There are five degrees of elasticity of
demand:-
(1) A perfectly
elastic demand is one in which any quantity
will be bought at the prevailing price. In this
case, a very little rise in price causes the
demand to fall to zero and a very little fall in
price cause the demand to extend to infinity. In
this case Elasticity of demand will be infinity.
In this diagram DD represents perfectly elastic
demand curve. It is parallel to OX-axis.
Ignorance :–
Giffen Goods :–
Q. Define Elasticity of Demand. What are the degrees of Price Elasticity
of Demand?
. :–
:–
:–
:–
Perfectly Elastic Demand :–
Elasticity of Demand
Types of Elasticity of Demand
Price Elasticity of Demand
Degrees of Price Elasticity of Demand
Y
P
O X
D D
Ed=¥
Price
Quantity
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X
D
D
Quantity
E =0
d
Y
P1
P
P2
O
Price
(2) A perfectly inelastic demand is one in
which a change in price produces no change in the quantity demanded. In
this case price elasticity of demand will be zero.
In this diagram DD represents the perfectly inelastic demand. It is parallel
to OY-axis.
(3) Unitary Elastic demand is one in which a
percentage change in price produces an equal percentage in quantity
demanded. If 5 percent fall in price is followed by 5 percent extension in
demand, then it will be a case of unitary elastic demand i.e. 5%/5% = 1
In this diagram DD represents the unitary elastic demand. In this diagram
PP (change in price) is equal to OQ (change in quantity). In this case Elasticity of
demand will be one.
(4) Greater than unitary elastic
demand is one which a given percentage change in price produces
relatively more percentage change in quantity demanded. If 5 percent fall
in price causes 20 percent extension in demand, then it will be an example
of greater than unitary demand i.e. 20% / 5%= 4
Perfectly Inelastic Demand :–
Unitary Elastic Demand :–
Greater than Unitary Elastic Demand :–
1 1
Y
P
P1
O Q Q1
D
X
D
E =1
d
Quantity
Price
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Y
P
P1
O Q Q1
D
X
D
E <1
d
Quantity
Price
Y
P
P1
O Q Q1
D
X
D
E >1
d
Quantity
Price
In this diagram DD represents greater than unitary elastic demand. In
this diagram OQ (change in price) is more than to PP (change in quantity). In
this case Elasticity of demand will be greater than one.
(5) Less than unitary elastic demand
is one in which a given percentage change in price produces relatively less
percentage change in demand. When fall in price by 4 percent is followed
by 2 percent extension in demand then elasticity of demand will be 2% /
4% = ½ i.e. less than unitary
In this diagram DD represents less than unitary elastic demand. In this
diagram OQ (change in price) is less than to PP (change in quantity). In this
case Elasticity of demand will be less than one.
1 1
1 1
Less than Unitary Elastic Demand :–
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Sr. Value of Degrees of Description
No. Elasticity Elasticity
Q. How can Price Elasticity of Demand be measured ?
:–
:–
Total Outlay Or Total Expenditure Method :–
Total Expenditure = Price X Quantity
1. E = Perfectly Elastic Little Change in price causes
Demand an infinite change in demand.
2. E =0 Perfectly Inelastic Change in price causes no
Demand change in quantity demanded
3. E =1 Unitary Elastic Percentage change in price is
Demand equal to percentage change
in demand
4. E >1 Greater than Percentage change in price is
Unitary Elastic less than percentage change in
Demand demand
5. E <1 Less than Unitary Percentage change in price is
Elastic Demand more than percentage change
in demand
Ans. The price elasticity of demand is equal to
the ratio of the percentage change in the quantity demanded to a percentage
change in the price, other things being equal. It measures how much the
quantity demanded of a good changes when its price changes.
Whether price elasticity of
demand is unitary, greater than unitary or less than unitary is know by its
measurement. There are five methods of measuring price elasticity of demand:-
1. Total Outlay or Total Expenditure Method
2. Percentage Or Proportionate Method
3. Point Elasticity Method
4. Arc Elasticity Method
5. Revenue Method
1. Total Expenditure method
was evolved by Marshall. According to this method, in order to measure
the elasticity of demand it is essential to know how much and in what
direction the total expenditure has changed as a result of change in the
price of a good.
d ¥
d
d
d
d
Price Elasticity of Demand
Measurement of Price Elasticity of Demand
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There may be three situations :–
Unitary Elasticity of Demand :–
Greater than Unitary Elasticity of demand :–
Less than unitary elasticity of demand :–
Proportionate Or Percentage Method :–
(i) Elasticity of demand is unitary
when due to rise or fall in the price of a good, total expenditure
remains unchanged.
(ii) Elasticity of demand
is greater than unitary when due to fall in price total expenditure goes
up and due to rise in price total expenditure goes down.
(iii) Elasticity of demand is
less than unitary when due to fall in price total expenditure goes
down and due to rise in price total expenditure goes up.
This relationship can also be reflected with the help of following table:-
2. The second method of
measuring price elasticity of demand is called percentage method.
According to this method, the price elasticity of demand is equal to the
ratio of the percentage change in the quantity demanded to a percentage
change in the price. Its formula is as under:-
Percentage change in Quantity Demanded of Commodity
E = (-) -----------------------------------------------------------------------
PercentageChange in Price of Commodity
1 E = 1 Unitary Elastic Price Increases..........No
Demand changes in Total Expenditure
Price Decreases.......No Change
in Total Expenditure
2 E > 1 Greater than Price Increases.............Total
Unitary Elastic Expenditure Decreases
Demand Price Decreases ...........Total
Eexpenditure Increases
3 E < 1 Less than Unitary Price Increases.............Total
Elastic Demand Expenditure Increases
Price Decreases ............Total
Expenditure Decreases
Sr. Vale of Degrees of Description
No. Elasticity Elasticity
d
d
d
Ø
Ø
Ø
Ø
Ø
Ø
d
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100 X Change in Quantity Demanded
———————————————————————
Initial Demand
E = (-) —————————————————-———————————-
100 X Change in Price
————————————————
Initial Price
100 (Q -Q)
———————
Q
E = (-) ————————————
100 (P -P)
———————
P
100 Q
——————
Q
E = (-) ————————————
100 P
———————
P
Q P
E = (-) ——— X ——–
Q P
Q = Initial Demand Q = New Demand
Q = Change in Demand (Q -Q) P = Initial Price
P = New Price P = Change in Price (P -P)
3. Point elasticity refers to price elasticity of
demand at any point on the demand curve. Its formula is:
Lower Segment
E = —————————————
Upper Segment
Price elasticity at different points of a straight line shown in the following
figure :–
d
1
d
1
d
d
1
1
1 1
d
D
D
D
D
D
D
Point Elasticity of Demand :–
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At point P, lower segment = PN & Upper Segment = PM
Lower Segment PN
E = ————————————— = ——————— = 1
Upper Segment PM
At point A, lower segment = AN & Upper Segment = AM
Lower Segment AN
E = ————————————— = ——————— >1
Upper Segment AM
At point B, lower segment = BN& Upper Segment = BM
Lower Segment BN
E = ————————————— = ——————— < 1
Upper Segment BM
At point M, Elasticity of Demand will be infinity.
At point N. Elasticity of Demand will be Zero.
4. Arc Elasticity is a measure of the average responsiveness
to price change shown by the demand curve over some definite portion
between two points on a demand curve. An arc is the portion between two
points on a demand curve. The portion between two points A and C on the
demand curve DD as shown in the given figure is called Arc.
Change in Quantity Change in Price
E = (-)—————————————— ––––———————
½ (Sum of Quantities) ½ (Sum of Prices)
Ø
Ø
Ø
Ø
Ø
d
d
d
d
Arc Elasticity :–
¸
Y
M
O N X
E =
d ¥
Quantity
Price
E >1
d
E =1
d
E <1
d
E =0
d
A
P
B
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Y
P
P1
O Q
Q1
D
X
D
A
C
(Q -Q) (P -P)
E = (-) ———————— —————
½ (Q +Q) ½ (P +P)
(Q -Q) ½ (P +P)
E = (-) ———————— X —————
½ (Q +Q) (P -P)
(Q -Q) (P +P)
E = (-) ——————— X —————
(Q +Q) (P -P)
P = Initial Price P = New Price
5. Sales proceeds that a firm is obtained by selling its
products is called its revenue. Supposing by selling 10 meters of cloth, a
firm gets Rs. 50 then this amount of Rs. 50 will be called the total revenue
of the firm. There are three types of revenue:-
(i) Sale proceeds of a firm is called total revenue.
(ii) When total revenue is divided by the number of
units sold we get average revenue.
(iii) Addition made to the total revenue by the sale
of one more unit of the commodity is called marginal revenue.
A
E = —————
A-M
A = Average Revenue
M = Marginal Revenue
Ed = Elasticity of Demand
Ans.
(A) The income elasticity of demand is equal
to the ratio of the percentage change in the quantity demanded to a
percentage change in the income, other things being equal. It measures
1 1
d
1 1
1 1
d
1 1
1 1
d
1 1
1
1
d
¸
Revenue Method :–
Total Revenue :–
Average Revenue :–
Marginal Revenue :–
According to Revenue Method Elasticity of Demand can be measured
from the following formula :–
Q. Write a short note on the following
(A) Income Elasticity of Demand.
(B) Cross Elasticity Or Elasticity of Substitution.
:–
Income Elasticity of Demand
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how much the quantity demanded of a good changes when consumer’s
income changes.
“Income Elasticity of demand means the ratio of the percentage change in
the quantity demanded to the percentage change in income”.
Income Elasticity can be measured by the following formula:-
Percentage Change in Quantity Demanded
E = —————————————————————————
Percentage Change in Income
100 Q
———————
Q
E = ————————————
100 Y
———————
Y
Q Y
E = ——— X ————
Q Y
Q = Change in Demand (Q -Q) Y = Initial Income
Y = New Income P = Change in Income (P -P)
Income Elasticity of demand
is of three types:
(1) Income Elasticity of demand
for a good is positive when with an increase in the income of a consumer
his demand for the good increases and with a decrease in the income of a
consumer his demand for the good decreases. Income elasticity of demand
is positive in case of normal goods.
Definition of Income Elasticity of Demand
Measurement of Income Elasticity
Degrees of Income Elasticity of Demand
:–
According to Watson
:–
:–
Positive Income Elasticity of Demand :–
y
d
d
1
1
1
1
D
D
D
D
D
D
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In this figure DY DY curve represents positive income elasticity of demand.
It shows that when income increased form OB to OA then demand also
increase from OQ to OQ . It slopes upward from left to right i.e. positive
slope.
(2) Income Elasticity of demand
for a good is Negative when with an increase in the income of a consumer
his demand for the good decreases and with a decrease in the income of a
consumer his demand for the good increases. Income elasticity of demand
is positive in case of inferior goods
In this figure Dy Dy curve represents negative income elasticity of
demand. It shows that when income increased form OB to OA then
demand decrease from OQ to OQ . It slopes downward right to left i.e.
negative slope.
(3) Income elasticity of demand is
zero, when change in the income of consumer evokes no change in his
demand
1
1
Negative Income Elasticity of Demand :–
Zero Income Elasticity of Demand :–
Y
A
B
O Q Q1
Dy
X
D
Quantity
Income
Dy
Y
A
O Q
Q1 X
Quantity
Income
B
Dy
Dy
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In this figure Dy, Dy curve represents zero income elasticity of demand. It
shows that when income increased form OB to OA then demand constant
at point OQ. In this case demand curve will be parallel to OY-axis.
(B) There is a
mutual relationship between change in price and quantity demanded of
two related goods. Change in the price of one good can cause change in the
demand for the related good. For example, change in the price of tea
ordinarily causes change in demand for coffee. The cross elasticity of
demand is the proportional change in the quantity demanded of good X
divided by the proportional change in the price of the related good Y.
Cross elasticity of
demand is measure by the following formula:-
Percentage Change in Quantity Demanded of good X
Ec = ———————————————————————————
Percentage Change in the Price of good Y
100 X Change in Quantity Demanded of X
———————————————————————
Initial Demand of X
E = —————————————————————————
100 X Change in Price of Y
————————————————
Initial Price of Y
100 Q x
———————
Qx
E = ———————————————
100 Py
———————
Py
Cross Elasticity of Demand OR Elasticity of Substitution
Measurement of Cross Elasticity of Demand
:–
:–
c
c
D
D
X
Dy
Dy
Quantity
Y
A
B
O Q
Income
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Qx Py
E = ——— X ——
Q x Py
Qx = Change in the quantity of good X
Qx = Initial demand of good X
Py = Change in price of good Y
Py = Initial price of good Y
Ec = Cross Elasticity of Demand
Cross elasticity of demand can
be of three types:
1. Cross Elasticity of demand is
positive in case of substitutes. In other words when goods are substitutes
of each other, then a given percentage rise in the price of a good will lead to
a given percentage increase in the demand for the substitute good. For
example, rise in the price of coffee will lead to increase in demand for tea,
because the two are close substitute of each other.
In this figure DS DS curves represents cross elasticity of demand. In this
diagram quantity of tea is shown on OX-axis and price of coffee on OY-
axis. When price of coffee is OB, demand for tea is OQ. When price of coffee
rises to OA, demand for tea increases to OQ1. This curve slopes upward
from left to right.
2. Price Elasticity of demand is
negative in case of complementary goods. In case of complementary goods.
Percentage rise in the price of one good leads to percentage fall in the
demand for the other.
D
D
D
D
c
Degrees of Cross Elasticity of Demand :–
Positive Cross Elasticity of Demand :–
Negative Cross Elasticity of Demand :–
Y
A
B
O Q Q1
Ds
X
D
Quantity fo Tea
Price
of
Coffee
Ds
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In this figure Dc, Dc curve represents the negative cross elasticity
demand. In this diagram quantity of butter is shown on OX-axis and price
of bread on OY-axis. When price of bread is OB, demand for butter OQ1.
When the price of bread rises to OA, demand for butter decreases to OQ. It
slopes downward from left to right.
3. Cross elasticity of demand is zero when two
goods are not related to each other. For example, rise in the price of wheat
will have no effect on the demand for books. Their cross elasticity of
demand will be called zero.
Ans.
(1) In economics all goods are divided into three
categories:
(i) Demand for necessaries like salt, kerosene oil, match
boxes etc. is less than unitary elastic or inelastic.
(ii) Price elasticity of comfort goods ,i.e. cooler, fan
etc. is unitary
(iii) Price elasticity of luxuries goods is greater than unitary
elastic. Change in the price of these goods has a great impact on the
demand.
(2) There are two possibilities:-
(i) The greater the number of
substitutes available for the product the greater will be its elasticity of
demand.
(ii) Commodities that do not
have any substitutes have inelastic demand.
(3) Goods that can be put to different uses have
Zero Elasticity of Demand :–
Q. Discuss factors which influence the Price Elasticity of demand.
:–
Nature of the Commodity :–
Necessaries :–
Comfort Goods :–
Luxuries :–
Availability of Substitutes :–
When Substitutes are available :–
When Substitutes are not available :–
Goods with Different uses :–
Factors Determining the Price Elasticity of Demand
Y
A
O Q Q1 X
Quantity of Butter
Price
of
Bread
B
Dc
Dc
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elastic demand. For instance, electricity has many uses. It can be used for
heating, lighting, cooling etc. When electricity charges are high, it is used
for lighting purpose only and so its demand for other less urgent uses will
fall considerably.
(4) Goods whose demand can be postponed to a
future period have elastic demand. On the other hand, goods whose
demand cannot be postponed have inelastic demand.
(5) People having very high or very low income
have inelastic demand. On the other hand demand of middle-income
people is elastic.
(6) Demand for those goods is inelastic to which
consumers become habituated e.g. cigarette, coffee, etc.
(7) Elasticity of demand tends to be more elastic in long period than
in short period. The longer the time, the more elastic will be the demand.
(8) Goods demanded jointly or complementary
goods, have relatively inelastic demand, e.g. car and petrol, pen and ink.
Rise in the price of petrol may not contract its demand if there is no fall in
the demand for cars.
Ans.
(1) A monopolist always takes
into consideration the price elasticity of demand of his product while
determining its price. There are two possibilities :–
(i) If demand is elastic, he will fix low price per unit.
(ii) If demand is inelastic, he will fix high price per unit.
(2) When a monopolist sells the same product at
different prices, it is called price discrimination. A monopolist can practice
price discrimination when price elasticity of demand for his product for
different uses and for different consumers is different. There are two
possibilities :–
(i) He will charge more price from those consumers whose demand is
inelastic
(ii) He will charge less price form those consumers whose demand is
elastic.
(3) Goods which are produced
simultaneously in the same act of production are called joint-supply
goods. Elasticity of demand of such goods is taken into consideration
while fixing their price.
Postponement of the Use :–
Income of the Consumer :–
Habit of the Consumer :–
Time :–
Complementary Goods :–
Q. What is the Importance of Price Elasticity of Demand?
:–
Determination of Price under Monopoly :–
Price Discrimination :–
Price Determination of Joint Supply :–
Importance of Price Elasticity of Demand
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(4) While planning new taxes, a finance
minister takes into consideration elasticity of demand:
(i) Taxes on goods having elastic demand will be low
(ii) Taxes on goods having inelastic demand will be high.
(5) The concept of elasticity of demand is also
important in the field of international trade. A country will gain by
increasing the price of exports if their demand in the importing country is
inelastic. If their demand in the importing country is elastic then the
exporting country will reduce the price.
(6) If the demand of their service of the labourers is
elastic, the possibility of getting their wages raised is less. If, on the other
hand, demand for their services is inelastic then labour unions succeed in
getting their wages increased
Ans. Consumer’s equilibrium refers to a situation
wherein a consumer gets maximum satisfaction out of his limited income and
he has no tendency to make any change in his existing expenditure.
Consumer’s equilibrium through utility analysis is based on
the following assumptions:
1. Consumer is assumed to be rational. A rational
consumer is one who is keen to get maximum satisfaction out of his
limited income.
2. Utilit of every commodity can be measured in terms of
cardinal numbers, such as, 1,2,3,4 etc.
3. It is assumed that the utility derived from one
good is not depend on the utility derived from other goods.
4. Marginal Utility of money is constant
5. It is assumed that the income of the consumer
and the price of the commodity remain fixed.
6. Tastes of the consumer also remain unchanged.
7. The consumer knows the different goods on which
he can spend his income.
(1) First of all we shall study the
Advantage to Finance Minister :–
International Trade :–
Wage Determination :–
Q. What do you mean by consumer’s equilibrium? Explain it with the
help of utility analysis?
:–
:–
Rational Consumer :–
Cardinal Utility :–
Independent Utility :–
Fixed Income and Price :–
Tastes are Constant :–
Perfect Knowledge :–
Determination of Consumer’s Equilibrium :– Consumer’s equilibrium
through utility analysis can be ascertained under tow different
situations :
A Single Commodity with One Use :–
Consumer’s Equilibrium
Assumptions
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equilibrium situation of a consumer who gets maximum satisfaction by
consuming a single commodity with one use. For each unit of commodity
he makes a sacrifice in terms of price. In return he gets some utility from
each unit. Obviously, a rational consumer will consume the commodity
upto a point where the marginal utility of the final unit of the commodity is
equal to the marginal utility of money paid for it.
It can also be explained with the help of following table and
diagram :–
Supposing the price of commodity ‘X’ is Rs. 1 per unit which in terms of
marginal utility is taken as equal to 20 utils. When the consumer buys 4 units
of the commodity then the marginal utility of commodity and marginal utility of
money is equal to each other. The consumer will be in equilibrium in this
situation.
Marginal Utility of good X = Price of good X
Explanation :–
:–
Consumer’s Equilibrium in case of One Commodity with One Use
1 50 20 30
2 40 20 20
3 30 20 10
4 20 20 0
5 10 20 -10
Unit of ‘X’ Marginal Utility Price of ‘X’ Surplus
Commodity of ‘X’ Commodity Commodity Or
OR MU of Deficit
Money
3 4 5
P E P
U
M MU=P
50
40
30
20
10
1 2
Quantity
Utility/Price
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In this figure Quantity is shown on OX-axis and Utility/Price is shown on OY-
axis. MU is the Marginal Utility curve. PP is the price line. E is the equilibrium
point. The consumer is in equilibrium at point E both where marginal utility of
4 unit of commodity is equal to its price.
(2) When a consumer spends his fixed income on
more than one commodity, he compares the marginal utilities of different
commodities with a view to getting maximum satisfaction. Consumer
arrives at a situation where the last unit of money spent on different
commodities yields him equal marginal utility. This will be the position of
his equilibrium.The position of consumer’s equilibrium is also explained
with the help of following table and diagram :–
Supposing a
consumer has Rs. 5 to be spent on two commodities, X and Y. Price of
each commodity is Re. 1 per unit.
1 12 10
2 10
3 8 6
4 6 4
5 4 2
The table indicates that to be in equilibrium the consumer will spend Rs. 3 on
X-commodity and Rs. 2 on Y-Commodity as he gets equal marginal utility (8)
from the last unit of money so spen
th
Several Commodities :–
:–
Quantity MU of X MU of Y
Commodity Commodity
MU of X = MU of Y = 8 utils
Consumer’s Equilibrium – Several Commodities
8
1
4
2
3
3
E
4
1
5
0
O
5
12
10
8
6
4
2
12
10
8
6
4
2
Quantity of X
Quantity of Y
MUx MUy
2
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In this figure Quantity is shown on OX-axis and Utility is shown on OY-axis.
MUx is the marginal utility curve of X commodity and MUy is the marginal
utility curve of Y commodity. Consumer’s equilibrium is at point E where the
consumer consumes 3 units of commodity X and 2 units of commodity Y and
the marginal utility (8) of both the commodities is equal.
Ans. An indifference curve is a curve which
shows different combinations of two commodities yielding equal satisfaction to
the consumer. It means all the points located on an indifference curve
represent such combinations of two commodities as yield equal satisfaction to
the consumer. Since the combination represented by each point on the
indifference curve yields equal satisfaction, a consumer becomes indifferent
about their choice. In other words, he gives equal importance to all the
combinations on a given indifference curve.
“An indifference curve represents all combinations of two commodities
that provided the same level of satisfaction to a person. That person is therefore
indifference among the combinations represented by the points on the curve”.
An indifference schedule refers to a schedule that
indicates different combinations of two commodities which yield equal
satisfaction. A consumer, therefore, gives equal importance to each of the
combinations. In other words, he becomes indifferent towards them. The
following indifference schedule indicates different combinations of apples and
oranges yielding equal satisfaction.
A 1 10
B 2 7
C 3 5
D 4 4
The above schedule shows that the consumer gets equal satisfaction from
all the four combinations, namely A, B, C and D of apples and oranges.
Q. What is an Indifference Curve? Discuss the main Properties or
Characteristics of an Indifference Curve.
:–
:–
According to H.L. Varian
:–
Indifference Schedule
Combination of Apples Apples Oranges
& Oranges
Meaning of Indifference Curve
Definition
Indifference Schedule
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Indifference Curve
Indifference Map
Properties of Indifference Curves
:–
:–
:–
An indifference Curve Slopes Downwards from Left to the Right :–
Indifference curve is a diagrammatic presentation of
indifference schedule. Indifference curve is shown in the following figure :–
In this diagram, Quantity of apples is shown on OX-axis and that of oranges on
OY-axis. IC is an indifference curve. Different points A, B, C and D on it indicate
those combinations of apples and oranges which yield equal satisfaction to the
consumer. This curve is also known as Iso-Utility curve.
An indifference map is that graph which represents a
group of indifference curves each of which expresses a given level of
satisfaction. Indifference map is shown in the following figure :–
The following are the main properties of
indifference curves :–
(1) An
indifference curve slopes downwards from left to right, or that, its slope is
negative. This property is based on the assumption that if a consumer
uses more quantity of one good he will use less quantity of the other, then
only he will have equal satisfaction from their different combinations. This
property can be explained with the help of following diagram:
Y
10
9
8
7
6
5
4
3
2
1
O 1 2
A
B
C
D
IC
Apples
Oranges
3 4 X
Apples
Oranges
Indifference
Map
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Y
O 1 2 3 4 X
IC1
5
IC2
A
B
C
(2) An indifference curve will ordinarily be
convex (bowed inward) to the point of origin. Convexity of the curve means
that it bows inward to the origin. The slope of the indifference curve is
called the marginal rate of substitution because it indicates the rate at
which the consumer is willing to substitute one good for the other. This
property can be explained with the help of following diagram :–
(3) Each
indifference curve represents different levels of satisfaction, so they do not
intersect or touch each other. This property can be explained with the help
of following diagram
Convex to the Point of Origin :–
Two Indifference Curves Never Touch or Intersect each other :–
Y
10
9
8
7
6
5
4
3
2
1
O 1 2 3 4 X
Apples
Oranges
IC
Y
10
9
8
7
6
5
4
3
2
1
O 1 2
Apples
3 4 X
Oranges
IC
60
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