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UNIT 1 MICROECONOMICS.pptx

The document provides an overview of microeconomics concepts including demand and supply, elasticity, equilibrium, and welfare analysis. It defines economics and discusses the nature and scope of economics as a social science. Key concepts around demand are explained such as the determinants of demand including price, income, tastes, and related goods. The law of demand and exceptions to the law of demand are outlined. Demand curves are introduced as a graphical representation of the relationship between price and quantity demanded.

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UNIT-I MICROECONOMICS: •Principles of Demand and Supply •Supply Curves of Firms •Elasticity of Supply; •Demand Curves of Households •Elasticity of Demand; •Equilibrium and Comparative Statics (Shift of a Curve and Movement along the Curve); •Welfare Analysis •Consumers’ and Producers’ Surplus.
DEFINITIONS Economics is a social science that focuses on the production, distribution, and consumption of goods and services, and analyzes the choices that individuals, businesses, governments and nations make to allocate resources. Adam Smith in his book “Wealth of Nations” (1776) defined economics as “An enquiry into the Nature and Causes of the Wealth of Nations”. Economics is “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses” – Dr.Alfred Marshall
NATURE & SCOPE The nature and scope of economics are thus much more than the mere consumption of goods and services. Economics covers all the central issues faced by society and is thus regarded as a social science. Hence, economics is a subject that can pave the way for many enlightening thoughts
DEMAND • Demand means desires. Demand in Economics means both the willingness as well as the ability to purchase a commodity by paying a price and also its actual purchase. A man may be willing to get a thing but he is not able to pay the price. It is not demand in the economic sense. • Demand is related to price. Generally demand for a commodity depends upon the price of the commodity. Generally the relation between price and demand is inverse. • When price of a particular commodity goes up, its demand falls and vice-versa.But in exceptional cases the two variables may move in the same direction.
DEMAND There are other factors that may influence the quantity demanded for a quantity. • One such factor is the income of the consumer. If a man’s income increases, obviously he will be able to demand more of the goods at a given price. • Except that, demand for a commodity depends upon the taste and preference of the consumers, the price of substitute goods etc.
Determinants Of Demand • There are many factors other than price that can affect the level of quantity demanded. This defines demand function. Demand determinants refer to the factors that affect demand for commodity (a consumer good), such as: 1. Price of the Commodity 2. Income of the Consumer 3. Price of related goods 4. Taste and preference of consumer 5. Growth of population 6. Government policy 7. Climatic conditions 8. Income distribution 9. Expected change in price 10. Future expectation about income etc.
Determinants Of Demand (i) Price of the Commodity : There is an inverse relationship between the price of the commodity and the quantity demanded. It implies that lower the price of commodity, larger is the quantity demanded and vice-versa.
Determinants Of Demand (ii) Income of the consumers: Usually there is a direct relationship between the income of the consumer and his demand. i.e. as income rises his demand rises and vice-a-versa. The income demand relationship varies with the following three types of commodities : (a) Normal Goods : In such goods, demand increases with increase in income of the consumer. For e.g.. demands for television sets, refrigerators etc. Thus income effect is positive. (b) Inferior Goods : Inferior Goods are those goods whose demand decrease with an increase in consumes income. For e.g. food grains like Malze , etc. If the income rises demand for such goods to the consumers will fall. Thus income effect is negative. (c) Giffen goods : In case of Giffen goods the demand increases with an increase in price but it decreases with the rise in income. Thus income effect is negative.
Income Of The Consumers
Determinants Of Demand (iii) Consumer’s Taste and Preference: Taste and Preferences which depend on social customs, habit of the people, fashion, etc. largely influence the demand of a commodity.
Determinants Of Demand (iv) Price of Related Goods: Related Goods can be classified as substitute and complementary goods. • (v) Substitute Goods: In case of such goods, if the price of any substitute of commodity rises, then the commodity concern will become relatively cheaper and its demand will rise. The demand for the commodity will fall if the price of the substitute falls. e.g.. If the price of coffee rises, the demand for tea will rise.
Substitute Goods
Determinants Of Demand (vi) Complementary Goods: In case of such goods like pen and ink with a fall in the price of one there will be a rise in demand for another and therefore the price of one commodity and demand for its complementary are inversely related. (vii) Consumer’s Expectation: If a consumer expect a rise in the price of a commodity in a near future, they will demand it more at present in anticipation of a further rise in price. (viii)Size and Composition of Population: Larger the population, larger is likely to be the no. of consumers. • Besides the composition of population which refers to the children, adults, males, females, etc. in the population. The demographic profile will also influence the consumer demand.
Complementary Goods
Demand Function Demand functions expresses the functional relationship between demand for a commodity (i.e. a consumer good) and its determinants. It can be written as : Dx= f (Px , Y, PR ,T, Pe , G, …………..) Where, Dx symbolizes demand for commodity X Px symbolizes price of commodity X Y symbolizes income of the consumer PR symbolizes price of related good R T symbolizes taste and presences Pe symbolizes expected change in price of commodity X G symbolizes growth of population
Kinds Of Demand There are three kinds of demand relations which are usually studied under demand analysis such as: Price Demand, Income Demand and Cross Demand. • Price Demand: Price demand studies how demand for a commodity (D) changes with respect to change in price(P) , ceteris paribus (other things remaining the same). • Dx= f (Px) x
KINDS OF DEMAND • Income Demand: Income Demand examines how demand for commodity (D) changes as a result of change in income of the consumer(Y) , other things remaining the same. • Dx= f (Y)x
KINDS OF DEMAND • Cross Demand: Cross demand studies how quantity demand of a commodity ( D) changes as a result of change in price of its related goods (P), ceteris paribus . Cross demand function can be denoted as follows: • Dx= f ( PR ) x
Law of Demand • The law of demand expresses the functional relationship between the price of commodity and its quantity demanded. • It states that the demand for a commodity tends to vary inversely with its price this implies that the law of demand states- Other things remaining constant, a fall in price of a commodity will lead to a rise in demand of that commodity and a rise in price will lead to fall in demand. • The Law of Demand says as “the quantity demanded increases with a fall in price and diminishes with a rise in price”. –Marshall • “The Law of Demand states that people will buy more at lower price and buy less at higher prices, other things remaining the same”. - Samuelson
Law of Demand
Law of Demand • Assumption: (i) Income of the people remaining unchanged. (ii) Taste, preference and habits of consumers unchanged. (iii) Prices of related goods i.e., substitute and complementary goods remaining unchanged (iv) There is no expectation of future change in price of the commodity. (v) The commodity in question is not consumed for its prestige value.
Importance of Law of Demand 1. Basis of the Law of Demand: The law of Demand is based on the consumers that they are prepared to buy a large quantity of a certain commodity only at a lower price. This results from the fact that consumption of additional units of a commodity reduces the marginal utility to him. 2. Basis of consumption Expenditure : The law of Demand and the law of equi-marginal utility both provide the basis for how the consumer should spend his income on the purchase of various commodities.
Importance of Law of Demand
Importance of Law of Demand 3. Basis of Progressive Taxation: Progressive Taxation is the system of Taxation under which the rate of tax increase with the increase in income. This implies that the burden of tax is more on the rich than on the poor. The basis of this is the law of Demand. Since it implies that the marginal utility of Money to a rich man is lower than that to a poor man. 4. Diamond-water paradox: This means that through water is more useful than diamond. Still the price of diamond is more than that of water. The explanation lies in law of diminishing marginal utility. The price of commodity is determined by its marginal utility. Since the supply of water is abundant the marginal utility of water is very low and so its price. On the contrary, supply of diamond is limited so the marginal utility of diamond is very high, therefore the price of diamond is very high.
Diamond-Water Paradox
Importance of Law of Demand • Demand Curve: Demand curve is a diagrammatic representation of the demand schedule when we plot individual demand schedule on a graph, we get individual demand curve and when we plot market schedule, we get market curve. Both individual and market demand curves slope downward from left to right indicating an inverse relationship between price and quantity demanded of goods.
Demand Curve • Demand curve is the graphical representation of the relationship between demand for a commodity (Dx) and its price (Px) .
Demand Curve • The demand curve is downward sloping because of the following reasons. • 1) Some buyer may simply not be able to afford the high price. • 2) As we consume more units of a product, the utility of that product becomes less and less. This is called the principle of diminishing Marginal Utility. • The quantity demanded rises with a fall in price because of the substitution effect. A low price of x encourages buyer to substitute x for other product.
Causes of downward slope of demand curve (i) Law of Diminishing Marginal Utility: This law states that when a consumer buys more units of same commodity, the marginal utility of that commodity continues to decline. This means that the consumer will buy more of that commodity when price falls and when less units are available, utility will be high and consumer will prefer to pay more for that commodity. This proves that the demand would be more at lower prices and less at a higher price and so the demand curve is downward sloping.
Causes Of Downward Slope Of Demand Curve (ii) Income effect: As the price of the commodity falls, the consumer can increase his consumption since his real income is increased. Hence he will spend less to buy the same quantity of goods. On the other hand, with a rise in price of the commodities the real income of the consumer will fall and will induce them to buy less of that good. (iii) Substitution effect: When the price of a commodity falls, the price of its substitutes remaining the same, the consumer will buy more of that commodity and this is called the substitution effect. The consumer will like to substitute cheaper one for the relatively expensive one on the other hand, with a rise in price the demand fall due to unfavourable substitution effect. It is because the commodity has now become relatively expensive which forces the consumer’s to buy less.
Income Effect
Substitution Effect
Causes Of Downward Slope Of Demand Curve (iv) Goods having multipurpose use: Goods which can be put to a number of uses like coal, aluminium, electricity, etc. are e.g.. of such commodities. When the price of such commodity is higher, it will not used for a variety of purpose but for use purposes only. On the other hand, when price falls of the commodity will be used for a variety of purpose leading to a rise in demand. For e.g. : if the price of electricity is high, it will be mainly used for lighting purposes, and when its price falls, it will be needed for cooking. (v) Change in number of buyers : Lower the price, will attract new buyers and raising of price will reduce the number of buyers. These buyers are known as marginal buyers. Owing to such reason the demand falls when price rises and so the demand curve is downward sloping.
Exception to Demand curve or Law of Demand • In some rare situations, the law of demand does not hold good. • In such situations, the demand curve slopes upward instead of sloping downward suggesting a rise in demand with rising price. • Cases in which this tendency is observed are referred to as exceptions to the general law of demand. In such situations, the demand curve slopes upward instead of sloping downward suggesting a rise in demand with rising price. • Here demand curve D-D curve is known as an exceptional demand curve.
Exceptions to the law of demand 1. Giffen Goods, 2. Conspicuous Consumption 3. Conspicuous Necessities, 4. Exceptional Demand Curves 5. Expected Changes In Price, 6. Extraordinary Situations Like Natural Disasters, Famine, Riots Etc
Exceptions to the law of demand • Conspicuous goods: These are certain goods which are purchases to project the status and prestige of the consumer. For e.g. expensive cars, diamond jewellery, etc. such goods will be purchased more at a higher price and less at a lower price. • Giffen goods: These are special category of inferior goods whose demand increases even if with a rise in price. For e.g.. coarse grain, clothes, etc.
Exceptions to the law of demand Giffen Goods: • In case of certain inferior goods called Giffen goods, when the price falls, quite often less quantity will be purchased than before because of the negative income effect and people’s increasing preference for a superior commodity with the rise in their real income. Few examples of giffen goods are cheap potatoes, coarse cloth, coarse grain, etc
Exceptions to the law of demand • Conspicuous Consumption: • Some expensive commodities like diamonds, expensive cars, exorbitantly high priced mobile phones etc., are used as status symbols to display one’s wealth or , to distinguish oneself from average people. The more expensive these commodities become, the higher their value as a status symbol and hence, the greater the demand for them. Law of demand does not apply here.
Conspicuous Goods
Exceptions to the law of demand • Share’s speculative market : It is found that people buy shares of those company whose price is rising on the anticipation that the price will rise further. On the other hand, they buy less shares in case the prices are falling as they expect a further fall in price of such shares. Here the law of demand fails to apply.
BandwagonEffect Here the consumer demand of a commodity is affected by the taste and preference of the social class to which he belongs to. If playing golf is fashionable among corporate executive, then as the price of golf accessories rises, the business man may increase the demand for such goods to project his position in the society.
Veblen Effect Sometimes the consumer judge the quality of a product by its price. People may have the expression that a higher price means better quality and lower price means poor quality. So the demand goes up with the rise in price for e.g.. : Branded consumer goods.
Exceptions to the law of demand • Conspicuous Necessities: Certain things become necessities of modern life. These are purchased even if their prices rise. E.g. TV, refrigerators, mobile phones, automobiles. • Expected Changes in Price: Expected or anticipated changes in price of a commodity in future also can affect quantity demanded of it at present. If it is expected that the price of a commodity will rise in future, the demand for it rise and vice versa. • Extraordinary Situations: War, famines, riots, natural calamities are extra ordinary situations when people’s behaviour becomes abnormal. Law demand does not apply in abnormal situations.
There Are Two Concepts : • Extension Of Demand • Contraction Of Demand Changes In Quantity Demanded/ Movement Along Demand Curve
Extension of demand Quantity Demanded O Price D D P2 Q2 Q1 B A Extension of Demand : Other things remaining the same, when more quantity of a commodity is demanded due to fall in its price, it is called extension of demand. There is a downward movement along the demand curve in case of extension of demand. Extension Of Demand P1
Contraction of demand Quantity Demanded O Price D D P2 Q2 Q1 P1 B A Contraction of Demand : Other things remaining the same, when less quantity of a commodity is demanded due to rise in its price, it is called contraction of demand . There is a upward movement along the demand curve in case of contraction of demand. Contraction Of Demand
Changes in Demand/ Shift in Demand Curve/ There are two concepts : • Increase in Demand • Decrease in Demand Changes in Demand /Shift in demands are caused by • Changes in income • Changes in price of substitutes • Changes towards the taste and preferences of the commodity • Changes in climate etc.
Demand O Price D D P2 Q2 Q1 P1 more demand at same price D/ D/ O Q1 Same demand at higher price Increase in Demand When , due to factors other than price, more quantity of a commodity is demanded at same price or same quantity is demanded at higher price, it is called increase in demand. There is a upward /rightward shift in demand. Price Demand
Demand O Price D D P2 Q2 Q1 P1 Less demand at same price D/ D/ O Q1 Same demand at lower price Decrease in Demand When , due to factors other than price, less quantity of a commodity is demanded at same price or same quantity is demanded at lower price, it is called decrease in demand. There is a downward /leftward shift in demand Price
Elasticity of Demand • Whenever a policy maker wishes to examine the sensitivity of change in quantity demanded due to the change in price, income or price of the related goods, he wishes to study the magnitude of this response with the help of “elasticity” concept. Thereby, the concept is crucial for business decision-making and also for forecasting future demand policies.
Determinants Of Elasticity Of Demand (i) Nature, Necessity Of A Commodity: The demand for necessary commodity like rice, wheat, salt, etc. is highly inelastic as their demand does not rise or fall much with a change in price. On the other demand for luxuries changes considerably with a change in price and than demand is relatively elastic.
Determinants Of Elasticity Of Demand (ii) Availability of substitutes: The Demand for commodities having a large number of close substitute is more elastic than the commodities having less or no substitutes. If a commodity has a large no. of substitutes its elasticity is high because when there is a rise in its prices, consumers easily switch over to other substitutes. (iii) Variety of uses : The Product which have a variety of uses like steel, rubber etc. have a elastic demand and if it has only limited uses, then it has inelastic demand. For e.g.. if the unit price of electricity falls then electricity consumption will increase, more than proportionately as it can be put to use like washing, cooking, as the price will go up, people will use it for important purposes only.
Determinants Of Elasticity Of Demand • (iv) Possibility of postponement of consumption : The commodities whose consumption can easily be postponed has more elastic demand and the commodities whose consumption cannot be easily postponed has less elastic demand for e.g.. for expensive jewellery, perfume it is possible to postpone consumption in case the price is high and so such goods are elastic on the other hand, the necessities of life cannot be postponed and so they are inelastic in demand. • (v) Durable commodities : Durable goods like furniture’s, etc, which will last for a longer time have valuably inelastic demand. This is because in such case, a fall in price will not lead to a large increase in demand and a rise in price again will not load to a huge fall in demand. But in case of perishable goods, the demand is elastic is nature.
Determinants Of Elasticity Of Demand
Elasticity Of Demand • Elasticity of demand is the measure of the responsiveness of quantity demanded of a commodity in response to change in a particular demand determinant (say price) while keeping other determinants constant( such as:, income, or price of related good , advertisement, growth of population and so on).
Concepts Of Elasticity Of Demand There may be as many as concepts of elasticity of demand as the number of demand determinants. Most important concepts of elasticity of demand are: • Price elasticity of demand (here the demand determinant is price of the commodity) • Income elasticity of demand (here the demand determinant is income of consumer) • Cross elasticity of demand (here the demand determinant is price of related goods)
Price Elasticity of Demand • It is defined as the degree of responsiveness of quantity demanded of a commodity due to change in its price when other factor remaining constant.
Kinds Of Price Elasticity Of Demand 1. Perfectly Elastic Demand : 2. Elastic Demand /Relatively Elastic Demand: 3. Unit Elastic Demand: 4. Inelastic Demand / Relatively Inelastic Demand : 5. Perfectly Inelastic Demand: 𝑒𝑃 > 1 𝑒𝑃 < 1
1. Perfectly Elastic Demand Price 0 Quantity Demand Perfectly elastic demand curve P D When quantity demanded of the commodity changes though there is no change in price, it is known as perfect elastic demand. Incase of Perfectly elastic demand, Q1 Q2
2. Relatively Elastic Demand Elastic demand curve 0 Quantity demanded Price D D When the proportionate change in demand is more than the proportionate changes in price, it is known as relatively elastic demand. E.g. luxury goods Incase of elastic demand, Q1 Q2 P2 P1 𝑒𝑃 > 1
3. Unit Elastic Demand Unit elastic demand equal 0 Quantity Demand Price D D When the proportionate change in demand is equal to proportionate changes in price, it is known as unitary elastic demand. Incase of unit elastic demand, P2 P1 Q1 Q2
4. Relatively Inelastic Demand Inelastic demand curve Quantity Demanded O Price D D When the proportionate change in demand is less than the proportionate changes in price, it is known as relatively inelastic demand. e.g. necessities, electricity etc. Incase of inelastic demand, P2 Q2 Q1 P1 𝑒𝑃 < 1
5.Perfectly Inelastic Demand D Perfectly inelastic demand curve 0 Price Quantity Demanded When a change in price, howsoever large, change no changes in quality demand, it is known as perfectly inelastic demand. E.g. salts , matchbox Incase of perfectly inelastic demand, P1 P2 Q
All Kinds Of (Price) Demand Curves Be Shown In One Diagram 0 Quantity Demanded Price 𝑒𝑃 > 1 𝑒𝑃 < 1
Importance of Price Elasticity of Demand (i) Business Decisions: The concept of price elasticity of demand helps the firm to decide whether or not to increase the price of their product. Only if the product is inelastic in nature, then raising of price will be beneficial. On other hand, if the product is elastic in nature, then a rise in price might lead to considerable fall in demand. Therefore the price of different commodities are determined on the basis of relative elasticity.
Importance of Price Elasticity of Demand (ii) To monopolist: A monopolist often practices price discrimination. Price discrimination is a process in which a single seller sells the same commodity in two different markets at two different prices at the same time. The knowledge of price elasticity of the product to the monopolist is important because he would charge higher price from those consumers who have inelastic demand and lower price from those consumers who have elastic demand. (iii) Determination of Factor Price: The concept of elasticity of demand also helps in determining the price of various factors of production. Factor having inelastic demand gets higher price and factors having elastic demand gets lower price.
Importance of Price Elasticity of Demand (iv) Route for International Trade: If demand for exports of a country is inelastic, that country will enjoy a favourable terms of trade while if the exports are more elastic than imports, then the country will lose in the terms of trade. (v) The Govt: Elasticity of demand is useful in formulation Govt. Policy particularly taxation policy and the policy of subsides if the Govt. wants to impose excise duty, or sales tax, the Govt. should have an idea about the elasticity of the product. If the product is elastic in nature, then the burden of the tax is shifted to the consumer and the demand might fall remarkably: on the other hand, if the demand is inelastic in nature, then any extra burden of indirect tax will not affect the demand to that extent.
Income Elasticity Of Demand • Income Elasticity of demand is the measure of the responsiveness of quantity demanded of a commodity in response to change in income of the consumer, ceteris paribus.
Kinds Of Income Elasticity Of Demand Positive Income elasticity of demand which includes • Unitary Income Elasticity (ey=1) indicates that a proportionate (percentage or relative )change in quantity demanded is equal to proportionate change in money income. • High Income Elasticity (ey > 1 ) indicates that a proportionate change in quantity demanded is more than proportionate change in money income. E.g. luxuries o Income elasticity less than unity • Low Income Elasticity (ey < 1) indicates that a proportionate change in quantity demanded is less than proportionate relative change in money income. e.g. necessities • Zero Income elasticity /Perfectly Inelastic Income demand (e y = 0) change in income will have no effect on the quantity demanded e.g. salts) • Negative income elasticity (e Y < 0) [in case of inferior goods] indicates that less is bought at higher incomes and more is bought at lower incomes.
Cross Elasticity Of Demand • Cross Elasticity of demand is the measure of the responsiveness of quantity demanded of a commodity in response to change in price of its related goods, ceteris paribus.
Kinds Of Cross Elasticity Of Demand • Positive Cross elasticity of demand (eAB > 0) when the goods A and B are substitutes] e.g. Coca cola and Pepsi, Chinese mobile phones and smart phones. • Negative Cross elasticity of demand (eAB < 0) [when the goods A and B are complementary] e.g. vehicle and petrol • Zero Cross elasticity of (e AB = 0 ) [when the goods A and B are independent/unrelated] e.g. gold and rice.
Geometric Method /Point Method Of Measuring Elasticity Of Demand Where, eP is price elasticity of demand Q is quantity demanded (initial) P is price of the commodity (initial) dQ is change in quantity demanded dP change in price Geometric method attempts to measure numerical elasticity of demand at a particular point on the demand curve. The is method is applied when changes in price and the resultant change in quantity demanded are infinitely small. As per point method,
O Price A B Demand D dP dQ P1 P2 Q1 Q2 C E Price elasticity of demand at point D at demand curve AB can be written as
0 Price Demand A B D D Arc method is applied when changes in price and the resultant change in quantity demanded are somewhat large or we have to measure elasticity over an arch of demand curve. The formula for arc elasticity is as follows: Arc Method Of Measuring Elasticity Of Demand 𝒆𝑷 = ( 𝒅𝑸 𝑸𝟏 + 𝑸𝟐 𝟐 ) ÷ ( 𝒅𝑷 𝑷𝟏 + 𝑷𝟐 𝟐 ) 𝒆𝑷 = ( 𝒅𝑸 𝒅𝑷 )𝑿( 𝑷𝟏+𝑷𝟐 𝑸𝟏+𝑸𝟐 ) Where Q1 is original quantity demanded Q2 is new quantity demanded P1 is original price P2 is final price Q1 Q2 P1 P2
Utility is defined as the power of commodity to satisfy a human want. • People know utility of goods by means of introspection and therefore is subjective. Being subjective, it varies from persons to persons. That is, different persons may derive different amount of utility/satisfaction from the same good. The desire for a commodity by a person depends upon the utility he expects to obtain from it. Total Utility And Marginal Utility Total Utility- Total psychological satisfaction obtained by a consumer from consuming a given amount of a particular commodity is called total utility. Marginal Utility - Marginal Utility is the extra utility derived by a consumer from the consumption of an additional unit of a particular commodity. Utility
Relationship Between Tu And Mu -5 0 5 10 15 20 25 30 35 1 2 3 4 5 6 7 Total/Marginal Utilities Quantity of Commodity The Law of Diminishing Marginal Utility TU MU Quantity (Q) TU (utils) MU=dU/dQ (utils) 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2
Total utility (TU) is the sum total of marginal utilities . TU=∑MU Marginal utility (MU) is the rate of change in total utility with respect to a unit change in quantity of the commodity consumed. MU=dU/dQ • dU symbolizes change in total utility • dQ symbolizes change in quantity of commodity consumed • When the MU decreases, TU increases at decreasing rate. • When MU becomes zero, TU is maximum. It is a saturation point. • When MU becomes negative, TU declines Relationship Between Tu And Mu.
It is a psychological fact that when a person consumes more and more units of a commodity during a particular time, the extra utility he derives from the successive units of the commodity will diminish. The Law of Diminishing Marginal Utility states that the additional satisfaction derived from the additional unit of a commodity goes on diminishing. The law highlights that while total wants of a man is unlimited, each single want is satiable. As a consumer more and more units of a commodity, intensity for the commodity goes on falling , and a point is reached where he does not want more of it. He is completely satisfied with the commodity which is reflected by zero marginal utility. The law of diminishing marginal utility also serve the basis for law of demand or downward sloping demand curve. Law Of Diminishing Marginal Utility
A consumer is in equilibrium when he maximises his utility or satisfaction by spending his given money income on different goods. •Consumer’s Equilibrium in Case of Single Good Let us take a simple model of single commodity X. The consumer either spends his money income on the good or retains his money income. In such situation, the consumer will be in equilibrium when MUX = PX •Where, MUX is marginal utility of commodity X •PX is price of the commodity X. • If MUX > PX , the consumer can increase his well-being by purchasing more units of the commodity X. • If MUX < PX , the consumer can increase his total cost satisfaction by cutting down the quantity of commodity X and keeping more of his income unspent. • Thus, he maximises his satisfaction when MUX = PX Consumer’s Equilibrium
Consumer’s Equilibrium In case of More Than One Good & Law of Equi-Marginal Utility The law of equi-marginal utility states that a consumer distributes his limited income among various commodities in such a way that marginal utility of money expenditure on each good is equal. This is the condition of consumer’s equilibrium in case of more than one commodity. Marginal utility of money expenditure on a good is the ratio of marginal utility of the commodity to price of it.
Consumer’s Equilibrium In Case Of More Than One Good And Law Of Equi-marginal Utility
Supply • Supply is defined as a quantity of a commodity offered by the producers to be supplied at a particular price and at a certain time. • Supply indicates quantities of a commodity of a offered for sale at each possible price at a given time period, other things constant
Individual Supply and Market Supply
Law of Supply • If the price of commodity rises, the level of quantity supplied rises, after factors remaining constant. • Supply Curve: in the graphical representation of supply schedule when the factors affecting supply remain constant. • • Movement from A to B: Extension in Supply • • Movement from B to A: Contraction in Supply
Law Of Supply • Law of supply states that normally, the quantity supplied varies directly with its price, other things constant. • In other words , law of supply states that lower the price, the smaller the quantity supplied and higher the price, the greater the quantity supplied.
Supply Curve 0 Supply Price S S Supply Curve Supply Curve Is The Graphical Representation Of The Relationship Between Supply Of A Commodity (Dx) And Its Price (Px) . Normally, a supply curve slopes upward from left to right indicating the operation of the law of supply.
0 E S(P) D(P) Surplus Price Demand/Supply Demand = Supply Shortage Equilibrium Price Equilibrium price a commodity is determined at point(E) where market demand is equal to market supply. At price P2 , supply is more demand and thus there is surplus in the market. Price will fall causing supply to fall and demand to rise. Price will continue to fall until it reaches equilibrium price Pe at which Demand=Supply ( Equilibrium point E). P2 P1 Q1 Q2 Qe At P1, demand is more than supply and as such there is shortage in the market. Price will raise causing demand to fall and supply to rise. Price will continue to rise until it reaches equilibrium price at which Demand=Supply ( Equilibrium point E). Pe
Determinants of Supply Determinants of Supply 1. Price of the product 2. State of technology 3. Prices of relevant resources 4. Prices of alternative goods 5. Producer expectations 6. Number of producers/sellers in the market
Factors Determining Supply or Supply Function (i) Price Of The Commodity: When the price of a commodity in the market rises, seller increases the price. • The cost of production remaining constant the higher will be the profit margin. This will encourage the producers to supply more at higher prices. The reverse will happen when the price fall. (ii) Goals Of The Firm: Firms may try to work on various goals for e.g.. Profit maximization, sales maximization, • employment maximization. If the objective is to maximize profit, then higher the profit from the sale of a commodity, the higher will be the quantity supplied by the firm and vice-versa. Thus, the supply of goods will also depend upon the priority of the firm regarding these goals and the extent to which it is prepared to sacrifice one goal to the other.
Factors Determining Supply or Supply Function
Factors Determining Supply or Supply Function (iii) Input Prices: The supply of a commodity can be influenced by the raw materials, labour and other inputs. If the price of such inputs rise leading to a lower profit margin becomes less. This will ultimately lead to a lower supply. On the other hand, if there is a fall in input cost firm, will be ready to supply more than before at a given price level. (iv) State of Technology : If improved and advanced technology is used for the production of a commodity, it reduces its cost of production and increases the supply. On the other hand, the supply of those goods will be less whose production depend on unfair and old technology.
Factors Determining Supply or Supply Function (v) Government policies: The imposition of sales tax reduces supply and grant of subsidy on the other hand increases the supply. (vi) Expectation about future prices: If the producers expect an increase in the price of a commodity, then they will supply less at the present price and hoard the stock in order to sell it at a higher price in the near future. This will be opposite in case if they anticipate fall in future price (e.g.. fruit seller)
Government Policies (Taxes)
Exceptions to the Law of Supply (i) Agricultural Goods: In case of such goods the supply cannot be adjusted to market conditions. • The production of agriculture goods is largely dependent on natural phenomenon and therefore its supply depends upon natural factors like rainfall, etc. Moreover the supply of such goods is mostly seasonal and therefore it cannot be increased with a rise in price. (ii) Rare objects : These are certain commodities like rare coins, classical paintings old manuscripts, • etc. whose supply cannot be increased or decreased with the change in price. Therefore, such goods are said to have inelastic supply and the supply curve is a vertical straight line parallel to Y – axis.
Exceptions to the Law of Supply
Factors Determining Supply or Supply Function (iii) Labour Market: In the labour market, the behaviour of the supply of labour goes against the law of supply.
Elasticity of Supply • Elasticity of supply is defined as the degree of responsiveness of quantity supplied of a commodity due to change in its price. Elasticity of supply is expressed as : • es = % changes in qty. supplied / % changes in price • = (dq/q x 100) /(dp/p x 100) • = (dq/dp x p/q) Where, • d = change, q = original quantity supplied, p = original price.
Determinants of Elasticity of Supply
Determinants of Elasticity of Supply (i) Nature Of The Commodity: The supply of durable goods can be increased or decreased effectively in response to change in price and hence durable goods are relatively elastic. • On the other hand the perishable goods cannot be stored and thus supply cannot be altered significantly in response to change in their price. Hence the price of the perishable goods are relatively less elastic. (ii) Time Factor: A price change may have a small response on the quantity supplied because output may change by small quantity in the short period since the production capacity may have been limited. Therefore, in the short run supply tends to be relatively inelastic. • On the other hand in the long run production capacity may be increased or supply may also be raised therefore in the long run supply is elastic.
Determinants of Elasticity of Supply (iii) Availability of facility for expanding output: If producers have sufficient production facilities such as availability of power, raw materials, etc, they would be able to increase their supply in response to rise in price.On the other hand if there is a shortage of such facilities then expansion of supply will not be possible due to rise in price. (iv) Change in cost of production: Elasticity of supply depends upon the change in cost. If an increase of output by a firm in an industry causes only a slight increase in the cost then supply will remain fairly elastic. On the other hand if an increase in output bring about a large increase in cost due to rise in price of inputs etc, then supply will be relatively inelastic. (v) Nature of inputs : Elasticity of supply depend upon the nature of inputs for the production of a commodity. If the production requires inputs that are easily available, then its supply will be relatively elastic. On the other hand, if it uses specialized inputs then its supply will be relatively inelastic. (vi) Risk Taking: If entrepreneurs are willing to take risk, then supply will be more elastic and if they are reluctant to take risk then supply would be inelastic.
Thanks…

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UNIT 1 MICROECONOMICS.pptx

  • 1.
    UNIT-I MICROECONOMICS: •Principles ofDemand and Supply •Supply Curves of Firms •Elasticity of Supply; •Demand Curves of Households •Elasticity of Demand; •Equilibrium and Comparative Statics (Shift of a Curve and Movement along the Curve); •Welfare Analysis •Consumers’ and Producers’ Surplus.
  • 2.
    DEFINITIONS Economics is asocial science that focuses on the production, distribution, and consumption of goods and services, and analyzes the choices that individuals, businesses, governments and nations make to allocate resources. Adam Smith in his book “Wealth of Nations” (1776) defined economics as “An enquiry into the Nature and Causes of the Wealth of Nations”. Economics is “the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses” – Dr.Alfred Marshall
  • 3.
    NATURE & SCOPE Thenature and scope of economics are thus much more than the mere consumption of goods and services. Economics covers all the central issues faced by society and is thus regarded as a social science. Hence, economics is a subject that can pave the way for many enlightening thoughts
  • 8.
    DEMAND • Demand meansdesires. Demand in Economics means both the willingness as well as the ability to purchase a commodity by paying a price and also its actual purchase. A man may be willing to get a thing but he is not able to pay the price. It is not demand in the economic sense. • Demand is related to price. Generally demand for a commodity depends upon the price of the commodity. Generally the relation between price and demand is inverse. • When price of a particular commodity goes up, its demand falls and vice-versa.But in exceptional cases the two variables may move in the same direction.
  • 9.
    DEMAND There are otherfactors that may influence the quantity demanded for a quantity. • One such factor is the income of the consumer. If a man’s income increases, obviously he will be able to demand more of the goods at a given price. • Except that, demand for a commodity depends upon the taste and preference of the consumers, the price of substitute goods etc.
  • 15.
    Determinants Of Demand •There are many factors other than price that can affect the level of quantity demanded. This defines demand function. Demand determinants refer to the factors that affect demand for commodity (a consumer good), such as: 1. Price of the Commodity 2. Income of the Consumer 3. Price of related goods 4. Taste and preference of consumer 5. Growth of population 6. Government policy 7. Climatic conditions 8. Income distribution 9. Expected change in price 10. Future expectation about income etc.
  • 16.
    Determinants Of Demand (i)Price of the Commodity : There is an inverse relationship between the price of the commodity and the quantity demanded. It implies that lower the price of commodity, larger is the quantity demanded and vice-versa.
  • 17.
    Determinants Of Demand (ii)Income of the consumers: Usually there is a direct relationship between the income of the consumer and his demand. i.e. as income rises his demand rises and vice-a-versa. The income demand relationship varies with the following three types of commodities : (a) Normal Goods : In such goods, demand increases with increase in income of the consumer. For e.g.. demands for television sets, refrigerators etc. Thus income effect is positive. (b) Inferior Goods : Inferior Goods are those goods whose demand decrease with an increase in consumes income. For e.g. food grains like Malze , etc. If the income rises demand for such goods to the consumers will fall. Thus income effect is negative. (c) Giffen goods : In case of Giffen goods the demand increases with an increase in price but it decreases with the rise in income. Thus income effect is negative.
  • 18.
    Income Of TheConsumers
  • 19.
    Determinants Of Demand (iii)Consumer’s Taste and Preference: Taste and Preferences which depend on social customs, habit of the people, fashion, etc. largely influence the demand of a commodity.
  • 20.
    Determinants Of Demand (iv)Price of Related Goods: Related Goods can be classified as substitute and complementary goods. • (v) Substitute Goods: In case of such goods, if the price of any substitute of commodity rises, then the commodity concern will become relatively cheaper and its demand will rise. The demand for the commodity will fall if the price of the substitute falls. e.g.. If the price of coffee rises, the demand for tea will rise.
  • 21.
  • 22.
    Determinants Of Demand (vi)Complementary Goods: In case of such goods like pen and ink with a fall in the price of one there will be a rise in demand for another and therefore the price of one commodity and demand for its complementary are inversely related. (vii) Consumer’s Expectation: If a consumer expect a rise in the price of a commodity in a near future, they will demand it more at present in anticipation of a further rise in price. (viii)Size and Composition of Population: Larger the population, larger is likely to be the no. of consumers. • Besides the composition of population which refers to the children, adults, males, females, etc. in the population. The demographic profile will also influence the consumer demand.
  • 23.
  • 24.
    Demand Function Demand functionsexpresses the functional relationship between demand for a commodity (i.e. a consumer good) and its determinants. It can be written as : Dx= f (Px , Y, PR ,T, Pe , G, …………..) Where, Dx symbolizes demand for commodity X Px symbolizes price of commodity X Y symbolizes income of the consumer PR symbolizes price of related good R T symbolizes taste and presences Pe symbolizes expected change in price of commodity X G symbolizes growth of population
  • 25.
    Kinds Of Demand Thereare three kinds of demand relations which are usually studied under demand analysis such as: Price Demand, Income Demand and Cross Demand. • Price Demand: Price demand studies how demand for a commodity (D) changes with respect to change in price(P) , ceteris paribus (other things remaining the same). • Dx= f (Px) x
  • 26.
    KINDS OF DEMAND •Income Demand: Income Demand examines how demand for commodity (D) changes as a result of change in income of the consumer(Y) , other things remaining the same. • Dx= f (Y)x
  • 27.
    KINDS OF DEMAND •Cross Demand: Cross demand studies how quantity demand of a commodity ( D) changes as a result of change in price of its related goods (P), ceteris paribus . Cross demand function can be denoted as follows: • Dx= f ( PR ) x
  • 28.
    Law of Demand •The law of demand expresses the functional relationship between the price of commodity and its quantity demanded. • It states that the demand for a commodity tends to vary inversely with its price this implies that the law of demand states- Other things remaining constant, a fall in price of a commodity will lead to a rise in demand of that commodity and a rise in price will lead to fall in demand. • The Law of Demand says as “the quantity demanded increases with a fall in price and diminishes with a rise in price”. –Marshall • “The Law of Demand states that people will buy more at lower price and buy less at higher prices, other things remaining the same”. - Samuelson
  • 29.
  • 30.
    Law of Demand •Assumption: (i) Income of the people remaining unchanged. (ii) Taste, preference and habits of consumers unchanged. (iii) Prices of related goods i.e., substitute and complementary goods remaining unchanged (iv) There is no expectation of future change in price of the commodity. (v) The commodity in question is not consumed for its prestige value.
  • 31.
    Importance of Lawof Demand 1. Basis of the Law of Demand: The law of Demand is based on the consumers that they are prepared to buy a large quantity of a certain commodity only at a lower price. This results from the fact that consumption of additional units of a commodity reduces the marginal utility to him. 2. Basis of consumption Expenditure : The law of Demand and the law of equi-marginal utility both provide the basis for how the consumer should spend his income on the purchase of various commodities.
  • 32.
  • 33.
    Importance of Lawof Demand 3. Basis of Progressive Taxation: Progressive Taxation is the system of Taxation under which the rate of tax increase with the increase in income. This implies that the burden of tax is more on the rich than on the poor. The basis of this is the law of Demand. Since it implies that the marginal utility of Money to a rich man is lower than that to a poor man. 4. Diamond-water paradox: This means that through water is more useful than diamond. Still the price of diamond is more than that of water. The explanation lies in law of diminishing marginal utility. The price of commodity is determined by its marginal utility. Since the supply of water is abundant the marginal utility of water is very low and so its price. On the contrary, supply of diamond is limited so the marginal utility of diamond is very high, therefore the price of diamond is very high.
  • 34.
  • 35.
    Importance of Lawof Demand • Demand Curve: Demand curve is a diagrammatic representation of the demand schedule when we plot individual demand schedule on a graph, we get individual demand curve and when we plot market schedule, we get market curve. Both individual and market demand curves slope downward from left to right indicating an inverse relationship between price and quantity demanded of goods.
  • 36.
    Demand Curve • Demandcurve is the graphical representation of the relationship between demand for a commodity (Dx) and its price (Px) .
  • 37.
    Demand Curve • Thedemand curve is downward sloping because of the following reasons. • 1) Some buyer may simply not be able to afford the high price. • 2) As we consume more units of a product, the utility of that product becomes less and less. This is called the principle of diminishing Marginal Utility. • The quantity demanded rises with a fall in price because of the substitution effect. A low price of x encourages buyer to substitute x for other product.
  • 38.
    Causes of downwardslope of demand curve (i) Law of Diminishing Marginal Utility: This law states that when a consumer buys more units of same commodity, the marginal utility of that commodity continues to decline. This means that the consumer will buy more of that commodity when price falls and when less units are available, utility will be high and consumer will prefer to pay more for that commodity. This proves that the demand would be more at lower prices and less at a higher price and so the demand curve is downward sloping.
  • 39.
    Causes Of DownwardSlope Of Demand Curve (ii) Income effect: As the price of the commodity falls, the consumer can increase his consumption since his real income is increased. Hence he will spend less to buy the same quantity of goods. On the other hand, with a rise in price of the commodities the real income of the consumer will fall and will induce them to buy less of that good. (iii) Substitution effect: When the price of a commodity falls, the price of its substitutes remaining the same, the consumer will buy more of that commodity and this is called the substitution effect. The consumer will like to substitute cheaper one for the relatively expensive one on the other hand, with a rise in price the demand fall due to unfavourable substitution effect. It is because the commodity has now become relatively expensive which forces the consumer’s to buy less.
  • 40.
  • 41.
  • 42.
    Causes Of DownwardSlope Of Demand Curve (iv) Goods having multipurpose use: Goods which can be put to a number of uses like coal, aluminium, electricity, etc. are e.g.. of such commodities. When the price of such commodity is higher, it will not used for a variety of purpose but for use purposes only. On the other hand, when price falls of the commodity will be used for a variety of purpose leading to a rise in demand. For e.g. : if the price of electricity is high, it will be mainly used for lighting purposes, and when its price falls, it will be needed for cooking. (v) Change in number of buyers : Lower the price, will attract new buyers and raising of price will reduce the number of buyers. These buyers are known as marginal buyers. Owing to such reason the demand falls when price rises and so the demand curve is downward sloping.
  • 43.
    Exception to Demandcurve or Law of Demand • In some rare situations, the law of demand does not hold good. • In such situations, the demand curve slopes upward instead of sloping downward suggesting a rise in demand with rising price. • Cases in which this tendency is observed are referred to as exceptions to the general law of demand. In such situations, the demand curve slopes upward instead of sloping downward suggesting a rise in demand with rising price. • Here demand curve D-D curve is known as an exceptional demand curve.
  • 44.
    Exceptions to thelaw of demand 1. Giffen Goods, 2. Conspicuous Consumption 3. Conspicuous Necessities, 4. Exceptional Demand Curves 5. Expected Changes In Price, 6. Extraordinary Situations Like Natural Disasters, Famine, Riots Etc
  • 45.
    Exceptions to thelaw of demand • Conspicuous goods: These are certain goods which are purchases to project the status and prestige of the consumer. For e.g. expensive cars, diamond jewellery, etc. such goods will be purchased more at a higher price and less at a lower price. • Giffen goods: These are special category of inferior goods whose demand increases even if with a rise in price. For e.g.. coarse grain, clothes, etc.
  • 46.
    Exceptions to thelaw of demand Giffen Goods: • In case of certain inferior goods called Giffen goods, when the price falls, quite often less quantity will be purchased than before because of the negative income effect and people’s increasing preference for a superior commodity with the rise in their real income. Few examples of giffen goods are cheap potatoes, coarse cloth, coarse grain, etc
  • 47.
    Exceptions to thelaw of demand • Conspicuous Consumption: • Some expensive commodities like diamonds, expensive cars, exorbitantly high priced mobile phones etc., are used as status symbols to display one’s wealth or , to distinguish oneself from average people. The more expensive these commodities become, the higher their value as a status symbol and hence, the greater the demand for them. Law of demand does not apply here.
  • 48.
  • 49.
    Exceptions to thelaw of demand • Share’s speculative market : It is found that people buy shares of those company whose price is rising on the anticipation that the price will rise further. On the other hand, they buy less shares in case the prices are falling as they expect a further fall in price of such shares. Here the law of demand fails to apply.
  • 50.
    BandwagonEffect Here the consumerdemand of a commodity is affected by the taste and preference of the social class to which he belongs to. If playing golf is fashionable among corporate executive, then as the price of golf accessories rises, the business man may increase the demand for such goods to project his position in the society.
  • 51.
    Veblen Effect Sometimes theconsumer judge the quality of a product by its price. People may have the expression that a higher price means better quality and lower price means poor quality. So the demand goes up with the rise in price for e.g.. : Branded consumer goods.
  • 52.
    Exceptions to thelaw of demand • Conspicuous Necessities: Certain things become necessities of modern life. These are purchased even if their prices rise. E.g. TV, refrigerators, mobile phones, automobiles. • Expected Changes in Price: Expected or anticipated changes in price of a commodity in future also can affect quantity demanded of it at present. If it is expected that the price of a commodity will rise in future, the demand for it rise and vice versa. • Extraordinary Situations: War, famines, riots, natural calamities are extra ordinary situations when people’s behaviour becomes abnormal. Law demand does not apply in abnormal situations.
  • 53.
    There Are TwoConcepts : • Extension Of Demand • Contraction Of Demand Changes In Quantity Demanded/ Movement Along Demand Curve
  • 54.
    Extension of demand Quantity Demanded O Price D D P2 Q2 Q1 B A Extensionof Demand : Other things remaining the same, when more quantity of a commodity is demanded due to fall in its price, it is called extension of demand. There is a downward movement along the demand curve in case of extension of demand. Extension Of Demand P1
  • 55.
    Contraction of demand Quantity Demanded O Price D D P2 Q2 Q1 P1B A Contraction of Demand : Other things remaining the same, when less quantity of a commodity is demanded due to rise in its price, it is called contraction of demand . There is a upward movement along the demand curve in case of contraction of demand. Contraction Of Demand
  • 56.
    Changes in Demand/ Shiftin Demand Curve/ There are two concepts : • Increase in Demand • Decrease in Demand Changes in Demand /Shift in demands are caused by • Changes in income • Changes in price of substitutes • Changes towards the taste and preferences of the commodity • Changes in climate etc.
  • 57.
    Demand O Price D D P2 Q2 Q1 P1 more demand atsame price D/ D/ O Q1 Same demand at higher price Increase in Demand When , due to factors other than price, more quantity of a commodity is demanded at same price or same quantity is demanded at higher price, it is called increase in demand. There is a upward /rightward shift in demand. Price Demand
  • 58.
    Demand O Price D D P2 Q2 Q1 P1 Less demand atsame price D/ D/ O Q1 Same demand at lower price Decrease in Demand When , due to factors other than price, less quantity of a commodity is demanded at same price or same quantity is demanded at lower price, it is called decrease in demand. There is a downward /leftward shift in demand Price
  • 59.
    Elasticity of Demand •Whenever a policy maker wishes to examine the sensitivity of change in quantity demanded due to the change in price, income or price of the related goods, he wishes to study the magnitude of this response with the help of “elasticity” concept. Thereby, the concept is crucial for business decision-making and also for forecasting future demand policies.
  • 60.
    Determinants Of ElasticityOf Demand (i) Nature, Necessity Of A Commodity: The demand for necessary commodity like rice, wheat, salt, etc. is highly inelastic as their demand does not rise or fall much with a change in price. On the other demand for luxuries changes considerably with a change in price and than demand is relatively elastic.
  • 61.
    Determinants Of ElasticityOf Demand (ii) Availability of substitutes: The Demand for commodities having a large number of close substitute is more elastic than the commodities having less or no substitutes. If a commodity has a large no. of substitutes its elasticity is high because when there is a rise in its prices, consumers easily switch over to other substitutes. (iii) Variety of uses : The Product which have a variety of uses like steel, rubber etc. have a elastic demand and if it has only limited uses, then it has inelastic demand. For e.g.. if the unit price of electricity falls then electricity consumption will increase, more than proportionately as it can be put to use like washing, cooking, as the price will go up, people will use it for important purposes only.
  • 62.
    Determinants Of ElasticityOf Demand • (iv) Possibility of postponement of consumption : The commodities whose consumption can easily be postponed has more elastic demand and the commodities whose consumption cannot be easily postponed has less elastic demand for e.g.. for expensive jewellery, perfume it is possible to postpone consumption in case the price is high and so such goods are elastic on the other hand, the necessities of life cannot be postponed and so they are inelastic in demand. • (v) Durable commodities : Durable goods like furniture’s, etc, which will last for a longer time have valuably inelastic demand. This is because in such case, a fall in price will not lead to a large increase in demand and a rise in price again will not load to a huge fall in demand. But in case of perishable goods, the demand is elastic is nature.
  • 63.
  • 64.
    Elasticity Of Demand •Elasticity of demand is the measure of the responsiveness of quantity demanded of a commodity in response to change in a particular demand determinant (say price) while keeping other determinants constant( such as:, income, or price of related good , advertisement, growth of population and so on).
  • 65.
    Concepts Of ElasticityOf Demand There may be as many as concepts of elasticity of demand as the number of demand determinants. Most important concepts of elasticity of demand are: • Price elasticity of demand (here the demand determinant is price of the commodity) • Income elasticity of demand (here the demand determinant is income of consumer) • Cross elasticity of demand (here the demand determinant is price of related goods)
  • 66.
    Price Elasticity ofDemand • It is defined as the degree of responsiveness of quantity demanded of a commodity due to change in its price when other factor remaining constant.
  • 67.
    Kinds Of PriceElasticity Of Demand 1. Perfectly Elastic Demand : 2. Elastic Demand /Relatively Elastic Demand: 3. Unit Elastic Demand: 4. Inelastic Demand / Relatively Inelastic Demand : 5. Perfectly Inelastic Demand: 𝑒𝑃 > 1 𝑒𝑃 < 1
  • 68.
    1. Perfectly ElasticDemand Price 0 Quantity Demand Perfectly elastic demand curve P D When quantity demanded of the commodity changes though there is no change in price, it is known as perfect elastic demand. Incase of Perfectly elastic demand, Q1 Q2
  • 69.
    2. Relatively ElasticDemand Elastic demand curve 0 Quantity demanded Price D D When the proportionate change in demand is more than the proportionate changes in price, it is known as relatively elastic demand. E.g. luxury goods Incase of elastic demand, Q1 Q2 P2 P1 𝑒𝑃 > 1
  • 70.
    3. Unit ElasticDemand Unit elastic demand equal 0 Quantity Demand Price D D When the proportionate change in demand is equal to proportionate changes in price, it is known as unitary elastic demand. Incase of unit elastic demand, P2 P1 Q1 Q2
  • 71.
    4. Relatively InelasticDemand Inelastic demand curve Quantity Demanded O Price D D When the proportionate change in demand is less than the proportionate changes in price, it is known as relatively inelastic demand. e.g. necessities, electricity etc. Incase of inelastic demand, P2 Q2 Q1 P1 𝑒𝑃 < 1
  • 72.
    5.Perfectly Inelastic Demand D Perfectlyinelastic demand curve 0 Price Quantity Demanded When a change in price, howsoever large, change no changes in quality demand, it is known as perfectly inelastic demand. E.g. salts , matchbox Incase of perfectly inelastic demand, P1 P2 Q
  • 73.
    All Kinds Of(Price) Demand Curves Be Shown In One Diagram 0 Quantity Demanded Price 𝑒𝑃 > 1 𝑒𝑃 < 1
  • 74.
    Importance of PriceElasticity of Demand (i) Business Decisions: The concept of price elasticity of demand helps the firm to decide whether or not to increase the price of their product. Only if the product is inelastic in nature, then raising of price will be beneficial. On other hand, if the product is elastic in nature, then a rise in price might lead to considerable fall in demand. Therefore the price of different commodities are determined on the basis of relative elasticity.
  • 75.
    Importance of PriceElasticity of Demand (ii) To monopolist: A monopolist often practices price discrimination. Price discrimination is a process in which a single seller sells the same commodity in two different markets at two different prices at the same time. The knowledge of price elasticity of the product to the monopolist is important because he would charge higher price from those consumers who have inelastic demand and lower price from those consumers who have elastic demand. (iii) Determination of Factor Price: The concept of elasticity of demand also helps in determining the price of various factors of production. Factor having inelastic demand gets higher price and factors having elastic demand gets lower price.
  • 76.
    Importance of PriceElasticity of Demand (iv) Route for International Trade: If demand for exports of a country is inelastic, that country will enjoy a favourable terms of trade while if the exports are more elastic than imports, then the country will lose in the terms of trade. (v) The Govt: Elasticity of demand is useful in formulation Govt. Policy particularly taxation policy and the policy of subsides if the Govt. wants to impose excise duty, or sales tax, the Govt. should have an idea about the elasticity of the product. If the product is elastic in nature, then the burden of the tax is shifted to the consumer and the demand might fall remarkably: on the other hand, if the demand is inelastic in nature, then any extra burden of indirect tax will not affect the demand to that extent.
  • 77.
    Income Elasticity OfDemand • Income Elasticity of demand is the measure of the responsiveness of quantity demanded of a commodity in response to change in income of the consumer, ceteris paribus.
  • 78.
    Kinds Of IncomeElasticity Of Demand Positive Income elasticity of demand which includes • Unitary Income Elasticity (ey=1) indicates that a proportionate (percentage or relative )change in quantity demanded is equal to proportionate change in money income. • High Income Elasticity (ey > 1 ) indicates that a proportionate change in quantity demanded is more than proportionate change in money income. E.g. luxuries o Income elasticity less than unity • Low Income Elasticity (ey < 1) indicates that a proportionate change in quantity demanded is less than proportionate relative change in money income. e.g. necessities • Zero Income elasticity /Perfectly Inelastic Income demand (e y = 0) change in income will have no effect on the quantity demanded e.g. salts) • Negative income elasticity (e Y < 0) [in case of inferior goods] indicates that less is bought at higher incomes and more is bought at lower incomes.
  • 79.
    Cross Elasticity OfDemand • Cross Elasticity of demand is the measure of the responsiveness of quantity demanded of a commodity in response to change in price of its related goods, ceteris paribus.
  • 80.
    Kinds Of CrossElasticity Of Demand • Positive Cross elasticity of demand (eAB > 0) when the goods A and B are substitutes] e.g. Coca cola and Pepsi, Chinese mobile phones and smart phones. • Negative Cross elasticity of demand (eAB < 0) [when the goods A and B are complementary] e.g. vehicle and petrol • Zero Cross elasticity of (e AB = 0 ) [when the goods A and B are independent/unrelated] e.g. gold and rice.
  • 81.
    Geometric Method /PointMethod Of Measuring Elasticity Of Demand Where, eP is price elasticity of demand Q is quantity demanded (initial) P is price of the commodity (initial) dQ is change in quantity demanded dP change in price Geometric method attempts to measure numerical elasticity of demand at a particular point on the demand curve. The is method is applied when changes in price and the resultant change in quantity demanded are infinitely small. As per point method,
  • 82.
    O Price A B Demand D dP dQ P1 P2 Q1 Q2 C E Price elasticityof demand at point D at demand curve AB can be written as
  • 83.
    0 Price Demand A B D D Arc method isapplied when changes in price and the resultant change in quantity demanded are somewhat large or we have to measure elasticity over an arch of demand curve. The formula for arc elasticity is as follows: Arc Method Of Measuring Elasticity Of Demand 𝒆𝑷 = ( 𝒅𝑸 𝑸𝟏 + 𝑸𝟐 𝟐 ) ÷ ( 𝒅𝑷 𝑷𝟏 + 𝑷𝟐 𝟐 ) 𝒆𝑷 = ( 𝒅𝑸 𝒅𝑷 )𝑿( 𝑷𝟏+𝑷𝟐 𝑸𝟏+𝑸𝟐 ) Where Q1 is original quantity demanded Q2 is new quantity demanded P1 is original price P2 is final price Q1 Q2 P1 P2
  • 84.
    Utility is definedas the power of commodity to satisfy a human want. • People know utility of goods by means of introspection and therefore is subjective. Being subjective, it varies from persons to persons. That is, different persons may derive different amount of utility/satisfaction from the same good. The desire for a commodity by a person depends upon the utility he expects to obtain from it. Total Utility And Marginal Utility Total Utility- Total psychological satisfaction obtained by a consumer from consuming a given amount of a particular commodity is called total utility. Marginal Utility - Marginal Utility is the extra utility derived by a consumer from the consumption of an additional unit of a particular commodity. Utility
  • 85.
    Relationship Between TuAnd Mu -5 0 5 10 15 20 25 30 35 1 2 3 4 5 6 7 Total/Marginal Utilities Quantity of Commodity The Law of Diminishing Marginal Utility TU MU Quantity (Q) TU (utils) MU=dU/dQ (utils) 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 -2
  • 86.
    Total utility (TU)is the sum total of marginal utilities . TU=∑MU Marginal utility (MU) is the rate of change in total utility with respect to a unit change in quantity of the commodity consumed. MU=dU/dQ • dU symbolizes change in total utility • dQ symbolizes change in quantity of commodity consumed • When the MU decreases, TU increases at decreasing rate. • When MU becomes zero, TU is maximum. It is a saturation point. • When MU becomes negative, TU declines Relationship Between Tu And Mu.
  • 87.
    It is apsychological fact that when a person consumes more and more units of a commodity during a particular time, the extra utility he derives from the successive units of the commodity will diminish. The Law of Diminishing Marginal Utility states that the additional satisfaction derived from the additional unit of a commodity goes on diminishing. The law highlights that while total wants of a man is unlimited, each single want is satiable. As a consumer more and more units of a commodity, intensity for the commodity goes on falling , and a point is reached where he does not want more of it. He is completely satisfied with the commodity which is reflected by zero marginal utility. The law of diminishing marginal utility also serve the basis for law of demand or downward sloping demand curve. Law Of Diminishing Marginal Utility
  • 88.
    A consumer isin equilibrium when he maximises his utility or satisfaction by spending his given money income on different goods. •Consumer’s Equilibrium in Case of Single Good Let us take a simple model of single commodity X. The consumer either spends his money income on the good or retains his money income. In such situation, the consumer will be in equilibrium when MUX = PX •Where, MUX is marginal utility of commodity X •PX is price of the commodity X. • If MUX > PX , the consumer can increase his well-being by purchasing more units of the commodity X. • If MUX < PX , the consumer can increase his total cost satisfaction by cutting down the quantity of commodity X and keeping more of his income unspent. • Thus, he maximises his satisfaction when MUX = PX Consumer’s Equilibrium
  • 89.
    Consumer’s Equilibrium Incase of More Than One Good & Law of Equi-Marginal Utility The law of equi-marginal utility states that a consumer distributes his limited income among various commodities in such a way that marginal utility of money expenditure on each good is equal. This is the condition of consumer’s equilibrium in case of more than one commodity. Marginal utility of money expenditure on a good is the ratio of marginal utility of the commodity to price of it.
  • 90.
    Consumer’s Equilibrium InCase Of More Than One Good And Law Of Equi-marginal Utility
  • 91.
    Supply • Supply isdefined as a quantity of a commodity offered by the producers to be supplied at a particular price and at a certain time. • Supply indicates quantities of a commodity of a offered for sale at each possible price at a given time period, other things constant
  • 92.
    Individual Supply andMarket Supply
  • 93.
    Law of Supply •If the price of commodity rises, the level of quantity supplied rises, after factors remaining constant. • Supply Curve: in the graphical representation of supply schedule when the factors affecting supply remain constant. • • Movement from A to B: Extension in Supply • • Movement from B to A: Contraction in Supply
  • 94.
    Law Of Supply •Law of supply states that normally, the quantity supplied varies directly with its price, other things constant. • In other words , law of supply states that lower the price, the smaller the quantity supplied and higher the price, the greater the quantity supplied.
  • 95.
    Supply Curve 0 Supply Price S S SupplyCurve Supply Curve Is The Graphical Representation Of The Relationship Between Supply Of A Commodity (Dx) And Its Price (Px) . Normally, a supply curve slopes upward from left to right indicating the operation of the law of supply.
  • 96.
    0 E S(P) D(P) Surplus Price Demand/Supply Demand = Supply Shortage Equilibrium Price Equilibrium pricea commodity is determined at point(E) where market demand is equal to market supply. At price P2 , supply is more demand and thus there is surplus in the market. Price will fall causing supply to fall and demand to rise. Price will continue to fall until it reaches equilibrium price Pe at which Demand=Supply ( Equilibrium point E). P2 P1 Q1 Q2 Qe At P1, demand is more than supply and as such there is shortage in the market. Price will raise causing demand to fall and supply to rise. Price will continue to rise until it reaches equilibrium price at which Demand=Supply ( Equilibrium point E). Pe
  • 97.
    Determinants of Supply Determinantsof Supply 1. Price of the product 2. State of technology 3. Prices of relevant resources 4. Prices of alternative goods 5. Producer expectations 6. Number of producers/sellers in the market
  • 98.
    Factors Determining Supplyor Supply Function (i) Price Of The Commodity: When the price of a commodity in the market rises, seller increases the price. • The cost of production remaining constant the higher will be the profit margin. This will encourage the producers to supply more at higher prices. The reverse will happen when the price fall. (ii) Goals Of The Firm: Firms may try to work on various goals for e.g.. Profit maximization, sales maximization, • employment maximization. If the objective is to maximize profit, then higher the profit from the sale of a commodity, the higher will be the quantity supplied by the firm and vice-versa. Thus, the supply of goods will also depend upon the priority of the firm regarding these goals and the extent to which it is prepared to sacrifice one goal to the other.
  • 99.
    Factors Determining Supplyor Supply Function
  • 100.
    Factors Determining Supplyor Supply Function (iii) Input Prices: The supply of a commodity can be influenced by the raw materials, labour and other inputs. If the price of such inputs rise leading to a lower profit margin becomes less. This will ultimately lead to a lower supply. On the other hand, if there is a fall in input cost firm, will be ready to supply more than before at a given price level. (iv) State of Technology : If improved and advanced technology is used for the production of a commodity, it reduces its cost of production and increases the supply. On the other hand, the supply of those goods will be less whose production depend on unfair and old technology.
  • 101.
    Factors Determining Supplyor Supply Function (v) Government policies: The imposition of sales tax reduces supply and grant of subsidy on the other hand increases the supply. (vi) Expectation about future prices: If the producers expect an increase in the price of a commodity, then they will supply less at the present price and hoard the stock in order to sell it at a higher price in the near future. This will be opposite in case if they anticipate fall in future price (e.g.. fruit seller)
  • 102.
  • 103.
    Exceptions to theLaw of Supply (i) Agricultural Goods: In case of such goods the supply cannot be adjusted to market conditions. • The production of agriculture goods is largely dependent on natural phenomenon and therefore its supply depends upon natural factors like rainfall, etc. Moreover the supply of such goods is mostly seasonal and therefore it cannot be increased with a rise in price. (ii) Rare objects : These are certain commodities like rare coins, classical paintings old manuscripts, • etc. whose supply cannot be increased or decreased with the change in price. Therefore, such goods are said to have inelastic supply and the supply curve is a vertical straight line parallel to Y – axis.
  • 104.
    Exceptions to theLaw of Supply
  • 105.
    Factors Determining Supplyor Supply Function (iii) Labour Market: In the labour market, the behaviour of the supply of labour goes against the law of supply.
  • 106.
    Elasticity of Supply •Elasticity of supply is defined as the degree of responsiveness of quantity supplied of a commodity due to change in its price. Elasticity of supply is expressed as : • es = % changes in qty. supplied / % changes in price • = (dq/q x 100) /(dp/p x 100) • = (dq/dp x p/q) Where, • d = change, q = original quantity supplied, p = original price.
  • 108.
  • 109.
    Determinants of Elasticityof Supply (i) Nature Of The Commodity: The supply of durable goods can be increased or decreased effectively in response to change in price and hence durable goods are relatively elastic. • On the other hand the perishable goods cannot be stored and thus supply cannot be altered significantly in response to change in their price. Hence the price of the perishable goods are relatively less elastic. (ii) Time Factor: A price change may have a small response on the quantity supplied because output may change by small quantity in the short period since the production capacity may have been limited. Therefore, in the short run supply tends to be relatively inelastic. • On the other hand in the long run production capacity may be increased or supply may also be raised therefore in the long run supply is elastic.
  • 110.
    Determinants of Elasticityof Supply (iii) Availability of facility for expanding output: If producers have sufficient production facilities such as availability of power, raw materials, etc, they would be able to increase their supply in response to rise in price.On the other hand if there is a shortage of such facilities then expansion of supply will not be possible due to rise in price. (iv) Change in cost of production: Elasticity of supply depends upon the change in cost. If an increase of output by a firm in an industry causes only a slight increase in the cost then supply will remain fairly elastic. On the other hand if an increase in output bring about a large increase in cost due to rise in price of inputs etc, then supply will be relatively inelastic. (v) Nature of inputs : Elasticity of supply depend upon the nature of inputs for the production of a commodity. If the production requires inputs that are easily available, then its supply will be relatively elastic. On the other hand, if it uses specialized inputs then its supply will be relatively inelastic. (vi) Risk Taking: If entrepreneurs are willing to take risk, then supply will be more elastic and if they are reluctant to take risk then supply would be inelastic.
  • 111.