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Consumer Behaviour and Demand

A. Consumer Behaviour

1. Human wants

2. Consumption

3. Consumers equilibrium (Various Utility concepts)

B. Demand

1. Concept

2. Factors affecting demand

3. Law of demand4. Elasticity of Demand

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Human Wants

Goods are priced because of their usefulness; Usefulnessleads to the demand while scarcity leads to its supply.Therefore the interaction of demand and supply is thepoint where the prices of goods is determined.

Human Wants : The basis of all economic activities is theexistence of human wants and the process of fulfillmentof this want is where all economics activities start.

Definition of Human Want :. Desire is the wish to have something. But want is aneffective desire for a particular thing, which can besatisfied by making an effort to acquire it.

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Human Wants

Three elements that make a desire, an effective desire ora want:

(i) willingness

(ii) resources for fulfilling the desire and

(iii) willingness to part with the resource to fulfill thatdesire

In other words its is want-effort-satisfaction which formsthe subject matter of economics

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Features of Human Wants

Classification of Human Wants : necessaries, comfort andluxuries.

Features :

1. Unlimited Wants2. Some wants are complementary3. A single want is satiable4. Substitutability of Wants5. Wants are competitive

6. Wants multiply7. Wants re-occur8. Some wants can be postponed9. Wants differ in urgency and intensity

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Economic Significance of Human

Wants1 The material prosperity of a country can be gauged

from the number and variety of human wants normallysatisfied.

2 Shows important features which are the basis ofimportant laws in Economics Laws of diminishingreturn, law of M.L. and law of substitution

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Consumption

Goods and services need to be consumed in order to satisfyhuman wants. Consumption is registered the beginning aswell as the end of all economic activities.

Definition/Meaning of Consumption: Consumption means theuse of goods and services in satisfying human wants.

Kinds: a. Final b. Productive c. Quick or fast movingd.slow

Importance of Consumption:# Importance to the Government# Importance to Businessman# Importance to Household# Importance to Society

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Utility

Utility refers to want satisfying power of a commodity.

In objective terms, utility may be defined as the amountof satisfaction derived from a commodity or service at a

particular time.

Assumptions: Utility can be measured. Marginal Utility of money remains constant No change in income of the consumer, his taste &

fashion to be constant No substitute Independent marginal utility of each unit of commodity

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Utility

Characteristics:

Utility is subjective/not measurable

Utility is variable

Utility is different from usefulness

Marginal Utility (MU)

The word Marginal means Border or Edge.It is the addition made to the total utility by consumingone more unit of a commodity.

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UtilityTotal Utility (TU)

Total Utility refers to the total satisfaction derived bythe consumer from the consumption of a given quantity

of a good.TU = Sum of all MU

The exponents of the utility analysis have developed twolaws which occupy a very important place in economicstheory and they are :-# Law of Diminishing Marginal Utility# Law of Equi-Marginal Utility

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Law of Diminishing Marginal Utility

Though wants of an individual are unlimited in number yeteach individual want is satiable. Because of this, themore we have a commodity, the less we want to havemore of it.

This law state that as the amount consumed of acommodity increases, the utility derived by theconsumer from the additional units, i.e marginal utilitygoes on decreasing.

According to Marshall, The additional benefit a personderives from a given increase of his stock of a thingdiminishes with every increase in the stock that healready has

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Law of Diminishing Marginal

UtilityExplanation:As more and more quantity of a commodity is consumed,

the intensity if desire decreases and also the utilityderived from the additional unit.

Assumptions: All the units of a commodity must be same in all

respects The unit of the good must be standard There should be no change in taste during the process

of consumption There must be continuity in consumption There should be no change in the price of the substitute

goods

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Law of Diminishing Marginal

UtilityExceptions:# Money

# Hobbies and Rare Things

# Liquor and Music

# Things of Display

Importance:

Basis of Law of Demand

Basis of Consumption Expenditure

The basis of Progressive Taxation

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Consumers Equilibrium

Consumer will attain its equilibrium (maximum satisfaction)at the point, where marginal utility of a product dividedby the marginal utility of a rupee, is equal to the price.

Consumers equilibrium = Marginal utility of a productMarginal utility of a rupee

= its price

Steps: Generation of alternatives Evaluation of alternatives Choice of the best alternativeAssumptions: Consumer behaviour is rational. Consumer behaviour is consistent. There are two commodities in consideration.

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Law of Equi-Marginal Utility

This law states that the consumer maximizing his totalutility will allocate his income among various commoditiesin such a way that his marginal utility of the last rupeespent on each commodity is equal.

Or

The consumer will spend his money income on differentgoods in such a way that marginal utility of each good isproportional to its price

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Limitations of Law of Equi-

Marginal Utility## It is difficult for the consumer to know the marginal

utilities from different commodities because utilitycannot be measured.

# Consumer are ignorant and therefore are not in aposition to arrive at an equilibrium.

# It does not apply to indivisible and inexpensivecommodity.

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Consumer Surplus

According to Marshall: Consumer Surplus is defined as theexcess of the price which a person would be willing topay rather than go without the thing over that which heactually does have to pay.

This excess of satisfaction is called Consumer satisfactionand hence Consumer Surplus.

Consumer Surplus = Total Utility (Mkt. Price * No. ofunits consumed)= T.U ( P * N)

Criticisms:

A Vague Idea Too many assumptions Applicable to a small number of cases only Neglects the income effect of the price change. Not applicable to highly superior & Giffen goods

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Demand

Meaning and Definition of DemandAccording to Benham: The demand for anything, at a

given price, is the amount of it, which will be boughtper unit of time, at that price.

According to Bobber, By demand we mean the variousquantities of a given commodity or service whichconsumers would buy in one market in a given period oftime at various prices.

Requisites:

a. Desire for specific commodity.b. Sufficient resources to purchase the desired commodity.c. Willingness to spend the resources.d. Availability of the commodity at(i) Certain price (ii) Certain place (iii) Certain time.

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Kinds of Demand1. Individual demand

2. Market demand

3. Income demand- Demand for normal goods (price ve, income +ve)- Demand for inferior goods (eg., coarse grain)

4. Cross demand- Demand for substitutes or competitive goods (eg.,tea &

coffee, bread and rice)- Demand for complementary goods (eg., pen & ink)

5. Joint demand (same as complementary, eg., pen & ink)6. Composite demand (eg., coal & electricity)7. Direct demand (eg., ice-creams)8. Derived demand (eg., TV & TV mechanics)9. Competitive demand (eg., desi ghee and vegetable oils)10.Demand of unrelated goods

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Factors Determining Demand

(i) Price of the commodity Normally there is an inverserelationship between the price of the commodity and thequantity demanded. (Px)

(ii) Income of the Consumer Determines the purchasingpower of the consumer. Generally, there is a directrelationship between the income of the consumer anddemand. (Y)

(iii) Consumers taste and preference (T)(iv) Price of related commodities (Pr)(v) Consumer Expectation (expected change in price)

(v) Distribution of income(vi) Size and composition of population(vii) Other Factors e.g., natural calamities

Qdx = f (Px, Pr ,Y , T, D)

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Demand Schedule

Demand Schedule: a tabular presentation showing differentquantities of a commodity that would be demanded atdifferent prices.

Types of Demand Schedules

Individual Demand Schedule Market Demand Schedule

Shows various quantities of acommodity that would bepurchased at differentprices by a household.

Shows the various commoditiesthat would be purchased atdifferent prices by all thebuyers of that commodity. Itis composed of the demandschedules of all the individuals

purchasing that commodity.

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Demand Curve

Demand Curves A demand curve is a graphical depictionof the law of demand. The picturization or the plottingof the demand schedule is called the demand curve. Itis the curve showing different quantities demanded at

alternative prices.

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Demand Curve

The demand curve slopes downwards from left to rightwhich indicates that there is an inverse relationshipbetween price and quantity demanded.

Demand Schedules for Apples

Price/kg Demand-A Demand-B Market(A+B)30 4 3 725 6 5 11

20 9 8 1715 13 12 2510 17 15 32

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Demand Curve

Movement along demand curve Vs. Shift in demand curve:Distinction between change in quantity demanded and

change in demand.

A. Change in quantity demanded When quantity demandedchanges ( rise or fall ) as a result of change in pricealone, other factors remaining the same.

Contraction/fall in quantity demanded Extension/Rise in quantity demanded

The change is depicted/ represented by the movement up ordown on a given demand curve. This does not require drawing anew demand curve.

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Demand Curve

B. Change in demand When the amount purchased of acommodity rises or falls because of the change infactors other than the price of the commodity. It iscalled change in demand.

Types of Changes

Increase in demand. Decrease in demand

This requires drawing altogether a new demand curve.Two extremes of demand are vertical & horizontal demandcurves, which represents perfectly inelastic demand (ED =zero) and horizontal demand curve which shows perfectlyelastic demand (ED = infinity)

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Demand Curve

Why does the demand curve Slope Downwardsto the Right?

Income Effect An increase in demand on account ofincrease in real income is known as income effect.

Substitution Effect

Increase in number of consumers

Several uses of commodity

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Law of Demand

Prof. Samuelson: Law of demand states that people willbuy more at lower price and buy less at higher prices,others thing remaining the same.

Ferguson: According to the law of demand, the quantitydemanded varies inversely with price.

Assumptions:

No change in tastes and preference of the consumers. Consumers income must remain the same. The price of the related commodities should not change. The commodity should be a normal commodity

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Law of DemandExceptions: Inferior goods Articles of snob appeal. Expectation regarding future prices Emergencies

Quality-price relationship Conspicuous necessities. Ignorance Change in fashion, habits, attitudes, etc..

Importance: Price determination. To Finance Minister To farmers In the field of Planning.

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Elasticity of Demand

Till now we were concerned with the direction of thechanges in price and quantities demanded. But here wewill answer the question By how much. Observe thefollowing:

As a result of a fall in the price of radios from Rs.500 to Rs 400, the quantity demanded increases from100 radios to 150 radios.

As a result of a fall in the price of wheat from Rs 10Kilograms to Rs 9 Per Kilograms the demand increasesfrom 500 Kilograms to 520 Kilograms.

In all the above cases we can notice that all respond toprice changes. But the difference in all the cases lies inthe degree of response of demand and this can be foundby comparing the percentage change in prices andquantities demanded. This is where the concept ofelasticity comes in.

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Factors affecting Elasticity of Demand

1. Availability of substitutes2. Postponement of consumption3. Proportion of expenditure (needles: inelastic; TV:

elastic)

4. Nature of the commodity (necessity vs. luxury)5. Different uses of the commodity (paper vs. ink)6. Time period (elastic in the long term)7. Change in income (necessaries: inelastic)8. Habits

9. Joint demand10.Distribution of income11.Price level (very costly & very cheap goods: inelastic)

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Definition: Elasticity of demand is defined as theresponsiveness of the quantity demanded of a good tochanges in one of the variables on which demanddepends.

These variables are price of the commodity, prices of the

related commodities, income of the consumer & othervarious factors on which demand depends. Thus, wehave Price Elasticity, Cross Elasticity, Elasticity ofSubstitution & Income Elasticity. It is always priceelasticity of demand which is referred to as elasticityof demand

A.Price ElasticityMeasures how much the quantity demanded of a good

changes when its price changes.Or

It may be defined as Percentage Change in Quantitydemanded over percentage change in price

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Price Elasticity

Price Elasticity Elastic Demand or more than 1 When quantity

demanded responds greatly to price changes Inelastic Demand or less than 1 When quantity

demanded responds little to price changes.

Unitary Elastic When quantity demanded respondsequally to the price changes.

Perfectly inelastic or 0 elastic demand Perfectly elastic or infinite elastic demand

Economic factors determine the size of price elasticity forindividual goods. Elasticity tends to be higher when thegoods are luxuries, when substitutes are available andwhen consumer have more time to adjust theirbehavior.

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Calculating Price Elasticity

PED = % Change in Qty Demanded

% Change in Price

Points to Remember:

We drop the minus sign from the numbers by treatingall % changes as positive. That means all elasticitys arepositive, even though prices and quantities move in theopposite direction because of the law of downwardsloping demand.

Definition of elasticity uses percentage changes in priceand demand rather than actual changes. That meansthat a change in the units of measurement does notaffect the elasticity. So whether we measure price inRupees or paisa, the price elasticity stays the same.

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Generally, above mid-point M of any straight line, demandis elastic, with ED >1. At Midpoint, demand is unit-elastic, with ED = 1, Below the midpoint, demand isinelastic, with ED1

ED=1

ED

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Elasticity & Revenue:

When demand is price inelastic, a price decreasereduces total revenue. When demand is price elastic, a price decrease

increases total revenue. In the borderline case of unit elastic demand, a price

decrease leads to no change in the total revenue

B. Income Elasticity of Demand: Is the degree ofresponsiveness of quantity demanded of a good to asmall change in the income of the consumer.

If the proportion of income spent on a good remains the

same as income increases, then income elasticity for thegood is equal to one. If the proportion spent on a good increases, then the

income elasticity for the good is greater than one. If the proportion decreases as income rises, then

income elasticity for the good is less than one.

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C. Cross Elasticity: A change in the demand for one goodin response to a change in the price of another goodrepresents cross elasticity of demand of the formergood for the latter good.

If two goods are perfect substitutes for each othercross elasticity is infinite and if the two goods aretotally unrelated, cross elasticity between them is zero.

Goods between which cross elasticity is positive can becalled Substitutes, the good between which the crosselasticity is negative are not always complementary as

this is found when the income effect on the pricechange is very strong.

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D.Elasticity of Substitution: Measures the ease withwhich one good can be substituted for another.

If two goods are perfect substitutes elasticity ofsubstitution will be infinite.

If two goods are to be used in fixed proportionelasticity of substitution will be zero

When it is difficult to substitute one good for another,then in that case elasticity will be lying between zero &infinity.

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Methods of measurement of

Elasticity1. Percentage or Proportionate Method= Percentage change in demand or;

Percentage change in price= Proportionate change in demand

Proportionate change in price

2. Total Outlay (Expenditure) MethodsTO=TQ * P ; where,TO=total outlay; TQ=total quantity; P=price of the commodity

3. Geometric (Point) method at any given point on the curve= lower segment of demand curveupper segment of demand curve

lec 6-10-08

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