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1. CONSUMER BEHAVIOUR AND THEORY OF DEMAND UNIT – 2 Ms. Priyanka Goel B.Com (Hons)1 st Semester

2. THEORY OF DEMAND Demand is a desire for a good , backed by ability and willingness to pay. Individual demand is the quantity of the commodity that an individual is willing to buy at a given price over a specified period of time, say a day, per week, per month, etc. Market demand refers to total quantity that all the users of a commodity are willing to buy at a given price over a specified period of time.

3. LAW OF DEMAND All other things remaining constant, the quantity demanded of a commodity increases when its price decreases and decreases when its price increases.

4. FACTORS BEHIND LAW OF DEMAND Income Effect Substitution Effect Diminishing Marginal Utility

5. EXCEPTIONS TO THE LAW OF DEMAND Expectations Regarding Future Prices Prestigious Goods Giffen Goods

6. DERIVATION OF MARKET DEMAND CURVE Market demand for a commodity is derived by doing summation of all the individual demands for the commodity at a given price, per unit of time.

7. DETERMINANTS OF MARET DEMAND Price of the Commodity Price of substitutes and complementary goods Consumer’s income Consumer tastes and preferences Consumer’s Expectations Demonstration Effect Consumer Credit facility Population of the country Distribution of National Income

8. DEMAND FUNCTION Linear Demand Function Non – Linear Demand Function Dynamic or Long run Demand Function

9. THEORY OF SUPPLY Supply means the quantity of a commodity which its producers or sellers offer for sell at given price, per unit of the time. Market supply is the summation of supplies of a commodity made by all individual firms or the suppliers. The law of supply of a commodity depends on its price and cost of production. The supply of a product increases with increase in its price and decreases with decrease in its price, other things remaining constant. Supply curve is an upward sloping curve.

10. SHIFTS IN SUPPLY CURVE Changes in input prices Technological progress Price effect of Product Diversification Nature and size of the Industry. Government Policy Non- economic factors

11. SHIFT IN DEMAND AND SUPPLY CURVES AND MARKET EQUILLIBRIUM Shift in demand curve: When there is an increase in demand, with no change in supply, the demand curve tends to shift rightwards. As the demand increases, a condition of excess demand occurs at the old equilibrium price. This leads to an increase in competition among the buyers, which in turn pushes up the price.

12. Under conditions of a decrease in demand, with no change in supply, the demand curve shifts towards left. When demand decreases, a condition of excess supply is built at the old equilibrium level. This leads to an increase in competition among the sellers to sell their produce, which obviously decreases the price.

13. Shift in Supply Curve: When supply increases, accompanied by no change in demand, the supply curve shift towards the right. When supply increases, a condition of excess supply arises at the old equilibrium level. This induces competition among the sellers to sell their supply, which in turn decreases the price. This decrease in price, in turn, leads to a fall in supply and a rise in demand. These processes operate until a new equilibrium level is attained. Lastly, such conditions are marked by a decrease in price and an increase in quantity

14. Both Supply and Demand curves shift simultaneously: Panel (a) shows that id the shift in the supply curve is higher than the demand curve then equilibrium price decreases and output increases. Panel (b) shows that effect of a bigger shift in the demand curve on the equilibrium price and output. In this case both the equilibrium prices and quantity increases. If the shift in supply and demand curves is of equal proportion then equilibrium price remains unchanged though output increases.

15. https://www.khanacademy.org/economics-finance-domain/microeconomics/supply-demand-equilibrium/market-equilibrium-tutorial/a/changes-in-equilibrium-price-and-quantity-the-four-step-process-cnx

16. DEMAND FORECASTING Demand forecasting is a highly complicated process as it deals with the estimation of future demand. It requires the assistance and opinion of experts in the field of sales management. Demand forecasting, to become more realistic should consider the two aspects in a balanced manner. Application of commonsense is needed to follow a pragmatic approach in demand forecasting

17. METHODS AND TECHNIQUES OF DEMAND FORECASTING

18. THEORY OF CONSUMER DEMAND The basis of consumer demand is Utility From commodity angle, utility is want- satisfying property of a commodity. From consumer’s point utility is the psychological feeling of satisfaction, pleasure, happiness or well being which a consumer derives from the consumption, possession or the use of a commodity.

19. APPROACHES TO CONSUMER DEMAND ANALYSIS Cardinal Utility Approach Ordinal Utility Approach

20. CARDINAL UTILITY APPROACH Attributed to Alfred Marshall and his followers, is also called the Neo- classical approach or Marshallian approach. Assumptions: Rationality Limited Money income Maximisation of satisfaction Utility is cardinally measurable Diminishing Marginal utility Constant Marginal Utility of Money Utility is additive Assuming that utility is measurable and additive, total utility may be defined as the sum of the utilities derived by a consumer from the various units of goods and services he consumes. Marginal utility may be defined as the addition to the total utility resulting from the consumption of one additional unit.

21. LAW OF DIMINISHING UTILITY This law states that as the quantity consumed of a commodity increases, the utility derived from each successive unit decreases, consumption of all other commodities remaining the same.

22. ORDINAL UTILITY APPROACH This is referred to as ordinal curve or indifference curve approach. An indifference curve is a locus of points in the commodity space showing different combination of two commodities which will give same level of satisfaction to the consumer so that he is indifferent in his approach. For instance, if you like both hot dogs and hamburgers, you may be indifferent to buying either 20 hot dogs and no hamburgers, 45 hamburgers and no hot dogs, or some combination of the two—for example, 14 hot dogs and 20 hamburgers (see point “A” in the chart below). Either combination provides the same  utility .

23. ASSUMPTIONS Rationality Utility’s Ordinal Consistency and Transitivity More is better than less

24. PROPERTIES OF INDIFFERENCE CURVE Indifference curves have a negative slope. Indifference curves are convex to the origin. Indifference curves do not intersect each other. Upper indifference curves indicate a higher level of satisfaction.

25. MARGINAL RATE OF SUBSTITUION (MRS) An indifference curve is formed by substituting one good for another. The MRS is the rate at which one commodity is substituted for another, the level of satisfaction remaining the same. The MRS between the two commodities X and Y may be defined as the quantity of X which is required to replace one unit of Y or quantity of Y required to replace one unit of X, in the combination of the two goods so that the utility of X or Y given up is equal to the utility of additional units of Y or X. The MRS is expressed as ∆Y/ ∆X, moving down the curve.

26. DIFFERENT SHAPES OF INDIFFERENCE CURVES Good: There are goods where more is preferred to less. Increase in consumption of good leads to increase in total utility and MU is positive. Bad: They are those goods whose MU is negative and less is always preferred to more. Increase in consumption leads to decrease in total utility. Neuters: They are those goods whose MU = 0 i.e. TU remains constant and increase in consumption will not lead to change in total utility.

27. BUDGET LINE OR PRICE LINE Budget line shows the different combinations of the two commodities which a consumer can buy with his given income and given prices of two commodities. I = P x .Q x + P y Q y I/P y = Q y I/P x = Q x The slope of budget line shows how much units of Y, the consumer must give up to buy one additional unit of X. As that budget line is a straight line therefore, the slope is constant at all points. The slope of budget line is equal to ratio of commodity prices Slope of Budget line = P x / P y - ratio of commodity prices.

28. SHIFTS IN BUDGET LINE The budget line will shift when either income changes or price changes. When price of X changes with price of Y and income remaining constant budget line will shift outwards and becomes flatters when price of X falls and vice versa. When price of Y changes with price of X and income remaining constant budget line rotates around X axis and shift outwards and vice versa. When both income and price change in same proportion ie .. Both are doubled or halved then the ratio of prices remains unaffected as a result the cost of one good in times of other remain unaffected. Thus, despite absolute change in income and prices, the budget line does not change ie , remains unaffected.

29. CONSUMER EQUILLIBRIUM Consumer Equilibrium refers to a state of maximum satisfaction. A situation where a consumer spends his given income purchasing one or more commodities to get maximum satisfaction and has no urge to change this level of consumption is known as the consumer's equilibrium. A state of equilibrium can be achieved by spending money on different goods and services with the given income. At this point, the consumer cannot change his situation by either earning more, spending more, or changing the quantity.

30. CONDITIONS OF CONSUMER EQUILLIBRIUM The consumer's equilibrium under the indifference curve theory must meet the following two conditions: Conditions of consumer's equilibrium using indifference curve analysis are  ( i )   Slope of IC = Slope of Budget Line ie . MRS xy = P x / P y (ii) IC is convex at the point of equilibrium.

31. CORNER EQUILLIBRIUM When Indifference curves are just convex ie .. Straight lines. MRS xy is constant. This is the case of perfect substitutes. Multiple equilibrium When Indifference curves are concave ie MRS xy is increasing. Thus, concave IC are not plausible.

32. PRICE CONSUMPTION CURVE (PCC) Pcc is a locus of points in the commodity space showing equilibrium commodity bundles resulting from variation in price ratio with money income remaining constant. The shape of Pcc will depend upon whether ed >, = or < 1. The slope of Pcc reveals the type of elasticity. If we take all the elasticities together then we geta U shaped Pcc which implies that Pcc slope downwards at higher prices and slope upwards at lower prices.

33. We can derive demand curve with help of Price consumption curve.

34. INCOME CONSUMPTION CURVE T he income effect means the change in consumer’s purchases of the goods as a result of a change in his money income. It generally leads to a positive change ie ,, when the income increases the consumer tends to i ncrease the consumption of both the commodities. But this will depend upon whether the good is normal good or inferior good. Normal good

35. RELATIONSHIP AMONG PRICE EFFECT, SUBSTITUTION EFFECT AND INCOME EFFECT PRICE EFFECT = SUBSTITUTION EFFECT + INCOME EFFECT Normal Good Inferior Goods

36. ENGLE’s CURVE Engel Curves are the locus of all points representing the quantities demanded of the goods at various levels of income, when prices and preferences are held constant. It was given by Sir Ernest Engles who used this concept to analyze the family expenditure pattern. Engles curve is derived from Icc by joining the equilibrium points related to different income levels.

37. For the sake of simplicity, these curves  have been shown as straight lines. On the other hand, if X or Y becomes an inferior good  x  to the consumer as his income rises beyond a certain level, the ICC would be bending to the y-or to the x-axis re­spectively.

38. According to Engel, for a  “necessary”  good like food, the expenditure of an average family would increase less than proportionately as its money income rises. So the Engel curve for a “necessary” item would be upward sloping and concave downwards, if expenditure on the good is measured vertically and income horizontally.

39. On the other hand, for a  “luxury”  item, the expenditure of an average family would increase more than proportionately as its money income rises. The Engel curve for such an item would be upward sloping and convex downwards. Lastly, according to Engel, there are some items for which the expenditure of an average family would increase proportionately with rises in money income.

40. CONSUMER SURPLUS Alfred Marshall, British Economist defines consumer’s surplus as follows: “Excess of the price that a consumer would be willing to pay rather than go without a commodity over that which he actually pays.” Hence, Consumer’s Surplus = The price a consumer is ready to pay – The price he actually pays. In Fig. 2 above, the total utility is equal to the  area  under the marginal utility  curve  up to point Q (ODRQ). However, for price = OP, the consumer pays OPRQ. Hence, he derives extra utility equal to DPR which is consumer surplus.

41. REVEALED PREFRENCE THEORY Samuelson’s RPT is based on a rather simple idea. A consumer will decide to buy some particular combination of items either because he likes it more than the other combinations that are available to him or because it happens to be cheap. Let us suppose, we observe that of two collections of goods offered for sale, the consumer chooses to buy A, but not B. We are then not in a position to conclude that he prefers A to B, for it is also possible that he buys A, because A is the cheaper collection, and he actually would have been happier if he got B. But price information may be able to remove this uncertainty. If their price tags tell us that A is not cheaper than B (or, B is no-more expensive than A), then there is only one plausible explanation of the consumer’s choice—he bought A because he liked it better.