You are on page 1of 49

# SESSION 3

Law of Demand

By Chhavi Jindal
BEFORE WE START- LET’S REVISE
 Total Utility & Marginal Utility Concept

 Consumer Equilibrium
Consumer
Equilibrium

Two
One
Commodity
Commodity
Model

## Law Of Equi Law of Gossen’s

Law Of Second law
Marginal maximum
Substitution
Utility Satisfaction
CONDITIONS TO BE FULFILLED

## 1. MUx/Px = MUy/Py = MUm

1. MUx = Px
2. MU falls as consumption
2. Price remains constant
increases- Law of DMU
3. Income of consumer is fixed
3. Price of commodity Remains
constant
4. Income of consumer is
fixed
CONSUMER’S EQUILIBRIUM IN CASE OF ONE
COMMODITY WITH ONE USE

## Unit of ‘x’ M.U. of ‘x’ Utility of ‘x’ surplus(

(1) (2) sacrificed 2-3)
in terms of
Price of ‘x’
(3)
1 50 20 30
2 40 20 20
3 30 20 10
4 20 20 0
5 10 20 -10
Units MUx MUy Mux/Px Muy/Py
1 20 16 20 16
2 14 12 14 12
3 12 8 12 8
4 7 5 7 5
5 5 3 5 3

Lets assume

Px = Re 1
Py= Re 1
Total Income = Rs 5

## In case 1- 1*3 + 1* 2 In case 2- 1*5+ 1*4

Case 2 in impossible given the income , hence
equilibrium at 12 utils
HOW WILL CONSUMER REACT IF HE HAS
NOT REACHED EQUILIBRIUM

## In this case consumer will consume more of x till

its MU reduces and comes equal to MU y (Check
schedule)

 Mux/Px< Muy/Py
In this case consumer will consume more of y till
its MU reduces and comes equal to MUx (Check
schedule)
DERIVATION OF INDIVIDUAL DEMAND
CURVE
 As already discussed, The law of diminishing
marginal utility states that as the consumer
purchases more and more units of a
commodity, he gets less and less utility from
the successive units of the expenditure. At the
same time, as the consumer purchases more
and more units of one commodity, then lesser
and lesser amount of money is left with him to
 A rational consumer, before, while purchasing
a commodity compares the price of the
commodity which he has to pay with the utility
of a commodity he receives from it. So long as
the marginal utility of a commodity is higher
than its price (MUx > Px), the consumer would
demand more and more units of it till its
marginal utility is equal to its price MUx = Px or
the equilibrium condition is established.

##  To put it differently, as the consumer

consumes more and more units of a
commodity, its marginal utility goes on
diminishing. So it is only at a diminishing
price at which the consumer would like to
demand more and more units of a commodity.
Derivation of Demand
Curve

Price
Marginal Utility
E1

E2

E3

Dx

MUx
In the above fig the MUx is negatively slopped. It shows that as the consumer
acquires larger quantities of good x, its marginal utility diminishes. Consequently
at diminishing price, the quantity demanded of the good x increases as is shown in
fig 2

At X1, quantity the marginal utility of a good is MU1. The consumer here demands
OX1 quantity of the commodity at P1 price. In the same way X2 quantity of the good
is equal to P2. Here at P2 price, the consumer will buy OX2 quantity of commodity.
and so on.
Conclusion for Derivation Of
Individual demand Curve
We conclude from above, that as the purchase of the
units of commodity X are increased, its marginal utility
diminishes. So at diminishing price, the quantity
demanded of good X increases as is evident from fig. 2.

## The rational supports the notion of down slopping

demand curve that when price falls, other things
remaining the same, the quantity demanded of a good
increases and vice verse.
 Demand refers to a schedule of quantities of a
good that will be bought per unit of time at
various prices, other things
constant.Graphically, it refers to the entire
demand curve.

##  Quantity demanded refers to a specific

amount that will be demand per unit of time at
a specific price. Graphically, it refers to a
specific point on the demand curve.
LAW OF DEMAND
 It states that demand for a commodity
increases when its price decreases and falls
when its price rises, other things remaining
constant

##  There is an inverse relationship between price

and quantity demanded

##  Other things include determinants of demand

like income, tastes, price of substitutes etc
LAW OF DEMAND

## “A RISE IN THE PRICE OF A

COMMODITY OR SERVICE IS
FOLLOWED BY A REDUCTION IN
DEMAND, AND A FALL IN PRICE IS
FOLLOWED BY AN INCREASE IN
DEMAND OTHER THINGS REMAINING
CONSTANT”
ASSUMPTIONS
 INCOME REMAINS THE SAME
 NO CHANGE IN NATURE OF CONSUMER
 NO CHANGE IN PRICE
 THE COMMODITY SHOULD NOT BE THE
PRESTIGIOUS ONE
DEMAND SCHEDULE & DEMAND CURVE
Demand Schedule: a tabular presentation showing
different quantities of a commodity that would be
demanded at different prices.

## Price per cup of No. of cups of tea Points

tea (Rs.) demanded by a representing
consumer per day price-qnty
combination
7 1 A
6 2 B
5 3 C
4 4 D
3 5 E
2 6 F
1 7 G
DEMAND CURVE FOR TEA
A

6
5
C
Price per cup (Rs)

D
4

E
3

F
2

G
1

DD
7

0 1 2 3 4 5 6 7

## Cups of tea demanded per day

THE DEMAND CURVE
 Demand Curve is a locus of points showing
various alternative price- quantity
combinations

##  It shows various quantities of a commodity

which a consumer would buy at different
prices per unit of time

##  Each point on the demand curve shows a

unique price quantity combination
FACTORS BEHIND LAW OF DEMAND
When Price of a commodity falls, prices of its
Substitution substitutes remaining constant, then the
Effect substitutes become relatively costlier or in
other words the commodity whose price has
fallen becomes relatively cheaper

## Since a utility maximizing consumer

substitutes cheaper goods for costlier ones,
demand for cheaper commodity increases..

## The increase in demand on account of this

factor is called substitution effect

## Example: Price of coffee falls, price of tea

remains the same, in this case quantity
demanded for tea will reduce even with same
price as coffee becomes relatively cheaper and
tea becomes relatively costlier
FACTORS BEHIND LAW OF DEMAND
When Price of a commodity falls, other things
Income remaining the same, then the real income of
the consumer increases,

## Effect Consequently his purchasing power increases

since he is required to pay less for a given
qnty

## Increase in real income encourages the

consumer to demand more of goods and
services. The increase in dd on account of
increase in real income is known as income
effect

## Income effect is negative in case of inferior

goods. Eg Price of Bajra (inferior good) reduces,
then consumer becomes relatively richer and
shifts to superior product (wheat) hence dd
decreases even if price decreases
FACTORS BEHIND LAW OF DEMAND
Utility Utility maximization behaviour under the law
Maximizing of diminishing marginal utility is also
responsible for increase in demand when
Behaviour price falls

## As discussed before when person buys a

commodity, he exchanges his money income
for the commodity. He continues to buy goods
and services as long as MUm is less than Muc.
He will purchase toll the point Mum=Pc=MUc

## When price falls equilibrium is disturbed and to

reach back to equilibrium quantity demanded
has to be increased
LETS SEE THE VIDEO TO CLEAR THE LAW
OF DEMAND CONCEPT
EXCEPTIONS TO LAW OF DEMAND
 Expectations regarding further prices – When
consumers expect a continuous increase in the price of
a commodity they buy more of it despite increase in
prices to avoid the pinch of much higher prices

##  Status Goods- The law of dd does not apply to goods

which are used as status symbol for enhancing social
prestige or for displaying wealth eg gold, paintings,
antiques

##  Giffen Goods- They are inferior goods consumed by poor

households as essential commodity. If price of such
goods increases their demand increases because income
effect is more than substitution effect. In this case poor
people cut the consumption of superior product so they
can buy sufficient inferior product to meet daily needs.
SHIFTS INDEMAND CURVE
VS
MOVEMENT ALONG THE DEMAND CURVE
 A movement along a demand curve is the
graphical representation of the effect of a
change in price on the quantity demanded.
Extension & Contraction of demand takes
place

##  A shift in demand is the graphical

representation of the effect of anything other
than price on demand. Increase & Decrease of
Demand takes place
CHANGE IN QUANTITY DEMANDED

P2 B
Price (per unit)

## Change in quantity demanded

(a movement along the curve)

A
P1

D1
0
100 200
Quantity demanded (per unit of time)
SHIFT IN DEMAND CURVE
 When dd curve changes its position, the
change is known as shift in demand curve

##  Example: in the above diag, at price OP1,

consumer will buy 200 qty other factors
remaining constant.
 Now if any other factor change (income, price
of substitutes) it will change consumers ability
& willingness to buy that commodity.
 Eg. If consumers disposable income increases
due to decrease in tax he would be able to buy
250 qty instead of 200. This will cause upward
shift in dd curve
SHIFT IN DEMAND

Change in demand
(a shift of the curve)
P2
Price (per unit)

B A
P1

D0

D1
100 200 250
Quantity demanded (per unit of time)
SHIFTS IN THE DEMAND CURVE
AN INCREASE IN DEMAND IS REPRESENTED BY A RIGHTWARD, OUTWARD, SHIFT IN THE
DEMAND CURVE, FROM D1TO D2. A DECREASE IN DEMAND IS REPRESENTED BY A
LEFTWARD, OR INWARD, SHIFT IN THE DEMAND CURVE, FROM D1 TO D3.
EXTENSION/ CONTRACTION VS INCREASE &
DECREASE IN DEMAND

P P
A
P1

B
P2
D1 D2
Q1 Q2
Q Q
CHANGE IN PRICE= CHANGE IN OTHER=
change in quantity change in demand
demanded
REASONS FOR SHIFT IN DEMAND CURVE

Increase in
Price of
consumer’s
substitutes
income

by producer complement
LETS HAVE A LOOK AT THE VIDEO TO
EXPLAIN THE CONCEPT
WHAT HAPPENS TO DEMAND IF…?

making company:

## (a) people change their preference

from hot dogs to hamburgers ?
What Happens to Demand if…?

making company:

## (b) the salaries of private companies

rises?
WHAT HAPPENS TO DEMAND IF…?

Hilfiger store

## You put the garments in your store on

SALE ??
WHAT HAPPENS TO DEMAND IF…?

Coffee

## Café Coffee day opens next to your

store giving inaugural discount to
customers
WHAT HAPPENS TO DEMAND IF…?

Dell laptops

## The prices of hp laptops reduces?

WHAT HAPPENS TO DEMAND IF…?

J.K.Cements

## The prices of bricks increases?

WHAT IS DEMAND?
 Will a beggar desiring to purchase Maruti Car
constitute Demand?
WHAT HAVE WE STUDIED IN LAST 3
CLASSES ??
WHY DO WE NEED TO STUDY ECONOMICS?

everyday life

## Some of this is just common sense, but economics

can put a theory behind our everyday actions.
HIGHEST SATISFACTION FOR THE PRICE
 It is common sense, but in
economics, we give it the term
of marginal utility theory.

## The idea is that a rational

person will be evaluating
how much utility (satisfaction) goods and services give
him compared to the price.

## To maximise your overall welfare, you will consume a

quantity of goods where total utility is maximised given

## For example, is it worth paying extra charges by airlines,

such as paying for more leg-room? Or pay to get priority
boarding?
OPPORTUNITY COST

## The main lesson of economics

is the issue of scarcity
and limited resources.
If we use our limited budget
for buying one type of good
(food), there is an opportunity cost – we cannot spend that money
on other goods such as entertainment.

## Example: There’s no such thing as free parking

no one likes to pay for parking, but would we be better off
if parking was free ?? Most likely not. If parking was free,
demand might be greater than supply causing people to waste
time driving around looking for a parking spot. Free parking
would also encourage people to drive into city centres rather
than use less environmentally friendly forms of transport. It
would increase congestion; therefore although we would pay less
for parking, we would face extra less obvious costs.
DIMINISHING RETURNS

## If we like chocolate cake, why do we not eat three

per day? The reason is diminishing returns. The
first chocolate cake may give us 10/10. The second
cake 3/10. The third cake may make us sick and
give a negative utility.
UNDERSTANDING MICRO & MACRO CONCEPTS- EXAMPLE
 Let us assume that your mother is managing various household expenses
and requirements with the limited monetary resource she holds. Let us
further assume that this limited resource is the income of your father earned
on monthly basis. Your mother, thus every month, undertakes budgeting or
allocation of resource exercise in order meet various household requirement
with the limited means that she holds in such a way, that such allocation of
resources leads to maximisation of benefits or gains for the individual
household. This is crux of the subject Microeconomics.
 Let us further assume that in the country where you are residing, the
problem of Inflation (Inflation is an economic problem in which an economy
experiences continous and persistent rise in prices of goods and services
being sold in the economy) emerges and this disturbs the monthly household
budget of your mother. Your mother cannot control or manage the problem
of inflation as inflation is a macroeconomic issue. Thus, in order to deal the
impact of inflation on her household budget, your mother will have to
reallocate her limited monetary resource among various goods and services
which she is currently buying. This reallocation of resource exercise will
most likely result in substitution of expensive goods and services with the
cheaper alternative options available in the market. Your mother will be
forced to do so because any increase in prices of goods and services in any
economy shrinks the real income of the individuals in the economy. This is
on account of the fall in the value of money and thus real income due to
continuous and persistent rise in prices

In this case the resource allocation exercise which your mother undertakes
is subject matter microeconomic theory while the problem of Inflation is
part of study of Macroeconomic theory.
MAIN ASSUMPTION OF MICRO ECONOMICS-
CETERIS PARIBUS

##  It is a latin phrase which means 'Other things remain

constant'.
 By using the assumption of 'Ceteris Paribus', it becomes easy
to understand the relationship between two variables or in
other words the impact of change in one variable on the other
variable while other variables remain constant.

##  Example: while explaining the Law of Demand, which states

that There is an inverse relationship between the price
and the demand of a good or service. Thus, whenever the
price increases the demand for the good decreases and
whenever the price decreases the demand for the good
increases - provided other things remain constant or
Ceteris Paribus. Here, the assumption of 'Ceteris Paribus'
helps us in understanding the relationship existing between
only price and the demand of good under consideration. By
assuming that 'other things remain constant', it becomes easy
to eliminate the impact of other factors on demand of a good or
service.
QUES:

## HAVE YOU EVER WONDERED WHY THE

TAX IMPOSED BY GOVERNMENT ON
GOODS LIKECIGRATTES, LIQOUR ETC
IS VERY HIGH?
 This is so because the Government understands that
consumer demand for such products is inelastic and high
tax rate on such goods will result in higher tax collection
for the Government and thus Government comes out with
the policy of high taxes on such commodities.

##  Similarly, if the Government of a country wishes to

discourage consumption of certain Goods then it can
impose very high taxes on such category of Goods. For
example Government tax is very high on Imported Cars
and Other Luxary Products in India

##  In the same manner, if Government of a country wishes to

encourage consumption of certain category of goods or may
be investment in production of certain category of Goods
then it reduces the related taxes for encouraging
Production/Consumption of such Goods.
ASSIGNMENT