What is Demand

-Willingness to Pay - Ability to Pay -Desire / Need -At a particular Time - The demand for anything at a given price is the amount of it which will be bought per unit of time at that price. -- Demand is always at a price. -Definition ; By demand we mean the various quantities of a given commodity or service which consumers would buy in one market place in a given period of time at various prices or at various Incomes or at various prices of Related goods

Definition : By demand we mean the various quantities of a given commodity or service which consumers would buy in one market place in a given period of time at various prices or at various Incomes or at various prices of Related goods

Three types of Demand

Price Demand Income demand Cross Demand

 Price Demand: Purchase at a given point in time and market; Income and price of other related goods is unchanged. Schedule is price vs quantity: Individual demand vs Industry Demand Income demand: Purchases made at various Income levels. Schedule is Income vs Quantity. Superior vs Inferior Goods Cross demand; Purchase of one good with reference to the change in price of a related good. (tea/coffee); Schedule Price of One commodity and the Quantity of another.

Demand Curve : Relation of Quantity and Price

D Demand Curve

Downward Sloping Curve Sellers Perspective it is the AR curve.

Price

Quantity

Why Downward Sloping

Unit of Money Increase: willing to Buy more ; Real Income Is more : Income Effect Good becomes cheaper ; Substitution happens wholly or partially; Substitution Effect Use Is more Urgent if price is high; example Water New buyers when prices are low thus more demand

Looking at a Utility Angle; disposal Income Maximum Satisfaction Apply Law of Substitution Marginal Returns Arrange Expenditure by buying more when prices drop Buy less or Substitute when prices rise

What causes Change in Demand

Change in Taste Change in Weather / climate Change in size and Composition of population Change in Money Supply Change in Price of the Commodity Change in real Income Change in the Level of Distribution Of Income Change in savings Change in Asset Preferences Conditions of trade Expectations and Anticipations Prices of related goods

Giffen Paradox Sir Robert Giffen

Demand Rises with Rise in Price Demand Falls with a Fall in price
Example : Fear of shortage; Confers Distinction / prestige; Ignorance; Necessity

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 a increase in demand if conditions of demand remain constant

Limitations
Change in Taste and Fashion Change in Income Change in Other prices Discovery Of substitutes Anticipatory change in Prices Commodity Quality

Elasticity of Demand
The Elasticity (or responsiveness ) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price and diminishes much or little for a given rise in Price

Five Cases Of elasticity

Perfectly elastic / Infinite Elasticity Perfectly Inelastic / Zero Elasticity Relatively Elastic Relatively Inelastic Unit Elasticity

Types of Elasticity
Price Elasticity Income Elasticity Cross Elasticity Advertising elasticity

Price Elasticity ( PEoD)

It measure the Responsiveness of buyers to Change in Price PEoD = (% Change in Quantity Demanded)/ (% Change in Price)
% Change in Quantity is [QDemand(NEW) QDemand(OLD)] / QDemand(OLD) % Change in Price is [Price(NEW) - Price(OLD)] / Price(OLD) Only positive figures are considered

 If PEoD > 1 then Demand is Price Elastic (Demand is sensitive to price changes) If PEoD = 1 then Demand is Unit Elastic If PEoD < 1 then Demand is Price Inelastic (Demand is not sensitive to price changes)

Income elasticity ( Income Sensitivity)

The rate of response of quantity demand due to a raise (or lowering) in a consumers income. IEoD = (% Change in Quantity Demanded)/ (% Change in Income) Negative scores are Important

 If IEoD > 1 then the good is a Luxury Good and Income Elastic If IEoD < 1 and IEOD > 0 then the good is a Normal Good and Income Inelastic If IEoD < 0 then the good is an Inferior Good and Negative Income Inelastic

Cross Elasticity
the rate of response of quantity demanded of one good, due to a price change of another good. Applicable Substitutes and Complementary Goods CPEoD = (% Change in Quantity Demand for Good X)/(% Change in Price for Good Y)

 If CPEoD > 0 then the two goods are substitutes If CPEoD =0 then the two goods are independent (no relationship between the two goods If CPEoD < 0 then the two goods are complements

Advertising elasticity
The change in sales that results from each monetary unit (e.g. each pound or dollar) that is spend on advertising. (% Change in Quantity Demanded)/ (% Change in Advertising Cost) Interpretation Similar to Income Elasticity . Negative changes are to be noted.

Significance of eD for Firms

It will help the firm determine whether an increase in the price of their good will increase or decrease total revenue.(Demand Curve is AR curve for firm) If demand is elastic, then an increase in price will lead to a more than proportionate decrease in quantity demanded. Therefore increasing the price for a good with elastic demand will decrease total revenue for the firm If demand is inelastic, then an increase in price will lead to a less than proportionate decrease in quantity demanded. Therefore increasing the price for a goods with inelastic demand will increase total revenue for the firm. Determining Advertising Decisions

UTLITY : It is the basic instinct of choosing commodities which give maximum Satisfaction
Marginal Utility and Total Utility
Quantity Consumed 0 1 2 3 Total Utility 0 4 7 8 Marginal Utility 0 4 3 1

Three Assumptions of Marginal Utility Analysis

Utility is a Cardinally Measureable : Imaginary Units Utilities are Independent: Different Goods ; Commodities are independent Constant Marginal Utility of Money : Since it is expressed in terms of money, Money Utility is constant Rationality of Consumer

Law of Diminishing Marginal Utility

Total Utility is Maximum when Marginal Utility is Zero. Law: The additional benefit which a person derives from a given increase in stock of a thing diminishes with every increase in stock that he already has.

Limitations of the Law

Suitable Units Suitable Time No Change in the Consumers Taste Normal Persons ( misers) Constant income Rare Collections Change in Other Peoples Stock Other Possessions Fashion Not Applicable to Money

Law of Equi Marginal Utility

Obtain Maximum Satisfaction from a given Budget Distribute income among different commodities Marginal utilities spent till last rupee spent is equal for both commodities When one MU is greater than the other , consumer with substitute one for the other. ( Graph) Limitations

Derivation of demand Curve

MU1 MU2

MU3

QUANTITY

Criticism of Utility Analysis

Unsound Psychology Unrealistic Motives of consumer Cardinal Measurement Not possible Wrong Assumption of Independent Utilities Income and Substitution Effect not explained Does not explain Giffen Paradox MU of Money is Constant Incorrect Single Commodity analysis

Indifference curves
It is on the basis of the Scale of preferences Assumptions
Completeness Non Satiation Consistency Substitutability Convexity ( Shows Marginal Rate of substitution)

Schedule and Curve

Combination 1 Apples 15 Mangoes 1

2
3 4 5

11
8 6 5

2
3 4 5

All Points on One curve give Equal Preference Change is indicated by Movement

IC3

IC2
IC1

Marginal rate of Substitution

Combination 1 2 3 4 5 Apples 15 11 8 6 5 Mangoes 1 2 3 4 5 MRS of Mangoes for apples 4:1 3:1 2:1 1:1

Define MRS of X for Y as the Quantity of Y which would just Compensate the Consumer for the Loss of Marginal Unit of X (This is Diminishining In nature)

Downward Sloping IC Curve

Should Give More Satisfaction Non Intersecting. At intersection Point they are equal Means A & B also is equal Convex ; Diminishing MRS rule applies

Budget Line
Price Line / Price opportunity Line/ Budget Constraint Line

Consumer Equilibrium / Max satisfaction

Scale of Pref bet two Commodities Constant amount of Money spent on Both Goods Prices of Goods are Constant Homogeneous and Divisible Consumer is Rational
K S P

Conditions for Equilibrium are

The Price line should be tangent to The IC curve Point of Equilibrium Should be Convex to the Origin ie MRS should apply Willingness to substitute one for another

Income Effect
Change in Income ICC Curve

Substitution effect
Change in Price of One Good PRICE EFFECT ; PCC Curve

Two components of Price Effect

It is a Result of Income and Substitution Effect
ICC
T

P1

PCC

Applications of IC curves
Measurement of National Income (Consumption Patterns) Rationing Cost of Living Index Price Discrimination Direct vs indirect Tax Effects of Subsidy Effect of tax and willing to work Increase in wage and effect on Supply of Labour

Consumer Surplus

Supply theory
Upward Sloping Increase Decrease

Price

Quantity

Law of Supply : Other Things remaining the same , as the Price of a commodity Rises its supply is extended, and as the price falls its supply is contracted.

Reasons for change in supply

Cost of Production Improved conditions Technology Improvements Political Disturbances Conscious changes by Suppliers No. of Sellers in the market Objective of the firm Taxation and external factors Price of related goods

Elasticity of Supply
Relatively elastic Relatively Inelastic Unit Elastic Perfect Elastic Perfect Inelastic

Market Equilibrium

Price

Quantity

Changes in Market equilibrium

Change in Demand with Constant Supply Change in Supply with constant Demand Change in Both

Application of Price Determination

Maximum Price Legislation Black Market Minimum Price Legislation

Production Analysis
The relationship Between input and output of a firm is Production Function Physical Relation determines the Cost of production X= f( L , N, K , e)

 Production in Momentary Run Production in the Short Run Production in the Log Run

Returns to Factor
Fully exploit the factors of Production , Then starts a phase of Negative Returns . Total Production starts declining and Variable Contribution in Negative Law of Variable Returns (short run) Total Quantity , Average Quantity and Marginal Quantity Increasing ,Decreasing and Negative Returns

ISOQUANTS (Production Indifferent Curves)

Similar to IC curves Combination of the Factors of Production Properties
Dowward Sloping Higher levels show Increased Output Do not intersect Cannot be Straight Lines

Marginal Rate of Technical Substitution

Combination Factor X Factor Y MRTSxy

A
B C D E

1
2 3 4 5

15
10 6 3 1

5 4 3 2

MRTS = MPx/MPy

Production in the Long Run

Additional Units of the Factors of production Increase for some time and then Diminish Increase in the output in relation to the increase in the factors is called Returns to Scale

Returns to Scale
Constant Returns Diminishing Returns Increasing Returns

Economies to Scale
Simple Term is advantages
Economies Effective Use of Capital Equipment Economy of specialized labour Better Utilization and Specialized management Economies in buying and selling Overhead Charges Rent, research , Ad Cost Utilization of By Products Cheap Credit Diseconomies Overworked management Individual Tastes Ignored No personal touch Possibility of Depression Dependence of Foreign Markets Competition International Complications Lack of Adaptibility

INTERNAL ECONOMIES
ECONOMIES
Real Economies
Labour Economies Technical Economies Selling and Marketing economies Managerial Economies Risk and Survival economies
Payment of Lower prices of Inputs

- Pecuniary Economies

 Diseconomies
Commerical Financial Managerial Risk Labour

External Economies
Economies of concentration Economies of Information Economies of Disintegration Locational Economies Technical Economies
Diseconomies Environmental pollution Aggolmeration

ISO COST & Expansion

Increase in budget lines Least Cost Combination Expansion Path Change on Factor prices and thus expansion path

Cost and Cost Curves

Money Cost ; Actual expenses of production Real Cost : Putting a monetary veil ( Social Cost) Opportunity Cost ; Next best Alternative forgone, best use in eco Economic Cost ; Suppliers (scarce resources) Implicit Cost ; Self employment etc Explicit Cost : Payments

Short run and Long Run

Entrepreneurs Cost : Wages , rent , depreciation etc Short Run; Not all Costs can be altered; Some are Fixed Long run ; All Cost are considered variable and can be altered

TC, AC, MC
Units 0 1 TFC 30 30 TVC 0 10 TC 30 40 AFC 30 AVC 10 40 10 AC MC

2
3 4 5

30
30 30 30

18
24 32 50

48
54 62 80

15
10 7.5 6

9
8 8 10

24
18 15.5 16

8
6 8 18

GRAPH

MC will be below when AC falls and MC much higher when AC rises

Long run Cost Curves

Rise and fall in AC is due to Economies
Graph

Long Run MC is based on the Short Run MC

Graph

When there are no economies to reap and all factors are infinitely divisible then LAC is horizontal

Long Run Average Cost

Stretched Saucer Shaped Curve ( reserve Capacity) Scales are same at all levels beyond a point
L Shaped AC Curve

Market types and Structures

Perfect Competition Large No of Buyers and sellers Homogeneity of the Product Free Entry and Exit of Firms Perfect Knowledge Cost of Transport is not Included Perfect Mobility of the Factors of Production Imperfect Competition Monopolistic Competition Oligopoly Monopoly

 Total revenue ; Price * Quantity, Upward Sloping Line Marginal revenue = TR(n) TR (n-1) Average Revenue: TR/Q ;
TR= P*Q
AR = P*Q/Q .Thus AR=P

Revenue Curves

If P is Constant AR and MR are a Horizontal Straight Line (Perfect Comp) If P Fluctuates the AR and MR are downward sloping

AR and MR
If P is Constant AR and MR are a Horizontal Straight Line (Perfect Comp) If P Fluctuates the AR and MR are downward sloping Slope will depend on the Elasticity MR below then AR quantum will depend on the Slope of the curves

Objectives of a Firm
Profit Maximization
Total Revenue and Total Cost approach Marginal Revenue and marginal Cost Approach 3 assumptions
Ent . Is Rational and aims to earn max. profits Firm is Producing only one commodity Enti is aware of the position where profits are max.

Sales maximization Welfare maximization

TR & TC approach
TC

TR Revenue

Quantity

MR and MC Approach
E is Pt of Equilibrium MC Profit is Max MR is more than MC Is max at this pt.

Q P S E

AC AR

MR

Sales Maximization is where TR is at the max.

Market Structures
Perfect Competition Large No of Buyers and sellers Homogeneity of the Product Free Entry and Exit of Firms Perfect Knowledge Cost of Transport is not Included Perfect Mobility of the Factors of Production
Examples : Stock / organized commodities some food stuffs etc

Imperfect competition Monopoly

One Seller with a unique product Price Maker of the market ( price Discrimination) Knowledge is imperfect ( Information Cost) Price elasticity is Highly Inelastic Regular Monopoly must practice public interest Eg; LNG and LPG

 Pure Oligopoly
Few Sellers with a homogenous product Formation of Cartels Imperfect knowledge Pe depends on demand of the product Impure Oligopoly Few Sellers with a product diffrenciation Few companies form the industry Pe depends on demand of the product Information cost as imperfect knowledge Ex; TV, Automobiles etc

 Duopoly Two players in the market with different products Pe depends on demand of the product Information cost as imperfect knowledge MONOPOLISTIC OMP Few Firms , each having monopoly tendency Diff Products Size of the firms vary Pe is large Ex: Resturants , beauty parlours

 Bilateral Monopoly
One Buyer and One Seller Tailor made products Overdependence on each other
MONOPSONY Many Sellers and one Buyer Buyer Dedicates the price

Equilibrium in Perfect Competition

In the Short Run (Identical Cost)
Supernormal Profits Normal Profits Losses Concept of Shut Down Point Long Run (MC is the Supply Curve)
Perfect Competition with Differential Cost

Equilibrium under Monopoly

Depends on the demand of the product Price Maker Price and Quantity manipulation Cannot control both : Price more Quantity less DD curve shows the AR curve

Price Equilibrium
MC AC

AR MR

Degree of Monopoly
In Perfect Competition AR =MC in equilibrium but in Monopoly it is different MR will lie below the AR Slope is based of Elasticity Higher the Elasticity Lower the Degree of Monopoly Inverse Relation called the Lerner Index (lies between 0-1) Perfectly Competition Lerner Index is 0

Discriminating Monopoly
Sir Pigou Same Product sold at Different Prices Ist degree: Buyer forced to pay the max price for the willingness to pay (Doctors) Second Degree: Diff prices for diff groups(Frequent Flyers) Third Degree: Seller breaks market into sub markets (Cinema Halls, Rentals) Aggregate MC and Aggregate MR, MR in all markets are equal

Monopolistic Competition
Equilibrium Making Profit / Loss Group equilibrium Optimal Advertising Cost Excess Capacity under monopolistic Competition

OLIGOPOLY
Non Collusive : No Explicit agreement
Cournot Edgeworth Bertand Stackberg Collusive : Formal Agreement
Carlets Price Leaership Market Share model

Kinky Demand Curve

D

MC

T D

S
N