Session 7-8
21 May 2023 12:28
Budget Line In a budget constraint, the quantity of one good is measured on the horizontal axis and the
quantity of the other good is measured on the vertical axis. The budget constraint shows the
various combinations of the two goods that the consumer can afford.
The budget line definition is held to be a straight line with a downward slope indicating the
different combination of two commodities. These two commodities are purchased by a
consumer by the given market price with income allocation. It is also termed as a budget
constraint. It's important to remember that the slope of the budget line corresponds to the cost
ratio of two commodities. The slope of the budget limitation is particularly significant.
Budget line in economics is based on two essential components – (a) purchasing power or the income of
the consumer, and (b) market price of the two commodities that have been considered.
Budget Line Equation Budget line is also termed as a budget constraint due to the fact that even though a consumer
will strive to achieve maximum utility across the indifference curve, he or she faces two very
robust constraints - market price of commodities and limited income.
Income acts as a major constraint because there is only a particular height which may be
reached in the indifference curve, given the income. It is this budgetary constraint that is
exhibited in the budget line equation below.
Example of Budget Line
Price change and consumer behaviour
Normal Good
Inferior good
Session 5-7 – 3rd June 2023
[Link] - Important case study to read for the class
Demand and Supply
• Difference b/w Need, want and demand
Demand
Individual The quantity demanded of a good by an individual consumer at different prices, ceteris paribus
Demand
Market The sum of all the individual demand for a particular good.
Demand
Law of Price and quantity demanded are inversely related. That is, as the price of a good rises (falls) and all other things
demand remain constant, the quantity demanded of the good falls (rises)
Market A curve indicating the total quantity of a good all consumers are willing and able to purchase at each possible price,
Demand Curve keeping all other external factors such as holding the prices of related goods, income, advertising, and other
variables constant.
a. Downward sloping demand curve
• The line is downward sloping, which reflects the law of demand, and that all other factors that influence
demand are held constant at each point on the line.
b. Upward Sloping demand curve
• An upward sloping demand curve occurs when an increase in prices of commodities leads to an increase in
quantity demanded. In other words, an upward sloping demand curve shows that there is a direct relationship
between prices and quantity demanded
• Example of upward sloping demand curves are Giffen goods (inferior goods) and Veblon goods (higher
superior quality goods)
Change in • Changes in the price of a good lead to a change in the quantity demanded of that good. This corresponds to a
quantity movement along a given demand curve.
demanded
• Movement along the demand curve only.
• Only affected by change in price.
Change in • Changes in variables other than the price of a good, such as income or the price of another good, lead to a
Demand change in demand. This corresponds to a shift of the entire demand curve.
Demand • Economists recognize that variables other than the price of a good influence demand.
Shifters • For example, the number of pairs of jeans individuals are willing and financially able to buy also depends on the
price of shirts, consumer income, advertising expenditures, and so on. Variables other than the price of a good
that influence demand are known as demand shifters.
• Demand shifters can be
Change in income
Change in prices of • Changes in the prices of related goods generally shift the demand curve for a
related goods good.
• For example, if the price of a Coke increases, most consumers will begin to
substitute Pepsi, because the relative price of Coke is higher than before. As
more and more consumers substitute Pepsi for Coke, the quantity of Pepsi
demanded at each price will tend to increase. In effect, an increase in the price
of Coke increases the demand for Pepsi. This is illustrated by a shift in the
demand for Pepsi to the right.
• Goods that interact in this way are known as substitutes.
• Goods are substitutes when an increase in the price of one good increases the
demand for the other good. Example – like coke and Pepsi as stated above.
• Not all goods are substitutes; in fact, an increase in the price of a good such as
computer software may lead consumers to purchase fewer computers at each
price. Goods that interact in this manner are called complements
• when good X is a complement to good Y, a reduction in the price of Y actually
increases (shifts to the right) the demand for good X. More of good X is
purchased at each price due to the reduction in the price of the complement,
good Y
Substitutes Goods for which an increase (decrease) in the price of one
good leads to an increase (decrease) in the demand for the
other good.
Complements Goods for which an increase (decrease) in the price of one
good leads to a decrease (increase) in the demand for the
other good.
[Link]
account-of-change-in-prices-of-related-goods/8605 - to learn more
Advertisement and • An increase in advertising shifts the demand curve to the right
Change in
Consumer's Taste
• Under the initial demand curve, D1 , consumers would buy 50,000 units of high-
style clothing per month when the price is $40. After the advertising, the
demand curve shifts to D2 , and consumers will now buy 60,000 units of the
good when the price is $40. Alternatively, when demand is D1 , consumers will
pay a price of $40 when 50,000 units are available. Advertising shifts the
demand curve to D2 , so consumers will pay a higher price—$50—for 50,000
units.
• Advertising often provides consumers with information about the existence or
quality of a product, which in turn induces more consumers to buy the product.
These types of advertising messages are known as informative advertising.
• Advertising can also influence demand by altering the underlying tastes of
consumers. For example, advertising that promotes the latest fad in clothing
may increase the demand for a specific fashion item by making consumers
perceive it as “the” thing to buy. These types of advertising messages are known
as persuasive advertising.
Change in • Changes in consumer expectations also can change the position of the demand
Consumer's curve for a product.
Expectation
• For example, if consumers suddenly expect the price of automobiles to be
significantly higher next year, the demand for automobiles today will increase.
In effect, buying a car today is a substitute for buying a car next year. If
consumers expect future prices to be higher, they will substitute current
purchases for future purchases. This type of consumer behavior often is
referred to as stockpiling and generally occurs when products are durable in
nature.
Population • The demand for a product is also influenced by changes in the size and
composition of the population.
• as the population rises, more and more individuals wish to buy a given product,
and this has the effect of shifting the demand curve to the right.
• It is important to note that changes in the composition of the population can
also affect the demand for a product. To the extent that middle-aged consumers
desire different types of products than retirees, an increase in the number of
consumers in the 30- to 40-year-old age bracket will increase the demand for
products like real estate
Other factors any variable that affects the willingness or ability of consumers to purchase a
particular good is a potential demand shifter. Health scares affect the demand for
cigarettes. The birth of a baby affects the demand for diapers.
Demand • A function that describes how much of a good will be purchased at alternative prices of that good and related
Function goods, alternative income levels, and alternative values of other variables affecting demand
• The demand function for good X describes how much X will be purchased at alternative prices of X and related
goods, alternative levels of income, and alternative values of other variables that affect demand. Formally, let
represent the quantity demanded of good X, Px the price of good X, Py the price of a related good, M income, and
H the value of any other variable that affects demand, such as the level of advertising, the size of the population,
or consumer expectations. The equation can be written as
Linear Demand • A representation of the demand function in which the demand for a given good is a linear function of prices,
Function income levels, and other variables influencing demand.
• Demand is linear if is a linear function of prices, income, and other variables that influence demand. The
equation can be written as :
• Ai s are fixed numbers that the firm’s research department or an economic consultant typically provides to
the manager.
By the law of demand, an increase in Px leads to a decrease in the quantity demanded of good X. This means
that ax <0 . The sign of ay will be positive or negative depending on whether goods X and Y are substitutes or
complements. If ay is a positive number, an increase in the price of good Y will lead to an increase in the
consumption of good X; therefore, good X is a substitute for good Y. If ay is a negative number, an increase in
the price of good Y will lead to a decrease in the consumption of good X; hence, good X is a complement to
good Y. The sign of aM also can be positive or negative depending on whether X is a normal or an inferior
good. If aM is a positive number, an increase in income (M) will lead to an increase in the consumption of
good X, and good X is a normal good. If aM is a negative number, an increase in income will lead to a decrease
in the consumption of good X, and good X is an inferior good.
Price Elasticity Price elasticity of demand gives us the percentage change in quantity demanded of a good following a one percent
of Demand change in the price of that good .
For equation – google it 😊
Consumer
Surplus
Supply
Supply • In the previous section we focused on demand, which represents half of the forces that determine the price in
a market.
• The other determinant is market supply
• Production Vs Supply –
Market Supply • A curve indicating the total quantity of a good that all producers in a competitive market would produce at
curve each price, keeping all other factors such as input prices, technology, and other variables affecting supply
constant.
• In a competitive market there are many producers, each producing a similar product. The market supply curve
summarizes the total quantity all producers are willing and able to produce at alternative prices, holding other
factors that affect supply constant.
• The fact that the market supply curve slopes upward reflects the inverse law of supply
• Changes in the price of a good lead to a change in the quantity supplied of that good. This corresponds to a
movement along a given supply curve
• The fact that the market supply curve slopes upward reflects the inverse law of supply: As the price of a good
rises (falls) and other things remain constant, the quantity supplied of the good rises (falls). Producers are
willing to produce more output when the price is high than when it is low
Change in • The movement along a supply curve, such as the one from A to B in Figure above , is called a change in quantity
quantity supplied.
supplied
• Changes in the price of a good lead to a change in the quantity supplied of that good. This corresponds to a
movement along a given supply curve
Change in • Changes in variables other than the price of a good, such as input prices or technological advances, lead to a
Supply change in supply. This corresponds to a shift of the entire supply curve.
• As seen in above figure , we have three different market supply curves.
• Variables that affect the position of the supply curve are called supply shifters.
Supply Shifters Supply shifters can be :
Input Price • The supply curve reveals how much producers are willing to produce at alternative prices.
• As production costs change, the willingness of producers to produce output at a given price
changes.
• In particular, as the price of an input rises, producers are willing to produce less output at
each given price. This decrease in supply is depicted as a leftward shift in the supply curve
Technology or • Technological changes and changes in government regulations also can affect the position of
Government the supply curve.
regulations
• Changes that make it possible to produce a given output at a lower cost, such as the ones
highlighted in Inside Business 2–2, have the effect of increasing supply. Conversely, natural
disasters that destroy existing technology and government regulations, such as emissions
standards that have an adverse effect on businesses, shift the supply curve to the left.
Number of • The number of firms in an industry affects the position of the supply curve. As additional firms
firms enter an industry, more and more output is available at each given price.
• This is reflected by a rightward shift in the supply curve. Similarly, as firms leave an industry,
fewer units are sold at each price, and the supply decreases (shifts to the left)
Substitutes in • Many firms have technologies that are readily adaptable to several different products. For
Production example, automakers can convert a truck assembly plant into a car assembly plant by altering
its production facilities. When the price of cars rises, these firms can convert some of their
truck assembly lines to car assembly lines to increase the quantity of cars supplied. This has
the effect of shifting the truck supply curve to the left.
Taxes • The position of the supply curve is also affected by taxes.
• Increase in tax amount levied on any product/services will decrease the supply of that
product/services.
Producer • Producer expectations about future prices also affect the position of the supply curve. In
Expectations effect, selling a unit of output today and selling a unit of output tomorrow are substitutes in
production. If firms suddenly expect prices to be higher in the future and the product is not
perishable, producers can hold back output today and sell it later at a higher price. This has
the effect of shifting the current supply curve to the left.
Change in • With unfavorable change in climate or force majeure, supply of a good will fall
Climate or
Natural
Calamity
Supply Function
Class – 4th June 2023
Market Equilibrium
Market The equilibrium price in a competitive market is determined by the interactions of all buyers and sellers in the market.
Equilibrium
Equilibrium in a competitive market is determined by the intersection of the market demand and supply curves. The
equilibrium price is the price that equates quantity demanded with quantity supplied. Mathematically, if Qd (P) and Qs
(P) represent the quantity demanded and supplied when the price is P, the equilibrium price, Pe , is the price such that
The equilibrium quantity is simply Qd (Pe ) or, equivalently, Qs (Pe ).
Market Equilibrium - link to understand better
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Change in • Supply and demand curves shift over time as market conditions change.
Market • In general change sin price and quantity depend on the amount by which each curve shifts and the shape of each
Equilibrium curve
Equilibrium • Government mandated maximum price that can be legally charged for a good.
with Price • The maximum legal price that can be charged in a market.
Ceilings
Equilibrium • Government mandated minimum price to be legally charge for a good.
with Price • The minimum legal price that can be charged in a market.
Floor
Consumer Extras value from a good that consumer get while just paying the competitive market price
Surplus
Producer • Extra revenue that producers receives in excess of what's necessary to induce them to produce the good while selling
Surplus it at the competitive market price