ECONOMICS

MODULE-2
A) MEANING AND DEFINITION OF DEMAND:
Before explaining the law of demand, it is significant to know about demand. Generally,
people refer to the want or the desire for a thing as demand. But more desire for a thi9ng is
not demand in economics. However, demand in economics necessitates three things, such
as:
 Desire for a commodity
 Willingness to buy and
 The purchasing power to pay
In economics, mere desire should not be called demand. The desire should be backed by
necessary purchasing power [money].

FEATURES OF DEMAND:
1. Demand depends upon utility of the commodity. A consumer is rational and demands
only those commodities which provide utility.
2. Demand always means effective demand, i.e. demand for a commodity or the desire to
own a commodity should always be backed by purchasing power and willingness to
spend it.
3. Demand is a flow concept, i.e. so much per unit of time.
4. Demand means demand for final consumer goods.
5. Demand is a desired quality. it shows consumer’s wish or need to buy the commodity.
B) DEMAND SCHEDULES AND DEMAND CURVES:
Demand schedule is a table or statement showing how much of a commodity is demanded
[purchased] in a particular market at different prices. A demand schedule is one of Alfred
Marshall’s contributions to the techniques of price theory. It is a list of prices and
quantities.
According to Benham, ‘’ a full account of the demand for any goods in a given market at a
given time should state what the (weekly) volume of sales would be at each of a series of
prices. Such an account taking the form of a tabular statement is known as a demand
schedule’’. A demand schedule thus states the relationship between the price and quantity
demanded.
In other words, demand schedule refers to the response of amount demanded to change
in price of a commodity. It summarises the information on prices and quantity demanded.
It is of two types:-

1. INDIVIDUAL DEMAND SCHEDULE:

 It tells the quantities demanded by an individual at different prices, considering
other things being equal. It refers to the series of quantities he is prepared to buy at
different prices. This can be illustrated with the help of a table. The following is an
imaginary demand schedule of a consumer for oranges.
INDIVIDUAL DEMAND SCHEDULE

Prices of oranges per dozen (Rs) Quantity of oranges [in dozen]

50 1
40 2
30 3
20 4
10 5
Etc., Etc.,

From the above table it is seen that as the price per dozen of oranges goes on increasing,
the quantity demanded goes on falling. The table brings out the inverse relationship
between price and quantity demanded. At a higher price, less is demanded and at a lower
price, more is demanded. The demand schedule is illustrated by the demand curve.

2. INDIVIDUAL DEMAND CURVE:

It refers to the quantity demanded by the consumer at different levels of prices. In fact,
demand curves are only a graphical representation of demand schedule. The relation
between the price and the amount bought can be plotted on a diagram as a demand curve.
It is usual to measure quantity demanded on X axis price on Y axis.
Demand curves may be any type. It may be of a straight line, or a convex curve, or partly
one and partly another. Most actual demand curves are squiggles rather than straight lines.
The imaginary demand curves based on the imaginary schedule will be a smooth descending
curve or straight line. But realistic curves with actual investigation will not be so smooth.
The only feature that is common to nearly all demand curves is that, whatever their shape
may be, they always slope downwards to the right indicating that more quantities will be
bought at a lower price than at a higher price with other conditions of demand remaining
the same.

C) DETERMINANTS OF DEMAND/FACTORS AFFECTING DEMAND:

There are many economics, social and political factors or determinants which greatly
influence the demand for a commodity. Some of these factors are as noted below:-

1) Price of a commodity: The foremost significant factor which influence the demand is
the price of the commodity. It causes an inverse change in the demand for commodity.
Ceteris paribus.

2) Price of related goods: Demand is also influenced by the change in the price of the
related goods. These goods are of two types viz. substitute goods or complementary
goods. Substitute goods are those which can replace each other in use like tea and
coffee while the complementary goods are those which are jointly demanded as petrol
and car.

3) Income of the consumer: This is another factor which influences demand. Generally,
there is direct relation between income of the consumer and his demand. The demand
for normal goods rises, with an increase in income and falls with a fall in income. In the
case of inferior goods, the demand falls with an increase in income and rises with
decrease in income. In the case of necessary goods, demand utility increases and then
becomes constant.

4) Distribution of wealth: The amount demanded of a commodity is also influenced by

the distribution of wealth in the society. If there is an equal distribution of income in
the society, the demand will be higher and in case of inequality, demand will be less.

5) Tastes and preferences: This factor influences the demand to a greater extent. They
include fashion, habits, customs, advertisement, climate, new inventions, etc. other
things being equal, as the taste of the commodity goes up, demand will also increase.
Demand goes down if the consumers have no taste in the commodity.

6) Government policy: This is also responsible in influencing the demand for the
commodity. The government imposes taxes on various goods that leads to an increase
in the price of the goods, as a result of which demand goes down.
 7) State of business: The demand for commodities also depends on business conditions
prevailing in the country or region. If the country is passing through the period of
boom, there will be an market demand will be on the lower side.

8) Population growth: The growth of population is another determinant. Increase in

population leads to an increase in demand for all type of goods, whereas decrease in
population means less demand for such commodities. Moreover, composition of
population also affects the demand.

9) Existence of substitutes and the price of substitutes: The existence of a number of

alternative good to satisfy a given demand will naturally divide the total demand
between the different goods. The large number of substitutes, the smaller will be the
demand for the alternative goods. At the same time, the level of prices of different
alternative goods has also great influence on the demand for every commodity.

10) Expectations of consumers about the future: If a consumer anticipates a rise I n prices
in the near future, they will start demanding larger quantities of the particular product
and vice versa. But this condition may be only temporary.

ASSUMPTIONS:
The law is valid only when the following assumptions hold:
1) The price of the related good remains the same.
2) The income of the consumers remains the same.
3) Tastes and preferences of the consumers remain the same.
4) All the units of the goods are homogeneous.
5) Commodity should be a normal good.
6) There should be no change in the size of population.
7) There should be perfect competition in the market.

D) SUPPLY FUNCTION:

1) MEANING AND DEFINITION:

In the common language the term “supply” may have several different meanings. It may
mean the total stock of goods in existence. It may also mean the amount of goods offered
for sale per unit of time. Economics agree that “supply means the commodity offered for
sale at a price”. This means that ‘supply’ refers to total supply offered for sale at a price by
retailers and wholesalers.
 Supply is one of the two forces that determine the price of a commodity in the market.
Therefore, the study of supply is important as the study of demand. Like demand, supply
definition is complete when it has the following elements:

1) Quality of a commodity that the producer is willing to offer for sale.

2) Price of the commodity and
3) Time during which the quality is offered for sale
The supply means the quality of a commodity offered for sale

2) FACTOR DETERMINING SUPPLY:

1) Price of the commodity [direct relationship]: At a higher price, producer offers more
quantity of the commodity for sale and at a lower price, less quantity of the
commodity.
2) Price of related good (Z): Supply depends upon the prices of its related goods,
specially substitute good. If the price of the substitute goes up, producers are
intended to direct their resources to the production of the substitute commodity.
3) State of technology: If there is a change in the technique of production leading to a
fall in the cost of production leading to a fall in the cost of production, supply of
commodity will increase.
4) Cost of production: with the rise in cost of production, generally supply tends to fall.
It is because it pushes up the price of the commodity.
5) Expected price of commodity X: If the producers expect an increase in price in the
near future, they will reduce the current supply so as to offer more goods at higher
prices in the future.
6) Government policy: This also affects the supply of a commodity. If heavy taxes are
imposed on a commodity, it will discourage producers and as a result, its supply will
decrease. On the contrary, tax concessions induce producers to raise the supply.
7) Development of transport and communication: The supply depends on the
available facilities of transport and communication. If the means of transport are
used for the export, then it would adversely affect the domestic supply.
8) Number of firms or seller: Supply is influenced by this factor . when sellers are few,
the supply will be small and large, when there are large number of sellers.

3) SUPPLY SCHEDULE AND CURVE:

1) SUPPLY SCHEDULE OF AN INDIVIDUAL FIRM:
This is a tabular that show the different quantities of a commodity supplied by an
individual firm with in a given period of time at different prices. A hypothetical
supply schedule of rice is given in the table.
 Price [Rs per kg] Quantity
supplied[kg/month]
1 5
2 10
3 15

The supply schedule obeys the law of supply i.e. as price of rice rises, its supply also rises.

Law of supply:
Law of supply derives the relationship between price and quantity supplied. According to
the law of supply, other things remaining the same, quantity of a commodity is directly related to
the price of commodity. In other words, other things remaining the same, when price of a
commodity rises, its quantity supplied increases and when its price falls, quantity supplied also falls.
Symbolically, the law of supply is expressed as:

Sx = f[px]1 ceteris paribus

Assumptions of the law of supply:

The law of supply is based on the assumption that all factors, other than price of the commodity
that affect the supply, remain the same, i.e.

(i) Price of related goods

(ii) State of technology
(iii) Cost of production
(iv) Future price of the good
(v) Government policy, etc – remain the same

Exceptions:
Though the case of upward sloping curve is true in all cases, it has its limitations:

1) The law of supply does not apply to rare articles; since their supply is fixed, it cannot
change with change in price.
2) The law of supply does not hold good to speculators as they sell at higher prices and
more at lower prices, respectively, in anticipation of profit.
3) Sellers will be ready to sell even at lower prices in case of perishable goods.
4) When in need of cash urgently, he likes to sell his stock at the lower price,
E) Meaning and measurement of utility:
Stanley jevons was the first economist who conceived the concept of utility. It is the wants-
satisfying power of a commodity or a service which determines the demand for commodity. Utility
does not mean usefulness. It means “expected satisfaction to a consumer when he is willing to
spend money on stock of commodity which has the capacity to satisfy his want”.

The concept utility is subjective and introspective. It depends on mental attitude and emotions
of the consumer. It has no physical or material existence. It cannot be equated with “usefulness”. A
commodity may existence. may not be useful, but it may have utility for a particular person. The
term carries no moral or legal significance. A commodity has utility for a consumer even when it is
not consumed. Also, the same commodity has different utilities for different person, and to the same
person at different points of time.

Utility can also be defined as "value-in-use" of commodity as the satisfaction which one gets
from the consumption of a good is its value-in-use. As long as goods satisfy human wants, they are
said to possess utility. It has been observed that non-material goods like the services of doctors,
teachers, and artists satisfy human wants as much as material goods. Thus, where there is utility,
there are non-material goods too.

According to Prof. Hibdon, "utility is the ability of a good to satisfy a want".

According to J.S. Nicholson, "utility may be the quality which makes a thing desirable".

Measurement of Utility:
As indicated, utility is a subjective and mental concept which cannot be measured precisely.
But there is a rough way of measuring utility. This "indirect" measurement is possible through the
"price" paid by the consumer to purchase the commodity, i.e. the price he is willing to pay for.
Money cannot be used for inter-personal comparison of utilities.

In spite of the defects, money is made as the measuring rod of utility. It is employed to draw
inferences about the utilities of various goods and services though it is an imperfect one. Economists
are aware of the imperfection and limitations of this analysis.

F) CONCEPTS OF UTILITY:
The concept of utility can be explained on the basis of the consumption of a commodity as:

[Link] utility

[Link] utility

[Link] utility

[Link] utility:
Initial utility means the utility derived from the consumption of its first unit. In other words, when
the consumption of a commodity is made the consumer get the utility at the first stage, it is known
as initial utility. It is always positive.

[Link] utility:
Marginal utility means the addition made to the total utility by consuming one more unit
(additional unit) of the commodity. According to prof, Boulding ,”The marginal utility which results
from a unit increase in consumption”. Similarly, [Link] says,” marginal utility in addition
made to total utility buy consuming one unit of a commodity”.prof. Bilas points out that”marginal
utility is defined as the change in utility resulting from a one unit change in the consumption of the
goods in question per unit of time”.

Types of Marginal utility:

Marginal utility can be of three kinds
(a)Positive Marginal utility: When total utility increase by the consumption of commodity ,it Is
called positive Marginal utility. Lets us suppose that what one eats biscuits, one gets total utility at
every additional unit as 10,18,24,28,30…. We see the total utility increase constanty. This is a case of
positive marginal utility.

(b)Zero Marginal utility: Is defined as no addition to the total utility by the consumption of an
additional unit. In the above example as total utility reaches 30 by using the fifth unit of biscuit, One
gets the same total utility i.e 30 at the next unit (sixth unit).Thus,here the consumer get zero
marginal utility.

(c)Negative Marginal utility: In the above eg, when consumers uses the 7th unit the total utility
diminishes by using one more unit i.e: from the 6 th unit to 7 th unit, total utility is 28 units. Therefore
at this stage, the consumers gets negative marginal utility after obtaining maximum certification
from the commodity i.e: Biscuits (28-30 = -2).

[Link] utility :
The total means the total satisfaction received by the consumer by the consumption of all units
take; together at a time. It is the aggregate of the utility that a consumer derives from the
consumption of a certain amount of a commodity.

FEATURES OF UTILITY:
[Link] is Subjective:
The utility of a commodity is always subjective because it depends upon the consumer as much as
on commodity. For example: coffee gives satification to one and dissatification to another. It is the
psychological feeling of the consumer. Utility is therefore internal and not external

[Link] is Relative and variable :

It varies from person to person and sometimes from time to time for the same person. Further
when a commodity gives utility it gives different amounts of utility to different people. The amount
of utility depends not only on his mental attitude but also on the intensity of his desire for the
commodity. Also it varies from time to time and place to place. For example – woollen clothes give
greater utility in cold places than in hot places.

[Link] is not Measurable:

It cannot be measured by in any measuring rod. It can be quantified. Hence,it cannot be added or
subtracted. It is thus having and immeasurable magnitude. However marshall and neo-classical
economists assumed that utility can be measured with a measuring rod of money

[Link] and usefulness :

Utility is different from usefulness. It means that a good possesses utility when even it may not be
useful in another words a harmful goods has utility. Example: Items used for smoking/alchohol. At
the same time, they are useful for a man who is habituated to it. Thus, these harmful goods have
utility for such peresons.
[Link] and Pleasure:
They are two different things. It is not necessary that a commodity processing utility also gives
pleasure whenever it is consumed. Medicine possesses utility for a person, though it is not
preferred. In this way. It can be stated that there is no relationship between utility and pleasure.

[Link] and morality:

Utility does not possesess and moral or ethical importants. It’s only related with satisfaction of
human wonts.

[Link] is Abstract :
In a sense, as it cannot be seen, or touched or felt. For example – services of doctors, advocates,
teachers can neither be seen or touched. Therefore, utility is abstract.

G) APPROCHES TO CONSUMER BEHAVIOUR

There are two approaches of consumers behaviour ie: Cardinal approach & Ordinal approach.[This
will be dealt in detail in the next chapter].

Cardinal Approach/utility Analysis :

This is called classicial approach in which utility [satisfaction] has been made measurable Prof.
Marshall and his follows advocated the cardinal approach to utility hence this approach has come to
be known as” Marshallian utility Analysis “.Alfred Marshall [1890] made important contribution to
marginal utility theory.

Under cardinal approach, there are two main laws ie.

(1) Law of Diminishing marginal utility and

(2) Law of Equi-marginal Utility

i. Law of diminishing marginal utility:

This law was first of all given by French Engineer, Gossen. Marginal utility theory is based on
the concept of law of diminishing marginal utility [DMU]. According to this law, as one
individual goes on consuming a commodity the marginal utility obtained from its additional
units goes on diminishing. i.e. the intensity of our desire for that things diminishes or tends
to diminish. For example: when one man is hungry and start to get the slice of bread, the
utility is maximum at first unit of that. At the second time, one gets less utility. This process
goes on and utility at every step goes on diminishing. Therefore, it is called gossen’s first law.

Assumptions of the law:

The main assumptions of the law are as follows:

i. Utility can be expressed in cardinal numbers like, 1,2,3….N units.

ii. The utility of a commodity depends on its own quantity rather than the quantities of other
commodities. 132
iii. The law applies only when the commodity is continu-ously consumed.
iv. All units consumed by the consumer are same in all respects i.e. same colour, shape and
taste etc. i.e. identical and homogeneous.
v. Marginal utility of money remains constant.
vi. There is no change in the price of the commodity and its substitute.
vii. There is no change in the taste, habits and fashion of the consumer.
viii. The unit consumed should be of the standard unit.
ix. The units consumed should be successive without interyal of time.
x. The income of the consumer remains constant and the mental and social conditions of the
consumer must be normal.

Explanation of the law:

The law of Diminishing Marginal Utility can be explained with the help of table and
diagram:

Quantity Total Marginal Utility

quantity
1 10 10 Initial
utility
2 18 18-10=8 Initial
utility
3 24 24-18=6 Initial
utility
4 28 28-24=4 Positive
utility
5 30 30-28=2 Positive
utility
6 30 30-30=0 Positive
utility
7 28 28-30=-2 Negative
utility
8 25 28-25=-3 Negative
utility
Exceptions of the Law:
The law is universally applicable if all assumptions are fully met with. But in practical life, it is
not so. Therefore, there are exceptions which are briefly discussed below:
(1) Rare things: The foremost exception of the law is that it does not apply in the case of
certain rare things like stamps, coins etc. But this exception cannot be regarded genuine
because the assumption of homogeniety is violated.
(2) Initial stages: When the initial units of commodity are used in less than appropriate
quantity, the marginal utility from additional units increases.
(3) Public goods: In case of public utility goods, marginal utility from additional units
increases. But this assumption is contrary to the law of diminishing marginal utility.
(4) Music and Poetry: It is said that by hearing music or poetry for the second time, we get
more satisfaction than the first hearing. Thus the hearing of music and poetry in another
exception to the law.
(5) Misers: It is stated that as the stock of money with a miser increases, the greed for
acquiring more and more money increases. It means the law of diminishing marginal utility
does not apply in the case of misers.
(6) Discontinuous consumption: The law of DMU does not apply if there is a time lag
between the use of commodity. It requires the continuous consumption for its application
(7) Things of Display: The law is not applicable in this case. For example: in case of fashion
and taste, the law is not properly applicable.
(8) Drunkards: A drunkard always demand more and more alcohol. So a drunkard is
considered to be another exception to this law.

Law of equi-marginal utility:

The law of equi-marginal utility was propounded in 19th century by a French Engineer
named Gossen. The law is nothing but an extension of the law of DMU. The law of
diminishing marginal utility applies in case of single commodity. In reality, the consumer
consumes a number of commodities at a given time. Therefore, the law of DMU has been
extended for this purpose, as "the law of Equi-Marginal Utility". It is also called the
"Gossen's Second Law". Dr. Marshall has called it as "The Law of Maximum satisfaction".
Similarly, Prof. Hibdon named it "The Law of Rational Consumers" and Lord Robbins "Law of
Economics", etc.
Marshall defined it as "if a person has a thing which can be put to several uses, he will
distribute it among these uses in such a way that it has the same marginal utility for if it had
a greater marginal utility in one use than in another, he would gain by taking away some of
it from the second use and applying it to the first".If the marginal utility is less than the price
paid by him, he will not buy the commodity. If the marginal utility is more, he will buy until
he gains. He will stop buying just when the marginal to price. This can be illustrated with a
diagram.