Microeconomics
Module 2 contnd…
Demand, Supply, Elasticity &Government
Intervention
Symbiosis International (Deemed University)
Government Intervention in the Market
Objective of Government Intervention: Social Welfare
• Price Ceiling :Legally established maximum price a seller can charge. To
protect the interests of the buyers.
Example: Drug Price Control order
Price ceiling on sanitizer during Covid period
Source
• Price Floor: A legally established minimum price a seller can be paid. To
protect the interests of the sellers.
Example: Minimum Support Price(MSP)
[Link]
Price Ceiling
• Govt imposed a price ceiling at $2
when it felt that the existing
market price of $3 is too high.
• When the price ceiling($2) is below
the market price ($3),there will be
a shortage in the market.
• When there is shortage in the
market ideally prices should go up
and reach the equilibrium
price($3).
• However the price ceiling in this
case prevents the prices from
going back to $[Link] market price
will not go $3 due to the ceiling of
$2.
• Therefore the price ceiling is
binding or effective in this case.
Price Floor
• Govt imposed a price floor at $4 when it felt
that the exiting market prices($3) is non
remunerative for the sellers.
• When the price floor($4) is fixed above the
equilibrium price($3) there will be surplus in
the market.
• Due to the surplus, ideally prices should
come down to the equilibrium price.
• However the price floor which is fixed at $4
is not letting the market prices to come
down to the equilibrium level.
• Therefore the price floor is binding/effective
in this case
Microeconomics
Module 3 Consumer Behavior
Symbiosis International (Deemed University)
Module 3 : Consumer Behavior
Preference Ordering
• Every individual or household has a fair idea about the income stream
and must spend their income on various goods and services. Why do
they spend more on one commodity and less on another?
• The answer is that they think that it will give them maximum
satisfaction. The consumers decide on a combination or bundles of
the commodities depending on their income, tastes and preferences,
etc.
• Considering the possible effects of all the variables, the consumer
selects the possible best combination of goods or bundle of goods or
services. It is known as preference ordering.
Feasible Set
The feasible choices that the consumer can be defined as
(Px*X + Py*Y) =M
Where
• Px is the price of Commodity X
• Py is the price of commodity Y
• X is quantity if X purchased
• Y is the quantity of Y purchased
• M is the income
Representing Feasible Set through Budget Line
The budget line is the set of goods a consumer can afford to
purchase. The budget line is the boundary of the budget set,
consisting of the goods that exhaust the consumer's budget.
Budget Line
• Exercise: Akash has Rs.4000, which he can spend in one month. And
there are two choices. The Cinema ticket is Rs.500, and the T-shirt
cost Rs.1000.
1. Draw a budget line for different combinations
2. What will be the maximum no of movies Akash can watch?
3. What is the maximum no of T-shirts Akash can purchase?
4. Can Akash watch five films and purchase two shirts within his
budget? Why?
5. What if Akash watches three films and purchases two shirts?
Budget Line
Shift in Budget Line due to change in Income
• If income increases and prices of X and Y
remain constant, the consumer will be
able to buy more of X and more of Y.
• If income decreases and prices of X and
Y remain constant, the consumer will be
able to buy less of X and less of Y.
• Budget line in the middle in the diagram
is the initial budget line(Black color)
• Budget line shifts upwards when there is
increase in income(Dark blue line)
• Budget line shifts downwards when
there is decrease in income(Light blue
line)
Shift in Budget Line due to change in Price of X
• BL indicates the initial
budget line
• BL’ indicates the budget line
when there was a decline in
price of X
• BL’’ indicates the budget
line when there was an
increase in price of X
Shift in Budget Line due to change in Price of Y
• BL indicates the initial
budget line
• B’L indicates the budget line
when there was a decline in
price of Y
• B’’L indicates the budget
line when there was an
increase in price of Y
Comparative Statics of Consumer Behavior
• Comparative statics compares two different economic outcomes
before and after some underlying exogenous parameter change.
• In price determination, demand for and supply of the commodity
depends on price. Here the price is an endogenous variable.
• But demand and supply are also influenced by other variables. They
are exogenous variables.
• Comparative statics is a tool for predicting exogenous variables'
effects on market outcomes.
Decline in Demand &Comparative Statistics
• Decline in demand is
indicated by a leftward
shift of the demand
curve(DD to D1D1).
• This shift has resulted in
decline in equilibrium
price from M to M1 and
decline in equilibrium
quantity from N to N1
Decline in Supply &Comparative Statistics
• Decline in supply is
indicated by a leftward
shift of the supply
curve(SS to S1S1).
• This shift has resulted in
increase in equilibrium
price from M to M1 and
decline in equilibrium
quantity from N to N1
Lexicographic orderings
• Lexicographic orderings describe comparative preferences where a consumer
prefers one good (X) to another (Y).
• As an example, if for a given bundle (X; Y; Z) a consumer orders his preferences
according to the rule X>Y>Z, then the bundles {(6;4;4), (6;2;7), (4,6,4)}would be
ordered, from most to least preferred:
a. 6;4;4
b. 6;2;7
c. 4;6;4
• Here, the total goods in the first option are less than those in the second option,
But the consumer prefers option 'a' because it has more Y.
• Note that when the number of Xs is the same, the consumer pays attention to Y.
• Option 'c' has the same total goods as option 'a'; the first option is still preferred
because it has more X.
• Option 'c' has more Y than option 'b'; the second option is still preferred because
it has more X.
Indifference Curve Analysis
• The indifference curve provides all the commodities combinations,
giving consumers the same level of satisfaction. Indifference curves
are also known as equal utility curves.
• As a consumer gets the same utility from different combinations, a
consumer is indifferent between any two combinations of goods
when it comes to decision making.
Assumptions of Indifference Curve Analysis
1. Only two commodities are considered
2. Consumer is rational. More will be preferred to less.
3. Consumer is consistent in decision-making. If a consumer prefers A
to B and and B to C, then A will be preferred over C.
Indifference Curve
Properties of Indifference Curve
[Link] curve slopes downwards from left to right. When a
consumer consumes more units of one commodity, he/she reduces the
consumption of the other commodity to remain on the same
indifference curve.
[Link] indifference curve right to the original one implies greater
satisfaction, and the left to the original one implies less satisfaction.
Properties of Indifference Curve
[Link] curves never intersect each other
[Link] curves are convex to the origin
[Link] goes on diminishing. MRS indicates Marginal Rate of
Substitution
• Initially, when the consumer wanted extra
mango, there was a readiness to sacrifice
four apples. So MRSxy was 4:1.
• But with each extra consumption of mango,
MRSxy goes on diminishing from 4:1 to 1: 1
Consumers' Equilibrium
• Consumer attains equilibrium when they maximize their total utility
from their consumption, given their income and the prices of goods
and services they consume.
• Equilibrium condition – Budget line should be tangent to the highest
possible indifference curve.
Price Effect = Income Effect + Substitution Effect
Price Effect( change in price leads to change in demand)
• When there is an increase in price of a product, it leads to
decline demand.
• When there is a decrease in price of a product, it leads to
increase in demand.
• Change in price leads to change in demand due to income
effect & substitution effect
Income Effect
• The Income Effect is a change in the real income due to the
change in the price of a commodity.
• Real income is the purchasing power of money income. How
much of a good can you buy with a certain amount of money
income?
• For example if the price of apple per kg is Rs.100 and if you
have decided to spent a part of your income say,Rs.500 to by
apple, you can buy 5kg of [Link] the purchasing power of
your Rs.500 is 5kg of apple.
Income Effect Example
Price per kg Money Quantity Price Change Real Income
for Apple in Income in that can be Change
Rs. Rs. purchased
(Real
Income)
100 500 5 kg Initial price Initial real
income
50 500 10 kg Price decline Increase in
real income
250 500 2 kg Price Increase Decrease in
real income
The real income change in this example is caused by change in
price
Substitution Effect
• The substitution effect is a change in the consumption
pattern due to changes in the relative prices of goods.
• For example when you go to purchase vegetables, if some
vegetables have become expensive, you may buy other
vegetables which are cheaper.
Session Outcomes
In this session you learned about:
1. Price Ceiling and floor
2. Budget line, indifference curve and consumer
equilibrium
3. Price, income and substitution effect
Thank You