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Unit 3: Demand Analysis and Consumer Choice, Concept of Demand:, The demand for a commodity is consumers attitude and reaction towards, commodity. Demand and desire are not the same thing. When a person desire and, is willing to pay for that desire, the desire is changed into demand. To be more, precise, the demand for a commodity is the amount of it that a consumer will, purchase or will be ready to take off from the market at various prices in a period, of time. Thus, demand in economics, implies both the desire to purchase and the, ability to pay for a good., Meaning of Demand:, In economics ‘Demand‟ means the quantity of goods and services which a person, can purchase with a requisite amount of money., According to Prof.Hidbon, “Demand means the various quantities of goods that, would be purchased per time period at different prices in a given market., Demand=Desire to buy + Ability to pay + Willingness to pay, Demand Analysis:, Demand analysis means an attempt to determine the factors affecting the demand, of a commodity or service and to measure such factors and their influences. The, demand analysis includes the study of law of demand, demand schedule, demand, curve and demand forecasting., , Demand Function:, Demand function shows the mathematical relationship between quantity, demanded for a particular commodity and the factors influencing it., Demand function of a commodity can be written as follows:, D = f (P, Y, T, Ps, U), Where, D= Quantity demanded, P= Price of the commodity, Y= Income of the consumer, T= Taste and preference of consumers, Ps = Price of substitutes, U= Consumers expectations & others, f = Function indicates how variables are related., There are 2 demand functions, 1. Individual Demand Function 2. Market Demand Function, 1. Individual Demand Function:, It refers to the functional relationship between individual demand and the factors, affecting individual demand., It is expressed as D=f(P,Y,T,Ps,U), Individual Demand refers to the demand for a commodity from the individual, point of view., 2. Market Demand Function:, It refers to the functional relationship between market demand and the factors, affecting market demand., It is expressed as D=f(P,Y,T,Ps,U, S, W), Where S= Size and Composition of Population W=Weather and Season, Market Demand refers to the total demand of all the buyers, taken together., Page. 1, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Determinants of Demand or Factors Influencing Individual and, Market Demand:, Demand of a commodity may change. It may increase or decrease due to changes, in certain factors. These factors are called determinants of demand. They are;, 1) Price of a commodity, 2) Nature of commodity, 3) Income and wealth of consumer, 4) Taste and preferences of consumer, 5) Price of related goods (substitutes and compliment goods), 6) Consumers expectations., 7) Number of Consumers in the Market., 8) Advertisement, 9) Season and Weather, 10) Change in fashion, 11) Change in population, 12) Customs, , Demand Schedule:, Demand function could be represented in the form of table. A tabular, statement of price/quantity relationship is called demand schedule. There, are 2 types of Demand Schedule, 1.Individual Demand Schedule 2. Market Demand Schedule, 1. Individual Demand Schedule:, An individual demand schedule is a list of quantities of a commodity purchased, by an individual consumer at different prices. The following table shows the, demand schedule of an individual consumer for apple., Price of Mango (₹ Per Unit) Quantity Demanded, 10, 1, 8, 2, 6, 3, 4, 4, 2, 5, When the price falls from ₹ 10 to ₹ 8, the quantity demanded increases from one, to two. In the same way as price falls, quantity demanded increases. On the basis, of the above demand schedule we can draw the demand curve as follows;, , The demand curve DD shows the inverse relation between price and demand of, Mango. Due to this inverse relationship, demand curve is slopes downward from, left to right. This kind of slope is also called “negative slope”., Page. 2, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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2. Market Demand Function:, Market demand refers to the total demand for a commodity by all the consumers., It is the aggregate quantity demanded for a commodity by all the consumers in a, market. It can be expressed in the following schedule., Price of Mango Demand by Consumers, Market, (₹ Per Unit), Demand, A, B, C, D, 10, 2, 2, 0, 0, 4, 8, 4, 3, 1, 0, 8, 6, 5, 4, 2, 1, 12, 4, 6, 5, 3, 2, 16, 2, 7, 6, 4, 3, 20, Derivation of market demand curve is a simple process. For example, let us, assume that there are four consumers in a market. When the price of one mango, is ₹ 10, A buys 2 mango and B buys 2 mango. When price falls to ₹ 8, A buys 4, , B buys 3 and C buys one mango. When price falls to ₹ 6, A buys 5 b buys 4,C, buys 2 and D buys one mango and so on. By adding up the quantity demanded, by all the four consumers at various prices we get the market demand curve., On the basis of the above demand schedule we can draw the demand curve as, follows;, , Why does demand curve slopes downward?, Demand Curve is a graphical presentation of a demand schedule and it, slopes downward from left to right (Negative Slope). There are many causes for, downward sloping of demand curve they are:, 1) Law of Diminishing Marginal utility: As the consumer buys more and more, of the commodity, the marginal utility of the additional units falls. Therefore, the, consumer is willing to pay only lower prices for additional units. If the price is, higher, he will restrict its consumption, 2) Principle of Equi- Marginal Utility: Consumer will arrange his purchases in, such a way that the marginal utility is equal in all his purchases. If it is not equal,, they will alter their purchases till the marginal utility is equal., 3) Income effect: When the price of the commodity falls, the real income of the, consumer will increase. He will spend this increased income either to buy, additional quantity of the same commodity or other commodity., Page. 3, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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4) Substitution effect: When the price of tea falls, it becomes cheaper., Therefore, the consumer will substitute this commodity for coffee. This leads to, an increase in demand for tea., 5) Different uses of a commodity: Some commodities have several uses. If the, price of the commodity is high, its use will be restricted only for important, purpose. For e.g. when the price of tomato is high, it will be used only for cooking, purpose. When it is cheaper, it will be used for preparing jam, pickle etc..., 6) Psychology of people: Psychologically people buy more of a commodity when, its price falls. In other word it can be termed as price effect., 7) Entry and Exit of Consumer: If the price of a particular commodity falls,, some new consumers enter in the market and start purchasing the commodity., The old consumers also start consuming more of the commodity. If the price, increases, new consumers withdraw and old consumers start consuming lesser, commodity., , Law of Demand:, The law of Demand is known as the” first law in market”. Law of demand shows, the relation between price and quantity demanded of a commodity in the market., According to Samuelson, “Law of Demand states that people will buy more at, lower price and buy less at higher prices”., In other words while other things remaining the same an increase in the price of, a commodity will decreases the quantity demanded of that commodity and, decrease in the price will increase the demand of that commodity. So the, relationship described by the law of demand is an inverse or negative relationship, because the variables (price and demand) move in opposite direction. It shows, the cause and effect relationship between price and quantity demand., Assumptions of Law of Demand:, 1) No change in consumers taste and preference., 2) No change in consumers income., 3) No future expectations., 4) No changes in the population., 5) No changes in prices of complementary and substitute goods., 6) No change in fashion., 7) No changes in government policy., 8) No change in weather condition., 9) There should be no substitute for the commodity., 10) No change in the range of goods available to the consumers., Exceptions to the Law of Demand. (Exceptional Demand Curve), The basic feature of demand curve is negative sloping. But there are some, exceptions to this. i.e... In certain circumstances demand curve may slope upward, from left to right (positive slopes). These phenomena may due to;, 1) Giffen Paradox (Inferior goods): The Geffen goods are inferior goods is an, exception to the law of demand. When the price of inferior good falls, the poor, will buy less and vice-versa. When the price of maize falls, the poor will not buy, it more but they are willing to spend more on superior goods than on maize. Thus, Page. 4, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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fall in price will result into reduction in quantity. This paradox is first explained, by Sir Robert Giffen., 2) Veblen or Demonstration effect (Prestige Goods): According to Veblen,, rich people buy certain goods because of its social distinction or prestige., Diamonds and other luxurious article are purchased by rich people due to its, high prestige value. Hence higher the price of these articles, higher will be the, demand., 3) Ignorance. : Sometimes consumers think that the product is superior or quality, is high if the price of that product is high. As such they buy more at high price., 4) Speculative Effect: When the price of commodity is increasing, then the, consumer buys more of it because of the fear that it will increase still further., 5) Fear of Shortage: During the time of emergency or war, people may expect, shortage of commodity and buy more at higher price to keep stock for future., 6) Necessaries: In the case of necessaries like rice, vegetables etc., People buy, more even at a higher price., 7) Brand Loyalty: When consumer is brand loyal to particular product or, psychological attachment to particular product, they will continue to buy such, products even at a higher price., 8) Festival, Marriage etc.: In certain occasions like festivals, marriage etc., people will buy more even at high price., Exceptional Demand Curve (perverse demand curve), , Change in Quantity Demanded vs Change in Demand:, The phrase changes in quantity demanded relates to the law of demand. It, refers to the changes in the quantities purchased by the consumers on, account of changes in price. The quantity demanded of a commodity, decreases when its price increases. But it is incorrect to say that demand, decreases when price increases or demand increases when price decreases., For ‘increase or decrease in demand, refers to changes in demand caused by, the changes in various other determinants of demand, price remaining, unchanged., I Extension and Contraction of Demand: (Changes in Quantity Demand), Demand may change due to various factors. The change in demand due to change, in price only, where other factors remaining constant, it is called extension and, contraction of demand., Page. 5, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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A change in quantity demand solely due to change in price is called extension and, contraction. When the quantity demanded of a commodity rises due to a fall in, price, it is called extension of demand. On the other hand, when the quantity, demanded falls due to a rise in price, it is called contraction of demand. It can be, understanding from the following diagram., , When the price of commodity is OP, quantity demanded is OQ. If the price falls, to P2, quantity demanded increases to OQ2. When price rises to P1, demand, decreases from OQ to OQ1. In demand curve, the area a to c is extension of, demand and the area a to b is contraction of demand. As result of change in price, of a commodity, the consumer moves along the same demand curve., II Shift in Demand (Increase or Decrease in demand) (Changes in Demand):, When the demand changes due to changes in other factors, like taste and, preferences, income, price of related goods etc(Price is constant). it is called shift, in demand. Due to changes in other factors, if the consumers buy more goods, it, is called increase in demand or upward shift. On the other hand, if the consumers, buy fewer goods due to change in other factors, it is called downward shift or, decrease in demand. Shift in demand cannot be shown in same demand curve., The increase and decrease in demand (upward shift and downward shift) can be, expressed by the following diagram., , DD is the original demand curve. Demand curve shift upward due to change in, income, taste & preferences etc of consumer, where price remaining the same. In, the above diagram demand curve D1- D1 is showing upward shift or increase in, demand and D2-D2 shows downward shift or decrease in demand., Page. 6, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Comparison between extension/contraction and shift in demand., SL. Extension/Contraction, of Shift in Demand(Change in Demand), No Demand, 1, Demand is varying due to changes Demand is varying due to changes in, in price., other factors. Like changes in income,, fashion,, population,, consumers, expectations, advertisement etc., 2, Other factors like taste, preferences, Price of commodity remain the same., income etc... remaining the same., 3, Consumer moves along the same Consumer may moves to higher or lower, demand curve., demand curve., 4, Also called changes in quantity Also called changes in demand or, demanded., increase and decrease in demand., ELASTICITY OF DEMAND:, Introduction: Law of demand explains the directions of changes in demand. A, fall in price leads to an increase in quantity demanded and vice versa. But it does, not tell us the rate at which demand changes to change in price. The concept of, elasticity of demand was introduced by Marshall. This concept explains the rate, at which changes in demand due to change in price., Meaning: Elasticity of demand refers to the degree of responsiveness of quantity, demanded of a good to a change in its determinants., Importance of Elasticity of Demand or Using Elasticity in Managerial, Decisions:, 1. Production- Producers generally decide their production level on the basis of, demand for their product. Hence elasticity of demand helps to fix the level of, output., 2. Price fixation- Each seller under monopoly and imperfect competition has to, take into account the elasticity of demand while fixing their price. If the demand, for the product is inelastic, he can fix a higher price., 3. Distribution- Elasticity helps in the determination of rewards for factors of, production. For example, if the demand for labour is inelastic, trade union can, raise wages., 4. International trade- This concept helps in finding out the terms of trade, between two countries. Terms of trade means rate at which domestic commodities, is exchanged for foreign commodities., 5. Public finance- This assists the government in formulating tax policies. In, order to impose tax on a commodity, the government should take into, consideration the demand elasticity., 6. Nationalization- Elasticity of demand helps the government to decide about, nationalization of industries., 7. Fixing the Tax Rate: While fixing up the tax rate, the government examines, the nature of the product. If the product is of inelastic nature, then the government, might increase the tax rate, because the commodity is so essential, that even if the, price of the product has been increased people will buy it., , Page. 7, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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8. Helpful in declaring public utility: If the demand for a product is so inelastic,, then the industry producing that might be declared as public sector. For example,, power, water, telephone etc., 9. Determination of rate of foreign exchange: The rate of foreign exchange is, also considered on the elasticity of imports and exports of a country., 10. Application for business: In decision making the concept of elasticity of, demand is of utmost practical use while taking decision for pricing policy the, Businessman has to know the likely effect of price changes on the demand for the, product in the market., 11. Application for the Government and Finance Minister: In determining, fiscal policy also the concept of elasticity of demand is very important to the, government. The finance minister has to consider the elasticity of demand while, selecting commodities for taxation. Tax imposition on commodities for getting, substantial revenue becomes worthwhile only if the tax and goods have an, inelastic demand., 12. Application for Trade Union: The concept of price elasticity is useful to, trade unions in wage bargaining. The union leaders, when they find that demand, for their Industries product is fairly elastic, will ask for a higher wage to workers, and use the producer to cut the price and increase sales which will compensate, for is loss in total profit., 13. Others- The concept elasticity of demand also helping in taking other vital, decision Eg. Determining the price of joint product, take over decision etc., Types of Elasticity of Demand:, I Price Elasticity of Demand, II Income Elasticity of Demand, III Cross Elasticity of Demand, IV Advertisement Elasticity of Demand, , I Price Elasticity of Demand:, Price Elasticity of demand measures the the ratio of percentage change in quantity, demanded to a percentage change in price. This can be measured by the following, formula., Price Elasticity = Proportionate change in quantity demanded, Proportionate change in price, or, Ep = (Q2-Q1)/Q1, (P2-P1) /P1, Where: Q1 = Quantity demanded before price change, Q2 = Quantity demanded after price change, P1 = Price charged before price change, P2 = Price charge after price change., Degrees of Price Elasticity of Demand:, 1) Perfectly elastic demand (infinitely elastic) :, When a small change in price leads to infinite change in quantity demanded, it is, called perfectly elastic demand. In this case the demand curve is a horizontal, straight line as given below. (Here ep= ∞), , Page. 8, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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2) Perfectly inelastic demand:, In this case, even a large change in price fails to bring about a change in quantity, demanded. I.e. the change in price will not affect the quantity demanded and, quantity remains the same whatever the change in price. Here demand curve will, be vertical line as follows and ep= 0., , 3) Relatively elastic demand:, Here a small change in price leads to very big change in quantity demanded. In, this case demand curve will be fatter one and ep=>1., , Page. 9, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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4) Relatively inelastic demand:, Here quantity demanded changes less than proportionate to changes in price. A, large change in price leads to small change in demand. In this case demand curve, will be steeper and ep=<1., , 5) Unit elasticity of demand (Unitary elastic):, Here the change in demand is exactly equal to the change in price. When both are, equal, ep= 1, the elasticity is said to be unitary., , Sl., No, 1, 2, 3, , Type, , 4, 5, , Page. 10, , description, , Shape of curve, , Perfectly elastic, Perfectly inelastic, Unitary elastic, , Numerical, expression, α, 0, 1, , infinity, Zero, One, , Relatively elastic, Relatively inelastic, , >1, <1, , More than one, Less than one, , Horizontal, Vertical, Rectangular, Hyperbola, Flat, Steep, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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II Income Elasticity of Demand:, Income elasticity of demand shows the proportionate change in quantity, demanded by the proportionate change in consumer’s income., Income elasticity of demand may be stated in the form of formula:, Income Elasticity = Proportionate Change in Quantity Demanded, Proportionate Change in Income, Ey =∆q X y, ∆y q, Where, Ey = income elasticity of demand, y = initial income, ∆q = change in quantity purchased as a result of a change in income, ∆y = small change in income, q = initial quantity purchased., Degrees of Income Elasticity:, 1) Zero Income Elasticity., 2) Negative Income Elasticity, 3) Positive Income Elasticity., 1)Zero Income Elasticity: In this case, quantity demanded remain the same, even, though money income increases.ie, changes in the income does not influence the, quantity demanded (Eg.salt,sugar etc). Here Ey = 0., 2)Negative Income Elasticity: In this case, when income increases, quantity, demanded falls. Eg, inferior goods. Here Ey = < 0., 3)Positive Income Elasticity: In this case, an increase in income may lead to an, increase in the quantity demanded. i.e., when income rises, demand also rises., Exp. Normal Goods. Here Ey => 0 This can be further classified in to three types:, a) Unit income elasticity: Demand changes in same proportion to change, in income.i.e, Ey = 1, b) Income elasticity greater than unity: An increase in income brings, about a more than proportionate increase in quantity demanded. i.e, Ey, =>1. Exp: Luxurious Goods., c) Income elasticity less than unity: when income increases quantity, demanded is also increases but less than proportionately. i.e., Ey =< 𝟏., Exp: Necessary Goods., , III Cross Elasticity of Demand:, Cross elasticity of demand is the proportionate change in the quantity demanded, of a commodity in response to change in the price of another related commodity., Related commodity may either substitutes or complements. Examples of, substitute commodities are tea and coffee. Examples of compliment commodities, are car and petrol. Cross elasticity of demand can be calculated by the following, formula;, Ec = Percentage charge in the quantity demanded of a Commodity, Percentage change in the price of Related Commodity, Page. 11, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Ec=∆qx X Py, ∆Py qx, Where, Ec = Cross elasticity of demand of X for Y, qx = Original quantity demanded of X, py = Price of good Y, ∆qx = Change in quantity demanded of good X, ∆px = Small change in the price of good Y., Degrees of Cross elasticity of demand:, 1) Positive Cross Elasticity:, The substitute goods (tea and Coffee) have positive cross elasticity because, the increase in the price of tea may increase the demand of the coffee and the, consumer may shift from the consumption of tea to coffee., 2) Negative Cross Elasticity:, Complementary goods (car and petrol) have negative cross elasticity because, increase in the price of car will reduce the quantity demanded of petrol., The concept of cross elasticity assists the manager in the process of decision, making. For fixing the price of product which having close substitutes or, compliments, cross elasticity is very useful., IV Advertisement Elasticity of Demand:, Advertisement or Promotional elasticity of demand is the percentage change in, demand that occurs given a one percent change in advertising expenditure., Advertising elasticity measures the effectiveness of an advertisement campaign, in bringing about new sales. Advertising elasticity of demand is generally, positive., Advertisement Elasticity =, Proportionate Increase in Sales, Proportionate increase in Advertisement expenditure, Advertisement Elasticity Interpretation:, Demand does not respond to increase in advertisement, 𝐸𝑎 = 0, expenditure, 𝐸𝑎 > 0 𝑏𝑢𝑡 < 1, , Change in demand is less than proportionate to the change in, advertisement expenditure, , 𝐸𝑎 = 1, , Demand changes in the same proportion in which, advertisement expenditure changes, , 𝐸𝑎 > 1, , Demand changes at a higher rate than change in advertisement, expenditure., , Advertisement elasticity helps in the process of decision making. It helps to, deciding the optimum level of advertisement and promotional cost. If the, advertisement elasticity is high, it is profitable to spend more on advertisement., Hence, advertisement elasticity helps to decide optimum advertisement and, promotional outlay., Page. 12, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Methods of Forecasting Price Elasticity of Demand:, There are various methods for the measurement of elasticity of demand., Following are the important methods:, 1. Proportional or Percentage Method:, Under this method the elasticity of demand is measured by the ratio between the, proportionate or percentage change in quantity demanded and proportionate, change in price., It is also known as formula method. It can be computed as follows:, ED = Proportionate change in quantity demanded, Proportionate change in price., or, , ED = (Q2-Q1)/Q1, (P2-P1) /P1, , 2. Expenditure or Outlay Method:, This method was developed by Marshall. Under this method, the elasticity is, measured by estimating the changes in total expenditure as a result of changes in, price and quantity demanded. This has three components, 1) If the price changes, but total expenditure remains constant, unit elasticity, exists., 2) If the price changes, but total expenditure moves in the opposite directions,, demand is elastic (>1)., 3) If the price changes and total revenues moves in the same direction,, demand is inelastic (< 1)., This can be expressed by the following diagram., , 3. Geometric or Point method:, This also developed by Marshall. This is used as a measure of the change in, quantity demanded in response to a very small change in the price. In this method, we can measure the elasticity at any point on a straight line demand curve by, using the following formula;, ED = Lower section of the Demand curve, Upper section of Demand curve, Page. 13, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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4.Arc Method:, The point method is applicable only when there are minute (very small) changes, in price and demand. Arc elasticity measures elasticity when the price changes is, larger., According to Watson,” Arc elasticity is the elasticity at the midpoint of an arc of, a demand curve”. formula to measure elasticity is:, =Change in D x Average P, Average D, Change in P, Where, ∆Q= change in quantity, P1 = original price, P2 = New price, , Q1= original quantity, Q2= new quantity, ∆P= change in price., , Introduction to Consumer Choice:, Consumers make choices that give them the greatest satisfaction, thereby, maximizing their utility. Each individual’s utility varies depending on the taste or, preference of that person. In this concept, we take a close look at how we make, choices. Some decisions seem to be based on feelings or come from personal, experiences., Decisions are being made every day, every hour, every second. We look around, us and see people making decisions: Should I go to college? Should I get married?, Should I buy this car? The choices never end. We always have to make choices, because of scarcity, and scarcity will always be with us., The theory of consumer choice is the branch of microeconomics that relates, preferences to consumption expenditures and to consumer demand curves. It, analyses how consumers maximize the desirability of their consumption as, measured by their preferences subject to limitations on their expenditures, by, maximizing utility subject to a consumer budget constraint., , Page. 14, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Consumer Sovereignty:, Consumer sovereignty is an economic concept where the consumer has some, controlling power over goods that are produced, and the idea that the consumer, is the best judge of their own welfare., Consumer sovereignty in production is the controlling power of consumers,, versus the holders of scarce resources, in what final products should be produced, from these resources. It is sometimes used as a hypothesis that the production of, goods and services is determined by the consumers' demand (rather than, say, by, capital owners or producers)., Limitations of Consumer Sovereignty:, 1)Inequitable distribution of income., 2)Availability of Resources, 3)Monopoly power, 4)Government Restrictions, 5)Irrational Consumer., 6)Combined Demand., UTILITY:, Introduction:, Utility describes the satisfaction one gets from making a choice. If Seetha has to, choose between going to school or going to the beach, she must weigh the utility, both choices give her. While on the surface the beach would give her plenty of, satisfaction, would going to school ultimately give her more utility ?., Meaning:, Utility refers to the total satisfaction receiving from consuming a good or, services. It is a subjective entity (concept) and differs from person to person., The Utility theory explains consumer behaviour in relation to the satisfaction that, a consumer gets the movement he consumes a good., There are 2 approaches of utility, they are, 1)Ordinal Utility Approach:, In ordinal utility, the consumer only ranks choices in terms of preference but we, do not give exact numerical figures for utility. For example, we prefer a Maruthi, Suzuki car to a Tata, but we don’t say by how much., Ordinal utility theory states that while the utility of a particular good or service, cannot be measures using a numerical scale., 2)Cardinal Utility Approach:, In this approach utility can be measured with numerical values (1,2,3) along a, scale. For example, people may be able to express the utility that consumption, gives for certain goods. For example, if a Tata car gives 5,000 units of utility, a, Maruthi Suzuki car would give 8,000 units., According to this theory, utility is a cardinal concept i.e. utility is a measurable, and quantifiable concept. Thus, a person can say that he derives utility equal to, 10 units from the consumption of 1 unit of commodity A., Page. 15, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Utility Analysis:, I Law of Diminishing Marginal Utility(DMU), II Law of Equi-Marginal Utility (EMU), I Law of Diminishing Marginal Utility(DMU):, Diminishing marginal utility describes the lessening of utility or satisfaction as, each additional unit is consumed., Since each want is satiable, as a consumer consumes more and more units of a, good, the intensity of his want for the good goes on decreasing and ultimately a, point is reached where the consumer no longer wants it. His marginal utility from, the product becomes zero., DMU is simply sates that other things being equal, the MU derived from, successive units of a given commodity goes on decreasing., Assumptions of DMU:, 1. Cardinal measurement of utility: It is assumed that utility can be measured, and a consumer can express his satisfaction in quantitative terms such as 1, 2 etc., 2. Consumption of reasonable quantity: It is assumed that a reasonable, quantity of the commodity is consumed., 3. Continuous consumption: It is assumed that consumption is a continuous, process. For example, if one ice-cream is consumed in the morning and another, in the evening, then the second ice-cream may provide equal or higher satisfaction, as compared to the first one., 4. No change in Quality: Quality of the commodity consumed is assumed to be, uniform. A second cup of ice-cream with nuts and toppings may give more, satisfaction than the first one, if the first ice-cream was without nuts or toppings., 5. Rational consumer: The consumer is assumed to be rational who measures,, calculates and compares the utilities of different commodities and aims at, maximizing total satisfaction., 6. Independent utilities: It is assumed that all the commodities consumed by a, consumer are independent. It means, MU of one commodity has no relation with, MU of another commodity., 7. Fixed Income and prices: It is assumed that income of the consumer and, prices of the goods which the consumer wishes to purchase remain constant., The following table would be useful to understand the above law, No. of Mangoes Marginal Utility (MU), Total Utility (TU), 1, 10, 10, 2, 8, 18, 3, 6, 24, 4, 4, 28, 5, 2, 30, 6, 0, 30, 7, -2, 28, 8, -4, 24, Page. 16, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Concepts of DMU:, 1)Initial Utility:, The utility derived from the first unit of a commodity is called initial utility., Utility derived from the first piece of bread is called initial utility. In the table, initial utility is 10., 2)Total Utility:, It is the sum of the utility derived from different units of a commodity consumed, by a consumer., Total utility is the sum of utility derived from different units of a commodity, consumed by an individual., TU=MU1+MU2+MU3……..+MUn, 3) Marginal Utility:, It is the utility derived from the additional unit of a commodity consumed., The change that takes place in the total utility by the consumption of an additional, unit of a commodity is called marginal utility., MU can be positive, zero or negative., MU=TU2-TU1, Relationship between Total Utility and Marginal Utility:, a) TU initially increases with the consumption of successive units of a, commodity. Ultimately, it begins to fall., b) MU continuously diminishes., c) As long aa MU is >0 or Positive, TU increases., d) TU is maximum when MU is 0. It falls when MU is negative., 4)Zero Utility: When the consumption of a unit of a commodity makes no, addition to the total utility, then it is the point of zero utility., 5) Negative Utility: It is the consumption of a unit of a commodity is carried to, excess, then instead of giving any satisfaction, it may cause dissatisfaction. The, utility in such cases is negative., Page. 17, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Exceptions of DMU:, 1.Hobbies: - it is believed that in the case of certain hobbies such as stamp, collection, antique (historic) collection, etc. MU goes on increasing with, acquisition of additional units. But here the person does not collect the same types, of stamps, and therefore, the assumption of homogeneity is not fulfilled., 2.Drunkards/Drug addicts: It is believed that every dose of drug or liquor increases, utility to the consumer. But in the case of drunkard or drug addict, there is no, rational behaviour is assumed., 3.Music and Poetry: -It is believed that more poetry and music give greater, satisfaction., 4.Reading: -Reading on more books provides more knowledge and in turn, greater, satisfaction. But the reader in search of knowledge does not read the same book, every now and then. Therefore, the assumption of homogeneity does not apply., 5.Money: It is assumed that an individual gets more satisfaction with more money, and he wants to have more of it. In the case of money, it is to be noted that money, alone does not satisfy a want directly. It only acts as purchasing power to, purchases goods and services., , II Law of Equi-Marginal Utility (EMU):, This second law is the extension of the first law. It tells us about the conditions, under which the consumer would derive the maximum possible satisfaction out, of his income., According to this law, a consumer would maximize his satisfaction when a rupee, spent on various commodities gives him an equal amount of marginal utilities., It is also known as law of substitution or law of maximum satisfaction., Assumptions of EMU:, 1) The consumer has a given amount of income and it remains constant., 2) He purchases two goods., 3) He behaves rationally., 4) He is fully aware of his utility schedules., 5) The goods are divisible and substitutable., 6) The prices of the goods do not change., Limitations of Law of EMU:, (i) Ignorance: If the consumer is ignorant or blindly follows custom or fashion,, he will make a wrong use of money. On account of his ignorance he may not, know where the utility is greater and where less., (ii) Inefficient Organization: In the same manner, an incompetent organizer of, business will fail to achieve the best results from the units of land, labour and, capital that he employs. This is so because he may not be able to divert, expenditure to more profitable channels from the less profitable ones., (iii) Unlimited Resources:The law has obviously no place where this resources, are unlimited, as for example, is the case with the free gifts of nature. In such, cases, there is no need of diverting expenditure from one direction to another., Page. 18, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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(iv) Hold of Custom and Fashion: A consumer may be in the strong clutches of, custom, or is inclined to be a slave of fashion. In that case, he will not be able to, derive maximum satisfaction out of his expenditure, because he cannot give up, the consumption of such commodities., (v) Frequent Changes in Prices: Frequent changes in prices of different goods, render the observance of the law very difficult. The consumer may not be able to, make the necessary adjustments in his expenditure in a constantly changing price, situation., Importance of Law of EMU:, (i) Consumption: A wise consumer consciously acts on this law while arranging, his expenditure. His expenditure is so distributed that the same price measures, equal utilities at the margin of different purchases., (ii) Production: The law is also of great importance in production. The producer, has to use several factors of production. He wants maximum net profit. For this, purpose, he must substitute one factor for another so as to have the most, economical combination., (iii) Exchange: The law also applies in exchange because exchange is nothing, else but substitution of one thing for another., (iv) Distribution: It is on the principle of marginal productivity that the share of, each factor of production (viz., land, labour, capital, organisation) is determined., (v) Public Finance: The Government, too, is guided by this law in public, expenditure. The public revenues are so spent as to secure maximum welfare of, the community., (vi) Influences Prices: The law of substitution influences prices. When a, commodity becomes scarce and its price soars high, we substitute for it things, which are less scarce. Its price, therefore, comes down., , INDIFFERENCE CURVE ANALYSIS:, Introduction: A very popular alternative and more realistic method of explaining, consumer’s demand is the Indifference Curve Analysis. This approach to, consumer behaviour is based on consumer preferences., The consumer’s preference approach, is, therefore an ordinal concept based on, ordering of preferences compared with Marshall’s approach of cardinality., Meaning: An indifference curve is a geographical presentation of a consumers, scale of preferences. It represents all those combinations of two goods which will, provide equal satisfaction to a consumer., Indifference Schedule:, It refers to a schedule that indicates different combinations of two commodities, which yield equal satisfaction. Therefore, consumer give equal importance to, each of the combinations., Supposing a consumer has 2 goods namely apples and oranges. The following, combination yield him equal satisfaction., Page. 19, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Combination of Apple, and Orange, A, B, , Apple, , Orange, , 1, 2, , 12, 06, , C, D, , 3, 4, , 04, 03, , Assumptions of the Indifference Curve Analysis:, 1)Rational behaviour of the consumer., 2)Utility is ordinal, 3)Diminishing marginal rate of substitution., 4)Consistency in choice., 5)Consumers preference not self-contradictory., , Properties or Features of Indifference Curves:, (1) Indifference Curves are Negatively Sloped:, Indifference curve being downward sloping means that when the amount of one, good in the combination is increased, the amount of the other good is reduced., This must be so if the level of satisfaction is to remain the same on an indifference, curve., Y, , Mangoes, ID, C, 0, , Apples, , X, , (2) Higher Indifference Curves Represent Higher Level of Satisfaction:, One more feature of the IDC is that the higher an IDC, the higher will be the level, of satisfaction represented by it. A right hand IDC shows more satisfaction than, a left hand side IDC. Here we can see two IDCs., , Page. 20, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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(3) Indifference Curves are Convex to Origin:, An IDC is a curve showing those combinations of any two goods, which give an, equal amount of satisfaction to the buyer. There are many properties of the IDCs., One of them is that the IDC is convex to the origin. It is explained here., , (4) Two Indifference Curves cannot Intersect Each Other:, Two IDC represent two different levels of satisfaction and therefore two IDCs, cannot intersect each other., , (5) Indifference Curves do not touch the horizontal or vertical axis:, If an indifference curve touches horizontal axis or vertical axis, it implies that the, customer prefers only one commodity because when it touches axes, one of the, commodities becomes zero quantity. Hence, an indifference curve does not, touch either horizontal axis or vertical axis., , Page. 21, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Superiority or Importance of indifference Curve Approach:, 1. It Dispenses with Cardinal Measurement of Utility, 2. It Studies Combinations of Two Goods Instead of One Good, 3. It Provides a Better Classification of Goods into Substitutes and Complements, and Others., 4. It Explains the Law of Diminishing Marginal Utility without the Unrealistic, Assumptions of the Utility Analysis, 5. It is Free from the Assumption of Constant Marginal Utility of Money, 6. It Explains the Dual Effect of the Price Effect, 7. It Explains the Proportionality Rule in a Better Way, 8. It Rehabilitates the Concept of Consumer’s Surplus, 9. It is more Realistic., Shortcomings of the Indifference Curve Approach:, 1)It does not provide any positive change in the utility analysis., 2)It retains the Marshallian assumption of diminishing marginal utility., 3)It unrealistically assume perfect knowledge of utility with the consumer., 4)It is weak in structure., 5)It has limited scope., 6)It is not applicable to indivisible goods., 7)It is introspective., , Theory of Revealed Preferences:, Revealed preference theory, in economics, a theory, introduced by the, American economist Paul Samuelson in 1938, that holds that consumers’, preferences can be revealed by what they purchase under different circumstances,, particularly under different income and price circumstances. The theory entails, that if a consumer purchases a specific bundle of goods, then that bundle is, “revealed preferred,” given constant income and prices, to any other bundle that, the consumer could afford. By varying income or prices or both, an observer can, infer a representative model of the consumer’s preferences., Revealed preference theory tries to understand the preferences of a consumer, among bundles of goods, given their budget constraint. For instance, if a, consumer buys bundle of goods A over bundle of goods B, where both bundles, of goods are affordable, it is revealed that they directly prefer A over B. It is, assumed that the consumer's preferences are stable over the observed time period,, i.e. the consumer will not reverse their relative preferences regarding A and B., Assumptions of the Theory:, 1)Two commodities model., 2)Given price-income situation., 3)Constancy of taste., 4)Rational consumer., 5)Strong ordering., 6)Transitivity condition., 7)Positive income elasticity of demand., Page. 22, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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Three Axioms of Revealed Preference, As economists developed the revealed preference theory, they identified three, primary axioms of revealed preference—the weak axiom, the strong axiom, and, the generalized axiom., , , , , , , Weak Axiom of Revealed Preference (WARP): This axiom states that, given incomes and prices, if one product or service is purchased instead of, another, then, as consumers, we will always make the same choice. The, weak axiom also states that if we buy one particular product, then we will, never buy a different product or brand unless it is cheaper, offers increased, convenience, or is of better quality (i.e. unless it provides more benefits)., As consumers, we will buy what we prefer and our choices will be, consistent, so suggests the weak axiom., Strong Axiom of Revealed Preference (SARP): This axiom states that in a, world where there are only two goods from which to choose, a twodimensional world, the strong and weak actions are shown to be equivalent., Generalized Axiom of Revealed Preference (GARP): This axiom covers, the case when, for a given level of income and or price, we get the same, level of benefit from more than one consumption bundle. In other words,, this axiom accounts for when no unique bundle that maximizes utility, exists., , DEMAND FORECASTING:, Forecasting of demand is the art and science of predicting the probable demand, for a product or a service at some future date on the basis of certain past behaviour, patterns of some related events and the prevailing trends in the present., Demand Forecasting refers to an estimate of future demand for the product. It is, an “objective assessment of the future course of demand”., TECHNIQUES OF DEMAND FORECASTING:, I Survey Methods, II Statistical Methods., I Survey Methods:, Under this method, information about the desire of the consumers and opinions, of experts are collected by interviewing them. This can be divided into four types;, 1. Opinion Survey method: This method is also known as Sales- Force –, Composite method or collective opinion method. Under this method, the, company asks its salesmen to submit estimate for future sales in their respective, territories. This method is more useful and appropriate because the salesmen are, more knowledgeable about their territory., 2. Expert Opinion: Apart from salesmen and consumers, distributors or outside, experts may also be used for forecast. Firms in advanced countries like USA, UK, etc... make use of outside experts for estimating future demand. Various public, and private agencies sell periodic forecast of short or long term business, conditions., Page. 23, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara

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3. Delphi Method: It is a sophisticated statistical method to arrive at a consensus., Under this method, a panel is selected to give suggestions to solve the problems, in hand. Both internal and external experts can be the members of the panel. Panel, members are kept apart from each other and express their views in an anonymous, manner., 4. Consumer Interview method: Under this method a list of potential buyers, would be drawn and each buyer will be approached and asked about their buying, plans. This method is ideal and it gives first-hand information, but it is costly and, difficult to conduct. This may be undertaken in three ways:, A) Complete Enumeration – In this method, all the consumers of the, product are interviewed., B) Sample survey - In this method, a sample of consumers is selected for, interview. Sample may be random sampling or Stratified sampling., C) End-use method – The demand for the product from different sectors, such as industries, consumers, export and import are found out., II Statistical Methods:, It is used for long term forecasting. In this method, statistical and mathematical, techniques are used to forecast demand. This method is relies on past data. This, includes;, 1. Trent projection method: Under this method, demand is estimated on the, basis of analysis of past data. This method makes use of time series (data over a, period of time). Here we try to ascertain the trend in the time series. Trend in the, time series can be estimated by using least square method or free hand method or, moving average method or semi-average method., 2. Regression and Correlation: These methods combine economic theory and, statistical techniques of estimation. in this method, the relationship between, dependant variables(sales) and independent variables (price of related goods,, income, advertisement etc..) is ascertained. This method is also called the, economic model building., 3. Extrapolation: In this method the future demand can be extrapolated by, applying binomial expansion method. This is based on the assumption that the, rate of change in demand in the past has been uniform., 4. Simultaneous equation method: This means the development of a complete, economic model which will explain the behaviour of all variables which the, company can control., 5. Barometric techniques: Under this, present events are used to predict, directions of change in the future. This is done with the help of statistical and, economic indicators like: Construction contract, Personal income, Agricultural, income, Employment, GNP, Industrial production etc., , Page. 24, , Prepared by Prakash.K Assistant Professor, GFGC Ramanagara