What is Demand

-Willingness to Pay
- Ability to Pay
-Desire / Need
-At a particular Time
-“ The demand for anything at a given price is the
amount of it which will be bought per unit of time at
that price.”
-- Demand is always at a price.

-Definition ; By demand we mean the various

quantities of a given commodity or service which
consumers would buy in one market place in a given
period of time at various prices or at various
Incomes or at various prices of Related goods
 Definition : By demand we mean the
various quantities of a given commodity
or service which consumers would buy
in one market place in a given period of
time at various prices or at various
Incomes or at various prices of Related
• Three types of goods
Demand
– Price Demand
– Income demand
– Cross Demand
• Price Demand: Purchase at a given point in time
and market; Income and price of other related
goods is unchanged. Schedule is price vs
quantity: Individual demand vs Industry
Demand
• Income demand: Purchases made at various
Income levels. Schedule is Income vs Quantity.
Superior vs Inferior Goods
• Cross demand; Purchase of one good with
reference to the change in price of a related
good. (tea/coffee); Schedule Price of One
commodity and the Quantity of another.
Demand Curve : Relation of
Quantity and Price
• Downward
D
Sloping
Demand Curve
Curve
• Sellers
Perspective
Price it is the AR
curve.

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

Looking at a Utility Angle; disposal Income –

Maximum Satisfaction – Apply Law of
Substitution – Marginal Returns – Arrange
Expenditure by buying more when prices
drop – Buy less or Substitute when prices
rise
 Giffen Paradox
Sir Robert Giffen
Demand Rises with Rise in
Price
Demand Falls with a Fall in
price
Example : Fear of shortage; Confers Distinction / prestige; Ignorance; Necessity
 What causes Change in
Demand
• Change in Taste
• Change in Weather / climate
• Change in size and Composition of population
• Change in Money Supply
• Change in Price of the Commodity
• Change in real Income
• Change in the Level of Distribution Of Income
• Change in savings
• Change in Asset Preferences
• Conditions of trade
• Expectations and Anticipations
• Prices of related goods
 Law of Demand: A rise in the Price of a
commodity or service is followed by a
reduction in demand and a fall in price is
followed by a increase in demand if conditions
of demand remain constant
• Limitations
– Change in Taste and Fashion
– Change in Income
– Change in Other prices
– Discovery Of substitutes
– Anticipatory change in Prices
– Commodity Quality
 Elasticity of Demand
The Elasticity (or
responsiveness ) of demand
in a market is great or small
according as the amount
demanded increases much or
little for a given fall in price
and diminishes much or little
for a given rise in Price
 Five Cases Of elasticity
• Perfectly elastic / Infinite Elasticity
• Perfectly Inelastic / Zero Elasticity
• Relatively Elastic
• Relatively Inelastic
• Unit Elasticity
 Types of Elasticity
• Price Elasticity
• Income Elasticity
• Cross Elasticity
• Advertising elasticity
 Price Elasticity ( PEoD)
• It measure the Responsiveness of buyers to Change
in Price
• PEoD = (% Change in Quantity Demanded)/
(% Change in Price)
– % Change in Quantity is [QDemand(NEW) -
QDemand(OLD)] / QDemand(OLD)
– % Change in Price is [Price(NEW) - Price(OLD)] /
Price(OLD)
– Only positive figures are considered
• If PEoD > 1 then Demand is Price
Elastic (Demand is sensitive to price
changes)
• If PEoD = 1 then Demand is Unit Elastic
• If PEoD < 1 then Demand is Price
Inelastic (Demand is not sensitive to
price changes)
 Income elasticity ( Income
Sensitivity)
• The rate of response of quantity demand due
to a raise (or lowering) in a consumers income.

• IEoD = (% Change in Quantity

Demanded)/
(% Change in Income)
• Negative scores are Important
• If IEoD > 1 then the good is a Luxury
Good and Income Elastic
• If IEoD < 1 and IEOD > 0 then the good
is a Normal Good and Income Inelastic
• If IEoD < 0 then the good is an Inferior
Good and Negative Income Inelastic
 Cross Elasticity
• the rate of response of quantity
demanded of one good, due to a price
change of another good.
• Applicable Substitutes and
Complementary Goods
• CPEoD = (% Change in Quantity
Demand for Good X)/(% Change in
Price for Good Y)
• If CPEoD > 0 then the two goods are
substitutes
• If CPEoD =0 then the two goods are
independent (no relationship
between the two goods
• If CPEoD < 0 then the two goods are
complements
 Advertising elasticity
• The change in sales that results from each
monetary unit (e.g. each pound or dollar) that is
spend on advertising.
• (% Change in Quantity Demanded)/
(% Change in Advertising Cost)
• Interpretation Similar to Income Elasticity .
Negative changes are to be noted.
Significance of eD for Firms
• It will help the firm determine whether an increase in the
price of their good will increase or decrease total revenue.
(Demand Curve is AR curve for firm)
• If demand is elastic, then an increase in price will lead to a
more than proportionate decrease in quantity demanded.
Therefore increasing the price for a good with elastic
demand will decrease total revenue for the firm
• If demand is inelastic, then an increase in price will lead to a
less than proportionate decrease in quantity demanded.
Therefore increasing the price for a goods with inelastic
demand will increase total revenue for the firm.
• Determining Advertising Decisions
 UTLITY : It is the basic
instinct of choosing
commodities which give
maximum Satisfaction
Marginal Utility and Total
Quantity Utility
Total Utility Marginal Utility
Consumed
0 0 0
1 4 4
2 7 3
3 8 1
 Three Assumptions of
Marginal Utility Analysis
• Utility is a Cardinally Measureable : Imaginary
Units
• Utilities are Independent: Different Goods ;
Commodities are independent
• Constant Marginal Utility of Money : Since it is
expressed in terms of money, Money Utility is
constant
• Rationality of Consumer
 Law of Diminishing Marginal
Utility

•Total Utility is Maximum when Marginal Utility is Zero.

Law: The additional benefit which a person derives from a given increase
in stock of a thing diminishes with every increase in stock
that he already has.
 Limitations of the Law
• Suitable Units
• Suitable Time
• No Change in the Consumers Taste
• Normal Persons ( misers)
• Constant income
• Rare Collections
• Change in Other Peoples Stock
• Other Possessions
• Fashion
• Not Applicable to Money
 Law of Equi Marginal Utility
• Obtain Maximum Satisfaction from a given Budget
• Distribute income among different commodities
• Marginal utilities spent till last rupee spent is equal for
both commodities
• When one MU is greater than the other , consumer with
substitute one for the other. ( Graph)
• Limitations
 Derivation of demand Curve

Price
MU1
MU2

MU3

QUANTITY
 Criticism of Utility Analysis
• Unsound Psychology – Unrealistic Motives of
consumer
• Cardinal Measurement Not possible
• Wrong Assumption of Independent Utilities
• Income and Substitution Effect not explained
• Does not explain Giffen Paradox
• MU of Money is Constant – Incorrect
• Single Commodity analysis
 Indifference curves
• It is on the basis of the Scale of
preferences
• Assumptions
– Completeness
– Non Satiation
– Consistency
– Substitutability
– Convexity ( Shows Marginal Rate of
substitution)
 Schedule and Curve
Combination Apples Mangoes

1 15 1
All Points on One curve
2 11 2 give Equal Preference
3 8 3
4 6 4 Change is indicated by
Movement
5 5 5

IC3
IC2
IC1
Marginal rate of Substitution
Combination Apples
1 15
2 11
3 8
4 6
5 5
Mangoes MRS of
Mangoes for
apples
1 -
2 4:1
3 3:1
4 2:1
5 1:1

Define MRS of X for Y as the Quantity of Y which would just Compensate

the Consumer for the Loss of Marginal Unit of X (This is Diminishining In nature)
Downward Sloping IC Curve

Should Give More Satisfaction

Non Intersecting. At intersection Point they are equal Means A & B also is equal

Convex ; Diminishing MRS rule applies

 Budget Line
• Price Line / Price opportunity Line/
Budget Constraint Line
Consumer Equilibrium / Max
satisfaction
• Scale of Pref bet
two Commodities
• Constant amount
of Money spent on
Both Goods K
• Prices of Goods are S
Constant
• Homogeneous and P
Divisible
• Consumer is
Rational
 Conditions for Equilibrium
are
• The Price line should be tangent to
The IC curve
• Point of Equilibrium Should be
Convex to the Origin ie MRS should
apply
• Willingness to substitute one for
another
 Income Effect

Change in Income
ICC Curve

Substitution effect

Change in Price of One Good

PRICE EFFECT ; PCC Curve
 Two components of Price
Effect
• It is a Result of Income and Substitution Effect

ICC
T

P1 PCC
P
 Applications of IC curves
• Measurement of National Income (Consumption
Patterns)
• Rationing
• Cost of Living Index
• Price Discrimination
• Direct vs indirect Tax
• Effects of Subsidy
• Effect of tax and willing to work
• Increase in wage and effect on Supply of Labour
Consumer Surplus
 Supply theory

Upward Sloping
Increase
Decrease
Price

Quantity

Law of Supply : Other Things remaining the same , as the Price of a commodity
Rises its supply is extended, and as the price falls its supply is contracted.
 Reasons for change in
supply
• Cost of Production
• Improved conditions
• Technology Improvements
• Political Disturbances
• Conscious changes by Suppliers
• No. of Sellers in the market
• Objective of the firm
• Taxation and external factors
• Price of related goods
 Elasticity of Supply
• Relatively elastic
• Relatively Inelastic
• Unit Elastic
• Perfect Elastic
• Perfect Inelastic
 Market Equilibrium

Price

Quantity
 Changes in Market
equilibrium
• Change in Demand with Constant
Supply
• Change in Supply with constant
Demand
• Change in Both
 Application of Price
Determination
• Maximum Price Legislation
• Black Market
• Minimum Price Legislation
 Production Analysis
• The relationship Between input and
output of a firm is Production
Function
• Physical Relation determines the
Cost of production
• X= f( L , N, K , e)
• Production in Momentary Run
• Production in the Short Run
• Production in the Log Run
 Returns to Factor
• Fully exploit the factors of Production , Then
starts a phase of Negative Returns .
• Total Production starts declining and Variable
Contribution in Negative
• Law of Variable Returns (short run)
• Total Quantity , Average Quantity and
Marginal Quantity
• Increasing ,Decreasing and Negative Returns
 ISOQUANTS (Production
Indifferent Curves)
• Similar to IC curves
• Combination of the Factors of
Production
• Properties
– Dowward Sloping
– Higher levels show Increased Output
– Do not intersect
– Cannot be Straight Lines
 Marginal Rate of Technical
Substitution
Combination Factor X Factor Y MRTSxy
A 1 15 -
B 2 10 5
C 3 6 4
D 4 3 3
E 5 1 2

MRTS = MPx/MPy
 Production in the Long Run
• Additional Units of the Factors of
production
• Increase for some time and then
Diminish
• Increase in the output in relation to
the increase in the factors is called
Returns to Scale
 Returns to Scale
• Constant Returns
• Diminishing Returns
• Increasing Returns
 Economies to Scale
• Simple Term is “advantages”
Economies Diseconomies
Effective Use of Capital Overworked management
Equipment
Economy of specialized Individual Tastes Ignored
labour
Better Utilization and No personal touch
Specialized management

Economies in buying and Possibility of Depression

selling
Overhead Charges Dependence of Foreign
Markets
Rent, research , Ad Cost Competition
Utilization of By Products International
Complications
 INTERNAL ECONOMIES
• ECONOMIES
– Real Economies
• Labour Economies
• Technical Economies
• Selling and Marketing economies
• Managerial Economies
• Risk and Survival economies
- Pecuniary Economies
• Payment of Lower prices of Inputs
• Diseconomies
– Commerical
– Financial
– Managerial
– Risk
– Labour
 External Economies
• Economies of concentration
• Economies of Information
• Economies of Disintegration
• Locational Economies
• Technical Economies
Diseconomies
Environmental pollution
Aggolmeration
 ISO COST & Expansion
• Increase in budget lines
• Least Cost Combination
• Expansion Path
• Change on Factor prices and thus
expansion path
 Cost and Cost Curves
• Money Cost ; Actual expenses of production
• Real Cost : Putting a monetary veil ( Social Cost)
• Opportunity Cost ; Next best Alternative forgone,
best use in eco
• Economic Cost ; Suppliers (scarce resources)
• Implicit Cost ; Self employment etc
• Explicit Cost : Payments
 Short run and Long Run
• Entrepreneur’s Cost : Wages , rent ,
depreciation etc

• Short Run; Not all Costs can be

altered; Some are Fixed
• Long run ; All Cost are considered
variable and can be altered
 TC, AC, MC
Units TFC TVC TC AFC AVC AC MC
0 30 0 30 - -
1 30 10 40 30 10 40 10
2 30 18 48 15 9 24 8
3 30 24 54 10 8 18 6
4 30 32 62 7.5 8 15.5 8
5 30 50 80 6 10 16 18

GRAPH

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

 Long run Cost Curves
• Rise and fall in AC is due to Economies
– Graph
• Long Run MC is based on the Short Run
MC
– Graph
• When there are no economies to reap
and all factors are infinitely divisible
then LAC is horizontal
 Long Run Average Cost
• Stretched Saucer Shaped Curve
( reserve Capacity)
• Scales are same at all levels beyond
a point
– L Shaped AC Curve
Market types and Structures
Perfect Competition
– Large No of Buyers and sellers
– Homogeneity of the Product
– Free Entry and Exit of Firms
– Perfect Knowledge
– Cost of Transport is not Included
– Perfect Mobility of the Factors of Production
Imperfect Competition
Monopolistic Competition
Oligopoly
Monopoly
 Revenue Curves
• Total revenue ; Price * Quantity, Upward Sloping Line
• Marginal revenue = TR(n) – TR (n-1)
• Average Revenue: TR/Q ;
– TR= P*Q
AR = P*Q/Q ….Thus AR=P
• If P is Constant AR and MR are a Horizontal Straight Line
(Perfect Comp)
• If P Fluctuates the AR and MR are downward sloping
 AR and MR
• If P is Constant AR and MR are a
Horizontal Straight Line (Perfect Comp)
• If P Fluctuates the AR and MR are
downward sloping
• Slope will depend on the Elasticity
• MR below then AR quantum will depend
on the Slope of the curves
 Objectives of a Firm
• Profit Maximization
– Total Revenue and Total Cost approach
– Marginal Revenue and marginal Cost Approach
– 3 assumptions
• Ent . Is Rational and aims to earn max. profits
• Firm is Producing only one commodity
• Enti is aware of the position where profits are max.
• Sales maximization
• Welfare maximization
 TR & TC approach

TC

TR
Revenue

Quantity
 MR and MC Approach
E is Pt of Equilibrium

MC Profit is Max

MR is more than MC
Q AC Is max at this pt.
E
P
AR
S

MR

Sales Maximization is where TR is at the max.

 Market Structures
Perfect Competition
– Large No of Buyers and sellers
– Homogeneity of the Product
– Free Entry and Exit of Firms
– Perfect Knowledge
– Cost of Transport is not Included
– Perfect Mobility of the Factors of Production

• Examples : Stock / organized commodities some food stuffs etc

Imperfect competition
• Monopoly
– One Seller with a unique product
– Price Maker of the market ( price
Discrimination)
– Knowledge is imperfect ( Information Cost)
– Price elasticity is Highly Inelastic
– Regular Monopoly must practice public
interest
– Eg; LNG and LPG
• Pure Oligopoly
– Few Sellers with a homogenous product
– Formation of Cartels
– Imperfect knowledge
– Pe depends on demand of the product

– Impure Oligopoly
– Few Sellers with a product diffrenciation
– Few companies form the industry
– Pe depends on demand of the product
– Information cost as imperfect knowledge
Ex; TV, Automobiles etc
• Duopoly
– Two players in the market with different products
– Pe depends on demand of the product
– Information cost as imperfect knowledge

– MONOPOLISTIC OMP
– Few Firms , each having monopoly tendency
– Diff Products
– Size of the firms vary
– Pe is large
– Ex: Resturants , beauty parlours
• Bilateral Monopoly
– One Buyer and One Seller
– Tailor made products
– Overdependence on each other

– MONOPSONY
– Many Sellers and one Buyer
– Buyer Dedicates the price
 Equilibrium in Perfect
Competition
• In the Short Run (Identical Cost)
– Supernormal Profits
– Normal Profits
– Losses
– Concept of Shut Down Point
– Long Run (MC is the Supply Curve)

Perfect Competition with Differential Cost

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

MC

AC

AR
MR
 Degree of Monopoly
• In Perfect Competition AR =MC in
equilibrium but in Monopoly it is different
• MR will lie below the AR
• Slope is based of Elasticity
• Higher the Elasticity Lower the Degree of
Monopoly
• Inverse Relation called the Lerner Index
(lies between 0-1)
• Perfectly Competition Lerner Index is 0
 Discriminating Monopoly
• Sir Pigou
• Same Product sold at Different Prices
• Ist degree: Buyer forced to pay the max price
for the willingness to pay (Doctors)
• Second Degree: Diff prices for diff
groups(Frequent Flyers)
• Third Degree: Seller breaks market into sub
markets (Cinema Halls, Rentals)
• Aggregate MC and Aggregate MR, MR in all
markets are equal
 Monopolistic Competition
• Equilibrium Making Profit / Loss
• Group equilibrium
• Optimal Advertising Cost
• Excess Capacity under monopolistic
Competition
 OLIGOPOLY
• Non Collusive : No Explicit agreement
– Cournot
– Edgeworth
– Bertand
– Stackberg
• Collusive : Formal Agreement
• Carlets
• Price Leaership
• Market Share model
Kinky Demand Curve
D

P
MC

T
D

N R