Consumer Behaviour and Demand

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Consumer Behaviour and Demand

• Consumer Behaviour
• 1. Human wants
• 2. Consumption
• 3. Consumers equilibrium (Various Utility
  concepts)
• B. Demand
• 1. Concept
• 2. Factors affecting demand
• 3. Law of demand
• 4. Elasticity of Demand

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Human Wants

• Goods are priced because of their usefulness
  Usefulness leads to the demand while scarcity
  leads to its supply. Therefore the interaction of
  demand and supply is the point where the prices
  of goods is determined.
• Human Wants The basis of all economic
  activities is the existence of human wants and
  the process of fulfillment of this want is where
  all economics activities start.
• Definition of Human Want
• . Desire is the wish to have something. But
  want is an effective desire for a particular
  thing, which can be satisfied by making an effort
  to acquire it.

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Human Wants

• Three elements that make a desire, an effective
  desire or a want
• (i) willingness
• (ii) resources for fulfilling the desire and
• (iii) willingness to part with the resource to
  fulfill that desire
• In other words its is want-effort-satisfaction
  which forms the subject matter of economics

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Features of Human Wants

• Classification of Human Wants necessaries,
  comfort and luxuries.
• Features
• 1. Unlimited Wants
• 2. Some wants are complementary
• 3. A single want is satiable
• 4. Substitutability of Wants
• 5. Wants are competitive
• 6. Wants multiply
• 7. Wants re-occur
• 8. Some wants can be postponed
• 9. Wants differ in urgency and intensity

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Economic Significance of Human Wants

• 1 The material prosperity of a country can be
  gauged from the number and variety of human wants
  normally satisfied.
• 2 Shows important features which are the basis of
  important laws in Economics Laws of diminishing
  return, law of M.L. and law of substitution

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Consumption

• Goods and services need to be consumed in order
  to satisfy human wants. Consumption is registered
  the beginning as well as the end of all economic
  activities.
• Definition/Meaning of Consumption Consumption
  means the use of goods and services in satisfying
  human wants.
• Kinds a. Final b. Productive c. Quick or fast
  moving
• d.slow
• Importance of Consumption
• Importance to the Government
• Importance to Businessman
• Importance to Household
• Importance to Society

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Utility

• Utility refers to want satisfying power of a
  commodity.
• In objective terms, utility may be defined as the
  amount of satisfaction derived from a commodity
  or service at a particular time.
• Assumptions
• Utility can be measured.
• Marginal Utility of money remains constant
• No change in income of the consumer, his taste
  fashion to be constant
• No substitute
• Independent marginal utility of each unit of
  commodity

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Utility

• Characteristics
• Utility is subjective/not measurable
• Utility is variable
• Utility is different from usefulness
• No legal or moral connotations

Marginal Utility (MU)
The word Marginal means Border or Edge. It
is the addition made to the total utility by
consuming one more unit of a commodity.
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Utility

• Total Utility (TU)
• Total Utility refers to the total satisfaction
  derived by the consumer from the consumption of a
  given quantity of a good.
• TU Sum of all MU
• The exponents of the utility analysis have
  developed two laws which occupy a very important
  place in economics theory and they are -
• Law of Diminishing Marginal Utility
• Law of Equi-Marginal Utility

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Law of Diminishing Marginal Utility

• Though wants of an individual are unlimited in
  number yet each individual want is satiable.
  Because of this, the more we have a commodity,
  the less we want to have more of it.
• This law state that as the amount consumed of a
  commodity increases, the utility derived by the
  consumer from the additional units, i.e marginal
  utility goes on decreasing.
• According to Marshall, The additional benefit a
  person derives from a given increase of his stock
  of a thing diminishes with every increase in the
  stock that he already has

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Law of Diminishing Marginal Utility

• Explanation
• As more and more quantity of a commodity is
  consumed, the intensity if desire decreases and
  also the utility derived from the additional
  unit.
• Assumptions
• All the units of a commodity must be same in all
  respects
• The unit of the good must be standard
• There should be no change in taste during the
  process of consumption
• There must be continuity in consumption
• There should be no change in the price of the
  substitute goods

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Law of Diminishing Marginal Utility

• Exceptions
• Money
• Hobbies and Rare Things
• Liquor and Music
• Things of Display

• Importance
• Basis of Law of Demand
• Basis of Consumption Expenditure
• The basis of Progressive Taxation

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Consumers Equilibrium

• Consumer will attain its equilibrium (maximum
  satisfaction) at the point, where marginal
  utility of a product divided by the marginal
  utility of a rupee, is equal to the price.
• Consumers equilibrium Marginal utility of a
  product
• Marginal utility of a rupee
• its price
• Steps
• Generation of alternatives
• Evaluation of alternatives
• Choice of the best alternative
• Assumptions
• Consumer behaviour is rational.
• Consumer behaviour is consistent.
• There are two commodities in consideration.

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Law of Equi-Marginal Utility

• This law states that the consumer maximizing his
  total utility will allocate his income among
  various commodities in such a way that his
  marginal utility of the last rupee spent on each
  commodity is equal.
• Or
• The consumer will spend his money income on
  different goods in such a way that marginal
  utility of each good is proportional to its price

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Limitations of Law of Equi-Marginal Utility

• It is difficult for the consumer to know the
  marginal utilities from different commodities
  because utility cannot be measured.
• Consumer are ignorant and therefore are not in
  a position to arrive at an equilibrium.
• It does not apply to indivisible and
  inexpensive commodity.

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Consumer Surplus

• According to Marshall Consumer Surplus is
  defined as the excess of the price which a
  person would be willing to pay rather than go
  without the thing over that which he actually
  does have to pay.
• This excess of satisfaction is called Consumer
  satisfaction and hence Consumer Surplus.
• Consumer Surplus Total Utility (Mkt. Price
  No. of units consumed)
• T.U ( P N)
• Criticisms
• A Vague Idea
• Too many assumptions
• Applicable to a small number of cases only
• Neglects the income effect of the price change.
• Not applicable to highly superior Giffen goods

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Demand

• Meaning and Definition of Demand
• According to Benham The demand for anything, at
  a given price, is the amount of it, which will be
  bought per unit of time, at that price.
• According to Bobber, By demand we mean the
  various quantities of a given commodity or
  service which consumers would buy in one market
  in a given period of time at various prices.
• Requisites
• Desire for specific commodity.
• Sufficient resources to purchase the desired
  commodity.
• Willingness to spend the resources.
• Availability of the commodity at
• (i) Certain price (ii) Certain place (iii)
  Certain time.

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Kinds of Demand

• Individual demand
• Market demand
• Income demand
• Demand for normal goods (price ve, income ve)
• Demand for inferior goods (eg., coarse grain)
• 4. Cross demand
• Demand for substitutes or competitive goods
  (eg.,tea coffee, bread and rice)
• Demand for complementary goods (eg., pen ink)
• 5. Joint demand (same as complementary, eg., pen
  ink)
• 6. Composite demand (eg., coal electricity)
• 7. Direct demand (eg., ice-creams)
• 8. Derived demand (eg., TV TV mechanics)
• 9. Competitive demand (eg., desi ghee and
  vegetable oils)
• 10.Demand of unrelated goods

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Factors Determining Demand

• (i) Price of the commodity Normally there is an
  inverse relationship between the price of the
  commodity and the quantity demanded. (Px)
• (ii) Income of the Consumer Determines the
  purchasing power of the consumer. Generally,
  there is a direct relationship between the income
  of the consumer and demand. (Y)
• (iii) Consumers taste and preference (T)
• (iv) Price of related commodities (Pr)
• (v) Consumer Expectation (expected change in
  price)
• (v) Distribution of income
• (vi) Size and composition of population
• (vii) Other Factors e.g., natural calamities
• Qdx f (Px, Pr ,Y , T, D)

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Demand Schedule

• Demand Schedule a tabular presentation showing
  different quantities of a commodity that would be
  demanded at different prices.
• Types of Demand Schedules

Individual Demand Schedule
Market Demand Schedule
Shows the various commodities that would be
purchased at different prices by all the buyers
of that commodity. It is composed of the demand
schedules of all the individuals purchasing that
commodity.
Shows various quantities of a commodity that
would be purchased at different prices by a
household.
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Demand Curve

• Demand Curves A demand curve is a graphical
  depiction of the law of demand. The picturization
  or the plotting of the demand schedule is called
  the demand curve. It is the curve showing
  different quantities demanded at alternative
  prices.

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Demand Curve

• The demand curve slopes downwards from left to
  right which indicates that there is an inverse
  relationship between price and quantity demanded.
• Demand Schedules for Apples
• Price/kg Demand-A Demand-B Market(AB)
• 30 4 3 7
• 25 6 5 11
• 20 9 8 17
• 15 13 12 25
• 10 17 15 32

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Demand Curve

• Movement along demand curve Vs. Shift in demand
  curve
• Distinction between change in quantity demanded
  and change in demand.
• A. Change in quantity demanded When quantity
  demanded changes ( rise or fall ) as a result of
  change in price alone, other factors remaining
  the same.
• Contraction/fall in quantity demanded
• Extension/Rise in quantity demanded

The change is depicted/ represented by the
movement up or down on a given demand curve. This
does not require drawing a new demand curve.
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Demand Curve

• B. Change in demand When the amount purchased
  of a commodity rises or falls because of the
  change in factors other than the price of the
  commodity. It is called change in demand.
• Types of Changes

Increase in demand.
Decrease in demand
This requires drawing altogether a new demand
curve. Two extremes of demand are vertical
horizontal demand curves, which represents
perfectly inelastic demand (ED zero) and
horizontal demand curve which shows perfectly
elastic demand (ED infinity)
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Demand Curve

• Why does the demand curve Slope Downwards to
  the Right?
• Income Effect An increase in demand on account
  of increase in real income is known as income
  effect.
• Substitution Effect
• Increase in number of consumers
• Several uses of commodity

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Law of Demand

• Prof. Samuelson Law of demand states that
  people will buy more at lower price and buy less
  at higher prices, others thing remaining the
  same.
• Ferguson According to the law of demand, the
  quantity demanded varies inversely with price.
• Assumptions
• No change in tastes and preference of the
  consumers.
• Consumers income must remain the same.
• The price of the related commodities should not
  change.
• The commodity should be a normal commodity

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Law of Demand

• Exceptions
• Inferior goods
• Articles of snob appeal.
• Expectation regarding future prices
• Emergencies
• Quality-price relationship
• Conspicuous necessities.
• Ignorance
• Change in fashion, habits, attitudes, etc..
• Importance
• Price determination.
• To Finance Minister
• To farmers
• In the field of Planning.

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Elasticity of Demand

• Till now we were concerned with the direction of
  the changes in price and quantities demanded. But
  here we will answer the question By how much.
  Observe the following
• As a result of a fall in the price of radios
  from Rs. 500 to Rs 400, the quantity demanded
  increases from 100 radios to 150 radios.
• As a result of a fall in the price of wheat from
  Rs 10 Kilograms to Rs 9 Per Kilograms the demand
  increases from 500 Kilograms to 520 Kilograms.
• In all the above cases we can notice that all
  respond to price changes. But the difference in
  all the cases lies in the degree of response of
  demand and this can be found by comparing the
  percentage change in prices and quantities
  demanded. This is where the concept of elasticity
  comes in.

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Factors affecting Elasticity of Demand

• Availability of substitutes
• Postponement of consumption
• Proportion of expenditure (needles inelastic
  TV elastic)
• Nature of the commodity (necessity vs. luxury)
• Different uses of the commodity (paper vs. ink)
• Time period (elastic in the long term)
• Change in income (necessaries inelastic)
• Habits
• Joint demand
• Distribution of income
• Price level (very costly very cheap goods
  inelastic)

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Elasticity of Demand

• Definition Elasticity of demand is defined as
  the responsiveness of the quantity demanded of a
  good to changes in one of the variables on which
  demand depends.
• These variables are price of the commodity,
  prices of the related commodities, income of the
  consumer other various factors on which demand
  depends. Thus, we have Price Elasticity, Cross
  Elasticity, Elasticity of Substitution Income
  Elasticity. It is always price elasticity of
  demand which is referred to as elasticity of
  demand
• A.Price Elasticity
• Measures how much the quantity demanded of a
  good changes when its price changes.
• Or
• It may be defined as Percentage Change in
  Quantity demanded over percentage change in
  price

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Price Elasticity

• Price Elasticity
• Elastic Demand or more than 1 When quantity
  demanded responds greatly to price changes
• Inelastic Demand or less than 1 When quantity
  demanded responds little to price changes.
• Unitary Elastic When quantity demanded responds
  equally to the price changes.
• Perfectly inelastic or 0 elastic demand
• Perfectly elastic or infinite elastic demand
• Economic factors determine the size of price
  elasticity for individual goods. Elasticity tends
  to be higher when the goods are luxuries, when
  substitutes are available and when consumer have
  more time to adjust their behavior.

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Calculating Price Elasticity

• PED Change in Qty Demanded
• Change in Price
• Points to Remember
• We drop the minus sign from the numbers by
  treating all changes as positive. That means
  all elasticitys are positive, even though prices
  and quantities move in the opposite direction
  because of the law of downward sloping demand.
• Definition of elasticity uses percentage changes
  in price and demand rather than actual changes.
  That means that a change in the units of
  measurement does not affect the elasticity. So
  whether we measure price in Rupees or paisa, the
  price elasticity stays the same.

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• Generally, above mid-point M of any straight
  line, demand is elastic, with ED gt1. At Midpoint,
  demand is unit-elastic, with ED 1, Below the
  midpoint, demand is inelastic, with EDlt1
  (Geometric point method)

EDgt1
ED1
EDlt1
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Elasticity Revenue

• When demand is price inelastic, a price decrease
  reduces total revenue.
• When demand is price elastic, a price decrease
  increases total revenue.
• In the borderline case of unit elastic demand, a
  price decrease leads to no change in the total
  revenue
• B. Income Elasticity of Demand Is the degree of
  responsiveness of quantity demanded of a good to
  a small change in the income of the consumer.
• If the proportion of income spent on a good
  remains the same as income increases, then income
  elasticity for the good is equal to one.
• If the proportion spent on a good increases, then
  the income elasticity for the good is greater
  than one.
• If the proportion decreases as income rises,
  then income elasticity for the good is less than
  one.

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Elasticity of Demand

• C. Cross Elasticity A change in the demand for
  one good in response to a change in the price of
  another good represents cross elasticity of
  demand of the former good for the latter good.
• If two goods are perfect substitutes for each
  other cross elasticity is infinite and if the two
  goods are totally unrelated, cross elasticity
  between them is zero.
• Goods between which cross elasticity is positive
  can be called Substitutes, the good between which
  the cross elasticity is negative are not always
  complementary as this is found when the income
  effect on the price change is very strong.

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Elasticity of Demand

• D.Elasticity of Substitution Measures the ease
  with which one good can be substituted for
  another.
• If two goods are perfect substitutes elasticity
  of substitution will be infinite.
• If two goods are to be used in fixed proportion
  elasticity of substitution will be zero
• When it is difficult to substitute one good for
  another, then in that case elasticity will be
  lying between zero infinity.

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Methods of measurement of Elasticity

• Percentage or Proportionate Method
• Percentage change in demand or
• Percentage change in price
• Proportionate change in demand
• Proportionate change in price
• 2. Total Outlay (Expenditure) Methods
• TOTQ P where,
• TOtotal outlay TQtotal quantity Pprice of
  the commodity
• 3. Geometric (Point) method at any given point
  on the curve
• lower segment of demand curve
• upper segment of demand curve