Microeconomics

Class - XI
Consumer's Equilibrium and Demand – Notes

Who is a consumer?
The person who takes decisions about what to buy for the satisfaction of wants both as an individual
and as a member of a household is called a consumer.
A rational consumer
A consumer who seeks to maximize utility or satisfaction by spending his income on goods and
services is a rational consumer.
Meaning of Utility
Utility refers to the satisfaction, actual or expected, derived from consumption of a good. Utility
differs from person-to-person, place-to-place and time-to-time.
Total Utility (TU)
Total utility refers to the total satisfaction obtained from the consumption of all possible units of
a commodity.
It measures the total satisfaction obtained from consumption of all the units of that good.
TU = U1 +U2 + U3 +………..UN where U1 is the utility derived from the
first unit of the good, U2 from the second,
U3 from the third and so on.
Marginal Utility (MU)
Marginal utility is the additions to total utility when one more unit of the commodity is
consumed. It is the utility derived from the last unit of a commodity consumed.

TU = MU1 + MU2 + MU3+…….+ MUN TU =𝜮MU MUN = TUN - TUN-1

MU is the rate of change in TU when one more unit is consumed or MU = ∆TU/∆Q  Area
under the MU curve is TU

Law of Diminishing Marginal Utility

Law of Diminishing Marginal Utility states that as the consumer consumes more and more units of
a commodity the additions to total utility (i.e marginal utility) derived from each successive unit
consumed keeps on decreasing.

Assumptions of Law of Diminishing Marginal Utility

1. Cardinal utility: It is assumed that utility or satisfaction can be measured cardinally and
expressed in quantitative terms i.e. in utils.
2. It is assumed that consumption is a continuous process.
3. The consumer is rational.
4. Income and prices of the goods remain unchanged during the period of consumption.

Utility Schedule
Units of X good Marginal Utility from X (Utils)
1 10
2 8
3 7
4 5
5 3
6 0
1
 7 -1
The marginal utility from each unit of X keeps on declining as the consumer increases his
consumption from 1 unit to 7 units. MU is falling but positive from 1st unit till the 5th unit. At the 6th
unit the additions to total utility (MU) is zero. After the 6th unit, there is negative utility or disutility
from any more units consumed.

Relation Between Total Utility (TU) and Marginal Utility (MU)

Units of Ice Marginal Utility Total Utility

Cream (Utils) (Utils)
1 20 20
2 17 37
3 10 47
4 6 53
5 0 53
6 -5 48

TU max.

TU falls
• When MU decreases but is positive, TU increases
TU increases at decreasing rate. (From 0 till the 4th unit)
at decreasing
rate
• When MU becomes zero, TU is
maximum.(at the 5th unit) This is called the
Point of Satiety
MU falls
but > 0
• When MU decreases and is negative, TU
Point of Satiety falls. (after the 5th unit)
MU =0

Consumer’s equilibrium – It refers to a situation when a consumer spends his income on the
purchase of a good (or combination of goods) in such a way that gives him maximum satisfaction
and he feels no urge to change.

Utility or Cardinal approach (It is assumed that utility or satisfaction can be measured cardinally
and expressed in quantitative terms i.e. in utils.)

Conditions for consumer’s equilibrium Assumptions:

1. The consumer is rational.
2. It is assumed that utility or satisfaction can be measured and expressed in quantitative terms
i.e. in utils.
3. Price of the good and income of the consumer is fixed.

• Single good case : When the consumer consumes only one good X. Condition 1:
MUx = Px

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 (Marginal utility of X in terms of money equals price of the good X)
Case 1: If MUx > Px then Marginal utility in terms of money is greater than the price of the good.
• Benefit received from the last unit consumed is more than cost for that unit, hence the
consumer will consume more of good X.
• As he consumes more of X, MUx declines (due to Law of DMU).
• This continues till MUx = Px and equilibrium is attained.

Case 2: If MUx < Px then Marginal utility in terms of money is less than the price of the good.
• Benefit received from the last unit consumed is less than cost for that unit, hence, the
consumer will consume less of good X.
• As he consumes less of X, MUx rises (due to Law of DMU).
• This continues till MUx = Px and equilibrium is attained.

Condition 2: Law of Diminishing Marginal Utility should hold true.

• Two goods case : When the consumer consumes two goods X and Y
(Law of equi-marginal utility)

MUx = MUy
Condition 1: Px Py

(MU from last rupee spent on X equals MU from last rupee spent on of Y)

Case 1: If MUx > MUy

Px Py

It means MU from last rupee spent on X is greater than MU from last rupee spent on Y.
• The consumer prefers good X to good Y.
• He will consume more of X and less of Y since income and prices are fixed.
• Due to Law of Diminishing Marginal Utility, MUx falls and MUy rises.
• This continues till MUx = MUy and equilibrium is restored.
Px Py

Case 2: If MUx < MUy

Px Py

It means MU from last rupee spent on X is less than MU from last rupee spent on Y.
• The consumer prefers good Y to good X.
• He will consume less of X and more of Y since income and prices are fixed.
• Due to Law of Diminishing Marginal Utility, MUx rises and MUy falls.
• This continues till MUx = MUy and equilibrium is restored.
Px Py

Condition 2: Law of Diminishing Marginal Utility should hold true.

If it does not hold true and MUx > MUy, then the consumer will end up spending all his income
Px Py
only on one good X and none on Y which is unrealistic and breaks the two-good assumption.

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Cardinal Utility Vs Ordinal Utility
1. Under cardinal utility approach, it is assumed that utility can be measured in cardinal or
quantitative terms. According to ordinal approach, utility cannot be measured, and we can
just rank the consumer’s preferences.
2. Under cardinal approach, the term ‘util’ was developed as a unit to measure utility, whereas
no such unit of measurement was developed under ordinal approach.
Indiffference Curve Approach or Ordinal Approach
(It is based on the assumption that the consumer can rank his preferences)
Indifference Curve
It is a graphical representation of various combinations of bundles of two goods among which the
consumer is indifferent or which give the same level of satisfaction to the consumer.

Indifference Schedule Indifference Curve

Marginal Rate of Substitution (MRS)- (Slope of indifference curve)

MRS is the rate at which the consumer is willing to sacrifice one good in order get an additional
unit of the other good without affecting total utility.

MRS = Change in the quantity of the good sacrificed = ΔY

Change in the quantity of the good obtained ΔX

Marginal Rate of Substitution

Combination Good X Good Y MRS

A 1 12 -
B 2 8 (-) 4/1
C 3 5 (-) 3/1
D 4 3 (-) 2/1
E 5 2 (-) 1/1
In the above given schedule:
1) The combinations of good X and good Y (A to E) give the same level of satisfaction to the
consumer. Hence, he is indifferent between the five combinations.
2) As he moves from combination A to B, he is willing to sacrifice 4 units of Y for an additional
unit of X.
3) Further as he moves from B to C, he is willing to sacrifice less of Y (3 units) for an additional
unit of X.
4) Similarly, the rate of sacrifice of Y (MRS) goes on declining because as he consumes more and
more units of X, his marginal utility from X starts declining (due to the Law of DMU), hence is
willing to sacrifice less and less of Y for an additional unit of X. This rate of sacrifice of Y for
obtaining an additional unit of X is called Marginal Rate of Substitution which declines as we
move down along an indifference curve.

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 If we have more and more of good X our desire to
have more good X will diminish and we will
forego less and less of good Y for good X
(MRSxy) =Δy/Δx

We can see as the consumer slides down Δy becomes

shorter and shorter while Δx is same.

Assumptions of indifference curves

• Two Commodities: It is assumed that the consumer has a fixed amount of income, whole of
which is to be spent on the two goods X and Y, given constant prices of both the goods.
• Non-Satiety: It is assumed that the consumer has not reached the point of saturation.
Consumer always prefers more of both commodities and higher consumption means higher
level of utility.
• Ordinal Utility: Consumer can rank his preferences on the basis of the satisfaction from each
bundle of goods.
• Diminishing MRS: Indifference curve analysis assumes diminishing marginal rate of
substitution. Due to this assumption, an indifference curve is strictly convex to the origin.
• Rational Consumer: The consumer is assumed to behave in a rational manner, i.e. he aims to
maximise his satisfaction.

Properties of indifference curves

1. Downward sloping left to right
In order to obtain more of one good (X), some quantity of the other good (Y) has to be
sacrificed to remain at the same level of satisfaction or utility.

2. Strictly convex to the origin

It is due to decreasing MRS (slope of IC). As a consumer consumes more and more units of
one good (X), the satisfaction obtained from each successive unit keeps on declining due to the
Law of Diminishing Marginal Utility , hence, he is willing to give up lesser and lesser units of
the other good (Y) in order to obtain an additional unit of X.

3. Higher indifference curve represents higher level of utility It

is due to monotonic preferences of the consumer.
Monotonic preference means that between any two bundles of two goods, the consumer prefers
the bundle which has more of at least one of the goods and no less of the other good as
compared to the other bundle.
Higher indifference curves represent bundles with more quantities of goods and higher
consumption means higher level of utility or satisfaction.

Indifference Map
Indifference map refers to the family of indifference
curves that represent consumer preferences over all the
bundles of two goods at different levels of satisfaction.

In the given diagram, the satisfaction derived from IC3

is the highest, followed by IC2 and then IC1.

(i.e IC 3> IC2 > IC1)

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Budget Line: It is a graphical representation of all possible combinations of two goods X and Y that
the consumer can buy given income and prices, which costs the consumer exactly his income.

Px.X + Py.Y = M Where Px and Py are prices of goods X and Y respectively

and M is the income of the consumer.

Slope of Budget Line (Market Rate of Exchange): It is the rate at which the consumer has to
sacrifice units of good Y to buy an additional unit of good X. MRE = (ΔY/ ΔX)
It is the ratio of prices of the two goods (X and Y) to be exchanged in the market (-) Px/Py

Px/Py is constant since prices are constant so the budget line is a straight line.

Determinants of Budget Line : Px, Py and M (prices of commodities and income of the consumer)

Budget Set – It is a set of different combinations of two goods X and Y that the consumer can
afford to buy, given income and prices of the goods.

Px.X + Py.Y ≤ M also referred to as Budget

Constraint

Properties of Budget Line

a) Downward sloping : To buy more of one good, some of the other good has to be sacrificed
since income is constant.
b) Straight Line: The slope of budget line is Px/Py which is constant as prices are constant so the
budget line is a straight line. Therefore, the market rate of exchange (i.e. Px/Py) between the two
goods remains constant

Shifts in Budget line: The budget line shifts parallel outwards or inwards if income level changes.
(No change in slope); slope changes due to change in Px/Py. Budget Line shifts due to changes in Px,
Py, M or all three.

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  There is a parallel shift
rightwards of the Budget
Line in case of increase in
income keeping prices
constant. Fig (a)

 There is a parallel shift

leftwards in case of a
decrease in income of the
consumer
constant. Fig (b) keeping
(Only income changes - Slope remains the same)
prices

 The Budget Line rotates

rightwards in case of a
decrease in price of good X
keeping price of good Y and
income constant. Fig (a)

 The Budget Line rotates

leftwards in case of an
increase in price of good X
keeping price of good Y and
income constant. Fig (b)

(Only price of X changes -

Slope changes)
 The Budget Line rotates
upwards in case of a
decrease in price of good Y
keeping price of good X and
income constant. Fig (a)

 The Budget Line rotates

income constant. Fig (b)

(a) (b)

downwards in case of an
increase in price of good Y
keeping price of good X and

(Only price of Y changes - Slope changes)

Consumer’s equilibrium – Ordinal / Indifference Curve Approach (Hicksian approach)

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Condition 1: MRS = Px / Py

Slope of IC = Slope of Budget Line

(The rate at which the consumer is willing to sacrifice units of Y for obtaining an additional unit
of X equals the market requirement i.e ratio of prices of X and Y)

Case1: If MRS > Px / Py

It means that the consumer is willing to sacrifice more units of good Y for obtaining an
additional unit of good X than what the market requires (price ratio).
• He values good X more than the market and consumes more of it.
• As he consumes more of good X and less of good Y, MRS declines.
• This continues till MRS = Px/ Py and equilibrium is restored.

Case 2: If MRS < Px / Py

It means that the consumer is willing to sacrifice less units of good Y for obtaining an
additional unit of good X than what the market requires (price ratio).
• He values good X less than the market and consumes less of it.
• As he consumes less of good X and more of good Y, MRS rises.
• This continues till MRS = Px/ Py and equilibrium is restored.

Condition 2: Indifference curves are strictly convex to the origin (MRS declines along the IC) to
avoid flat spots and have a unique equilibrium.

• IC1, IC2 and IC3 are the three indifference curves

and AB is the budget line.
• Point C & D lie on a lower indifference curve
(IC1) indicating a lower level of satisfaction.
H • Point H lies on a higher indifference curve (IC3) is
desirable due to higher utility but is unattainable.

The budget line is tangent to indifference curve IC2 at

point 'E' where MRS = Px/Py.
(Slope of IC = Slope of Budget Line).

‘E’ is the point of

consumer’s equilibrium,
where the consumer purchases OQx quantity of
'X' and OQy quantity of 'Y'.
Therefore, Point E, point of tangency between the budget line and IC2 is the consumer’s
equilibrium (MRS = Px/ Py ) where the consumer maximizes his satisfaction.
DEMAND

Demand: It refers to the quantity of a commodity that a consumer (or group of consumers taken
together) are willing and able to buy at a particular price during a given period of time.

Individual Demand Market Demand

It refers to the quantity of a good that a It refers to the quantity of a good that all consumer is
willing and able to buy at a given consumers taken together are willing and able price during a given
period of time. to buy at a given price during a given period of time.
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 Demand Function
It gives the functional relationship between demand for a good and the factors affecting demand.

Where P is the own price of the good

Dx = f(P, P r, I, T &P , E) Pr is the price
of related goods
I is the income of the consumer
T&P is tastes and preferences of the consumer
E is the expectation of change in price in future
Determinants of demand (individual demand)

1) Own price of the commodity: There exists an inverse relationship between price and quantity
demanded of a commodity keeping all other factors affecting demand constant. It means, as
price increases, quantity demanded falls. For example, If price of given commodity (say, tea)
increases, its quantity demanded will fall . This relation is given by the Law of Demand.
The following determinants are termed as 'other factors' or factors other than own price.

2) Price of related goods: Related goods are the goods in which change in price of one good (say,
x) causes a change in the demand for other good (say, y). Related goods are of two types:

(a) Substitute Goods: Substitute goods are those goods which can be used in place of one
another for satisfaction of a particular want.
• An increase in the price of substitute good makes the given good relatively cheaper in
comparison to its substitute and so leads to an increase in the demand for given good.
• A decrease in the price of substitute good makes the given good relatively costlier in
comparison to its substitute and so leads to a decrease in the demand for given good.
For example: If price of a substitute good (say, coffee) increases, then demand for given
good (say, tea) will rise as tea will become relatively cheaper in comparison to coffee. So,
demand for a given good is directly affected by change in price of substitute goods. Hence
, there is a direct relationship between the price of substitute good and demand for the
given good.
(b) Complementary Goods: Complementary goods are those goods which are used jointly to
satisfy a particular want.
• An increase in the price of complementary good makes the joint consumption of the
given good with the complementary good costlier which leads to a decrease in the
demand for the given good.
• A decrease in the price of complementary good makes the joint consumption of the
given good with the complementary good cheaper which leads to an increase in the
demand for the given good.
For example: If price of a complementary good (say, sugar) increases, then demand for
given good (say, tea) will fall as it will be relatively costlier to use both the goods together.
Hence , there is an inverse relationship between the price of complementary good and
demand for the given good.

3) Income of the consumer: The effect of change in income on demand depends on the nature of
the commodity under consideration.

(a) Normal Good: Normal goods refer to those goods whose demand increases with increase in
income (or whose demand decreases with decrease in income) of the consumer.

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 • There is a direct relationship between income of the consumer and demand for the
normal good. For example: If with an increase in income of the consumer, demand for
wheat rises, it is a normal good for the consumer.

(b) Inferior Good: Inferior goods refer to those goods whose demand decreases with increase
in income (or whose demand increases with decrease in income) of the consumer.
• There is an inverse relationship between income of the consumer and demand for the
inferior good. For example: If with an increase in income of the consumer, demand for
Bajra falls, it is an inferior good for the consumer.

4) Tastes and preferences: Tastes and preferences of the consumer directly influence the demand
for a commodity. They include changes in fashion, customs, habits, etc.
• If there is a favourable change in tastes and preferences, then the demand for such a
commodity rises.
• On the other hand, demand for a commodity falls, if there is an unfavourable change in
tastes and preferences for the commodity.

5) Expectation of change in price in future: If the price of a good is expected to rise in future,
people will buy more of the good in the current period. For example: If price of petrol is
expected to rise in future, its present demand will increase.

Determinants of market demand

Market demand is influenced by all the factors affecting individual demand for a commodity. In
addition, it is also affected by the following factors:

(a) Size and Composition of Population: Market demand for a commodity is affected by size of
population in the country. An increase in population raises the market demand, while a
decrease in population reduces the market demand for a commodity. Composition of
population, i.e. ratio of males, females, children and number of old people in the population
also affects the demand for a commodity. For example: If a market has larger proportion of
women, then there will be greater demand for articles of use for women such as women’s
clothes, cosmetics etc.
(b) Distribution of Income: If income distribution is in favour of the rich, there will be more
demand for luxuries while if the income distribution is in favour of the poor, necessities would
be demanded more.

Law of Demand
The law of demand states that there is an inverse relationship between change in price of a good and
the consequent change in quantity demanded for that good, keeping all other factors affecting
demand constant (ceteris paribus).
‘Other factors’ refer to the income of the consumer, price of related goods (prices of substitute and
complementary goods) and consumer’s tastes and preferences.
Reason behind the Law of Demand
Law of Diminishing Marginal Utility – Since the marginal utility declines as a consumer consumes
more units of a good, he will be willing to pay a price equal to the marginal utility derived from that
unit of good. (MUx = Px). Thus, he will demand more units only at a lower price.
Proving the Law of Demand using Utility Approach

Single good case:

Equilibrium condition: : MUx = Px

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Now if the price of X falls,
Then, MUx > Px i.e. Marginal utility in terms of money is greater than the price of the good.
• Benefit received from the last unit consumed is more than cost for that unit, hence the
consumer will consume more of good X.
• As he consumes more of X, MUx declines (due to Law of DMU).
• This continues till MUx = Px and equilibrium is attained.
Conversely, if the price of X rises, less of X is demanded.

Hence, as price falls, more of X is demanded showing an inverse relationship between price
and quantity demanded of a commodity which proves the Law of Demand

Two goods case:

Equilibrium condition: MUx = MUy
Px Py
(MU from last rupee spent on X equals MU from last rupee spent on of Y)

Now if the price of X falls: MUx > MUy

Px Py
It means MU from last rupee spent on X is greater than MU from last rupee spent on Y.
• The consumer prefers X to Y.
• He will consume more of X and less of Y since income and prices are fixed.
• Due to Law of Diminishing Marginal Utility, MUx falls and MUy rises.
• This continues till MUx = MUy and equilibrium is restored.
Px Py
Conversely, if the price of X rises, less of X is demanded.

Hence, as price falls, more of X is demanded showing an inverse relationship between price
and quantity demanded of a commodity which proves the Law of Demand

Demand Schedule and Demand Curve

Individual demand schedule

It is a table showing various quantities of a commodity that a consumer is willing and able to buy at
different prices during a given period of time assuming no change in other factors affecting
demand.

Individual demand curve

It is graphical representation of the individual demand schedule such that each point on the curve
shows the quantity of a good that an individual consumer is willing and able to buy at a given price
during a given period of time assuming no change in other factors affecting demand.

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 700
Price of Coffee Quantity (kg)
600 (` per kg)

P2 Q2
500 700 30
P1 Q1

600 40
P3
Q3
500 50 30
40 50

Individual Demand Curve Individual Demand Schedule

As price falls from ` 600 to ` 500, quantity demanded rises from 40 units to 50 units. As price rises
from ` 600 to ` 700, quantity demanded falls from 40 units to 30 units. This shows an inverse
relationship between price and quantity demanded of a commodity keeping all other factors
constant.

Market demand schedule

Market demand schedule refers to a table showing various quantities of a commodity that all the
consumers taken together are willing and able to buy at different prices, during a given period of
time assuming no change in other factors affecting demand.
It is the sum of demand schedules of all individual consumers of a commodity at each price.
Price (`) Quantity demanded by A Quantity demanded by B Market Demand
QA (units) QB (units) Qm = QA + QB (units)
1 25 30 25+30 = 55
2 20 25 20+25 = 45
3 15 20 15+20 = 35
4 10 15 10+15 = 25
5 5 10 5+10= 15
Market demand curve
It is graphical representation of the market demand schedule such that each point on the curve
shows the quantity of a good that all consumers taken together are willing and able to buy at a given
price during a given period of time. It is a horizontal summation of individual demand curves.

In the diagram given below: At price `3, AB + CD = AD (15+20 =35)

A B C D A D

Market demand curve is flatter than the individual demand curves. It happens because as price
changes, proportionate change in market demand is more than proportionate change in individual
demand.
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Slope of Demand Curve
Slope of a curve is defined as the change in the variable on the Y-axis divided by the change in the
variable on the X-axis. So, the slope of the demand curve equals the Change in Price divided by the
Change in Quantity demanded.

Slope of demand curve = ΔY = ΔP

ΔX ΔQ

• The demand curve is generally downward sloping showing an inverse relationship between price
and quantity demanded of a commodity. So, slope is Negative.

• Slope of the demand curve measures the flatness or steepness of the demand curve.

Movements along the demand curve (Change in quantity demanded)

It refers to a change in quantity demanded of a good caused by a change (increase or decrease) in
own price of the good keeping all other factors affecting demand constant.
Two types of movements:
a) Downward movement (Expansion of Demand )
Expansion of demand refers to a rise in the quantity demanded of a Expansion of Demand
good due to a fall in its own price, keeping all other factors affecting
demand constant. D

• It leads to a downward movement along the same demand curve.

• It is also known as 'Expansion of Demand' or 'Increase in Quantity
Demanded'.
Price (`) Demand
20 100
15 150
When price falls from `20 to `15, quantity demanded rises from 100
units to 150 units , resulting in a downward movement from A to B along the same demand
curve DD.

b) Upward movement (Contraction of Demand )

Contraction of demand refers to a fall in the quantity demanded of a Contraction of Demand
good due to a rise in its own price, keeping all other factors affecting
demand constant.
• It leads to an upward movement along the same demand curve.
• It is also known as 'Contraction of Demand' or 'Decrease in
Quantity Demanded'.
Price (`) Demand
20 100
25 70

When price rises from `20 to `25, quantity demanded falls from 100
units to 70 units , resulting in an upward movement from A to B along the same demand curve
DD.

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Shifts of demand curve (Change in demand)
It refers to a change in demand of a good caused by a change in any of the factors affecting demand
other than own price of the commodity.

Increase in demand Reasons

Rightward shift

(i) Change in price of substitute goods.

(ii) Change in price of complementary goods.
(iii) Change in income of consumers.
(iv) Change in tastes and preferences.
Decrease in
demand (v) Expectation of change in price in future.
Leftward shift

Two types of shift

• Rightward Shift: Increase in demand is shown by rightward shift of demand curve from DD to
DD1. Demand rises from OQ to OQ1 due to a favourable change in any of the other factors
affecting demand, keeping own price of the good constant at OP. More is demanded at the same
price.
• Leftward Shift: Decrease in demand is shown by leftward shift of demand curve from DD to
DD2. Demand falls from OQ to OQ2 due to an unfavourable change in any of the other factors
affecting demand, keeping own price of the good constant at OP. Less is demanded at the same
price.

Movements along the demand curve Vs Shifts of the demand curve

Movements along the demand curve Shifts of the demand curve (change
(change in quantity demanded) in demand)

It refers to a change in quantity demanded of It refers to a change in demand of a good

a good caused by a change (increase or caused by a change in any of the factors
decrease) in own price of the good keeping affecting demand other than own price of the
all other factors affecting demand constant. commodity.

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 Types of movements Types of shifts

a) Downward movement or Expansion of a) Rightward shift or Increase in demand occurs

demand. (due to fall in own price of the due to an increase in the price of substitute
good keeping all other factors affecting good, increase income of the consumer in
demand constant.) case of normal good, decrease in price of
complementary good, decrease in income of
b) Upward movement or Contraction of the consumer in case of inferior good and
demand. (due to rise in own price of the favourable change in tastes and preferences
good keeping all other factors affecting for the good.
demand constant.)
b) Leftward shift or Decrease in demand occurs
due to a decrease in the price of substitute
good, decrease income of the consumer in
case of normal good, increase in price of
complementary good, increase in income of
the consumer in case of inferior good and
unfavourable change in tastes and
preferences for the good.

Change in Quantity Demanded Vs Change in Demand

Change in Quantity Demanded Change in Demand

It refers to a change in the quantity It refers to a change in the demand of a

demanded of a commodity due to a change in commodity due to a change in any of the other
its own price, keeping all other factors factors affecting demand, keeping own price
affecting demand constant. constant.
It leads to a movement along the same It leads to a shift of the demand curve
demand curve. • A rightward shift of the demand curve is due
• A movement upwards along the same to favourable changes in any of the factors
demand curve is due to a rise in price of the affecting demand other than own price.
commodity (known as Contraction in (known as Increase in demand)
demand) keeping all other factors affecting
demand constant.
• A leftward shift of the demand curve is due
• A movement downwards is due to a fall in
to unfavourable changes in any of the factors
price of the commodity (known as
affecting demand other than own price.
Expansion in demand) keeping all other
(known as Decrease in demand)
factors affecting demand constant.
Price Quantity 25, Price Quantity
25 50 20 50 s from
favourable changes
20 70 20 70
) other
15 100 20 100

15
 15, )
• When price rises from `20 to ` quantity • At the same price `20,, demand
demand falls
rise from
demanded falls from 70 to 50 70to 100 units due to
units. Less is demanded at a higher other
in any of the factors affecting demand
price. (Contraction of demand than own price. More is demanded at the Less
same price. (Increase in demand
• When price falls from `20 to ` • At the same price `20 to 50 units due to
quantity demanded rises from 70 to 100 70unfavourable changes
units. More is demanded at a lesser in any of the factors affecting demand
price. (Expansion of demand) than own price. (Decrease in demand) is
demanded at the same price.
Increase in demand
Upward movement Rightward shift
Contraction of demand

Downward
movement
Expansion of demand

Decrease in demand
Leftward shift

O O

• A movement upwards along the same • A rightward shift of the demand curve from
demand curve is due to a rise in own price D to D1 is due to favourable changes in any
of the commodity from OP1 to OP3, keeping of the other factors affecting demand keeping
all other factors affecting demand constant. own price constant at OP.(Increase in
(Contraction in demand from OQ1 to OQ3) demand from OQ to OQ1)
• A movement downwards is due to a fall in • A leftward shift of the demand curve is due
own price of the commodity from OP1 to to unfavourable changes in any of the other
OP2 keeping all other factors affecting factors affecting demand keeping own price
demand constant. (Expansion in demand constant at OP. (Decrease in demand from
from OQ1 to OQ2) OQ to OQ2)
Contraction in Demand (Decrease in Quantity Demanded) Vs Decrease in Demand
Contraction in Demand Decrease in Demand
(Decrease in Quantity Demanded)
It refers to a fall in quantity demanded( of a good
due to an increase in own price, keeping all It refers to a fall in the demand of a commodity
other factors affecting demand constant. caused due to an unfavourable change in any of the
factors affecting demand other than own price of the
commodity.
For example: Due to unfavorable change in the other
factors like decrease in the prices of substitutes.
increase in the prices of complementary goods,
decrease in income of the consumer in case of
normal goods, unfavourable change in tastes and
preferences of the consumer etc.
Price Quantity Price Quantity any of
20 100 20 100 than own price

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 25 70 , quantity 20 70

keeping At the same price

`20, demand falls from 100 to an
When price rises from `20 to `25 demanded 70 units due to of
unfavourable change in
falls from 100 units to 70 units. Less is the good.
the factors affecting demand other
demanded at a higher price all other factors Less is demanded at the same price.
affecting demand constant.
There is an upward movement along the same There is a leftward shift of the demand curve.
demand curve.

The demand curve shifts leftwards from DD to DD1

When price rises from `20 to `25, quantity Demand falls from 100 units to 70 units at the same
demanded falls from 100 to 70 units. It is an price `20 showing a decrease in demand.
upward movement along the same demand
curve (from A to B).

PRICE ELASTICITY OF DEMAND (Ed)

Price elasticity of demand means the degree of responsiveness of demand for a commodity with
reference to a change in its price.

The price elasticity of demand for a good is defined as the percentage change in quantity
demanded for the good divided by the percentage change in its price.

It is a pure number and has no units.

Percentage method for measuring price elasticity of demand

According to this method, elasticity is measured as the ratio of percentage change in the quantity
demanded of a good to percentage change in its price.

Ed = % Change in Quantity Demanded = ∆Q x P

% Change in Price Q ∆P

Where:
1. Change in Quantity (∆Q) = Q1 - Q0.
2. Change in Price (∆P) = P1 - P0
3. Percentage change in Quantity demanded = Change in Quantity (∆Q) x 100
Initial Quantity (Q)
4. Percentage change in Price = Change in Price (∆P) x 100
Initial Price (P)

For example: If price elasticity of demand is (-) 2, it means that one percent fall in price leads to 2
percent rise in demand or one percent rise in price leads to 2 percent fall in demand.

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The value of price elasticity of demand (Ed) is always negative because of the inverse relationship
between change in price and change in quantity demanded.

Degrees of price elasticity of demand

Name Value Remark

1. Perfectly Inelastic Demand Ed = 0 % change in quantity demanded = 0

2. Inelastic Demand Ed < 1 % change in quantity demanded < % change in
price
3. Unit Elastic Demand Ed = 1 % change in quantity demanded = % change in
price
4. Elastic Demand Ed >1 % change in quantity demanded > % change in
price
5. Perfectly Elastic Demand Ed = ∞ There is infinite change in quantity demanded.
Demand curves with same value of price elasticity of demand all along the demand curve

1) Perfectly inelastic demand 2) Perfectly elastic demand 3) Unit elastic demand

O O

When the percentage change When the percentage change in When the percentage change in
in quantity demanded is zero, quantity demanded quantity demanded is equal to
no matter how price is is infinite even if the percentage change in price. In
changed, the demand is said to percentage change in price is a rectangular hyperbola, area
be perfectly inelastic. zero, the demand is said to of rectangles formed under the
be perfectly elastic. Infinite curve are equal i.e expenditure
demand at given price. (PxQ) remains same.

Factors affecting price elasticity of demand

1) Nature of commodity: Elasticity of demand of a commodity is influenced by its nature.
• When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand
is generally inelastic as it is required for human survival and its demand does not change
much with change in its price.
• Luxuries will have more elastic demand as its demand varies greatly with a change in its
price.
• Commodities, which have become habitual necessities for the consumers, have less elastic
or inelastic demand. It happens because such a commodity becomes a necessity for the
consumer and he continues to purchase it even if its price rises. Alcohol, tobacco,
cigarettes, etc. are some examples of habitforming commodities.

2) Number of substitutes : More is the number of substitutes of a good, more is its price elasticity
of demand.

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 • The reason is that even a small rise in its price will induce the buyers to shift the demand to
its substitutes. For example: A rise in the price of Pepsi encourages buyers to buy Coke
and vice-versa.
• Commodities with few or no substitutes like wheat and salt have less elastic or inelastic
demand.

3) Number of uses: More is the number of uses of a good, more is the price elasticity of demand.
• When price of such a commodity increases, its number of uses can be reduced, thus
reducing its demand. When its price falls, the number of uses it is put to, can be increased,
thus increasing its demand.
• For example: Milk can be put to many uses like making cheese, butter, curd, icecreams or
drinking as it is and so on. In case of a rise in price of milk, some of these uses can be cut
down, thereby reducing its demand, while in case of a price fall, it can be put to more
number of uses, thus increasing its demand. Thus, demand for milk is elastic.

4) Income level: Higher is income level more inelastic will be the demand for any commodity.
• It happens because rich people are not affected much by changes in the price of goods. But
poor people with lesser incomes are highly affected by a change in the price of goods as it
will affect their budget significantly. As a result, demand for lower income group is highly
elastic.

5) Proportion of income spent on a commodity : Higher is the proportion of income spent on a

commodity, more will be its price elasticity of demand.
• Demand for goods like salt, needle, soap, matchbox, etc. tends to be inelastic as consumers
spend a very small proportion of their income on such goods. When prices of such goods
change, consumers continue to purchase almost the same quantity of these goods as it does
not affect their budget significantly.
• However, if the proportion of income spent on a commodity is large, then demand for such
a commodity will be elastic as it will affect their budget significantly.

6) Time period: More is the time period, more will be the price elasticity of demand.
• Demand is generally inelastic when the time period is short. It happens because consumers
find it difficult to change their habits, in the short period, in order to respond to a change in
the price of the given commodity.
• However, demand is more elastic in the long-run as it is comparatively easier to shift to
other substitutes if the price of the given commodity rises.
Recap
• Utility refers to the satisfaction, actual or expected, derived from consumption of a good.
• Total utility refers to the total satisfaction obtained from the consumption of all possible units of
a commodity.
• Marginal utility is the additions to total utility when one more unit of the commodity is
consumed.
• Law of Diminishing Marginal Utility states that as the consumer consumes more and more units
of a commodity the additions to total utility (i.e marginal utility) ) derived from each successive
unit consumed keeps on decreasing.
• Consumer’s equilibrium refers to a situation when a consumer spends his income on the
purchase of a good (or combination of goods) in such a way that gives him maximum satisfaction
and he feels no urge to change.
• Indifference curve is a graphical representation of various combinations of bundles of two goods
among which the consumer is indifferent or which give the same level of satisfaction to the
consumer.
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• Marginal Rate of Substitution is the rate at which the consumer is willing to sacrifice one good
in order get an additional unit of the other good without affecting total utility.
• Properties of indifference curves  Downward sloping left to right
 Strictly convex to the origin
 Higher indifference curve represents higher level of utility
• Budget Line is a graphical representation of all possible combinations of two goods X and Y that
the consumer can buy given income and prices, which costs the consumer exactly his income.
Px.X + Py.Y = M
• The consumer’s equilibrium is located at the point of tangency between the budget line and an
indifference curve where MRS = Px/Py
• Law of Demand states the inverse relationship between price and quantity demanded of a
commodity, keeping all other factors affecting demand constant (ceteris paribus).
• The demand curve is generally downward sloping showing an inverse relationship between price
and quantity demanded of a commodity.
• Movement along demand curve occurs, when the quantity demanded changes due to a change in
its own price, keeping other factors affecting demand constant.
• Shift in demand curve occurs when the demand changes due to change in any factor other than
the own price of the commodity,
• Substitute goods are those goods which can be used in place of one another for satisfaction of a
particular want. For example: Tea and Coffee.
• Complementary goods are those goods which are used together to satisfy a particular want. For
example: Tea and Sugar.
• The demand for a normal good increases (decreases) with increase (decrease) in the consumer’s
income. The demand for an inferior good decreases (increases) as the income of the consumer
increases (decreases).
• The price elasticity of demand for a good is defined as the percentage change in quantity
demanded for the good divided by the percentage change in its price. The elasticity of demand is
a pure number.
• Factors affecting Price Elasticity of Demand
(a) Nature of the commodity (b) Number of substitutes.
(c) Income Level (d) Number of uses
(e) Proportion of income spent on a commodity (f) Time Period

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