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DEMAND ANALYSIS AND THEORY OF CONSUMER’S CHOICE
INTRODUCTION
*What is demand in economics?
People demand goods and services in an economy to satisfy their wants. All goods and services have wants satisfying capacity that is known as “UTILITY” in economics. Utility is highly subjective concept; it is different from person to person. Utility (level of satisfaction) is measured by means of introspection. By demand for goods and services economists essentially mean the attitude and reaction towards a commodity. Therefore demand for any commodity or services is dependent upon the utility to satisfy one’s desire.
SIGNIFICANCE OF DEMAND IN ECONOMICS
Demand is one of the most important decision making variables in present globalised, liberlised and privatized economy. Under such type of an economy consumers and producers have wide choice. There is full freedom to both that is buyers and sellers in the market. Therefore Demand reflects the size and pattern of the market. The future of a producer is depends upon the well analysed consumer’s demand. Even the firm dose not want to make profit as such but want to devote for ‘customer services’ or ‘social responsibilities’. That is also not possible without evaluating the consumer’s tastes, preferences, choice etc. All these things are directly built into the economic concept of demand.
The survival and the growth of any business enterprise depends upon the proper analysis of demand for its product in the market. Demand analysis has profound significance to management for day today functioning and expansion of the business. Thus the short term and long term decisions of the management are depend upon the trends in demand for the product. Any rise or fall in demand for the product has to be to find out reasons and revised production plans, technology or change in advertisement, packging, quality etc.
SPECIFICATION OF DEMAND
“When desire is backed by willingness and ability to pay for it that is known as demand in economics”
Here, important point in economics is that the time element. That is desire should be satisfied within given period of time.
Law of demand
All other things are being constant if price of a commodity changes then the demand for that commodity also changes.
Thus the price is the major determinant of demand
DEMAND FUNCTION
Dx= f(Px)
^Px ------------- ^Qdx
Rise in Px -----leads to --------------fall in Qdx ---------and vice-versa
Fall in Px----------------rise in Qdx
If Px is bar----------------------Qdx bar
There is inverse or opposite relationship between price and quantity demanded of a commodity.
Demand Schedule of an Individual Consumer
Demand Curve of an Individual Consumer
Diagram of Demand curve
DETERMINANTS OF DEMAND
Whether the price is the only determinant of demand?
Ans. NO. But price is the major determinant of demand
Along with price there are many determinants of demand. They are prices of its close substitutes, income of consumer, wealth, size of population, fashion, taste of consumer for that commodity or services etc.
Therefore new demand function is :
Dx = f (Px, Py,_Pn, Y , W, A F Pz T etc )
Dx ----Demand for a commodity
Px ------Price of a commodity
Py --------Price of a Y good which is close substitute for X good
Y --------Money income of a consumer
W -----------Wealth of a consumer
Al l the above factors play an important role in the determination of demand. But among these entire factors price plays a very important role.
But law of demand says all other things being constant and when price of a commodity changes …….
Here we try to establish a relationship between price and quantity demanded of a commodity.
Now our equation of demand function :
Qdx = f (Px, Py, ………Pn, Y, W,F A T Zp etc. ) All these are determinants of demand (#Link)
Here Px is only variable all other things are constant
When demand changes due to change in price of that commodity that phenomenon is known as variation in demand whereas when demand changes due to other factors, that is known as change in demand.
CONCEPT OF VARIATION-IN-DEMAND AND CHANGE-IN-DEMAND
Therefore law of demand is concerned with the phenomenon that is VARIATION IN DEMAND which is accompanied by Rise and Fall in price, or known as expansion and contraction in demand and not with CHANGE IN DEMAND which is accompanied by increased and decreased in demand
( # Diagrammatic Representation)
TYPES OF DEMANDS
*Direct demand and Derived demand.
*Individual demand and Market demand.
Domestic and Industrial Demand
Autonomous and Induced Demand
New and Replacement Demand etc.
.
*Why does demand curve slop downward?
*Exceptions to the Law of demand.
*Demand analysis (Flow Chart)
*Qualitative * Quantitative
Law of Demand Elasticity of Demand
It shows only directionIt shows how much
theoretically useful practically Usefull
Introspective Behaviouristic Price Income Cross C Surplus DF
Self Questioning Actual Observations of CBH
Cardinal & Ordinal Cardinal Ordinal
MUA ICA HLWO RPT
Principle
LDMU LDMRSxy
Conclusion is based on guessing
Therefore misleading
Not scientific
There are different theories of demand put forwarded by different economists:
1* Marginal Utility Analysis OR Cardinal Utility Approach ……………by Alfred Marshall (year )
2*Indifference Curve Analysis OR Ordinal Utility Approach…by J R Hicks & R G D Allen (1939)
3*Revealed Preference Theory OR Behaviourist Ordinalist Approach…..by Paul Samuelson ( )
4*Hick’s Logical Weak Ordering by Prof J R Hicks (1956)
5*Theory of Consumer’s Choice Under Risk and Uncertainty by Von-Neumann and Margestern
6*Some Latest Development
The Marshallian Theory of Demand
*Cardinal Utility Analysis
- or
- Marginal Utility Analysis.
Alfred Marshall was the first person who explained the relationship between price and quantity demanded of a commodity. Therefore, Marshall’s Marginal Utility Approach is the oldest theory of demand analysis.
According to Marshall, first of all why does a consumer desire a commodity? He says it gives the consumer utility or satisfaction or happiness from the act of consuming the commodity. Utility was defined as the power or ability of commodity to satisfy human wants. Utility is thus a measure of satisfaction that consumer receives from the consumption of a commodity. Thus the utility is a subjective concept. Utility of the same commodity is different from person to person.
Assumptions
- Rationality
Consumer is rational. His major is to maximize the satisfaction within his budget. He will go on spending as long as he gets satisfaction (MU= +ve) He will stop spending when satisfaction derived is zero (MU=zero)
- Cardinal Measurement
According to Marshall utility (level of satisfaction) derives from the consumption of any commodity can be measured in cardinal numbers that is 1, 2, 3,………n. He assumes utility can be measured in terms of money (i. e. in terms of price) that is each consumer is ready to pay rather than go without it.
- Principle of Law of Diminishing Marginal Utility
This law is applicable in case of all the goods As consumer goes on consuming the successive units of a particular commodity marginal utility derives from each unit goes on diminishing, after sometimes it reaches to zero and then it start becoming negative.
- Money is an acceptation to this law.
Marginal utility of money remain constant. Therefore money is the best unit of measurement of utility. Utility of money does not change with change in income of a consumer.
- Utility is additive
Utility derived from each unit is independent and it can be added. Therefore the total utility is the summation of all the units consume by the consumer.
TUxn = f ( X1 + X2 +……………Xn ) or
TUn = f ( MUx + MUy + MUz + etc )
- Other things remain same
The theory is valid as long as other things like consumer’s income, price of a commodity, preferences and choice.
- Single commodity model
a.Only one commodity and
b. only one consumer.
According to Marshall any rational consumer will pay the maximum price for any commodity which is exactly equal to the maximum marginal utility derives from it. It rarely exceeds the satisfaction derived from it, generally it is less than satisfaction derived from it.
MUx =Px
In reality there is no single consumer and single commodity in the market. Again aim of a consumer is to maximize satisfaction within the budget. The level of satisfaction not only depends upon the quantity of goods only but that also depend upon the quality and variety. Therefore single commodity model is not useful in practical life of a consumer.
II Multi-Commodity Model
This is based on the following assumptions
There is only on consumer and many commodities in the market. Law of equi-marginal utility is applicable. Consumer tries to equate the ratio of marginal utility and prices on one commodity with other so that total satisfaction is maximize.
Equilibrium = MUx/Px = MUy/Py = ………………. MUz /Pz = Mum/Pm
Thus with multi- commodity model we can show the consumer’s equilibrium that is the perfect choice.Because its suits in his buget and which gives him maximum total satisfaction
CRITICISM of MARSHALLIAN UTLITY ANALYSIS
Marshall has been criticized by a number of economists like Prof J.R. Hicks, R G D Allen, Edgeworth, Pareto, Slutsky and others on various grounds. According to them Marshall’s Marginal utility analysis has no practical importance because it is based on number of unrealistic assumptions, like rationality, cardinal measurement, and constant marginal utility of money. Hicks and others developed the Indifference Curve Analysis as an alternative of understanding consumer behaviour
CONSUMER’S SURPLUS (C S)
*Introduction
Then concept of consumers’ surplus is originally developed by prof. Dupit. Then it is propounded by Alfred Marshall. According to Marshall there are several low price goods ‘These goods are daily part of our consumption. These goods are indispensible in our day today life. These goods are daily part of our consumption. Consumer cannot deal his day without the consumption of such goods.
According to Marshall in the event of non availability of such goods consumer is ready to pay much higher price than what he pays daily. He cannot remain without consumption of such goods. It shows consumer gets the satisfaction than what he pays in normal times. It means he gets surplus satisfaction (extra) than he makes the payment for it.
Because any rational consumer will pay the maximum price for any commodity which is exactly equal to the satisfaction derived from that commodity. Generally try to pay the price any commodity which is less than the satisfaction derived from it. He rarely pays the price which is greater than the satis faction derived from it.
*Equation
MUx = Px at the most Marshall’s equilibrium Position
MUx > PX generally disequilibrium position
MUx < Px Rarelydisequilibrium
CONSUMER’S SURPLUS = MAXIMUM PRICE READY TO PAY --- ACTUAL PRICE PAID FOR IT
Scheduled of Consumer’s Surplus
Units MU Maximum price ready to pay Actual price Paid Consumer’s Surplus
1 1o 10 2 8
2 8 8 2 6
3 6 6 2 4
4 4 4 2 2
5 2 2 2 0
Max.Units Tux Max price ready Actual Price Paid Total Consumer’s Surplus
5 30 30 10 20
Consumer’s Surplus in Money Terms (C.S.)
C. S- = Maximum Price Ready to Pay – Actual Price Paid
20 = 30 - 10
Consumer’s Surplus in Utility Terms
C.S. = TUxn =Px (MUxn)
PRT = ORTQ - OPRQ
*Diagram
*Usefulness or Application of Consumer Surplus
Water Diamond Paradox
/Evaluating loss and benefit from the tax
/Evaluating gains from a Subsidy/
Use in cost benefit analysis
*Limitations
