Demand Analysis

Theory of Demand
If necessity is the
mother of invention,
then demand is the
mother of production.

A Bit of
History

Leon Walras (1834-1910) a French

economist, gave demand theory as
a
fundamental
principle
of
microeconomics which gives the
analysis of the relationship between
the demand for goods or services
and prices or incomes.
The theory was subsequently
developed by English economist
Alfred Marshall (1842-1924), Italian
Vilfredo Pareto (1848-1923), Soviet
Eugen
Slutsky
(1880-1948),
American Kenneth Arrow (1921- )
and the French-born Gerard Debreu
3
(1921- ).

Demand is the basis of all productive activities.

Demand theory is an economic theory that
concerns the relationship between the demand
for goods and their prices; it forms the core of
microeconomics.
The generation of demand can be pictorially
shown as below,

NEED

WA
NT

DEMAN
D

What is Demand?
Demand means effective desire or want
for a commodity which is backed up by
the ability (purchasing power) and
willingness to pay for it.
Demand = Desire + Ability to pay +
Willingness to spend
Demand is a relative concept not
absolute
It is related to price , time and place.
The demand for a commodity refers to
the amount of it which will be bought per

Demand

Law of
Demand
The
law of

demand is
normally depicted
as an inverse
relation of
quantity
demanded and
price: the higher
the price of the
product, the less
the consumer will
demand, ceteris
paribus ("all other
things being
equal").

Hedonic
theory
It is an economic
theory that the
price an
individual will
pay for a good
reflects the sum
of the
characteristics
of that good.
6

Individual and Market demand

Individual Demand : Individual demand for a product
is the quantity of it a consumer would buy at a given
price, during a given period of time.
Market demand : Market demand for a product is the
total demand of all the buyers in the market taken
together at a given price during a given period of time.
Demand Schedule: A tabular statement of price
quantity (demanded) relationship at a given period of
time
Individual demand schedule
Market demand schedule.

Demand Schedule: A demand schedule is a tabular

presentation of the amount of goods consumers are
willing and able to buy at different level of prices over a
given
periodCurve:
of time. The graphical representation of
Demand

Price perDVD rentals

cassette demanded
per week
Rs.

A
B
C
D
E

0.50
1.00
2.00
3.00
4.00

9
8
6
4
2

Price per DVDs (in

rupees)

demand schedule is the demand curve. The demand

curve is a downward sloping curve from left to right. This
characteristic of the demand
6.0 curve is due to the inverse
A Demand
relationship between price and
quantity
demanded.
0
A Demand Table
Curve
5.0
0
4.0
3.5
0
3.0
0
0
2.0
0
1.0
0
.50

E
G

C
F

Deman
d for
DVDs
A

1 2 3 4 5 6 7 8 9 10
Quantity of DVDs demanded
(per week)

Types of demand
Individual demand & Market demand
Demand for capital goods and demand for
consumer goods
Autonomous demand & Derived demand
- Direct & indirect demand
Demand for durable & non-durable goods
- Replacement demand in case of durable
goods
Short term demand & Long term demand

Determinants of Demand

Price of the product

Price of the related goods
Consumers income level
Distribution pattern of national income
Consumers taste and preferences
Advertisement of the product
Consumers expectation about future price and supply position
Demonstration effect and Band-Wagon effect
Consumer credit facility
Demography and growth rate of population
General std. of living and spending habits
Climatic and weather conditions
Customs

Demand Function: It states the (functional/mathematical) relationship

between the demand for the product ( dependent variable) and its
determinants ( independent variables).

Law of demand
Statement of Law : Other things being equal, the higher the price of a
commodity, the smaller is the quantity demanded and lower the price, larger
the quantity demanded.
Factors behind Law of demand

Substitution effect
Income effect
Utility Maximising behaviour
Exceptions to Law of demand

Expectation regarding future prices

Giffen goods
Articles of snob appeal / Veblen effect
Consumers psychological bias ( about quality and price relationship)

Exceptions to Law of demand

Giffen Goods:
In the case of certain Giffen goods, when
price falls, quite often less quantity will
be purchased because of the negative
income effect and peoples increasing
preference for a superior commodity with
rise in their real income.
E.g. staple foods such as cheap potatoes,
cheap bread, pucca rice, vegetable ghee,
etc. as against good potatoes, cake,
basmati rice and pure ghee.

Exceptions to Law of demand

Articles of Snob appeal (Veblen effect) :
Sometimes,
certain
commodities
are
demanded just because they happen to be
expensive or prestige goods and have a snob
appeal.
They satisfy the aristocratic desire to preserve
the exclusiveness for unique goods.
These goods are purchased by few rich people
who use them as status symbol.
When prices of articles like diamonds rise,
their demand rises. Rolls Royce car is another
example.

Exceptions to Law of demand

Speculation:
When people are convinced that the price
of a particular commodity will rise further,
they will not contract their demand; on
the contrary they may purchase more for
profiteering.
In the stock exchange, people tend to buy
more and more when prices are rising
and unload heavily when prices start
falling.

Exceptions to Law of demand

Consumers psychological bias or
illusion:
When the consumer is wrongly biased
against the quality of a commodity with
reduction in the price such as in the case
of a stock clearance sale
Does not buy at reduced prices, thinking
that these goods on sale are of inferior
quality.

REASONS BEHIND DEMAND

The Income Effect: There is an income
effect when the price of a good falls
because the consumer can maintain
current consumption for less expenditure.
The Substitution Effect: There is also a
substitution effect when the price of a good
falls because the product is now relatively
cheaper than an alternative item and so
some consumers switch their spending
from the good in competitive demand to
16

CONDITIONS OF DEMAND
The conditions of demand for a product in a
market can be summarized as follows:
D = f (Pn, PnPn-1, Y, T, P, E)
Where:
Pn = Price of the good itself
PnPn-1 = Prices of other goods e.g. prices of
Substitutes and Complements
Y = Consumer incomes including both the level
and distribution of income
T = Tastes and preferences of consumers
P = The level and age-structure of the population
E = Price expectations of consumers for future
17
time periods

EXCEPTIONS TO THE LAW OF

DEMAND

ostentatious consumptioneffects
ofpotential
speculative
deman
The
buyers
The demand for the
are interested not just
product is a direct
in the satisfaction
function of its price.
they may get from
It
comprises
of
consuming the
luxury items. They
product, but also the
are called Veblen
potential rise in
goods.
market price leading
Eg.
Expensive
to a capital gain or
perfumes, designer
profit.
clothes etc.
Eg. Housing & shares
etc.
18

Changes in quantity demanded & Changes

in demand
Changes in quantity demanded is related to law
of demand i.e. due to changes in price.
When with a fall in price more of a commodity is
demanded, there is EXTENSION of demand & when with
a rise in price less of a commodity is purchased, there is
CONTRACTION of demand.

Changes in demand is caused by changes in

various other determinants of demand, the price
remaining unchanged.
When more of a commodity is bought than before at any
given price there is INCREASE in demand & when less of
a commodity is bought than before at any given price
there is DECREASE in demand.

ELASTICIT
Y OF
DEMAND

Definition Of Price Elasticity Of

Demand
The
change
in
the
quantity
demanded of a product due to a
change in its price is known as Price
elasticity of demand.
Thus,
the
sensitiveness
or
responsiveness of demand to change
in price is as called elasticity of
demand

KINDS OF PRICE ELASTICITY OF DEMAND

1)
2)
3)
4)
5)

Perfectly elastic demand

Relatively elastic demand
Elasticity of demand equal to utility
Relatively inelastic demand
Perfectly inelastic demand
Let Us See Some Views On Them

PERFECTLY ELASTIC DEMAND

When
the
demand for a
product changes
increases
or
decreases even
when there is no
change in price,
it is known as
perfect
elastic
demand.

y
Perfectly
elastic demand
curve

P
R
I

RELATIVELY ELASTIC DEMAND

y
P

Relatively elastic
demand curve

I
C
E

demand

When
the
proportionate
change
in
demand is more
than
the
proportionate
changes in price,
it is known as
relatively elastic
demand.

ELASTICITY OF DEMAND EQUAL TO

UTILITY

y
D

P
R

Elasticity of
demand
equal to
utility curve

I
C
E

D
0

demand

When
the
proportionate
change in demand
is
equal
to
proportionate
changes in price,
it is known as
unitary
elastic
demand

RELATIVELY INELASTIC
DEMAND
Y

Relatively
inelastic demand
curve

P
R
I
C
E
D
O

demand

When
the
proportionate
change
in
demand is less
than
the
proportionate
changes in price,
it is known as
relatively
inelastic demand

PERFECTLY INELASTIC DEMAND

Y
D
Perfectly
inelastic
demand curve

P
R
I
C
E

D
demand

When a change
in
price,
howsoever large,
change
no
changes
in
quality demand,
it is known as
perfectly
inelastic demand

ALL KINDS OF DEMAND CAN BE

SHOWN IN ONE DIAGRAM AS FOLLOW
Y

P
RD
I
C
E

D4
0

D5
DEMAND

WHERE
D1) Perfectly elastic
demand
D2)Relatively
elastic
demand
D1
D3)Elasticity of demand
equal to utility
D2
D4)Relatively inelastic
D3
demand
D5)Perfectly
inelastic
X
demand

MEASUREMENT
OF
PRICE
ELASTICITY OF DEMAND
There are main methods like
1. Percentage method or proportionate
method
2. Total outlay method or total revenue
method
3. Geometric method or point method
4. Arc elasticity of demand

The Percentage Method

The price elasticity of demand is measured by its
coefficient Ep. This coefficient Ep measures the
percentage change in the quantity of a commodity
demanded resulting from a given percentage
change in its price: Thus

Where q refers to quantity demanded, p to price and

to change. If Ep> 1, demand is elastic. If Ep< 1,
demand is inelastic, it Ep= 1 demand is unitary
elastic.
With this formula, we can compute price elasticities
of demand on the basis of a demand schedule.

The Percentage Method

Demand Schedule:
Combination

Price (Rs) per kg

of X

Quantity Kgs of X

10

20

30

40

50

60

The Percentage Method

Let us first take combinations and D.
(i) Suppose the price of commodity X falls from Rs. 5 per
kg. to Rs. 3 per kg. and its quantity demanded increases
from 10 kgs. to 30 kgs. Then

This shows elastic demand or elasticity of demand greater

than unitary.
Note: The formula can be understood like this:
q =q2q1where <q2is the new quantity (30 kgs.) and
q1the original quantity (10 kgs.)
p p2 P1where p2is the new price (Rs. 3) and <$Ep sub
1> the original price (Rs. 5)
In the formula, p refers to the original price (p,) and q to
original quantity (q1). The opposite is the case in example

The Percentage Method

(ii) Let us measure elasticity by moving in the reverse
direction. Suppose the price of X rises from Rs. 3
per kg. to Rs. 5 per kg. and the quantity demanded
decreases from 30 kgs. to 10 kgs. Then

This shows unitary elasticity of demand.

Notice that the value of Ep in example (ii) differs
from that in example (i) depending on the direction
in which we move. This difference in the elasticities
is due to the use of a different base in computing
percentage changes in each case.

The Percentage Method

Now consider combinations D and F.
(iii) Suppose the price of commodity X falls from Rs. 3 per kg. to Re. 1 per
kg. and its quantity demanded increases from 30 kgs. to 50 kgs. Then

This is again unitary elasticity.

(iv) Take the reverse order when the price rises from Re. 1 per kg. to Rs. 3
per kg. and the quantity demanded decreases from 50 kgs. to 30 kgs.
Then

This shows inelastic demand or less than unitary.

The value of Epagain differs in this example than that given in example
(iii) for the reason stated above.

The Point Method

Prof. Marshall devised a
geometrical
method
for
measuring elasticity at a
point on the demand curve.
Let RS be a straight line
demand curve in Figure 11.2.
If the price falls from
PB(=OA) to MD(=OC). the
quantity demanded increases
from OB to OD.
Elasticity at point P on the RS
demand curve according to
the formula is: Ep= q/p x
p/q

The Point Method

Where q represents changes in quantity
demanded, p changes in price level
while p and q are initial price and quantity
levels.
From Figure 11.2
q = BD = QM
p = PQ
p = PB
q = OB
Substituting these values in the elasticity
formula:

The Point Method

The Point Method

With the help of the point
method, it is easy to point out
the elasticity at any point
along a demand curve.
Suppose that the straight line
demand curve DC in Figure
11.3 is 6 centimetres.
Five points L, M, N, P and Q are
taken oh this demand curve.
The elasticity of demand at
each point can be knownwith
thehelp of the above method.
Let point N be in themiddle of
the
demandcurve.
So
elasticity of demand at point.

The Point Method

We arrive at the conclusion
that at the mid-point on the
demand curve the elasticity of
demand is unity.
Moving up the demand curve
from the mid-point, elasticity
becomes greater.
When the demand curve
touches the Y-axis, elasticity is
infinity.
Ipso facto, any point below
the mid-point towards the Xaxis will show elastic demand.
Elasticity becomes zero when
the demand curve touches the
X-axis.

ARC Elasticity
We have studied the measurement of
elasticity at a point on a demand curve.
But when elasticity is measured between
two points on the same demand curve, it
is known as arc elasticity.
In the words of Prof. Baumol, Arc
elasticity is a measure of the average
responsiveness to price change exhibited
by a demand curve over some finite
stretch of the curve.

ARC Elasticity
Any two points on a demand
curve make an arc.
The area between P and M
on the DD curve in Figure
11.4 is an arc which
measures elasticity over a
certain range of price and
quantities.
On any two points of a
demand curve the elasticity
coefficients are likely to be
different depending upon
the method of computation.

ARC Elasticity
Consider the price-quantity combinations
P and M as given in Table 11.2.
Point
P
M

Price (Rs)
8
6

Quantity (in kg)

10
12

If we move from P to M, the elasticity of

demand is:

ARC Elasticity
If we move in the reverse direction from M to P, then

Thus the point method of measuring elasticity at two

points on a demand curve gives different elasticity
coefficients because we used a different base in
computing the percentage change in each case.
To avoid this discrepancy, elasticity for the arc (PM in
Figure 11.4) is calculated by taking the average of the
two prices [(p1, + p21/2] and the average of the two
quantities [(q1, + q2) 1/2].
The formula for price elasticity of demand at the midpoint (C in Figure 11.4) of the arc on the demand curve is

ARC Elasticity

On the basis of this formula, we can measure arc elasticity of demand when
there is a movement either from point P to M or from M to P.
From P to M at P, p1= 8, q1, =10, and at M, P2= 6, q2= 12
Applying these values, we get

Total Outlay Method

Marshall evolved the total outlay, total
revenue or total expenditure method as a
measure of elasticity.
By comparing the total expenditure of a
purchaser both before and after the change
in price, it can be known whether his demand
for a good is elastic, unity or less elastic.
Total outlay is price multiplied by the
quantity of a good purchased: Total Outlay =
Price x Quantity Demanded. This is explained
with the help of the demand schedule in
Table 11.3.

Total Outlay Method

(i) Elastic Demand
Demand is elastic, when with the fall in
price the total expenditure increases and
with the rise in price the total expenditure
decreases.
Table 11.3 shows that when the price falls
from Rs. 9 to Rs. 8, the total expenditure
increases from Rs. 180 to Rs. 240 and
when price rises from Rs. 7 to Rs. 8, the
total expenditure falls from Rs. 280 to Rs.

Total Outlay Method

(ii)Unitary Elastic Demand:
When with the fall or rise in price, the total expenditure
remains unchanged; the elasticity of demand is unity.
This is shown in the Table when with the fall in price from Rs.
6 to Rs. 5 or with the rise in price from Rs. 4 to Rs. 5, the
total expenditure remains unchanged at Rs. 300, i.e., E p= 1.
(iii) Less Elastic Demand:
Demand is less elastic if with the fall in price the total
expenditure falls and with the rise in price the total
expenditure rises.
In the Table when the price falls from Rs. 3 to Rs. 2 total
expenditure falls from Rs. 240 to Rs. 180, and when the price
rises from Re. 1 to Rs. 2 the total expenditure also rises from
Rs. 100 to Rs. 180. This is the case of inelastic or less elastic
demand, Ep < 1.

(5) Factors Affecting Price

Elasticity Of Demand

FACTORS AFFECTING PRICE ELASTICITY

OF DEMAND

Nature of the Commodity

Availability of Substitutes
Variety of uses of commodity
Postponement
Influence of habits
Proportion of Income spent on a
commodity
Range of prices

FACTORS
AFFECTING
ELASTICITY OF DEMAND
Income Groups
Elements of time
Pattern of income distribution

PRICE

(6) Practical Importance

of the Concept of Price
Elasticity Of Demand

PRACTICAL IMPORTANCE OF THE CONCEPT

OF PRICE ELASTICITY OF DEMAND
The concept is helpful in taking Business
Decisions
Importance of the concept in formatting
Tax Policy of the government
For determining the rewards of the
Factors of Production
To determine the Terms of Trades
Between the Two Countries

PRACTICAL IMPORTANCE OF THE CONCEPT

OF PRICE ELASTICITY OF DEMAND

Determination of Rates of Foreign

Exchange
For
Nationalization
of
Certain
Industries
In economic Analysis ,the concept of
price elasticity of demand helps in
explaining the irony of poverty in the
midst of plenty.

(7) Income Elasticity Of

Demand

TYPES OF
DEMAND

INCOME

ELASTICITY

OF

Positive Income elasticity of

demand
Negative Income elasticity of
demand
Zero Income elasticity of
demand

POSITIVE INCOME ELASTICITY OF DEMAND

Income

P
A

D
B S
Quantity Demanded

POSITIVE INCOME ELASTICITY OF DEMAND

Income Elasticity Equal to

Unity or One
Income
Elasticity
Greater
Than Unity Or One
Income Elasticity Less Than
Unity or One

INCOME

ELASTICITY

Price

NEGATIVE
DEMAND

Total Revenue
B

Quantity Demanded (000s)

OF

ZERO INCOME ELASTICITY OF DEMAND

D

Income

D
Quantity Demanded

ALL INCOME GRAPHS REPRESENTATION

F
E

Incom
e

B
A

Quantity Demanded

MEASUREMENT OF INCOME
ELASTICITY OF DEMAND

Income Elasticity Of
Demand =
i.e.
Income Elasticity Of
Demand =

Proportionate change in
Demand
Proportionate change in
Income
q

+ y
Q
Y

MEASUREMENT
OF
INCOME
ELASTICITY OF DEMAND
Here , q = Change in the quantity
demanded.
Q = Original quantity demanded.
y = Change in income.
Y = Original income.
For e.g. ,when Income of the consumer =
2,500/- , he purchases 20 units of X, when
income = 3,000/- he purchases 25 units of
X

Measurement Of Income
Elasticity Of Demand
Thus
Income Elasticity
of
Demand
y
q
+
=
Q

= (5/20) + (500/2500)
= 1.5
therefore here the IED is 1.5 which is
more than one.

FACTORS AFFECTING INCOME OF DEMAND

Income Itself Only.

Price Of the Commodity

IMPORTANCE OF THE CONCEPT OF

INCOME ELASTICITY OF DEMAND
In production planning and management
In forecasting demand when change in
consumers income is expected
In classifying goods as normal and
inferior
In expansion and contraction of the firm
by the figure of income elasticity of
demand
Markets situations could be studied with
the help of IED

(8) ELASTICITY OF
SUBSTITUTION

The selection between two product

or thing is called substitution
So
Elasticity
of
Substitution
measures the rate at which the
particular product is substituted .
Thus EOS is the degree to which one
product could be substituted in
context of price and proportion

ELASTICITY OF
SUBSTITUTION

Elasticity of Substitution
= Proportionate change in the
quantity ratios of goods x & y
DIVIDED BY Proportionate change in
the price ratios of goods x & y.

TYPES OF ELASTICITY OF SUBSTITUTION

Zero Elasticity of Substitution.

Infinite Elasticity Of Substitution
Elasticity of Substitution greater than
unityor1
Elasticity of Substitution is equal to
one
Elasticity of Substitution is less than
one

TYPES OF ELASTICITY OF SUBSTITUTION

ON GRAPH
Change in QUANTITIY ratio of good
x&y

E4
E3

E5

E2
E1
X
Change in PRICE ratio of good x & y

RELATIONSHIP
BETWEEN
PRICE
ELASTICITY, INCOME ELASTICITY AND
SUBSTITUTION ELASTICITY

As Price is depended on income and

substitution effect similarly Price
Elasticity is depended on Income
Elasticity and Substitution Elasticity .
These
relationship
can
be
represented by
Ep = Kx E1 + ( 1 Kx ) es

PRICE ELASTICITY OF DEMAND

DEPENDS ON:
Proportion of income spent
particular good say X.
Income elasticity of demand.
Elasticity of substitution.
Proportion of income spent
product other than X.

on

on

CROSS ELASTICITY OF DEMAND

Cross
elasticity
of
demand
express a relationship between
the change in the demand for a
given product in response to a
change in the price of some other
product
E.g. if the X tea demand reduces
tremendously than it effect could be
seen in demand of sugar and milk.

TYPES OF CROSS ELASTICITY OF DEMAND

Cross Elasticity of Demand Equal to

Unity or One
Cross Elasticity of Demand Greater
than Unity or one
Cross Elasticity of demand less than
unity or one

MEASUREMENT
CROSS
ELASTICITY OF DEMAND
Cross Elasticity of
Demand =
i.e.
Cross Elasticity of
Demand =

Proportionate change in
Demand for product X
Proportionate change in Price
of product Y
qx
Qx

p y
Py

Price of
Y

CROSS ELASTICITY OF DEMAND FOR

SUBSTITUTES
Y
D

D
O

Demand for

CROSS ELASTICITY OF DEMAND FOR

COMPLEMENTARY PRODUCTS
D

Price of
Y

D
O

Demand for

CROSS ELASTICITY OF DEMAND

FOR NEUTRAL PRODUCTS
Y

Price of
Y

Demand for

IMPORTANCE
OF
ELASTICITY OF DEMAND

CROSS

The concept is of very great

importance in changing the price of
the products having substitutes and
complementary goods .
In demand forecasting
Helps in measuring interdependence
of price of commodity .
Multiproduct firms use these concept
to measure the effect of change in

ADVERTISING ELASTICITY OF DEMAND

Advertising elasticity of demand

is the measure of the rate of
change in demand due to change
in advertising expenditure
The amount of change in demand of
goods due to advertisement is
known as Advertisement Elasticity of
Demand .

ADVERTISING ELASTICITY
OF DEMAND

Advertising Elasticity of
Demand =
i.e.

Advertising Elasticity of
Demand =

Proportionate change in
Demand for product
Proportionate change in
Advertising expenditure
qx
Q

a
A

Relationship Between Advertising

Expenditure and Sales
Y

Sale
s

Advertising

Factors Affecting Advertising

Elasticity Of Demand
The stage of the Products Market
Development .
Reaction of market Rival Firms.
Cumulative Effect of Past
Advertisement.
Influence of Other Factors.

IMPORTANCE
OF
THE
ADVERTISING
ELASTICITY
OF
DEMAND IN BUSINESS DECISIONS
It is useful in competitive industries.
Though advertisement shifts the
demand curve to right path but it
also increases the fixed cost of the
firm.

LIMITATION OF ADVERTISING
ELASTICITY OF THE DEMAND
The impact of advertising on sales is
different under different conditions,
even if other demand determinants
are constant.
Like wise, it is difficult to establish
any
co-relationship
between
advertising expenditure and volume
of
sales
when
there
counter
advertisements by rival firm in the

INDIFFERENCE CURVE SUPERIOR THAN

MARSHALLIAN UTILITY ANALYSIS
It is more realistic.
It uses the concept of scale of preferences with
lesser assumptions than the Marshallian concept
of utility.
It dispenses with the assumption of constant
marginal utility of money.
It is wider in scope.
It uses concept of Marginal Rate of Substitution
which is scientific and measurable.
It expresses the conditions of consumer
equilibrium in a better way.
It analyses the price effect in a better way.

SHORTCOMINGS
OF
THE
INDIFFERENCE CURVE APPROACH
It does not provide any positive change in
the utility analysis.
It retains the Marshallian assumption of
diminishing marginal utility:
It unrealistically assumes perfect knowledge
of utility with the consumer.
It is weak in structure.
It has limited scope.
It is introspective.
It is not applicable to indivisible goods.
It assumes transitivity condition.

Demand forecasting
Demand forecasting is predicting or anticipating the
future demand for a product.
Micro level Industry level Macro level

USES OF DEMAND FORECASTING DATA

Short term demand forecasting
1)
2)
3)
4)
5)

Evolving production policy

Determining price policy
Evolving purchase policy
Fixation of sales targets
Short term financial policy

Long term demand forecasting

1)
2)
3)

Business planning
Man power planning
Long term financial planning

Individual Demand
Analysis

Basis of Individual demand

Utility
- From the commodity point of view
- From Consumers point of view

Approaches to Consumer Demand Analysis

o Cardinal Utility approach
- Total utility
- Marginal utility
LAW OF DIMINISHING MARGINALUTILITY

Assumptions underlying cardinality approach

-

Rationality
Limited money income
maximisation of satisfaction
Utility is cardinally measurable
Diminishing marginal utility
Constant marginal utility of money

 Consumers equilibrium
- One commodity model
- Multiple commodity model THE LAW OF EQUIMARGINAL UTILITY
Ordinal Utility Approach
Assumptions underlying ordinal approach

Rationality
Ordinal utility
Transitivity & consistency in choice
Nonsatiety
Diminishing marginal rate of substitution

Marginal rate of substitution - MRS is the rate at which one commodity can be
substituted for another, the level of satisfaction remaining the same.
Diminishing MRS The quantity of a commodity that the quantity of a
commodity that a consumer is willing to sacrifice for an additional unit of
another goes on decreasing when he goes on substituting one commodity
for another.
Indifference Curve - Indifference curve is a locus of points, each
representing a different combination of two substitute goods, which yield
the same level of utility or satisfaction to the consumer.
Indifferent Map

 Properties of Indifference curve

-

Indifference curves have a negative slope

Indifference curves are convex to the origin
Indifference curves do not intersect with each other
Indifference curves are not tangent to one another
Upper indifference curve always indicate a higher level of satisfaction

Budgetary constraint & The Budget Line

The limitedness of the income acts as a constraint on how high a
consumer can ride on his/her indifference map.

Consumers Equilibrium