Theory of Demand

Meaning of demand
Demand is the desire backed by ability and willingness to pay for a commodity. if a person is willing to pay, but has no ability to pay, there is only desire and no demand. Demand for a commodity thus implies three things:a) Desire to acquire it. b) Willingness to pay for it, and c) Ability to pay for it.

Law of Demand
The relation of price to demand or sales is known in economics as the law of demand. The law of demand states that higher the price lower the demand and vice versa, other things remaining the same.

Demand schedule
Demand schedule is a table which shows the amounts of a commodity demanded at a given period of time at various prices. Price of ice cream cones 0.00 0.50 1.00 1.50 2.00 2.50 3.00 Quantity of cone demanded 12 10 8 6 4 2 0

Demand curve
Demand curve is a graphical representation of demand schedule.

Why the demand curve slope downward

The reasons for the inverse relation between price and quantity demanded are the following: 1. Income effect 2. Substitution effect 3. Diminishing marginal utility 4. Price effect 5. Alternate uses of commodity 6. Change in number of consumers

Exceptions to the law of demand

The law of demand does not apply to the following cases:

1. Expectations regarding price variations 2. Status symbol goods 3. Inferior goods or Giffen goods 4. Depression 5. Demand for necessaries 6. Ignorance 7. Change in fashion 8. Special occasions 9. Brand loyalty 10. Goods of high prices 11. Emergencies

Determinants of demand
The various factors that determine the demand for a commodity are as follows: 1. Price of the commodity 2. Consumers income 3. Price of related goods 4. Consumers taste and preferences 5. Consumers expectations 6. Nature of commodity 7. Population of the country 8. Usefulness 9. Change in the volume of money in circulation 10. Change in climate 11. Innovations 12. Government policy 13. Business cycle 14. Consumer credit facility 15. Distribution of national income 16. Demonstration effect 17. Advertisement

Types of demand
The different ways of classifying demand are as follows: 1. 2. 3. 4. 5. Individual demand and market demand Demand for consumers goods and producers goods Demand for durable and perishable goods Derived demand and autonomous demand Industry demand and company demand

Elasticity of demand
Elasticity of demand primarily refers to the demand-price relation. Elasticity of demand means relationship or the degree of responsiveness of demand to the change in its various determinants. The important demand elasticity are:1. Price elasticity of demand Price elasticity = percentage change in quantity demanded Percentage change in price 2. Income elasticity of demand Income elasticity= percentage change in the quantity demanded Percentage change in income 3. Cross elasticity of demand Cross elasticity= percentage change in substitute goods Percentage change in complementary goods 4. Advertising or promotional elasticity Advertisement elasticity= percentage change in sales Percentage change in advertisement expenditure

Demand forecasting
Demand forecasting is predicting future demand for a product.

Methods of demand forecasting

The methods of demand forecasting are:I. Survey methods 1. Consumer survey: Direct interviews y Complete enumeration y Sample survey y End-use method 2. Option poll methods y Expert opinion survey (a) Market tests (b) Delphi method y Market studies and experiments (a) Market tests (b) Laboratory tests Statistical methods 1. Trend projection methods y Graphical method y Fitting trend equation or least square method y Box-jenkins method 2. Barometric methods y Lead lag indicators y Diffusion indices Econometric methods y Regression method (a) Simple or bivariate regression technique (b) Multivariate method y Simultaneous methods

II.

III.

Theory of utility
Meaning of utility
The term utility refers to the want satisfying capacity of a commodity or a service. Utility is a psychological phenomenon. It is highly subjective and differs from consumer to consumer.

Total utility
Total utility is defined as the total psychological satisfaction a consumer obtains from consuming a given amount of a particular good.

Marginal utility
Marginal utility means additional utility from the consumption of an additional unit of a good.

Law of diminishing marginal utility

Prof. Alfred marshal state that as the consumer consumes more and more units of a good, the additional utility obtained from each additional units goes on decreasing. Units consumed(apple) 0 1 2 3 4 5 6 7 Marginal utility 0 10 8 6 3 2 0 -2 Total utility 0 10 18 24 27 29 29 27

Cardinal and Ordinal concepts of Utility

Ordinal utility

A method of analyzing utility, or satisfaction derived from the consumption of goods and services, based on a relative ranking of the goods and services consumed. Cardinal utility A method of quantitatively measuring the preference of an individual towards a certain commodity.

Analysis of consumer behavior Cardinal utility approach

Cardinal utility approach assumes utility is measurable in cardinally quantitative terms. The cardinal utility approach to consumer analysis makes the following assumptions: (a) Rationality (b) Limited money income (c) Maximization of satisfaction (d) Utility is cardinally measurable (e) Diminishing marginal utility (f) Constant marginal utility of money (g) Utility is additive

Consumers equilibrium
A consumer is said to be in equilibrium when he gets maximum satisfaction out of his limited income and he has no tendency to make any change in the existing expenditure.

Analysis of consumer behavior-Ordinal utility approach

Ordinal utility approach, pioneered by J.R Hicks, a Nobel laureate and R.GD. Allen, is also called the indifference curve analysis. Ordinal utility approach

assumes utility is measurable only ordinally, i.e., in relative terms(more or less), not cardinally. Assumptions of ordinal utility theory (a) Rationality (b) Ordinal utility (c) Transitivity and consistency of choice (d) Nonsatiety (e) Diminishing marginal rate of substitution The meaning and nature of indifference curve An indifference curve may be defined as the locus of points, each representing a different combination of two substitute goods, which yield the same utility or level of satisfaction to the consumer. A schedule showing the different combinations of apples and bananas which gives the consumer equal satisfaction could then be drawn up-it might be like this one.

INDIFFERENCE CURVES
24 22 20 18 16 14 12 10 8 6 4 2 0 1 2 3 4

A(1, 22)

INDIFFERENCE SCHEDULE
Combination Apples Oranges

A B C D E

1 2 3 4 5

22 14 10 8 7

Oranges

IC1 Apples
5

The marginal rate of substitution (MRS) Marginal rate of substitution is the rate at which the consumer, given his basket of two goods, substitute one good for another in such proportions that the total satisfaction remains unaffected. MRS is expressed as DY/DX moving down on the IC.

THEORY OF INCOME
Definition of national income
National income is the aggregate money value of all goods and services produced in a country during an accounting year.

Theories of consumption
There are four prominent theories of consumption:a) The absolute income hypothesis The basic hypothesis of Keynesian theory of consumption is that current consumption expenditure is the function of current real income. the main properties of the Keynesian consumption theory can be:1. Real consumption expenditure is a function of real income. 2. The marginal propensity to consume (MPC) is greater zero but less than consume. (APC) 3. The MPC declines as income increases. 4. b) Duesenberrys relative income theory c) Friedmans permanent income theory d) Ando-Midiglianis life cycle theory of consumption

Measures of national income

Gross National Product (GNP) Gross National Product is defined as the total market value of all final goods and services produced during the year plus earnings from abroad. GROSS Domestic Product (GDP) Gross Domestic Product is the money value of all final goods and services produced in the domestic territory of a country during an accounting year.

Net Domestic Product (NDP) NDP at market prices is the market value of all final goods and services produced within the domestic territory of a country during an accounting year minus depreciation. Net National Product (NNP) NNP is the total value of all final goods and services produced in an economy in an year after providing for depreciation of capital assets.

Methods of measuring National income

National income may be measured by three different corresponding methods:(a) Net output or value added method (b) Factor-income method (c) Expenditure method