Consumer Behaviour and Demand

A. Consumer Behaviour
1. Human wants
2. Consumption
3. Consumer’s equilibrium (Various Utility concepts)

B. Demand
1. Concept
2. Factors affecting demand
3. Law of demand
4. Elasticity of Demand
 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.
 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
 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
 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
 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
 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
 Utility

Characteristics:
• Utility is subjective/not measurable
• Utility is variable
• Utility is different from usefulness

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.
 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
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”
 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
 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
 Consumer’s 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.

Consumer’s 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.
 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
 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.
 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
 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:
a. Desire for specific commodity.
b. Sufficient resources to purchase the desired commodity.
c. Willingness to spend the resources.
d. Availability of the commodity at
(i) Certain price (ii) Certain place (iii) Certain time.
1. Individual demand
Kinds of Demand
2. Market demand

3. 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
 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) Consumer’s 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)
 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

Shows various quantities of that would be purchased at
a commodity that would be different prices by all the
purchased at different buyers of that commodity. It
prices by a household. is composed of the demand
schedules of all the individuals
purchasing that commodity.
 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.
 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(A+B)

30 4 3 7
25 6 5 11
20 9 8 17
15 13 12 25
10 17 15 32
 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.
 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)
 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
 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.

• Consumer’s income must remain the same.
• The price of the related commodities should not change.
• The commodity should be a normal commodity
 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.
 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 radio’s 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.
Factors affecting Elasticity of Demand
1. Availability of substitutes
2. Postponement of consumption
3. Proportion of expenditure (needles: inelastic; TV: elastic)
4. Nature of the commodity (necessity vs. luxury)
5. Different uses of the commodity (paper vs. ink)
6. Time period (elastic in the long term)
7. Change in income (necessaries: inelastic)
8. Habits
9. Joint demand
10.Distribution of income
11.Price level (very costly & very cheap goods: inelastic)
 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”
 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.
 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 elasticity’s 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.
Generally, above mid-point M of any straight line, demand
is elastic, with ED >1. At Midpoint, demand is unit-
elastic, with ED = 1, Below the midpoint, demand is
inelastic, with ED<1 (Geometric point method)

ED>1

ED=1

ED<1
 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.
 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.
 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.
 Methods of measurement of
Elasticity
1. 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

TO=TQ * P ; where,
TO=total outlay; TQ=total quantity; P=price of the commodity

3. Geometric (Point) method – at any given point on the curve

= lower segment of demand curve
upper segment of demand curve