CHAPTER-II

THEORY OF DEMAND
Introduction:
Economics is the study of the ordinary activities of human life. It is the systematic study of economics activities of human beings. It studies how people earn income and how do they spend it for the fulfillment of their different wants. Economic activities take place because people have to satisfy different wants. In order to satisfy wants they make demand for goods and services. Demand is the powerful market force and is the basis of market, without knowledge of demand; understanding and being successful in business is very difficult, and therefore, its study is of paramount significance to take appropriate decisions.

Meaning of demand:
Demand is that effective desire which can be fulfilled. It means that desires are simply imaginations, they may not be fulfilled. Demand pre-supposes the presence of resources and the willingness to part with the resources to satisfy the desires. Demand is the desire for a commodity or service backed by willingness to spend and ability to pay. Demand is the quantity that consumers demand at alternative prices during a given period of time. It is always expressed in relation to a certain quantity, time and price.

Definitions of demand:
According to Bobber, demand means 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. According to Benham, 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 Hibdon, demand means the various quantities of goods that would be purchased per time period at different prices in a given market.

Features of demand:
1. Demand depends upon utility of the commodity. A consumer is rational

and demands only which provide positive utility. 2. Demand means effective demand i.e. demand for commodity or desire to own a commodity should always be backed up by purchasing power and willingness to spend. 3. Demand is a flow concept. It is always expressed as so much per unit of time. 4. Demand is a relative term. It is always expressed in relation to certain quantity, time and price. 5. Demand means demand for final consumer goods. 6. Demand is the desired quantity. It shows consumers wish or need to buy the commodity.

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Determinants of demand:
The decision of a household to buy a commodity is influenced by a number of factors. Demand is a multivariate relationship, i.e. it is determined by many factors simultaneously. The following are the most important factors which affect demand.

1.Price of Commodity:
The price of a commodity is the most important factor which determines demand. Other factor being same, demand for the commodity entirely depends upon its price. The price of a commodity and its demand are inversely related. It implies that a rise in the price of a commodity brings in the fall in demand and a fall in the price of a commodity leads to rise in its demand. This of demand is called Price Demand.
2. Price of related goods:

The demand for a commodity depends upon the price of related goods when the other things remain same. Related commodities are of two types:

a.

Complementary goods:

Complementary goods are those goods which are consumed simultaneously. One good has no utility in the absence of another related good. For example, car and petrol, food and water etc., are complementary goods. Change in the price of one good affects the demand of the other commodity. The relationship between price of one good and demand of another good is inverse or negative. The demand curve would be downward sloping demand curve.

b.

Price of Substitutes:

Substitutes or competitive goods are those goods that can be substituted for each other. In other words, consumption of one good can be replaced can be replaced by another. For example, a motor cycle can replace scoter, coffee and tea etc. Change in the price of one good affects the demand of the other commodity. The relationship between price of one good and demand of another good is direct or positive relationship. The demand curve would be upward sloping demand curve.

3.Income of the Consumer:

Demand for the commodity depends upon the level of money income of the consumer. Ordinarily, with the increase in the consumers income their demand for goods increases. However, this may not be true always. In order to see the impact of change in income on demand for a commodity we have consider three types of commodities:

a. Necessities :
Necessities occupy a high order of priority in a consumers budgetary expenditure. As the income of the consumer, the demand for necessities also increases in the beginning and becomes income inelastic (constant) thereafter. The demand curve is positively relatively inelastic and becomes perfectly inelastic after certain point.

b. Comforts and luxuries:

Demand for comforts and luxuries are positively related to income. As the money income of the consumer increases, the demand for comforts and
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luxuries also increases. Demand for cars, air-conditioners, high quality cloth and garments etc, increases with the increase in consumers income. The demand curve is positively relatively elastic.

c. Inferior goods:
Demand for inferior goods is inversely related to income. At a very low level of income, it is possible that demand for inferior goods may increase with increase in the income of the consumer. But beyond a certain level of income, the demand for inferior goods decreases with the increase in the income. It is so because increased income makes a consumer better off than before and the consumer starts substituting a superior good to inferior good, As a result, the demand for inferior good declines. The demand curve of an inferior is backward sloping demand curve. The above mentioned relationship between income and quantity demanded is called income demand.
4. Tastes and preferences of consumer:

Other thing remaining same, demand for a commodity depends upon consumers tastes and preferences. The terms tastes and preferences embrace all the non-monetary determinants o demand, viz, age , family composition, community size, occupation, fashion, rationality, etc. these factors, more or less, remain relatively stable for large body of consumers, and hence are bracketed together as such. Any change in tastes, when it occurs, shall have a direct bearing on the demand for affected commodities. A positive change in tastes shall lead to an increase in demand and negative change in tastes shall lead to a decrease in demand.
5. Consumer expectations about future price:

If consumer expectation about future is rise in prices then demand rises in the present and future expectation is fall in the prices then demand falls in the present.

6.Demographic factors: a. Size of population:

Ordinarily, larger the size of population of a country, region or family, more will be the demand for commodities. Size of population determines the number of consumers and number of consumers has a direct bearing on demand for commodities.

b. Composition of population:
If the number of children is large, demand for toys, biscuits, sweets, baby-foods, etc., will be large, similarly, if there are more old people in a region, goods such as spectacles, sticks, artificial teeth, etc., will be more in demand.
7. Income or wealth distribution:

While equitable distribution of income in the community leads to an increase in demand, an unequal distribution of income brings a fall in the quantity demanded.

8.Sociological conditions:
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Consumers purchases are also influenced by such sociological factors as class, groups family background, education, marital status, age and place of residence- particularly urban or rural.

9.Weather conditions:
Changes in weather conditions also influence consumers demand. For example, a sudden rainfall on a hot summer day brings down the demand for ice. Prolonged cold-spell tends to push up the demand for firewood, room heaters, etc.

10.

Advertisement effect:

Advertisement is informative in nature. Advertisement brings in the awareness about the commodities and services in the minds of consumers. This awareness affects the demand of the commodities.

Law of Demand:
The law of demand expresses the functional relationship between price and quantity demanded. Price and demand are inversely related, rise in the price of a commodity brings fall in its demand and fall in price of a commodity leads to rise in its demand. According to Marshall there is inverse relationship between price and demand. Other things being same if price of a commodity falls, the quantity demanded of it will rise or extend, and if price of the commodity rises, its quantity demanded will decline or contract.

Assumptions:
1. No change in Income. 2. No change in the tastes and preferences of the consumer. 3. Price of related goods remains constant. 4. Commodity should be a normal commodity. 5. No change in population size and composition. 6. No expectations of future changes in prices of commodity in question or study.

Features of Law of demand:

1.There is functional relationship between price of a good and quantity demanded of that good. 2.There is definite inverse relationship between the price of the good and the quantity demanded of that good. 3.The demand curve slopes downwards from left to rightwards.

Demand Schedule:
Demand schedule is tabular presentation showing the different quantities of a good that buyers are willing to buy at different prices during a given period of time. If refers to the response of quantity demanded to change in price of a commodity. The law of demand can be illustrated with the help of the demand schedule and the demand curve. Demand schedule and curve may be two types:

1.Individual demand schedule:

An individual demand means quantity demanded of a commodity by an individual consumer at various prices per time period.

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Price of X (Rs.) Quantity Demanded of X 1 50 2 40 3 30 4 20 5 10 This above table shows an inverse relationship between price and quantity demanded, if other things being equal.

2.Market demand schedule:

Market demand schedule is the aggregate of the quantities demanded by all consumers in the market at different prices per time period. When we add the individual demands for various schedules we get market demand schedule. Price of X Rs. CONSUMERS Total market demand (A+B+C) A B C 1 50 40 10 100 2 40 35 5 80 3 30 30 3 63 4 20 25 2 47 5 10 20 1 31 It indicates that market demand also inverse relationship between price and quantity demanded.

Factors Affecting Individual and Market Demand: Individual demand Market demand
1. Price of a good 1.Price of a good 2. Price of related goods 2.Price of related goods 3. Income of the consumer 3.Income of the consumer 4. Tastes and preferences of the 4.Tastes and preferences of the consumer consumer 5. Advertisement 5.Number of consumers in the market 6.Distribution of income 7.Age and gender of population 8.Sociological conditions 9.Weather conditions 10. Advertisement.

Demand Curve:
Demand Curve is a graphic presentation of quantities of good or commodity demanded by the consumer at various possible prices in a period of time. Graphical presentation of demand schedule is known as demand curve. Both Individual and market demand curves slopes downward from left to right indicating an inverse relationship between price and quantity demanded. Market demand curve is horizontal summation of individual demand curves. The law of demand is a qualitative statement because it explains trend not exactness of demand for the commodities.

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Why Demand curve slopes downwards or rationale for Law of Demand.

1. Substitution effect: When the price of a commodity falls, it becomes relatively cheaper than other substitute commodities. This induces the consumer to substitute the commodity whose price has fallen for other commodities, which have now become relatively expensive. As result of this substitution effect, the quantity demanded of the commodity, whose price has fallen, rises. 2. Income Effect or Real Income effect: When the price of a commodity falls, the consumer can buy more quantity of the commodity with his given income, as a result of a fall in the price of the commodity, consumers real income or purchasing power increases. This increase induces the consumer to buy more of that commodity. This is called income effect. 3. Number of consumers: When price of a commodity is relatively high, only few consumers can afford to buy it, and when its price falls, more numbers of consumers would start buying it because some of those who previously could not afford to buy may now buy it. Thus, when the price of a commodity falls, the number of consumers for the commodity increases and this also tends to raise the market demand for the commodity. 4. Law of diminishing Marginal Utility: The law of demand is based on the law of diminishing marginal utility which states that as the consumer purchases more and more units of a commodity, the utility derived from each successive unit goes on decreasing. It means as the price of commodity falls, consumer purchases more of that commodity until the consumer reaches the saturation point i.e. until his or her marginal utility becomes zero for the commodity. 5. Several uses: Some commodities can be put to several uses which lead to downward slope of demand curve. When the price of such commodities goes up they will used for important purposes, so their demand will limited. On the other hand, when the price falls, the commoditys demand extends.

Exceptions to the Law of demand:

1. Conspicuous goods or Articles of Distinction:

Some consumers measure the utility of a commodity by its price i.e., if the commodity is expensive they think that it has got more utility. As such, they buy its less of this commodity at low price and more of it at high price. Diamonds are often given as an example of this case. The higher the price of diamonds, higher is the prestige value attached to them and hence higher is the demand for them. 2. Giffen Goods: Giffen goods are those goods, which are considered inferior by consumers, and examples of such goods are low quality of rice and wheat. Sir Robert Giffen, found that when price of bread increased, the British workers purchased more bread not less of it. This was something against the law of demand. Why did this happen? The reason given for this is that when the price of bread went up, it
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caused such a large decline in the purchasing power of the poor people that they were forced to cut down the consumption of meat and other more expensive foods. Since bread, even when its price was higher than before was still the cheapest food article; people consumed more of it and not less when its price went up. Such goods which exhibit direct price demand relationship are called Giffen goods. In case of a Giffen good, demand curve will be backward falling to the left. 3. Conspicuous necessities: The demand for certain goods is affected by the demonstration effect of the consumption pattern of a social group. These goods, due to their constant usage, have become necessities of life. For example the prices of television sets, refrigerators, coolers, cooking gas etc. have been continuously rising, but their demand does not fall. 4. Future expectations about prices: It has been observed that when price are rising, households expecting that the prices in the future will be still higher, tend to buy larger quantities of commodities. For example, when there is an expectation that prices of share would rise in future, and then demand for the same rises at present. 5. Demonstration effect: Sometimes, a section of society tends to imitate the consumption patterns of higher income groups. In this case, law of demand gets violated because demand more of that commodity which higher income group people are buying, even at higher prices. 6. Ignorance effect: Generally, it is assumed that a household has perfect knowledge about price and quality of goods. However, in practice, a household may demand larger quantity of a commodity even at a higher price because it may be ignorant of the ruling price of the commodity. 7. Emergency : In case emergencies like war, curfew, drought, famine etc, the law of demand does not hold. In such situations, there is general insecurity and fear of shortage of necessities. Hence, consumers demand more goods even at higher prices. 8. Snob appeal: Certain items of historical, cultural or sociological importance have a snob appeal. These are classic pieces of art. More are demanded at higher prices.

Analysis of change in demand:

1. Extension and contraction in demand:

A movement along the demand curve is caused by a change in the price of the commodity, other thing remaining constant. It is also called change in the quantity demanded of the commodity. Movement is always along the same demand curve, i.e. no new demand curve is drawn. Movement along demand can bring about: A. Expansion or Extension of demand, or B. Contraction of demand
A. Expansion or Extension of demand:

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Expansion or extension of demand refers to rise in demand due to fall in price of the commodity. A downward movement along the demand curve represents extension of demand.
B. Contraction of demand:

Contraction of demand refers to fall in demand due to rise in price of commodity. An upward movement along the demand curve represents contraction of demand.

2. Increase and decrease in demand:

A shift of demand curve is caused by changes in factors other than price of the commodity. The factors are price of related goods, consumers income, consumers taste and preferences etc, a change in any of these factors causes shift of demand curve. It is also called change in demand. In a shift, a new demand curve is drawn. A shift of the demand curve can bring about: A. Increase in Demand, or B. Decrease in demand
A. Increase in Demand: It refers to more demand at a given price or same quantity demanded at a higher price. A rightward shift in demand curve represents increase in demand.

Causes of increase in demand: 1.Rise in price of substitutes 2.Fall in price of a complementary good 3.Rise in income 4.Taste and preference becoming stronger in favour of the commodity 5.Increase in population B. Decrease in demand It refers to less quantity demanded at a given price or same quantity demanded at a lesser price. A leftward shift in demand curve represents increase in demand. Causes of Decrease in Demand: 1.Fall in price of substitutes 2. Rise in price of a complementary goods 3.Fall in income 4. Taste and preferences becoming towards the commodity 5.Decrease in population

Difference between expansion of demand and increase in demand Expansion in demand Increase of demand
1. It refers to movement along the demand curve. 2. In this, the consumer moves downwards on the same demand curve. 3. It is due to fall in the price of the commodity. 4. Expansion of demand is defined as rise in demand due to fall in the price of commodity.
General Economics 1. It refers to shift of a demand

curve. 2. In this, there is a rightward shift of demand curve. 3. It is due to shift factors. 4. Increase in demand is defined as the rise in demand at the same price of the commodity.

2.8 Theory of Demand, Consumer Behaviour and supply.

Difference between contraction of demand and decrease in demand contraction in demand Decrease of demand
1. It refers to movement along the demand curve. 2. In this, the consumer moves upwards on the same demand curve. 3. It is due to rise in the price of the commodity. 4. Contraction of demand is defined as fall in demand due to rise in the price of the commodity. 1. It refers to shift of a demand curve. 2. In this, there is a leftward shift of demand curve. 3. It is due to shift factors. 4. Decrease in demand is defined as the fall in demand at the same price of the commodity.

Demand function:
The relation between the consumers optimal choice of the quantity of a good and its price is called function. Demand is the combined effect of all the determinants of demand, it can expressed in a mathematical form known as demand function. Qd =f (Px, I, Pr, T, A etc) Qd = Quantity demanded. Px = Price of commodity x. I = Income of the consumer. Pr = Price of related goods. T = Tastes and preferences of the individual consumer. A = Advertising effect on consumer.

Linear Form of demand function:

Qd = f ( Px) , If other factors except price are constant. Qd = a- b Px Qd = Quantity demanded. a = constant parameter signifying initial demand irrespective of the price. b = a constant parameter which represents a functional relationship between price and demand. b having a minus sign a negative function. It implies that the demand for a commodity is a decreasing function of its price p. In fact it measures the slope of the demand curve. b indicates that the demand curve is downward sloping.

Elasticity of Demand:
Elasticity of demand may be defined as the degree of responsiveness of quantity demanded of a good to a change in the variable on which demand of good depend, the variable may be the price of the commodity, Income of the consumer, or the prices of related goods or commodities.

Types of Elasticity of demand:

1. 2. 3. Price Elasticity of demand. Income elasticity of demand. Cross elasticity of demand.

1. Price Elasticity of demand:

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Price elasticity of demand measures the responsiveness of demand of a good to a change in its price. Degrees of price elasticity: 1. Perfectly elastic demand 2. perfectly inelastic demand 3. Unitary elastic demand 4. Relatively elastic demand 5. Relatively inelastic demand.
1. Perfectly elastic demand (Ed= ):

When the demand for a commodity rises or falls to any extent without any change in price, the demand for the commodity is said to be perfectly elastic. It exists under perfect competition, which is an ideal and imaginary situation. It means demand of commodity is perfectly flexible in case of perfectly elastic demand. In perfectly elastic demand, the demand curve will be horizontal.

2.More than unitary elastic demand (Ed>1):

When a change in price leads to a more than proportionate change in demand, the demand is said to be elastic or more than unit elastic, the coefficient of elasticity of demand is greater than unity. The demand curve is downward sloping and flatter. It exists in case of luxuries.
3. Unitary elastic demand (Ed=1):

When the percentage change in demand of a commodity is equal to percentage change in price, the demand for commodity is said to be unitary elastic. The elasticity is unitary elastic. The unitary elastic demand curve is a straight line forming 45o angles with both the axes. It is also a rectangular hyperbola. It exists in case of normal goods.

4.Less than unit elastic demand (Ed<1):

When percentage change in demand of a commodity is less than percentage change in price of the commodity, the elasticity is relatively inelastic. The slope of an inelastic demand is steep. It exists in case of necessities like food, fuel, etc.

5.Perfectly inelastic demand (Ed=0) :

When the demand of a commodity does not change as a result of change in its price, the demand is said to be perfectly inelastic. The perfectly inelastic demand curve is a vertical line parallel to y-axis. It exists in case of essentials like life savings drugs.

Determinants or factors determining elasticity of demand:

1. Nature of the Commodity:

(a) Necessaries of life. For necessaries of life the demand is inelastic because people buy the required amount of goods whatever their price. (b) Conventional Necessaries. The demand for conventional necessaries is less elastic or inelastic. People are accustomed to the use of goods, like intoxicants which they purchase at any price. (c) Luxury commodities.
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The demand for luxury is usually elastic as people buy more of them at a lower price and less at a higher price. Number of Uses: Elasticity of demand for any commodity depends on its number of uses. Demand is elastic; if a commodity has more uses and inelastic if it has only one use.
2.

Substitutes: Demand is elastic for those goods which have substitutes and inelastic for those goods which have no substitutes.
3.

Raw Materials and Finished Goods: The demand for raw materials is inelastic but the demand for finished goods is usually elastic.
4.

Postponement: Demand is more elastic for goods the use of which can be postponed. Demand is inelastic for those goods the use of which is urgent and therefore, cannot be postponed.
5.

Price Level: The demand is elastic for moderate prices but inelastic for lower and higher prices.
6.

Income Level: The demand is inelastic for higher and lower income groups and elastic for middle income groups.
7.

Habits: Habits usually have inelastic demand.

8.

Methods of Measurement of price elasticity:

1.

2.
3. 4.

5.

Total expenditure method. Proportionate method. Point elasticity of demand method. Arc or average elasticity of demand method. Revenue method.

1. Total expenditure or outlay method:

Total outlay or expenditure by consumers is the revenue earned by the sellers. When price of a good changes, it brings about a change in the total revenue of the seller. The change in the total revenue (expenditure for the consumer) depends upon the price elasticity of demand. When price of a commodity changes three situations can take place:
(a) E = 1: When as a result of a change in price, the total expenditure

remains the same, the commodity is said to have a unitary elastic demand.

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(b)E>1: When as a result of a rise in price, the total expenditure on the

commodity falls and as a result of a fall in price, the total expenditure rises, the commodity is said to have more than unit elastic demand.
(c) E<1: When as a result of a rise in price, the total expenditure on the

commodity rises and as a result of a fall in price the total expenditure falls, the commodity is said to have Less than unitary elastic demand.

Price change and its effect on Total expenditure:

Type s E=1 E<1 E>1 Elastici ty Unitary Inelastic Elastic Price change (P) or Total Expenditure (TE) No change Relation No relation Positive relation between P and TE Negative relation between P and TC

2. Proportionate Method:

method

or

Percentage

Method

or

Ratio

It is measured as percentage change in quantity demanded divided by the percentage change in price, other things remaining equal.
Ed = Percentage Change in Qunatity demanded %Q or Percentage Change in price %P Q P0 Ep = x P Q0

Where Ed = Price elasticity of demand P = Price Q = quantity = Change

3. Point elasticity method:

This is also known as geometrical method. This method is used when we have to find out elasticity at a point on the demand curve. It is a qualitative measure of price elasticity of demand. Elasticity lies between zero and infinity. Ep = Lower Segment on the demand curve ( LS ) Upper Segment on the demand curve (US )

4. Arc elasticity method:

When there is a large change in price and quantity demanded, such that it relates to a stretch over the demand curve, then the percentage formula is modified. It is called arc elasticity. Arc elasticity is defined as the price elasticity of demand between two points on a demand curve. It is also known as average method of measuring price elasticity of demand. In arc elasticity, we use the average of the two prices and quantities figures (original and new). Thus, the formula of measuring arc elasticity of demand is: Q 0 Q1 P 0 + P Q ( P 0 + P1 ) / 2 1 x Ep = x or Ep = Q 0 + Q1 P 0 P P (Q 0 + Q1 ) / 2 1

5. Revenue method:
Revenue method was given by Mrs. Joan Robinson. According to her, elasticity of demand can be measured with the help of average revenue and
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marginal revenue. The formula to measure elasticity of demand can be written as,
Ep =

Where Ed = elasticity of demand, A= Average revenue. M= Marginal revenue.

A AM

Note:
Due to negative relation between price and quantity, we ignore the negative sign and consider only the numerical value of the elasticity.

Importance of price elasticity of demand:

The concept of price elasticity of demand is very useful for monopolists, business firms, government, farmers, international trade and factor pricing. It helps in determination of exact change in price and quantity demanded of the commodity. The various uses of the concept of price elasticity of demand are: 1. To the monopolist: A monopolist is a price maker. He will fix high prices for those commodities which have inelastic demand and low prices for the ones having elastic demand. 2. To the finance minister: The government aims at maximizing tax revenue. Therefore, it levies heavy taxes on those goods which have an inelastic demand less taxes for goods having elastic demand. 3. In factor pricing: A factor with inelastic supply gets higher price compared to a factor whose supply is elastic. 4. International trade: Devaluation of currency helps in increasing the exports of the country because goods become cheaper in the international market. Devaluation is successful only if elasticity of demand for exports is inelastic and for imports is elastic. 5. Paradox of plenty: The paradox of plenty states that a bumper harvest will generally bring poverty to farmers. The reason for this lies in the elasticity of demand for food stuffs. The demand for food products, which is a necessity, is inelastic. An increase in their supply tends to lower price. The lower price does not increase quantity demanded very much due to its inelastic demand.

2.Income elasticity of demand:

Income elasticity if demand shows the degree of responsiveness of quantity demand of a good to a small change in the income of the consumers or customers.

Types of Income Elasticity:

It may be of three types: 1. Positive Ey In case of Normal / Luxury good, there will be positive relation between income and demand because as income increases demand increases and vice versa. Positive income elasticity may be of three types: (a) Ey = 1 (Equal to one) unitary elasticity.
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(b) Ey > 1 (Greater than one) relatively elastic. (c) Ey < 1 (Less than one) relatively in elastic Sometimes its found in necessities. The above elasticities are also called greater than zero.
2. Negative Ey (Ey<0 less than zero):

In case of Inferior Goods, the income elasticity of demand is negative because there will be an inverse relation between income and demand for inferior goods. As income increases demand for inferior goods decreases and vice versa.
3. Zero (Ey = 0) :

In case of Necessaries goods whether income increases or decreases the quantity demanded remains the same. So zero income elasticity is found here.

Methods of measuring income elasticity of demand:

1. Proportionate or percentage or ratio method 2. Arc method

1. Proportionate Method:

method

or

Percentage

Method

or

Ratio

It is measured as percentage change in quantity demanded divided by the percentage change in price, other things remaining equal.
Ed = Percentage Change in Qunatity demanded %Q or Percentage Change in income %I Q I0 EI = x I Q0

Where Ed = Income elasticity of demand I = Income Q = quantity = Change

2. Arc method:

When there is a large change in Income and quantity demanded, such that it relates to a stretch over the demand curve, then the percentage formula is modified. It is called arc elasticity. . In arc elasticity, we use the average of the two Income levels and quantities figures (original and new). Thus, the formula of measuring arc elasticity of demand is: Q ( I + I 1 ) / 2 Q Q1 I + I 1 Ep = x x or Ep = I (Q + Q1 ) / 2 Q + Q1 I I 1
3. Cross elasticity of demand:

Cross elasticity of demand refers to degree of responsiveness of demand for one commodity in response to the change in the price of another commodity in the market for the product.
1. Positive Ec :

In case of substitute goods for e.g., Tea and Coffee, there is positive relation so positive cross elasticity is found here. Positive elasticity lies between 0 and .
2. Negative Ec:

In case of complementary goods like Car and Petrol, there is inverse relation, so negative cross elasticity is found here. Negative elasticity lies between 0 and .
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3. Zero Ec :

When we examine the relation between two goods which are not having any relation it can be called as Zero Cross Elasticity. For example price of cement and demand for school bags.

Methods of measuring cross elasticity of demand:

3. Proportionate or percentage or ratio method 4. Arc method

3. Proportionate Method:

method

or

Percentage

Method

or

Ratio

It is measured as percentage change in quantity demanded divided by the percentage change in price, other things remaining equal.
Ed = Percentage Change in Qunatity demandedof X Percentage Change in price of Y x Py 0 Q Ep = x y Qx 0 P or %Qx %Py

Where Ed = Income elasticity of demand P = Price Q = quantity = Change

4. Arc method:

When there is a large change in price of one commodity and quantity demanded of another commodity, such that it relates to a stretch over the demand curve, then the percentage formula is modified. It is called Arc elasticity. In Arc elasticity, we use the average of the two price levels of one commodity and quantities figures (original and new) of another commodity. Thus, the formula of measuring cross Arc elasticity of demand is:
Ep = Qx ( Py 0 + Py1 ) / 2 x Py (Qx 0 + Qx1 ) / 2 or Qx 0 Q1 Py 0 + Py1 Ep = x Qx 0 + Q1 Py 0 Py1

Consumer Behaviour
Introduction:
The law of demand states that quantity demanded of a commodity is inversely related to its price. The theory of demand attempts to explain why law of demand operates. In other words, the theory gives the logical basis of the law of demand from the analysis of consumers behaviour. The various theories or approaches of study consumer behaviour are as follows: 1. Cardinal utility theory of consumer behavior and, 2. Ordinal utility theory of consumer behavior, popularly known as the indifference curve analysis.

Concept of Utility:
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When the consumer consumes or buys a commodity, he derives some benefit in the form of satisfaction of a certain want. This benefit or satisfaction experienced by the consumer is referred to by economists as utility. Utility is something experienced by the consumer about the given commoditys significance relating to its want-satisfying power. Utility is the ability and capacity of a commodity or a service to satisfy a human want. Utility is want satisfying power in the commodity or service. Characteristics of utility: 1. Utility depends upon the intensity of consumers desire or want. 2. Utility is a relative term. In other words, It changes from person to person, place to place and time to time. 3. Utility has no social or ethical implication. 4. Utility is subjective phenomenon and cannot be quantified objectively. 5. Utility is different from usefulness. 6. Utility can be expected satisfaction or realized satisfaction. Utility as expected satisfaction to consumer is represented by willingness to spend money on a stock of commodity by the consumer which has the capacity to satisfy his/her want. Expected satisfaction takes place when the commodity has not been bought but the consumer is willing to buy it. Realised satisfaction is the actual utility derived by the consumer after consuming the good or service.

Cardinal Utility theory of consumer behaviour

The Marshallian approach of the theory of consumer behaviour is based on the following postulates. 1. Concept of utility and its cardinal (numerical) measurement. 2. The law of diminishing marginal utility; and 3. The law of Equi-marginal utility. 4. Concept of consumer surplus

Basic Concepts and Postulates of the Marshallian Cardinal Utility Approach:

1. Cardinal Measurement of Utility:

Marshall assumes cardinal measurement of utility. Cardinal measurement is a numerical expression. Marshall believed that utility could be measured in numerical terms in its own units called Utils. To him, utility of commodity is quantifiable, hence measurable numerically. 2. Total Utility: The concept of total utility and marginal utility are the basic concepts in the cardinal measurement of utility. Total utility means total satisfaction experienced or attained by the consumer regarding all the units of a commodity taken together in consumption or acquired at a time. It is the sum of utility derived form different units of commodity consumed by a consumer. TU = MU or TU = MU1 + MU2 + MU3MUn etc. Marginal Utility: Marginal utility is the extra utility obtained from an extra unit of any commodity consumed or acquired. Marginal utility may be defined as the satisfaction derived by a consumer from the consumption of an additional unit of a particular good. MU = TU / Qty. consumer or Tun Tun-1.
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Units of apples Consumed 1 2 3 4 5 6 7

Total utility 10 18 24 28 30 30 28

MU is zero, TU maximum MU is negative, TU decreases The utility schedule provides the following information: 1. As the consumer has more and more of the good, the total utility increases at a diminishing rate and marginal utility gradually declines. 2. When no unit of x is consumed, total utility is zero and marginal utility is maximum. 3. When total utility is maximum, marginal utility is zero, it indicates saturation point. 4. If consumer is rational, he will stop at 6 units. This is because if he consumes more than 6 units, then total utility will decline and marginal utility will become negative. At that point the commodity will give disutility. 5. If any one of the schedule is given the other can be easily derived. 6. The utility schedule illustrates the law of diminishing marginal utility which states that as consumer has more and more of a good, the marginal utility derived from the good diminishes.

Margin al Utility 10 8 6 4 2 0 (-2)

Analysis MU decreases increases and TU

Relation between total utility and marginal utility curves:

1. Total utility curve starts from the origin, increases at a decreasing rate,

reaches a maximum level and then starts falling. 2. Marginal utility curve is the slope of total utility curve. 3. When total utility curve is maximum, marginal utility curve is zero, which indicates saturation point. 4. When total utility curve is rising, marginal utility curve falls. 5. When total utility curve is falling, marginal utility curve becomes negative. 6. The falling of marginal utility curve exhibits the law of diminishing marginal utility.

Marginal utility Analysis:

Alfred Marshall explains how a consumer spends his income on different goods and services so as to attain maximum satisfaction. Basic Assumptions of Marshallian Utility Analysis: The basic premises underlying the Marshallian theory of demand may, however, be enlisted as under: 1. The cardinal measurability of utility: - According to this theory, utility is measurable and quantifiable entity in the terms of money, which a person is ready to pay

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Constancy of the MU of money: The MU of money remains constant throughout when the individual is spending money on a good. 3. The hypothesis of independent utility: - It means independent unit have independent utility and it ignores complementarily between goods. 4. Rationality: It is assumed that consumer is rational while spending money. He is not making impulsive purchases. 5. Additive Utility: it is assumed that utility can be added to total utility.
2.

1.

The Law of Diminishing Marginal Utility:

The law of Diminishing Marginal Utility (DMU) lies at the center of the cardinality approach. The law of diminishing utility or diminishing marginal utility is based on the satiability characteristics of human wants, that a single want taken separately at a time, can be fully satisfied. Assumptions of the Law: The law of diminishing marginal utility is conditional. Its validity is subject to the following assumptions or conditions: Taste, income of the consumer remains unchanged. The units of the commodity are identical in all aspects i.e. Homogeneity. There is no time gap between the consumption i.e. Continuity in consumption. Reasonability. Constancy. Rationality. Constancy of Marginal Utility of Money. Cardinal Measurement of Utility. Statement of the Law: According to Alfred Marshall, Other things being equal, as the quantity of commodity consumed or acquired by the consumer increases, the marginal utility of the Commodity tends to diminish. In mathematical terms, the law implies a decreasing functional relationship between the quantity of a commodity consumed and marginal utility derived. This means each additional unit of consumption adds relatively less and less to the total utility obtained by the consumer. Law of Diminishing Marginal Utility (DMU) states that after consuming a certain amount of a good or service, the marginal utility from it diminishes as more and more of it is consumed. As a consumer consumes successive units of a commodity, its total utility increases up to a certain level but at a diminishing rate, then it becomes constant and starts decreasing gradually. The laws of DMU can be understood with the help of following table and figure Units of apples Total Marginal consumer utility Utility 1 10 10 2 18 8 3 24 6 4 28 4 5 30 2 6 30 0 7 28 (-2)
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In the table as MU decreases, TU increases and when MU is zero then TU is maximum. This is called Saturation point and after the saturation point when MU becomes negative then TU decreases.

Limitations of the law of diminishing marginal utility:

Cardinal measurement of utility is not possible. Marginal utility of money (MUm) does not remain constant. Law is applicable if there are identical units. Law is applicable if there is no change in habits, taste & preferences and income of the consumer. 5. Law is applicable if there is standard unit sufficient unit-not more not less. 6. Law is applicable if there is no time gap or interval between the consumption. 7. The law may not apply to some articles like gold, money, music and hobbies. 8. The shape of utility curve may be affected by the presence of substitutes or complementary goods.
1. 2. 3. 4.

2.The Law of Equi- Marginal Utility or the Proportionality Rule: The law of equi-marginal utility was propounded by a French engineer Gossen. The law of Equi-marginal is the logical extension of the law of diminishing marginal utility. The law of diminishing marginal utility applies in case of a single commodity however in reality consumers consume a number of commodities at a given time. Therefore, the extension of law of diminishing marginal utility is done to explain realistic situation, the extended law is known as the law of Equi-marginal utility. It is also known as Gossens second law, the law of maximum satisfaction, the law of rational consumer and the law of substitution.

Statement of Law:
According to Alfred Marshall, Other things being equal, a consumer gets maximum total utility from spending his given income, when he allocates his expenditure to the purchase of different goods in such a way that the marginal utilities derived from the last unit of money spent on each term of expenditure tends to be equal. The law essentially means, the consumer maximizes his satisfaction when he obtains equi-marginal utilities from all the goods purchased at a time. The Proportionality Rule: When the ratios of marginal utility to prices of different goods are equalized with the given marginal utility of money income of the consumer, total utility so derived would be the maximum.

Assumptions of the Law:

The law of Equi-marginal utility is based on the following assumptions: 1. The consumer is rational economic man who seeks maximum total satisfaction. 2. Utility is measurable in cardinal terms. 3. The consumer has given scale of preferences for the goods in consideration. He has perfect knowledge of utilities derived. 4. Prices of goods are unchanged. 5. Income of the consumer is fixed. 6. The marginal utility of money is constant. The law of equi-marginal utility is based on the following assumptions.
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Limitations of the Law:

The law has been subject to certain criticisms and it also has certain limitations. These are outlined below: 1. The law is based on unrealistic assumptions. It being an extension of the law of diminishing marginal utility, it, too, involves all the unrealistic ceteris paribus assumptions and conditions such as homogeneity, continuity, constancy, etc., on which the law of diminishing marginal utility is based. 2. The Proportionality rule presumes cardinal measurement of utility, but it is not a realistic approach. 3. The law is cannot be applied to indivisible goods. On practical grounds, it looks ridiculous to equate utility of a TV set to coffee per rupee. 4. The consumer does not behave rationally all the time. Quite often, his behaviour is influenced by habit, social customs, fashions, advertising, propaganda, occasional requirements etc., 5. It has also been pointed out by many critics that it is wrong to assume that marginal utility of money will remain constant. Actually, when money is spent, the remaining units of money will tend to have a greater marginal utility. Thus, here there is a backward operation of the law of diminishing marginal utility. CONSUMERS SURPLUS Dupuit originated the concept of consumers surplus. But it was Marshall who popularized it by presenting it in a most refined way. Definition: Consumers Surplus (CS) is the difference between the total amount of money the consumer would have been willing to pay for a quantity of a commodity and the amount he actually had to pay for it. Consumer surplus is the difference between maximum price a person is willing to pay for a goods and its market price or say it is the difference between what a consumer is ready to pay and what he actually pays. CS = what a consumer is ready to pay What he actually pays. What a consumer ready to pay is taken in terms of MU and what he actually pays is taken in terms of Price. So, CS = MU P The concept is derived form the law of diminishing utility. As the consumer purchase more units of a good its marginal utility goes on diminishing. The consumer is in equilibrium when MU = P. But for the proceeding units, the MU > P he actually pays for them. This is because the price is constant for him. Schedule showing marginal utility, price and consumer surplus: No. of Marginal Price (Rs.) Consumer units Utility (Ready Actually Pays (in Surplus (in to pay) Rs.) Rs.) 1 30 20 10 2 28 20 8 3 26 20 6 4 24 20 4 5 22 20 2 6 20 20 0 (MU = P) 7 18 20 -----General Economics

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In the above table and figure consumer is in equilibrium at the 6 th unit because here MU = P i.e., 20 and in this way when he will consume 6 units then he is total ready to pay 150 (30+28+26+24+22+20) but total amount actually paid is 120 (20+20+20+20+20+20), So total consumer surplus will be Rs. 150-120 = 30, which is maximum. Assumptions: Marshall bases his concept of consumers surplus on the following assumptions: 1. Cardinal Measurement of Utility. 2. Diminishing Marginal Utility Limitations: 1. Consumers surplus cannot be measured because it is difficult to measure the MU 2. In the cases of necessaries, the marginal utilities of the earlier units are highest, In such case the consumers surplus is always infinite. 3. CS is affected by the availability of substitutes. 4. There is no simple rule of deriving the utility of articles of prestige value (e.g. diamonds) 5. Marginal utility of money does not remain constant and this assumption is unrealistic 6. It is a Hypothetical and illusory Concept.

Importance of the Concept of Consumer Surplus:

The theoretical and practical importance of the concept of CS may be pinpointed as under: 1. It Clarifies the Paradox of Value. 2. It gives assessment of enjoyment of real income. 3. Importance to the Monopolist. 4. Importance in Taxation Policy. 5. Importance in Welfare Economics. 6. Importance of International Trade.

Limitations of the Marshallian Approach:

Following are the major limitations of Marshalls marginal utility approach. 1. Untenable cardinal measurement of utility 2. Wrong conception of additive utility 3. Marshalls separate measurement of utility of each commodity is not always correct 4. Constancy of marginal utility of money: 5. Inapplicability in case of indivisible or bulky goods: 6. Inadequate explanation of Giffen goods: 7. Limited scope 8. No empirical test.

Indifference curve analysis:

Indifference Curve Analysis or Ordinal Utility Approach Indifference curve analysis is an alternative approach to the theory of demand. Indifference curves have been devised to represent the ordinal measurement of utility. The Concept of Scales of Preferences: Ordinal Utility

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Professor Hicks introduced the concept of Scale of Preferences of a consumer as the base of indifference curve technique. Hicks discarded the Marshallian assumption of cardinal measurement of utility and suggested ordinal measurement. Ordinal measurement implies comparison and ranking without quantification of the magnitude of differences of satisfaction enjoyed by the consumer. In the ordinal sense, utility is viewed as the level of satisfaction rather than the amount of satisfaction. The level of satisfaction is relatively comparable but not quantifiable. Hicks mention that it is possible to observe from the experience and by experiment the preferences which consumers display when choosing between different goods. He, however, asserts that people are not interested in any one commodity at a time as assumed by the marginal utility approach. Generally consumers are at a time, interested in a number of commodities, and the satisfaction result from their combinations. Besides, they can always compare the level of satisfaction yielded by one particular combination of goods with that of another combination. In fact the level of satisfaction is an increasing function of the stock of goods. A larger stock of goods, apparently, yields, and a higher level of satisfaction than a smaller stock of goods would yield. A rational consumer, obviously, prefers that stock or combination of goods which yields a higher level of satisfaction than the one which yields a lower one. Thus, the consumer can conceptually arrange goods and their combinations in the order of their significance or the level of satisfaction. This Conceptual (mental) arrangement of combination of goods and services set in the order of the level of significance is called the scale of preferences. Scale of preference: The conceptual or mental arrangement of combination of two goods and services set in the order of the level of significance is called the scale of preference. The indifference curve is a geometrical device representing all such combinations of two goods yielding equal satisfaction of a particular level. An indifference curve represents different combinations of two goods that give the same level of satisfaction. Any point on a single indifferent curve indicates the same level of satisfaction as any other point on the same curve. Each indifference curve indicates only one level of satisfaction. Higher the indifference curve, higher is the level of satisfaction, and lower it is, lower will be the level of satisfaction. Definition of indifference Curve: According to Hicks, It is the locus of the points representing parts of quantities between which the individual is indifferent and so it is termed as an indifference curve. According to Meyers, An indifference curve may be defined as a schedule of various combinations of goods which will be equally satisfactory to the consumer concerned. Assumptions: 1. Rational Behaviour: The behaviour of the consumer will be rational. It means that the consumer will like to get maximum satisfaction out of his total income.
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2. Ordinal Utility: Consumer will determine his preferences on the basis of

3.

4.

5.

6.

7.

satisfaction derived from different goods or combinations. Utility can be expressed in terms of ordinal numbers i.e. first, second so on. Diminishing marginal rate of substitution: It means as the stock of commodity increases with the consumer, he will substitute if for the other commodity at a diminishing rate. Non-Satiety: A consumer does not like to possess any good more than the required quantity. He does not reach the level of satiety. He prefers more quantity if a good to less quantity. Consistency in selection: There is consistency in the behaviour of the consumer. It means that at a given time a consumer prefers. A combination to B combination. Then at another time, he will not prefer B combination to A combination (A>B=B>A). Transitivity: It means if a consumer prefers A combination to B combination and B combination to C combination , he will prefer A Combination to C Likewise if he is different to A and B and he is also indifferent toward B and C then he will also be indifferent to A and C. Independent Scale of Preference: Consumers scale of preference is independent of his income and price in the market.

Indifference Schedule: The indifference curve schedule may be defined as a schedule of various combinations of two goods that will be equally satisfactory to the individual concerned. In other words, an indifference schedule is a list of combinations to which the consumer is indifferent. Indifference Curve: An indifference curve is the locus of the combination of two goods that are equally satisfactory to the consumer or to which the consumer is indifferent. In other words, it is graph of an indifferent schedule. Any point on the curve denotes a particular level of satisfaction. So combination of commodities of X and Y that yields the same satisfaction when joined gives a curve, known as indifference curve. Indifference map: An indifference map may show all the indifference curves which rank preferences of the consumer. These curves are like contour lines on a map which shows all places in the same height above the sea level. Each curve represents equal level of utility. In short; it is a device of ranking of consumer preference. We can show different schedules graphically each with its own curve. Properties of Indifference Curves: 1. Indifference Curves slope from Left Downward to Right. An indifference curve has a negative slope that implies that it slopes downward from left to right. The reason underlying this property is that if the consumer has to stay at the same level of satisfaction, the quantity of one commodity must decrease when the quantity of the other commodity increases. Indifference curves slope from left downward to right means when the amount of one commodity in the combination increases, the amount of other commodity reduces. If for instance the amount of commodity X is increased in the combination and the amount of commodity Y remains unaltered, the consumer

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will prefer new combinations to the original one and two combinations will not lie on the same indifference curve. 2. Indifference Curves are Convex to the Origin. The other property of indifference curves is that they are convex to the origin. It means as we move from left down to the right along the IC, the marginal rate of Substitution between the two commodities goes on diminishing. It has been observed that as more and more of one commodity (X) is substituted for another (Y), the consumer is willing to part with less and less of the commodity being substituted (i.e. Y). This is called law of diminishing marginal (Law of DMRS xy) rate of substitution between X and Y goods.
3. Indifference Curve will not Touch either X-axis or Y-axis.

The indifference curve will not touch either X-axis or Y-axis as we have assumed that the individual is interested in different combinations of two commodities. If it touches either of the axes, it will mean that the consumer is interested in one commodity only.
4. Indifference Curve neither Touches nor intersects Each Other.

Another property of indifference curve is that indifference curves can neither touch nor intersect each other so that only one indifference curve can pass through any one point of the indifference map. 5. Higher indifference Curve represents Higher Level of Satisfaction. An indifference curve which lies above and right to another indifference curve represents a higher level of satisfaction. In other words, the consumer will prefer the combination which lies on a higher indifference curve as compared to the combinations lying on a lower indifference curve.
6. Indifference Curves need that not be parallel to Each Other.

This is because they are not based on the cardinal number system of measurability of utility. Secondly, the rate of substitution between two commodities need not be the same in all indifference schedules. From this it follows that curves may be drawn in any way parallel to each other or otherwise. The only condition is that the two indifference curves should not touch or cut each other. Marginal rate of substitution (MRS): Marginal rate of substitution (MRS) is the rate at which the consumer is prepared to exchange good X and Y. In the following table we can define the MRS of X and Y as the amount of Y whose loss can just be compensated by a unit gaming of X in such a manner that the level of satisfaction remains the same. COMBINATIO X Y MRS N xy A 1 1 -----2 B 2 6 6 C 3 4 2 D 4 3 1 In the above table as good X increases; good Y decreases at a diminishing rate. This is called Law of Diminishing Marginal Rate of substitution between X and Y commodities (Law of DMRSxy).
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Budget line: Budget line shows all those combinations of two goods which the consumer can buy spending his given money income on the two goods at their given prices. A consumer is in equilibrium when he is deriving maximum possible satisfaction from the goods and is in no position to rearrange his purchases of goods. Assumptions: 1. The consumer has a given indifference map. 2. He has fixed money income. 3. Prices of goods are fixed. 4. Goods are homogeneous and divisible. Consumers equilibrium can be understood with the help of IC MAP and BUDGET LINE. To show which combination of two goods x and y the consumer will buy to be in equilibrium we bring his indifference map and budget line together. Thus at the equilibrium point E, MRSxy = MUx Px = MUy Py We can therefore express the condition for the consumers equilibrium in two ways: (i) Price line must be tangent to the indifference curve. (ii) The marginal rate of substitution of good X for good Y must be equal to the ratio between the prices of the two goods.

Supply and Law of Supply Introduction:

Supply is one of the two forces that determine the price a commodity in the market. The study of supply, therefore, is as important as the study of demand. In simple words, supply means the quantity offered for sale in the market. Just as demand for a product is always at a price, supply of a product is also at a price. The supply of a product then varies with the change in price. The supply also depends upon time. Thus supply means the quantity of a commodity offered for sale at a particular price during a given period of time.

Definition:
Supply refers to the quantity of a commodity offered for sale at given price in a given market at a given time. The term supply refers to the amount of a good or service that the producers are willing and able to offer to the market at various prices during a period of time. Supply is a flow. Thus stock is not supply, because supply is the part of stock. S = f (P, Pr, Pf, T, G, E, O)

Determinants Influencing Supply:

1. Price of the product (P): Other things being equal, when price increases supply increase and when price decreases then supply decreases. Thus there is positive relation between price and supply.
2. Price of related goods (Pr):

The supply of a commodity depends upon the prices of all other commodities. If prices of related commodities (substitutes or complementary goods) rise, they
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will become relatively more attractive to produce and the supply of that commodity rises. But supply of another commodity will fall. So there is an inverse relationship substitutes and positive relationship between complementary goods. 3. Prices of factors of production (Pf): A rise in prices of factors of production of a commodity will make the production of that commodity less profitable, so supply will decrease. If costs of production Decreases then supply will increase. There is also an inverse relation between supply and cost of production. 4. New Inventions and State of Technology (T): Technology advances based on new discoveries and innovations reduce the Cost of production and results in more and more supply of the commodity. With the traditional technology supply can not be increased. 5. Government policy (G): The Govt., policy may affect the supply by imposing taxes and providing subsidy. If Govt., policies are favorable (decrease in taxes and increase in subsidy) then supply will increase and if Govt., policies are unfavourable (increase in taxes and decrease in subsidy) then supply will fall. 6. Future Expectation about price (E): If there is future expectation about rise in price then supplier will not increase the supply at present and if thee is future expectation about fall in price then supplier will increase his supply. 7. Other factors (O): a. Use of Inputs. b. Development of Transportation and Communication. c. Agreement among the producers. The supply of product also depends upon natural factors, governments industrial and foreign policies, infrastructure facilities, market structure and production capacity. Law of Supply: Other things remaining the same, as the price of a commodity rises, its supply is extended and as the price falls supply is contracted. This means that when the price rises, the quantity of commodity produced and offered for sale will increase and when price falls, the quantity of commodity offered for sale will decrease. According to Dooley The law of supply states that the higher the price, the greater the quantity supplied or the lower the price the smaller the quantity supplied. Thus supply varies directly with the price. In other words, the relationship between supply and price is direct. Higher the price larger is the supply, the lower the price, the smaller is the supply. Hence the law indicates the direction in which the supply will move as a result change in price. Thus supply has positive relation with price. S = f (P)

Assumptions :
1. No 2. No 3. No 4. No 5. No change change change change change in in in in in Price of related goods (Pr) Price of factor of production (Pf) Technology (T) Government policy (G) future expectation about prices (E) 2.26
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6. No Change in other factors (O)

Exceptions:
In case of exceptions to the law of supply, the supply curve will be negative sloped and elasticity of supply will be less than zero (Es<0). 1. Law of supply is not applicable to agricultural products, social distinction goods and perishable goods like milk or curd. 2. The Law of supply does not apply to rare articles like ancient coins etc., their supply being fixed, can not change with change in price. 3. The law of supply does not hold good to speculators- Bulls and Bears They sell less and more at higher and lower prices respectively in anticipation of profit 4. Sellers will be ready to sell incase of perishable goods. 5. In case seller is hard pressing for cash he will like to sell his stock at the lower price. He may also lower the price further to attract the purchaser. Types of supply schedule and supply curve: There may be two types of supply schedule and supply curve: 1. Individual supply schedule and supply curve (Single Seller) 2. Market supply schedule and supply curve (No. of sellers) But both supply schedule and curves have positive between price and supplied quantity. This can be understood with the help of following table: Price Quantity (Rs.) Supplied 1 10 2 20 3 30 4 40 5 50 In the above schedule there is positive relation between price and quantity supplied.

Extension and Contraction in Supply:

When supplied quantity changes due to change in only price, it is called movement. Movements are two types: a. Expansion in supply. b. Contraction in supply. The most important factor which brings about changes in supply is the change in price. In other words, with a rise in price, the amount supplied extends (Expansion in supply) while with the fall in price, the supply contracts. (Contraction in supply) 1.Extension of supply: Other things remaining same, extension in supply refers to an increase in Supply due to increase in price. Rise in supply due to rise in its price, is called Expansion in supply. 2. Contraction in Supply: Other things remaining same, contraction in supply refers to a fall in supply due to fall in price. Fall in supply due to fall in its price is called Contraction in supply.

Increase and Decrease in Supply:

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An upward shift in supply curve irrespective of any change in price is called increase in supply. Increase in supply refers to more supply at the same price or same supply at lower price. On the contrary, if the same amount is supplied at a higher price or less is supplied at the same price, supply is said to be decreased. Increase in Supply: Increase in supply refers to more supply at same price or same supply at fewer prices. This increase in supply is of two types. Same Price More Supply: Suppose, the price of a commodity is Rs.3, quantity supplied 3 units. If the price of commodity remains Rs. 3 quantity supplied increases to 4 units it is called the increase in supply at same price. Less Price same supply: When the price of commodity is Rs. 3 quantity supplied 3 units. If the price falls to Rs. 2, quantity supplied remain 3 units is called same supply at less price. Causes of Increase in supply 1. Decrease in price of related goods 2. Decrease in factor price (cost of production) 3. Advanced technology 4. Favourable Govt. policy (Decrease in taxes and increase in subsidy) 5. Future expectation about decrease in price 6. Others Decrease in Supply: Decrease in supply refers to less supply at same price and same supply at high price it is of two types. Same Price less supply: Suppose price of commodity is Rs. 3 its quantity supplied is 3 units. If price remains Rs.3 quantity supplied falls to 2 units is called less supply at same price. More Price Same Supply: When the price of the commodity is Rs.3 units. If the price increase to Rs. 4 quantity supplied remains 3 units is called same supply at more price. When supply of a commodity changes due to change in factors other than price i.e., Pr, Pf, T, G, E, O. Causes of Decrease in supply: 1. Increase in price of related goods. 2. Increase in factor price (cost of production). 3. Traditional technology. 4. Unfavourable govt. policy (Increase in taxes and decrease in subsidy). 5. Future expectation about increase in price. 6. Others. ELASTICITY OF SUPPLY: The elasticity of supply is defined as the responsiveness of the quantity supplied of a good to a change in its independent variable. Elasticity of supply is measured by dividing the percentage change in quantity supplied of a good by

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the percentage change in its independent variable. The independent variable is price of the commodity. Methods of measurement of elasticity of supply: 1. Percentage or proportionate or ratio method: Elasticity of supply is the percentage change in quantity supplied of a good divided by the percentage change in its price. Es = %Change in Qty. Supplied %Q Q P or or x %Change in price %P P Q

Arc elasticity: In measurement of Arc elasticity, we use the average of the two price figures (original and subsequent) and average of the two quantity figures (original and subsequent). Thus the formula for measuring arc elasticity of supply is:
2.

Arc Elasticity =

Q ( P 0 + P1) / 2 Q 0 Q1 P 0 + P1 x or x P (Q 0 +Q1 / 2 Q 0 +Q1 P 0 P1

Where P and Q are original price and quantity respectively and P1, Q1 are subsequent price and quantity respectively

Types of Elasticity of Supply:

1.

Perfectly elastic supply (Es = ): It is a situation in which supply of a commodity continuously change without any change in price. In perfectly elastic supply curve, the supply curve will be horizontal parallel to quantity axis. 2. More than unitary elastic supply (Es>1): It refers to a situation by which percentage of change in supply of a commodity of a commodity is higher than percentage change in price of that commodity. 3. Unit elastic supply (Es=1): When percentage change in supply of a commodity is equal to percentage change in price, elasticity is unitary elastic. 4. Less than unit elastic supply (Es<1): When percentage change in supply of a commodity is less than percentage change in price, elasticity is relatively inelastic. 5. Perfectly inelastic supply (Es = 0): When Price of commodity does not influence supply of that commodity that situation is called perfectly inelastic supply. In perfectly inelastic supply curve, the supply curve will be vertical parallel to Y-axis.

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