5 Consumer’s Equilibrium

and Demand
“The identity of an individual is essentially a function of her choices, rather than the
discovery of an immutable attribute.” —Amartya Sen
“Every man lives by exchanging.” —Adam Smith
“Consumption is the sole end and purpose of all production” —Adam Smith
Unit 5: Consumer’s Equilibrium and Demand
Consumer’s equilibrium – meaning of utility, marginal utility, law of diminishing marginal
utility, conditions of consumer’s equilibrium using marginal utility analysis.
Indifference curve analysis of consumer’s equilibrium-the consumer’s budget (budget set
and budget line), preferences of the consumer (indifference curve, indifference map) and
conditions of consumer’s equilibrium.
Demand, market demand, determinants of demand, demand schedule, demand curve and
its slope, movement along and shifts in the demand curve; price elasticity of demand -
factors affecting price elasticity of demand; measurement of price elasticity of demand –
percentage-change method and total expenditure method.
Make a note:

Meaning:
The consumer occupies a pivotal place in the economic activity. He/ She is an economic agent who consumes
goods and services for satisfaction of his/her wants.
The satisfaction of the wants is the beginning and end of all economic activities. The objective of a consumer is
to get the maximum satisfaction from the expenditure incurred on various goods and services.

To study a consumer’s behaviour we assume that the consumer is rational and has to decide how to spend his/
her money on two different goods. This is problem of choice. Most naturally, a consumer will opt for the
combination of goods which gives him/her maximum satisfaction.

What will be this ‘best’ combination? This depends on the likes of the consumer and what the consumer can
afford to buy. The ‘likes’ of the consumer are also called ‘preferences’. And what the consumer can afford to
buy, depends on prices of the goods and the income of the consumer.
Make a note:

Consumer’s equilibrium is achieved when a consumer finds out the best

combination of two goods which gives him maximum satisfaction and he/ she can
afford to spend on.

There are two different approaches to study consumer behaviour and equilibrium

Utility Approach Indifference Curve Approach

Make a note:

Consumer’s
Behaviour

- It is the behaviour
in which the
consumer spends
his/ her limited
income on various
goods and services
in such a way that
he/she obtains
maximum
satisfaction
Make a note:
Utility
- The term ‘utility’ refers to the want satisfying power of a commodity. In other words,
amount of satisfaction, actual or expected, obtained from consuming goods and services
is called utility.

Characteristics : -
a) Utility depends upon urgency or intensity of want :- More intensity of want implies higher
utility (satisfaction) for a commodity. Ex - A pen gives more utility during examination than
during summer vacation.

b) Utility is subjective :- Satisfaction derived from a commodity will vary from person to
person. Ex. A hungry person will derive more satisfaction from chapatis than a person
who isn't hungry.

c) Utility is measurable :- There are two approaches for the measurement of utility -
Cardinal utility and Ordinal Utility.

d) Utility is not essentially useful :- Higher utility does not always mean greater usefulness.
Ex. Drugs or Alcohol may give utility to an addict but are not useful otherwise.
Make a note:
ORDINAL UTILITY

Economists - John Hicks and Roy Allen in 1934 first produced a paper which mentioned
ordinal utility.

In ordinal utility, the consumer only ranks choices in terms of preference but we do not
give exact numerical figures for utility. It measures utility in qualitative order like first
preference, second preference, third preference and so on. It is measured in ranks.

For example, we prefer a BMW car to a Nissan car, but we don’t say by how much.

It is argued this is more relevant in the real world. When deciding where to go for lunch,
we may just decide I prefer an Italian restaurant to Chinese. We don’t calculate the exact
levels of utility, hence, It is more practical and sensible.

This approach is used while examining the Indifference curve analysis to explain the
Consumer’s equilibrium.
Make a note:
CARDINAL UTILITY

The theory was given by Alfred Marshall. Cardinal Utility is the idea that
economic welfare can be directly observable and be given a value. It measures
utility in quantitative order like 1, 2, 3, 4…. Etc. The units of utility is called “utils”.
It is measured in absolute numbers.

For example, if a Nissan car gives 5,000 units of utility, a BMW car would give
8,000 units OR Sam says that pizza gives him 60 utils of satisfaction whereas
burger gives only 40 utils.

It is less practical.

This approach is used while examining the utility analysis explain the
Consumer’s equilibrium.
● A consumer, in general, consumes many goods; but for simplicity, we shall consider the
consumer’s choice problem in a situation of a single good or where there are only two goods:-
Good X and Good Y.

● Any combination of the amount of the two goods will be called a consumption bundle or, in
short, a bundle.

● In general, we shall use the variable Qx to denote the quantity of Good X and Qy to denote
the quantity of Good Y. Qx and Qy can be positive or zero.

● (Qx, Qy) would mean the bundle consisting of Qx quantity of Good X and Qy quantity of Good
Y. For particular values of Qx and Qy, (Qx, Qy), would give us a particular bundle.

● For example, the bundle (5,10) means 5X + 10Y; the bundle (10, 5) means 10X + 5Y, whose
market prices are Px and Py respectively.

● In economics, it is assumed that the consumer chooses his consumption bundle on the basis
of his taste and preferences over the bundles in the budget set. It is generally assumed that
the consumer is a rational individual and he has well defined preferences over the set of all
possible bundles.
(CARDINAL UTILITY)
Make a note: Concepts of Utility
There are two types of utility - Total utility and Marginal utility

a) Total utility (TU) : It is defined as total psychological satisfaction, a consumer derives from
consumption of a certain amount of a commodity. Mathematically, TU is aggregation of
Marginal utility derived from consumption of different units of a commodity.
TUn = MU1 + MU2 + ……. + MUn

More of commodity X provides more total utility (TU) to the consumer. Thus, TU depends on
the quantity of the commodity X consumed. TU is the sum of the utilities from all the units
consumed.

For example:- if the 1st unit of commodity X gives the consumer a satisfaction of 12 units
and 2nd one gives 6 units, then, TU from 2 units of commodity X is 12 + 6 = 18 units.

If the 3rd unit of commodity X gives satisfaction of 4 units, then TU from 3 units of commodity
X will be 12 + 6 + 4 = 22 units.
Make a note:

b) Marginal utility (MU) : It is an addition made to total utility by consuming an additional unit of
the commodity or it is the additional utility derived from consumption of one more unit of the
given commodity.
MUn = TUn - TUn- 1 (when units consumed change in consecutive order, one by one)
OR
MUn = TUx (when units do not change in consecutive order)
Qx
So, MU is the utility derived from the last unit of a commodity consumed.

Example, when 3rd unit of commodity X is consumed, TU increases from 18 units to 22 units.
Therefore, MU of the 3rd unit of commodity X = TU3 – TU2 = 22 – 18 = 4 units.

Example - 2 units of commodity X gives the consumer 18 units of total utility and 4 units give him
24 units of total utility. So, MU = 6/2 = 3 units.

This simply means that TU derived from consuming n units of commodity X is the sum total of
marginal utility of first unit (Mu1), marginal utility of second unit (MU2), and so on, till the marginal
utility of the nth unit. So, basically we can say that TU = ⅀ MU
Hermann Heinrich Gossen
- was a Prussian economist who is often regarded as the first
to elaborate a general theory of marginal utility.
- The law of Marginal Diminishing utility is popularly known
as Gossen’s first law of consumption. This law states that
as the stock of goods for consumption increases, the utility
derived from it decreases.

Alfred Marshall states that “ the additional benefit which a person

derives from a given increase of his stock of a thing diminishes with
every increase in the stock that he already has.”
Make a note:

Law of Diminishing Marginal Utility states that: "As a consumer

consumes more and more units of a specific commodity, without
a time lag, the additional utility (satisfaction), he expects to derive
from each successive unit will go on diminishing."

This happens as after having obtained some amount of the commodity,

the desire of the consumer to have still more of it becomes weaker.
Make a note Assumptions of Law of DMU
a) Utility can be measured in cardinal form (nos. 1,2, 3 etc. )
b) Unit of measurement should be standard (neither be very large nor
small) .
c) There should be no gap between consumption of units of the same good.
(cant have one unit in the morning and second in the evening)
d) Units are homogeneous (same physical characteristics and qualities)
e) No change in price of the good and the income of the individual
f) Consumer is rational and aims at maximising his satisfaction
g) Taste and preferences of a consumer do not change.
h) MUM remains constant for all units of the commodity in question
Make a note

Exceptions of Law of DMU

The law is not applicable in the following

scenarios-
a) Hobbies like collecting stamps, antiques, coins etc
b) Intoxicants like drugs, narcotics
c) Miserly behavioural trait
d) Knowledge based activities eg Music, poetry, reading
e) Display of money
Make a note:

Practical Applications of TU and MU

1. Calculate MU from the following :-

Make a note:

Practical Applications of TU and MU

2. Calculate MU from the following :-

Make a note:

Practical Applications of TU and MU

3. Calculate MU from the following :-

Make a note:

Practical Applications of TU and MU

4. Complete the table

Make a note:

Practical Applications of TU and MU

4. Complete the table

Make a note:

Practical Applications of TU and MU

5. Complete the table

Make a note Tabular presentation of Law of DMU

The point
at which
Marginal
Utility of a
commodity
is Zero and
its Total
Utility is
maximum,
it is
referred as
Point of
Satiety.
Make a note

Graphical
presentation
of Law of
DMU
Make a note Relationship between TU and MU
1. As long as MU is positive, TU increases - When MU falls +vely, TU increases at a
diminishing rare. . In the example- units 1 to 5, TU increases from 10 to 30 utils and MU falls from
10 to 2 utils. [the area before point A (TU) and B(MU)]
2. When MU is zero, TU is maximum and constant - In the example, when MU is 0 at the
6th unit, TU is maximum and constant at 30 utils. This is called as the point of saturation [shown
by point A(TU) and B(MU)].
3. When MU is negative, TU decreases - In the example, when MU becomes negative at 7th,
8th and 9th units - ie, -2,-4,-6; TU decreases. It implies that beyond 6th unit, further consumption
gives disutility. [area after point A(TU) and B(MU)]
4. Total utility is summation of MU - TU = ⅀MU and also, MU can be derived from TU -
MU = TUn - TUn-1
5. MU curve is the slope of TU curve - MU = ΔTU
ΔQ
Make a note

Exceptions/limitations to the Law of DMU

a) Dissimilar commodities
b) Change in taste, fashion, customer’s income
c) Intervals between consumption of the good.
d) Rare good (collection of stamps,antiques, old coins)
e) Value of money spent on the good is different for different people ( a poor person
will attach more value (hence more satisfaction) to the money he/she spends on
a particular good in comparison to a rich person OR a Miser whose greed
increases with acquisition of money)
f) Irrational behaviour of consumer ( eg. drunkard, addict, etc)
g) Music, poetry, reading activities ( this would give more satisfaction to a person
who is inclined towards them)
Conditions of Consumer’s equilibrium
(Using Cardinal Utility Analysis)

Consumer’s equilibrium in case Consumer’s equilibrium in case

a single commodity of two commodities
Make a note

MARGINAL UTILITY OF MONEY (MUM)

Money is the general purchasing power and it enables a consumer to
spend it on the commodities which give her/him satisfaction. Hence, at no
point in an economic scenario, money ceases to be desired. Marginal utility
of money is the satisfaction that a consumer expects to gain
moneywise.(not while consuming the product itself, but purchasing it)

Ex. if 1 rupee can buy 100 g of sugar and 500 g of rice and if the total utility from
these goods is 4 utils,
Then, 1 rupee = 4 utils
Make a note

Consumer’s equilibrium in case of single commodity

Consumer’s equilibrium refers to the situation in which a consumer spends his
income on purchase of commodity in such a way that gives her/him maximum
satisfaction. Consumer equilibrium is determined when the following condition is
satisfied:

a) Marginal Utility (MUx) = Price (Px)

b) Total gain decreases with additional purchase after equilibrium
Here, MU implies satisfaction and Price implies sacrifice
Make a note
Condition 1 : Marginal Utility (MUx) = Price (Px)
[ Why not MUx > Px OR MUx<Px ?? ]
● When MUx > Px, a consumer gains more satisfaction as compared to the
sacrifice he/she makes in terms of the price paid by him/her. Hence, he/she gets
prepared to buy more. Law of DMU ensures that as he/she buys more of the
commodity, his/ her satisfaction keeps falling and eventually reaches a point
where his MU becomes equal to price
● When MUx < Px, a consumer suffers losses as he is paying more than what he
actually gains. He reduces his consumption of the commodity. Law of DMU
operates in opposite direction and MU tends to increase till a point where it
becomes equal to Px.
Hence a consumer is at equilibrium at MUx = Px
Make a note

Condition 2 : Total gain decreases with additional purchase after equilibrium

● It is because marginal utility is falling (Law of DMU) and after equilibrium, it
becomes smaller than the price paid for the additional units of the commodity.

Hence, MUx = Px = MUM

Make a note MARGINAL UTILITY OF MONEY (MUM)
● Marginal utility of rupees is purchasing power of a rupee in terms of utils. It refers
to the worth of a rupee as defined by a consumer in terms of satisfaction that
he/she obtains from the quantity of goods purchased using it.
MU in money terms/ Rupees [MUM]= MU (utils)
MU of rupees
Eg - If MU of a rupee is 3 utils, it means that by spending one rupee, a consumer gets
3 utils of satisfaction. If in the same example, if MU(utils) is 12,
MU M = 12 utils = Rs 4
3 utils
It means that he will have to spend Rs 4 to get satisfaction equal to 12 utils as one
rupee can buy him 3 utils of satisfaction.
Make a note

The schedule is based upon three

assumptions :

a) MU falls as per law of DMU

b) MUM of a rupee = 2 utils
c) Price of the commodity is Rs 3 per unit
Make a note

Here, equilibrium is struck at 3 units of

the commodity. It implies that the
consumer should buy 3 units of the
commodity as at this level MU = Px

In other words,
Condition 1 -
Satisfaction MUx = Sacrifice Px at 3 units

Condition 2 -
Total gain (2 + 1 + 0) falls after this level as
MUx < Px.
Make a note

1. Suppose, burgers sell for Rs 10 each. Mr. X has already eaten 5 burgers. His
marginal utility of one rupee is 5. Should he consume more or stop? Given than
MUx = 50 utils.
Solution
1. Suppose, burgers sell for Rs 10 each. Mr. X has already eaten 5 burgers. Given
than MUx = 50 utils. 1 re = 1 util

Solution: 50 rs … 50 rs = 50 utils

However , in this case, MUM = MUx = 50 =

Px 50

Hence, the consumer

Make a note

2. Given below is the utility schedule of a consumer for commodity X. The price of the
commodity is Rs 6 per unit. How many units should the consumer purchase to
maximise his satisfaction. Given that Re. 1 = 1 util. Give reasons for your answer.
Solution

Consumer equilibrium is determined at 4th unit of

consumption as,
MUx = Px = MUM
6 = 6 = 6
- If the consumer purchases less than 4 units, then
MUx > Px so he would increase the consumption
to gain more satisfaction till MUx = Price.
- If the consumer purchases more than 4 units, then
MUx < Px, so he would buy less quantity to
increase the satisfaction and reach equilibrium.
Make a note
Make a note

Consumer’s equilibrium in case of two commodity

Law of equi marginal utility helps in determining consumer’s equilibrium in case
of two commodities. Hence, a consumer gets maximum satisfaction when ratios
of MU of two commodities to their respective prices are equal.
There are two ways in which consumer equilibrium can be determined in case of
two commodities:
a) When price of each commodity is the same
b) When prices of two commodities are different,
Make a note

In both the cases, the conditions for consumer’s

equilibrium remains same -

1. MU of good X = MU of good Y
OR
MUx = MUY = MUM
Px PY

2. Law of diminishing marginal utility operates. ( more you consume, MU falls)

Make a note
Consumer’s equilibrium is determined at
point E as MUx = Px.

- Before point E, MUx > Px, hence

the consumer should buy more till
he reaches equilibrium
- After point E, MUx < Px, hence the
consumer should not go beyond
point E as he/she suffers losses
1. A consumer consumes only two goods - X and Y. Marginal utilities of X
and Y is 3 respectively. Price of X and price of Y are Rs 3 and Rs 4 per
unit. Is consumer in equilibrium? What will be further reaction of the
consumer? Give reasons.
Solutions:
A consumer consumes only 2 goods - X and Y. The marginal utilities of X
and Y is 3. Prices of X and Y are Rs 2 and Rs 1 respectively. Is consumer
in equilibrium? What will be further reaction of the consumer? Give reason.
Solutions:
A consumer consumes only two goods X and Y. Marginal utilities of X and Y are 5 and 4
respectively. The prices of X and Y are `Rs 4 per unit and `Rs 5 per unit respectively. Is
the consumer in equilibrium? What will be the further reaction of the consumer? Explain.

A consumer consumes only two goods X and Y. The marginal rate of substitution is 1,
prices
of X and Y are `Rs 3 and ` Rs 4 per unit respectively. Is the consumer in equilibrium?
What will be further reaction of the consumer? Give reason.

A consumer consumes only two goods X and Y. The marginal utilities of X and Y are 4
and 3 respectively. Price of X and price of Y is `Rs 3 per unit. Is consumer in
equilibrium? What will be further reaction of the consumer? Give reasons.

A consumer consumes only two goods X and Y. The marginal utilities of X and of Y is 3.
Prices of X and Y are Rs 2 and Rs 1 respectively. Is consumer in equilibrium? What will
be further reaction of the consumer? Give reasons.
A consumer consumes only two goods X and Y both priced at `Rs 3 per unit. If the consumer
chooses a combination of these two goods with Marginal Rate of Substitution equal to 3, is
the consumer in equilibrium? Give reasons. What will a rational consumer do in this
situation? Explain.

A consumer consumes only two goods X and Y whose prices are Rs 4 and Rs 5 per unit
respectively. If the consumer chooses a combination of the two goods with marginal utility
of X equal to 5 and that of Y equal to 4, is the consumer in equilibrium? Give reasons. What
will a rational consumer do in this situation? Use utility analysis.

A consumer consumes only two goods, each priced at Rupee one per unit. If the consumer
chooses a combination of the two goods with Marginal Rate of Substitution equal to 2, is
the consumer in equilibrium? Give reasons. Explain what will a rational consumer do in this
situation.

A consumer consumes only two goods X and Y whose prices are Rs 2 and Rs 1 per unit
respectively. If the consumer chooses a combination of the two goods with marginal utility
of X being 4 and that of Y also being 4, is the consumer in equilibrium? Give reasons.
Explain what will a rational consumer do in this situation. Use Marginal Utility Analysis.
 CONSUMER BEHAVIOUR
THROUGH
ORDINAL UTILITY ANALYSIS
Consumption Bundle :
It is a combination of the quantities of two goods. This is also called
bundle of two goods e.g (x1, x2) which denotes that this bundle has
x1 amount of good 1 and x2 amount of good 2. Similarly, (34,40)
would mean 34 units of good 1 and 40 units of good 2.
Budget set :
It refers to all consumption bundles that a consumer can buy using
her/his money (income) at the prevailing market price. Budget set
depends on two factors:
a) Consumer’s income and b) Price of good 1 and good 2.
So, at the given prices, the Budget set includes all those
Consumption bundles that cost less than or equal to a consumer’s
income.
Indifference Map and Monotonic Preferences
Slope of Indifference Curve ( Marginal Rate of Substitution (MRS)

Combination Good X Good Y

Biscuits Bananas

MRS = Δ Loss
Δ Gain

As a consumer increases consumption of Good X (Biscuits), he sacrifices his consumption of Good Y

(Bananas)
Properties of Indifference Curve

1.An Indifference Curve Slopes downwards 2. An Indifference curve is convex to the point of origin

3. Every Indifference curve to the right represents

higher satisfaction level
Indifference Map
↓
Properties of Indifference Curve

4. Indifference curves do not cut each other.

5. Indifference Curve never touches X- axis or Y axis.

Consumer’s Budget set :
It refers to all consumption bundles that a consumer can buy
using her/his money (income) at the prevailing market price.

Budget set depends on two factors:

a) Consumer’s income and
b) Price of good 1 and good 2.

So, at the given prices, the Budget set includes all those
Consumption bundles that cost less than or equal to a consumer’s
income.
Px.Qx + Py.Qy ≤ M
Consumer Budget constraint :
It refers to a situation when expenditure on two goods by the
consumer has to be limited based on his/ her income.

Budget line ( ) is also called as Budget constraint as it

shows the maximum limit that a consumer can buy goods.

For example -
If P1 = Rs 4 and P2 = Rs 2 and M = Rs 20, then the following bundles are not
affordable by the consumer.
(i) (0,14) = (4 x 0 + 2 x 14) ≠ 20
(ii) (1,20)
iii) (2,34)
If P1 = Rs 4 and P2 = Rs 2 and M = Rs 20,
Px. Qx + Py. Qy = 20

(0, 10) (1, 8) (2, 6) (3, 4) (4, 2) (5, 0) = 20

( 1, 1) (2, 5)

(1, 5)
Budget line/ Price line :
It represents the different bundles that the consumer can purchase.

Characteristics of Budget line/ Price line :

a) Budget line is a straight line (assumption -
entire income is spent)

b) It is negatively/downward sloping (if good X

↑, then good Y ↓)

c) Points on the line or inside the Price line are

called Attainable combinations and points
outside the Price line are called
unattainable combinations.
Budget line/ Price line :
Since it, represents the different bundles that the consumer can
purchase. Here,

Hence, it is a graphical presentation of all those bundles whose total

amount is equal to the income of the consumer.

Expenditure =
Graphical presentation -

Budget line

a) Attainable combinations
All points on AF as well as within
it are called attainable
combinations

b) Non-attainable combinations
All points on the outside AF are
called unattainable combinations
Changes in Budget line/ Price line :

a) Change in Income

Increase in Income Decrease in Income

Changes in Budget line/ Price line :

a) Change in Price of Good X (Good Y remains same)

Increase in price of Good X Decrease in price of Good X

Changes in Budget line/ Price line :

a) Change in Price of Good 2 (Good 1 remains same)

Increase in price of Good Y (2) Decrease in price of Good 2

Solution
A consumer consumes only two goods X and Y.
His money income is `Rs 24
and the prices of Goods X and Y are `Rs 4 and
`Rs 2 respectively. Answer the following
questions:
(i) Can the consumer afford a bundle 4X and 5Y?
Explain.
(ii) What will be the MRSXY when the consumer
is in equilibrium? Explain.
2.2 Theory of Demand
Demand of a commodity:

- The demand for a good is defined as the quantity of the

good a consumer is willing to buy at a particular price during
a given period of time.

According to Prof. 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.”
The main features of demand for a commodity are:
(a) Demand depends upon utility of the commodity. A consumer is rational and
demands only those commodities which provide utility.

(b) Demand always means effective demand i.e., demand for a commodity or
the desire to own a commodity should always be backed by purchasing power
and willingness to spend.

(c) Demand is a flow concept, i.e., so much per unit of time.

d) Demand means demand for final consumer goods.

(e) Demand is a desired quantity. It shows consumer’s wish or need to buy

the commodity.
Kinds of Demand

a) Price demand
b) Income demand
c) Cross demand
d) Derived demand
e) Direct demand
f) Joint demand
g) Composite demand
 Determinants of Individual demand

DEMAND FUNCTION - It shows the functional relationship

between demand for a commodity and its determinants.
It can be expressed as:

Dx = f(Px, Pr, Y, T&P, E)

Market Demand
Determinants of Market Demand

Market Demand Function

Dx = f(Px, Pr, Y, Yd, G, N, T&P, E, S)

Contraction - Upward Movement

Extension - Downward Movement

Extension in Demand for Goods
When the quantity demanded of a good rises due to the fall in price, it is called extension of demand

Price Quantity Demanded

Extension in Demand
20 (a) 100

15 (b) 150

Extension - Downward movement

of demand curve

When Px↓ - Dx ↑
Contraction in Demand for Goods
When the quantity demanded falls due to the rise in price, it is called contraction of demand.

Price Quantity Demanded

20 100

25 70

Contraction - Upward movement

of demand curve

When Px↑ - Dx ↓
Increase in demand - Rightward
Shift

Decrease in demand- Leftward shift

Change in Demand for Goods
When the demand of a commodity changes due to change in any factor other than the own price of the
commodity, it is known as change in demand. It is expressed as a shift in the demand curve.

Reasons for Shift in Demand Curve:

(i) Change in price of substitute goods; (ii) Change in price of complementary goods;

(iii) Change in income of consumers; (iv) Change in tastes and preferences;

(v) Expectation of change in price in future; (vi) Change in population;

(vii) Change in distribution of income; (viii) Change in season and weather.

Increase in Demand for Goods
Increase in Demand refers to a rise in the demand of a commodity caused due to any factor other than
the own price of the commodity. In this case, demand rises at the same price. It leads to a rightward
shift in the demand curve.

Px Dx

20 100

20 150

Increase in demand - Rightward shift

of demand curve

When Px(same) - Dx
Decrease in Demand for Goods
Decrease in Demand refers to a fall in the demand of a commodity caused due to any factor other than
the own price of the commodity. In this case, demand falls at the same price. It leads to a leftward shift
in the demand curve.

Px Dx

20 100

20 70

Decrease in demand - Leftward shift of demand curve

When Px(same) - Dx
 Income effect

Normal and Inferior Good

- Income effect refers to the change in the demand for a Normal/ Inferior good
as a result of a change in the income of a consumer.
When Consumer consumes Normal good before Income (Y) changed

Normal Good Inferior Good

= no impact
When Consumer consumes Normal good before Income (Y) changed

Normal Good Inferior Good

= no impact
When Consumer consumes Inferior good before Income (Y) changed

Inferior Good Normal Good

 When Consumer consumes Inferior good before Income (Y) changed

Inferior Good Normal Good

 Cross price effect

Normal and Inferior Good

- When Price of Normal good/ Inferior

Good changes
When Consumer consumes Normal good before Price of NG changed

Normal Good Inferior Good

When Consumer consumes Normal good before Price of NG changed

Normal Good Inferior Good

When Consumer consumes Inferior Good before Price of IG changed

Inferior Good Normal Good

When Consumer consumes Inferior Good before Price of IG changed

Inferior Good Normal Good

 Substitute Goods

When Price of one substitute good /

(Ex - PETROL CAR/ DIESEL CAR)
Petrol car Diesel Car
a) P =D(petrol car) result = Demand(Diesel car)

a) P(petrol carl) increase

Petrol car demand curve Diesel car demand curve

 Petrol car Diesel Car
b) P =D(petrol car) result = Demand(Diesel car)
b) P(petrol car) Decrease

Petrol car demand curve Diesel car demand curve

 Complementary Goods

When Price of complementary good /

(Ex - Ink pen / Ink)
 Ink Ink Pen
a) P =D(Ink ) result = Demand(Ink Pen)
a) P(ink) increase

Ink demand curve Ink Pen demand curve

 Ink Ink Pen
b) P =D(Ink ) result = Demand(Ink Pen)
b) P(ink) Decrease

Ink demand curve Ink pen demand curve

Extension and Contraction Increase and Decrease
Of Demand of Demand
1. Find Market demand from the following and draw
a market demand curve
2. Construct diagrams for the following schedules.
What do these represent?

(i) (ii)
1. Given that demand function is Qd = 100 - 5P,

a) Calculate demand at price of Rs 4

Solution =
(given) Qd = 100 - 5P, so using P = Rs 4,
Qd = 100 - 5 x 4
= 100 - 20
= 80 units

b) Calculate demand at price of Rs 6, (ans = 70 units)

2. Given that demand function is Qd = 42 - 2Px, construct
a demand schedule at price (Rs) 5, 4, 3, 2, 1

Solution =

Qd = 42 - 2Px, so using P =Rs 5, 32 units (ans), and so on

2. Given that demand function is Qd = 42 - 2Px, construct
a demand schedule at price (Rs) 5, 4, 3, 2, 1

Solution = Price Qd = 42 - 2Px

5 32
4 34
3 36
2 38
1 40
3. The demand function of good X is Qd = 100 - 10P,
find out the price of X where quantity demanded is
a) 20 units b) 15 units c) 0 units
 Qty demanded DD function Price (Rs)

a) 20 units Qd = 100 - 10P

So, 20 = 100 - 10P
10P = 100 -20 = 80
P = 80 / 10 = 8

b) 15 units = 8.5

c) 0 units = 10
Elasticity of demand refers to
percentage change in demand
of a commodity due to
percentage change in any of
the factors affecting demand of
that commodity.

There are three types of

elasticity :
a) Price elasticity of demand
b) Income elasticity of demand
c) Cross elasticity of demand
1. Availability of Close Substitute. A good having close substitutes will have an elastic
demand and a good with no close substitutes will have an inelastic demand. Example:
commodities such as pen, cold drink, car, etc. have close substitutes. When the price of
these goods rise, the price of their substitutes remaining constant, there is
proportionately greater fall in the quantity demanded of these goods. That is, their
demand is elastic. Commodities such as prescribed medicines and salt have no close
substitutes and hence, have an inelastic demand.

2. Income of the Consumers. If the income level of consumers is high, the elasticity of
demand is less. It is because change in the price will not affect the quantity demanded
by a greater proportion. But in low income groups, the elasticity of demand is high.

3. Luxuries versus Necessities. The price elasticity of demand is likely to be low for
necessities and high for luxuries. A necessity is a good or service that the consumer
must have such as food (bread, milk) and medicines. Luxuries are goods that are
enjoyable but not essential. Example: eating in a 5-Star hotel. If the price of necessities
rise, then demand will not fall by a greater proportion because their purchase cannot be
delayed. That is why, the price elasticity of demand in case of necessity is low.
4. Proportion of Total Expenditure Spent on the Product. Higher the cost of the good
relative to total income of the consumer, more will be the price elasticity of demand. If
the price of bread, ink, salt, match box, etc., which is relatively low, doubles it would
have almost no effect on the quantity demanded of them. On the other hand, if price of
car doubles then the quantity demanded will fall by a greater proportion showing high
price elasticity of demand.

5. Number of Uses of the Commodity. The more the number of uses a commodity can
be put to, the more elastic is the demand. If a commodity has few uses, it has an
inelastic demand. Examples: goods like milk, eggs and electricity can be put to many
different uses and hence, enjoy elastic demand, i.e., when prices are low, demand
increases by a greater proportion as the goods can now be put to less important uses
also.

6. Time Period. If the time period needed to find substitutes of the commodity is more,
the price elasticity of demand is more and vice versa. Example: flying by aeroplane has
inelastic demand as no substitutes are available in the short run.
Px Qd

10 20

10 30

10 40
Px Qd

10 30

20 30

30 30
Relatively Elastic Demand e>1

Px Qd

100 100

150 30
Px Qd

100 100

150 80
 Px Qd

10 40

5 60

% change in Qd = % change in price

Price falls by 50% and QD rises by 50 %. This
is also called as rectangular hyperbola
Measuring Price Elasticity of Demand

1. The Percentage Method

2. The Point Method
3. The Arc Method
4. Total Expenditure Method.
Price Elasticity of Demand

- Alfred Marshall : first to formulate the concept of price elasticity of

demand as the ratio of a % change in quantity demanded of a
commodity to a % change in its price.
Formula:-

Ed = ( - )

=
4. If price of a commodity rises by 40% and its
demand falls by 80 %, Calculate the Price elasticity
of demand.

Ed =

= (-) 80 %
40%
= (-) 2% …. As we ignore the (-) sign,
Ed = 2%. The price elasticity of demand is Greater
than unitary elastic demand
5. Price of a good rises by 25% but there is no effect on
demand of the good due to this price rise. Calculate
price elasticity of demand.

6. Calculate price elasticity of demand for a commodity

when its price rises by 25% and quantity demanded
falls from 150 units to 120 units.

7. Calculate and comment on nature of Price elasticity

of demand, if, with a rise in price of Good X from
10 to 12, the quantity demanded falls by 40%.
8. A 5% fall in the price of Good X, leads to a 10% rise in its
quantity demanded. A 20% rise in price of Good Y, leads to a
10% fall in its quantity demanded. Calculate the price
elasticities of demand of the two goods. Out of the two Goods
which one is more elastic ?

9. Price elasticity of demand of two goods A and B is (–) 3 and

(–) 4 respectively. Which of the two goods
has higher elasticity and why?

10. Due to 10% fall in price of a commodity, its quantity

demanded rises from 400 units of 450 units. Calculate its
price elasticity of demand.
5. 0, Perfectly inelastic

6. (0.8 - Less than unitary)

7. eD = 2 (eD > 1, More than - elastic demand)

8. [Ans. 2 and 0.5]
9. Good B has higher elasticity as compared to A. It is
because with change in price by one per cent,
percentage change in demand for B is 4% while in case
of good A it is only 3%.
10. -1.25 (more than elastic )
11. A consumer buys 10 units of a commodity at Rs 5
per unit. He buys 12 units, when price falls to Rs 4 per
unit. Calculate price elasticity of demand.

- There are two ways to solve this -

a) We find % change in Qty and % change in Price and
use -

b) We use formula -
Solution :
Old price (P) = 5, New price (P1) = 4,
Δ P = New price - Old price = - 1

Old Qty (Q) = 10, New Qty (Q1) = 12

Δ Q = New Qty - Old Qty = 2

P.e =
D (ignore the (-) sign while computing)
= 5 x 2__
10 (-1)
= (-1) or 1 (Unitary elastic demand)
12. Price of a good rises from Rs 10 to Rs 12
and its demand falls from 120 units to 100
units. Calculate P.eD
13. Calculate P.e , if a person spends Rs 500 at Rs 5
D

per unit and Rs 420 at Rs 6 per unit.

Price (Rs) Total Expenditure (Rs) Quantity Demanded

(units)
5 500 100 (500/5)
6 420 70 (420/6)
14. A dentist was charging Rs 300 for a standard cleaning
job which generated her a revenue of Rs 30,000 per
month.She increased the price to Rs 350 which earned her
Rs 33,250 per month. Find P.e D

Price (Rs) Total Revenue (Rs) Quantity Demanded

(units)

300 30,000 100 (30,000/300

350 33250 95 (33250/350)

15. A consumer buys 80 units of a good at a price of
Rs 4 per unit. Due to fall in its price, he buys 100 units
of the good. If price elasticity of demand is (-)1. Find the
new price.
P = 4, New P = ? , so Δ P = ?
Q = 80, New Q = 100, so Δ Q = New Q - Q = 20
( note: price has fallen = demand will increase)
P.e =
D if, Δ P = - 1
(-1) = 4 x 20_ Δ P = New P - P
80 ΔP (-1) = New P - 4
ΔP= -1 (-1) + 4 = New P = 3
16. A consumer buys 30 units of a good at a price of
Rs 10 per unit. Price elasticity of demand for the good
is (-1). How many units the consumer will buy at a price
of Rs 9 per unit. Calculate.

17. What will be the effect of 10% rise in price of a good

on its demand if price elasticity of demand is
(a) zero, (b) (-1) and (c ) (-2)

18. A consumer buys 100 units at Rs 5 per unit, P.e = 2

D

At what price will the consumer buy 140 units?

16. A consumer buys 30 units of a good at a price of Rs 10
per unit. Price elasticity of demand for the good is (-1). How
many units the consumer will buy at a price of Rs 9 per unit?

PEd =(-1) ( note: price has fallen = demand will increase)

P = 10, New P = 9 , so Δ P = New P - P = 9 -10 = (-1)
Q = 30, New Q = ? , so ΔQ=?

P.e =
D if, Δ Q = ????
(-1) = 10 x Δ Q_ Δ Q = New Q - Q
30 (-1)
Δ Q = ???? New Price = ? Rs
17. What will be the effect of 10% rise in price of a good on its
demand if price elasticity of demand is

PEd =0, Δ P = 10 %, Δ Q = ? PEd =(-1) Δ P = 10 %, Δ Q = ? PEd =(-2) Δ P = 10 %, Δ Q = ?

P.e d =
D % change in Qd P.e d =
D % change in Qd P.e d =
D % change in Qd
% change in P % change in P % change in P

0 = % change in Qd (-1) = % change in Qd (-2) = % change in Qd

10 10 10

= ???? = ???? = ????

18. A consumer buys 100 units at Rs 5 per unit, P.e = -2 D

At what price will the consumer buy 140 units?

PEd = -2 ( note: price has fallen = demand will increase)

P = 5, New P = ? , so Δ P = ?
Q = 100, New Q = 140 , so Δ Q = 140 - 100 = 40 units

P.e =
D if, Δ P = ????
2 = 5 x 40_ Δ P = New P - P
100 ΔP
Δ P = ???? New Price = ? Rs
19. The demand for a good is 300 units at Rs 20, if price rises
by Rs 5 and demand falls, find the new demand if P.e is -3.
D

20. The demand for a good at Rs 10 per unit is 40 units. Price

falls by Rs 5, if price elasticity of demand is 3, Calculate
demand after price falls.

21. Find elasticity of demand.

a) When price falls from Rs 10 to Rs 9, and demand rises
from 9 to 10 units
b) When price falls from Rs 8 to Rs 6 and demand rises from
20 to 40 units.
19. The demand for a good is 300 units at Rs 20, if price rises
by Rs 5 and demand falls, find the new demand if P.e is -3. D

PEd =-3
P = 20, , Δ P = 5 Rs, ( note: price increase = demand decrease)
Q = 300, New Q = ? , so ΔQ=?

P.e =
D if, Δ Q = ????
-3 = 20 x Δ Q_ Δ Q = New Q - Q
300 -5
Δ Q = ???? New Quantity = ? units
20. The demand for a good at Rs 10 per unit is 40 units. Price
falls by Rs 2, if price elasticity of demand is -5, Calculate
demand after price falls.

PEd = -5
P = 10, , Δ P = 8 Rs ( note: price has fallen = demand will increase)
Q = 40, New Q = ? , so ΔQ=?

P.e =
D if, Δ Q = ????
2 = 20 x Δ Q_ Δ Q = New Q - Q
300 2
Δ Q = ???? New Quantity = ? units
21. Find elasticity of demand.
a) When price falls from Rs 10 to Rs 9, and demand rises from 9 to 10
units
b) When price falls from Rs 8 to Rs 6 and demand rises from 20 to 40
units.
P = 10, New P = 9 , so Δ P = (-1) P = 8, New P = 6 , so Δ P = (- 2)
Q = 9, New Q = 10, so Δ Q = 1 Q = 20, New Q = 40, so Δ Q = 20

P.e =
D P.e =
D

= 10 x 1__ = 8 x (-2)_
9 (-1) 20 20

= ?? = ??