Microeconomics series: Theory of Consumers Behaviour part 1

                                                              THEORY OF CONSUMERS BEHAVIOUR: PART 1

  • Concept of demand was given by Alfred Marshall.
  • DEMAND: Consumer’s desire to purchase as well as willingness to pay a price for a specific good or services.
  • Determinants of demand:
  • Income of the buyers
  • Price of own goods
  • Price of related goods: substitutes and complementary
  • Tastes and preferences
  • Future expectations of price
  • Law of demand (partial equilibrium analysis): It was given by Alfred Marshall. The law states that there is inverse relation between price and quantity demanded of the commodity, given all other things constant.
  • Market demand curve is the horizontal summation of individual demand curves. Market demand curve is flatter than individual demand.
  • Demand curve is downward sloping due to Law of diminishing marginal utility.
  • Law of diminishing marginal utility: The law states that as the consumer consumes more and more of a good, the marginal utility derived from each successive unit keeps on decreasing. It is also known as Gossen’s First Law.
  • Law of equi-marginal utility: this is second law of Gossen tells that consumer spends his income on two or more goods in such a way that marginal utility gained from these good are equal. Marshal modified it and named law of proportional utility.
  • Increase in demand leads to rightward and decrease in demand leads to leftward shift in demand curve.
  • A downward movement along the demand curve leads to expansion of demand and an upward movement along the demand curve implies contraction of demand, keeping factors other than price to be constant.
  • Exceptions to law of demand: Veblen goods, Giffen goods, Ignorance, war, &expectations about price
  • Giffen goods have positive relationship with the change in price. If price increases the demand for giffen good increases. It was named after Sir Robert Giffen.
  • All giffen goods are inferior goods but all inferior goods are not giffen goods.
  • Snob effect: desire to possess a unique commodity having prestigious value. Small the number of owning the goods, higher the snob effect will be of that good.
  • Bandwagon effect: People purchase those goods which are in fashion and trend.
  • Veblen good: Luxury goods for which demand increases as price increases.
  • Elasticity of demand: The responsiveness or change in demand due to change in factors like price, income, price of related goods etc.
  • Types of elasticity:
  • Price elasticity: It is the proportionate change in quantity demanded to the proportionate change in price.

Price elasticity (Ep  )  = (-) [ (Δ𝑸/𝑸)/(Δ𝑷/𝑷)]

( Ep)  < 1Inelastic
(Ep  )  > 1Elastic
(Ep  )  = 1Unitary
( Ep )  = infinitePerfectly elastic
(  Ep)  = 0Perfectly inelastic
  • Income elasticity: the proportionate change in quantity demanded to proportionate change in income.

Income elasticity (Ei) = [(Δ𝐐/𝐐)/(Δ𝐘/𝐘)]

(Ei)> 0Normal good
(Ei)< 0Inferior good
(Ei)> 1Luxury good
0 <(Ei)< 1Necessity good
  • Cross elasticity: It is the degree of responsiveness of change in the demand for one good in response to the change in price of another good.

               Cross elasticity (Ec) = (𝚫𝐐𝐱/𝚫𝐏𝐲) * (𝐏𝐲 /𝐐𝐱)

(Ec)> 0Substitute goods
(Ec)< 0Complementary goods
(Ec) = 0Not related
  • Methods to calculate elasticity:
  • Percentage method: (-) [(Δ𝑸/𝑸)/(Δ𝑷/𝑷)]
  • Point elasticity method: (lower segment)/ (upper segment)
  • Arc elasticity method: [𝑸𝟏/(𝒒𝟏+𝒒𝟐)]/[Δ𝑷/(𝑷𝟏+𝑷𝟐)]
  • Total expenditure method:
(Δ T.E/ΔP)< 0Elastic
(ΔT.E/ΔP)> 0Inelastic
(ΔT.E/ΔP) = 0Unitary elastic

Find the PDF attachment here.

Prepared by: Anuradha

            Department of Economic Studies and Policy

            Central University of South Bihar

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