Complete Book of Economics PDF

CHAPTER-1 THEORY OF DEMAND DEMAND- Demand for a commodity refers to the number of units of a particular goods or services that consumers are willing and able to purchase during a specified period at different prices. TYPES OF D...

CHAPTER-1 THEORY OF DEMAND DEMAND- Demand for a commodity refers to the number of units of a particular goods or services that consumers are willing and able to purchase during a specified period at different prices. TYPES OF DEMAND Individual Demand- The Quantity of a commodity that an individual consumer is willing to purchase at a given price during a given period of time is known as Individual Demand. Market Demand- It refers to the total quantity of a commodity that all the households are willing to buy at a given price during a given period of time. Ex-Ante Demand- It refers to the amount of goods that consumers want to or willing to buy during a particular time period. Ex-Post Demand- It refers to the amount of the goods that the consumers actually purchase during a specific period. Joint Demand- It refers to the demand for two or more goods which are used jointly or demanded together. For example: Car & Petrol, Bread & Butter, Milk & Sugar etc. Derived Demand- The demand for a commodity that arises because of the demand for some other commodity is called Derived Demand. For instance, demand for steel, bricks, cement, stones, wood etc. is a derived demand. Composite Demand- Demand for goods that have multiple uses is called composite demand. For example: the demand for steel arises from various uses of steel in making utensils, bus bodies etc. DETERMINANTS OF DEMAND Price of the Commodity- There is an inverse relationship between the price of the commodity and its quantity demanded. It implies that lower the price of the commodity, larger is the quantity demanded and higher the price, lesser is the quantity purchased. This type of demand is known as Price Demand. Income of the Consumer- There is a direct relationship between the income of the consumer and his demand for a product i.e. with an increase in income the demand for the commodity increases. While discussing the relationship between income of the consumer and the demand for a commodity, we may distinguish between three types of commodities: (i) Normal Goods (ii) Inferior Goods; (iii) Inexpensive necessities of life (I) Normal Goods: Normal Goods are those goods the demand for which increases with increase in income of the consumers and decreases with fall in income. For instance, a consumer may increase his demand for clothes, refrigerators, etc. as his income increases. (II) Inferior Goods- Inferior Goods are those goods the demand for which falls with increase in income of the consumer. For example: the demand for inferior goods like maize may decrease when income increases. (III) Inexpensive Goods of Necessities: In case of these necessities of life such as salt and matchbox, quantity purchased increases with increase in income upto a certain level and thereafter it remains constant irrespective By Kartik Garg: 8439993339  of the level of income. The functional relationship between the demand for a commodity and the level of income is known as income demand. In figure, income of the consumer is plotted on the Y-axis and the quantity purchased of a commodity is plotted on the X-axis. The curve NG has a positive slope, i.e. it moves upwards to the right, indicating that demand for such goods increases with increase in income of the consumer. The relation between income and demand for inferior goods is shown by the curve IG in the above figure. Demand for such goods may initially increase with increase in income (say upto Y1 when OQ1 quantity is demanded), but the quantity demanded decreases as income increases beyond Y1. The relation between income and inexpensive necessities of life is shown by the curve IN. This curve shows a vertical straight line indicating that a further increase in income does not lead to any increase in demand. Consumer’s Tastes & Preferences- Tastes and preferences depend on social customs, habits of the people, fashion, the general lifestyle‟s of the people etc. Customer‟s preferences may change because of change in fashion. As a consequence, people switch over from the cheaper, old-fashioned goods to costlier “MAD” goods. Price of Related Goods- These goods can be classified into two categories as follows: SUBSTITUTE GOODS COMPLEMENTARY GOODS These are those goods which satisfy the same type These are those goods which are complementary to of need and hence can be used in place of another one another in the sense that they are used jointly to satisfy a given want such as tea and coffee, coke or consumed together to satisfy a given want like & pepsi. There is a direct relationship between the car and petrol, gas and gas stoves. demand for a product (say tea) and the price of its For example, an increase (or decrease) in the price substitute (say coffee) as indicated by positively of petrol causes not only a decrease in demand of sloping curve KL in figure. For example, if the petrol but also in the demand of cars. price of coffee rises, many consumers will shift from consumption of coffee to the consumption of tea. The positively sloping curve KL is shown. It The negatively sloping demand curve is shown as implies if the price of coffee rises, many consumers HR here which implies that as the price of petrol will shift from the consumption of coffee to the increases demand for cars will go down and vice consumption of tea because demand for tea has versa. now become relatively cheaper. Consumer’s Expectations- If a consumer expects a rise in price of a commodity in future, they would demand greater amount of commodity today with a view to avoid purchasing at a higher price in future. Similarly, if people expect an increase in their income, they will buy more commodities in anticipation of a rise in their income. By Kartik Garg: 8439993339 Consumer Credit facility- If the consumers are able to get credit facilities or they are able to borrow from the banks, they would be tempted to purchase certain goods they could not have purchase otherwise. For instance, the demand for cars in India has increased partly because people are able to get loans from the banks to purchase cars. Distribution of income: If the distribution of income in a country is unequal, there will be more demand for luxury goods like cars and LED television. On the other hand, if the income is evenly distributed, there will be less demand for luxury goods and more demand for essential goods (necessities). Government policy- Economic policy of the govt. also influences the demand for commodities. If the government imposes taxes on various commodities in the form of GST, the prices of these commodities will increase. As a result, demand for these commodities will fall and vice versa. DEMAND FUNCTION- The determinants of demand can be stated together as a Demand Function. Thus, we can say that demand for a cup of coffee depends upon (i) price of coffee, (ii) price of tea (a competitive good), (iii) income of the consumer, and (iv) tastes and preferences of the consumer. Likewise, demand for Honda civic car is influenced by (i) price of Honda civic, (ii) price of Toyota altis, (iii) income of the household, and (iv) tastes and preferences of the household. A demand function is an algebric expression of the relation between the demand for a commodity and its various determinants like the price of the commodity, the prices of related goods, the level of disposable income, tastes and preferences, etc. The relationship is, more generally, expressed in the following form: DN = f (PN, PR, Y, T, E, H, G,……..) Demand Schedule: It is a tabular statement that shows different quantities of a commodity that would be demanded at different prices. It is of two types: (i) Individual Demand Schedule: It is the table which shows various quantities of a commodity that would be purchased at different prices by a household during a given period. Price (per KG) Quantity Demanded (KG per week) 100 1 90 2 80 4 70 6 (ii) Market Demand Schedule: It is the table which shows various quantities of a commodity that all the buyers will purchase at different prices by a household during given period. It can be obtained by adding up the quantities purchased at different prices by all the households in the market. Price (per Quantity Demanded by Quantity Demanded by Total Market KG) A (KG per week) B (KG per week) Demanded (A + B) (KG per week) (1) (2) (3) (4) 100 1 2 1+2=3 90 2 3 2+3=5 80 4 5 4+5=9 70 6 7 6 + 7 = 13 By Kartik Garg: 8439993339 Demand Curve: It is a graphic presentation of the law of demand. The picturisation of the demand schedule is called the demand curve. (i) Individual Demand Curve: It is the curve that shows different quantities of the good which a consumer is willing to buy at different prices during a given period of time. As per the schedule given above the price of apples is plotted on the vertical axis & quantity on the horizontal axis. (ii) Market Demand Curve: It is the horizontal summation of the demand curves of all the households. As the table shows demand of household A & B together we Quantity obtain market demand. LAW OF DEMAND The law of demand states that, cetris peribus, i.e., other things being constant, there obtains an inverse relationship between the price of a commodity and its quantity demanded. In the words of Alfred Marshall: The quantity demanded earns an inverse relationship to the price of a commodity; quantity demanded increases with a fall in price of the commodity, and vice versa, certis peribus. ASSSUMPTIONS OF LAW The law of demand is based upon a number of assumptions; more or less, these assumptions are common to whole set of economic laws. These are:  A person acts rationally  Prices of substitute goods do not change.  Consumer‟s income remains unchanged.  Taste and preferences do not change.  Prices of other complementary goods do not change. DEMAND SCHEDULE AND DEMAND CURVE The inverse relationship can be presented in a tabular & graphical form as follows: Demand Schedule P Q Ordinarily, a By Kartik Garg: 8439993339  10 90 demand curve 15 85 slopes downwards 20 80 from left to the 25 75 right, i.e., it has a negative slope. REASONS FOR DOWNWARE SLOPE OF THE DEMAND CURVE TO THE RIGHT/ REASONS FOR THE OPERATION OF LAW OF DEMAND Law of Diminishing Marginal Utility: The law of diminishing marginal utility states that when an additional unit of a commodity is consumed the marginal utility derived from it is declining. This law to a large extent affects the law of demand. A rational consumer would naturally prefer to buy this additional unit only at a lower price. This, therefore, causes an inverse relationship between price and demand. A consumer will maximize his satisfaction when he equalizes the marginal utility of the commodity with its price Marginal utility of a commodity = price of a commodity. Income Effect: It implies effect of change in consumer‟s real income resulting from change in the price of a commodity on his demand. As the price of a commodity decreases, the real income of the consumer increases. Hence, the consumer will now be able to demand more quantity of the commodity by spending the same amount of money. Substitution Effect: Substitution effect is the effect that a change in relative prices of substitute goods has on the quantity demanded. When price of any commodity increase while prices of other substitute goods remain unchanged, consumers would like to prefer the substitute goods. Ex. When there is rise in price of tea demand for coffee will increase because Coffee has become relatively cheaper. Hence, demand for coffee will increase and that of tea will reduce. Price Effect = Income Effect + Substitution Effect Entry and Exit of Customers: When the price of a commodity falls, new consumers, who were unable to purchase this commodity earlier, will start buying it as they find it within their reach now. Conversely, in case of increase in its price, even some of the old consumers find it difficult to purchase the commodity. In this way, the change in number of customers in the market determines the law of demand. Various Uses: Some commodities have alternative uses. For example, milk can be used for preparing curd, cheese, sweets, tea etc. If the price of such a commodity rises, it is used for more important uses. Consequently, (5) demand will go down. On the other hand, when price falls, the commodity will be put to more uses where it was not being used earlier and its demand will go up. EXCEPTIONS TO THE LAW Giffen Goods: These are a special type of inferior goods (named after the economist Sir Robert Giffen) such that a rise in their prices leads to an increase in quantity demanded for these goods and vice versa. By Kartik Garg: 8439993339 Giffen goods are those goods whose quantity demanded falls with a fall in their prices and rises witn an increase in their price. Inferior goods, on the other hand, are those goods whose demand falls with an increase in the income level of consumer. With a fall in consumer’s income, demand for such goods normally rises. Example: Cheap cereals like bajra, cheap read, cheap vegetables etc. As the price of an inferior commodity (like maize) falls, real income of the consumer (i.e.,consumer‟s purchasing power)rises. With an increase in real income, a consumer may afford to purchase superior food, rice or wheat. Since the total quantity of food intake remains fixed, an increase in the quantity demanded of rice would result in a fall in the quantity demanded of maize, i.e., at a lower price, less quantity of maize will be demanded. Conversely, if the price of maize rises, a consumer, due to fall in his real income, would be forced to cut back on the consumption of rice and divert this income to purchase more of maize. In other words, at a higher price more quantity of maize will be demanded. In this type of situation, demand curve for maize (i.e., a Giffen good) would slope upwards, and not downwards, as shown in figure. Here, at OP price, OQ quantity of maize is demanded. As price rises to OP2, quantity demanded of maize rises to OQ 2. At a lower price of OP1, quantity demanded of maize falls to OQ1. Conspicuous consumption/ Article of Snob Appeal: A few goods are purchased only by rich and wealthy sections of the society, because their prices are so high that they are beyond the reach of the common man. More of these commodities are demanded when their prices go up steeply. Thosrtein Bunde Veblen has term it as conspicuous consumption. Example: diamonds, fancy cars, high-priced shoes and cellphones etc. Rich persons demand diamonds simply because they are expensive and out of reach of low-income households. As diamonds become costlier, rich persons buy more of them. At lower prices, diamonds lose their sheen for the rich and they buy less of them. Future changes in prices: Households also act as speculators. When prices are rising, households tend to purchase larger quantities of the commodity, out of apprehension that prices may go up further. Likewise, when prices are expected to fall, a reduced price may not be a sufficient incentive to induce households to purchase more. Example: shares of good corporate at the stock exchanges, etc. As share prices falls, people keep postponing their purchases in the expectation that prices may fall further. By Kartik Garg: 8439993339 Emergencies: In a situation like that of war or a famine, households behave in an abnormal way. They purchase more of the commodities even when the prices are going up. This only worsens the situations. Similarly, during depression, no fall in price is a sufficient inducement for consumers to demand more. Change in fashion: When a commodity goes out of fashion, no reduction in its price is a sufficient inducement for a buyer to purchase more of it. Example: Big-sized handsets, old edition of a textbook on Indian Ecomony, etc. Ignorance: This is especially so when a consumer believes in the dictum that a high-priced commodity is better in quality than a low-priced one. However, notwithstanding the above expectations, the universal applicability of the law of demand is not to be doubted. MOVEMENT AND/OR SHIFT IN DEMAND CURVE  In a single demand schedule, we have seen that with an increase in price of a commodity its quantity demanded falls and with a fall in price, quantity demand increases. Graphically, these changes are shown with the help of a downward sloping demand curve. We move up and down on a given demand curve.  Now, we will compare two or more demand schedules, as in Table below. A B C Price Quantity Price Quantity Price Quantity (Rs.) Demanded (Rs.) Demanded (Rs.) Demanded (Units) (Units) (Units) MOVEMENT SHIFT SHIFT 10 100 10 80 10 120 15 75 15 60 15 90 20 50 20 40 20 80  In (A), quantity demanded of chocolates changes as we change the price of chocolates. At a higher price, lesser quality is demanded and vice versa. The change in quantity demanded is indicated as a vertical movement in a given demand schedule.  Demand schedule in (B) is different. Earlier, consumers were ready to buy 100 units at the price of Rs. 10 each. May be now there is a change in tastes and preferences. Consumers demand only 80 units (as against 100 units earlier) at the price of Rs.10. The entire demand schedule has changed. We say there is a change in demand for chocolates. This change is shown as a horizontal shift of the demand schedule.  Likewise, demand schedule in (C) is different. Maybe it is Christmas time. Consumers are willing to buy 120 chocolates at a price of Rs.10 each. The entire demand schedule has changed. When the price changes, while all over variables are held constant, the resulting change is known as ‘change in quantity demanded’. Graphically, it is shown as a movement on a given demand curve. By Kartik Garg: 8439993339  If the price is held constant, and any of the other determinants of demand changes, the resulting change is known as the ‘change in demand’. Graphically, change in demand is shown with the help of a new curve. A „change in quantity demanded‟ illustrated as a movement on the given demand curve. This is shown in Figure.  Original demand curve is DD.  Quantity demanded at price OP equal OQ.  With a fall in price to OP1 the quality demanded expands to OQ1. The coordinate point move from E to E1.  With a rise in price to OP2, quantity demanded contracts to OQ2. The coordinate point moves from E to E2. That is, the curve remains the same. Up and down movement is recorded. The up movement is known as a contraction in demand. The down movement is known as the expansion in demand. A contraction in demand occurs when the quantity demanded of a commodity falls due to a rise in the price of the commodity. An extension in demand occurs when the quantity demanded of a commodity rises due to a fall in the price of the commodity. A change in demand involves a total shift of the entire demand curve, either to the left (to show a decrease in demand) or to the right (to show an increase in demand). Consumers at a given price. Example: During a festival season there is increased demand for sweets, clothes, gift items, etc. The onset of cricket World Cup results in increase in demand for T.V. sets. Increase in demand can be illustrated  Original demand curve is DD. At the price graphically as a rightward shift of the entire OP, OQ quantity is being demanded. demand curve. Decrease in demand can be  As the demand changes, the demand curve illustrated graphically as a leftward shift of the shifts either to the left (DD1) or to the right entire demand curve. This is shown in Figure (DD2). below.  At DD1, only OQ1 quantity is being demanded at the price OP. This shows a decrease in demand.  This has been caused by a factor other than the price of the commodity. At DD2, OQ2 quantity is being demanded at the price OP. This shows an increase in demand, caused by a factor other than the price of the commodity. Increase in Demand: An Increase in Demand takes place when the consumer demand more of a commodity, not due to a change in price of a commodity, but due to a change in any of the other determinants of demand. By Kartik Garg: 8439993339 Decrease in Demand: A Decrease in Demand takes place when the consumers demand less of a commodity, not due to any change in the price of the commodity but due to a change in any of the other determinants of demand (e.g., income, prices of related goods, tastes and preferences, etc.) COMTRACTION OF DEMAND AND DECREASE IN DEMAND Contraction of Demand takes place due to a rise in the price of a commodity. Decrease in Demand takes place due to a change in any other determinant of demand. For Example, fall in the income of the household, a fall in the price of a substitute good, a rise in the price of a complementary good, unfavourable changes in tastes and preferences, higher taxation by the government, etc. DISTINCTION BETWEEN CONTRACTION OF DEMAND AND DECREASE IN DEMAND Basis Contraction of Demand Decrease in Demand Meaning When the quantity demanded of a When the quantity demanded of a commodity falls due to a rise in the commodity falls due to a change in price of a commodity, it is known any of the other determinants of as Contraction of demand. demand and not due to any change in price, it is known as Decrease in demand. Causes It is caused due to change in price It is caused due to change in of a commodity. determinants of demand other than price. Effect on DD Curve Upward movement on the demand Demand curve shifts towards left. curve. Graph EXPANSION OF DEMAND AND INCREASE IN DEMAND Expansion of demand takes place due to a fall in the price of a commodity. Increase in demand takes place due to a change in any other determinant of demand, For example, a rise in the income of a household, a rise in the price of a substance good, a fall in the piece of complementary good, favorable changes is tastes and preferences, lower taxes by the government, etc. DISTINCTION BETWEEN EXPENSION OF DEMAND AND INCREASE IN DEMAND Basis Extension of Demand Increase in Demand Meaning When the quantity demanded of a When the quantity demanded of a By Kartik Garg: 8439993339  commodity rises due to a fall in the commodity rises due to a change in price of a commodity, it is known as any of the other determinants of expansion of demand. demand and not due to any change in price, it is known as increase in demand. Causes It is caused due to change in price of It is caused due to change in a commodity. determinants of demand other than price. Effect on DD Curve Downward movement on the Demand curve shifts towards right. demand curve. Graph A contraction (or an expansion) in demand is A decrease (or an increase) in demand is shown in shown in the form of a movement on a given the form of a shift in the demand curve. demand curve. PAST YEAR QUESTIONS 2020  Explain the meaning of Income Effect?  Explain any two factors affecting demand of a commodity other than its price. 2019  How does an increase in income affect the demand for the following: (i) A normal good; (ii) An inferior good  Explain the various degrees of price elasticity of demand at different points on a straight line demand curve.  Discuss any two exceptions to the law of demand. 2018  Differentiate between contraction of demand and decrease in diagram, using diagrams.  Discuss how prices of related goods affect the demand for a commodity. 2017  What is meant by ex-ante demand and ex-post demand?  Give a reason for each of the following: (a) the demand for good increases when the income of the customer increases. (b) X and Y are substitute goods. A rise in the price of X results in a rightward shift of the demand curve of Y.  Find the elasticity of demand of x and y on the basis of the demand schedule given below and specify which one is more elastic. Good X Good Y Px (Rs.) Dx (units) Py (Rs.) Dy (units) 8 10 8 10 4 12 6 25  Explain any four reasons for the demand curve to be downward sloping. 2015  Discuss the relationship between income of the customer & demand for commodity w.r.t normal goods, inferior goods & necessities. By Kartik Garg: 8439993339   Differentiate between Extention & Increase in Demand using Diagram. 2014  Explain the demand Curve for a necessity commodity. 2013  What is the shape of the Demand Curve? Or How does an increase in the price of a commodity affect its quantity demanded? Show it with the help of a diagram.  Explain how the income effect & Substitution are the reasons for downward slope for demand curve. 2012  Explain with an example, what kind of commodity will have an inverse relationship between income & demand?  Explain how the following phenomena are exceptions to the law of demand: 1. Expectations regarding future prices; 2. Conspicuous consumption by a consumer. 2011  Discuss 4 causes for the inverse relationship between price & quantity demanded for a commodity. How are Giffen goods an exception to the law of demand?  Complete the demand schedule for commodity X: Price Quantity Quantity Market Demand Demanded by A Demanded by B (Dozen) (Dozen) 15 50 85 -- 20 45 -- 105 25 -- 45 85 30 35 35 -- Draw the Market Demand Curve from the above schedule. 2010  With the help of Diagram show the Shift & Movement on the Demand Curve.  State the Law of Demand with two assumptions. By Kartik Garg: 8439993339  CHAPTER-2 THEORY OF CONSUMER BEHAVIOUR Utility: It refers to want satisfying power of a commodity. Total Utility: It refers to the total satisfaction derived by the consumer from the consumption of a specific quantity of a commodity. Marginal Utility: It refers to the additional utility derived from the consumption of an additional unit of a commodity. Relationship between TU & MU UNITS TU MU(UTILS) 0 0 Undefined 1 10 10 (10-0) 2 17 7 (17-10) 3 21 4 (21-17) 4 22 1 (22-21) 5 22 0 (22-22) 6 19 -3 (19-22) Here, TU is the total utility from n units. It is the sum of MUs of various units of a commodity. TU = MU1 + MU2 + …………MUNth MU = TUN – TuN-1 The table shows that TU & MU of the first mango are identical (10 utils). Further, MU keeps diminishing, the total utility continues to increase so long as the marginal utility is positive, i.e., the total utility increases so long as the MU does not drop to zero. At last, MU becomes negative & TU starts declining. The relationship between TU & MU can be indicated in terms of 3 propositions: 1. The TU curve is concave from above which indicates declining marginal utility. Thus, upto point M,TU curve has a positive slope, but its slope goes on decreasing steadily as quantity consumed is increased. This shows that as long as TU increases, MU is positive. 2. When TU is maximum, MU is zero. It is shown at point M. By Kartik Garg: 8439993339  3. After M, the slope of the TU curve becomes negative showing that the MU is negative. Thus, when TU declines, MU is negative. Law of Diminishing MU: The law states that as the amount consumed of a commodity increases, the utility derived by the consumer from the additional unit, i.e., marginal utility goes on diminishing. Assumptions: 1. All the units of a commodity must be identical i.e. same in all respects-in size, colour, design, quality etc. 2. The units of the good must be standard. 3. There should be no change in taste during the process of consumption. 4. There must be continuity in consumption. 5. There should be no change in the prices of substitute goods. 6. The utility is measurable. Explanation of the Law: 1. As more and more quantity of a commodity is consumed, the intensity of desire decreases, and therefore, the utility derived from the additional unit decreases. 2. The second explanation is that if there are many uses of a commodity, the most urgent requirement will be fulfilled first, followed by the next important use and so on. CONSUMER EQUILIBRIUM: CRADINAL UTILITY APPROACH A consumer will be in equilibrium when he/she spends his/her given income on the purchase of different goods & services so as to maximize his/her total utility. Assumptions: 1. Consumer is rational. 2. Utility can be measured in money terms. 3. The law of DMU operates. 4. The utility of each unit of money remains constant. 5. Consumer‟s income is given & remains constant. IN CASE OF ONE COMMODITY: Symbolically, consumer‟s equilibrium is attained when MUX = PX. Where MUX is MU of commodity X & PUX is price for commodity X. The schedule and Graph given below explains the following: UNITS MU PRICE 1 700 600 2 650 600 3 600 600 4 500 600 5 350 600 Suppose, the consumer wants to purchase shirts. Here he gets utility from different units of shirt as indicated in table. It is obvious from table that the consumer gets MU equal to Rs. 700 from the first shirt. By Kartik Garg: 8439993339 As he consumes additional unit of shirt, the MU goes on diminishing. Price of the shirt is assumed to be Rs. 600. The downward sloping MU curve indicates Law of DMU. The horizontal line P shows the price of a shirt. The MU curve and price line P intersect each other at point E. Therefore, the consumer is in equilibrium at point E, where the MU = P. In our example, this condition is satisfied when he/she purchases 3 shirts. At any point above E, MU > P. For instance, the 2 nd shirt gives him/her satisfaction equal to Rs. 650, while the price of the shirt is Rs. 600. Consumer will not like to purchase the 4th shirt because it gives him /het utility equal to Rs. 500, which is less than the price of the shirt (Rs.600). The point E is the point of equilibrium where MU of shirt is equal to the price of the shirt. IN CASE OF ONE COMMODITY-LAW OF EQUI MARGINAL UTILITY The consumer maximizing his/her TU will allocate his/her income among various commodities in such a way that the MU of the last unit of money spent on each commodity is equal. Here, the consumer will be in equilibrium while purchasing X & Y, when MUX/PX= MUY/PY = MU per unit of Money. Example; we assume that a consumer wants to spend Rs.40 on the purchase of two commodities X & Y, the prices of which are Rs.5 & Rs.10 respectively. The table shows that MU of these two goods X & Y. Units MUX MUY MUX/PX MUY/PY Combinations Total Expenditure (Rs.5) (Rs.10) 1 50 80 10 8 2 45 70 9 7 1) 3 units of X + 1 unit of Y Rs.25 (3*5+1*10) 3 40 60 8 6 2) 4 units of X + 2 unit of Y Rs.40 (4*5+2*10) 4 35 50 7 5 3) 5 units of X + 3 unit of Y Rs.55 (5*5+3*10) 5 30 40 6 4 4) 6 units of X + 4 unit of Y Rs.70 (6*5+4*10) 6 25 30 5 3 Here, the consumer has to spend Rs.40 on the purchase of X & Y. If the purchases combination (1) he/she will be able to spend Rs.25 only. If he purchases combination (3) & (4) he/she is required to spend Rs.55 and Rs.70 respectively, which are out of his reach, given his/her budget. It is only when he/she purchases combination (2) that he/she will be able to incur an expenditure of Rs.40. Thus, the consumer will be in equilibrium when he/she buys 4 units of X & 2 units of Y and thereby spends a total sum of Rs.40 as shown in the above table. INDIFFERENCE CURVE (IC) ANANLYSIS/ORDINAL UTILITY ANALYSIS The IC analysis is based on the idea of a given scale of preference on the part of the consumer as between different combinations of two goods. TO explain this, we give our imaginary household some quantities of two goods – say clothing and food which give him equal satisfaction. This is shown by an indifference schedule. An indifference schedule refers to a schedule that shows various combinations of two goods which give equal amount of satisfaction to the customer. Combination Food Clothing MRS (units) (units) A 1 10 - B 2 7 1:3 C 3 5 1:2 D 4 4 1:1 By Kartik Garg: 8439993339 The above schedule shows that the household gets equal satisfaction from all the 4 combinations, namely A, B, C & D of food and clothing. It is clear that in order to have one or more unit of food, he has to sacrifice some amount of the clothing in such a way that there is no change in the level of his satisfaction from each of these combinations. If we show these combinations diagrammatically, we get an indifference curve. An IC is a diagrammatic presentation of indifference schedule. In this diagram, quantity of food is shown on OX-axis and that of clothing on OY-axis. Combinations A, B, C & D are plotted from table. It is the locus of various points, each point representing a different combination of two goods, which yield the same level of satisfaction to the consumer so that he is indifferent between these combinations. Thus, different points A, B, C & D on IC shows those combinations of food & clothing which give equal amount of satisfaction to the consumer. An IC is also known as ISO-utility curve. Indifference Map: It is a group or set of ICs each one of which represents a given level of satisfaction. The figure given below shows an indifference map consisting of various indifference curves IC 1, IC2, IC3 & IC4. Each IC represents different level of satisfaction. All the points on a particular IC indicate alternative combinations of food & clothing that give the household equal amount of satisfaction. The farther the curve from the origin, the higher is the level of satisfaction it represents. Marginal Rate of Substitution: It is the rate at which the consumer is willing to substitute one good for another without changing the level of satisfaction. MRS of Y for X (MRSYX)is defined as the amount of Y the consumer is willing to give up to get one additional unit of X so that the same level of satisfaction is maintained MRS of clothing for food is illustrated in Col.4 of the table. For example; when consumer moves from combination „A‟ to combination „B‟, he/she is willing to give up 3 units of clothing for 1 unit of food, i.e., MRS of clothing for food is 1:3. Properties of IC: (i) An IC slopes downward from left to the right: It has negative slope. This property is based on the assumption that if a consumer consumes more of one commodity (food), he/she must consume less quantity of the other (clothing), then only he/she will have the same level of satisfaction from different combinations of the two commodities. (ii) An IC is convex to the origin: Convexity of the curve implies that it bows inward to the origin. In other words, the slope of the IC decreases as we move down the IC. This follows from the assumption of diminishing MRS. The assumption implies that lesser is the amount of one commodity consumed by a household, the lesser willing the household will be to give up a unit of that commodity to obtain an additional unit of the other commodity. (iii) Higher IC yield higher satisfaction: An IC which lies above and to the right of another IC gives a higher level of satisfaction than the lower one. Higher IC represents those combinations which yield more satisfaction that the combinations on the lower IC. (iv) Two IC never intersect each other: These curves may lie close to each other, but they never intersect. This follows from the fact that each IC represents different level of satisfaction. Therefore, two IC do not intersect or touch each other. Budget Line: It shows the various combinations of two commodities which can be purchased with a given budget at given prices of the two commodities. By Kartik Garg: 8439993339 Suppose that the consumer has RS.200 to spend on food and clothing and suppose that the price of food is RS.20 per unit and price of clothing is Rs. 40 per unit. How much of food and clothing can the consumer buy, given the consumer‟s expenditure and the prices of two commodities? Units Units Expenditure (Clothing) (Food) 5 0 Rs.200 (5*40 + 0*20) 4 2 Rs.200 (4*40 + 2*20) 3 4 Rs.200 (3*40 + 4*20) 2 6 Rs.200 (2*40 + 6*20) 1 8 Rs.200 (1*40 + 8*20) 0 10 Rs.200 (0*40 + 10*20) The combinations shows that if the consumer spends entire amount of RS.200 on clothing, then 5 units of clothing and no units of food can be purchased. If the consumer buys 4 units of clothing at Rs.40 per unit then Rs. 160 will be spent on clothing and remaining Rs.40 can be spent in buying 2 units of food. On the other extreme, if the consumer spends entire amount of Rs.200 on food, then 10 units of food and no units of clothing can be bought. The units of clothing are shown on the vertical axis and units of food are shown on the horizontal axis, and then we plot various combinations of clothing and food from the table. These points then are connected with a line, starting from the upper left with zero units of food and 5 units of clothing and ending on the right with 10 units of food and zero unit of clothing. Consumer’s Equilibrium through IC Approach: IC approach explains consumer‟s equilibrium with use of consumer‟s indifference map and budget line. Two conditions need to be fulfilled for the consumer to be in equilibrium. (i) MRSXY = PX/PY (ii) The IC should be convex to the origin. The consumer cannot purchase any combination, which lies to the right of the budget line KL such as combination „D‟, because it is out of his/her reach with the given income and given prices of the two commodities. On the other hand, any combination inside the budget line, such as combination A, is within the reach of him/her. But any such combination will give him/her less utility than any combination on the budget line because it lies on a lower IC. As clear from the figure, the highest IC with a point on the budget line is the one that just touchés i.e.is tangent to the budget line. This occurs at point T. The tangency point is the highest level of utility or the highest indifference curve that the consumer can achieve subject to the budget constraint. It is the combination of OM of clothing and ON of food that the consumer purchases. At the point of tangency T, the slope of the price line and the indifference curve IC2 are equal. Thus, this is the situation of By Kartik Garg: 8439993339  Consumer‟s Equilibrium. PAST YEAR QUESTIONS 2020  hState the law of Diminishing Marginal Utility. Mention any two assumptions of the same.  Explain the concept of Diminishing Marginal Rate of Substitution and show how it affects the indifference curve.  The marginal utility schedule of a rational consumer is given below. If the price of a commodity is Rs.35. Explain with the help of diagram, how the consumer attains equilibrium. No. of Commodity bought 1 2 3 4 5 MU 50 45 40 35 30 2019  Explain the indifference map, with the help of a diagram.  Explain how a consumer attains equilibrium using indifference curve analysis. 2018  Define total utility. How is marginal utility derived from total utility?  A consumer consumes goods X & Y. Given below is his marginal utility schedule for goods X & Y. Suppose, the price of X is Rs.2, Y is Rs.1 and income Rs.12. State the law of Equi-marginal utility and explain how the consumer will attain equilibrium. Units 1 2 3 4 5 6 MUX 16 14 12 10 8 6 MUY 11 10 9 8 7 6 2017  Explain with the help of a diagram the relationship between total utility and marginal utility.  Explain any two characteristics of an indifference curve. 2016  Discuss two differences between cardinal utility & ordinal utility.  What is meant by Budget Line?  Explain the concept of Consumer Equilibrium with the help of Indifference curve Analysis. 2015  Define MU. When can it be negative?  Explain the help of diagram the Consumer Equilibrium through Utility Approach.  Discuss any two properties of Indifference curve. 2014  Study the schedule given below and identify how much of commodity A & commodity B will a utility maximizing consumer buy: Units of A MU of A Units of B MU of B 1 10 1 30 2 8 2 24 3 6 3 20 4 4 4 16 5 2 5 14 6 1 6 8 Price A = Rs.2; Price B = Rs.4 & Income = 20. Explain the law of Equi-Marginal Utility using the above schedule. By Kartik Garg: 8439993339 2013  A Marginal Utility schedule of a person is given below. Discuss the law underlined the given schedule. Pen (Units) MU (Units) 1 25 2 20 3 15 4 10 5 5 2012  State the Law of Equi-Marginal Utility.  The following table shows the Marginal Utility derived from the purchase of book. The price of the book is Rs.500. Draw a diagram to explain consumers equilibrium where MU = P. No. of Books MU 1 500 2 600 3 500 4 400 5 300 2011  State two assumptions of Law of Diminishing Marginal Utility. By Kartik Garg: 8439993339  CHAPTER-3 ELASTICITY OF DEMAND Elasticity of Demand: Elasticity of Demand refers to the responsiveness of Quantity demanded of a commodity to a change in any one of the determinants of demand. There are 3 types of Elasticity of Demand 1. Price Elasticity of Demand 2. Cross Elasticity of Demand 3. Income Elasticity of Demand. Price elasticity of demand: It may be defined as the degree of responsiveness of quantity demanded of a commodity to a in its price. EP = (Percentage change in Quantity demanded of a commodity) / (Percentage change in price of the commodity) Symbolically, EP = ∆Q/∆P * P/Q OR Price Elasticity of Demand refers to the ratio of the percentage of a commodity to a given percentage in its price. TYPES / DEGREES OF ELASTICITY OF DEMAND 1. Perfectly Inelastic Demand (EP = 0): When quantity demanded of a commodity does not respond to change in its price, then the elasticity of demand is zero. No matter what the price, the same quantity is demanded. A demand curve of zero elasticity is known as perfectly inelastic demand curve. As per the figure illustrated here, it shows D1 curve, which is parallel to Y-axis, is perfectly inelastic demand curve. The amount purchased remains OQ irrespective of whether price is OP or OP1. Cases of this demand are very rare. Example: Basic Necessities. 2. Perfectly Elastic Demand (EP = ∞): When consumers are prepared to purchase all that they can get at a particular price but nothing at all at a slightly higher price, then the price elasticity of demand for a commodity is said to be infinite. The figure illustrated here, shows the demand curve D2 which is parallel to X-axis. At price OP1 nothing is demanded but at a slightly lower price OP an infinitely large quantity is demanded. This is the extreme or upper limit of price elasticity. 3. Unitary Elastic Demand (EP = 1): When a given percentage change in price of commodity causes an equivalent percentage change in the quantity demanded, then the elasticity of demand is said to be unitary By Kartik Garg: 8439993339  (one). For example: if a fall in price of the commodity by 10 percent causes an increase in the amount purchased by 10 percent, the elasticity of demand is equal to one. Demand curve D2 has unitary elasticity at all the points on the curve. Such a curve is known as rectangular hyperbola curve. This curve is a curve in which the total area at different points on the curve is same. 4. More Than Unit Elastic Demand (EP > 1): When the percentage change in quantity demanded of a commodity exceeds the percentage change in its price, the elasticity of demand is greater than unitary elastic. For example: if a fall in the price of the commodity by 10 percent causes an increase in amount demanded by 15 percent, the demand is said to be elastic. Here, DD is elastic between A and B because the percentage changes in quantity demanded from OQ1 to OQ2 is relatively larger than the percentage change in price from OP1 to OP2. 5. Less Than Unit Elastic Demand (E, < 1): Demand is inelastic when the percentage change in quantity demanded of a commodity is less than the percentage change in its price. The elasticity of demand here is less than unity. For instance, if a fall in the price of a commodity by 10 percent leads to an increase in quantity demanded by 8 percent, the demand is inelastic. Here, DD is inelastic demand curve because the percentage change in quantity demanded from OQ1 to OQ2 is smaller than the percentage change in price from OP1 to OP2. By Kartik Garg: 8439993339 FACTORS AFFECTING PRICE ELASTICITY OF DEMAND 1. Availability of Substitutes: If a commodity has many substitutes, its demand is likely to be elastic. Even a small fall in price will induce more people to buy this commodity rather than its substitutes. For example: Coffee and Tea are close substitutes for one another. When the price of coffee falls, given the price of tea, many consumers will buy more of coffee and less of tea. On the other hand, if the commodity has no or weak substitutes, the demand for it would be inelastic. This is the case with the milk, salt and sugar which do not have good substitutes. 2. Nature of the Commodity: The nature of the commodity i.e. whether it is „necessity‟ or a „luxury‟ or a commodity of „comfort‟. Demand for necessities such as food items is generally inelastic. These essential-to-life commodities will be purchased in more or less fixed quantities, whether the price is high or low. On the other hand, commodities of „luxuries‟ and „comfort‟ are not essential for existence and their consumption can be dispensed with or postponed. Thus their demand is elastic. For example: fall in price of ACS or Colour TV sets may bring about a large increase in the quantity demanded of these goods. 3. Proportion of the Income Spent: The smaller is the proportion of income spent on a commodity, the smaller will be the elasticity of demand and vice versa. For example: soap, salt, matches etc. is highly inelastic. On the other hand, the demand for clothes, furniture etc. is likely to be elastic since the consumer spends a large fraction of his/her income on these goods. 4. The number of uses of a commodity: The greater is the number of uses to which a commodity can be put to, the greater will be its price elasticity of demand. If the price of the commodity is very high, consumer will purchase this commodity for the most important use only and, hence, the demand will be very small. As its price falls, more of the commodity will be brought to be devoted to less important uses. For example: electricity can be used for lighting, heating, cooking etc. If electricity is very expensive, it might be used for lighting only. 5. Postponement of Consumption: Demand for a commodity is elastic if its consumption can be postponed. Therefore consumption of clothing may be postponed, thus its demand is elastic. But the consumption of food items cannot be postponed. Therefore, their demand is inelastic. 6. Habits of Consumers: If consumers are habitual of consuming some commodities, they will continue to consume these even at higher prices. For instance, a smoker does not reduce much the numbers of cigarettes smoked as the price of cigarette go up. The demand for such commodities will be usually inelastic. METHODS OF PRICE ELASTICITY OF DEMAND Percentage/Proportionate Method Price Elasticity of demand is measured by the ratio of Percentage change in the quantity demanded to percentage change in the price of the commodity. EP = Percentage Change in Quantity demanded / Percentage Change in Price OR EP= ∆Q/∆Px P/Q TOTAL EXPENDITURE/OUTLAY METHOD This method is suggested by Marshall. According to Expenditure method, “Elasticity of demand can be measured by considering the change in total expenditure incurred on a commodity as a result of change in the price of commodity. By using this method, we can categorize three types of elasticities: 1. Elastic Demand (EP > 1): When as fall in the price of a commodity results in increase in total expenditure and a rise in the price leads to decrease in TE, elasticity of demand will he greater than one. It can be shown from the following schedule: Price (Rs.) Quantity(Units) Total Exp. (Rs.) As price falls, TE increases from Rs.600 60 10 600 to Rs.650. Thus, demand is elastic. 50 13 650 2. Inelastic Demand (EP < 1): When a fall in price of a commodity reduces TE and a rise in price increases it, price elasticity of demand will be less than one. By Kartik Garg: 8439993339  Price (Rs.) Quantity(Units) Total Exp. (Rs.) Here, demand is inelastic because with a 60 10 600 fall in price from Rs.60 to Rs.50, TE 60 50 11 550 falls from Rs.600 to Rs.550. 3. Unitary Elastic (EP = 1): When TE does not change with change in price of the commodity, the elasticity of demand is equal to unitary. Price (Rs.) Quantity(Units) Total Exp. (Rs.) 60 10 600 50 12 600 We can summarize these results through the following table: Change in Types of Elasticity of Demand Price Unitary Inelastic Elastic Elastic Fall in Price TE TE falls TE rises constant Rise in Price TE TE rises TE falls constant Point Method/ Geometric Method: According to this method, price elasticity of demand can be measured at any point on the demand curve. EP = (Line segment below the point on Demand curve) / (Line segment above the point on the demand curve) OR EP =Lower line segment /Upper line segment We can use the above method (or formula) of point elasticity in measuring elasticity at different points on a straight line demand curve starting from Y-axis and terminating at X-axis. The figure given aside is shown as follows: Here, AB is a straight line demand curve, with A as its intercept, B as X intercept and D as its mid-point. 1. At point A: EP (A) = Lower line segment below A/ Upper line segment below A = AB/0= Infinity (∞) 2. At any point above the mid-point but below A, say at E: EP (E) = BE /EA>1 [Because the lower segment is greater than the upper segment i.e. BE > EA] 3. At mid-point D: EP(D) = BD/DA = 1 [Because the lower segment equals the upper segment] 4. At any point below the mid-point but above B, say at C: By Kartik Garg: 8439993339  EP(C) =BC/CA< 1 [Because the lower segment is smaller than the upper segment i.e. BC > CA] 5. At point B: EP(B): 0/ AB =0(Where demand curve touches X-axis) Income Elasticity of Demand: It measures the degree of responsiveness of quantity demanded of a commodity to changes in income of the consumers. EY= (Percentage change in Qty. Demanded) / (Percentage change in Income) TYPES OF INCOME ELASTICITY 1. Positive Income Elasticity: It is said to be positive when with increase in income of the consumers amount purchased of a commodity increases and vice versa. Goods with positive income elasticities are called normal goods. For normal goods, we can classify income elasticity into three categories: I. Income Elastic: If the percentage change in Qty. demanded is greater than the percentage change in income, EY will exceed unity. II. Income Inelastic: If the percentage change in Qty, demanded is smaller than the percentage change in income, EY will be less than unity. III. Unitary Income Elasticity: If the percentage change in Qty. demanded is equal to percentage change in income, EY will be equal to unity. 2. Negative Income Elasticity: Income elasticity of demand is said to be negative when an increase in income of the consumers leads to a fall in the amount purchased of a commodity and vice versa. In case of inferior commodities, an increase in income leads to a fall in the Qty. demanded. 3. Zero Income Elasticity: It implies that a rise in income leaves Qty. demanded unchanged. For instance, Salt. Cross Elasticity: It is defined as the percentage change in Qty, demanded of a commodity with respect to the change in the price of its related commodity. EXY= (Percentage change in Qty. Demanded of Commodity X) / (Percentage change in Price of Commodity Y) Types of Cross Elasticity: 1. Positive Cross Elasticity: Cross elasticity of demand is said to be positive, when increase in the price of one commodity (Y) leads to an increase in the demand for other commodity (X). When two goods are substitutes for each other, cross elasticity be positive. For example: A fall in the price of coffee (Y) increases the quantity of coffee demanded but reduces the quantity of tea (X) demanded. 2. Negative Cross Elasticity: It is said to be negative when a fall in the price of Y leads to an increase in the demand for X. For example: bread and butter are complementary goods. 3. Zero Cross Elasticity: It is said to be zero when a change in the price of one commodity (Y) does not affect the demand for another commodity (X), if the two goods are not related to each other, say tea and TV sets, cross elasticity will be zero. By Kartik Garg: 8439993339  PAST YEAR QUESTIONS 2020  When a price of commodity X changes from Rs. 40 per unit to 20 per unit, its demand increases by 20 units. If price elasticity of demand is 0.5, calculate the initial & final quantity demand of commodity X. 2018  Explain any two factors affecting the price elasticity of demand. 2017  Find the elasticity of demand of x and y on the basis of the demand schedule given below and specify which one is more elastic: Good X Good Y PX (Rs.) DX (units) PY (Rs.) DY (units) 8 10 8 10 4 12 6 25 2016  What is meant by Income elasticity of Demand?  The quantity demanded of a commodity at a price of Rs. 10 per unit is 40 units. Its price elasticity of demand is (-2). The price falls by Rs. 2 per unit. Calculate the Quantity demanded at a new price. 2015  Draw the diagram to show elasticity of demand when it is : a) Greater than 1: b) Less than 1: c) Unity 2014  The demand for a commodity at Rs. 4 Per unit is 100 unit. The price of the commodity rises & as a result, its demand falls to 75 units. Find the new price, if the price elasticity of demand of that commodity is 1.  Discuss the effects of Elasticity of demand on: a) A commodity which has many substitutes; b) A small part individual's income spend on a commodity. 2013  What does zero cross elasticity of demand between two goods imply? Give an example to explain.  En = 1. A household buys 50 units of this product when its price is Rs.10 per unit. If its price rises to Rs.12 per unit, how much quantity of the product will be bought by the household? 2012  Calculate the Quantity demanded of a commodity when its price from Rs.4 to Rs.6. The original Quantity demanded was 40 units & the price elasticity of demand is 0.5.  What will be the price elasticity of demand of the point A, B, L & K in the diagram given below:  How is the Elasticity of demand of a commodity affected by the following factors: I. Existence of Substitute of a commodity: II. Nature of a commodity. By Kartik Garg: 8439993339 2011  Explain any four determinants of price elasticity of demand.  If demand increases by 50% due an increase in income by 75%, calculate the income elasticity of demand.  What would be the elasticity of demand of a commodity when: a) Price & Total Expenditure move in the opposite direction. b) Price & Total Expenditure move in the same direction. CHAPTER-4 SUPPLY & ELASTICITY OF SUPPLY Concept of Supply: Supply refers to the quantity of a commodity offered for sale by a producer at different prices during a given period. Thus defined, it is also called intended supply. Thus defined, the concept of supply shows the following features: 1. Supply is a desired quantity; i.e., how much quantity of a commodity producers are willing to sell at different prices. It does not show how much quantity the producers actually sell. The quantity of commodity actually sold in the market is called actual supply. 2. Supply is a flow concept; it has a time dimension. Thus, we say Maruti Suzuki can supply 10, 00,000 cars during a year; McDonald's can supply 10,000 burgers during a year. 3. Of course, any reference to quantity supplied is in relation to a specified price of the commodity. Supply and Stock: Stock of a commodity refers to the total quantity of the commodity (i.e., actual supply) available with the seller at a given time. But it is not necessary that the seller may offer whole of his stock of the commodity for sale at the given price at any given time. The part of the stock which a seller offers for sale at any price at a given time is called supply (or intended supply). Example: immediately after harvest, a farmer acquires large stock of a crop. In this period, the price tends to be low. The farmer holds back his stock. He does not offer all of his stock. Gradually, as the price of the commodity goes up, the farmer offers more and more stock for sale. Supply and Quantity Supplied: We may note the distinction between „supply‟ and the „quantity supplied‟. Supply descries the behaviour of sellers at every price. At a particular price there is a particular quantity supplied. This term „quantity supplied‟ makes sense only in relation to a particular price. Thus defined, „supply‟ also can be defined as „intended supply‟, and „quantity supplied‟ as „actual supply‟. Joint Supply & Composite Supply: Joint supply may be defined as that relation where two or more products are obtained at the same time, in a single production process. It is also called joint costs, because where two or more commodities are produced together, their costs of production cannot be entirely separated. Composite supply occurs when two or more products are used for one purpose. Supply Function: Supply of a commodity I influenced by a number of factors; these are known as determinants of supply. All these factors can be put together in what is called a supply function. A supply function is a set of determinants of Supply. To understand the nature of supply function we may distinguish between individual supply and market supply. Individual supply refers to the quantity offered for sale by one single and producer of a commodity. Market supply refers to the quantity of a commodity offered for sale y all the producers of that commodity taken together. A simple individual supply function can be stated as follows: SN= f (PN, PR, F, T, G) Supply function descries the functional relationship between supply of a commodity (say N) and other determinants of supply, i.e., price of the commodity (P N), price of a related commodity (PR) price of the factors of production (F), technical know-how (T) and goals or general objectives of the producer (G). Determinants of Supply: By Kartik Garg: 8439993339  (i) Price of the commodity: The most important determinant of supply of a commodity is its price. Higher the price of a commodity, the producers will offer more quantities for sale in the market. This type of relationship between price and quantity supplied is illustrated by the law of supply. (ii) Price of related goods: Supply of a commodity also depends upon the prices of the related goods, especially substitute goods. If the price of substitute goods goes up, producers will be tempted to produce the substitute goods. For example, if the price of wheat goes up, the land will be put under cultivation of wheat, instead say, that of pulses. Supply of wheat will increase, whereas that of pulses will fall. (iii) Prices of the Factors of production: Prices of the factors of production used in the production of a commodity constitute the cost of production of this commodity. If the prices of these factors go up, its total cost of production may rise. In such a situation, the producers may divert their resources to the production of some other commodities which can be produced at a lower cost. As a result, the supply of this commodity will decrease. (iv) Goals of producers: Ordinarily, every firm tries to attain maximum profit. But at times, Individual producers may be induced to increase the supply of a commodity, not because it rings in more profits for them but because its supply in the market is a source of status and prestige in the market. (v) State of technology: Over time, technical knowledge changes. Discoveries and innovations help raise the productivity of the factors, and thus contribute to the raising of the supply upwards. DETERMINANTS OF MARKET SUPPLY Market supply is influenced by all those factors that influence an individual producer‟s decisions. In addition, market supply is influenced by some more factors. These can be stated in a form of a market supply function as follows: SN = f(PN, PR, F, T, N, t, g, E, A) Where N are natural factors, t is availability of means of transportation and communication, g is government policy relating to taxation, E stands for further expectations of rise in prices and A stands for agreement among producers. We discuss below these factors: (i) Natural Factors (N): The supply of the agricultural goods to a great extent depends upon the natural conditions. Adequate rain, fertility of land, irrigation facilities, favorable climatic conditions, etc., help in raising the supply of agricultural produce. Contrary to that, heavy rains, floods, drought conditions, etc., adversely affect the agricultural production. (ii) Means of transportation and communication (t): proper development of means of transportation and communication helps in maintaining adequate supply of the commodities. In case of short supply, goods can be rushed from the surplus areas to the deficient areas. But if the developed means of transportation are used to export goods, it will create scarcity of goods in the domestic market. (iii) Taxation policy (g): Imposition of heavy taxes on a commodity discourages its production, and as a result, its supply diminishes. On the other hand, tax concessions of various kinds induce producers to raise the supply. (iv) Further expectations of rise in prices (E): If the producers expect an increase in the price in the near future, then they will curtail the current supply, so as to offer more goods in future at higher prices. (v) Agreement among the producers (A): sometimes the producers of a commodity form their associations or enter into an agreement so as to earn profit. It motivates them to create artificial scarcity of the commodity. LAW OF SUPPLY The law of supply states that, other things remaining the same, the quantity of any commodity that firm produces and offers for sale rises with an increase in price and falls with a decrease in price. The law of supply explains the positive or direct relationship between price of a commodity and its quantity supplied, other things remaining the same. Price and supply are directly related. A rise in price induces producers to supply more quantity of the commodity and a fall in price makes them reduce the supply. This hypothesis has a strong common sense By Kartik Garg: 8439993339 appeal, since the higher is the price of the commodity, the larger is the profit that can be earned, and thus the greater is the incentive to produce more of the commodity and offer it in the market. Likewise, at lower prices, profit margin shrinks and hence producers reduce the sale. Supply Schedule and Supply Curve: Law of supply can be illustrated with the help of a schedule and a supply curve. A supply schedule is a tabular statement that gives a full account of supply of a commodity in a given market at a time. It states what the quantity of goods offered for sale would be at each of a series of prices. Supply schedule is of two types: (i) Individual supply schedule, and (ii) Market Supply Schedule. (i) Individual Supply Schedule states the quantities of a commodity that a producer would be offer for sale at various price: Suppose, M/s A.C. Ltd. Is willing to sell 10,000 units of their products per week at the price of Rs.4 each. If the price goes up to Rs.5 each, they may be willing to sell 12,000 units, and at Rs.6 each, 15.000 units. We record this relationship in table 1 with the increase in price the quantity supplied increases, and vice versa. Table: 1 Individual Supply Schedule Price (Rs.) 4 5 6 7 8 Quantity (Units) 10,000 12,000 15,000 18,000 20,000 (ii) A market supply schedule furnishes exactly the same information. A market supply schedule for a given commodity is the sum of individual supply schedules of all those firms which are engaged in the production of a given commodity during a given time. Suppose, there are only two firms, A and B, producing a commodity. The market supply schedule of this commodity will be the sum of individual supply schedules of A and B. This is illustrated in Table 2. Table 2: Market Supply Schedule Price Quantity Supplied (Rs.) Rs. By A By B Market 4 10,000 6,000 16,000 5 12,000 10,000 22,000 6 15,000 15,000 30,000 7 18,000 20,000 38,000 8 20,000 25,000 45,000 Market supply schedule also shows the direct positive relation between the price and supply of a commodity. A supply curve shows, graphically, the relation between the price of a commodity and its quantity supplied. A supply curve conveys the same information as a supply schedule does. But it exhibits the information graphically instead of arithmetically. Supply curve may be (a) Individual supply curve, or (b) Market supply curve. (a) Individual supply schedule of Table 1. Is plotted as individual supply curve in Fig. 1. By Kartik Garg: 8439993339  Price is measured along the vertical axis and quantity along horizontal axis. Direct positive relation between the price and the quantity supplied is shown y SS‟ curve. The higher the price, the more will be the quantity supplied. (b) Market supply curve will be the horizontal summation of individual supply curves as shown in Fig. 2 based Table 2. SA is the supply curve of firm A, SB is the supply curve of firm. SM curve is the horizontal summation of SA and SB curves. If there are more than two producers, the market supply will be the horizontal summation of supply curve of all the firms. Assumption: The law of supply is based on the assumption of cetris peribus. (i) Cost of production is unchanged. (v) No change in transport costs (ii) No change in technique of production (vi) No speculation (iii) Fixed scale of production (vii) The prices of other goods are held constant. (iv) Government policies are unchanged Why Supply Curve has a Positive Slope? Or Basis of the Law of Supply The direct relationship between the price and its quantity supplied can be explained by the following factors: (i) Rising Marginal Cost of production: When the law of diminishing marginal returns applies, firm's marginal cost keeps rising. A firm will not find it profitable to increase output if it cannot; at least, cover the additional costs (i.e., marginal cost) that are incurred. As the price of the product rises, the firm can increase its output until the cost of producing an additional unit (i.e., marginal cost) rises to the level where it is first covered by the price at which that unit can be sold. In brief, because the cost of raising output increases, as more is being produced already, higher and higher prices are needed to induce firms to make successive increases in output. The result is a positively sloped curve, indicating that the higher the price the more will be produced. (ii) Higher prices mean more profits: As the price of a commodity goes up, profit margin for the producer increases. Rising profit margins work as an incentive to produce more and offer a larger quantity for sale. (iii) Incentives to other firms: Rising prices work as an incentive not only for existing firms to expand the level of output, out also induce new firms to enter the industry. With the entry of new firms, commodity will be produced in a larger quantity, and hence supplied in a larger quantity. By Kartik Garg: 8439993339  Exceptions to the Law of Supply: There may be situations where the direct relation between the price of a commodity and its quantity supplied does not obtain. These situations may be treated as exceptions to the law of supply. The important exceptions to the law of supply are: In all these cases, supply curve SS is a vertical straight line, parallel to the Y-axis, as shown in Fig 3. Here, the supply curve SS is a vertical straight line. OQ quantity is supplied at OP price. If the price falls to OP, quantity supplied remains unchanged at OQ. Likewise, at a higher price OP2, quantity supplied remains unchanged at OQ. (i) Agricultural Goods whose supply cannot be adjusted to market conditions: Higher price of wheat may not see any response from the farmers. He cannot produce and supply more wheat. Its supply is almost fixed from one crop-season to another. (ii) Perishable goods that cannot be stored: Fish is a highly perishable commodity it cannot be stored for long. And its supply cannot be changed in response to a change in its price. (iii) Goods having Social Distinction: These goods command high prices only because of their limited availability. Higher prices need not result in a higher supply by the producers. SUPPLY OF LABOUR Supply of labour is a unique example relationship between the wages rate and the working-hours that the labourers would be ready to put in. To begin with, every increase in wage rate will include labour to work longer hours (more work will be at the cost of leisure). A point may reach when the labour may realize that working more has adversely affected his leisure-time activities, once he has reached this point, every further increase in wages-rate presents him with an opportunity to give up some work hours, and enjoy more of leisure. This situation is presented in Table 3. Table: 3 Supply Labour Wage Supply Leisure Rate per of hours in hour (Rs.) Labour a day Hours 500 8 16 600 10 14 800 12 12 1,000 12 12 1,200 10 14 1,400 8 16 Diagrammatically, if we plot this tale we will get a backward sloping supply curve as shown in Fig.3.4 the supply curve takes a backward end when labour is offered Rs.1200 per hour of work. Henceforth, labour is willing to enjoy more leisure, Elasticity of Supply: Elasticity of supply is a measure of the degree of responsiveness of quality supplied to changes in the product’s own price. It can be represented as follows: Elasticity of Supply = Percentage Change in the quality supplied/Percentage Change in price. Symbolically, Es= ∆Q/∆P * P/Q Supply elasticity is normally positive, since supply curve have, more generally, positive slopes. By Kartik Garg: 8439993339  Kinds of Elasticity of Supply Perfectly Supply of a commodity is said to be perfectly inelastic Inelastic if the quantity offered for sale does not change with a Supply change in price. Supply of rare books, stamps, coins, etc., is of this type. The supply of these commodities cannot change in response to the prices changes. Graphically, a perfectly inelastic supply curve will be straight line parallel to the vertical axis as shown in Fig.5. Inelastic or less than Unit Elastic: Supply of a commodity is said to be inelastic if the percentage change in quantity supplied is less than the percentage change in price. Table: 4 Supply of Machine Gears Price per 1,000 2,000 Unit (Rs.) Quantity 2 3 Supplied It can be seen from Table 4 that the producer would like to take advantage of the increase in price. But, his capacity to produce gears is limited by his capacity. He may be in a position to produce an additional unit. Elasticity of supply calculated by the elasticity formula comes out to be: ES =∆Q/∆P * P/Q = 1/1,000 * 1,000/2 = 0.5 which implies that one per cent increase in price will result in 0.5 per cent increase in supply. Graphically, the supply curve will move upwards. The curve will be steeper as shown in Fig 6. Unit Elastic: Supply of a commodity is said to be unit elastic if the percentage change in quantity supplied equals the percentage change in the price. Consider the following supply schedule relating to a producer‟s supply of ready-made garments: Table: 5 Supply Schedule of Garments Price per Quantity Unit (Rs.) Supplied (Nos.) 50 100 75 150 In the above situation, elasticity of supply will equal unity, i.e., 50 percent increase in price will meet with 50 per cent increase in supply. This type of curve is plotted in Fig 7. More than Unit Elastic: Supply of a commodity is said to be more than unit elastic if the percentage change in quantity supplied exceeds the percentage change in price. By Kartik Garg: 8439993339 Consider the following supply schedule relating to a producer‟s supply of tea leaves: Table: 6 Supply Schedule of Tea Leaves Price per Quantity Unit (Rs.) Supplied (Nos.) 30 100 40 200 If we calculate elasticity of supply in the above situation, we will find that it is more than one. Let us work it out. ∆Q/∆P * P/Q = 100/10 * 30/100 = 3. It implies that one per cent change in price leads to 3 per cent change in supply. More than unit elastic curve is plotted in Fig 8. Perfectly elastic supply: Supply of a commodity is said to be perfectly elastic when the supply of it may increase or decrease to any extent irrespective of any change or infinitesimal change in its price. It is purely an imaginary concept and can only be explained with the help of an imaginary supply schedule. Consider the following supply schedule for commodity-X: Table: 7 Supply of Commodity-X Price per Quantity Unit (Rs.) Supplied (Nos.) 30 100 40 200 It can be seen from Table 7 that the producer increases the supply of commodity X irrespective of the fact that its price has not changed at all. In this situation, if we calculate the elasticity of supple, the numerical value of elasticity of supply will be infinite (∞) as shown below: ES = ∆Q/∆P * P/Q = 2/0 * 3/3 = ∞. Elasticity of supply is infinite, which means that the quantity supplied may increase or decrease up to any extent irrespective of change in price. Diagrammatically, the supply curve will have a horizontal slope. All five types of curves are illustrated in Fig. 9 and Fig. 10. By Kartik Garg: 8439993339 A horizontal curve shows perfect elasticity, while a vertical curve shows a perfect inelasticity. Generally speaking, if a supply curve originates from Y-axis it will show elastic supply, if the curve originates from X-axis it shows inelastic supply, and a curve originating from the point of origin, O, shows unit elasticity. In short, the value of elasticity coefficients shall vary from zero to infinity. Percentage Method: The percentage method of measuring the price elasticity of supply is based on the definition of elasticity, i.e., the ratio of proportionate change in quantity supplied of a commodity to a given proportionate change in its price. Thus, the formula for measuring price elasticity of supply is: ES = (Percentage Change in Quantity Supplied) / (Percentage Change in price) In terms of symbol, we can write: ES = ∆Q/ ∆P * P/Q Where, ES stands for elasticity of supply, Q stands for initial quantity, ∆Q stands for change in quantity supplied, P stands for initial price, ∆P stands for change in price. Geometric or Point Method: Geometric method is used to measure the elasticity of supply at a point on the supply curve. That is why it is also known as the point method of measuring elasticity of supply. This method I explained below in Fig 11. Suppose we want to measure price elasticity of supply at point K on the supply curve SS in Panel (i). Point K indicates that at OP price the quantity supplied is O. Extend supply curve SS downward so that it meets X-axis at A. the elasticity of supply at point K on the supply curve SS is measured by the formula AB/OB, i.e., the ratio of horizontal segment AB divided by the quantity supplied OB. It is clear that in Panel (i), AB is smaller than OB. Therefore, the supply elasticity AB/OB is less than unity. In panel (ii) supply curve S1S1 when extended meets the X-axis at the point of origin so that AB = OB. Therefore, the elasticity of supply AB/OB is greater than unitary. We have explained above the geometric measurement of the elasticity of supply at a point on the straight line supply curve. But if we want to measure elasticity at a point on a non-linear (curve type) supply curve, the same general principle and method is used. At any point on the non-linear supply curve, a By Kartik Garg: 8439993339 tangent is drawn. The supply elasticity is measured by the tangent on that given point. This is explained in Fig 12. In Fig 15, supply elasticity is to be estimated at point K on the supply curve SS. We draw a tangent to at point K on the supply curve. This tangent is extended to meet the X-axis at A. At point K, the slope of the supply curve is equal to the slope of the tangent. Therefore, elasticity of supply at point K on the supply curve is AB/OB. Since AB is smaller than OB, the supply elasticity here is less than unitary. In the same way, we can estimate the point elasticity on any other point on the supply curve by drawing a tangent at it. If the tangent drawn at any point on a supply curve intersects the X-axis, the elasticity of supply at that point is less than unity. If the tangent passes through the origin, elasticity of supply at that point is less than unity. If the tangent passes through the origin, elasticity of supply ay that point tangency is equal to unity. If the tangent intersects the Y-axis, elasticity of supply is more than unity. Movement on a Supply Curve and Shift in Supply Curve: Movement on a given supply curve occurs due to change in the price of a commodity, other things being the same. Let us look at Table 7. Table: 7 Supply Schedule Price (Rs.) 1 2 3 4 5 Qty. Supplied 2 4 6 8 10 At a given price of Rs.3 per unit, 6 kg of a commodity are supplied. If the price rises to Rs.4, quantity supplied increases to 8 kg. Conversely, if the price falls to Rs.2, quantity supplied falls to 4 kg. Increase in quantity supplied due to a rise in price is called ‘expansion in supply’. Conversely, a fall in quantity supplied due to a fall in price is called ?