Demand curves

Individual Demand Schedule for Shirts:

(In Dollars)
Price per shirt 100 80 60 40 20 10

Quantity demanded per year Qdx 5 7 10 15 20 30

According to this demand schedule, an individual buys 5 shirts at $100 per shirt and 30 shirts at $10 per
shirt in a year.

Law of Demand Curve/Diagram:

Demand curve is a graphic representation of the demand schedule. According to Lipsey:

"This curve, which shows the relation between the price of a commodity and the amount of that
commodity the consumer wishes to purchase is called demand curve".

It is a graphical representation of the demand schedule.

In the figure (4.1), the quantity. Demanded of shirts in plotted on horizontal axis OX and "price is
measured on vertical axis OY. Each price- quantity combination is plotted as a point on this graph. If we
join the price quantity points a, b, c, d, e and f, we get the individual demand curve for shirts. The DD /
demand curve slopes downward from left to right. It has a negative slope showing that the two variables
price and quantity work in opposite direction. When the price of a good rises, the quantity demanded
decreases and when its price decreases, quantity demanded increases, ceteris paribus.

Assumptions of Law of Demand:

According to Prof. Stigler and Boulding:

There are three main assumptions of the Law:

(i) There should not be any change in the tastes of the consumers for goods (T).

(ii) The purchasing power of the typical consumer must remain constant (M).

(iii) The price of all other commodities should not vary (Po).

Limitations/Exceptions of Law of Demand:

Though as a rule when the prices of normal goods rise, the demand them decreases but there may be a
few cases where the law may not operate.

(i) Prestige goods: There are certain commodities like diamond, sports cars etc., which are purchased
as a mark of distinction in society. If the price of these goods rise, the demand for them may increase
instead of falling.

(ii) Price expectations: If people expect a further rise in the price particular commodity, they may buy
more in spite of rise in price. The violation of the law in this case is only temporary.

(3) Ignorance of the consumer: If the consumer is ignorant about the rise in price of goods, he may buy
more at a higher price.

(iv) Giffen goods: If the prices of basic goods, (potatoes, sugar, etc) on which the poor spend a large
part of their incomes declines, the poor increase the demand for superior goods, hence when the price of
Giffen good falls, its demand also falls. There is a positive price effect in case of Giffen goods.

Importance of Law of Demand:

(i) Determination of price. The study of law of demand is helpful for a trader to fix the price of a
commodity. He knows how much demand will fall by increase in price to a particular level and how much
it will rise by decrease in price of the commodity. The schedule of market demand can provide the
information about total market demand at different prices. It helps the management in deciding whether
how much increase or decrease in the price of commodity is desirable.

(ii) Importance to Finance Minister. The study of this law is of great advantage to the finance minister. If
by raising the tax the price increases to such an extend than the demand is reduced considerably. And
then it is of no use to raise the tax, because revenue will almost remain the same. The tax will be levied at
a higher rate only on those goods whose demand is not likely to fall substantially with the increase in
price.

(iii) Importance to the Farmers. Goods or bad crop affects the economic condition of the farmers. If a
goods crop fails to increase the demand, the price of the crop will fall heavily. The farmer will have no
advantage of the good crop and vice-versa.
Engel curve
From Wikipedia, the free encyclopedia

An Engel curve describes how household expenditure on a particular good or service varies with
household income.[1][2] There are two varieties of Engel Curves.

Engel curves, Microeconomics

Engel Curves

-Engel curves relate quantity of good consumed to income.

-If good is a normal good, Engel curve is sloping upward.

-If good is an inferior good, the Engel curve is sloping downward.

Supply
The cobweb model or cobweb theory is an economic model that explains why prices might be subject
to periodic fluctuations in certain types of markets. It describes cyclical supply and demand in a market
where the amount produced must be chosen before prices are observed. Producers' expectations about
prices are assumed to be based on observations of previous prices. Nicholas Kaldor analyzed the model
in 1934, coining the term 'cobweb theorem'
  If the supply curve is steeper than the demand curve, then the fluctuations decrease in
magnitude with each cycle, so a plot of the prices and quantities over time would look
like an inward spiral, as shown in the first diagram. This is called the stable or convergent
case.
 If the slope of the supply curve is less than the absolute value of the slope of the demand
curve, then the fluctuations increase in magnitude with each cycle, so that prices and
quantities spiral outwards. This is called the unstable or divergent case.

Two other possibilities are:

 Fluctuations may also remain of constant magnitude, so a plot of the outcomes would
produce a simple rectangle, if the supply and demand curves have exactly the same slope
(in absolute value).
 If the supply curve is less steep than the demand curve near the point where the two
curves cross, but more steep when we move sufficiently far away, then prices and
quantities will spiral away from the equilibrium price but will not diverge indefinitely;
instead, they may converge to a limit cycle.

In either of the first two scenarios, the combination of the spiral and the supply and demand
curves often looks like a cobweb, hence the name of the theory.

The divergent case: each new outcome is successively further from the intersection of supply and
demand.
The convergent case: each new outcome is successively closer to the intersection of supply and demand.

Relationship between Total Utility (TU) and

Marginal Utility (MU):
When a consumer goes on to consume the units of a commodity continuously the marginal utility
derived from the successive units of the commodity goes on to fall constantly while other factors
are held constant.

From the above statement regarding the consumer behavior the relationship between total utility
(TU) and marginal utility (MU) is deducted as under:

1. MU is the rate of change of TU.

2. When the MU decreases, TU increases at decreasing rate.
3. When MU becomes zero, TU is maximum. It is a saturation point.
4. When MU becomes negative, TU declines

The standard quadratic form of the TU function is written as follows:

TU = aQ - bQ2

and MU = dTU / dQ = a - 2bQ

Slope of MU = dMU/dQ = -2b

By taking the successive values of Q, the relationship between MU and TU is represented in the
following schedule:

Quantity Total Utility Marginal Utility

1 10 10
2 18 8
 3 24 6
4 28 4
5 30 2
6 30 0
7 28 -2

With the help of above schedule the relationship between TU and MU is explained as:

1. In the above schedule MU decreases and TU increases at a decreasing rate upto 5th unit
of commodity.
2. MU becomes zero at 6th unit and TU = 30 become maximum.
3. When MC becomes negative, the TU declines from 30 to 28 units at 7th units of a
commodity.

With the help of the above schedule the relationship between MU and TU can be represented in
the diagram.

1. In figure (2), MU curve moves downward having negative slope while in figure (1) TC
curve, having negative positive slope moves upward but tendency to move is towards x-
axis, which shows decreasing rate.
2. A point F´ in figure (2) MU curve cuts the s-axis at the 6th unit and TU curve has its
maximum point F which is saturation point.
 3. At 7th unit MU curve is below x-axis as in figure (2) and TU curve declines from point
'F' to 'G' as in figure (1).

Relationship Between Total Utility (TU) and Marginal Utility (MU):

4. a) TU rises at diminishing rate whenever MU is declining and Positive.

b) TU is maximum whenever MU is 0 (Zero).
c) Whenever MU becomes Negative, TU refuses.
5.

Mathematically:

MU = Change in TU / change in quantity consumed

MU = ∆TU / ∆Q

=8/1

=8

From point B to C

MU = ∆TU / ∆Q

=6/1

=6

This process remains upto point E and MU decreases.

From E to point F

MU = ∆TU / ∆Q
 =0/1

=0

It is the representation of zero marginal utility.

While from point F to G

MU = ∆TU / ∆Q

-2 / 1

= -2

It is the representation of negative utility and total utility declines.

Utility maximization
Cobb-Douglas
When the utility function is U(X,Y,Z)=XaYbZc, we say it is in Cobb-Douglas form. With Cobb-
Douglas form, we will see eventually, X*=(a/(a+b+c))*M/Px, Y=(b/(a+b+c))*M/Py,
Z*=(a/(a+b+c))*M/Pz. That means, the total amount spend on each of the good, is the proportion
of the income determined by the subscript of that good in the utility equation. Typically, the sum
of the superscript equals to one.

Production theory

The Significance of the Factor Mobility

Mobility enables different factor combinations to be made into use. For instance, more capital and
labour can only be used if either of these factors is mobile to facilitate a change in the production
technique. This enables the producers to search for a least cost method of production.
Mobility of factors of production do facilitate the movement of factors of production from surplus areas to
deficit areas. This automatically elaborates that if factors are sufficiently mobile, unemployment will
consequently be avoided in surplus areas as production will be enhanced in deficit areas. This leads to a
more efficient utilization of resources.

Mobility of factors of production thus enables the benefits of economic growth of a country to be
spread evenly throughout. Thus,many industries are located in urban areas primarily because of the
urban market and economies of scale. If at all industries can be encouraged to locate in rural areas
through incentives, then the benefits of industrial development in a particular country can be spread more
evenly.

Mobility of factors of production equally enables the transfer of expertise to areas where it is
efficient and in demand. For instance,in the event of mobility experienced, managers can contribute to
the development of aspects of the firm lacking in managerial expertise and in some cases they can transfer
their skills internationally.

The possibility of vertical occupational mobility of labour can have motivational effects in that if
workers perceive chances of being promoted for outstanding work, they are in general likely to be more
efficient at their work therefore contributing to the overall efficiency of their business enterprise.

Mobility may also be deemed to be significant in that if workers are occasionally allowed to perform
various/different tasks and are capable of performing them, then they are less likely to experience the
monotony often associated with specialization attributed by its accompanying negative effects.

Factor mobility is also significant in production in that factors of production that are immobile
occupationally and have no alternative use, are considerd to have no opportunity cost and are thus not
regarded by economists as scarce resources.

Therefore,the above aspects of significance of factor mobility is as idicated below:

i. Unemployment
ii. Income distribution
iii. Regional disparities
iv. Flexibility in production
v. Utilization of the otherwise idle resources
vi. Incentive to investment – Economic minimization of losses while maximizing profits/earnings.

(ii) Regional imbalance can be said ot be the uneven distribution of economic resources between different
regions in a given state.
The policy recommendations to reduce regional development imbalance would include:
• Industrial decentralization.
• Human resource mobility and development – regional human resource development initiatives and
participatory change in terms of cultural aspects like cattle rustling etc.
• Infrastructure – the aspect of accessibility that is to allow for efficient utilization of potential resources
eg in the agricultural rural sector.
• Comprehensive development plans and strategies.
• Security, law and order eg. The influx of refugees in areas such as the North eastern Province of Kenya.
• Non-governmental initiatives and support systems eg. Micro-financing of the community development
projects.
• Factor rewards’ differentials eg. Difference in wage compensation between different regions –
allowances for those working in designated hardships areas etc.

In economics, the Cobb–Douglas production function is a particular functional

form of the production function, widely used to represent the technological
relationship between the amounts of two or more inputs, particularly physical
capital and labor, and the amount of output that can be produced by those
inputs. The Cobb-Douglas form was developed and tested against statistical
evidence by Charles Cobb and Paul Douglas during 1927–1947.

Formulation

In its most standard form for production of a single good with two factors, the function is

where:

 Y = total production (the real value of all goods produced in a year)

 L = labor input (the total number of person-hours worked in a year)
 K = capital input (the real value of all machinery, equipment, and buildings)
 A = total factor productivity
 α and β are the output elasticities of capital and labor, respectively. These values are constants
determined by available technology.

Output elasticity measures the responsiveness of output to a change in levels of either labor or
capital used in production, ceteris paribus. For example if α = 0.45, a 1% increase in capital
usage would lead to approximately a 0.45% increase in output.

Further, if

α + β = 1,

the production function has constant returns to scale, meaning that doubling the usage of capital
K and labor L will also double output Y. If

α + β < 1,
returns to scale are decreasing, and if

α+β>1

returns to scale are increasing. Assuming perfect competition and α + β = 1, α and β can be
shown to be capital's and labor's shares of output.

Cobb and Douglas were influenced by statistical evidence that appeared to show that labor and
capital shares of total output were constant over time in developed countries; they explained this
by statistical fitting least-squares regression of their production function. There is now doubt
over whether constancy over time exists.

Various representations of the production function

The Cobb–Douglas function form can be estimated as a linear relationship using the following
expression:

Where:





The model can also be written as

As noted, the common Cobb–Douglas function used in macroeconomic modeling is

where K is capital and L is labor. When the model exponents sum to one, the production function
is first-order homogeneous, which implies constant returns to scale—that is, if all inputs are scaled by
a common factor greater than zero, output will be scaled by the same factor.