Theory of Consumer

(Energy Planning and Management)

Rabin Shrestha
Visiting Faculty
Pulchowk Campus, 2010

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 Demand
• The quantity demanded of a good or service
is the amount that consumers plan to buy in a
given period of time at a particular price.
• The Law of demand
– Other things remaining same, the higher the price of a
good, the lower is the quantity demanded.
• Demand refers to the entire relationship
between the quantity demanded and the
price of a good.
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 Demand and consumption
• Demand is an ex ante concept, it shows what
quantity will be purchased at a given price.
• Consumption is ex post concept, it shows the
quantity purchased at a given price.
• Demand can be taken as consumption when
there no restriction in supply.

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 Consumer Demand
• Economic system is a collection of people, it is
natural to start the analysis with individual behavior.
• Each individual is a consumer; each individual
provides productive services; each individual votes
in political process
• Rational behavior: Completeness in decision;
Transitivity; Continuity
• Ceteris Paribasu Assumption (other things being
equal)

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 Theory of Demand
• The satisfaction a consumer receives from consuming
commodities is called Utility
• Utility function U=U(Q1, Q2, …, Qn, Z)
n

• Budget constraint: I ≥∑PiQi

i =1

• Where Qi are quantities of different commodities

consumed including electricity and Pi are price of
different commodities

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Utility Maximization of Consumer
• Max U subject to budget constraint yields Marshallian
demand functions for each good consumed by
household:
• Lagrangian equation:
£ = U(Q1, Q2, …, Qn) + λ(I-∑PiQi)

• Solving the first order condition for maximum:

Qi=Qi (P1, P2, …, Pn, I) for i = 1 to n

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 Cobb-Douglas Utility Function

• U=Q1α Q2β (Cobb-Douglas Utility Function)

• Solving the first order condition for maximum:

Q1= αI/P1 (inverse demand)

Q2= βI/P2 (inverse demand)

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 Energy Demand
Energy demand by household at any time
Qe=Qe (Pe, Pgas, Pkero, Pequip, I, Z)

Qe= αI/Pe

Per capita agricultural GDP is used as proxi for

consumer income

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 Market Demand

• Demand for groups of individual consumer

or group of firms are Market demand

• Requires some form of aggregation

assuming similarity of consumers or firms

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 Market Demand
D = ∑Qe = No of consumers x Qe

= Population x (Pe, Per capita GDP)

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 Consumer Surplus
Price

P1

A B

P2

Q1 Q2 Quantity

The difference between what consumers are prepared to

pay for the product and what they actually pay 11
Elasticity Concepts

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 Definition
• Demand Elasticities refer to measure of the
responsiveness of quantity demanded to
changes in the determinants of demand

• Short run elasticity and long run elasticity

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 Categories of Elasticity
• Own price elasticity: Proportionate change in demand w.r.t.
proportionate change in price, (assuming all other factors
affecting demand remains constant)
• Cross price elasticity: Proportionate change in demand
w.r.t. proportionate change in price of substitute
• Income elasticity: Proportionate change in demand w.r.t.
proportionate change in income
• Output elasticity: Proportionate change in demand w.r.t.
proportionate change in output
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Own Price Elasticity
∂D
ε= D Point Elasticity
∂P
P

∆D
ε= D Arc Elasticity
∆P
P

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 Terminology of Elasticity

• Inelastic if elasticity is less than one in

absolute value

• Unit elastic if elasticity is one

• Elastic if elasticity is more than one

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 Estimates of Own Price
Elasticity
Range Mean
New South Wales -0.22 to -0.52 -0.37

Victoria -0.23 to -0.53 -0.38

Queens Land -0.14 to -0.44 -0.29

South Australia -0.17 to -0.47 -0.32

North East Market -0.20 to -0.50 -0.35

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 Income Elasticity
∂D
ε= D Point Elasticity
∂I
I

∆D
ε= D Arc Elasticity
∆I
I

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 Income Elasticity
• For normal good income elasticity is +ve
• For inferior good income elasticity is –ve
• Luxury good is normal good having income
elasticity greater than 1
• Necessary good is normal good having
income elasticity less than 1

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 Income and Price Elasticity

Source: Electricity Demand in Asia and Effects on Energy Supply and

Investment Environment, 1995, World Bank

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 Inferences on Elasticities

• High price elasticity – conservation effort,

price has greater impact on conservation
• Low income elasticity – conservation effort

• High income elasticity – growth in new

appliances

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Cross-Price Elasticity
∂D
ε= D Point Elasticity
∂P '

P'

∆D
ε= D
Arc Elasticity
∆P '

P'

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 Cross Price Elasticity

• If cross price elasticity is positive for two

fuel or energy sources they are substitute

• If cross price elasticity is negative, good are

complements

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The End

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