CONSUMER BEHAVIOUR AND DEMAND ANALYSIS

LAW OF DEMAND

• According to the Law of Demand – “Ceteris Paribus, that is,

other things remaining constant, when the price of a commodity
x falls, the quantity demanded of commodity x increases and
when the price of commodity x rises, the quantity demanded of
commodity x decreases”
• There is an inverse relationship
 LAW OF DEMAND
• Table and Diagram
D

Price of x Quantity Demanded of x

PRICE OF X
1 5

2 4

3 3

4 2

5 1 D

QUANTITY DEMANDED
OF X
LAW OF DEMAND

• ASSUMPTIONS
• No change in consumer’s income
• No change in price of related goods
• No change in taste
• No uncertainty about the future
LAW OF DEMAND

• ASSUMPTIONS
• No change in advertising
• No change in the size of population and its composition –
income, age, gender, education
• No change in government policy – mainly taxation
• No change in natural factors – mainly climate
LAW OF DEMAND

• EXCEPTIONS
• Giffen goods
• Snob value
• Future price expectation
• Emergencies
• Fashion
• Necessary goods
• Inferior goods
LAW OF DEMAND

• DETERMINANTS OF DEMAND
• Price of the commodity
• Income of the consumer
• Price of related commodities
• Taste and preferences
• Size and composition of the population
LAW OF DEMAND

• DETERMINANTS OF DEMAND
• Future expectation of the price of the product
• Expenditure on advertising and promotion
• Cost of credit or interest rate
• Social factors – customs, traditions, practices, value system
based on culture, language, religion etc.
DEMAND FUNCTION

• A demand function expresses the relationship between the quantity

demanded of a commodity and its determinants.
• QX = f{PX,Y,PS,PC,T,N,E,A,I,S}
• Where,
• PX - price of the commodity x
• Y – income of the consumer
• Ps – price of substitute goods
• Pc – price of complementary goods
DEMAND FUNCTION

• T – taste and preferences

• N – size and composition of the population
• E – future expectation of price
• A – expenditure on advertising and promotion
• I – interest rate or cost of credit
• S - socio-cultural factors
 DEMAND FUNCTION

• It represents a relationship between the quantity demanded and determinants of

demand
• The factors or variables listed are only some of the possible variables that affect
demand, in reality, there could be many more
• Demand is inversely related to some of the variables like price of the commodity
itself and price of substitutes but directly related to the other variables like
income, price of complementary goods etc.
 DEMAND FUNCTION

• Some of the variables are easily quantifiable e.g. price, income, interest rate etc.,
while others like taste, future expectations etc. are not
• The degree of control that a firm has over the variables differs. The firm has
control only over the price of the commodity under question and the expenditure
on advertising and promotion and no control on others.
DEMAND CURVE FOR INFERIOR GOODS AND
GIFFEN GOODS
• Inferior good
• An inferior good is a type of good whose demand declines when
income rises. In other words, demand of inferior goods is inversely
related to the income of the consumer.
• For example, there are two commodities in the economy -- wheat flour
and jowar flour -- and consumers are consuming both.
DEMAND CURVE FOR INFERIOR GOODS AND
GIFFEN GOODS
• Giffen goods
• A Giffen good is a low income, non-luxury product that defies standard
economic and consumer demand theory. Demand for Giffen goods rises
when the price rises and falls when the price falls. In econometrics, this
results in an upward-sloping demand curve, contrary to the fundamental 
laws of demand which create a downward sloping demand curve.
EXAMPLES :
 MARKET DEMAND AND SUPPLY CURVES

MD – Market Demand Curve

MD
MS MS – Market Supply Curve

E – Equilibrium Point – where

the market demand is equal to
the market supply. It is also
PRICE

called the Market clearing price

E

MD
MS

QUANTITY
ELASTICITY OF DEMAND
MEANING OF ELASTICITY

• In general terms, we can define elasticity as “the percentage

change in one variable ‘a’ to the percentage change in another
variable ‘b’.
• Elasticity measures the ‘responsiveness’ of ‘a’ to a change in ‘b’
• Coefficient of Elasticity = Percentage change in ‘a’
• Percentage change in ‘b’
THE 3 TYPES OF VARIABLES?

There are three main types of variables in a scientific experiment:

1. Independent variables, which can be controlled or manipulated;
2. Dependent variables, which (we hope) are affected by our changes to
the independent variables; and
3.control variables, which must be held constant.
MEANING OF ELASTICITY

• Coefficient of Demand Elasticity =

• Percentage change in quantity demanded
• Percentage change in the relevant variable
TYPES OF ELASTICITY OF DEMAND

• There are FOUR types of Elasticity of Demand depending

upon the variable being changed
• Price Elasticity of Demand
• Income Elasticity of Demand
• Cross Elasticity of Demand
• Promotional Elasticity of Demand
 PRICE ELASTICITY OF DEMAND

• The Price Elasticity of Demand measures the ‘responsiveness of the

quantity demanded of a commodity x to a change in its price’
• Ep = Percentage change in quantity demanded of x
• Percentage change in the price of x
 PRICE ELASTICITY OF DEMAND

• The coefficient of Elasticity of Demand for Price for normal

goods is always negative since price and quantity demanded
move in the opposite direction
• If price increases, quantity decreases and vice versa
 PRICE ELASTICITY OF DEMAND

• The coefficient of Elasticity of Demand for Price for inferior goods is

positive since price and quantity demanded will move in the same
direction
• It price decreases, quantity decreases and vice versa
• When we analyse the Coefficient value, we ignore the sign and take
only the number
TYPES OF PRICE ELASTICITY OF DEMAND

• There are five types of Price Elasticity of Demand

• Perfectly Inelastic Demand
• Relatively Inelastic Demand
• Unitary Elasticity of Demand
• Relatively Elastic Demand
• Perfectly Elastic Demand
Coefficient of Price Shape of the Demand
Elasticity Type of Price Elasticity Implications Curve
Quantity demanded does not
Quantity demanded does not Vertical and parallel to the
Ep = 0 Perfectly Inelastic change at all with a change Vertical and parallel to the
Ep = 0 Perfectly Inelastic change at all with a change Y-axis
in price Y-axis
in price
Quantity demanded changes
0 < Ep < 1 Relatively Inelastic by less than
Quantity the change
demanded in
changes Downward sloping but steep
0 < Ep < 1 Relatively Inelastic by less thanprice
the change in Downward sloping but steep
price changes
Quantity demanded
exactly as the change in
Quantity demanded
price changes
Aexactly
15% riseas the change
in price in
would Downward sloping
Ep = 1 Unitary Elasticity price
lead to a 15% contraction in Rectangular Hyperbola
A 15%
demandriseleaving
in pricetotal
would Downward sloping
Ep = 1 Unitary Elasticity
lead to a 15%
spending the contraction
same at eachin Rectangular Hyperbola
demandpriceleaving
level. total
spendingdemanded
Quantity the same at each
changes
1 < Ep < Relatively Elastic by moreprice
than level.
the change in Downward sloping but flat
price
Quantity demanded changes
Relatively Elastic At
bythe given
more price,
than demandinis Downward sloping but flat
the change
unlimited but
priceeven with a Horizontal and parallel to the
Ep = Perfectly Elastic
small change in price, X-axis
Atdemand will
the given become
price, zero is
demand
unlimited but even with a Horizontal and parallel to the
Perfectly Elastic
Type of price elasticity
1. Perfectly Inelastic :
Water, Essential Medicines, Salt
2. Relatively Inelastic
Electricity, Life saving drugs, Low price commodities like matchbox etc
3.Unitary Elasticity
Comfort goods like A.C, Automobiles, Refrigerator
4.Relatively Elastic
Some Air packages for travelling, tour packages for traveling
5.Perfectly Elastic
follow perfect competitions: Discounts and free gifts on some products
Elastic;
Furniture goods, motor vehicle, Engineer goods, comfort goods
Inelastic:
Gas, Electricity, water, clothes, medicines etc.
INCOME ELASTICITY OF DEMAND

• This measures the responsiveness of the demand for a

commodity ’x’ to a change in the consumer’s income
• Ey = Percentage change in quantity demanded of ‘x’
• Percentage change in income
INCOME ELASTICITY OF DEMAND

• Products can be classified according to the value of the

Income Elasticity of Demand as:
• Normal goods – income elasticity is positive
• Inferior goods – income elasticity is negative
• Neutral goods – income elasticity is zero
NEUTRAL GOODS 

May refer either to goods whose demand is independent of income, or those which

have no change on the consumer's utility when consumed. Under the first
definition, neutral goods have substitution effects but not income effects.

Examples of a neutral good = necessities, salt, basic foods, soap and paper products.

Really depends on individual tastes and preferences.

 
CROSS ELASTICITY OF DEMAND

• It measures the responsiveness of the demand for

product ‘x’ to a change in the price of product ‘y’
• Ec = Percentage change in the quantity demanded of ‘x’
• Percentage change in the price of ‘y’
CROSS ELASTICITY OF DEMAND

• If the cross elasticity of demand is positive, then the two

products ‘x’ and ‘y’ are substitutes
• If the cross elasticity of demand is negative, then the two
products ‘x’ and ‘y’ are complements
• If the cross elasticity of demand is zero, then the two products
‘x’ and ‘y’ are said to be ‘unrelated’
PROMOTIONAL ELASTICITY OF DEMAND

• It measures the responsiveness of the quantity demanded of a

product ‘x’ to a change in the expenditure on promotion for the
product ‘x’
• EA = Percentage change in the quantity demanded of ‘x’
• Percentage change in promotional expenditure on ‘x’
• The promotional elasticity is usually positive but it can be zero
or negative also.
Indifference curve
A popular alternative to the marginal utility analysis of demand is the
indifference curve analysis.

This is based on consumer preference and believes that we cannot

quantitatively measure human satisfaction in monetary terms. This approach
assigns an order to consumer preferences rather than measure them in terms
of money. Let us take a look.
Marginal utility analysis
marginal utility analysis helps us understand the behavior of a consumer by
looking at the way he spends his income on different goods and services to attain
maximum satisfaction. In this article, we will look at the assumptions, laws, and
limitations under marginal utility analysis.

Consumer preference theory

to understand consumer behaviour, it is important to know what
guides consumer preferences. Central to consumer preferences is the idea of
utility. What is meant by ‘utility’?
Utility refers to the ability of a commodity to serve human wants. It is the
amount of satisfaction a consumer gets from the consumption of a good or
service. ‘Utility’ can be of two Approches:
CARDINAL UTILITY APPROACH
1.also known as marginal utility analysis.
2. Cardinal utility theory states that utility is measurable in number.
3. The unit in which utility can be measured is ‘utils’.
4. Thus, those goods that give a consumer higher level of satisfaction will be assigned
5.higher utils than those which give the consumer lower satisfaction.
6.Cardinal theory is a quantitative method of utility measurement.

ORDINAL UTILITY APPROACH

1.also known as indifference curve analysis.
2.It states that satisfaction derivable from consumption of goods cannot be measured in
numbers.
3.It uses ‘ranks’ to describe different levels of utility.
4.Thus, goods that provide a higher level of satisfaction should be assigned higher ranks
5.than those which give the consumer lower satisfaction.
The ordinal theory is a qualitative method of utility measurement.
What is an indifference curve?
1. It is a curve that represents all the combinations of goods that give the same
satisfaction to the consumer.
2. Since all the combinations give the same amount of satisfaction, the
consumer prefers them equally. Hence the name indifference curve.

3. Here is an example to understand the indifference curve better. A Person has 1

unit of food and 12 units of clothing. Now, we ask Person how many units of
clothing is he/she willing to give up in exchange for an additional unit of food
so that his level of satisfaction remains unchanged.
4. A Person agrees to give up 6 units of clothing for an additional unit of food.
Hence, we have two combinations of food and clothing giving equal satisfaction
to a person as follows:
1 unit of food and 12 units of clothing
2 units of food and 6 units of clothing
by asking him similar questions, we get various combinations as follows
Combination Food Clothing

A 1 12

B 2 6

C 3 4

D 4 3
Graphical representation:
the diagram shows an indifference curve (IC). Any combination lying on this
curve gives the same level of consumer satisfaction. It is also known as iso-utility
curve.
Indifference map
an indifference map is a set of indifference curves. It depicts the complete picture
of a consumer’s preferences. The following diagram showing an indifference map
consisting of three curves:
1.We know that a consumer is indifferent among the combinations lying on the
same indifference curve.

2.However, it is important to note that he prefers the combinations on the higher

indifference curves to those on the lower ones.

3.This is because a higher indifference curve implies a higher level of satisfaction.

4.Therefore, all combinations on IC1 offer the same satisfaction, but all
combinations on IC2 give greater satisfaction than those on IC1.
Properties of an indifference curve or IC

1.an IC slopes downwards to the right

this slope signifies that when the quantity of one commodity in combination is
increased, the amount of the other commodity reduces. This is essential for the
level of satisfaction to remain the same on an indifference curve.

2.An IC is always convex to the origin

from our discussion above, we understand that as person substitutes clothing for
food, he/she is willing to part with less and less of clothing. This is the diminishing
marginal rate of substitution.
3.Indifference curves never intersect
each other
two ics will never intersect each other.
Also, they need not be parallel to each
other either. Look at the following
diagram:
Fig 3 shows tow ICs intersecting each
other at point A.
1.Since A and B lie on IC1, the give the
same satisfaction level.
2.Similarly, A and C give the same
satisfaction level, as they lie on IC2.
3.Therefore, we can imply that B and C
offer the same level of satisfaction,
which is logically absurd.
4.Hence, no tow ICs can touch or
intersect each other.
4. A higher IC indicates a higher level of satisfaction as compared to a lower
IC
A higher IC means that a consumer prefers more goods than not.

An IC does not touch the axis

this is not possible because of our assumption that a consumer considers different
combinations of two commodities and wants both of them. If the curve touches
either of the axes, then it means that he is satisfied with only one commodity and
does not want the other, which is contrary to our assumption.
Budget line
1.since a higher indifference curve represents a higher level of satisfaction, a
consumer will try to reach the highest possible IC to maximize his satisfaction.

2.In order to do so, he has to buy more goods and has to work under the following
two constraints:

3. A Person has to pay the price for the goods and

he/she income is limited, restricting the availability of money for purchasing these
goods
As can be seen above, a budget line
shows all possible combinations of two
goods that a consumer can buy within the
funds available to him/her at the given
prices of the goods.
All combinations that are within his reach
lie on the budget line.

A point outside the line (point H)

represents a combination beyond the
financial reach of the consumer. On the
other hand, a point inside the line (point
K) represents under-spending by the
consumer.
Concept of Utility
 
In the ordinary language, 'utility' means 'usefulness'. In Economics, utility is
defined as the power of a commodity or a service to satisfy a human want.
 
Utility is a subjective or psychological concept.
The same commodity or service gives different utilities to different people.
For a vegetarian, mutton has no utility. Warm clothes have little utility for
the people in hot countries. So utility depends on the consumer and his need
for the commodity.
 
Total utility
total utility refers to the sum of utilities of all units of a commodity consumed. For
example, if a consumer consumes ten biscuits, then the total utility is the sum of
satisfaction of consuming all the ten biscuits.

Marginal utility
marginal utility is the addition made to the total utility by consuming one more unit of a
commodity. For example, if a consumer consumes 10 biscuits, the marginal utility is the
utility derived from the 10th unit. It is nothing but the total utility of 10 biscuits minus the
total utility of 9 biscuits.

Thus
MUn = TUn - TUn-1
where
MUn = marginal utility of ‘n th ' commodity. TUn = total utility of n units.
TU n-1 = total utility of n-1 units.
Relationship between marginal utility and total utility
marginal utility total utility

(i) declines increases

(ii) reaches zero reaches maximum

(iii) becomes negative declines

Law of Diminishing Marginal Utility

The law of diminishing marginal utility explains an ordinary experience of a consumer. If a

consumer takes more and more units of a commodity, the additional utility he derives from
an extra unit of the commodity goes on falling. Thus, according to this law, the marginal
utility decreases with the increase in the consumption of a commodity. When marginal
utility decreases, the total utility increases at a diminishing rate.

Gossen, Bentham, Jevons, Karl Menger contributed initially for the development of these
ideas. But Alfred Marshall perfected these ideas and made it as a law.
This Law is also known as Gossen's I Law.

Definition

According to Marshall, 'The additional benefit which a person derives from a given increase
of his stock of a thing diminishes with every increase in the stock that he already has'.
1.From Table 3.1 and figure 3.1 it is very clear that the marginal utility (addition made to the
total utility) goes on declining.
2. The consumer derives 20 units of utility from the first apple he consumes.
3. When he consumes the apples continuously, the marginal utility falls to 5 units for the
fourth apple and becomes zero for the fifth apple.
4. The marginal utilities are negative for the 6th and 7th apples.
5. Thus when the consumer consumes a commodity continuously, the marginal utility
declines, reaches zero and then becomes negative.
6.The total utility (sum of utilities of all the units consumed) goes on increasing and after a
certain stage begins to decline. When the marginal utility declines and it is greater than zero,
the total utility increases.
7. For the first four units of apple, the total utility increases from 20 units to 50 units. When
the marginal utility is zero (5th apple), the total utility is constant (50 units) and reaches the
maximum.
8.When the marginal utility becomes negative (6th and 7th units), the total utility declines
from 50 units to 45 and then to 35 units.