U N I T- I I

CONSUMER BEHAVIOUR AND

DEMAND
16 INTRODUCTORY MICROECONOMICS

CHAPTER 2
CONSUMER CHOICE
AND THE DEMAND CURVE

In Chapter 1 it was stated that, in a market-

•
2.1 Consumer's Equilibrium
2.2 Meaning and
•
Determinants of Demand
oriented economy, the central problems of
“what”, “how” and “for whom” are solved
through forces of demand and supply for
various goods and services. Who demands a
particular good and who supplies it? This
depends on the type of good or service in

•
2.3 Market Demand Curve question.
Consider a final product such as alu
2.4 Price Elasticity of bhujia.1 As consumers, households are the
demanders of alu bhujia and companies like
•
Demand
Bikanerwala and Leher are the suppliers.
Another example is the service of a computer
programmer. This service is demanded by
companies or firms. Who are the suppliers of
this service? The households, because some
members of some households work as
computer programmers.
In summary, in case of final goods and
services, households demand them and firms
supply them. In case of services that are
required for production, households are the

1
Final goods and services include things that are consumed
by households, e.g. a piece of bread, a haircut, a bicycle
repair job etc. As opposed to final goods and services,
there are “intermediate” goods (or raw materials) that
are “consumed” (i.e. used up) by businesses. The
examples are steel in a bicycle factory, wheat in a flour
mill, and various automobile components in a Maruti car
workshop.
CONSUMER CHOICE AND THE DEMAND CURVE
suppliers and the fir ms are the
demanders.
This chapter deals with households
as consumers and their demand for
final goods and services. How should a
consumer decide how much of a
product to buy? What factors do affect
this decision and how?
2.1 CONSUMER’S EQUILIBRIUM:
THE BASIS OF THE LAW OF
DEMAND
Let us ignore for the moment the word
“equilibrium” or the phrase “Law of
Demand”, and focus on the question of
how much of any particular good a
consumer should demand (or buy) at
a given point of time. In order to
understand this, we first have to learn
a few concepts.
2.1.1 Utility Concepts
We begin with the notion that a
consumer derives some satisfaction
from consuming a product; otherwise,
she would not demand it at all. This is
captured by a term called total utility,
defined as the total psychological
satisfaction a consumer obtains from
consuming a given amount of a
particular good. Consider for example
your consumption of gol guppa - the
mouth-watering small round-shaped
puffed puris, served with tamarind
(imli) – water and fillings.1
Imagine that you are hungry and
have come to your favourite gol guppa
vendor. Suppose that if you consume
only one gol guppa you derive 20
units of pleasure or utility measured
in some units. Let this (psychological)
1
Incase gol guppa is not known to the children, the teachers can use other popular eatable as
example to explain the concept.
17
unit be called “utils.” Thus, the total
utility from consuming one gol guppa
is 20 utils. Suppose that you like gol
guppa so much that eating just one
increases your appetite for it. Let the
second unit give an additional utility
of 22 utils. Then, the total utility from
consuming two gol guppas is 20+ 22 =
42 utils. In the same manner we can
calculate total utility from consuming
three, four or five units and so on.
Besides total utility, there is
another important concept called
marginal utility, defined as the utility
from the last unit consumed. Thus
the marginal utility from consuming
one gol guppa is 20 and that from
consuming two gol guppas is 22. You
can now notice the relationship that
total utility is the sum of marginal
utilities.
Getting on with our story, your
intensity of desire for gol guppa must
fall, after consuming a certain amount,
regardless of how much you like gol
guppa. Suppose that, in your case,
such decline in the intensity of desire
starts with the third gol guppa you
consume. Accordingly, let the third
unit give you utility equal to a number
less than 22, say, 18 utils. That is, the
marginal utility and the total utility
obtained from consuming three gol
guppas are 18 and 42 +18 = 60 utils
respectively. The next (fourth) unit
gives you still less utility, say,
14 utils, and so on.
This pattern of marginal utility is
called the law of diminishing
marginal utility. It states that, after
consuming a certain amount of a good
18 INTRODUCTORY MICROECONOMICS

or service, the marginal utility from it
diminishes as more and more is
consumed. If you think about it, this
law is very natural and should hold
for any product one consumes. In fact
it is considered as a fundamental
psychological law. You will see the
critical role of it a little later.
Let us resume our story once again.
When you have already consumed quite
a few gol guppas – say 8, and you are
very full in your stomach – suppose
that the next (9th) unit gives zero utility.
Imagine what will happen if you keep
gulping more. Suppose that eating the
10th unit makes you vomit! This is
obviously not a pleasant experience and
should give you negative satisfaction.
Accordingly, let the utility associated
with the 10th unit be -7 utils. That is,
the marginal utility of ten gol guppas is
-7 utils. (If you are crazy and still eat
more, each additional one can only give
you more negative utility.)
Table 2.1 summarises your
experience with gol guppa in terms of
marginal utility and total utility up to
10 units of consumption. Columns (2)
and (3) present the marginal and total
utility schedules.
2.1.2 How many Gol Guppas will
you consume or buy?
From Table 2.1, it is clear that if you
are a rational (not crazy) consumer,
you will eat less than 10 gol guppas,
since consuming 10 or more gives you
negative marginal utility. If gol guppas

Table 2.1 Marginal and Total Utility

Units Consumed of Marginal Utility Total Utility

Gol guppa (in utils) (in utils)

0 - 0
1 20 20
2 22 42
3 18 60
4 14 74
5 11 85
6 8 93
7 4 97
8 2 99
9 0 99
10 -7 92
CONSUMER CHOICE AND THE DEMAND CURVE
were free, i.e., its price were zero, you
would have consumed 8 or 9 units at
which your total utility is at its
maximum. But as long as you pay
something for it, you may not wish to
consume so many. You would like to
know how much utility you could have
obtained if you had spent some
amount on other items, e.g., ice cream,
chocolate etc. In other words, exactly
how many gol guppas you will eat
would depend not only on marginal
and total utility from consuming gol
guppas, but also on the price of gol
guppas, and, how much a rupee is
worth to you in terms of other goods.
We now define marginal utility of
one rupee as the extra utility when an
additional rupee is spent on other
available goods in general. Suppose
that, for you, it is 4 utils and let the
price of gol guppa be Rs. 2 per piece.
Having the information on price
and marginal utility of a rupee, we can
determine how many gol guppas you
will consume. Consider first whether
you will buy just one gol guppa. From
consuming only one, you obtain utility
equal to 20 utils (from Table 2.1). Since
the marginal utility of a rupee is 4 utils,
we can say that, from consuming
one gol guppa, you get utility worth
Rs. 20/4 = Rs. 5. On the other hand,
you pay – and thus sacrifice – Rs. 2 for
it. Hence you will buy the first unit.
Similarly, from the second unit, you
get utility worth Rs. 22/4 = Rs. 5.50,
while you pay only Rs. 2. Hence you
will buy the second gol guppa also.
We keep on making such
comparisons for successive units. For
19
example, the 5th gol guppa is worth
having it since it gives Rs. 11/4 =
Rs. 2.75 worth of utility, which is
greater than the price.
What happens with the 6 th gol
guppa is a bit different. It gives you
utility worth Rs. 8/4 = Rs. 2, which is
equal to the price. Will you buy it? The
answer is that you will be “indifferent,”
that is, whether or not you buy the 6th
unit does not make any difference.
However, it is clear that you will not buy
(consume) more than 6. Because, at any
level of consumption beyond 6, the
marginal utility in terms of rupees is
less than the price (you can check this
directly). Hence we have found the
answer to our query: you will buy 5 or
6 gol guppas.
The above comparisons between
how much of marginal utility in terms
of money you get and the price you pay
implies that, at either of these two levels
of consumption, the difference between
the total utility in terms of money and
your total expenditure on gol guppas
(defined as price × quantity purchased)
is maximised. Table 2.2 illustrates this.
Its second column gives total utility in
terms of money, defined as total utility
divided by the marginal utility of one
rupee (equal to 4 utils in this example).
Column (3) gives your total expenditure
or spending on gol guppas. The last
column gives the difference between
these two columns; this is like the net
gain to a consumer. We see that this
difference is maximised (equal to
Rs. 11.25) when your gol guppa
consumption is either 5 or 6.
Having gone through the example,
we can now understand why this
20 INTRODUCTORY MICROECONOMICS

Table 2.2 Difference between Total Utility in Terms of Money and Total
Expenditure

Amount Consumed Total Utility in Total Difference

of gol guppas terms of money (Rs.) Expenditure (Rs.) (Rs.)

0 0 0 0
1 5 2 3
2 10.50 4 6.50
3 15 6 9
4 18.50 8 10.50
5 21.25 10 11.25
6 23.25 12 11.25
7 24.25 14 10.25
8 24.75 16 8.75
9 24.75 18 6.75
10 23 20 3

section is titled “Consumer’s consumer’s equilibrium with respect to

Equilibrium.” The word “equilibrium”,
frequently used in economics, means a
position of rest. In this example, you
will rest, stop – or, as economists say,
attain consumer’s equilibrium – at 5
or 6 gol guppas. Because you do not
want to consume less or more than
these quantities. In general, we can
then say that consumer’s equilibrium
with respect to the purchase of one
good is attained when the difference
between total utility in terms of money
and the total expenditure on it is
maximised.
any particular good. Recall that one of
our answers is 6 gol guppas. Ignoring
the other answer for the moment, note
that, at this level of consumption, the
marginal utility in terms of money (Rs.
2) is equal to price (Rs. 2). This is indeed
the principle and we can state this in
two alternative ways. That is, the
consumer’ s equilibrium is attained
when
Marginal Utility of a Product
(A)
Marginal Utility of a Rupee
= Its Price Or

2.1.3 The General Principle Marginal Utility of a Product

(B )
Its Price
From the example just worked out, we
can now derive the general principle of = Marginal Utility of a Rupee.
CONSUMER CHOICE AND THE DEMAND CURVE
In particular, the condition (A) says
that the marginal utility of a product in
terms of money be equal to its price.
Sometimes, this is loosely stated as
“marginal utility is equal to price.”
Now go back to the example once
again and see that the consumer’s
equilibrium is also attained at 5 gol
guppas, where the principle is not
satisfied. This possibility exists because
gol guppas are not perfectly divisible:
they cannot be measured continuously
like points on a straight line. If, instead,
a product is perfectly divisible and thus
can be measured continuously, for
example by weight on a weighing scale,
there will be just one level of
consumption at which the consumer’s
equilibrium is achieved, with condition
(A) [or (B)] met.
We do implicitly assume from now
on that a product is perfectly divisible
and thus treat (A) or (B) as the condition
of consumer’s equilibrium.2
2.2 MEANING AND DETERMINANTS
OF DEMAND
Our analysis of consumer’s equilibrium
implies that the price of a product is an
important factor in determining how
much of the product a consumer will
be willing to buy within a given time
period. It is because, as the product
price changes, the ratio of marginal
utility to price changes so that the
consumer’s equilibrium will occur at a
different level of consumption.
2
Nothing essential or important is gained by deviating from this assumption. The only modification is
that, when a good is not perfectly divisible, the condition (A) or (B) holds either exactly or approximately.
21
This forms the basis of defining
demand for a particular good by a
consumer: it is the quantity of the
good that she is willing to buy at
different prices within a given period
of time.
However, the price of a product is
not the only factor that influences how
much a consumer should buy of that
product. For example, if there is a taste
change, it will change the marginal
utilities from a product, and, the
consumer’s equilibrium condition will
be fulfilled at some other level of
consumption even when there is no
change in price.
Moreover, while our preceding
analysis is confined to one good (e.g.
gol guppa), in reality, a consumer
buys many goods. The consumer’s
equilibrium analysis with respect to
many goods (which is outside our
scope) suggests two other factors,
namely, prices of related goods and
income. This is quite natural. If a
person consumes, for example, tea
and coffee, then a change in the price
of tea should affect her consumption
of coffee and vice versa. Also, if income
changes, different amounts can be
bought even when the prices of goods
and services she consumes remain
unchanged.
The last three factors just
mentioned are called the
determinants of demand. They are
namely,
22 INTRODUCTORY MICROECONOMICS

(a) prices of related goods, The law of demand in tabular form

(b) income and is called a demand schedule. If we
(c) tastes. 3 graph a demand schedule, we obtain a
The next question is how the own demand curve. It typically measures
price of a product as well as these three own price along the y-axis and quantity
factors affect the quantity demanded of demanded on the x-axis. The demand
a particular good. curve corresponding to the demand
schedule in Table 2.3 is shown in
2.2.1 Own Price: The Law of fig. 2.1. We see that the demand curve
Demand is downward sloping. It is because an
increase in the own price lowers the
To isolate its effect, hold the other
factors constant and ask how the Table 2.3 A Demand Schedule
quantity demanded of a product
changes as its own price changes. The Own Price Quantity Demanded
answer is summarised as what is called (in Rs.) of Apples
the Law of Demand. It states that other 12 24
things remaining unchanged, as the
own price of a commodity increases, 13 17
the quantity demanded of it by a 14 12
consumer falls. “Other things” refer to
15 9
the prices of related goods, income and
tastes. 16 7
Suppose that, for a particular family, 17 6
within a month, Table 2.3 lists its
quantities demanded of apples at quantity demanded. Each point of the
different prices, which are consistent with demand curve shows the quantity
its consumer’s equilibrium. The left demanded that is consistent with
column lists various prices, while the consumer’s equilibrium.
right column lists the corresponding
quantities demanded. It is assumed that Why is the Demand Curve Downward
the prices of related goods, family income Sloping?
and tastes are kept fixed at some Isn’t it obvious that the demand curve
pre-determined levels. is downward sloping? That is, as

3
Apart from (a), (b) and (c), there may be other determinants of demand for a good, e.g., future price
expectation. Consider an essential product, say, edible oil or sugar. Suppose there is a weather
prediction that your village or town will be hit by a severe cyclone in the next three days. You would
then anticipate that supply interruptions would occur and prices of these commodities would sky-
rocket. If you are a rational consumer, you would buy more of these commodities now (and store them)
even if prices, income or tastes do not change.
Moreover, taste changes can occur not only because of natural changes in a person’s liking, but also due
to advertising of products.
CONSUMER CHOICE AND THE DEMAND CURVE
Fig. 2.1 Demand Curve Corresponding
to Table 2.3
the own price increases, the quantity
demanded of a product falls.
Interestingly, it is not. There is a reason
behind it, namely, the law of
diminishing marginal utility. Indeed,
the demand curve is essentially the
marginal utility curve.4
Consider Table 2.4, which lists the
marginal utility from consuming
T-shirts. Mark that, for simplicity,
diminishing marginal utility sets in with
the very first unit of consumption.
Assume further, again for simplicity of
exposition, that the marginal utility of
a rupee is equal to 1 util. Then, our
consumer’s equilibrium condition (A)
can be stated as “Marginal Utility =
Price.”
To begin with, suppose that the
price of a T -shirt is Rs. 45. The
consumer’s equilibrium condition
holds at 7 T-shirts consumed. This can
4
An intuitive way to see this is that, as a consumer buys more of a good, her marginal utility decreases
and therefore she is willing to pay less per unit. This can be turned around to say that if the price of a
product falls, a consumer buys more of it.
23
Table 2.4 Marginal Utility
Schedule and the Demand
Schedule
Quantity of Marginal Utility of
T-shirts T-shirts
1 75
2 70
3 65
4 60
5 55
6 50
7 45
be restated as follows. The quantity
demanded of T-shirts is 7 when the
price is Rs. 45. Thus the pair (45, 7)
will be on the demand curve. Similarly,
suppose that the price of T -shirts
increases to Rs. 65. The consumer’s
equilibrium condition now holds at 3
T-shirts consumed, that is, at price
Rs. 65, the quantity demanded is 3.
Hence the pair (65, 3) will be on the
demand curve too. Likewise, we can
determine that all other points on the
marginal utility schedule are points on
the demand schedule. This means that
the marginal utility curve itself is the
demand curve, and, the demand curve
is downward sloping because of the law
of diminishing marginal utility.
24 INTRODUCTORY MICROECONOMICS

2.2.2 Determinants of Demand in consumption. Thus, if the price of tea

Now turn to the remaining factors that
affect the quantity demanded of a
particular product, or, what we have
called the determinants of demand.
Change in Price of a Related Good
Suppose that Mrs. Das, who lives next
door to you, has a weakness for sweets.
Burfi and gulab jamun are her
favourites. Suppose that burfis become
more expensive: from Rs. 5 a piece to
Rs. 8 a piece. How will this affect Mrs.
Das’s demand for gulab jamun? It will
increase. Why, because burfi and gulab
jamun are substitutes of each other in
consumption. Consider another
example: that of tea and coffee. The
same should happen to the demand for
tea if the price of coffee rises or vice
versa, because tea and coffee are also
substitutes. We say that good A is a
substitute of good B if an increase in
the price of good B increases the
demand for good A.
On the other hand, consider tea and
sugar. Sugar is complementary to tea
goes up, the quantity demanded of tea
should fall, which will reduce the
demand for sugar. Another example of
a pair of complementary products is
petrol and cars. If the price of petrol rises,
the quantity demanded of cars should
fall. In other words, good A is said to be
complementary to good B if an increase
in the price of good B decreases the
demand for good A.
These examples illustrate cross
price effects: how the demand for one
particular product is affected by a
change in the price of another.
Numerical examples of cross price
effects are given in Tables 2.5 and 2.6.
In Table 2.5, note that as the price
of coffee rises from Rs. 200 to Rs. 250,
the quantity demanded of tea increases
for any given price of tea. For example,
given price of coffee = Rs. 200, at tea
price equal to Rs. 170, the quantity
demanded of tea is 11, whereas, given
coffee price = Rs. 250, at the same tea
price (Rs. 170), the quantity demanded
of tea is 18. The demand schedules of

Table 2.5 Effect of an Increase in the Price of Coffee on Demand for Tea

Price of Tea Quantity Demanded of Tea Quantity Demanded of Tea

(per kg) when Price of Coffee when Price of Coffee
Rs. (per kg) = Rs. 200 (per kg) = Rs. 250

150 20 28
170 11 18
190 5 10
210 2 7
230 1 4
CONSUMER CHOICE AND THE DEMAND CURVE 25

Table 2.6 Effect of an Increase in the Price of Tea on Demand for Sugar

Price of Sugar Quantity Demanded of Quantity Demanded of Sugar

(per kg) Sugar when Price of Tea when Price of Tea
Rs. (per kg) = Rs. 170 (per kg)= Rs. 200

5 20 12
8 14 7
11 9 4
14 6 2
17 5 1

tea given in column (2) and (3) of

Table 2.5 are graphed in Figure 2.2.
We see that demand curve for tea
when the price of coffee is Rs. 250 lies
to the right of that when the price of
coffee is Rs. 200. Hence, an increase
(a decrease) in the price of a substitute
good shifts the demand curve for a
product to the right (left).
Similarly, in Table 2.6, notice that,
as the tea price increases from Rs. 170
to Rs. 200, the quantity demanded of
sugar decreases for any given price of
sugar. Figure 2.3 graphs Table 2.6. Fig. 2.2 Change in demand due to increase
in the price of a substitute good
The demand curve for sugar when tea
price is Rs. 200 lies to the left of that they are cheap. Suppose that your
when the sugar price is Rs. 170. Thus, pocket money increases. Will you buy
an increase (a decrease) in the price more of ice cream, more of peanuts or
of a complementary good shifts both? We bet that you will buy more
the demand curve for a product to the ice cream. Whether you will buy more
left (right). peanuts is not clear. Very likely, you will
buy less of peanuts, not because your
A Change in Income
taste changes but because you can
Suppose that you only buy peanuts afford more ice cream, which is your
and ice cream from your pocket money. favourite.
Ice cream is your favourite but it is Hence, generally, we can say that,
costly. You like peanuts much less, but as income increases, a consumer may
26 INTRODUCTORY MICROECONOMICS

buy more or less of a product. If she
buys more (e.g. ice cream), then we say
that the product in question is a normal
Fig. 2.3 Change in demand due to
increase in the price of a
complementary good
good. If she buys less (e.g. peanuts),
then we say that it is an inferior good.
Put differently, nor mal goods are
those, for which demand increases as
income increases. Inferior goods are
those, for which demand falls as
income rises.
Table 2.7 presents numerical
examples of both normal and inferior
goods. Observe that, at any given price,
as income increases, quantity
demanded of the normal good increases
(by comparing columns (2)-(3)) and that
of the inferior good decreases (by
comparing columns (5)-(6)). These are
graphed in figs. 2.4 and 2.5. The
original demand curve for the normal
good, when income is Rs. 300, is
indicated by the line NN0 in fig. 2.4.
This represents the column pair (1)-(2).
The new demand curve, when income
of Rs. 400, is marked by NN 1 that
represents the column pair (1)-(3).
Hence an increase in income shifts the
demand curve to the right if the good
is nor mal. For the inferior good,
the demand curves are indicated
by FF 0 (original) and FF 1 (new) in

Table 2.7 Normal and Inferior Goods

A Normal Good An Inferior Good
Own Price (Quantity (Quantity Own Price Quantity Quantity
Demanded: Demanded: Demanded: Demanded:
Income = Income = Income = Income =
Rs. 300 Rs. 400 Rs. 300 Rs. 400

1 15 19 3 20 15
2 12 16 4 17 12
3 9 13 5 14 9
4 7 11 6 11 6
5 5 9 7 8 3
6 3 7 8 5 0
CONSUMER CHOICE AND THE DEMAND CURVE
fig. 2.5. Thus an increase in income
shifts the demand curve to the left if
the good is inferior.
In the real world, there are much
fewer examples of inferior goods than
normal goods. Yet there are important
examples. In India, cereals as a single
category of goods (that includes rice,
wheat, bajra, jowar etc.) constitute an
inferior good. Within this category, the
inferior-good characteristic applies to
bajra, jowar, maize and related cereals.
A Change in Tastes
Finally, consider a taste change.
Suppose you are impressed by an
advertisement in TV, in which your
favourite actor drinks Coca Cola, and,
as a result, your liking for Coca Cola
increases. This will shift your demand
curve for Coca Cola to the right. This is
an example of a “favourable” change in
tastes. An unfavourable change in taste
will imply the opposite. We can then say
Fig. 2.4 Change in demand due to
increase in income (Normal Good)
27
Fig. 2.5 Change in demand due to
increase in income (Inferior Good)
that a favourable (an unfavourable)
change in tastes shifts the demand
curve to the right (left).
A taste change may result from a
change in a person’s liking, or, from some
other source. If, for instance, for health
reasons, you have to consume more of a
product although you don’t like it, this
is also considered a taste change.
2.2.3 Change in Quantity
Demanded Versus Change/
Shift in Demand
We have seen that the quantity
demanded of a product depends on
own price and “other” factors like
prices of related goods, income and
tastes. The law of demand refers to the
effect of a change in the own price. A
graphical representation of this is the
demand curve, which is downward
sloping. A change in the own price
causes a movement along a given
demand curve: higher (lower) the price,
less (more) is the quantity demanded.
28 INTRODUCTORY MICROECONOMICS

Such a movement is called a change

in the quantity demanded.
In contrast, when a change in any
other factor causes a (left or rightward)
shift of a demand curve, we call this a
change in demand.
The distinction between the two
concepts is illustrated in fig. 2.6.
Fig. 2.6(a) illustrates a change in the
quantity demanded. There is a price
change from P0 to P1. As a result, there
is a movement along the same demand
curve from A to B. The quantity
demanded changes from Q0 to Q1. In
(a) Change in Quantity Demanded
contrast, fig. 2.6(b) shows a change in
demand, meaning a shift of a demand
curve from DD0 to DD1 due to a change
in the prices of related goods, income
or tastes.
2.3 MARKET DEMAND CURVE
We have studied consumer’s
equilibrium and the determinants of
demand for a good from the perspective
of a single individual. How do we get
the demand curve of a product by all
individuals together in an economy,
e.g., the economy of a region or a (b) Change in Demand
country? The economy-wide demand Fig. 2.6 Change in Quantity Demanded
curve for a particular product is called Versus Change in Demand
the market demand curve. It is
obtained by summing up the demand (3, 19) is a point on the market demand
curves across consumers or curve. Repeat the same exercise for
households. other possible prices and obtain the
Consider the market for, say, gulab corresponding points. Plot the points,
jamun. Suppose that there are three join them and you get the market
consumers in the market: Amar, Akbar demand curve.
and Anthony. If at the price equal to A numerical example is given in
Rs. 3 a piece, Amar demands 5, Akbar Table 2.8. Individual demand
6 and Anthony 8 per week, then the schedules are given by column pairs
total quantity demanded is 19. Hence (1)-(2), (1)-(3) and (1)-(4). The column
CONSUMER CHOICE AND THE DEMAND CURVE 29

pair (1)-(5) gives the market demand
schedule. Note that for each row (price),
the entry in column (5) is the sum of
corresponding entries in columns (2),
(3) and (4).
These individual demand schedules
and the market demand schedule are
graphed in fig. 2.7. Amar’s, Akbar’s and
Anthony’s demand curves are
respectively marked by their names.
The right most line is the market
demand curve. This is obtained by
horizontally summing the individual
demand curves.
What are the determinants of the
market demand curve? They are the
determinants of the individual demand
curve described earlier plus how many
consumers buy the product, that is,
(a) prices of related goods;
(b) income levels across individuals, or
what we can call, the distribution
of income;
(c) consumers’ tastes
(d) the number of consumers who buy
the product, or what we can call, the
market size.5
2.4 PRICE ELASTICITY OF
DEMAND
We have seen how various factors like
own price and income affect the demand
for a commodity. The direction of
change was our focus - whether the
quantity demanded increases or
decreases as price, income or other
factors change. The concept of elasticity
captures the magnitude of change or
the degree of responsiveness. For
example, the price elasticity of demand
quantifies the effect of a change in own
price on the quantity demanded.

Table 2.8 Individual and Market Demand Schedules for Gulab Jamun

Price of Gulab Amar’s Akbar’s Anthony’s Market

Jamun in Rs. Demand Demand Demand Demand

1 7 15 13 35
2 6 10 10 26
3 5 6 8 19
4 4 3 7 14
5 3 1 6 10
6 2 0 5 7

5
Many multinational firms today look at the Indian or the Chinese market as very lucrative, because of
their market sizes, which refer to the huge number of consumers in these countries.
30
Fig. 2.7 Individual and Market Demand Curves
2.4.1 Definition and Formulas
Formally, Elasticity of demand is
defined as
(C ) Price elasticity of demand = e D
% change in the quantity demanded
=−
% change in the own price
Since the changes in price and
quantity along a demand curve occur
in opposite directions, the ratio of %
change in quantity demanded and that
in the own price is negative in sign.
Hence attaching a negative sign in front
of the ratio makes the sign of eD positive.
Some other textbooks define the price
elasticity the same way as above, except
for the “minus” sign. But there is no
reason to get confused. Strictly speaking,
our definition gives the absolute value
of the elasticity, which is, often, referred
to as “elasticity”.
INTRODUCTORY MICROECONOMICS
Along a given demand curve, let the
original price be P0 and the original
quantity be Q0. Suppose that the price
increases to P 1 and the quantity
demanded falls to Q1. Then the %
changes in price and quantity
demanded are respectively equal to
[(P1–P0)/P0]×100 and [(Q1–Q0)/Q0]×100.
Thus (C) can be written as
(Q1 − Q0 ) / Q0
(D ) e D = − .
(P1 − P0 ) / P0
If we further denote a change in
quantity as ∆Q and a change in price
as ∆P, we can also write
∆Q/Q0
(E ) eD = − .
∆P / P0
Consider the following numerical
example. Suppose that in your home
town, rasgoolas were being available at
Rs. 5.00 per piece and the residents of
CONSUMER CHOICE AND THE DEMAND CURVE
the town were buying 1200 rasgoolas
per day. Now they become more
expensive for some reason, at Rs. 5.50
per piece. Fewer people are eating
rasgoolas and many who eat, are eating
less. Suppose that the people in the
town are now buying 960 rasgoolas per
day. What is the price elasticity of
demand?
We have to do some arithmetic. The
% change in the price is equal to
[(5.50 – 5.00)/5.00] ×100 =10. The %
change in quantity is equal to [(960 –
1200)/1200] ×100 = – 20. Hence, eD, the
price elasticity, is equal to 20/10 = 2.
Properties
1. A very desirable property of the
elasticity formula in measuring the
degree of responsiveness is that it
is independent of the choice of
units. It is because any percentage
change of a variable is independent
of units.
2. If two demand curves intersect, at
their point of intersection, the
elasticity associated with the
flatter demand curve is higher. This
is exhibited in fig. 2.8. The demand
curves DD and DD´ intersect at the
point C. At this point, P0 is the price
of the product. The claim is that, at
price P0, the elasticity is greater
along the flatter demand curve DD´.
Why? Because the original quantity
demanded is the same, equal to D0,
along both demand curves, and, if
there is an increase in price, say to
P1, the quantity demanded falls
more along the flatter demand curve
(by amount D2D0 as compared to
31
D1D0 along DD). This implies that,
while the % change in price is the
same along both demand curves,
the % change in quantity demanded
is greater along DD´. Therefore,
price elasticity associated with DD´
is higher.
3. Higher the value of the price
elasticity, greater is the degree of
responsiveness of quantity
demanded to price. In particular, if
eD>1, then the % change in quantity
demanded must exceed the %
change in price. We then say that
the product demand is elastic (e.g.
jewellery). If eD<1, the % change in
quantity demanded is less than that
of the price, and, we say that the
product demand is inelastic.
Typically, the demand for luxury
goods is elastic and that for
necessary goods (e.g. basic food
items) is inelastic. Finally, if eD =1, it
is said that the demand is unitarily
elastic. In this special case, the
demand curve takes a particular
Fig. 2.8 Elasticity Comparison
32 INTRODUCTORY MICROECONOMICS

shape, called rectangular hyperbola 2.4.2 Factors Affecting the

in geometry. It is a curve, which Magnitude of Price Elasticity
extends towards the x-axis and y-axis In general, the magnitude of price
in a uniform manner without elasticity depends on the following
touching them. Fig. 2.9 exhibits this. factors.
4. There are two other special cases. If
the product is absolutely essential, Availability of Close Substitutes: If
like demand for a rare medicine or close substitutes of a product are
some very bad case of addiction to readily available, its price elasticity of
undesirable products like opium, demand is likely to be high, because
the demand curve is vertical. In this even a very small increase in price will
case, the price elasticity is zero, i.e., make consumers switch to other
the product demand is totally or
perfectly inelastic. This is evident,
because, along a vertical demand
curve, the quantity demanded is
totally insensitive to any change in
price. This case is exhibited in
fig. 2.10(a). The last special case is
the one, where demand curve is
horizontal and thus the demand is
perfectly elastic, i.e., the price

(a) Perfectly Inelastic Demand

Fig. 2.9 Unitarily Elastic Demand

elasticity is equal to infinity.

Fig. 2.10(b) shows this. An (b) Perfectly Elastic Demand
economic example of this demand
curve will be given in Chapter 4. Fig. 2.10 Elasticitiy = 0, ∞
CONSUMER CHOICE AND THE DEMAND CURVE
products in a big way. Otherwise, in the
absence of close substitutes, the
elasticity is likely to be small. For
example, if it is a staple food item of a
particular region, say, rice in Orissa or
West Bengal, by definition, there are no
(very) close substitutes available. It is
indispensable. Hence the demand for
rice is likely to be inelastic. More
generally, the demand for essential
products is likely to be inelastic. On the
other hand, “luxury” items like eating
in a restaurant, buying a big-size
colour TV etc. are relatively dispensable.
Hence the demand for these items is
likely to be relatively elastic.
Proportion of Total Expenditure
Spent on the Product: If the amount
spent on a product constitutes a very
small fraction of the total expenditure
on all goods and services you consume,
then the price elasticity is likely to be
small. The demand for salt is an
example. On the other hand, if it is a
high-price item and takes a major
portion of your total expenditure, your
demand for it is more sensitive to a price
change; that is, the elasticity of demand
is likely to be high.
Habits: Some products which are not
essential for some individuals are
essential for others. A form of
consumption such as eating out in five-
star restaurants is a luxury for many
people; therefore, their demand for it is
very elastic. But, for someone who is
very rich, it may be an essential
demand, because he is already
habituated. Hence his demand for five-
33
star restaurant food is inelastic.
Similarly, for an opium addict, the
demand for opium is very inelastic,
whereas for other casual opium takers,
the demand is likely to be elastic.
Time Period: All other things remaining
the same, the longer the time period,
more elastic is the demand for any
product. The consumption of petrol is
a prime example. In the 1970s, when
OPEC (Organisation of Petroleum
Exporting Countries) dramatically
increased the price of oil for the first time
in history, the whole world was
shocked. Countries could not
immediately find and adopt any other
forms of energy for their needs. In other
words, substitutes of oil could not be
available and the demand for oil was
very inelastic. But over years alternative
types of energy were developed, and,
substitutes became more readily
available. The demand for oil is more
elastic today than it was 30 years ago.
Clip 2-1 reports price elasticities for
various products that have been
estimated by various authors.
2.4.3 Measurement of Elasticity
Finding price elasticity of demand
using its definition as such is called the
percentage method of measuring
elasticity. In particular, when the price
change is very small, a graphical
formula or a geometric method can
also be used to measure elasticity.
Suppose that it is a straight-line
demand curve, as shown in fig. 2.11,
having intercepts A and B respectively
on the price axis and quantity axis
34 INTRODUCTORY MICROECONOMICS

Clip 2-1
Price Elasticity Estimates
Price elasticities have been estimated for various products and services and in
the context of different countries. Five examples are reported below, four of which
are for India and one for America.
As you see, the price elasticities for food items and clothing are less than one, as
these are essential items. Note that item No. 4 is an example of a service: long
distance phone calls from PCOs. The elasticity for this item is also less than one.
It indicates that long-distance telephone calls are not a “luxury” demand anymore;
they have become a necessity in a country like India.
The item no. 5 shows that the demand for residential land in America is elastic,
equal to 1.64.

Product/Service Price Elasticity Estimate Source

1. Cereals & cereal 0.544 Meenakshi and Ray

substitutes (1999)
(India)
2. Other foods 0.804 Meenakshi and Ray
(India) (1999)

3. Clothing 0.560 Meenakshi and Ray

(India) (1999)

4. Long distance 0.580 Das and Srinivasan

phone calls (1999)
from Public
Call Offices
(India)

5. Residential 1.640 Gyourko and Voith

Land in (2001)
Philadelphia
(U.S.A.)

Das, P. and P.V. Srinivasan, “Demand for Telephone Usage in India,”

Information Economics and Policy, 11, 1999, pages 177-194. Meenakshi, J. V.
and Ranjan Ray, “Regional Differences in India’s Food Expenditure Pattern: A
Complete Demand Systems Approach,” Journal of International Development,
11, 1999, pages 47-74. Gyourko, J. and R. Voith, “The Price Elasticity of Demand
for Residential Land: Estimation and Some Implications for Urban Reform,”
mimeo, Wharton School of Management, 2001.
CONSUMER CHOICE AND THE DEMAND CURVE 35

respectively. Suppose that initially the

price is P0, and the quantity consumed
is Q0, that is, the consumer is at point C
on the demand curve. Then, for small
price changes, the price elasticity turns
out to be equal to BC/AC. This
graphical formula is called point
elasticity. In other words, point
elasticity, at a certain point along a
straight-line demand curve, is equal to
the lower segment divided by the upper
segment of the demand curve at that
point.
A proof of it is given in Appendix 2.
Fig. 2.11 Point Elasticity along a Straight
The point elasticity formula implies
Line Demand Curve
that, as price increases, the ratio of the
lower segment to the upper segment rasgoolas, does consumer spending or
increases (as we are looking at points total expenditure on rasgoolas increase
higher up on the demand curve) and or decrease? By definition, the total
therefore the product becomes more expenditure on a particular good =
elastic.6,7,8 price × quantity. If we denote total
expenditure by TE, price by P and
2.4.2 Total Expenditure and Price quantity by Q, then TE = PQ. Let us now
Elasticity calculate TE. Originally, P and Q were
The concept of price elasticity does not respectively Rs. 5.00 and 1,200; hence
just quantify the relationship between TE was equal to Rs. 6,000. At the new
price and quantity demanded, it also price Rs. 5.50 and quantity = 960, TE
indicates the direction in which the total = Rs. 5,280. Thus the total expenditure
expenditure on a product changes, as has fallen. Note also that the elasticity
there is a change in price. is equal to 2. That is, in the example,
Return to the rasgoola example the demand for rasgoola is elastic, and,
and ask the following simple question. as there is a price increase, the total
Because of the increase in the price of expenditure falls.

6
This is not a general property of price elasticity. It may not hold when the demand curve is not a straight
line.
7
At point B the elasticity is zero and at point A it is infinity.
8
If it is not a straight-line demand curve, then the point elasticity measure at a point on it is based on
the tangent to the curve at that point. You will find a treatment of this in a higher-level micro economics
textbook.
36 INTRODUCTORY MICROECONOMICS

It turns out that such opposite scope. However, it is quite intuitive. If

movements in the directions of price
and total expenditure changes hold, not
just in this example, but always, when
the product demand is elastic. Similarly,
if the product demand is inelastic, the
total expenditure always increases as
price increases. Moreover, as a special
case, if the product demand is unitarily
elastic, then the total expenditure does
not change with any price change. You
can relate the last case to fig. 2.9, which
depicts the unitarily-elastic case. That
is, the total expenditures at all points
on that demand curve are the same.
There is thus a general relationship
between the direction of price change
and the direction of change in total
expenditure, depending on the
magnitude of price elasticity. If the
product demand is elastic, unitarily
elastic or inelastic, an increase in price
leads respectively to a decrease, no
change or an increase in the total
expenditure on the product. Table 2.9
presents this result in a tabular form.
This result can be proven
algebraically, but it is beyond our
Table 2.9 Price Change and Its Effect on Total Expenditure
Price Change Elasticity
the demand for a product is elastic, it
means that a small price change invites
a relatively large adjustment in the
quantity. Hence the total expenditure
must change in the same direction in
which the quantity changes. Now you
see that, as price increases, quantity
falls and the fall in quantity is associated
with a fall in the total expenditure. Just
the opposite holds when the product
demand is inelastic. In this case a large
price change leads only to a relatively
small adjustment in quantity. Hence the
total expenditure must change in the
same direction as the price change, i.e.,
a price increase leads to an increase in
total expenditure.
So far we have discussed how we
can determine the direction of change
in total expenditure, given the direction
of change in the price and given
whether the product is elastic or
inelastic. Alternatively, if we know the
direction of change in price and the
direction of change in total expenditure,
we can infer whether the product
demand is elastic or inelastic. For
Total Expenditure

↑ eD > 1 ↓

↓ eD > 1 ↑

↑ eD < 1 ↑

↓ eD < 1 ↓

↑↓ eD = 1 No Change
CONSUMER CHOICE AND THE DEMAND CURVE 37

instance, if because of a price increase, thinking about increasing the price of

the total expenditure increases, then
the product demand must be inelastic.
You can readily verify that from Table
2.9.
This link, via price elasticity, between
changes in price and total expenditure has
important practical implications. Return
once again to the rasgoola example.
Suppose that there is only one (giant)
halwai shop in town, who sells rasgoolas.
If you are the halwai shop owner and are
rasgoola, wouldn’t you want to know if a
price increase would increase or decrease
your total sales in rupees? From a seller’s
perspective, the total value of sales is
usually called total revenue and note that
total revenue is equal to the total
expenditure by the consumers.9 Hence
the relationships between elasticity, price
change and total expenditure are
important from the viewpoint of decision
making by a producer or a firm.

SUMMARY
l Total utility is equal to the sum of marginal utilities.
l A rational consumer will never consume that much of a product such
that the marginal utility from it is negative.
l At the consumer’s equilibrium, the difference between total utility in
terms of money and the total expenditure on a good is maximised.
l Consumer’s equilibrium is attained when the condition that the
marginal utility in terms of money is equal to the price is met.
l The law of demand defines demand curve, which is downward sloping.
l The demand curve is downward sloping because of the law of
diminishing marginal utility.
l The demand curve is essentially same as the downward sloping portion
of the marginal utility curve.
l A shift of the demand curve is caused by a change in the prices of related
goods, a change in income or a change in tastes.
l An increase in the price of a substitute good causes an increase in
demand or a rightward shift of the demand curve, while an increase in
the price of a complementary good causes a decrease in demand or a
leftward shift of the demand curve.
l As income increases, the demand for a product increases or decreases,
i.e., the demand curve shifts to the right or left, depending on whether
the good is normal or inferior.

9
We will see the use of the term “total revenue” in Chapters 4, 6 and 7.
38 INTRODUCTORY MICROECONOMICS

l A favourable taste change increases the demand for a good, i.e.,

shifts the demand curve to the right; an unfavourable change does
the opposite.
l Market demand curve is obtained by horizontally summing up
the individual demand curves.
l The determinants of market demand curve are prices of related
goods, distribution of income, tastes and the market size.
l The price elasticity of demand is independent of the choice of units.
l When two demand curves intersect, the elasticity associated with
the flatter demand curve is greater.
l Greater the availability of close substitutes of a product, the higher
is the price elasticity of demand for a product.
l Typically, the demand for luxury products is elastic and that for
necessary goods is inelastic.
l Greater is the share of the total budget spent on a particular good,
the more elastic is the demand for it.
l Longer the time horizon, the more elastic is the demand for a
product.
l If the demand curve is vertical (horizontal), the price elasticity is
zero (infinity). In case of elasticity equal to one, the demand curve
is a rectangular hyperbola.
l Given that the demand is a straight line, the point elasticity is
equal to the lower segment divided by upper segment of the
demand curve at that point.
l If demand is elastic (inelastic), an increase in the price of the
product leads to a decrease (an increase) in the total expenditure
on the product.
l In case of a unitarily elastic demand, a change in price leaves the
total expenditure on the product unchanged.

EXERCISES

Section I
2.1 Define total utility.
2.2 Define marginal utility.
CONSUMER CHOICE AND THE DEMAND CURVE 39

2.3 How is total utility derived from marginal utilities?

2.4 State the law of diminishing marginal utility.
2.5 Give the meaning of demand.
2.6 Name two determinants of the demand.
2.7 List the factors that cause changes in demand.
2.8 What is the law of demand?
2.9 What is a demand schedule?
2.10 Give an example of a pair of commodities that are substitutes of
each other.
2.11 Give an example of a pair of commodities such that one of them
is complementary in consumption to the other.
2.12 If the price of good X rises and it leads to an increase in demand
for good Y, how are the two goods related?
2.13 If the price of good X rises and this leads to a decrease in demand
for good Y, how are the two goods related?
2.14 Define price elasticity of demand.

Section II
2.15 A person’s total utility schedule is given below. Derive her
marginal utility schedule.

Amount Consumed Total Utility

0 0
1 10
2 25
3 38
4 48
5 55

2.16 A person’s marginal utility schedule is given below. Derive her

total utility schedule. (Assume that the total utility of consuming
zero is zero.)
40 INTRODUCTORY MICROECONOMICS

Amount Consumed Marginal Utility

1 7
2 10
3 8
4 6
5 3
6 0

2.17 What is consumer’s equilibrium.

2.18 State the condition of consumer’s equilibrium.
2.19 Starting from an initial situation of consumer’s equilibrium, suppose
that the marginal utility of a rupee increases. Will it increase or
decrease the quantity demanded of the product?
2.20 Ice creams sell for Rs. 30. Lakhmi, who loves ice cream, has already
eaten 3. Her marginal utility from eating 3 ice creams is 90. Suppose
further that, for her, the marginal utility of one rupee is 3. Should
she eat more ice cream or should she stop?
2.21 Explain the determinants of demand.
2.22 What is meant by cross price effects? Give two numerical examples
to illustrate this.
2.23 What is meant by one good being a substitute of another?
2.24 What is meant by one good being complementary to another?
2.25 Differentiate between substitute and complementary goods.
2.26 How will an increase in the price of coffee affect the demand for tea?
2.27 How will an increase in the price of tea affect the demand for sugar?
2.28 Suppose that good A is a substitute of good B. How will an increase
in the price of good B affect the demand curve for good A?
2.29 Suppose that good A complementary to good B in consumption.
How will an increase in the price of good B affect the demand curve
for good A?
2.30 Give two examples of normal goods and two examples of inferior
goods.
2.31 How does an increase in income affect the demand curve for a normal
good?
CONSUMER CHOICE AND THE DEMAND CURVE 41

2.32 How does an increase in income affect the demand curve for an
inferior good?
2.33 Define (a) complementary goods, (b) substitute goods, (c) inferior
good and (d) normal good.
2.34 Distinguish between a change in quantity demanded and a
change in demand.
2.35 How is the market demand curve derived from the individual
demand curves?
2.36 There are four consumers of a fruit called Smile. They are Isha,
Ifraah, Ila and Ibema. Their demand curves for Smile are given
below. Derive the market demand curve.

Price Quantity Quantity Quantity Quantity

(Rs.) Demanded by Demanded by Demanded by Demanded by
Isha Ifraah Ila Ibema
1 16 7 15 8
2 11 6 12 6
3 7 5 9 4
4 4 4 6 2
5 2 3 3 0
6 1 2 0 0

2.37 Explain the determinants of the market demand curve.

2.38 Distinguish between individual and market demand curves.
2.39 Originally, a product was selling for Rs. 10 and the quantity
demanded was 1000 units. The product price changes to
Rs. 14 and as a result the quantity demanded changes to 500
units. Calculate the price elasticity.
2.40 Which of the following commodities have inelastic demand? Salt,
a particular brand of lipstick, medicine, mobile phone and school
uniform.
2.41 Draw diagrams showing elasticity equal to (a) zero, (b) one and
(c) infinity.
42 INTRODUCTORY MICROECONOMICS

2.42 Draw a straight line demand curve. Choose any three points on
it and compare the point elasticities at these three points.
2.43 Consider the above straight line demand curve. Compare the
point elasticities between the points A, B and C.
2.44 The price elasticity is 2. The % change in price is equal to 5.
Find the % change in quantity.
2.45 The price elasticity is 0.5. The % change in quantity is 4. What
is the % change in price?
2.46 As the price of peanut packets increases by 5%, the number of
peanut packets demanded falls by 8%. What is the elasticity of
demand for peanut packets?
2.47 As the price of a product decreases by 7%, the total expenditure
on it has gone up by 3.5%. What can we say about the elasticity
of demand for this product?
2.48 The price of cauliflower goes up by 8% and the total expenditure
by a family on cauliflower goes up by 8%. What can we say
about the elasticity of demand for cauliflower by this family?
2.49 Show the effect of an increase in price on total expenditure
depending on the values of price elasticity.
2.50 A dentist was charging Rs. 300 for a standard cleaning job and
per month it used to generate total revenue equal to Rs. 30,000.
She has since last month increased the price of dental cleaning
to Rs. 350. As a result, fewer customers are now coming for
dental cleaning, but the total revenue is now Rs. 33,250. From
this, what can we conclude about the elasticity of demand for
such a dental service?
CONSUMER CHOICE AND THE DEMAND CURVE 43

2.51 “If a product price increases, a family’s spending on the product

has to increase.” Defend or refute.
2.52 Determine how the following changes (or shifts) will affect market
demand curve for a product.
(a) A new steel plant comes up in Jharkhand. Many people who
were previously unemployed in the area are now employed.
How will this affect the demand curve for colour TVs and
Black and White TVs in the region?
(b) In order to encourage tourism to Goa, the Government of
India suggests Indian Airlines to reduce air fare to Goa from
the four major cities, Chennai, Kolkata, Mumbai and New
Delhi. If the Indian Airlines reduces the air fare to Goa, how
will this affect the market demand curve for air travel to Goa?
(c) There are train and bus services between New Delhi and
Jaipur. Suppose that the train fare between the two cities
comes down. How will this affect the demand curve for bus
travel between the two cities?

Section III
2.53 Discuss how the market demand curve is derived from the
individual demand curves and the determinants of market
demand.
2.54 Explain why consumer’s equilibrium is attained when the
marginal utility of a product in terms of money is equal to its
price.
2.55 Suppose there are three consumers in a particular market:
Leander, Andre and Tim. Their demand schedules are given in
the following table.

Price Quantity Demanded Quantity Demanded Quantity Demanded

by Leander by Andre by Tim
1 60 55 24
2 50 40 13
3 40 25 5
4 30 10 0
5 20 0 0
44 INTRODUCTORY MICROECONOMICS

(a) Derive the market demand schedule and plot the market demand
curve.
(b) Suppose Andre drops out of the market. Derive the new market
demand curve.
(c) Suppose Andre stays in the market and another person, Marat, joins
the market, whose quantity demanded at any given price is half of
that of Leander. Derive the new market demand curve.
2.56 Why does the demand curve slope downwards?
2.57 Explain the factors affecting the magnitude of price elasticity of demand.