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# Unit-II : UTILITY APPROACH

2.1 Meaning and Definition.
2.2 Marginal deminishing Utility Theory.
2.3 Equi Marginal Utility Theory.
2.4 Demand : Meaning, Definition, Change in Demand.
2.5 Law of Demand & its Exceptions.

Utility
Demand for a commodity depends on the utility it offers to the consumer. Utility means the level of satisfaction
which people derive from the consumption of a commodity. Utility is a subjective concept. Different people derive
different level of utility from a given good. Harmful goods such has liquor is also said to have utility from economic
stand point as people want them. Thus, the concept of utility is ethically neutral.
Example: A person may derive 100% satisfaction from drinking coffee, while another may not receive any
satisfaction.
Utility, from the economic point of view, is said to be ethically neutral. This is because even harmful items like
cigarettes, alcohol etc. are demanded, as people want them. Thus, the concept of utility does not distinguish
between harmful and non-harmful objects.
When a consumer gets maximum satisfaction, it is called equilibrium and it is also called the most comfortable
position. In order to call it the equilibrium position, two conditions are required viz.
1. The consumer should get maximum satisfaction
2. The consumer should not prefer to change

Classification of utilities

Marginal Utility:
It is the utility derived by the consumer by consuming an additional unit at a given time.
Example
If a consumer consumes 12 chocolates, the Marginal Utility is the utility derived from the 12th unit. It is nothing but
the Total Utility of 12 chocolates minus the Total Utility of 11 chocolates. Thus,
MU n = TU n – TU n-1

Where
MUn = Marginal Utility of ‘nth’ commodity
TUn = Total Utility of n units
TUn-1= Total Utility of n-1 units

UNIT-II B.COM I-SEM-I NOTES COMPILED BY PROF.RUPESH DAHAKE

Approaches to utility analysis Every Consumer is a rational consumer i.5 ………….RUPESH DAHAKE . where consumer derives maximum satisfaction is known as ‘Equilibrium’. They are:  Law of Diminishing Marginal Utility We study Indifference Curve Analysis  Consumer’s Equilibrium with Single Commodity  Law of Equi-Marginal Utility. + Un Place utility: When the goods are transferred from one place to another place their utility increases. Example Goods transported from the place of plenty to the place of scarce. he always tries to get the maximum satisfaction with the limited income he has. Ordinal analysis Cardinal Analysis Ordinal Analysis This approach was developed by Alfred This approach was developed by J.3.2. This equilibrium concept could be explained in two different ways. Cardinal analysis 2..e. then the Total Utility is the sum of satisfaction of consuming all the 12 chocolates. R. Total Utility: U1 + U2 + U3 + ……. Example If a consumer consumes 12 chocolates.Total Utility: It is the utility obtained by the consumer from the consumption of all the units at a given time.. Hicks Marshall and R. D. Time utility: When the seller stores the goods now and releases at the time when there is a scarcity it is called as time utility.  Consumer Surplus UNIT-II B. Allen This analysis assumes that satisfaction that a This analysis condemns cardinal measurability consumer derives from various goods and of utility and argues that satisfaction can’t be services could be expressed in terms of cardinal measured in terms of numbers but only could numbers.COM I-SEM-I NOTES COMPILED BY PROF.. They are: 1. be arranged/ranked in the order of preference We study four basic concepts under this. J. The point.4. Like 1.

Statement: “The additional benefit that a person derives from a given increase in the stock of anything diminishes with the increase in the stock.. Prof.120) be explained through the diagram also.  Marginal Utility (MU): refers to the additional or extra utility that the consumer gets from the consumption of one more extra unit. This law is based on one of the important characteristic of human want i. This concept could 6 120 0 (120. 7 100 −20 (100-120) UNIT-II B.Law of Diminishing Marginal Utility (LDMU) The Law of Diminishing Marginal Utility is one of the very important and fundamental laws of consumption. “Some Human wants could be satisfied”. that he already has” – Marshall. 4 110 15 (110-95) If a consumer goes on consuming beyond this point.RUPESH DAHAKE . This is also known as “Gossen’s 1st Law of Consumption”. This concept of LDMU has two important aspects. Symbolically Marginal Utility is represented as MU = TU ν – TUn- 1. Let us understand these two aspects more clearly through a imaginary table: Number of Mangoes TU MU = TUn – TUn-1 Here we may note that TU increases with 1 50 50 the consumption of every successive units but at a diminishing rate. (Here n-1 denotes the previous total utility) In other words the MU could also be defined as the difference between the Total Utility of the newly consumed good and that of the Total Utility of the previously consumed good. the TU goes on diminishing and 5 120 10 (120-110) MU will be negative.COM I-SEM-I NOTES COMPILED BY PROF. 3 95 20 (95-75) When MU=0. named after an Austrian economist Gossen’s who introduced it. This LDMU states – if one goes on consuming a particular commodity without any time gap. the marginal utility that he derives from every successive unit goes on diminishing. On the other 2 75 25 (75-50) hand MU goes on diminishing with the consumption of every successive unit. the TU will be the maximum.e. Alfred Marshall has developed this LDMU. They are:  Total Utility (TU): refers to the aggregate amount of utility derived from consuming all the units of a particular commodity.

Thus. utility can be expressed in the form of numbers. • No time gap: In the process of consumption the successive units must be consumed successively one after the other. size. colour. • No changes in the taste. For Example: When a vegetarian consumes egg. habits and the customs of the consumer: During the course of consumption there shouldn’t be any change in the taste. etc. The Units must be similar. • Cardinal measurability of utility: According to this theory. If they are too small or too large. this may not be true in reality.Assumptions to Law of Diminishing Marginal Utility (LDMU) The LDMU is based on certain assumptions. In other words. They are: • Identical or homogeneous units: The different units of a particular commodity consumed by a person should be identical or same in all respect i. • Constancy of the Marginal Utility of money: This is an important assumption without which Marshall could not have measured Marginal Utilities of goods in terms of money. • Reasonably large units or normal standard units: The units taken for consumption must be normal standard units and reasonably large units.. this law willn’t hold good. quality. However.RUPESH DAHAKE . 90 utils of satisfaction from the consumption of chocolate and so on. But gradually when he consumes successive units.COM I-SEM-I NOTES COMPILED BY PROF. It states that UNIT-II B. initially he may not like it and may not get any utility. this LDMU willn’t be applicable. If there is a long interval between the consumption of one unit and the another unit. a person can say that he derives 10 utils of satisfaction from the consumption of bread.. habits and the customs of the consumer. taste. he may start getting utility from egg. a person can express the satisfaction he derives from the commodity in quantitative cardinal terms.e. For Example: When a person is thirsty he should consume water in glass not spoon-by-spoon. then LDMU willn’t hold good. If there is any change.

UNIT-II B. • Useful for Government to fix the Tax Rate: The value of additional money for a rich person is relatively less. separate utilities of different goods can be added to obtain the total sum of the utilities of all the goods purchased. The consumer will prefer to spend money on the commodity from which he will derive maximum utils. • The hypothesis of independent utility: This assumption states that the Total Utility which a person derives from a collection of goods purchased is simply the sum total of the separate utilities of goods i.  Not applicable for money: The LDMU is not applicable for money. With every increase in the stock of money. but it is priced low and diamond is less useful than water and it is priced high. Hence in order to induce the consumer to purchase more. Example: 10 utils of satisfaction from the consumption of bread + 90 utils of satisfaction from the consumption of pizzas = 100 utils of satisfaction. Importance/ Application of the Law of Diminishing Marginal Utility • LDMU concept is used to explain “Value Paradox”: This “Value Paradox” was developed by Prof. For Example: a thousand or five hundred rupees to a millionaire will not make much difference.RUPESH DAHAKE . the Marginal Utility of money remains constant throughout the period when the individual is spending money on a good. • The LDMU is a single commodity model. what consumer is actually prepared to pay and the price that he actually pays. • The LDMU. Initially a consumer will be ready to pay more price for a product. Government levies high rate tax on rich people and low tax on poor people. Adam Smith. He says that water is more useful than diamond. Limitations to Law of Diminishing Marginal Utility (LDMU) The exponent of the LDMU has himself given few areas where this law wouldn’t be applicable. Criticisms to Law of Diminishing Marginal Utility (LDMU) The main criticisms of the LDMU are as follows: • Cardinal measurability of utility is not possible. • Rationality: Here the consumer is assumed to be rational. coins. currency of different countries. • To explain ‘Law of Demand’: When a consumer goes on consuming a particular commodity. the marginal utility goes on diminishing. This concept is also known as ‘Diamond –water paradox’. because our satisfaction increases with every increase in the stock of these goods. For this LDMU could be used. But whereas the value of the same additional money to a poor person is more.  Not applicable to Liquor: The level of intoxication of the drinker increases with every additional drink of liquor. the price of the commodity has to be reduced. to some extent applies to money also. • Used to explain Consumer Surplus: consumer surplus might be defined as the difference between the price.e. gradually the same consumer will be ready to offer very less price for the same product. marginal utility will be high. They are:  Rare Collections: The law of LDMU is not applicable to some of the rare collections like stamps. This is because more is the quantity or the stock of a product the marginal utility starts diminishing and if the availability of a product is less. Nobody can express their utility in terms of numbers. antique goods etc. the greed goes on increasing. Hence the government follows ‘Progressive Tax system’. This is because law of diminishing marginal utility operates over there.COM I-SEM-I NOTES COMPILED BY PROF. the price that he will be ready to offer will also be less. When the utility that consumer gets is less..

According to the law of equi-marginal utility. will try to spend his limited income on goods X and Y to maximise his Total Utility or satisfaction. the consumer will be in equilibrium at the point where the utility derived from the last rupee spent on each item is equal. According to Alfred Marshall. chocolates and ice creams. X and Y. it is called Gossen’s second Law of consumption. the consumer will try to maximize his satisfaction when there are substitutes available in the market.Gossen (1810-1858) of Germany. but the income which is available to the consumer to satisfy all his wants is limited. So.H. The law of equi-marginal utility explains the behaviour of a consumer when he consumes more than one commodity. Symbolically. According to this law.RUPESH DAHAKE . The marginal utility derived from both these commodities is as under: UNIT-II B. a consumer gets maximum satisfaction when he allocates his limited income to the purchase of different goods in such a way that the Marginal Utility derived from the last unit of money spent on each item of expenditure tend to be equal.The Law of Equi-Marginal utility (LEMU) The idea of equi-marginal utility was first mentioned by H. the consumer will be in equilibrium when Where MUx = Marginal Utility of commodity X MUy = Marginal Utility of commodity Y Px = Price of commodity X Py = Price of commodity Y MUm = Marginal Utility of money Let us illustrate the law of equi marginal utility with the help of the following table: Suppose a lady has ₹ 5 with her. Hence. which she wishes to spend on two commodities. he will substitute one item in place of the other such that his Marginal Utility is proportional to the price. This law explains how the consumer spends his limited income on various commodities to get maximum satisfaction. Only at that point of maximum satisfaction. the consumer being rational. so he wants to get maximum satisfaction • The utility of each commodity is measurable • The Marginal Utility of money remains constant • The income of the consumer is given • The prices of the commodities are given • The law is based on the law of diminishing marginal utility Explanation of Law of Equi-Marginal utility (LEMU) Suppose there are two goods. on which a consumer has to spend a given income. Wants are unlimited.” Assumptions to Law of Equi-Marginal utility (LEMU) • The consumer is rational. Alfred Marshall made significant refinements to this law in his ‘Principles of Economics’. “Other things being equal.COM I-SEM-I NOTES COMPILED BY PROF. the consumer will be in equilibrium.

00 on chocolates and ₹ 2.00 on chocolates and ₹ 3. she gets 40 utils (10+8+6+4+12=40).00 on the purchase of chocolates.  By spending ₹ 1. the total utility is then maximum i. She can spend this money in three ways.00 on chocolates and ₹ 3. When she spends ₹ 2.e.00 on ice creams and will get the maximum satisfaction.00 may be utilized for the purchase of ice creams only.00. Units of MU of Chocolates MU of Ice creams Money 1 10 12 2 8 10 3 6 8 4 4 6 5 2 3 ₹5 Total Utility = 30 Total Utility = 39 A rational consumer would like to get maximum satisfaction from ₹ 5.  Some amount may be spent on the purchase of chocolates and some on the purchase of ice creams.00 on chocolates and ₹ 3.00 on ice creams.  By spending ₹ 2. she gets 30 utils. the total utility derived is 39 which is higher than chocolates. she gets 46 utils (10+12+10+8+6=46).00 on chocolates and ₹ 1.  By spending ₹ 3.00 on ice creams. In order to make the best of the limited resources. she gets 48 utils (10+8+12+10+8=48). 48 as is clear from the schedule given above..  ₹ 5. she adjusts her expenditure.  By spending ₹ 4. If she spends ₹ 5.00 may be spent on chocolates only.RUPESH DAHAKE . If the prudent consumer spends ₹ 5.  ₹ 5.00 on the purchase of ice creams. When the marginal utilities of the two commodities are equalized. The sensible consumer will spend ₹ 2.00 on chocolates and ₹ 4. UNIT-II B.00 on ice creams. the Marginal Utility derived from both these commodities is equal to 8.00 on ice creams. The law of equi-marginal utility can be explained with the help the diagrams.COM I-SEM-I NOTES COMPILED BY PROF. she derives 46 utils (10+8+6+12+10=46).00 on ice creams.

On the other hand. • Indivisible goods: It is not applicable to indivisible goods. the Marginal Utility derived from the consumption of both the items (chocolates and ice creams) is equal to 8 units (EP=NC). if the consumer purchases a refrigerator and a cup of coffee. ignorance.00 on chocolates and ₹ 3. the expenditure on chocolates falls from OP amount (₹ 2) to OC’ amount (₹ 1. Even if we assume that budget period is one year. It is difficult to measure. • Consumer is not a computer: a consumer has to keep a complete record of income and continuously calculate the marginal utilities but human mind is incapable of making such calculations. monthly or yearly. For example. The consumer does not derive maximum satisfaction except in the combination of expenditure of ₹ 2. • Marginal Utility of Money is not constant: Marshall assumes that marginal utility of money is constant but Hicks argues that money is also a commodity and the marginal utility also diminishes slowly. The loss in utility (chocolates) is greater than that of its gain in ice creams.00 on chocolates (OC’ amount) and ₹ 4.. scarcity etc. MU is the marginal utility curve for chocolates and KL of ice creams.COM I-SEM-I NOTES COMPILED BY PROF. car etc. Fashion of the day impede the operation of the law as one may UNIT-II B. If divided they will lose their utility.00 on ice creams and by no other alteration in the expenditure. • Durable goods: It is difficult to measure the utility in respect of durable goods such as car and machinery. fashions. advertisements etc.In the diagram. When a consumer spends OP amount (₹ 2) on chocolates and OC (₹ 3) on ice creams. it is very difficult to equalize the Marginal Utility of a refrigerator which lasts for several years with a cup of coffee. • Cardinal Measurement of Utility: Critics point out that utility is an abstract term. • Indefiniteness of budget period: The income may be daily.RUPESH DAHAKE . Limitations of Law of Equi-Marginal utility (LEMU) • Rational behavior: It is true that consumer is irrational sometimes. it is very difficult to calculate the utilities as he purchases various commodities. which cannot be measured. The consumer gets maximum utility when she spends ₹ 2. We now assume that the consumer spends ₹ 1..: Customs make the consumption of an article compulsory irrespective of marginal utilities. which exhausts at the single act of consumption. There is a toss of utility equal to the area C’PEE’.00 on chocolates and ₹ 3.00). • Utility is subjective: Utility is subjective and psychological concept. • Customs. the added utility is equal to the area CQ’ N’N. There are certain goods such as fans. which cannot be divided or sub divided. It is behavior is greatly influenced by habits.00 on ice creams. • Multiplicity: Multiplicity of commodities prevent the consumer from making a rational choice. tv’s.00 (OQ’) on ice creams. If CQ’ more amount is spent on ice creams. He neither has time nor the ability to calculate marginal utilities.

purchase a commodity much against his wish to be in tune with the fashion. Two things are to be noted about quantity demanded. • Choice between Savings and Consumption: If the future consumption yields more satisfaction than the present consumption. Thus. Moreover prices are subject to change. but also has practical application in our daily life.COM I-SEM-I NOTES COMPILED BY PROF. effective demand for a thing depends on (i) desire (ii) means to purchase and (iii) willingness to use those means for that purchase. The society gets the maximum economic benefit at the point where the sacrifice made by people on account of paying taxes is exactly equal to the benefits that they get from the government. Thus the law has very wide application. Unless demand is backed by purchasing power or ability to pay. The consumer distributes his limited income among various commodities in such a way that the Marginal Utility or the satisfaction that he gets is equal to its price. but due to lack of means to purchase it. because he knows that if he continues consumption. Importance of Law of Equi-Marginal utility (LEMU) The Law of Equi-marginal utility is not only theoretical. for instance. • Exchange: a person having surplus. • Scarcity aspect: this law applies to all fields of economic activity where limited resources are to be profitably employed. or at various prices of related goods”. • The theory of public finance: The objective of public finance is to achieve maximum social advantage. At different prices different quantities of a commodity are generally demanded. We are concerned not with a single isolated purchase. the satisfaction will be less and the price he is going to pay is more. In short “By demand. Prof. or at various incomes. his demand is not effective. is something more than desire to purchase though desire is one element of it. • The theory of production: The law helps the producer to maximise his profits by substituting one factor of production to another till the marginal productivity of all the factors are equalised. we mean the various quantities of a given commodity or service which consumers would buy in one market in a given period of time. but with a continuous flow of purchases and we must therefore express demand as so much per period of time – one thousand dozens of oranges per day. in that case the consumer will decide to save his income rather than spending it. at various prices. where it could be used are: - • The Theory of Consumption: The expenditure pattern of every consumer is based on this law. Some of the areas.RUPESH DAHAKE . Marshall puts the significance of the law in the following words: “The application of this principle could be extended to every field of economic enquiry”. seven thousand dozens oranges per week and so on. UNIT-II B. It is to be noted that demand. exchange with the person who has scarcity till marginal utility become equal. Scarcity consumer is compelled to purchase an alternative or a substitute good if there is scarcity. This helps the consumer to maximise his satisfaction. in Economics. it does not constitute demand. One is that quantity demanded is always expressed at a given price. Consumer does not possess complete knowledge of all commodities and their prices in the market. DEMAND MEANING OF DEMAND The concept ‘demand’ refers to the quantity of a good or service that consumers are willing and able to purchase at various prices during a given period of time. A beggar. The second thing is that quantity demanded is a flow. may desire food. At that point he stops further consumption.

if the price of a commodity falls. It thus attempts to isolate the influence exerted by the price of the good upon the amount sold. the smaller must be the price at which it is offered in order that it may find purchasers or in other words the amount demanded increases with a fall in price and diminishes with a rise in price”. Thus. the quantity demanded by him rises to 60 units. he purchases 15 units of the commodity.LAW OF DEMAND The law of demand is one of the most important laws of economic theory. may not result in a decrease in the quantity demanded of it. The law of demand may be illustrated with the help of a demand schedule and a demand Demand Schedule : To illustrate the relation between the quantity of a commodity demanded and its price. then the inverse price-demand relationship may not hold good. Alfred Marshall defined the law thus: “The greater the amount to be sold. Similarly. When the price falls to ` 4. there is an inverse relationship between price and quantity demanded. For example. the constancy of these other factors is an important assumption of the law of demand. that at ` 5 UNIT-II B. the quantity demanded of it will rise and if the price of a commodity rises. Demand schedule of an individual consumer Price Quantity demanded (`) (Units) A 5 10 B 4 15 C 3 20 D 2 35 E 1 60 When price of commodity X is ` 5 per unit. The other things which are assumed to be equal or constant are the prices of related commodities. other things being same. when the price further falls. Definition of the law of Demand Prof. Point A. The above table depicts an inverse relationship between price and quantity demanded. 1. its demand goes on falling. we may take a hypothetical data for prices and quantities of commodity X. If these factors which determine demand also undergo a change. tastes and preferences of consumers. and such other factors which influence demand. Demand curve: We can now plot the data from Table 1 on a graph with price on the vertical axis and quantity on the horizontal axis. we have shown such a graph and plotted the five points corresponding to each price- quantity combination shown in Table 1. a consumer purchases 10 units of the commodity. then an increase in the price of a commodity. its quantity demanded will decline. Thus. According to law of demand. as the price of the commodity X goes on rising.RUPESH DAHAKE . shows the same information as the first row of Table 1. A demand schedule is drawn upon the assumption that all the other influences remain unchanged. if incomes of consumers increase. other things being equal. income of consumers.COM I-SEM-I NOTES COMPILED BY PROF. In Fig. the quantity demanded by him goes on rising until at price ` 1.

1. Fig. its downward slope indicates that the quantity of ‘X’ demanded increases as its price falls. as the price of the good falls. Figure 2 shows the market demand curve for commodity ‘X’. as stated above. Table 2 : Market Demand Schedule Quantity demanded by Price (`) P Q R Total market demand 5 10 8 12 30 4 15 12 18 45 3 20 17 23 60 2 35 25 40 100 1 60 35 45 140 When we add quantities demanded at each price by consumers P. we get the market demand curve. the market demand for commodity ‘X’ is 30 units (i. only 10 units of X will be demanded. Market Demand Schedule : When we add up the various quantities demanded by the number of consumers in the market we can obtain the market demand schedule. The market demand curve. it is very likely that new buyers will enter the market which will further raise the quantity demanded of the quantity demanded of the good. the quantity demanded will be 60 units. 10+8+12). 140 units are demanded in the market. The Table 2 shows their individual demands at various prices.per unit. 2 : Market Demand Curve Market Demand Curve : If we plot the market demand schedule on a graph. when price is ` 5 per unit. The curve is called the demand curve for commodity ‘X’. How the summation is done is illustrated in Table 2.e. Q and R we get the total market demand. When price falls to ` 4. slopes downwards to the right because it is nothing but the lateral summation of individual demand curves. At Re. We now draw a smooth curve through these points. Thus. describes an inverse price-demand relationship. Suppose there are three individual buyers of the goods in the market. The curve shows the quantity of ‘X’ that a consumer would like to buy at each price.RUPESH DAHAKE . The market demand schedule also indicates inverse relationship between price and quantity demanded of ‘X’. when the price is ` 1. the market demand is 45 units. Besides. UNIT-II B. like individual demand curve. Point E shows the same information as does the last row of the table. Thus the downward sloping demand curve is in accordance with the law of demand which.COM I-SEM-I NOTES COMPILED BY PROF.

e. He is induced to buy additional units in order to maximize his satisfaction or utility. rises they will be put to limited uses only. however there are certain cases where this law does not hold good. (1) Law of diminishing marginal utility : According to Marshall people will buy more quantity at lower price because they want to equalize the marginal utility of the commodity and its price. When the price of such commodities are high. The following are the important exceptions to the law of demand. (2) Substitution effect : Hicks and Allen have explained the law in terms of substitution effect and income effect. The diminishing marginal utility and equalizing it with the price is the cause for the downward sloping demand curve.COM I-SEM-I NOTES COMPILED BY PROF. Veblen effect takes place as some consumers measure the utility of a commodity by its price i. if the commodity is expensive UNIT-II B. This increase in the real income induces him to buy more of that commodity. demand for that commodity (whose price has fallen) increases. it becomes relatively cheaper than other commodities. (4) Arrival of new consumers : When the price of a commodity falls. So a rational consumer will not pay more for lesser satisfaction. Thus. Thus. (3) Income effect : When the price of a commodity falls. other things being equal.. This was found out by Veblen in his doctrine of “Conspicuous Consumption” and hence this effect is called Veblen effect or prestige goods effect. When the price of a commodity falls. This is called income effect. The result is that the total demand for the commodity whose price has fallen increases.RUPESH DAHAKE . Rationale of the Law of Demand : Why does demand curve slope downwards? Different economists have given different explanations for the operation of law of demand. more consumers start buying it because some of those who could not afford to buy it previously may now afford to buy it. the consumer can buy the same quantity of the commodity with lesser money or he can buy more of the same commodity with the same amount of money. If their prices fall they will be used for varied purposes and demand for such commodities will increase. This is called substitution effect. Exceptions to the Law of Demand : According to the law of demand. (5) Different uses : Certain commodities have multiple uses. It induces consumers to substitute the commodity whose price has fallen for other commodities which have now become relatively expensive. different uses of a commodity make the demand curve slope downwards reacting to changes in price. In other words. These are given below. Such articles will not conform to the usual law of demand. (i) Conspicuous goods : Articles of prestige value or snob appeal or articles of conspicuous consumption are demanded only by the rich people and these articles become more attractive if their prices go up. more of a commodity will be demanded at lower prices than at higher prices. This raises the number of consumers of a commodity at a lower price and hence the demand for the commodity in question. consumer’s real income or purchasing power increases. as a result of fall in the price of the commodity. Due to the operation of income effect and substitution effect. price effect operates or law of demend holds. The law of demand is valid in most cases.

the law will not remain valid. in spite of the fact that the prices of television sets. When. UNIT-II B. the British workers purchased more bread and not less of it. households expecting that the prices in the future will be still higher. Such goods which exhibit direct price-demand relationship are called ‘Giffen goods’. was surprised to find out that as the price of bread increased. prices of other goods and tastes of the consumers remain same but the price of apples falls to ` 80 per kilogram and the consumer now buys two kilograms of apples. as a result of decrease in price. (iii) Conspicuous necessities : The demand for certain goods is affected by the demonstration effect of the consumption pattern of a social group to which an individual belongs. at times consumers tend to be irrational and make impulsive purchases without any rational calculations about price and usefulness of the product and in such contexts the law of demand fails. They demand greater quantities of foodgrains as their price rise. have been continuously rising. as a result of increase in price. low quality rice and wheat etc. we say that there is a change in quantity demanded or there is an expansion of demand. For example. have become necessities of life. Irrespective of price changes. they think that it has got more utility. when there is wide-spread drought. cooking gas etc. even when its price was higher than before. Since bread.COM I-SEM-I NOTES COMPILED BY PROF. was still the cheapest food article. But it is to be noted that here it is not the law of demand which is invalidated but there is a change in one of the factors which was held constant while deriving the law of demand. namely change in the price expectations of the people. However. suppose the price of apples at any time is ` 100 per kilogram and a consumer buys one kilogram at that price. DEMAND EXPANSION AND CONTRACTION OF DEMAND The demand schedule. Higher the price of diamonds. people expect that prices of foodgrains would rise in future.RUPESH DAHAKE . For example. in practice. in Economics. demand curve and the law of demand all show that when the price of a commodity falls. Under such circumstances. it caused such a large decline in the purchasing power of the poor people that they were forced to cut down the consumption of meat and other more expensive foods. Generally those goods which are considered inferior by the consumers and which occupy a substantial place in consumer’s budget are called ‘Giffen goods’. we say that there is contraction of demand. tend to buy larger quantities of the commodities. people consumed more of it and not less when its price went up. a household may demand larger quantity of a commodity even at a higher price because it may be ignorant of the ruling price of the commodity. their demand does not show any tendency to fall. Diamonds are often given as example of this case. (vii) Speculative goods: In the speculative market. we say that there is an expansion of demand and when. its quantity demanded increases. due to their constant usage. Examples of such goods are coarse grains like bajra. they buy less of this commodity at low price and more of it at high price. (ii) Giffen goods : Sir Robert Giffen. This was something against the law of demand. Now. Why did this happen? The reason given for this is that when the price of bread went up. people have to consume the minimum quantities of necessary commodities. an economist. As such. (v) The law has been derived assuming consumers to be rational and knowledgeable about market-conditions. (vi) Demand for necessaries: The law of demand does not apply much in the case of necessaries of life. coolers. the quantity demanded increases. refrigerators. other things being equal. (iv) Future expectations about prices : It has been observed that when the prices are rising. Similarly. These goods. higher is the prestige value attached to them and hence higher is the demand for them. the quantity demanded decreases. if other things such as income. particularly in the market for stocks and shares. For example. more will be demanded when the prices are rising and less will be demanded when prices decline.

the quantity demanded rises to ON. The phenomena of expansion and contraction of demand are shown in Figure 3. the demand of that good will decline. the goods are out of fashion. the quantity demanded falls to OL. resulting in the shift of the demand curve to the left. Similarly. If the income of a consumer rises. the demand curve shifts to the right. on the other hand. On the contrary. he would be able to purchase the commodities which he earlier could not afford.’ INCREASE AND DECREASE IN DEMAND In case of expansion and contraction of demand. there is an increase or decrease in demand and the demand curve shifts either to its right or left. given other things equal. we say that there is ‘expansion of demand’ or ‘a rise in quantity demanded’ or ‘a downward movement on the same demand curve. all other factors remaining constant. If as a result of increase in price (OP”). if the price of apples rises to ` 150 per kilogram and consumer buys only half a kilogram.COM I-SEM-I NOTES COMPILED BY PROF. If. When all the other factors influencing demand also change. as a result of fall in price to OP’.RUPESH DAHAKE .  Rise in income  Rise in the price of substitutes in demand  Fall in the price of a complement  Favourable change in tastes of a good (A shift in the demand curve towards the right)  Increase in population  Goods in fashion  Rise in income  Rise in the price of substitutes Decrease in demand  Fall in the price of a complement  Favourable change in tastes of a good (A shift in the demand curve towards the left)  Increase in population  Goods in fashion UNIT-II B. we say that there is ‘a fall in quantity demanded’ or ‘contraction of demand’ or ‘an upward movement along the same curve’. we have seen that the change takes place as a result of changes in price. we say that there is a contraction of demand. The figure shows that when price is OP quantity demanded is OM. This would result in an increase in demand and therefore.

UNIT-II B.RUPESH DAHAKE .COM I-SEM-I NOTES COMPILED BY PROF.