Managerial Economics

Unit 2
• Consumer Behavior- I

Demand, types of demand, factors affecting demand &

demand function. Making of linear demand function & linear
demand curve. Law of demand. Consumer’s surplus.
 What is Market ?

• We can divide individual economic units into two broad groups such as
buyers and sellers. Buyers include consumers who purchase goods and
services, and firms, which buy labour, capital and raw materials that they
use to produce goods and services.

• Sellers include firms, which sell their goods and services; workers who
sell their labour, and resource owners who rent land or resources to firms.
 What is Market ?

• A market is a group of buyers and sellers of a particular good

or service. The buyers as a group determine the demand for the
product, and the sellers as a group determine the supply of the
product. Supply and demand are the forces that make market
economies work. They determine the quantity of each good
produced and the price at which it is sold.
 What is demand?
• Demand is not mere desire. When that desire is supported by or
willingness is supported by ability to pay then it is called demand.
The quantity demanded of any good is the amount of the good that
buyers are willing and able to purchase.
• Many things determine the quantity demanded of any good but the most
important determinant is the price of the good.

• And what is the relationship between quantity demanded and price?

• Inverse. The relationship between them is called law of demand.

Individual Demand function

 The relationship between demand and price in inverse.

 When consumer’s income increases, demand for a commodity will
rise. These are known as normal goods. On the other hand, increase in
income results in a fall in demand for a commodity, it is inferior.
The demand for a commodity also depends on the price of related
commodities. The individual will purchase more of a commodity when
the price of substitute increases or when the price of complementary
commodity falls
 Law of Demand

Other things being equal, the quantity demanded of a

good falls when the price of the good rises. The
functional relationship between quantity demanded
and its price in the form of equation is:
 Demand Schedule and Demand Curve

• Demand schedule shows the relationship between the price of

a good and the quantity demanded

1 25
2 20
3 15
4 10
5 5
Individual Demand Curve
 Individual demand curve

• Relationship between the quantity of a good that consumers

are willing to buy and the price of the good.

• It slopes downward from left to right indicating demand and

price of a commodity are inversely related.
 From Individual to Market

• Individual Demand – An Individual demand schedule

represents the demand for a good by a single individual. Market
Demand- Market demand is the sum of all the individuals
demands in the market for any particular goods or service at a
particular price. Thus market demand is the summation of all
individual buyers quantity demanded at different prices.
Individual and market demand Schedule

Price A’s demand B’ demand Market demand

10 50 100 150

20 40 90 130

30 30 80 110

40 20 70 90

50 10 60 70
Market Demand Curve
 Determinants of demand
• Price : If the price of ice cream increases, we buy less of it. On the other hand, if it falls,
we buy more of it. Hence we say that quantity demanded is negatively related to price of a
commodity. The relationship between quantity demanded and price of a commodity is so
pervasive that economists call it as law of demand. Other things remaining constant,
demand for a commodity is inversely related to price.

• Income: What would happen to demand for ice cream if you lost your job? Most likely, it
would fall. A lower income means you have less to spend on total, so you would spend less
on some. When demand for good falls when income falls, the good is called as normal good.

.
 Determinants of demand
• Prices of related goods: Suppose there are only two cell phones in the market:
Samsung and Sony. If price of Samsung falls then law of demand says that
more people will buy Samsung cell phone. At the same time, people will buy
less of Sony cell phone. When a fall in the price of one good reduces the
demand for another good then the two goods are called substitutes.

• Now suppose that the price of petrol falls, what would happen to demand for
car? The demand for car will rise. When a fall in price of one good raises the
demand for another good, the two goods are called complements
Tastes: The most obvious determinant of demand is your
tastes. If you like ice cream, you buy more of it. Economists
normally do not try to explain people’s tastes because tastes
are based on historical and psychological forces that are
beyond the scope of economics. Economists, however,
examine what happens when tastes change.
Expectations: Our expectations about the future affect our
demand for good or service. For instance, if you expect that the
price of gold would rise in future, you buy gold today rather
than tomorrow. So expectations about the future price affect
the demand for a commodity
Shifts in Demand Curve and movement along the demand
curve
• Demand for a commodity not only depends on its price but
also factors other than price.

• When factors other than price change then demand curve

shifts to rightward or leftward.
• When price alone changes then it causes movement along the
demand curve. ( other factors remain constant)
Shifts in Demand Curve
Shift vs movement along demand curve
e buyers

Movement and Shifts in demand curve

Variables that affect quantity A change in this variable
demanded

Price Movement along the demand

curve

Income Shits the demand curve

Prices of related goods Shits the demand curve

Expectations Shits the demand curve

Number of buyers Shits the demand curve

 Linear demand function and linear demand curve:

• A linear demand function is in the form of an equation

• is called linear demand function. Here

 Linear Demand function and curve

• For example

• Now if the market price is Rs.40 then quantity demanded is 40

units. So let us find out quantity demanded at various prices of a
commodity. Find QD when p changes from 0 to 5. Draw the graph
Linear demand function

Price Quantity demanded

10 160

20 120

30 80

40 40

50 0
 Linear Demand Function : Problem
• Problem:
• Assume that a linear demand function is

• Calculate the quantity demanded for prices from 0 to Rs.10.

• Draw the demand curve.
• Y (QD) ( dependent) = a (100) + b (8)x (P) ( independent)
• a = intercept b = slope what is slope? Measures rate of
change in QD due to change in price= Slope=- =
 Consumer Surplus

• Individual consumer surplus is the difference between the

maximum amount that a consumer is willing to pay for a good
and the amount that the consumer actually pays.
• That is :
• Consumer Surplus: What a consumer is willing to pay – what
he actually pays
 Consumer Surplus
• Suppose, for example, that a student would be willing to pay Rs. 500 for a
movie even though she actually pays Rs. 200.The Rs.300 difference is her
consumer surplus. When we add the consumer surpluses of all consumers who
buy a good, we obtain a measure of the aggregate consumer surplus.

• The Willingness to Pay refers to the maximum amount that a

buyer will pay for a good. The willingness to pay measures
how much that buyer values the good.
 Measurement of Consumer Surplus using the
Demand Curve

• Let us take following example. Let us assume that the price of bread is Rs.16.
When deciding how many breads to buy, our buyer might reason as follows. The
first bread cost him Rs. 16 but the consumer is willing to pay or he values that
bread worth of Rs. 20. This valuation is obtained by using the demand curve to
find the maximum amount the consumer will pay for each additional bread. The
first bread generates Rs 4 surplus value above the price. The second bread is
worth purchasing because it generates a surplus of Rs.3 and so on. Consumer is
indifferent in buying 5th unit of bread because it generates zero surplus.
Measurement of Consumer Surplus using the
Demand Curve

Price of Buyer’s willingness Consumer

Bread to pay Surplus
Rs. 16 Rs.20 Rs.4
Rs.16 Rs.19 Rs.3
Rs.16 Rs.18 Rs.2
Rs.16 Rs.17 Rs.1
Rs.16 Rs.16 Rs.0
--------- ----------- Total
Measurement of Consumer Surplus using the
Demand Curve

we can always measure consumer surplus by finding the area

below the demand curve and above the price line.
Decrease in price increases consumer surplus
• With the decrease in price of a commodity, consumer surplus
increases because existing consumers pay less and new consumers
enters the market at lower price.