Chapter 2

lesson 1

Theory of Demand and Supply

 Utility Analysis

Consumer behavior: is the foundation of utility

Utility:is the quality or capacity of a product which enables it to

satisfy human needs and wants. It is a power to satisfy want.
The question of good or bad, ethical or unethical are not the
part of the utility.

utility is the quality or capacity of a good which enables it to

satisfy human wants. ---(Meyers)
 Forms of Utility:

i) Form utility: change basic structure of product (wood)

ii) Time utility: having a product available when we want
iii) Place utility: product is ready accessible to customer
iv) Possession utility: transfer the ownership
v) Information utility: when information create value
vi) Image utility: when image create value
 Basic Assumptions of utility Analysis
i) Rational consumer: people purchase product rationally
ii) Fixed time: it deals with fixed time period
iii) Income and test: of the people is constant
iv) Independent: differ from product to product
v) MU of money: is constant; rich vs. poor money utility
vi) Introspection: differ from one people to another
 Diminishing Marginal Utility:
Law of Diminishing Marginal Utility:
The additional benefit which a person derives from a given
increase of this stock of anything diminishes with the growth
of the stock that he already has. ( prof. Marshall)

Marginalism: the revolution of marginal concept in the

thought of economics. Individual units are controlled through
this concept.
 Utility Schedule
Utility Total utility Marginal utility
1. 20 20
2. 38 18
3. 53 15
4. 64 11
5. 70 06
6. 70 00
7. 62 - 08
8. 46 - 18

Relationship between TU and MU

Draw an Utility Curve from this Schedule
 Limitations Law of Diminishing Marginal Utility
(DMU)

Suitable Units and suitable time

Proper amount: hungry or thirsty person
Change of taste:
 Human passion : collecting post cards.
Popular item: telephone
 Impact of alternative product: pen & ink
Not Applicable to Money
 Paradox of Value
i) Rules: Higher utility = higher price
Lower utility = lower price

ii) Paradox: the opposite of the rules

a) Higher utility = low price: water has higher utility but
the price of water is very low.
b) Lower utility = higher price: diamond has lower utility
but the price of diamond is very high.

iii) Analysis: the criticism of paradox value

a) Available supply: create low utility=low price like
water
b) Limited supply: high utility = high price like diamond
 Marginal utility and price
• Marginal utility and price are inter-related
• The consumer stops where the price and
marginal utility are equal.
• But marginal utility does not determine the
price (paradox), it simply indicates it. If the
price changes marginal utility changes too
 Demand

Demand: The desire for any commodity backed by need,

ability and willingness to spend is considered as demand in
economics;
i) Need
ii) Ability to pay
iii) Willingness to spend
 Types of Demand
1.Price Demand: Assuming other factors as constant, a
relationship between the price and demand of a commodity is
known as Price Demand.
Price Demand can be shown as:
Dx = f(Px)
Where,
Dx = Demand for the given Commodity
f = Functional Relationship
Px = Price of the given Commodity
 Types of Demand (cont.)
2. Cross Demand:
Assuming other things remaining as constant, a relationship
between the demand of a given commodity and the price of
related commodities is known as Cross Demand.

3. Income Demand:
Assuming other factors as constant, a relationship between the
consumer’s income and the quantity demanded for a commodity
is known as Income Demand. Income Demand can be shown as:
Dx = f(Y)
Where,
Dx = Demand for the given Commodity
f = Functional Relationship
Y = Income of the Consumer
 Types of Demand (cont.)
4. Joint Demand:
When demand for two or more goods arises simultaneously
for satisfying a particular want of the consumer, then such
type of demand is known as Joint Demand. For example, the
demand for milk, coffee beans, and sugar is a joint demand
as all these goods are demanded together to prepare coffee.

5. Composite Demand:
When a commodity can be used for more than one purpose,
then such type of demand is known as Composite Demand.
For example, the demand for water is a composite demand
as it can be used for various purposes like bathing, drinking,
cooking, etc.
 Types of Demand (cont.)
6. Derived Demand:
The kind of demand for a commodity, which depends on the
demand for other goods, is known as Derived Demand. For
example, demand for workers/labour, producing bags is a
derived demand as it depends on the demand for bags.

7. Direct Demand:
When a commodity directly satisfies the demand of
consumers, then its demand is known as Direct Demand.
For example, demand for books, stationery, clothes, food,
etc., is a direct demand as these goods directly satisfy the
wants.
 Types of Demand (cont.)
8. Competitive Demand:
When two commodities are close substitutes of each other and an
increase in the demand for one commodity will decrease the
demand for the other commodity, then the demand for any one of
the commodities is known as Competitive Demand. For example,
an increase in demand for tea might decrease the demand for
coffee, which makes the demand for these goods competitive
demand. This happens because when consumers purchase more
of one commodity (say tea), it leads to a lesser requirement for
the other commodity (say coffee).

9. Alternative Demand:
Demand for a commodity is known as alternative demand when
it can be satisfied by using different alternatives. For example,
there are number of alternatives to satisfy the demand for clothes
like jeans, shirts, trousers, suits, saree, pants, etc.
 Demand Concepts:
Law of Demand:
Express the financial relationship between price and quantity. If
the price of a commodity falls, the quantity demanded of it
will rise (other things remaining the same).

Demand Schedules and Curve:

The law of demand can be illustrated by carve or schedule.
i) Schedule is table; carve is graphic presentation
ii) Schedule is first; from schedule prepare a curve
iii) Schedule is row & column based; upward to downward
iv) Schedule indicates1, 2, 3, ; curve indicate p, q, r
v) Schedule is singular form; curve is different types
 Y
Price Quality D
Y X 12
12 10
10
10 20
08
08 30

06 40 06

04 50
04

02 60 02
D1
00 00 0 X
10 20 30 40 50 60

OX = Quantity OY = Price
 Exceptions to the law of demand

• Change of taste : cell-phone, play station

• Increased income
• Situational cause: fish
• Assumption of price hike in future: oil
• Conspicuous consumption: Rolex Watch
• Giffen Goods :Rice, Cloth, Grains etc.
• Alternative goods: acts similarly
Why Does Demand Curve Slop Downward?

i) Law of diminishing marginal utility: law of DMU is

applicable in demand theory.
ii) Income effect: low price, increased purchase quantity
iii) Substitution effect: high price of tea, increase the demand of
coffee.
iv) Change of using pattern: changes of test, habit, dress; if the
price low consumer purchase more.
v) Number of customer: increase the customer of existing
product, if the price low customer purchase more.
 Limitations of Law of Demand

Limitations of Law of Demand

i) Other things remaining constant: it is not impossible
ii) Change of expectation: influence demand
iii) Giften goods: low price good, high price high demand
iv) Prestigious product: high price high demand
v) Shortage of product: if possibility of out of market
vi) Emergency product: for medicine or food
vii) Lack of knowledge: high price means quality product
viii) Environment: forced demand negatively