Scribd Logo
Upload

Welcome to Scribd!

  • 17 views

    Economics Book

    Uploaded by

    Leisha Vishwakarma

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd

    Economics Book

    Uploaded by

    Leisha Vishwakarma
    17 views68 pages

    Copyright

    © © All Rights Reserved

    Available Formats

    PDF or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Download as pdf
    17 views68 pages

    Economics Book

    Uploaded by

    Leisha Vishwakarma

    Copyright:

    © All Rights Reserved
    Download as PDF or read online from Scribd
    Download as pdf
    of 68
    Microeconomics. eee Schedules uaa snp © Mat! Sart SUBD SNE 2 i: nereaNe at it and Shift of the Supply e ie tween Movement : 8.12.1 Meaning of Eau termination of 3.13 Ghange n Equilibrium Pic a 3.13.1 Change in Demand 3.13.2 Change in Supply 3.14 Laws of Demand and Supply 3.15 Prices in Inflation + Points to Remember + Review Questions 3.1 CONCEPT OF DEMAND 3.1.1 Definition and Features of Demand Demand refers to entire relationship between $7) nq refers to the quantity price and quantity. Demand is the quantity that | 4 the commodity which a consumers demand at alternative prices during | consumer is willing to buy at a a given period of time. particular price during a particular On the other hand, quantity demanded refers to | period of time. the particular quantity which buyers are willing and able to buy on a given price during a given period of time. Demand for a commodity is defined as the quantity of that commodity which a consumer is willing to buy ata particular price during a particular period of time. pe eee 4 consumer demands 2 kg'of wheat in a month at the price of - 20 per kg. This is a complete example of demand for a commodity as it has \ all the three components of demand—quantity, pri i it of demand for a commodity are: aires Tiana feta consumers’ optimal choice of the quantity of a pace i between the consumers’ optimal good and its price is called the demand function. choice of the quantity of a _76 understand the influence of factors affecting, Demand, SUPPIY and Price 33 pemand is a desired quantity. It shows consumer's wish or need to buy the § Commodity. 4.1.2 Factors Determining Demand and the Demand Function is a multivariate relationship, ic. itis Getermined by many factors simultaneously. | Factors Affecting Demand. ‘of the most important factors determining, Gemand for a commodity of an individual household are its own price, prices of other goods, income, tastes and preferences. Some other miscellaneous factors affecting ‘consumers demand are income distribution, population growth, government policy, wealth of the ‘change in weather conditions, etc. Individual demand for a commodity ‘consumers, ‘es depending upon the four major variables is expressed symbolically as: a PRP. PLY, 7,5) where D,= Demand for commodity X - Py= Price of commodity X “i P, = Price of other good Z Y= Consumers’ income T= Consumers’ taste and preferences S= Sociological factors 4 =fPp Pe VTS) Demand Function = D, = fP) 3.2 LAW OF DEMAND 3.2.1 Definition and Assumptions of the Law of Demand Definition. There is a definite inverse relationship between the price of the good and the quantity demanded of that good. Symbolically, Dy= AP), ceteris paribus where D,= Quantity P= Price of the good Function. The relation between the |Demand Function. The relation and its price is called the demand demand on quantity demanded we use partial equilibrium analysis, developed by Alfred Marshall. In this analysis, quantity demanded is made a function of any one factor affecting demand and the other three factors are assumed to remain constant. For this the latin phrase Ceteris Paribus, meaning other things being equal, is used. Keeping other factors constant, the relationship between price and quantity demanded of a good is called the law of demand. It states that, the consumer’s demand for a good must be inversely related to the price of that good. ee principlen vaMICPRCErOMiCs 34 i J ‘Assumptions of the law of emant 4 ‘The law is valid only when the followin’ eid jing the same- 1. The price of the related g00ds remains 2 The income of the consumers remains Ul! of the consumers 3. Tastes and preferences 4. All the units of the goods are homogeneous 5 Commodity should be @ normal good. 3.2.2 The Demand Schedull and the Demand Curve of the law of [Demand Schedule It is a tabular presentation showing | the different quantities of a good that buyers of the good are willing to buy at different prices during a remain the same. The tabulation presentation demand is called the demand schedule. Table 3.1 shows a hypothetical demand schedule for wheat. given period of time. ‘Table 3.1 Demand Schedule for Wheat Price Quantity Demanded | Reference Point (Rs. per kg) (kg per month) Fig. 3.1) 20 6 4 30, 5 B 40 4 c tx 50 3 F Demand Schedule It is a tabular presentation ood that rs showing the diffe pe sen ferent quantities of iS rate willing to buy at different prices during a gi a a = The demand schedule shows an inverse relationship Sees rae P Price and the quantity Demand Curve The graphical rey g -presentat function is called a ae 38 teen la Pi 3.1 demand curve for ain is a lich shows different quantiti eer lemanded at different prices in gi thea month. a i Price (Rs. per kg) 35 8 Quantity (ka per month) Fig. 3.4 The Demand Curve. ‘The demand curve, d, slopes downward to the right or is negatively sloped. This law of downward sloping demand has been empirically tested and verified. The independent variable (price) is measured along the y-axis and dependent variable (quantity) is measured along the x-axis. The demand curve shows the quantity demanded by the consumers at each price. 3.2.3 Reasons behind Downward Slope of the Demand Curve The demand curve obeys the law of demand which states that there is an inverse relationship between price and quantity demanded of a good. The reasons behind downward slope of the demand curve, 1. Law of Diminishing Marginal Utility: This law was formulated by Marshall and it states that as the consumer has more and more of a good its marginal utility to him goes on declining. A consumer is not Reasons behind Downward Slope of the Demand Curve of Diminishing Marginal 2. Substitution Effect. 3, Income Effect. 4.New Consumers Creating Demand. interested in buying more units ofthe same | Substitution Effect. It is defined commodity at the same price Instead, he | Sr Quanity ‘6.Numerical example: 6.Numerical example: Increase in Demand Extension in Demand Py Oy P, _ & 3 90 3 90 3 100 Z 100 ‘Table 3.7 Difference between Decrease in Demand and Contraction of Demand Decrease in Demand Contraction of Demand 1. It refers to shift of a demand curve. 2 In this, there is a leftward shift . the demand curve. 3 It is due to: (@ fall in consumer’s income (© fall in the price of substitute goods (0 rise in the price of complem- entary goods (@) unfavourable changes in con- sumer’s taste for this good. 4.It is defined as fall in demand at the same price of the commodity. 5. Graphical representation: 1. It refers to movement along 2 demand| curve. 2. Inthis the consumer moves upward on| the same demand curve. 3. It is due to rise in the price of the commodity. A. It is defined as fall in demand due to| rise in price of the commodity, 5, Graphical representation: zee \ i 3.8.4 Defir pam, spp mean the amount offered for sa, According prof. Bena hom. mine supply of £0045 i the quan ia sording 101" at a given time at various prices.” ity of antity of the commodity Which is a of e particular time. ictual} mn following elements: ime.” Ace crime an supply of 60m Larne Sure at 2 Ne Pee Age the rn i complete WS it has yeleme 1 ‘oven of a commodity that the producer 1s willing to offer for sq) sale; 2. Price of the commodity and tity is of 3. Time during which the quat A supplies 50 kg of wheat at the pric. ffered for sale. Example: A supply statement Is: firm Rs. 40 per kg in a month. 3.8.2 Difference Between Suppl} Stock ‘of a commodity is the total quantity that is available in a market tne Spy tpt Fie ee reaty to sell a price during a certain time. Thus, supply is that part ell at a cena, Spee nee Bc are, y ‘part of stock which is actuay For ee eal as produced 400 penis. This is the stock of il, 12 1g to offer fe 3 of pe Bel, 120 pencils at Rs. 2 each; 150 ee pencils at the rate of Re ps is 400 pencils, but the supply of pencil Rs. 3 each and so on. In this ca. ee ferent prices 3.8.3 Supply Function ly and Stock ‘ Mie, Demand, Supply and Price e "Seco Pe Pes tr mv iy a ae lower price, less quantity of the commodity 1. |S # direct relationship between price and quantity supplied as shown by law of supply. 2. Price of Related Good (Z) : Supply of a commodity depends upon the price of its related goods, specially substitute goods. If the price of a commodity remains constant and the price of its substitute good Z increase, the producers would prefer to produce substitute good Z. As a result, the supply of commodity X will decrease and that of substitute good Z will increase. This will shift the supply curve of good ¥ leftward. Thus, an increase in the price of substitute good will lead to decrease in supply curve of the other good and vice versa. 3. State of Technology : If there is a change in the technique of production leading to a fall in the cost of production, supply of commodity will increase. Example. New photostating technique, printing technique, computerised calculations, etc. Such advancement will lower the Marginal Cost (MC) at each level of output, when MC values are plotted, the new MC curve lies below the old MC curve. Rising portion of MC curve is the supply curve. Thus, with technological advancement supply curve shifts to the right (that is supply will increase). 4. Cost of Production : A change in the cost of production, i., prices of factors of production also affects the supply of a commodity. If wages of labour of price of raw materials increase, then MC of production will rise. As a result, supply of the good will fall because producers would prefer to produce some other commodities that can be produced at a lower cost. An increase in input price or cost will shift the supply curve to the left (decrease in supply) and vice versa. 5. Government Policy : Government’s policy also affects the supply of a commodity. If heavy excise taxes are imposed on a commodity, it will discourage producers and as a result, its supply will decrease. It is because excise duty is levied on the total production cost of a firm. An increase in excise duty will raise firm’s total variable cost, which will raise MC curve. MC curve will shift to the left. Thus, supply curve will also shift to the left. Thus, an increase in excise tax will shift the supply curve to the left and vice ‘versa. IE LAW OF SUPPLY 9.1 Definition and Assumptions of the Law of Supply Definition Law of supply derives the relationship between price and quantity supplied. According to the law of supply, other things remaining the same, quantity Supplied of a commodity is directly related to the price of the commodity. \n you Show show 8S, in age mle 320 when price of a ining the 82 of @ comma, cxher things emai when its price falls, quantity supplieg sane expressed 85: sty i, also ft assumptions Of | 1 ban on 8 assumption that all factors, other than the The law otal ibe ce sup en the same, i.c., ofthe comme ed goods remains the SAC Price 1, Price of relate 2 State of technology i the same. ‘ost of production remains the same. 4. Government policy remains the same. 3.9.2 The Supply Schedule and the Supply Curve Supply schedule is a tabular statement that gives tel law of supply, Le, ied of a commodliy at diferent prices per unit of tin, different quantity suppl iy at ‘A hypothetical supply schedule of wheat is given in Table 3.8. Table 3.8 Supply Schedule of Wheat Price (Rs. per Kg) | Quantity Supplied | Reference Point (Kg per Month) (Fig 3.9) 1 3 Fi E 8 3 a 2 c Ti Be ped ae mer the law of supply, ie., as price of wheat rise: eae Sania ral peione the relationship benvee relationship between the pri eee =z eae aha positive or direc resionhip bermeen quantity supplied of the ity. With i Price, the curve rises upward from left to the right as ake a 7 ig. 3.10. s Principles of Microeca,, Ses: 0 Demand, Su where SS is the \ 3.9.3 Re ‘The reas 1. Law of val cost so a 2. Goa aim ine 3.10 3.40 Ani an i ua vei the si st pemand, Supply and Price 324 where ‘55 is the upward sloping supply curve obeying the law of supply” 3.9.3 Reasons Behind Upward Sloping Supply Curve ‘The reasons behind an upward sloping supply curve are: 1s more units 1. Law of diminishing marginal productivity: The law states that a df variable factor are employed, the addition made to total production falls, ost of production rises. Thus, more quantity is supplied only at higher prices 0 as to cover the rise in cost of production. 2 Goal of profit maximization: The aim of producers is to aim can be achieved by raising price of the goods. At higher price increase supply of goods. 3.40 FROM INDIVIDUAL SUPPLY TO MARKET SUPPLY maximise profits. The producers truction of Individual and market Supply Schedules ies different quantities offered for sale by ‘an individual firm at different prices. A marker supply schedule reflects total quantities of the commodity offered for sale by alll the individual firms at different Froes in a particular time period, Thus, market supply is obtained Py aerseatins the supplies of all firms selling that commodity at altemative prices. Suppose, there are only two firms A and B in the market for wheat Individual supply schedules and the resultant market supply schedule is given in Table 3.9. ‘Table 3.9 Construction of Market Supply Schedule 3.10.1 Cons’ An individual supply schedule indicat Price Individual Supply Scheduiles | Market Supply Schedule (Rs per Kg) (Kg per month) A+B Firm A Firm B (Kg per month) 3 12 B 3 #4 8 6 i 4 6 3 u 3.10.2 Construction of Individual and Market Supply Curves Supply curve is a graphical representation of a supply schedule. Individual supply curve reflects an individual supply ‘schedule and market supply curve represents a market supply schedule, Market supply curve is obtained by horizontal ‘summation of all individual supply curves as shown in Fig. 3.11. Inthe figure, quantity supplied is taken onthe x-axis and price at which commodity is supplied on-the y-axis. S, and S, are individual supply curves. SS is the market supply curve which is obtained by horizontally aggregating S, and S, at each level of price. ny, you ‘show show th “d “ ¢ @ © © S & e " v sonomics—) 3.22 principles of Microee Pr Market supply a 2§ 3 4 Ac a o 1 14 25 Supply ‘ Oo 6 8 12 Supy o 8 6 %% eo ve « Fig. 3.11 Construction of Market SuPPIY Cu 1 2 PLY CURVE a L 3.11. MOVEMENT versus SHIFT OF SU yh 3.14.1 Movement: Expansion or Construction of Supp! — j A movement atong the supply cuirve t caused by CRANES in the im e of ‘ e ‘g00d, other things remain constant. It is also called change in quantity supplied of the commodity. In a movement, no new supply curve in drawn. Movement can be of two types: 1. Expansion on increase in quantity supplied 2 Contraction or decrease in quantity supplied i 4 Expansion or increase in quantity supplied refers to rise in supply due to rise in price of the good. Contraction or decrease in quantity supplied refers to fall in supply due to fall in price of the good. Movement along a supply curve is graphically shown in Fig, 3.12. Point A on the supply curve, S, is the original situation. Fig. 3.12 Movement along Supply Curve es 3 fi pe aoe fon. Point ig fe @ point such as C shows expansion or more P -. A downward movement from poit it Point B shows contraction or less Supply at a lesser aS ae poshensas* 3.11.2 Shift: Increase or Decrease in Supply A shift in supply curve is caused the good. These factors are,” NAMB M factors other than ihe price of 1, Price of other commodities v Demand, Supply and Price 3.23 atte y 2, State of technology tang, Re econon Sh ee Bn conn ‘4. Government policy, Iya shows {A change in any of these factors causes shif in the supply curve. It is also called OF Price change in supply. In shift, a new supply curve is drawn. A shift of the supply curve can bring about: 1. Increase in supply, or S the 2. Decrease in supply Sex Mert wi ‘ terme 24 sett 1. Increase in supply: When supply of a commodity rises due to favourable ™S markep NET and changes in factors other than price of the commodity, it is called increase in supply. Favourable changes imply: (@ Improvement in technique of production ten the by : ‘Bag ee buy. (6) Fall in the price of substitute goods rou} © Fall in the cost of production ‘Sthe ma, (@ Favourable changes in government policy. TEE Meer Increase in supply is graphically shown in Fig. 3.13 where quantity supplied is ‘ker measured on the x-axis and price of the commodity on the y-axis. any one p, bong oot ty ely 3 Pp me = ° x xX ‘Supply Fig. 3.43 Shift in Supply Curve: Increase in Supply ‘55s the original supply eurve. An increase in supply is shown by rightward shit of the supply curve from SS to 5,5, , An increase in supply shows that: @ either at the original price of OP, more units (XX,) of the good are supplied. In the original situation OX units were supplied, (©) or same units (OX) are supplied at a lower price of OP. * 2 Decrease in Supply: When supply of a commodity falls due to unfavourable changes in factors other than its price, itis called decrease in supply. The causes of decrease in supply are: (@ Obsolete technique of production (Increase in the price of substitute goods crease in the cost of production Infavourable changes in government policy. Principles OF Mietoecongm, og, lied at a higher price oF less g ie is supply is shown graphically jn ice. 324 3 Mant Fig3,) on vase means we snp ote same Pe" x ‘Supply Fig. 3.14 Shiftin Supply Curve: Decrease in Supply ae in supply is shown is the original supply curve, A decrease in supp! ey Sheer eo ae from SS to S,S, . A decrease in supply shows th. 1, either at the original price of OP, lesser units (XX,) of the good are suppiie; “Th the oxiginal situation, OX ails, were supplied. 2 or same units OX are supplied at a higher price of OP,. The difference in the causes of increase and decrease in the supply is summarise: in Table 3.10. Table 3.10 Difference in the Causes of Shift in the Supply Tnerease in Supply (Rightward shift of supply) 1. Improvement in techniques of Decrease in Supply (Leftward shift of supply) © 1. Technique of production becoming Production, obsolete, > Fall in the price of substimte goods| 2 Rise in the price of substitute goods 3. Fall in cost, 3. Rise in ‘cost. 4. Favourable changes in the 4 Unfavourable changes in the government policy, 3.11.3 Difference cae Between Movement and Shift of the Supply The di z anit ea Summarised in Tables 3.1] and 3.12, ible 3,11 Difference Betw tse Increase in Increase in Sy ey 1. Tis shit oF suppty curve, 2. In this there is 4 rightward shi of the supply cure, it 3. It is due to favourable in factors like: oe £0vemment policy, Demand, Supply and Price (@) improvement in technique of production (6) Decrease in cost of produetion (©) Decrease in price of related goods. 4, It is defined as rise in supply at | 4. It is defined'as the rise in supply at the same price of the good. higher price of the good. 3. Graphical representation: t iy 33 e iP AF ih [> g 2 “euGif Table 3.12 Difference Between Decrease in Supply and : Decrease in Quantity of Supplied __ Decrease in Supply Decrease in Quantity Supplied 1. It is shift of supply curve. _ |1, It is movement along a supply curve. 2. In this the consumer moves to the left ‘on the same supply curve. _|3. Itis due to fall in the price of the good.) iies1 326 Principles of Microeconor™ 3.12 EQUILIBRIUM PRICE 3.12.1 Meaning of Equilibrium Price Page. tn change. Equilibrium literally means a state of balance or rest oF potiien eadeaey Ba economics, the term equilibrium means the state in which there Te To Te tir the part of consumers and producers to change. Two factors det price are—demand and supply. are equal to Thus, equilibrium price is the price at which demand and supply are eg! each other. At this price, there is no incentive to change. 3.12.2 Determination of Equilibrium Price by the equality between demand and supply. At Equilibrium price is determined this price, Quantity Demanded = Quantity Supplied so Prof. Marshall compared demand and supply to the two blades eS ae ce scissors, A moment of reflection will show that itis not blade alone that Sus the cloth, Both the blades together do it, Similarly it is not demand or supply alone that determines the price of a commodity. Together, through interaction they determine the equilibrium price of a commodity. In the very short period, supply is fixed. Thus, demand is more active in determining price. In the long-run, supply plays a more active role in determining price. ‘The process of determination of equilibrium price has to be studied under three headings: 1. Demand 2. Supply 3. Equilibrium between demand and supply 1, Demand: A commodity is demanded because it has utility and satisfies human Want, The law of demand states that there is an inverse relationship between Price and quantity demanded of a commodity. The aim of consumer is to maximise satisfaction. The maximum price a consumer a commodity to maximise satisfaction, is equal to ue eae ta he sera ‘marginal utility of the i Demand, Supply and Price 327 Equilibrium price will be determined where quantity demanded is equal to quantity supplied. This is called market price. A demand and supply schedule and curve will show the determination of equilibrium price. Table 3.13 Demand-Supply Schedules Price Demand Supply | Equilibrium Rvikg) (Kg/month) (Kg/month) 3 3 Excess supply 7 4 Excess supples 6 3 3 Equilibrium 3 + z Excess demand 4 5 1 Excess demand Px D 2 Excess Supply oe POO NeR 6}---- oD= ss Excess Demand s' feet een a Demand and Supply Fig. 3.15 Equilibrium Price In Table 3.13, quantity demanded and supplied of a commodity at different prices is shown. Equilibrium price is fixed at Rs. 6 where quantity demanded and the ‘quantity supplied are equal, Le., equal to 3 units. In Fig. 3.15, quantity demanded and supplied are measured on the x-axis and price on the y-axis. DD is the negatively sloping demand curve and SS is the positively sloping supply curve. Both these curves intersect each other at point E which is the unique equilibrium point and it implies that at price of Rs. 6, demand is of 3 units and supply is also of 3 units. Thus, equilibrium price is Rs. 6. Ata price higher than equilibrium price, ‘excess supply or surplus takes place. Price will fall till equilibrium price is reached. On the other hand, at a price lower than the equilibrium price, excess demand or shortage occurs. Price will rise till equilibrium price is reached. The occurs due to “Invisible Hand’ which is at play whenever there is imbalance inthe market. The concept of “Invisible Hand’ was given by Adam Smith, ‘Invisible Hand’ raises the price in case of excess demand, and lowers the price in case of excess supply, % Mlustration. If demand function is given by Q, = $0 ~ 0.5P and supply function 8 0, =_104p, ilibrium pric , e + P, find out equilibrium price and quantity. Delhi Unix. B.A. Prog. Sem I 2011) , il atte and, "mand, fanoeh my an 'S they ferme oppecrasasek BE — 3.28 Principles of Microeconomics-1 Solution : Equilibrium occurs where: Q, =2, 50-0.5P = -10+ P = 1.5P = 60 Equilibrium Price Quantity is = 30 units 3.13 CHANGE IN EQUILIBRIUM PRICE AND QUANTITY Equilibrium price is derived by that point where quantity demanded is mel 4 quantity supplied. Therefore, if either demand changes or supply changes or bot change, equilibrium price and output will change. The effect of changes in demand and supply on equilibrium price and output can be studied under the following situations: 3.13.4 Change in Demand Changes in demand take place due to (1) Changes in prices of related goods, (2) Change in income of the consumer. (3) Change in taste, and (4) Change in sociological factor. Due to shifts in the demand curve, supply curve remaining the same, there is a change in the equilibrium price and output. Demand may (a) Increase or (b) Decrease. (@) Increase in demand: When demand of a commodity increases, while supply remains constant, equilibrium price will increase. At the same time, quantity sold and purchased will also increase. This is shown in Fig. 3.16. In the original situations, the DD and SS curves intersect at poi i equilibrium price as OP and output as OO. Keon Goiphy eh the demand increases the demand curve shifts from DD to D,D.. The equilibrium is established at point E,. The equilibrium price gots lip from OP to OP, and output from OQ to OQ,. Therefore, when col a shi ‘“pwards or rightwards, equilibrium price and output increases, ‘a ® Decrease in demand: If the demand of a comm odity decr i the de A / decreases, while suy cae Fig ee it, the equilibrium price and Output will fall. This is pret Demand, Supply and Price 3.29 ry @ Q Demand and Supply Fig. 3.16 Increase in Demand ° QQ; Demand and Supply Fig. 3.17 Decrease in Demand In the figure, DD is the original demand curve. SS is the original supply curve and E is the equilibrium point. Decrease in demand is given by leftward shift of DD curve to D,D,. New demand curve intersects the supply curve at point ,. Eauilibrium price falls from OP to OP, and output falls from OO to OQ, Therefore, when demand curve shifts leftwards, both equilibrium price and output falls. 3.13.2 Change in Supply Like demand, supply of a commodity also changes. Changes in supply occur due to (1) Changes in the cost of production, (2) Changes is production techniques, (3) Change in excise tax, (4) Change in price of substitute goods, and (5) Change in number of firms. Due to changes in these factors, supply curve shifts. It may (@) Increase, or (b) Decrease. (@) Increase in supply: If the supply of a commodity increases, while demand ‘Temains constant, equilibrium price will fall. This is shown in Fig. 3.18. In the figure, quantity demanded and supplied are shown on the x-axis and price of Commodity on the y-axis. DD is the original demand curve. SS is the original Supply curve. E is the original equilibrium point. SS increases to S,S, . New Supply curve cuts demand curve DD at point E,, which is the new equilibrium Point. At this equilibrium point, price falls from OP to OP, and quantity demanded = Principles of | Microeconomics-| and supplied rises from OQ to OO,. Thus, if supply increases, while demand is constant, equilibrium price will decrease and the quantity will increase, P, ° g Pp Pp, D ° @ Q Demand and ‘Supply Fig. 3.18. Increase in Supply (6) Decrease in supply: \f the supply of a commodity decreases, while demand remains constant, equilibrium price will increase. It is shown in Fig. 3.19. In the figure, DD is the original demand curve. SS is the original supply curve. E is the original equilibrium point. Supply decreases to S,S,. New supply curve cuts the demand curve DD at £,, which is the new equilibrium point. Equilibrium price has gone up from OP to OP, and the quantity has decreased from OQ 10 00, Thus, if supply decreases, while demand remains constant, equilibrium price will rise and output will fall. Pe ei QQ Demand and ‘Supply Fig. 3.19 Decrease in Supply A summary of these change i ee ge in deman oe quantity is given in Table 3,14 2 n'4 2nd StpPly on equilibrium price and Demand, Supply and Price ‘Table 3.14 Effect of Changes in Demand and Supply on Equilibrium: Price and Equilibrium Quantity. Situations Effect on Equilibrium Change in Demand so . (@) demand increases rises rises (6) demand decreases falls falls Change in Supply (a) supply increases falls rises (®)supply decreases rises falls 3.14 LAWS OF DEMAND AND SUPPLY Laws of demand and supply are: 1, Arise in demand for a commodity, raises both the equilibrium price and the quantity. 2. A fall in demand for a commodity reduces both the equilibrium price and the quantity. 3. Arise in supply of a commodity, reduces the equilibrium price and raises the equilibrium quantity. 4. A fall in supply of a commodity, raises the equilibrium price and reduces the equilibrium quantity. 3.145 PRICES IN INFLATION Under the ceteris paribus assumption, we assumed all other prices to be constant. Does this mean that the price theory is inapplicable during an inflationary period when almost all prices are rising? Answer is no. Price changes in the price theory are changes relating to the average level of all prices. In an inflationary period, a rise in the relative price of one product means that its price rises by more than the rise in the general price level. A distinction is necessary in the following terms: (@) Absolute price: \t is price of the product in money term. It is also called money ‘price. (6) Relative price: It is price of a product expressed in relation to other prices. (© General price level: It is changes in the product’s owii price relative to changes in the average of all other prices. In price theory, whenever we talk of a change in the price of one product, we mean a chainge in relation to the general price level. 52 principles of Microeconomics-1 5.1 DEFINITION OF PRICE ELASTICITY OF DEMAND ‘The low of demand states tat when the price of a good falls, CORTES demand more units of the good. But how much more? It is important and useful to have magnitude of change in quantity demanded to a change in Price It is called price elasticity of demand. Price elasticity of demand -measures the responsiveness of demand of a good to a change in its price. Alfred Marshall was the first economist to formulate the concept of price elasticity of demand as the ratio ofa relative change in quantity demanded to a relative change in price. A relative measure is needed so that changes in different measures can be compared. in demand and price are measured by percentage changes of units. Numerically, price elasticity of Price Elasticity of Demand. It is defined good to 2 percentage change in its price “These relative changes 4Q = Change in i Oe Oe eee AP = Change in price (or P, ~ P) P= Original price y~ Coefficient of elasticity of demand. ¢, i is negative. The ratio is inet ar rice ond anon dosened ort = sums, the minus sign is dropped from the numbers and all positive. percentage changes are treated as nics.) ‘mand have Price the in its St to ad as ed to eded Res: Ly of ervice are: medicines and salt have demand. 2, Incom' the price elasticity nnsticty of Demand and Supply of necessity is low. : Higher the cost of the good relative to total income of the , will be the price elasticity of demand. If the price of bread, ete., ‘ntity demanded will fall by a greater proportion showing, 63 5.2 FACTORS AFFECTING PRICE ELASTICITY OF DEMAND ‘The factors which determine the price elasticity of demand for a commodity or {. Availability of Close Substitute: 4 good having close substitutes will have an elastic demand and a good with no close substitutes will have an inclestie demand. Example: commodities such as pen, cold drink, car, ete, have close ites. When the price of these goods rise, the price of their substitutes ing constant, there is proportionately greater fallin the quantity demanded Mpthese goods. Tha is their demand is elastic. Commodities uch ss peeerbed no close substitutes and hence, have an inelastic ye of the Consumers: If the income level of consumers is high, the ‘elasticity of demand is less. It is because change in the price will not affect the quantity demanded by a greater proportion. But in low income groups, elasticity of demand is high. 3, Luxuries versus Necessities: The price elasticity of demand is likely to be low for necessities and high for luxuries. A necessity is a good or service that the consumer must have such as food (bread, milk) and medicines. Luxuries are goods that are enjoyable but not i le: travelling by ai fa 5-star hotel. If the price of ; rise, then demand will not proportion because their cannot be delayed. That is Factors Affecting Price Elasticity of Demand ‘Availability of Close Substiture Income of the Consumers Luxuries versus Necessities Proportion of Total Expenditure Spent on the Produet ‘Number of Uses of the commodity 5. Time Period Ree of demand in which is relatively low, doubles it would have almost demanded of them. On the other hand, if price of car 15 sha AT pain Principles of Microeconomics, 5A i ine period needed to find substitutes of the commodi 6. Time Period. If 1h Mr of demand is less and vice versa. Example: today fable for petrol. It has an elastic demand. Thay is more, the pric there are many substi is ifits price rises, demand wi re available and its pri itutes avail 1), > 1): When e, > | and pri : “0 price (P) falls, quantity demanded (0) i Coe er nes tn ns es a case of elastic demand. It exists in Sea pooe | & S ty of Demand and Supply jon 2. Equal to One (e, = 1), = 1 and price falls, quantity dem; i i an) ty demanded in, i wen price. Hence, total expenditure (P = ¢) remus tiiengete ta with fesange mies there i mo change i the expending inna a (it is difficult to give an example of this situation). a i yion 3- Less than One (e,, <1), ; sil i it a < 1 and price falls, quantity demanded increases in te propor f i 83 th the fill in price. Hence, total expenditure falls. That is, Price aad Gapanatd 10 in the same direction. It is a case of inelastic demand. te exists in are tof inferior goods. ‘The three situations of outlay method are summarised in Table 5.2, 85 ‘Table 5.2 Situations: ‘of Outlay Method Quantity demanded rises in a greater proportion Quantity demanded rises in the same proportion ‘Quantity demanded rises | in a lesser proportion : 'z ‘af, grees Principles of Microeconomics , ie gras 5.3.2 Percentage Method or Proportionate Method el Percentage method is also called proportionate method. According to this methgy es 2, is calculated by the following formula: Percentage change in quantity demanded e Percentage change in price AQ P or “= APO ‘The absolute value of the coefficient of elasticity of demand ranges from zero 1, infinity (0 rthere are large change in price and quantity deman vetoh over the demand curve, then the percentage pacii thai relates to a st elasticig, defined as the price elasticity of demand betmecn west calc Jomand curve which are located for firm cach othe, Poms on a problem arises as the same pair of price and quantity figures ar ‘hich elasticity is measured. To avoid this problem, the price an. peel ents, the formula for wre elasticiy es ene Rte, 4Q 2 eo at 270, 2 AQ (+P) % AE“) ~ 4P'(0,+0,) 5.3.3 Geometric Method This method is used to find the point elasticit illustrated in Fig. 5.8. of demand. It is graphically LG, a m Fig. 5.8 Geometric Method of Finding Point Elasticity ot clasticty at point R, take point S very close to point R (for clarity _ from R). Join points R and Sand extend RS to meet x-axis at point B Janis at point A, 2 oo AP = RT. TIED) Ag-s/o0)= 75: Principles of Microeconomics, 512 P = OP =RO Q= 0 ni substituting in the percentage formula of point elasticity, we get oe >> APO ES ARO = RT’ 0g ”) ‘Since ARTS and ARQB are similar because each corresponding angle is equay we have sed ~ RT RO 0°) Substituting the value obtained in equation (2) in equation (1), we obtain: OBE RO. RO-0O 2, Os “= 00 Also, AAPR and AROB are similar. Hence, QB. PR RQ AR Since PR = OO, substituting, we get 2B, | 00 RO AR QB RB 4 00 ~ “AR 4408 is a right-angled triangle and PR is parallel to OB. Thus, QB | RB “op 00" AR’ AP Therefore, to measure elasticity at any point on a non-linear demand curve, ér2 a tangent to the curve at this point meeting the two axes. The value of elasticity is the ratio between the lower segment to the upper segment on the demand curve and on the price axis. The value of elasticity on the quantity axis is the ratio between right-hand side (RHS) segment to the left-hand side (LH ft. Thus, value of elasticity is then calculated by the formula: peat giastl 64 Ther Case iis that aca Cas Itis that infin Cas It is hype chat ont . By for =-(1) qual, -Q) are sticitY ratio Thus resticity of Domand and Supply ¢, (at a point) — Right hand side segment Left hand side segment ( 54 CONSTANT ELASTICITY OF DEMAND CURVES fF constar i here are three cases of constant elasticity of demand curves. These are case 1. ép is constant at zero. itigshown in Panel 4 of the Fig. 5.9. The demand curve (d,) is vertical. 1 that whatever be the price, quantity demanded is given atthe level OO, In ocn a case [ép| is always zero. Demand curve is perfectly inelastic. Case 2. ¢, is constant at infinity, Itis shown in Panel B of the figure. The demand curve (d,) is horizontal. It shows that at a price, quantity demanded can be anything. In such a case, |e, is always infinity, Demand curve is perfectly elastic. Case 3. ¢, is constant at one. Ii is shown in Panel C of the figure. The demand curve (d,) is a rectangular hyperbola. Itshows that percentage change in price always leads to equal percentage change in quantity demanded. In such a case, |e,| is equal to one at every point on the demand curve, The demand curve is unitary elastic. Panel A: e=0 Panel Be, == Panel C:ey=1 | a { 3 % 3g é a é Oy . Quantity 2 Quantity © ‘Quantity Fig. 5.9 Constant Elasticity Demand Curve 55 ELASTICITY ALONG A LINEAR DEMAND CURVE : ae ometrie Method, the elasticity of demand is measured by using the re ee eet orang carve . ise ~ Upper segment of demand curve Sl a a dy sai Bt Principles of Microeconomic, 4B is a negatively sloped straight line demand curve joining the two axes , Fig. 5.10). Elasticity at different points on demand curve can be calculate a follows: 2 2 & Quantity Fig. 5.10 e, on a Linear Demand Curve Lower Segment BC E At Point C = Upper Segment = AC’ As BC < AC, -. &y <1 BD At mid-point D = 77, as = BD = 4D, Se 1 BE int E = ——, BE> AE, At point E = 7, BE > AE, . 0 At point B= = 2 ey=0 A At points A = -> 5.6 APPLICATIONS OF ELASTICITY OF DEMAND Ailicaton 1: Two linear intersecting demand curves have different elasticit at the price corresponding to point of intersection. The two straight line intersecting demand curves DD, and D,D, are drawn Fig. 5.11. Point & is the point of intersection. Extending point R to cut the price axis at point P, and the quantity axis at point X. 22 APO @, at point R = " g : Since DD, and D,D, are intersecting at point R, then om will be same. giastic tno ute f Sine or papryrtas ‘0, Mom. a ° aXe, ley. Ge, Mage Jasticll rawn in ne pric? me asticity of Demand and Supply 518, P Ratio @ for DD, at point R = a RX P patio g fr DD, at point R= EX P er words, the second part of the e,, formula, — can be ; o formula, Gan be ignored, Comparing A ah rs pt 2 of the formula, we get: TEP 2 for DD, at point R= “¥ Ratio 2 for D,D, at poin(s)- a” Since LN > LM LN | LM EN. EM iy fda BO) ea ee oa ap} ratio of DD, > | Ap) ratio of D,D, e, of DD, > e, of DD, Ds, Dy AR (0,) cD) Fig. 5.14 Point Elasticity at Price P for Two Intersecting Demand Curves Application 2: Two parallel Demand Curves have Different Elasticities at a Given Price, aFig. 5.12, two straight li DD, is parallel to .12, two straight line parallel demand curves are drawn, DD, sce elasticity at a price, say point P, we draw PS parallel to the ig fe apne ‘the geometric ees we obtain: seu sie aoud amp uo “q quiod sures ox woy SuneuISt0 umeup are “Gq pue ‘gq sano Puewiep raul] OMI “E]“¢ “Sty Uy 22d UP8D 0 I puouag fo Syousory sung savy sry aoteg aus No nmog uns 217 wWo4f SunoupStsg saxam> punnuag sony om) 2¢ wonosyddy “@'q 30 Auonseye aip wep 2100 st 'gq 30 ase ang gee 10 ‘aa > dd. dO dO “dd > dd souls dd _'GS _ 5 ymod ‘g°q 103 do ‘as f. aft Nee Mts Cie, es eat do ‘aw Bq] ON JO} BU BE ANSE! WIG ZS “B14 ors PS21woucze011y 40 sejdioulrd ‘psaan aoja pue pucUIOP HI UO P2tAa] aq pinoys soxei ysiy Sujavy spoos s04 151 aye ayy 02 au Jo papueuiap Anuenb pu aoud ur auey> yoexo Jo uoneuruuaap Hd 10.98} pue apen jeuonewoqUT “srowLey uoumuiano8 Nedouow 40j rgasn Aion si Kuonseja aud 30 sdzou0o ayy ONVWA3G JO ALIOLLSW13 S9Iud dO SONVLNOdWI 25 ‘Aynuenb Pav (a'@) usw onseja ssoq st (gg) sano Puewep amp TY s} yNsax ayy ‘aa 309 <‘G'qyo% a 'd <'a6 sous, yo § autod ye ‘7%q 103 Yo 00 _ A _ y ywod ‘aq 305 ‘G6 "ay SSNun9 PuBWed jolfexed JBOUr] OM| J04 AINUEND LAA ee. ‘Ayonse | Wwiod Shs “Big ‘aa pue ‘a “Guan u2ary 2 2 2 woppeonddy UME Miasaffier asvy sanuny puanuog jayoind AOOULT OL £5 HODPID a9 gs rau ‘SHO280/011y 40 Sajd}ULe ‘ods: nS Das > ado 69 poi 13 oad = 40} 9AIND PULMOP OU) [TIAL "PUeUIap Jo AyDK oy) UE Sot] SiKy 40} “SHOULIE ay) 0} Ats9A0d Buug £]pes9U23 \d Jo xopered ayy :Aiuayd jo xopesed “S S1 suodxa 405 puewiap jo Auonse|e }2P apen ssonpau uonen|eAsp “UH an) op yas Wry ‘tadeayp suodxo sayeUut ana a pu 90 Joy 804% 10398} © 02 V Suroud somes up ¢ Ur tat 01983 ‘Aids Bue puewed jo Apogee a a al 1*eras . po ” 5.29 le rem is that the same pair of pri &, i Price and it ey te ete of elasticity. The value of iaday das figures are giving two ee is measured. To avoid this problem, the ve tee fitection in sb > rik it sie eagd. The formal of ac els of demant in ee) =H , B+ P, Arc e, = —— + x AQ p+p, ee Pearce arias: dnt = Spoke stration 24 ¥ ang = Given two demand schedules, determine their elasticity of demand usi osmataet ity of using the total [a 5 4 3 2 1 a 200 210 230 255 300 Qs 200 260, 370 600 1300 Solution. Calculating total expenditure for good A and good B, we get: Total Expenditure 2, Total Expenditure on A on B 1000 200 1000 840 260 1040 690 370 1110 510 600 1200 300 1300 1300 Therefore, good A has inelastic demand (e, < 1) since expenditure falls with fall in price, Good B has elastic demand (e, > 1) as expenditure rises with fall in price. 58 INCOME ELASTICITY OF DEMAND 5.8.1. Definition of Income Elasticity of Demand The income elasticity is a quantitative measure of the degree to which quantity demanded responds to a change in income, ceteris paribus. Income ssticity Bi demand (hy) is calculated as the percentage change in quantity demand due to percentage change in income. That is, % change in quantity demanded ‘ome a Principles of Mleroeconem, mee y= Initial income Q= Initial quantity demanded AQ= Change in quantity demanded AY= Change in income Coefficient of income elasticity of demand 6, Tncome Elasticity: The income elasticity of demand ulated as the percentage change in quantity demanded due to percentage change in income. ps 5.8.2 Types of Income Elasticity of Demand Income elasticity can be positive or negative. Income elasticity can take five different values. These are: I. Greater than One This occurs when the percentage change in quantity demanded is greater than the percentage change in income. It is called high income elasticity. It takes place in case of luxury goods. 2. Equal to One This occurs when the percentage change in quantity demanded is equal to the Percentage change in income. It is called unitary income elasticity. It holds for those normal goods which fall between the category of necessities and luxuries. 3. Less than One ‘This occurs when the percentage change i ge in quantit i Percentage change in income, | ee ct soe in case of necessities, called low income elasticity, This takes place 4. Equal t0 Zero inferior good, 5. Less than Zero This occurs when the ‘i change in income, tt he camte® change in quantt inferior goods. Mics, five 1 the e in the for ies. the ace ae. a3 4 ust of Demand and Supply 531 ne 59 summarises the five different values of income elasticity. ‘Table 5.9 Different Values of Income Elasticity of Demand Terminology ‘Type of Good value of 6 High Income elasticity Luxury good Unitary income elasticity | Normal good which isa necessity as well as semi-luxurious ‘Low Income elasticity Necessity Zero Income elasticity Can be a poor quality necessity Negative Income elasticity | Inferior Good 5.8.3 Graphical Representation of Income Elasticity Engel curve named after Ernst Engel to establish a systematic relationship odities. Engelcurve is shown Income elasticity is graphically shown by (1821-96). Emst Engel used this device cchold income and expenditure on comm: between hous: in Fig, 5.16. Quantity Fig. 5.16 Engel's Curve ‘showing e,, In the figure, 4 ‘The range of Engel’s curve between origin till Y, Between origin and ¥, ~ income level shows that nothing is demanded at income jess than ¥. So, e, = 0 for income less than Y,- Between ¥, and Y, = Between incomes of ¥, and ¥,, as income rises quantity demand rises. It implies e, > 0 and the good is normal good. A normal good can be a necessity oF # luxury. Beyond Y, = Beyond income level ¥,, quantity demanded falls 2 income rises. It shows e, <0 and the good is a” inferior. a o s ao 0 Be ie Principles of Microsconomicy pa” whet 5. ee es @ ce 00 LASTICITY OF DEMAND 5 Om one & 5.9 CROSS El of Os | i or oe 5.9.1 Definition of Cross Elasticity of Demand wf, a a z is a quantitative measure of the eff w s-elasticity of demand (e,,) is a quantitative measure o fect on the se fly demanded of good x due to change in price of good 2. That is, : seat Of the responsiveness of the quantity demanded of x to a perorye ENe- change inthe price of 2. The cross-elastcty between two goods x and zis calevaey 1 as: 2 % change in quantity demanded of x ‘ % change in price of 2 - where pel P, = Initial price of good z 5.10 Initial quantity demanded of good x glasticitY mmodi ‘OX = Change in quantity demanded of good x os AP. = Change in price of good z the degre €,, = Coefficient of cross-elasticity of demand Cross Elasticity of Demand: It is a measure of the responsiveness of the quantity demanded of x to a percentage change in the price of z. 5.9.2 Types of Cross Elasticity of Demand The valus of cross-elasticity ranges from minus infinity to plus infinity. (<6, < +2). The various values of cross elasticity of demand are: wher (@) Greater than Zero (e,, > 0) This occurs when the two goods x and z are substitutes. The higher the numerical value of... the greater the degree of substitutability. If e,, = co, then x and z are perfect substiautes. The positive sign on the e,, explains the positive relationship between the price of a good and the quantity demanded of its substitute. If the Price of tea falls then the quantity demanded of its substitute, coffee, will fall. Thus, cross elasticity between tea and coffee is positive. a () Less than Zero (e., < 0) re This occurs when the two goods x and z are complements. The lower the numerical value of ¢,,, the greater is the degree of complementarity. If e, =-2 then x and 2 are perfect complements. The negative sign on the e,, explains that when the price of a good increases the quantity demanded of its complements moves in the f opposite direction. Ifthe price of sugar increases, the quantity demanded of tea will fall. Thus, cross elasticity between tea and sugar is negative, EEE ee ronomics., ect on the is, itis eFcentage -alculateg ity. nd and Supply yotyoreme 5.33 geet er0 (Ex, 9) the two goods x and z are occurs when unrelated. That is, a change in the ‘er one good does not affect the quantity demanded of the other ood # of cross elasticity of demand is summarised in Table 5.10. @ Table 5.10 Values of, ENO. Value of ¢,. Relationship between x and z e,--2 x and z are perfect complements x and z are complements x and z are unrelated x and z are substitutes x and z are perfect substitutes | 5,10 DEFINITION OF PRICE ELASTICITY OF SUPPLY Elasticity of supply is defined as the responsiveness of quantity supplied ofa ‘commodity 10 change in its own price. The value of elasticity of supply will give the degree or quantity of change in supply to a change in price. It is calculated as: Percentage change in quantity supplied Percentage change in price Bg els egia ey ~ Coefficient of price elasticity of supply P= Initial price of the good Q = Initial quantity supplied ‘AQ = Change in quantity supplied ‘AP = Change in price ‘The positive sign indicates that price and ‘quantity supplied of a good are positively related, ie. greater units of the good will be placed in the market only at higher prices and vice versa. [soe of Supply: It is defined as the responsiveness of quantity supplied of a commodity to change in its own price. Principles of Microeconom, 5.34 5.11 FACTORS AFF! ‘The important factors MA Beene ECTING PRICE ELASTICITY OF Supp, ffecting price elasticity piepelyee: a factor: The longer the time period, the more elastic is the Supply 1, Time factor: acne good: Inelastic supply in case of perishable goods becay, ‘Nature of its supply can neither be increased ea 7 ae Period Production capacity: If unlimited haces i ie; Production can be increased easily), then there is el ee supply. Production capacity exists, then there is inelastic supp! oe b 4, Production methods and techniques: If an industry uses complicate methods and techniques of production, supply of the commodity produces by that industry will be relatively inelastic. On the contrary, if an industry uses simple methods and techniques of production, supply of the commodity produced by that industry will be relatively elastic. Stage of laws of return: If the law of diminishing return is applied on the production of a commodity, elasticity of supply for such a commodity will be inelastic. On the contrary, if the law of increasing return is applied on the production of a commodity, supply of such a commodity will be elastic - Future price expectation: Ifthe producers expect that the price will rise in future then they will supply Jess quantity in the market Presently. Thus supply will become inelastic. If the producers expect that the price will fall in the future, supply will become elastic. 2 5 g i é z é lasticity of supply is given in Table 5.11. Table 5.11 Determinants of Elasticity of Supply iw ae és is more when... Nature ofthe goog ~ More time is available Production capacity ~ Durable goods are available Production ehigues ~ Unlimited production capacity exi S Stage of laws Of return ~ Production techniques ‘are simple ‘ Future pric > bay i i ie nan "| 7 TA Meta seas sprain Number of prods ting is expected that 2 Produced by an industry ted try ity ‘Supply orbemand and L f a eASUREMENT OF PRICE ELASTICITY OF SUPP Y i 0d elasticity of supply: : two methods of measuring ‘qhere are tw rcentage Method ee the formula: 4 by the formu sary of supply is measures ; : pee Percentage change in quantity supplied SS Percentage change in price dQ P “yP'O city of supply. They are summarised in here are five degrees or types of elasticity of supply: Table 5.12. ‘Table 5.12 Values of Elasticity of Supply Coett. of | Types of Description Shape of Supply ¢ e Curve s 5 i e,=0 | Perfectly | This oocurs when to a percentage | Vertical (SN) inelastic | change in price there is no supply | change in quantity supplied. 2. 0

    You might also like

    pFad - Phonifier reborn

    Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

    Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


    Alternative Proxies:

    Alternative Proxy

    pFad Proxy

    pFad v3 Proxy

    pFad v4 Proxy