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2- Demand Analysis
Learning Outcomes
Introduction-
1) Income effect –
The increase or decrease in the income can be shown by the parallel shift of
the budget line.
Diagram
Qty of Y
A1
A
A2
B2 B B1
According to the diagram:
Diagram
Qty of Y
A2
A1 ICC
B B1 B2
Qty of X
ICC is the Income Consumption Curve which shows the impact of changes in the
income on the level of consumption.
2) Substitution effect –
It is defined as the change in the equilibrium consumption of
good in response to the change in the relative prices of goods when the utility
level of the consumer remains the same. It is measured through the movement of
the consumer equilibrium along the same indifference curve.
Diagram
Qty of Y
A
E1
A1
E
IC 1
B B1
3) Price effect –
It is the change in consumption of a good because of the changes in the
price of the good.
Diagram
(P.T.O)
Qty of Y
A
A1 E
E2
E1
IC2
IC 1
M M1 B M2 B1 B2
This is very important result yielded from ordinal approach. Such a neat
division of PE into IE and SE is possible only through the ordinal approach.
(P.T.O)
Derivation of Demand curve –
Diagram 1
QY
A
B B1 B2 Q X
D
Price
QX
According to the diagram, the upper panel shows the price effect and shift
in the equilibrium from E1 to E2 to E3 because of the decline in the price of x.
In the lower panel the demand curve is drawn by considering the
respective quantities of commodities from the upper panel. Thus the downward
sloping demand curve of the lower panel gives the inverse relation between the
price and the quantity demanded.
Consumer Surplus –
Diagram
PX
6
5
4
3
1 2 3
Qty
According to the diagram at price Rs. 6/- or more, the individual does
not demand any amount of x. The consumer would be willing to pay Rs. 5/- for
the first unit of x rather than go without it. Similarly, he would be willing to pay Rs.
4/- for second unit and so on.
Thus the total amount the consumer is willing to pay for two units is Rs. 9/-
(= 5+4). However, he actually only Rs. 8/- (= price Rs. 4 x 2 units). Thus his
notional gain is Rs. 1/- when he consumes 2 units.
“What is the policy implication of the “consumer’s surplus” to the
manager?” Consumer’s surplus shows the potential revenue a seller or a
government can raise from the consumers of a good under very special
conditions.
Activity: -
Analyze the situation in which “artificial scarcity is created to increase the
profit” in terms of consumer’s surplus.
Exercises-
Q.1 Analyze the diagram given below and answer the question :
1. State the case of giffen goods. [Hint : MM2 = MM1 + (-M2M1)]
2. From commodity x and y, which is a giffen goods?
Diagrams
Qty of Y
A
A1 E2
IC2
E
E1
IC 1
M2 M B M1 B1 B2