Theory of Consumer Behaviour - Class 12 Economics - Chapter 2 - Notes, NCERT Solutions & Extra Questions
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Extra Questions - Theory of Consumer Behaviour | Microeconomics | Economics | Class 12
What happens to total expenditure on a commodity when its price falls and its demand is price elastic?
When the price of a commodity falls and its demand is price elastic, total expenditure on the commodity increases. This is because the percentage increase in quantity demanded is greater than the percentage decrease in price, leading to an overall increase in expenditure.
Consider the demand for a good. At a price of Rs. 4, the demand for the good is 25 units. Suppose the price of the good increases to Rs. 5, and as a result, the demand for the goods falls to 20 units. Calculate the price elasticity.
To calculate the price elasticity of demand for the given good, follow these steps:
Identify initial and final prices and quantities:
Initial price ($P_0$) is Rs. 4, and initial quantity demanded ($Q_0$) is 25 units.
Final price ($P_1$) is Rs. 5, and final quantity demanded ($Q_1$) is 20 units.
Calculate the changes in price and quantity:
Change in price ($\Delta P$) = $P_1 - P_0 = 5 - 4 = 1$
Change in quantity ($\Delta Q$) = $Q_1 - Q_0 = 20 - 25 = -5$
Use the formula for price elasticity of demand ($E_d$):$$ E_d = -\left(\frac{\Delta Q}{\Delta P} \times \frac{P_0}{Q_0}\right) $$
Substitute the values and calculate:$$ E_d = -\left(\frac{-5}{1} \times \frac{4}{25}\right) = 0.8 $$
Conclusion: The price elasticity of demand for this good is 0.8, which indicates that the demand for this good is inelastic, meaning a percentage increase in price leads to a smaller percentage decrease in demand.
Who is known as the "Father of Modern Economics"?
A. Amartya Sen
B. Karl Marx
C. Adam Smith
D. George Loewenstein
(E) None of the above
The correct answer is C. Adam Smith.
Adam Smith was a philosopher from the 18th century, famously recognized as the father of modern economics. His key contribution was advocating laissez-faire economic policies, which promote minimal government interference in the economy.
Which of the following statement(s) is/are correct?
A. Hitesh made a chair with the help of wooden logs that he got from a tree. Here, the tree is the producer.
B. Ranjeet uses the chair made by Hitesh. Ranjeet is a consumer.
C. The economy plays a major role between a producer and a consumer.
D. Economics determines how resources are distributed among members of a society.
The correct statements are:
B. Ranjeet uses the chair made by Hitesh. Ranjeet is a consumer.
C. The economy plays a major role between a producer and a consumer.
D. Economics determines how resources are distributed among members of a society.
Explanation:
Producers are individuals or entities that create goods or services. Hitesh, who made the chair from wooden logs, acts as a producer.
Consumers use or consume the goods or services produced; hence Ranjeet, who uses the chair, represents a consumer in this context.
The economy significantly influences the interaction between producers and consumers; it shapes transactions, distribution, and consumption.
Economics, as a discipline, studies how societies distribute resources like money, labor, and materials among different members, impacting everything from production to consumption norms in society.
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What do you mean by the budget set of a consumer?
The budget set of a consumer refers to the collection of all possible bundles of goods that the consumer can purchase given their income and the market prices of the goods. In other words, it includes all combinations of goods and services that a consumer can afford to buy without exceeding their budget. The budget set is constrained by the consumer's income and the prices of the goods.
What is the budget line?
The budget line represents all the combinations of two goods that a consumer can purchase with her entire income, given the prices of those goods. It is defined by the equation:
$$ p_1 x_1 + p_2 x_2 = M $$
Where:
$p_1$and $p_2$ are the prices of the two goods,
$x_1$ and $x_2$are the quantities of the two goods,
(M) is the consumer's total income.
The budget line has a negative slope, which reflects the trade-off between the two goods; spending more on one good means spending less on the other. The slope of the budget line is $-\frac{p_1}{p_2}$, indicating the rate at which the consumer can substitute one good for another while spending their entire budget. Points on the line indicate all combinations of goods that exactly use up the consumer's income, while points below the line are affordable but do not use the full budget, and points above are unaffordable.
Explain why the budget line is downward sloping.
The budget line is downward sloping due to the trade-off between the two goods being considered within a fixed budget. Here’s why:
Fixed Income: The consumer has a certain fixed amount of money to spend.
Prices are Given: The prices of both goods (say, bananas and mangoes) are fixed in the market.
Trade-off Between Goods: If a consumer chooses to buy more of one good (bananas), they must spend more of their fixed income on that good. Consequently, they will have less money available to purchase the other good (mangoes).
Derivation from Equation: The budget line equation, given by: $$ p_1 x_1 + p_2 x_2 = M $$ Here, $ p_1 $ and $ p_2 $ are the prices of goods 1 and 2, respectively, $x_1 $ and $ x_2 $ are the quantities of these goods, and ( M ) is the total money available. If we solve for $ x_2 $: $$ x_2 = \frac{M}{p_2} - \frac{p_1}{p_2} x_1 $$ This shows that $ x_2$ decreases as $ x_1$ increases, which mathematically represents a downward slope.
Slope Interpretation: The slope of the budget line, $-\frac{p_1}{p_2}$, indicates how many units of $ x_2 $ (mangoes) must be given up to purchase one additional unit of $ x_1 $ (bananas). This negative slope signifies that an increase in the purchase of one good leads to a decrease in the ability to purchase the other, given the constant budget.
In summary, the downward slope of the budget line represents the limitations imposed by a fixed budget combined with constant prices, enforcing a trade-off between the amounts of two goods a consumer can purchase.
A consumer wants to consume two goods. The prices of the two goods are Rs 4 and Rs 5 respectively. The consumer’s income is Rs 20.
(i) Write down the equation of the budget line.
(ii) How much of good 1 can the consumer consume if she spends her entire income on that good?
(iii) How much of good 2 can she consume if she spends her entire income on that good?
(iv) What is the slope of the budget line?
a. How does the budget line change if the consumer’s income increases to Rs 40 but the prices remain unchanged?
b. How does the budget line change if the price of good 2 decreases by a rupee but the price of good 1 and the consumer’s income remain unchanged?
c. What happens to the budget set if both the prices as well as the income double?
(i) Equation of the Budget Line
The budget line equation can be represented as: $$ p_1 x_1 + p_2 x_2 \leq M $$ where $ p_1 $ and $ p_2 $ are the prices of the two goods and ( M ) is the consumer's income.
Given:
$ p_1 = 4 $ (Price of good 1)
$ p_2 = 5 $ (Price of good 2)
$ M = 20 $ (Consumer's income)
The equation of the budget line is: $$ 4x_1 + 5x_2 = 20 $$
(ii) Maximum Consumption of Good 1
If the consumer spends her entire income on good 1: $$ 4x_1 = 20 $$
$$ x_1 = \frac{20}{4} = 5 $$ The consumer can consume up to 5 units of good 1.
(iii) Maximum Consumption of Good 2
If the consumer spends her entire income on good 2: $$ 5x_2 = 20 $$
$$ x_2 = \frac{20}{5} = 4 $$ The consumer can consume up to 4 units of good 2.
(iv) Slope of the Budget Line
The slope of the budget line is given by the negative ratio of the prices of the two goods: $$ \text{Slope} = -\frac{p_1}{p_2} = -\frac{4}{5} $$
(a) Change in Budget Line with Increase in Income
If the consumer's income increases to Rs 40, the new budget line equation will be: $$ 4x_1 + 5x_2 = 40 $$ This results in a parallel shift outward of the budget line, allowing the consumer to potentially purchase more of both goods.
(b) Change in Budget Line with Decrease in Price of Good 2
If the price of good 2 decreases to Rs 4 (previously Rs 5), the new equation becomes: $$ 4x_1 + 4x_2 = 20 $$ This change results in a flatter slope (from -4/5 to -1) and an increase in the potential quantity of good 2 that can be purchased.
(c) Doubling of Prices and Income
If both the prices and the income double:
New prices: $ p_1 = 8 $, $ p_2 = 10 $
New income: ( M = 40 )
The new budget line will be: $$ 8x_1 + 10x_2 = 40 $$ This reverts to the original equation scaled by the doubling factor, so the consumer's relative purchasing power and the choice possibilities remain unchanged (similar trade-offs between the goods as before). The budget set in terms of consumption possibilities effectively remains the same.
Suppose a consumer can afford to buy 6 units of good 1 and 8 units of good 2 if she spends her entire income. The prices of the two goods are Rs 6 and Rs 8 respectively. How much is the consumer’s income?
The consumer's income is ₹100.
Suppose a consumer wants to consume two goods which are available only in integer units. The two goods are equally priced at Rs 10 and the consumer’s income is Rs 40.
(i) Write down all the bundles that are available to the consumer.
(ii) Among the bundles that are available to the consumer, identify those which cost her exactly Rs 40.
Analysis
Let's consider that the consumer wants to consume two goods, $x_1$ and $x_2$, where both goods are priced equally at Rs 10 each, and the consumer's income (budget, (M)) is Rs 40.
Available Bundles to the Consumer
The consumer's budget constraint given by:
[ p_1 x_1 + p_2 x_2 \leq M ]
where $ p_1 = 10 $ (price of good $x_1$) and $ p_2 = 10 $ (price of good $x_2$) can be simplified as:
[ 10x_1 + 10x_2 \leq 40 ]
or
[ x_1 + x_2 \leq 4 ]
Since both goods are available only in integer units, valid combinations of $x_1$ and $x_2$ are those integer pairs that satisfy the budget equation.
(i) All Available Bundles to the Consumer
The bundles satisfying ( x_1 + x_2 \leq 4 ) are as follows:
[ \begin{align*} (0,0) & : \text{ 0 bananas, 0 mangoes} \\ (0,1) & : \text{ 0 bananas, 1 mango} \\ (0,2) & : \text{ 0 bananas, 2 mangoes} \\ (0,3) & : \text{ 0 bananas, 3 mangoes} \\ (0,4) & : \text{ 0 bananas, 4 mangoes} \\ (1,0) & : \text{ 1 banana, 0 mangoes} \\ (1,1) & : \text{ 1 banana, 1 mango} \\ (1,2) & : \text{ 1 banana, 2 mangoes} \\ (1,3) & : \text{ 1 banana, 3 mangoes} \\ (2,0) & : \text{ 2 bananas, 0 mangoes} \\ (2,1) & : \text{ 2 bananas, 1 mango} \\ (2,2) & : \text{ 2 bananas, 2 mangoes} \\ (3,0) & : \text{ 3 bananas, 0 mangoes} \\ (3,1) & : \text{ 3 bananas, 1 mango} \ (4,0) & : \text{ 4 bananas, 0 mangoes} \\ \end{align*} ]
(ii) Bundles Costing Exactly Rs 40
We need to find combinations where:
[ 10x_1 + 10x_2 = 40 ]
or
[ x_1 + x_2 = 4 ]
The valid combinations are:
[ \begin{align*} (0,4) & : \text{ 0 bananas, 4 mangoes} \\ (1,3) & : \text{ 1 banana, 3 mangoes} \\ (2,2) & : \text{ 2 bananas, 2 mangoes} \\ (3,1) & : \text{ 3 bananas, 1 mango} \\ (4,0) & : \text{ 4 bananas, 0 mangoes} \\ \end{align*} ]
These are the bundles that cost the consumer her complete budget of Rs 40.
What do you mean by ‘monotonic preferences’?
Monotonic preferences imply that a consumer always prefers a bundle of goods that has more of at least one good and no less of the other good compared to another bundle. This means the consumer prefers larger quantities of goods, assuming other factors are constant. Essentially, more is always better from the consumer's perspective when it comes to monotonic preferences.
If a consumer has monotonic preferences, can she be indifferent between the bundles (10, 8) and (8, 6)?
No, if a consumer has monotonic preferences, she cannot be indifferent between the bundles (10, 8) and (8, 6).
Monotonic preferences imply that a consumer always prefers bundles that have more of at least one good and no less of the other goods compared to another bundle. In this case, the bundle (10, 8) has more bananas and more mangoes than the bundle (8, 6). Hence, under monotonic preferences, a consumer would prefer the bundle (10, 8) over the bundle (8, 6) and would not be indifferent between them.
Suppose a consumer’s preferences are monotonic. What can you say about her preference ranking over the bundles (10, 10), (10, 9) and (9, 9)?
Given the monotonic preferences of a consumer, we can analyze her preference rankings over the bundles (10, 10), (10, 9), and (9, 9).
Under monotonic preferences, a consumer consistently prefers bundles that have more of at least one good and no less of the other compared to another bundle. This means:
The bundle (10, 10) is preferred over (10, 9) since it has more of one good ( (10 > 9) ) without reducing the other.
Similarly, the bundle (10, 10) is also preferred over (9, 9) because it has more of both goods.
Between (10, 9) and (9, 9), the bundle (10, 9) is preferred because it has more of one good without any decrease in the other.
Thus, with monotonic preferences, the consumer ranking from most preferred to least preferred is: (10, 10) > (10, 9) > (9, 9).
Suppose your friend is indifferent to the bundles (5, 6) and (6, 6). Are the preferences of your friend monotonic?
Based on the information that your friend is indifferent between the bundles ( (5, 6) ) and ( (6, 6) ), we analyze their preference behavior. If a consumer is indifferent between these two bundles, it means they derive equal utility from both. The second bundle, ( (6, 6) ), includes the same amount of the second good but more of the first good compared to the first bundle, ( (5, 6) ).
Monotonic preferences imply that a consumer prefers more of at least one good while keeping the consumption of other goods constant or increased. If a consumer's preferences are monotonic, then they should prefer ( (6, 6) ) over ( (5, 6) ) since it offers more of the first good without reducing the second good. Therefore, the indifference between these bundles suggests that the preferences are not monotonic. In monotonic preferences, a bundle with strictly more of any good should be strictly preferred if the quantities of other goods are constant.
Suppose there are two consumers in the market for a good and their demand functions are as follows:
$d_1 (p) = 20 – p$ for any price less than or equal to 20, and $d_1(p) = 0$ at any price greater than 20.
$d_2(p) = 30 – 2p$ for any price less than or equal to 15 and $d_1 (p) = 0$ at any price greater than 15.
Find out the market demand function.
To find the market demand function, we add up the individual demand functions, $d_1(p)$ and $d_2(p)$. Let's analyze these functions across the relevant price ranges.
Consumer 1's Demand Function:
$d_1(p) = 20 - p$, valid for $p \leq 20$
$d_1(p) = 0$, for $p > 20$
Consumer 2's Demand Function:
$d_2(p) = 30 - 2p$, valid for $p \leq 15$
$d_2(p) = 0$, for $p > 15$
Constructing the Market Demand Function:
For price values $p$ greater than 15:
$d_1(p) = 0$ for $p > 20$.
$d_2(p) = 0$ for $p > 15$.
Thus, for $p > 15$, the market demand $D(p) = 0$.
For price values $p \leq 15$:
$d_1(p) = 20 - p$,
$d_2(p) = 30 - 2p$.
Add these up to get the market demand:
$D(p) = (20 - p) + (30 - 2p) = 50 - 3p$.
Therefore, the market demand function $D(p)$ can be summarized as:
$D(p) = 50 - 3p$ for $p \leq 15$,
$D(p) = 0$ for $p > 15$.
In summary, the market demand function considering the overlapping of individual price ranges is given by these equations.
Suppose there are 20 consumers for a good and they have identical demand functions:
$d(p) = 10 – 3p$ for any price less than or equal to $\frac{10}{3}$ and $d_1(p) = 0$ at any price greater than $\frac{10}{3}$ What is the market demand function?
To find the market demand function given the individual demand functions of identical consumers, we can aggregate the demand from all consumers.
Each consumer has the demand function: [ d(p) = 10 - 3p ] for ( p \leq \frac{10}{3} ), and [ d_1(p) = 0 ] for ( p > \frac{10}{3} ).
Since there are 20 consumers, and all have identical demand functions, the market demand function will be 20 times the individual demand function for each price level.
So, the market demand function will be: [ D(p) = 20 \times (10 - 3p) ] for ( p \leq \frac{10}{3} ), and [ D(p) = 0 ] for ( p > \frac{10}{3} ).
Thus, simplified: [ D(p) = 200 - 60p ] for ( p \leq \frac{10}{3} ), and [ D(p) = 0 ] for ( p > \frac{10}{3} ).
This market demand function is the horizontal summation of the individual demand functions, summed across all 20 consumers.
Consider a market where there are just two consumers and suppose their demands for the good are given as follows:
p | d1 | d2 |
---|---|---|
1 | 9 | 24 |
2 | 8 | 20 |
3 | 7 | 18 |
4 | 6 | 16 |
5 | 5 | 14 |
6 | 4 | 12 |
Calculate the market demand for the good.
To calculate the market demand for the good, we need to sum up the demands of the two consumers at each price level. Here are the calculations for the market demand:
At price $p = 1$: $d1 + d2 = 9 + 24 = 33$
At price $p = 2$: $d1 + d2 = 8 + 20 = 28$
At price $p = 3$: $d1 + d2 = 7 + 18 = 25$
At price $p = 4$: $d1 + d2 = 6 + 16 = 22$
At price $p = 5$: $d1 + d2 = 5 + 14 = 19$
At price $p = 6$: $d1 + d2 = 4 + 12 = 16$
The market demand at different prices are as follows:
At price $p = 1$, the market demand is $33$ units.
At price $p = 2$, the market demand is $28$ units.
At price $p = 3$, the market demand is $25$ units.
At price $p = 4$, the market demand is $22$ units.
At price $p = 5$, the market demand is $19$ units.
At price $p = 6$, the market demand is $16$ units.
This shows the typical downward sloping demand curve where demand decreases as price increases.
What do you mean by a normal good?
A normal good is a type of good for which demand increases as the consumer's income increases, and decreases as the income declines. This positive relationship between income and demand is because consumers generally have more discretionary spending as their income levels rise. Typically, as people's earnings increase, they tend to purchase more of these goods. Examples of normal goods include higher-end products like electronics, brand-name clothing, and restaurant services. Conversely, when income decreases, the demand for normal goods also falls as consumers might switch to cheaper alternatives or forego purchases altogether.
What do you mean by an ‘inferior good’? Give some examples.
An inferior good refers to a type of good for which demand decreases as the consumer's income increases. This is in contrast to "normal goods," where demand increases as income increases. Inferior goods are typically lower in price and considered lower in quality compared to alternatives that serve similar purposes.
Examples of Inferior Goods:
Generic brand groceries: Instead of branded or organic options, consumers might opt for generic brands when they have lower incomes.
Public transportation: As incomes rise, people might prefer to travel by their own cars or use taxis rather than using public buses or trains.
Second-hand clothing: With higher income, consumers tend to buy new and branded clothing instead of shopping at second-hand stores.
In essence, as people have more money to spend, they often choose higher-quality substitutes, reducing their consumption of inferior goods.
What do you mean by substitutes? Give examples of two goods which are substitutes of each other.
Substitutes refer to goods that can be used in place of each other to fulfill similar needs or desires. When the price of one good increases, the demand for its substitute typically increases because consumers switch to the cheaper alternative. Conversely, if the price of one good decreases, the demand for its substitute generally decreases as consumers prefer to buy the more economical option.
Examples of Substitutes:
Tea and Coffee: These are common substitutes in the beverage category. If the price of tea rises, people might switch to drinking coffee, and vice versa.
Butter and Margarine: These are substitutes in cooking and baking. An increase in the price of butter may lead people to buy more margarine as an alternative.
What do you mean by complements? Give examples of two goods which are complements of each other.
Complements refer to goods that are typically used together, implying that the consumption or use of one good enhances the usage or value of another. When one of the goods in a complementary pair becomes more expensive or cheaper, it tends to similarly affect the demand for the other.
Examples of goods that are complements include:
Tea and Sugar: Both are often used together; when the price of sugar rises, the demand for tea might decline, and vice versa.
Shoes and Socks: These items are usually purchased and used in combination, meaning if the price of socks increases, people might also reduce their purchasing of shoes.
Explain price elasticity of demand.
Price Elasticity of Demand
Price elasticity of demand (often referred to simply as price elasticity) measures how the quantity demanded of a good changes in response to a change in the price of that good. It is defined mathematically as the percentage change in quantity demanded divided by the percentage change in price.
The formula to calculate the price elasticity of demand is:
$$ e_D = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}} = \left(\frac{\Delta Q}{Q}\right) \times \left(\frac{P}{\Delta P}\right) $$
Where:
$\Delta Q$ is the change in quantity demanded,
$Q$ is the initial quantity demanded,
$\Delta P$ is the change in price,
$P$ is the initial price.
Key Characteristics of Price Elasticity
Sign: Typically, demand elasticity is negative, reflecting the inverse relationship between price and quantity demanded. However, it's common to refer to the absolute value of elasticity when discussing it.
Magnitude:
If $|e_D| > 1$, the demand is elastic; consumers are highly responsive to price changes.
If $|e_D| < 1$, the demand is inelastic; consumers are less responsive to price changes.
If $|e_D| = 1$, the demand is unit elastic; percentage change in quantity demanded equals the percentage change in price.
Factors Influencing Elasticity:
Availability of substitutes: More substitutes make demand more elastic.
Necessity vs. luxury: Luxury goods tend to have more elastic demand than necessities.
Time horizon: Demand often becomes more elastic over time as consumers find substitutes or adjust their behavior.
Proportion of income spent on the good: Goods that take up a significant portion of income tend to have more elastic demand.
Economic Implications:
Revenue changes: For inelastic goods, an increase in price leads to an increase in total revenue, while for elastic goods, it leads to a decrease.
Price changes impact on expenditure: The response of total expenditure on a good to a price change can be predicted by its elasticity.
Understanding price elasticity helps businesses set prices strategically and allows policymakers to predict the impact of taxes and subsidies on the consumption of goods.
Consider the demand for a good. At price Rs 4, the demand for the good is 25 units. Suppose price of the good increases to Rs 5, and as a result, the demand for the good falls to 20 units. Calculate the price elasticity .
To calculate the price elasticity of demand, we use the formula:
$$ e_D = \left| \frac{\Delta Q / Q}{\Delta P / P} \right| = \left| \frac{\frac{Q_2 - Q_1}{Q_1}}{\frac{P_2 - P_1}{P_1}} \right| $$
where $Q_1 $ and $ P_1$ are the initial demand and price, and $ Q_2$ and $ P_2 $ are the final demand and price, respectively.
Given:
Initial price ($ P_1 $) = Rs 4
Final price ($ P_2 $) = Rs 5
Initial demand ($Q_1 $) = 25 units
Final demand ($ Q_2 $) = 20 units
Let's calculate the price elasticity of demand.
The price elasticity of demand for the good, given the changes in price and quantity demanded, is 0.8. This value indicates that the demand for this good is somewhat elastic, but not extremely so; a 1% increase in price leads to a 0.8% decrease in demand.
Consider the demand curve $D (p) = 10 – 3p$. What is the elasticity at price $\frac{5}{3}$ ?
Let's calculate the elasticity of the demand curve $D(p) = 10 - 3p$ at a price $p = \frac{5}{3}$.
The elasticity of demand is given by the formula: $$ e_D = \frac{dp}{dq} \cdot \frac{q}{p} $$ where $\frac{dp}{dq}$ is the derivative of $p$ with respect to $q$, and $q$ and $p$ are the quantity and price respectively.
The inverse demand function from $D(p) = 10 - 3p$ is: $$ p = \frac{10 - q}{3} $$ So, the derivative $\frac{dp}{dq} = -\frac{1}{3}$.
Substituting $p = \frac{5}{3}$ into the demand equation: $$ D\left(\frac{5}{3}\right) = 10 - 3 \left(\frac{5}{3}\right) = 10 - 5 = 5 $$ So, $q = 5$.
The elasticity at $p = \frac{5}{3}$ is then: $$ e_D = \left(-\frac{1}{3}\right) \cdot \frac{5}{\frac{5}{3}} = -\frac{1}{3} \cdot \frac{15}{5} = -1 $$
Therefore, the price elasticity of demand at $p = \frac{5}{3}$ is $-1$. This implies that the demand is unit elastic at this price.
Suppose the price elasticity of demand for a good is – 0.2. If there is a 5 % increase in the price of the good, by what percentage will the demand for the good go down?
If there is a 5% increase in the price of the good, the demand for the good will go down by 1%.
Suppose the price elasticity of demand for a good is – 0.2. How will the expenditure on the good be affected if there is a 10 % increase in the price of the good?
The price elasticity of demand (PED) for a good measures how responsive the demand for that good is to changes in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. A negative value of PED, such as (-0.2) in this case, implies that the demand for the good decreases when the price increases, which is a typical behavior for most goods.
Here, with a PED of (-0.2) and a 10% increase in the price, let's understand the impact on expenditure:
PED value (-0.2) indicates that for each 1% increase in price, the quantity demanded decreases by 0.2%.
10% price increase will lead to a (0.2 \times 10% = 2%) decrease in quantity demanded.
Effects on Expenditure
Expenditure on a good is calculated as the product of its price and quantity demanded (Expenditure = Price × Quantity).
When the price of the good increases by 10%:
Price becomes $1.10 \times \text{original price}$
Quantity decreases to $0.98 \times \text{original quantity}$) (100% - 2% = 98%)
The new expenditure will be:
New Expenditure = $1.10 \times \text{original price} \times 0.98 \times \text{original quantity}$
Simplified: New Expenditure = $1.078 \times \text{original expenditure}$
Conclusion:
Since $\left(1.078 \times \text{original expenditure} \right > \text{original expenditure}$, the expenditure on the good increases as a result of a 10% increase in price, despite the decrease in quantity demanded. This is due to the relatively inelastic nature of the demand ($\left| \text{PED} \right| < 1$). Here, the increase in the price has a greater proportional effect on expenditure compared to the impact of the reduction in quantity demanded.
Suppose there was a 4 % decrease in the price of a good, and as a result, the expenditure on the good increased by 2 %. What can you say about the elasticity of demand?
Given that the price of a good decreased by 4% and expenditure on the good increased by 2%, the elasticity of demand for this good can be discussed using the relationship between price elasticity of demand and changes in total expenditure.
Here are the steps to determine the nature of the price elasticity of demand:
Price decrease: The price has decreased, which typically results in an increase in quantity demanded.
Expenditure Increase: Despite the price decrease, total expenditure on the good has increased.
Elasticity Analysis: According to economic principles, if the percentage increase in quantity demanded (as a response to a price drop) is more than the percentage drop in price, the demand is considered elastic. This situation leads to an increase in total expenditure.
In this specific scenario, because the decrease in price led to an increase in expenditure, it indicates that the demand for this good is elastic. The elasticity of demand is greater than one, signifying that the quantity demanded is quite responsive to price changes.
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Ask Chatterbot AINotes - Theory of Consumer Behaviour | Class 12 Microeconomics | Economics
Theory of Consumer Behaviour: Class 12 Notes
Understanding consumer behaviour is crucial for comprehending how individuals make choices regarding their consumption of goods. This article delves into various aspects of consumer behaviour in economics, tailored for Class 12 students.
Introduction to Consumer Behaviour
Defining Consumer Behaviour
Consumer behaviour refers to the actions and decision-making processes of individuals in allocating their income towards the purchase of various goods and services.
Importance in Economics
Understanding consumer behaviour helps economists predict market trends, design effective policies, and improve business strategies to meet consumer needs.
Assumptions in Consumer Behaviour Theory
Preliminary Notations and Assumptions
In economics, consumers are assumed to aim for the highest satisfaction level with their limited income. Preferences play a critical role in determining how they allocate resources among different goods.
Utility Analysis
Defining Utility
Utility refers to the satisfaction or benefit a consumer derives from consuming a good or service. It's subjective and varies from person to person.
Cardinal Utility Analysis
Cardinal utility analysis assumes that the level of utility can be measured in numerical terms.
Total Utility
Total utility is the aggregate satisfaction received from consuming a certain quantity of a good.
Marginal Utility
Marginal utility is the additional satisfaction gained from consuming an extra unit of a good.
graph LR
A[Total Utility] -->|Increase| B[Quantity Consumed]
Law of Diminishing Marginal Utility
As consumption of a good increases, the marginal utility derived from each additional unit decreases.
Ordinal Utility Analysis
Ordinal utility analysis focuses on ranking preferences rather than measuring them numerically.
Indifference Curves
Indifference curves represent different combinations of goods that provide the consumer with the same level of satisfaction.
Marginal Rate of Substitution (MRS)
MRS is the rate at which a consumer is willing to give up one good in exchange for another while maintaining the same level of satisfaction.
Consumer's Budget Constraints
The Budget Set and Budget Line
The budget line represents all the combinations of two goods that a consumer can afford given their income and the prices of the goods.
Price Ratio and the Slope of the Budget Line
The slope of the budget line is determined by the ratio of the prices of the two goods.
Changes in the Budget Set
Any change in the consumer's income or the prices of goods will shift the budget line, altering the available set of consumption bundles.
Optimal Choice of the Consumer
Tangency Condition Between Budget Line and Indifference Curve
The optimal consumption bundle for the consumer is found where the budget line tangents an indifference curve.
Equality of MRS and Price Ratio
At the optimal point, the MRS between the two goods equals the price ratio.
Rational Consumer Behaviour
A rational consumer will choose the bundle that maximises their utility within their budget constraints.
Derivation of the Demand Curve
From Cardinal Utility
The demand curve can be derived using cardinal utility by analysing changes in consumption with changes in prices.
From Ordinal Utility
It can also be derived using indifference curves and budget constraints to observe consumption choices at different prices.
Law of Demand
The law of demand states that there is an inverse relationship between the price of a good and its quantity demanded.
Types of Goods and Their Demand
Normal and Inferior Goods
- Normal Goods: Demand increases with an increase in income.
- Inferior Goods: Demand decreases with an increase in income.
Substitutes and Complements
- Substitutes: Goods that can be used in place of each other. An increase in the price of one increases the demand for the other.
- Complements: Goods that are used together. An increase in the price of one decreases the demand for the other.
Shifts in Demand Curve
Factors Causing Shifts
Changes in income, prices of related goods, and consumer preferences can shift the demand curve.
Movements vs. Shifts in Demand Curve
- Movement: A change in the quantity demanded due to a change in the price of the good.
- Shift: A change in demand due to factors other than the price of the good.
Market Demand
Aggregating Individual Demands
The market demand curve is the horizontal summation of individual demand curves.
Horizontal Summation of Demand Curves
Adding up the quantities demanded by all consumers at each price level gives the market demand curve.
Price Elasticity of Demand
Definition and Calculation
Price elasticity of demand measures the responsiveness of the quantity demanded to changes in the price of the good.
Factors Determining Elasticity
The availability of substitutes, the necessity of the good, and consumer income levels are significant factors that determine price elasticity.
Elasticity and Total Expenditure
The total expenditure on a good is affected by its price elasticity. If demand is elastic, an increase in price reduces total expenditure, while if demand is inelastic, an increase in price increases total expenditure.
Conclusion
Understanding the theory of consumer behaviour helps us grasp how consumers make choices and how various factors influence these choices. This knowledge is vital for economic policy-making, business strategy, and overall economic analysis.
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