CBSE Class 11 Micro Economics: Consumers Equilibrium & Demand (Chapter 2) Revision Notes

Utility

Utility refers to the want-satisfying power of a commodity. It is a subjective concept that varies from person to person, time to time, and place to place. There are two main approaches to measuring utility:

Cardinal Utility Approach

The cardinal utility approach, propounded by Alfred Marshall, assumes that utility can be measured in hypothetical units called 'utils'. This approach is based on the following concepts:

• Total Utility (TU): The total satisfaction derived from consuming a given quantity of a commodity. It increases as consumption increases, though at a decreasing rate.
• Marginal Utility (MU): The additional utility derived from consuming one more unit of a commodity.

Law of Diminishing Marginal Utility

This law states that as a consumer consumes more and more units of a commodity, the marginal utility derived from each successive unit goes on diminishing. Eventually, marginal utility becomes zero and then negative, while total utility is maximum when marginal utility is zero.

Ordinal Utility Approach

The ordinal utility approach, developed by Hicks and Allen, assumes that utility cannot be measured numerically. It proposes that consumers can only rank their preferences for different combinations of goods. This approach introduces the concept of indifference curves and is considered more realistic than the cardinal approach.

Consumer Equilibrium

Consumer equilibrium refers to a situation where a consumer, with given income and prices of commodities, allocates his expenditure in such a way that maximizes total satisfaction. The consumer reorganizes consumption until he reaches a point where he cannot increase satisfaction with the given income and prices.

Consumer Equilibrium with Single Commodity

When a consumer spends his income on a single commodity, equilibrium condition is:

If MU_x / P_x > MU_m, the consumer will buy more of X to increase satisfaction.

If MU_x / P_x < MU_m, the consumer will buy less of X to increase satisfaction.

Consumer Equilibrium with Two Commodities

When a consumer has to allocate income between two commodities X and Y, equilibrium condition is:

Where X and Y are two commodities, MU_x and MU_y are their marginal utilities, and P_x and P_y are their prices.

Indifference Curve Analysis

An indifference curve shows all combinations of two goods that give the consumer the same level of satisfaction. Key properties of indifference curves include:

• They slope downward from left to right
• They are convex to the origin
• Two indifference curves cannot intersect
• Higher indifference curves represent higher levels of satisfaction

Consumer equilibrium in indifference curve analysis occurs where the budget line is tangent to the highest possible indifference curve, given the consumer's income and prices.

Demand

Demand refers to the quantity of a commodity that a consumer is willing and able to purchase at a given price during a given period of time. It is important to distinguish between desire and demand - desires become demands only when they are backed by purchasing power.

Individual Demand vs Market Demand

• Individual Demand: The quantity demanded by an individual consumer at various prices.
• Market Demand: The aggregate of individual demands of all consumers in the market at various prices.

Factors Affecting Demand

Law of Demand

The law of demand states that other things remaining constant, there is an inverse relationship between price and quantity demanded of a commodity. As price falls, quantity demanded increases, and vice versa.

The law of demand operates due to:

• Diminishing Marginal Utility: As consumption increases, marginal utility decreases, so consumers will only buy more at lower prices.
• Income Effect: When price falls, real income increases, enabling the consumer to buy more.
• Substitution Effect: When price falls, the commodity becomes relatively cheaper than its substitutes, leading to increased demand.

Exceptions to the Law of Demand

• Giffen Goods: Inferior goods with a large income effect where demand increases with price.
• Veblen Goods: Luxury goods where demand increases with price due to the prestige value.
• Emergency Situations: In emergencies like war, consumers may buy more at higher prices.
• Expectations of Future Price Changes: If consumers expect prices to rise further, they may buy more at current higher prices.

Elasticity of Demand

Elasticity of demand measures the responsiveness of quantity demanded to a change in one of its determinants, while other determinants remain constant. It helps businesses and policymakers understand how consumers respond to changes in market conditions.

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of quantity demanded to a change in price. It can be measured as:

Where Q is change in quantity, P is change in price, Q is initial quantity, and P is initial price.

Types of Price Elasticity of Demand

• Perfectly Inelastic Demand (E = 0): Quantity demanded remains unchanged regardless of price change. The demand curve is vertical.
• Inelastic Demand (E < 1): Percentage change in quantity demanded is less than percentage change in price. Steeper demand curve.
• Unitary Elastic Demand (E = 1): Percentage change in quantity demanded equals percentage change in price. Rectangular hyperbola.
• Elastic Demand (E > 1): Percentage change in quantity demanded is greater than percentage change in price. Flatter demand curve.
• Perfectly Elastic Demand (E = ): Any slight increase in price leads to zero quantity demanded. Horizontal demand curve.

Determinants of Price Elasticity of Demand

• Nature of the Commodity: Necessities have inelastic demand, luxuries have elastic demand.
• Availability of Substitutes: More substitutes lead to more elastic demand.
• Proportion of Income Spent: Higher proportion of income spent leads to more elastic demand.
• Time Period: Demand is more elastic in the long run than in the short run.
• Number of Uses: Commodities with multiple uses have more elastic demand.
• Brand Loyalty: Higher brand loyalty leads to more inelastic demand.

Income Elasticity of Demand

Income elasticity of demand measures the responsiveness of quantity demanded to a change in consumer's income.

• YED > 0 for normal goods (positive income elasticity)
• YED < 0 for inferior goods (negative income elasticity)
• YED > 1 for luxury goods
• YED < 1 for necessities

Cross Elasticity of Demand

Cross elasticity of demand measures the responsiveness of quantity demanded of one commodity to a change in price of another commodity.

• XED > 0 for substitute goods (price increase of Y increases demand for X)
• XED < 0 for complementary goods (price increase of Y decreases demand for X)
• XED = 0 for unrelated goods