Unit-II : UTILITY APPROACH

2.1 Meaning and Definition.

2.2 Marginal deminishing Utility Theory.
2.3 Equi Marginal Utility Theory.
2.4 Demand : Meaning, Definition, Change in Demand.
2.5 Law of Demand & its Exceptions.

Utility
Demand for a commodity depends on the utility it offers to the consumer. Utility means the level of satisfaction
which people derive from the consumption of a commodity. Utility is a subjective concept. Different people derive
different level of utility from a given good. Harmful goods such has liquor is also said to have utility from economic
stand point as people want them. Thus, the concept of utility is ethically neutral.
Example: A person may derive 100% satisfaction from drinking coffee, while another may not receive any
satisfaction.
Utility, from the economic point of view, is said to be ethically neutral. This is because even harmful items like
cigarettes, alcohol etc. are demanded, as people want them. Thus, the concept of utility does not distinguish
between harmful and non-harmful objects.
When a consumer gets maximum satisfaction, it is called equilibrium and it is also called the most comfortable
position. In order to call it the equilibrium position, two conditions are required viz.
1. The consumer should get maximum satisfaction
2. The consumer should not prefer to change

Classification of utilities

Marginal Utility:
It is the utility derived by the consumer by consuming an additional unit at a given time.
Example
If a consumer consumes 12 chocolates, the Marginal Utility is the utility derived from the 12th unit. It is nothing but
the Total Utility of 12 chocolates minus the Total Utility of 11 chocolates. Thus,
MU n = TU n TU n-1

Where
MUn = Marginal Utility of nth commodity
TUn = Total Utility of n units
TUn-1= Total Utility of n-1 units

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Total Utility:
It is the utility obtained by the consumer from the consumption of all the units at a given time.
Example
If a consumer consumes 12 chocolates, then the Total Utility is the sum of satisfaction of consuming all the 12
chocolates.
Total Utility: U1 + U2 + U3 + .. + Un

Place utility:
When the goods are transferred from one place to another place their utility increases.
Example
Goods transported from the place of plenty to the place of scarce.
Time utility:
When the seller stores the goods now and releases at the time when there is a scarcity it is called as time utility.

Approaches to utility analysis

Every Consumer is a rational consumer i.e., he always tries to get the maximum satisfaction with the
limited income he has. The point, where consumer derives maximum satisfaction is known as Equilibrium.
This equilibrium concept could be explained in two different ways. They are:

1. Cardinal analysis
2. Ordinal analysis

Cardinal Analysis Ordinal Analysis

This approach was developed by Alfred This approach was developed by J. R. Hicks
Marshall and R. J. D. Allen

This analysis assumes that satisfaction that a This analysis condemns cardinal measurability
consumer derives from various goods and of utility and argues that satisfaction cant be
services could be expressed in terms of cardinal measured in terms of numbers but only could
numbers. Like 1,2,3,4,5 .. be arranged/ranked in the order of preference

We study four basic concepts under this. They

are:

Law of Diminishing Marginal Utility

We study Indifference Curve Analysis
Consumers Equilibrium with Single
Commodity
Law of Equi-Marginal Utility.
Consumer Surplus

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Law of Diminishing Marginal Utility (LDMU)
The Law of Diminishing Marginal Utility is one of the very important and fundamental laws of consumption.
This is also known as Gossens 1st Law of Consumption, named after an Austrian economist Gossens
who introduced it. This law is based on one of the important characteristic of human want i.e., Some
Human wants could be satisfied. Prof. Alfred Marshall has developed this LDMU.
Statement: The additional benefit that a person derives from a given increase in the stock of anything
diminishes with the increase in the stock, that he already has Marshall. This LDMU states if one goes
on consuming a particular commodity without any time gap, the marginal utility that he derives from every
successive unit goes on diminishing.
This concept of LDMU has two important aspects. They are:

Total Utility (TU): refers to the aggregate amount of utility derived from consuming all the units of a
particular commodity.
Marginal Utility (MU): refers to the additional or extra utility that the consumer gets from the
consumption of one more extra unit. Symbolically Marginal Utility is represented as MU = TU TUn-
1. (Here n-1 denotes the previous total utility)
In other words the MU could also be defined as the difference between the Total Utility of the newly
consumed good and that of the Total Utility of the previously consumed good.
Let us understand these two aspects more clearly through a imaginary table:

Number of Mangoes TU MU = TUn TUn-1

Here we may note that TU increases with
1 50 50 the consumption of every successive units
but at a diminishing rate. On the other
2 75 25 (75-50) hand MU goes on diminishing with the
consumption of every successive unit.
3 95 20 (95-75)
When MU=0, the TU will be the maximum.
4 110 15 (110-95) If a consumer goes on consuming beyond
this point, the TU goes on diminishing and
5 120 10 (120-110) MU will be negative. This concept could
6 120 0 (120- 120) be explained through the diagram also.

7 100 20 (100-120)

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Assumptions to Law of Diminishing Marginal Utility (LDMU)
The LDMU is based on certain assumptions. They are:

Identical or homogeneous units: The different units of a particular commodity consumed by a

person should be identical or same in all respect i.e., colour, size, quality, taste, etc., The Units
must be similar.
No time gap: In the process of consumption the successive units must be consumed
successively one after the other. If there is a long interval between the consumption of one
unit and the another unit, then LDMU willnt hold good.
Reasonably large units or normal standard units: The units taken for consumption must be
normal standard units and reasonably large units. If they are too small or too large, this LDMU
willnt be applicable. For Example: When a person is thirsty he should consume water in glass
not spoon-by-spoon.
No changes in the taste, habits and the customs of the consumer: During the course of
consumption there shouldnt be any change in the taste, habits and the customs of the
consumer. If there is any change, this law willnt hold good. For Example: When a vegetarian
consumes egg, initially he may not like it and may not get any utility. But gradually when he
consumes successive units, he may start getting utility from egg.
Cardinal measurability of utility: According to this theory, a person can express the satisfaction
he derives from the commodity in quantitative cardinal terms. In other words, utility can be
expressed in the form of numbers. Thus, a person can say that he derives 10 utils of satisfaction
from the consumption of bread, 90 utils of satisfaction from the consumption of chocolate and
so on. However, this may not be true in reality.
Constancy of the Marginal Utility of money: This is an important assumption without which
Marshall could not have measured Marginal Utilities of goods in terms of money. It states that

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 the Marginal Utility of money remains constant throughout the period when the individual is
spending money on a good.
The hypothesis of independent utility: This assumption states that the Total Utility which a
person derives from a collection of goods purchased is simply the sum total of the separate
utilities of goods i.e., separate utilities of different goods can be added to obtain the total sum
of the utilities of all the goods purchased. Example: 10 utils of satisfaction from the
consumption of bread + 90 utils of satisfaction from the consumption of pizzas = 100 utils of
satisfaction.
Rationality: Here the consumer is assumed to be rational. The consumer will prefer to spend
money on the commodity from which he will derive maximum utils.
Limitations to Law of Diminishing Marginal Utility (LDMU)
The exponent of the LDMU has himself given few areas where this law wouldnt be applicable. They are:
Rare Collections: The law of LDMU is not applicable to some of the rare collections like stamps, coins,
currency of different countries, antique goods etc. because our satisfaction increases with every
increase in the stock of these goods.
Not applicable to Liquor: The level of intoxication of the drinker increases with every additional drink
of liquor.
Not applicable for money: The LDMU is not applicable for money. With every increase in the stock of
money, the greed goes on increasing.
Criticisms to Law of Diminishing Marginal Utility (LDMU)
The main criticisms of the LDMU are as follows:

Cardinal measurability of utility is not possible. Nobody can express their utility in terms of
numbers.
The LDMU, to some extent applies to money also. For Example: a thousand or five hundred
rupees to a millionaire will not make much difference.
The LDMU is a single commodity model.
Importance/ Application of the Law of Diminishing Marginal Utility

LDMU concept is used to explain Value Paradox: This Value Paradox was developed by
Prof. Adam Smith. This concept is also known as Diamond water paradox. He says that water
is more useful than diamond, but it is priced low and diamond is less useful than water and it
is priced high. This is because more is the quantity or the stock of a product the marginal utility
starts diminishing and if the availability of a product is less, marginal utility will be high.
Useful for Government to fix the Tax Rate: The value of additional money for a rich person is
relatively less. But whereas the value of the same additional money to a poor person is more.
Hence the government follows Progressive Tax system. Government levies high rate tax on
rich people and low tax on poor people. For this LDMU could be used.
To explain Law of Demand: When a consumer goes on consuming a particular commodity,
the marginal utility goes on diminishing. When the utility that consumer gets is less, the price
that he will be ready to offer will also be less. Hence in order to induce the consumer to
purchase more, the price of the commodity has to be reduced.
Used to explain Consumer Surplus: consumer surplus might be defined as the difference
between the price, what consumer is actually prepared to pay and the price that he actually
pays. Initially a consumer will be ready to pay more price for a product, gradually the same
consumer will be ready to offer very less price for the same product. This is because law of
diminishing marginal utility operates over there.
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The Law of Equi-Marginal utility (LEMU)
The idea of equi-marginal utility was first mentioned by H.H.Gossen (1810-1858) of Germany. Hence, it is called
Gossens second Law of consumption. Alfred Marshall made significant refinements to this law in his Principles of
Economics.
According to this law, the consumer will try to maximize his satisfaction when there are substitutes available in the
market. So, he will substitute one item in place of the other such that his Marginal Utility is proportional to the price.
The law of equi-marginal utility explains the behaviour of a consumer when he consumes more than one commodity.
Wants are unlimited, but the income which is available to the consumer to satisfy all his wants is limited. This law
explains how the consumer spends his limited income on various commodities to get maximum satisfaction.

According to Alfred Marshall, Other things being equal, a consumer gets maximum satisfaction when he allocates
his limited income to the purchase of different goods in such a way that the Marginal Utility derived from the last
unit of money spent on each item of expenditure tend to be equal.

Assumptions to Law of Equi-Marginal utility (LEMU)

The consumer is rational, so he wants to get maximum satisfaction

The utility of each commodity is measurable
The Marginal Utility of money remains constant
The income of the consumer is given
The prices of the commodities are given
The law is based on the law of diminishing marginal utility

Explanation of Law of Equi-Marginal utility (LEMU)

Suppose there are two goods, X and Y, on which a consumer has to spend a given income, the consumer being
rational, will try to spend his limited income on goods X and Y to maximise his Total Utility or satisfaction. Only at
that point of maximum satisfaction, the consumer will be in equilibrium. According to the law of equi-marginal
utility, the consumer will be in equilibrium at the point where the utility derived from the last rupee spent on each
item is equal.
Symbolically, the consumer will be in equilibrium when

Where MUx = Marginal Utility of commodity X

MUy = Marginal Utility of commodity Y
Px = Price of commodity X
Py = Price of commodity Y
MUm = Marginal Utility of money
Let us illustrate the law of equi marginal utility with the help of the following table:
Suppose a lady has 5 with her, which she wishes to spend on two commodities, chocolates and ice creams. The
marginal utility derived from both these commodities is as under:

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 Units of
MU of Chocolates MU of Ice creams
Money

1 10 12

2 8 10

3 6 8

4 4 6

5 2 3

5 Total Utility = 30 Total Utility = 39

A rational consumer would like to get maximum satisfaction from 5.00. She can spend this money in three ways.

5.00 may be spent on chocolates only.

5.00 may be utilized for the purchase of ice creams only.
Some amount may be spent on the purchase of chocolates and some on the purchase of ice creams.
If the prudent consumer spends 5.00 on the purchase of chocolates, she gets 30 utils. If she spends 5.00 on the
purchase of ice creams, the total utility derived is 39 which is higher than chocolates. In order to make the best of
the limited resources, she adjusts her expenditure.

By spending 4.00 on chocolates and 1.00 on ice creams, she gets 40 utils (10+8+6+4+12=40).
By spending 3.00 on chocolates and 2.00 on ice creams, she derives 46 utils (10+8+6+12+10=46).
By spending 2.00 on chocolates and 3.00 on ice creams, she gets 48 utils (10+8+12+10+8=48).
By spending 1.00 on chocolates and 4.00 on ice creams, she gets 46 utils (10+12+10+8+6=46).
The sensible consumer will spend 2.00 on chocolates and 3.00 on ice creams and will get the maximum
satisfaction. When she spends 2.00 on chocolates and 3.00 on ice creams, the Marginal Utility derived from both
these commodities is equal to 8. When the marginal utilities of the two commodities are equalized, the total utility
is then maximum i.e., 48 as is clear from the schedule given above.

The law of equi-marginal utility can be explained with the help the diagrams.

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In the diagram, MU is the marginal utility curve for chocolates and KL of ice creams. When a consumer spends OP
amount ( 2) on chocolates and OC ( 3) on ice creams, the Marginal Utility derived from the consumption of both
the items (chocolates and ice creams) is equal to 8 units (EP=NC). The consumer gets maximum utility when she
spends 2.00 on chocolates and 3.00 on ice creams and by no other alteration in the expenditure.
We now assume that the consumer spends 1.00 on chocolates (OC amount) and 4.00 (OQ) on ice creams. If
CQ more amount is spent on ice creams, the added utility is equal to the area CQ NN. On the other hand, the
expenditure on chocolates falls from OP amount ( 2) to OC amount ( 1.00). There is a toss of utility equal to the
area CPEE. The loss in utility (chocolates) is greater than that of its gain in ice creams. The consumer does not
derive maximum satisfaction except in the combination of expenditure of 2.00 on chocolates and 3.00 on ice
creams.

Limitations of Law of Equi-Marginal utility (LEMU)

Rational behavior: It is true that consumer is irrational sometimes. It is behavior is greatly influenced
by habits, advertisements etc.,
Cardinal Measurement of Utility: Critics point out that utility is an abstract term, which cannot be
measured.
Utility is subjective: Utility is subjective and psychological concept. It is difficult to measure.
Marginal Utility of Money is not constant: Marshall assumes that marginal utility of money is constant
but Hicks argues that money is also a commodity and the marginal utility also diminishes slowly.
Consumer is not a computer: a consumer has to keep a complete record of income and continuously
calculate the marginal utilities but human mind is incapable of making such calculations.
Multiplicity: Multiplicity of commodities prevent the consumer from making a rational choice. He
neither has time nor the ability to calculate marginal utilities.
Indivisible goods: It is not applicable to indivisible goods. There are certain goods such as fans, tvs, car
etc., which cannot be divided or sub divided. If divided they will lose their utility.
Durable goods: It is difficult to measure the utility in respect of durable goods such as car and
machinery. For example; if the consumer purchases a refrigerator and a cup of coffee, it is very difficult
to equalize the Marginal Utility of a refrigerator which lasts for several years with a cup of coffee, which
exhausts at the single act of consumption.
Indefiniteness of budget period: The income may be daily, monthly or yearly. Even if we assume that
budget period is one year, it is very difficult to calculate the utilities as he purchases various
commodities.
Customs, fashions, ignorance, scarcity etc.: Customs make the consumption of an article compulsory
irrespective of marginal utilities. Fashion of the day impede the operation of the law as one may
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 purchase a commodity much against his wish to be in tune with the fashion. Consumer does not possess
complete knowledge of all commodities and their prices in the market. Moreover prices are subject to
change. Scarcity consumer is compelled to purchase an alternative or a substitute good if there is
scarcity.

Importance of Law of Equi-Marginal utility (LEMU)

The Law of Equi-marginal utility is not only theoretical, but also has practical application in our daily life. Some of
the areas, where it could be used are: -

The Theory of Consumption: The expenditure pattern of every consumer is based on this law. The
consumer distributes his limited income among various commodities in such a way that the Marginal
Utility or the satisfaction that he gets is equal to its price. At that point he stops further consumption,
because he knows that if he continues consumption, the satisfaction will be less and the price he is
going to pay is more. This helps the consumer to maximise his satisfaction.
Choice between Savings and Consumption: If the future consumption yields more satisfaction than the
present consumption, in that case the consumer will decide to save his income rather than spending it.
The theory of production: The law helps the producer to maximise his profits by substituting one factor
of production to another till the marginal productivity of all the factors are equalised.
The theory of public finance: The objective of public finance is to achieve maximum social advantage.
The society gets the maximum economic benefit at the point where the sacrifice made by people on
account of paying taxes is exactly equal to the benefits that they get from the government.
Exchange: a person having surplus, exchange with the person who has scarcity till marginal utility
become equal.
Scarcity aspect: this law applies to all fields of economic activity where limited resources are to be
profitably employed. Thus the law has very wide application. Prof. Marshall puts the significance of the
law in the following words: The application of this principle could be extended to every field of
economic enquiry.

DEMAND
MEANING OF DEMAND

The concept demand refers to the quantity of a good or service that consumers are willing and able to purchase at
various prices during a given period of time. It is to be noted that demand, in Economics, is something more than
desire to purchase though desire is one element of it. A beggar, for instance, may desire food, but due to lack of
means to purchase it, his demand is not effective. Thus, effective demand for a thing depends on (i) desire (ii) means
to purchase and (iii) willingness to use those means for that purchase. Unless demand is backed by purchasing power
or ability to pay, it does not constitute demand. Two things are to be noted about quantity demanded. One is that
quantity demanded is always expressed at a given price. At different prices different quantities of a commodity are
generally demanded. The second thing is that quantity demanded is a flow. We are concerned not with a single
isolated purchase, but with a continuous flow of purchases and we must therefore express demand as so much per
period of time one thousand dozens of oranges per day, seven thousand dozens oranges per week and so on.

In short By demand, we mean the various quantities of a given commodity or service which consumers would buy
in one market in a given period of time, at various prices, or at various incomes, or at various prices of related
goods.

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LAW OF DEMAND
The law of demand is one of the most important laws of economic theory. According to law of demand, other things
being equal, if the price of a commodity falls, the quantity demanded of it will rise and if the price of a commodity
rises, its quantity demanded will decline. Thus, there is an inverse relationship between price and quantity
demanded, other things being same. The other things which are assumed to be equal or constant are the prices of
related commodities, income of consumers, tastes and preferences of consumers, and such other factors which
influence demand. If these factors which determine demand also undergo a change, then the inverse price-demand
relationship may not hold good. For example, if incomes of consumers increase, then an increase in the price of a
commodity, may not result in a decrease in the quantity demanded of it. Thus, the constancy of these other factors
is an important assumption of the law of demand.

Definition of the law of Demand

Prof. Alfred Marshall defined the law thus: The greater the amount to be sold, the smaller must be the price at
which it is offered in order that it may find purchasers or in other words the amount demanded increases with a fall
in price and diminishes with a rise in price. The law of demand may be illustrated with the help of a demand
schedule and a demand

Demand Schedule : To illustrate the relation between the quantity of a commodity demanded and its price, we may
take a hypothetical data for prices and quantities of commodity X. A demand schedule is drawn upon the assumption
that all the other influences remain unchanged. It thus attempts to isolate the influence exerted by the price of the
good upon the amount sold.

Demand schedule of an individual consumer

Price Quantity demanded

(`) (Units)
A 5 10
B 4 15
C 3 20
D 2 35
E 1 60

When price of commodity X is ` 5 per unit, a consumer purchases 10 units of the commodity. When the price falls
to ` 4, he purchases 15 units of the commodity. Similarly, when the price further falls, the quantity demanded by
him goes on rising until at price ` 1, the quantity demanded by him rises to 60 units. The above table depicts an
inverse relationship between price and quantity demanded; as the price of the commodity X goes on rising, its
demand goes on falling.

Demand curve: We can now plot the data from Table 1 on a graph with price on the vertical axis and quantity on
the horizontal axis. In Fig. 1, we have shown such a graph and plotted the five points corresponding to each price-
quantity combination shown in Table 1. Point A, shows the same information as the first row of Table 1, that at ` 5

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per unit, only 10 units of X will be demanded. Point E shows the same information as does the last row of the
table, when the price is ` 1, the quantity demanded will be 60 units.

We now draw a smooth curve through these points. The curve is called the demand curve for commodity X. The
curve shows the quantity of X that a consumer would like to buy at each price; its downward slope indicates that
the quantity of X demanded increases as its price falls. Thus the downward sloping demand curve is in accordance
with the law of demand which, as stated above, describes an inverse price-demand relationship.

Market Demand Schedule : When we add up the various quantities demanded by the number of consumers in the
market we can obtain the market demand schedule. How the summation is done is illustrated in Table 2. Suppose
there are three individual buyers of the goods in the market. The Table 2 shows their individual demands at various
prices.

Table 2 : Market Demand Schedule

Quantity demanded by
Price (`) P Q R Total market demand
5 10 8 12 30
4 15 12 18 45
3 20 17 23 60
2 35 25 40 100
1 60 35 45 140

When we add quantities demanded at each price by consumers P, Q and R we get the total market demand. Thus,
when price is ` 5 per unit, the market demand for commodity X is 30 units (i.e. 10+8+12). When price falls to ` 4,
the market demand is 45 units. At Re. 1, 140 units are demanded in the market. The market demand schedule also
indicates inverse relationship between price and quantity demanded of X.

Fig. 2 : Market Demand Curve

Market Demand Curve : If we plot the market demand schedule on a graph, we get the market demand curve.
Figure 2 shows the market demand curve for commodity X. The market demand curve, like individual demand
curve, slopes downwards to the right because it is nothing but the lateral summation of individual demand curves.
Besides, as the price of the good falls, it is very likely that new buyers will enter the market which will further raise
the quantity demanded of the quantity demanded of the good.

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 Rationale of the Law of Demand : Why does demand curve slope downwards?
Different economists have given different explanations for the operation of law of demand.
These are given below.
(1) Law of diminishing marginal utility : According to Marshall people will buy more quantity
at lower price because they want to equalize the marginal utility of the commodity and its
price. So a rational consumer will not pay more for lesser satisfaction. He is induced to
buy additional units in order to maximize his satisfaction or utility. The diminishing marginal
utility and equalizing it with the price is the cause for the downward sloping demand curve.
(2) Substitution effect : Hicks and Allen have explained the law in terms of substitution
effect and income effect. When the price of a commodity falls, it becomes relatively cheaper
than other commodities. It induces consumers to substitute the commodity whose price
has fallen for other commodities which have now become relatively expensive. The result
is that the total demand for the commodity whose price has fallen increases. This is called
substitution effect.
(3) Income effect : When the price of a commodity falls, the consumer can buy the same
quantity of the commodity with lesser money or he can buy more of the same commodity

with the same amount of money. In other words, as a result of fall in the price of the
commodity, consumers real income or purchasing power increases. This increase in the
real income induces him to buy more of that commodity. Thus, demand for that commodity
(whose price has fallen) increases. This is called income effect. Due to the operation of
income effect and substitution effect, price effect operates or law of demend holds.
(4) Arrival of new consumers : When the price of a commodity falls, more consumers start
buying it because some of those who could not afford to buy it previously may now afford
to buy it. This raises the number of consumers of a commodity at a lower price and hence
the demand for the commodity in question.
(5) Different uses : Certain commodities have multiple uses. If their prices fall they will be
used for varied purposes and demand for such commodities will increase. When the price
of such commodities are high, rises they will be put to limited uses only. Thus, different
uses of a commodity make the demand curve slope downwards reacting to changes in price.
Exceptions to the Law of Demand : According to the law of demand, more of a
commodity will be demanded at lower prices than at higher prices, other things being equal.
The law of demand is valid in most cases; however there are certain cases where this law does
not hold good. The following are the important exceptions to the law of demand.
(i) Conspicuous goods : Articles of prestige value or snob appeal or articles of conspicuous
consumption are demanded only by the rich people and these articles become more
attractive if their prices go up. Such articles will not conform to the usual law of demand.
This was found out by Veblen in his doctrine of Conspicuous Consumption and hence
this effect is called Veblen effect or prestige goods effect. Veblen effect takes place as some
consumers measure the utility of a commodity by its price i.e., if the commodity is expensive
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 they think that it has got more utility. As such, they buy less of this commodity at low
price and more of it at high price. Diamonds are often given as example of this case.
Higher the price of diamonds, higher is the prestige value attached to them and hence
higher is the demand for them.

(ii) Giffen goods : Sir Robert Giffen, an economist, was surprised to find out that as the price
of bread increased, the British workers purchased more bread and not less of it. This was
something against the law of demand. Why did this happen? The reason given for this is
that when the price of bread went up, it caused such a large decline in the purchasing
power of the poor people that they were forced to cut down the consumption of meat and
other more expensive foods. Since bread, even when its price was higher than before, was
still the cheapest food article, people consumed more of it and not less when its price went
up.
Such goods which exhibit direct price-demand relationship are called Giffen goods.
Generally those goods which are considered inferior by the consumers and which occupy
a substantial place in consumers budget are called Giffen goods. Examples of such goods
are coarse grains like bajra, low quality rice and wheat etc.
(iii) Conspicuous necessities : The demand for certain goods is affected by the demonstration
effect of the consumption pattern of a social group to which an individual belongs. These
goods, due to their constant usage, have become necessities of life. For example, in spite of
the fact that the prices of television sets, refrigerators, coolers, cooking gas etc. have been
continuously rising, their demand does not show any tendency to fall.
(iv) Future expectations about prices : It has been observed that when the prices are rising,
households expecting that the prices in the future will be still higher, tend to buy larger
quantities of the commodities. For example, when there is wide-spread drought, people
expect that prices of foodgrains would rise in future. They demand greater quantities of
foodgrains as their price rise. But it is to be noted that here it is not the law of demand
which is invalidated but there is a change in one of the factors which was held constant
while deriving the law of demand, namely change in the price expectations of the people.
(v) The law has been derived assuming consumers to be rational and knowledgeable about
market-conditions. However, at times consumers tend to be irrational and make impulsive
purchases without any rational calculations about price and usefulness of the product
and in such contexts the law of demand fails.
(vi) Demand for necessaries: The law of demand does not apply much in the case of necessaries
of life. Irrespective of price changes, people have to consume the minimum quantities of
necessary commodities.
Similarly, in practice, a household may demand larger quantity of a commodity even at a
higher price because it may be ignorant of the ruling price of the commodity. Under such
circumstances, the law will not remain valid.
(vii) Speculative goods: In the speculative market, particularly in the market for stocks and
shares, more will be demanded when the prices are rising and less will be demanded
when prices decline.
DEMAND EXPANSION AND CONTRACTION OF DEMAND
The demand schedule, demand curve and the law of demand all show that when the price of
a commodity falls, its quantity demanded increases, other things being equal. When, as a result
of decrease in price, the quantity demanded increases, in Economics, we say that there is an
expansion of demand and when, as a result of increase in price, the quantity demanded
decreases, we say that there is contraction of demand. For example, suppose the price of apples
at any time is ` 100 per kilogram and a consumer buys one kilogram at that price. Now, if
other things such as income, prices of other goods and tastes of the consumers remain same
but the price of apples falls to ` 80 per kilogram and the consumer now buys two kilograms of
apples, we say that there is a change in quantity demanded or there is an expansion of demand.
UNIT-II B.COM I-SEM-I NOTES COMPILED BY PROF.RUPESH DAHAKE
 On the contrary, if the price of apples rises to ` 150 per kilogram and consumer buys only half
a kilogram, we say that there is a contraction of demand.
The phenomena of expansion and contraction of demand are shown in Figure 3. The figure
shows that when price is OP quantity demanded is OM, given other things equal. If as a result
of increase in price (OP), the quantity demanded falls to OL, we say that there is a fall in

quantity demanded or contraction of demand or an upward movement along the same

curve. Similarly, as a result of fall in price to OP, the quantity demanded rises to ON, we say
that there is expansion of demand or a rise in quantity demanded or a downward movement
on the same demand curve.

INCREASE AND DECREASE IN DEMAND

In case of expansion and contraction of demand, we have seen that the change takes place as a result of
changes in price, all other factors remaining constant. When all the other factors influencing demand also
change, there is an increase or decrease in demand and the demand curve shifts either to its right or left. If
the income of a consumer rises, he would be able to purchase the commodities which he earlier could not
afford. This would result in an increase in demand and therefore, the demand curve shifts to the right. If, on
the other hand, the goods are out of fashion, the demand of that good will decline, resulting in the shift of
the demand curve to the left.

Rise in income
Rise in the price of substitutes
in demand Fall in the price of a complement
Favourable change in tastes of a good
(A shift in the demand curve towards the right) Increase in population
Goods in fashion

Rise in income
Rise in the price of substitutes
Decrease in demand Fall in the price of a complement
Favourable change in tastes of a good
(A shift in the demand curve towards the left) Increase in population
Goods in fashion

UNIT-II B.COM I-SEM-I NOTES COMPILED BY PROF.RUPESH DAHAKE

UNIT-II B.COM I-SEM-I NOTES COMPILED BY PROF.RUPESH DAHAKE