Season 6

CHAPTER: 9 CONSUMER'S EQUILIBRIUM: INDIFFERENCE
CURVE ANALYSIS
Indifference Curve Analysis is an alternative explanation of consumer's equilibrium state.
6.1 INTRODUCTION
The Indifference Curve Analysis is an alternative explanation of the consumer's behaviour. It
is an alternative in two respects: different assumptions and different tools. Let us see how
assumptions are different.
6.1.1 Cardinal Utility vs. Ordinal Utility

The utility analysis assumed Cardinal utility, i.e. utility expressable in exact units. In the last
chapter we talked of consumer getting so many units of utility by consuming so many units of a
good. This assumption is also a source of criticism of utility analysis. The criticism is that utility
is a psychological phenomenon, a feeling of mind, and it cannot be expressed in exact numerical
terms. The indifference curve analysis adopted a more realistic assumption.
The indifference curve analysis assumed Ordinal utility. Ordinal utility is expressed in
terms of ranking as first, second, third rank etc. (The cardinal utility is expressed in terms of
exact units like 1 util,2 utils, 3 utils, etc.). For example, when a consumer declares only that
he got less utility from the consumption of second unit of a good as compared to the first unit,
he is simply ranking the utilities obtained from the two units. He has assigned first rank to the
first unit and second rank to the second unit without mentioning the exact utility derived from
each unit.
The 'Ordinal utility' assumption is more realistic than the 'Cardinal utility' assumption. In
this respect, the Indifference Curve Analysis is considered to be an improvement over the
Utility Analysis. There are other respects too. Their discussion is beyond the scope of the
book.
6.1.2 Different Tools
The Utility Analysis used the concept of Marginal Utility, the Law of Diminishing
Marginal Utility and the Law of Equi-Marginal Utility to analyse consumer's behaviour. The
Indifference Curve Analysis used the concepts of indifference curve, budget line, and others,
to analyse how a consumer behaves in addition to the tools used in the Utility Analysis.
Although some tools are different, the basic approach of the two analyses is more or less the
same.
The study of consumer's equilibrium with the use of the Indifference Curve Analysis is
divided into three parts.
l. Concept of indifference curve
2. Concept of budget line
3. Conditions of the consumer's equilibrium.
6.2 CONCEPT OF INDIFFERENCE CURVE
6.2.1 The Two Goods Assumption
There are many things the Indifference Curve Analysis takes as given. For example, throughout
the analysis, it is assumed that the Consumer buys only two goods. The assumption is made more
as a matter of convenience rather than a matter of fact. The entire analysis uses graphs liberally. A
graph has only two axes. Therefore, only two goods can be represented, one on each axis. This
limitation of graphic presentation has forced the analysis to assume the consumption of only two
goods.
But does it not make the analysis unrealistic? After all, consumer does consume more than two
goods. But suppose, instead of two goods we talk of two groups of goods. For example, we can
take the two groups as food goods and non-food goods. The two groups cover the entire range of
goods consumed by the consumer. We can make other such groups. So, if we look at the two goods
as two groups of goods, the two goods assumption may look more nearer to reality.
6.2.2 The Indifference Schedule
Let the two goods be X and Y. Suppose, that the consumer is in a position to make such different
combinations of the two goods that each combination gives the consumer same amount of
satisfaction or utility. To elaborate, we take a numerical example. Let the combinations made by
the consumer be as given in Table 6.1.
Table 6.1
The Indifference Schedule of a Consumer
Combinations Good X Good Y Marginal Rate of Substitution
(units) (units) (∆Y/∆X)
A 1 8 ---
B 2 4 4Y : 1X
C 3 2 2Y : 1X
D 4 1 1Y : 1X
The combinations given in Table 6.1 are based on the assumption that each combination gives the
consumer same utility. For this to happen, two things are necessary.
First, if the quantity of one good consumed is increased, the quantity of the other good
consumed must be decreased. For example, when consumer moves from combination A to B, the
good X increases by one unit, while Y decreases by 4 units. Why so? It is so because if X is
increased while Y is not decreased, the consumer will have more quantity of goods and more goods
means more utility which is against the basic assumption of indifference schedule that each
combination has same utility. Similarly, if Y is decreased and simultaneously X is not increased, the
utility level will fall.
Second, as the quantity of one good goes on increasing the quantity of the other good not only
decreases but decreases at a decreasing rate. Note that as the consumer moves from combination
A to B, he is willing to give up 4Y to obtain I X. In other words, 4 units of Y is the price the
consumer is willing to pay to obtain one unit of X.
Now, note that when the consumer moves from B to C, he is willing to give up only 2Y to obtain 1
X. Why is he willing to give up less now? The answer is found in the Law of Diminishing Marginal
Utility. The law states that as consumption of a good rises, the marginal utility obtained from it goes
on falling. Since the consumer gets less utility from each new unit consumed of X, he would be
willing to sacrifice less and less of Y to obtain a new unit of X. This is why the consumer is willing
to give up only 2Y for the third unit of X and IY for the fourth unit of X. The falling rate of sacrifice
gives a new concept called Marginal Rate of Substitution. It is the basic concept on which the
analysis of consumer's equilibrium is based. The concept is explained below.
6.2.3 Marginal Rate of Substitution (MRS)
MRS is the rate at which the consumer is willing to sacrifice one good to obtain one more unit
of the other good.
MRS=Change∈the quantity of the good the consumer is willing ¿ sacrifice ¿
Change∈the quantity of the good the consumer
In our example in Table 6.1, Y is being sacrificed to obtain X.
Since we have named the two goods as X and Y and also declared that X being substituted in
place of Y, we can call MRS as MRS xy. MRS is thus a general term while MRS xy is specific to
goods X and Y. It is more convenient to use the general term while explaining the theory. As
such we will use MRS.
Therefore,
∆Y
MRS=
∆X
When the consumer moves from the combination A to B, he is willing to give up 4Y to obtain
one unit of X. Therefore,
∆ Y −4
MRS= = = 4 (absolute value)
∆X 1
Note that in mathematical terms, the value of MRS should be -4 and not 4. It is because the
numerator by definition has a negative value. But, in the analysis, we always take the absolute
value. This makes the comparison meaningful. For example, when consumer moves from B to
C, the MRS in mathematical terms should be -2. When we compare -4 with -2, we may conclude
that MRS has risen. But, if we take only absolute values of MRS has fallen. The absolute value is
meaningful because the rate of sacrifice actually falls. Note that in the Table 6.1, the absolute
value of MRS declines continuously.
6.2.4 Indifference Curve
If you have grasped what an indifference schedule is, the understanding of the concept of
indifference curve becomes easy. The indifference curve is simply the diagrammatic
representation of the indifference schedule. Refer to Figure 6. I
ABCD is the indifference curve as the locus of combinations A, B, C and D as given in the
indifference schedule (Table 6.1). Assuming that the consumer consumes only two goods, we can
define indifference curve as.
An indifference curve is the locus of different combinations of the two goods, the
consumer consumes with each of the combination having the same utility.
What do you observe about the shape? We observe two things. First, the indifference curve is sloping
downwards from left to right. In other words, it is negatively sloped. It is because when consumer
increases consumption of X, he must reduce consumption of Y to keep the utility level unchanged.
Also, note that the indifference curve continuously approaches the two axes but never touches them.
It is because the consumer consumes some quantity of each good. If it touches any of the axis it
creates a possibility that consumer consumes only one good.
Second, the indifference curve is strictly convex towards the origin. It is because MRS continuously
declines as the consumer moves downwards along the indifference curve. In the language of graph,
the slope of the indifference curve is nothing but MRS.
Slope of indifference curve
Slope of indifference curve between any two points is simply the MRS between those two points. For
example, when consumer moves from combination A to B downward he is willing to give up 4Y (=
AE) to obtain IX (= EB). The slope between A and B is then
∆Y AE 4
Slope (A) → B) = ∆ X = EB = 1
Similarly,
BF 2
Slope (B→C) = FC = 1 =2
CG 1
And Slope (C→D) = GD = 1 =1
Remember that we take only the absolute values of slope. We find that slope is continuously
declining as we move downwards along the curve. This gives convex shape to the
indifference curve.
6.2.5 Concept of Indifference Map
One indifference curve has one utility level all along its course. Like this, another Good Y
indifference curve has another utility level. The consumer has as many indifference curves as there
are utility levels. The set of all possible indifference curves the consumer has, is called
Indifference Map. Refer to Figure 6.2.
The Indifference Map contains three indifference curves. (We have taken only three indifference
curves just for the sake of illustration. Conceptually, the entire preference space enclosed by the
two axes is full of indifference curves, one indifference curve passing through each point in the
space.)
Out of the three, indifference curve 1 2 is placed higher than 1 2, and 13 higher than 12. The
higher indifference curve has higher utility. 1 2 has higher utility than 11. 13 has higher utility
than 12. As we move from one indifference curve to another indifference curve towards the
right, each higher placed curve has a higher utility level. Why? What is the explanation?
The explanation is that a higher indifference curve represents more quantity of both the goods
taken together. The assumption in the Indifference Curve Analysis is that more quantity of
goods means more utility. We can show this. Refer to Figure 6.3.
Compare points A and B on 1 1 and 12 respectively. At A, the consumer has Ox 1 of X and Oy1
of Y. At B, the consumer has Ox 2 of X and Oh of Y. Since Ox 2 is greater than Ox1 and Oy2 is
greater than Oh, point B on higher placed I 2 represents more goods and by assumption 6.3 :
Higher Indifference Curve higher utility level.
The assumption 'more goods more utility' implies that utility is an increasing function of
consumption. When a function is always increasing (or decreasing) is called monotonic
function. The preferences based on the monotonic utility function are called monotonic
preferences.
Monotonic preferences mean that as consumption increases total utility also increases
alongwith.
Indifference map is based on the assumption that preferences are monotonic. Understandably,
the consumer will like to have more and more of consumption. Graphically, it means that
consumer will like to reach as high an indifference curve as possible. This is an important
element in determining the consumer's equilibrium.
Properties of Indifference Curve
The above description of the concept of indifference curve reveals the following properties, or
characteristics, of indifference curves:
(1) Sloping downwards from left to right
The curve is negatively sloped because to obtain more quantity of one good the consumer
must give up some quantity of the other good in order to remain at the same utility level the
curve represents.
(2) Strictly convex towards the origin
It is because the marginal rate of substitution continuously declines as the consumer moves
downwards along the curve. This is due to the Law of Diminishing Marginal Utility.
(3) Higher indifference curve represents higher utility
This is because of the assumption that preferences are monotonic and more quantity
consumed means more utility. Higher indifference curve represents more quantity of goods.
There is another property, that two indifference curves never intersect each other. The study
of this property is beyond the scope of the book.
(4) Two indifference curves cannot intersect each other.
"Two indifference curves (ICs) cannot intersect each other" is the fourth property of an IC.
We can show this in two alternative ways. As a first step let us assume the two ICs (1 1 and 12)
intersecting each other at point A.
One Way
 The intersection point A gives the combination Ox + Oy which lies on both the ICs, 11
and 12.
 On one combination of the two goods the consumer gets only one level of satisfaction.
 By definition two ICs must have different satisfaction levels.
 From the above it can be concluded that O x + Oy gives two satisfaction levels. It is an
absurd result and against the basic feature of an IC.
Alternative Way
 Let the satisfaction level be denoted U.
Satisfaction levels associated with I1 and I2 are respectively U1 and U2
 Since each point on I1 must have the same satisfaction U1. Similarly on I2 each point must
have satisfaction level U2
 From the above it can be concluded that
U at A = U at B
and U at A U at C
= U at C …..(i)
 But since B lies on a lower IC as compared to C,

U at B < U at C ...(ii)
 Results (i) and (ii) contradict each other.
This shows that two ICs cannot intersect each other.
6.3 THE BUDGET LINE
6.3.1 Introduction
Given that preferences are monotonic, the consumer will like to consume more and more. But it
does not matter only what he desires, it will also matter that how much can he afford. The
maximum quantities of the two goods, he can possibly get, will depend upon his income and the
prices prevailing in the market. What possible utility level a consumer can realise will depend
upon the possible combinations of the two goods he can afford from his income and the market
prices. How much the consumer can afford is the subject matter of budget line.
For a study of budget line, it is first necessary to be familiar with the concepts of budget set and
budget constraint.
6.3.2 Budget set and budget constraint
Budget set refers to the set of possible combinations of the only two goods the consumer
consumes which he can afford from his income and given prices.
Given two goods X and Y and their respective prices Px and Py . The total expenditure incurred on
the two goods by the consumer is then:
Px.X + Py.Y = Total expenditure
Where X and Y are the quantities of the two goods purchased.
Let the income be 'm'. Clearly, so long as the two goods cost the consumer less than or equal to
income, the consumer can afford all such bundles or combinations. This situation can be expressed in
the form of a equation in the following way:
Px.X + Py.Y ≤ m
The equation is often referred to as budget constraint. The budget constraint says that the amount of
money spent on the only two goods which the consumer consumes must be no more than the income
of the consumer. (For a diagrammatic presentation of the budget set refer to Figure 6.4 given later.)
6.3.3 Budget Line
Meaning
We have learnt that a budget set is the whole collection of bundles of the two goods a consumer can
afford from his given income with each bundle costing either less than the income or exactly the
income.Budget line is a narrower concept as compared to budget set. A budget line is the graphical
presentation of the whole collection of the combinations of two goods, which costs the consumer
exactly his income. In this way the collection of combinations on the budget line is a part of
combinations in the budget set. The equation of a budget line is:
Px . X + P y . Y = m
Example
Suppose, the following is given about a consumer.
Income (m) = ₹50
Price of X (Px ) = ₹10 per unit
Price of Y (Py) = ₹ 5 per unit
It is assumed that consumer spends his entire income. One possible way is to buy only X. The
maximum of X he can buy is 5 units(= 50/10). Another possible way is to spend only on Y. He can
buy a maximum of 10 Y (= 50/5). Still another way is to spend 50% of income on X and 50% on Y.
He can buy 2.5X and 5 Y. Like these, there can be many other possibilities. If we avoid fractions, all
these possibilities areas given in Table 6.2.
Table 6.2
Consumption Possibilities Schedule
Combinations Good X Good Y Market Rate of Exchange
(units) (units) ∆Y
(Px/Py) or ∆ X
A 0 10 2Y : 1X
B 1 8 2Y : 1X
C 2 6 2Y : 1X
D 3 4 2Y : 1X
E 4 2 2Y : 1X
F 5 0 2Y : 1X
The 4th column records the rate at which the two goods can be exchanged in the market.
Suppose the consumer wants one more unit of X, which costs ₹10. Since his income is limited, in
order to obtain an extra unit of X, he must give up his plan to purchase ₹10 worth of Y. He can get 2
units of Y from ₹10. It amounts to that to obtain one unit of X he must give up 2 units of Y. The rate
at which the market requires sacrifice of one good to obtain extra unit of the other good is called
Market Rate of Exchange
(MRE). In exact terms:
¿
MRE = Oty . of the good needed ¿ be sacrificed Oty . of the good needed ¿ be obtained ¿
In our illustration, Y is sacrificed to obtain X, therefore,
∆Y 2
MRE = ∆ X = 1 =2
MRE can also be expressed as ratio of prices.
It is expressed as:
Price of the good obtained
MRE = Price of the good obtained
In our illustration, X is obtained and Y is Sacrificed
Therefore,
Px 10
MRE = P = 5 =2
y
Note that, MRE is costant throughout because Px and Py are costant throughout.
MRE is constant throughout because PX and P on the basis of which AX and AY are calculated are
constant throughout.
Graphical Presentation
Let good X be represented on the X-axis and good Y on the Y-axis. By plotting the consumption
possibilities on a graph, we can get the budget line. Refer to Figure 6.4.
Points A, B, C, D, E and F represent different consumption possibilities, which cost the consumer
exactly his income. Joining these we get budget line.
Budget Line is locus of different combinations of the two goods, which the consumer consumes
and which cost the consumer exactly his income.
Note that a budget line is a downward sloping straight line. It is downward sloping because to buy
more of one good, the consumer must reduce the purchase of the other good. It is a straight line
because market rate of exchange between the two goods is constant, further because prices of the
two goods are constant.
Budget line vs Budget set
Refer to Figure 6.4. In this figure, the budget line is AF, while the budget set is OAF. All bundles on
the budget line AF cost the consumer exactly his income. All bundles in the budget set OAF cost the
consumer exactly his income or less than income. In this way, budget line is a part of budget set.
It is the budget line, which is relevant for locating consumer's equilibrium because of the assumption
that consumer spends the entire income. In that case, equilibrium bundle must lie on the budget line
only.
6.3.4 Slope of Budget Line
Market rate of exchange, or the ratio of prices of the two goods is the value of the slope of budget
line.
Qty . of the good sacrificed
Slope = Qty , of the good obtained =MRE
Price of the good obtained
Or Slope = Price of the good sacrificed
In our illustration, Good X is obtained by sacrificing Y. Therefore,
∆Y
Slope = ∆ X
Px
Or Slope ¿ P
y
6.3.5 Shift of Budget Line

A budget line is constructed on the basis of the consumer's income (m), price of X (Px) and price of
Y (Py ). Therefore, if any one of these determinants changes, the budget line changes. There are
some exceptions where the budget line may not change. Let us see how the budget line shifts.
(1) Suppose income changes
Suppose income rises by 10 percent. As a result, the quantity of each good in each of the bundles
consumer can afford, must also increase by 10 percent. Suppose the bundle before the income
change was 10X + 20Y. After income rises by 10%, the composition of bundle rises to 11X + 22Y.
This will happen with every bundle, which is within the reach of the consumer.
Graphically, rise in income, with prices remaining unchanged, shifts the budget line O parallel
upwards as shown in Figure 6.5.
Before income rise, the budget line is AB. After income rise, it is A 1B1. If income falls, the budget
line shifts downwards to A2B2
(2) Suppose price of X changes

It is assumed that where there is change in price of X there is no change in income and price of Y.
Suppose Px falls by 10%. This raises the maximum purchase of X which consumer can make by
10%. The maximum purchase limit of Y remains unchanged because there is no change in P
Graphically, it means that fall in P x shifts the X-axis end of the budget line to the right along the X-
axis. In case of rise in Px, the X-axis end shifts to the left. The two possiblities are shown in Figure
6.6.
Given budget line AB before price of X changes. When P x falls, it shifts to the right, for example, to
AB1. When Px rises, it shifts to the left, for example, to AB2
(3) Suppose price of Y changes
s assumed that there is no change in income and price of X. Suppose P y falls. This raises the maximum
chase of Y, which consumer can make. The maximum purchase limit of X remains unchanged because
re is no change in P
phically, fall in P shifts the Y-axis end of the budget line along the Y-axis upwards. In case of rise in P ,
Y-axis end shifts along the Y-axis downwards. The two possibilities are shown in Figure 6.7.
en the budget line AB before P changes. When P falls, it shifts to A1B. When P rises, it shifts to A2B.
) When more than one determinants change

A large number of possibilities emerge depending upon the relative changes. Some cases are given
below
(i) When both Px and P change by the same percentage and in the same direction, there is parallel
shift, upwards in case of fall and downwards in case of rise.
(ii) When income and both the prices change by the same percentage and in the same
direction, there is no shift. The budget line remains unchanged. For example, a rise in
income by 10% with simultaneous increase in both prices by 10% leaves the budget line
unchanged. It is because the different bundles consumer can afford remains unchanged.
(iii) When Px falls and P rises, the shift is as follows (Figure 6.8).
The X-axis end shifts to the right while the Y-axis end shifts downwards. The new budget
line is A1B1
(iv) When Px rises and P falls, the shift is as shown in Figure 6.9.
The X-axis end shifts to the left while the Y-axis end shifts upwards. The new budget line is A 1B1
(v) When both Px and Py change in the same direction but in different percentages there will be a
shift but not a parallel one.
In addition to above, there are many other possibilities of shifts depending upon the nature of
change in determinants.
6.4 CONSUMER'S EQUILIBRIUM

6.4.1 Introduction
We are given a consumer's preferences, his income and the market prices of the two goods he
consumes. The preferences determine what the consumer will like to get. The income and the
market prices together determine the possible combinations of the two goods the consumer can afford.
Out of the various possible combinations the consumer can afford, he will choose the one which gives
him highest utility. This is how consumer attains equilibrium. What conditions must be fulfilled to
reach an equilibrium? This is the point of study in this section. Before we study the conditions, let us
state the assumptions about consumer's behaviour on which the analysis is based.
6.4.2 Assumptions
The main assumptions are:
(i) The consumer is rational.
This implies that the consumer aims at maximising satisfaction. Graphically, it means that
the consumer wants to reach as high on indifference curve as possible.
(ii) Utility is expressed ordinally.
It implies that utility is expressed in term of ranking (i.e. first, second, third, etc.) and not
in terms of exact units (i.e. 1, 2, 3, etc.).
(iii) MRS decreases continuously.
It means that as the consumer obtains more and more units of a good, the rate at which he
is willing to sacrifice the other good, goes on decreasing. It is another way of saying that
the Law of Diminishing Marginal Utility is working. Graphically, it means that the
indifference curves are strictly convex.
(iv) Utility is an increasing function of consumption.
It means that more quantity consumed means more utility. Such preferences are called monotonic
preferences. Graphically, it means that higher indifference curve represents higher utility level.
6.43 Conditions of Equilibrium
Given income and prices, and given that consumer spends his entire income and consumes both the
goods, and subject to the assumptions stated above, the consumer attains equilibrium when the two
conditions are fulfilled These are
(i) Marginal rate of substitution (MRS) equals Market rate of exchange (MRE).
(ii) MRS falls as more is consumed of one good in place of another. Let us explain these
conditions.
(i) First condition : MRS = MRE
Since MRE equals ratio of prices of the two goods, the condition can also be stated as
MRS = Ratio of prices = Px /Py
Given that the two goods consumed are X and Y. Further, suppose that consumer wants more of X in
place of Y, then MRS is the rate at which the consumer is willing to sacrifice Y to obtain one more
unit of X. On the other hand, MRE is the rate at which the consumer has to sacrifice Y units to
obtain one more unit of X.
Understandably, the transactions can take place only when MRS is higher or at least equal to MRE.
The consumer will continue to transact so long as MRS is higher than MRE. As he buys more of X,
MRS goes on falling and at some stage becomes equal to MRE. When MRS becomes equal to MRE,
he stops purchasing more. He has no incentive to buy more or less of X. The consumer comes at rest
and is in equilibrium.
Why is there equilibrium only when MRS equals MRE? Why is there no equilibrium when
MRS is not equal to MRE?
Suppose MRS is greater than MRE.
It means that to obtain one more unit of X, the consumer is willing to sacrifice more units of Y
then the market requires. In other words, the consumer is willing to pay price higher than market
requires. The consumer values X more than what market values. This induces the consumer to buy
more of X and buy less of Y. This brings down MRS. The consumer continues to consume more of X
till MRS becomes equal to MRE and the equilibrium is restored.
Now suppose that MRS is less than MRE.
It means that to obtain one more unit of X, the consumer is willing to sacrifice less units of Y than
the market requires. The consumer values less than when market values. He is willing to pay a price
lower than the market price. This induces the consumer to reduce consumption of X and in place
consume more Y. MRS start rising. The consumer stops reducing consumption of X till MRS rises
enough to become equal to MRE and equilibrium is restored.
To sum up, there will be no tendency on the part of consumer to change consumption of any of the
two goods if MRS equals MRE (or the ratio of prices). Let us now explain this condition graphically.
Refer to Figure 6.10. Given indifference map and budget line, MRS MRE condition graphically
implies :
MRS = MRE = Px/ Py
Slope of IC Slope of budget line.
The two slopes are equal where the budget line is tangent to the indifference curve, i.e., IC.
The tangency condition is fulfilled at E. This is consumer's equilibrium. The highest the consumer can
reach is the utility level indicated by the indifference curve 1 2. The utility maximising, i.e. optimum,
combination of the two goods is Ox1 of X plus Oy1 of Y.
The consumer can afford all the combinations on the budget line AB. Then, why does he choose E
only. What is wrong with combination F or combination G? The wrong is that both the combinations
lie on a lower indifference curve I2, which means lower utility. Why should the consumer choose a
lower utility level (I1) when he is conveniently getting the higher utility level (I 2), especially when
both cost him the same.
We can now generalise. Like the points F and G, every other point to the left of E or to the right of
E on the budget line will lie on a lower indifference curve, i.e., will have lower utility level as
compared to the tangency point. Therefore, the consumer will choose only the tangency point on
the budget line.
Can the consumer reach the indifference curve 13, i.e., a higher utility level? The answer is "No".
His income and market prices do not permit him to go beyond I2. The consumer cannot afford I3.
Can the consumer choose a point below the budget line? No, because this violates the assumption
that consumer must spend the whole of income. There is another reason. Any combination below the
budget line will lie on a lower indifference curve, which means lower utility level. The consumer
must choose a combination that lies on the budget line.
(ii) Second condition: MRS continuously falls
This is according to the Law of Diminishing Marginal Utility. The condition ensures that if MRS
is not equal to MRE, the falling MRS will lead to equality again, as explained in the first condition.
Graphically, the condition means that the indifference curve is strictly convex, i.e., rounded
throughout. There is no flat spot. This ensures a unique equilibrium.
POINTS TO REMEMBER
 The indifference curve analysis is based on ordinal utility as compared to the cardinal utility,
which is used in the utility analysis.
 The Cardinal Utility is expressed in terms of exact units as 1, 2, 3, etc., while the ordinal
utility is expressed in terms of ranking as first, second, third, etc.
 An Indifference Schedule is a table showing different combinations of the two goods such
that utility from each combination is the same. It is based on two asumptions : (i) As the
quantity of one good is increased the quantity of the other good must be decreased; and (ii)
decreased at decreasing rate.
 Marginal Rate of Substitution (MRS) is the rate at which the consumer is willing to sacrifice
one good to obtain one more unit of the other good.
 An indifference curve is a diagrammatic representation of an indifference schedule. It is
defined as the locus of different combinations of the two goods the consumer consumes
with each of the combination having the same utility.
 The value of Slope of an indifference curve between any two points is simply the MRS
between these points.
 An Indifference Map is the set of all possible indifference curves the consumer has in which
higher indifference curve has higher utility level.
 Monotonic preference means that as consumption increases total utility also increases.
The main properties of indifference curves are .
1. Slopes downwards from left to right.
2. Strictly convex towards the origin.
3. Higher indifference curve represents higher utility.
4. Two indifference curves cannot intersect each other.
 Budget set refers to the set of possible combinations of the two goods the consumer
consumes, which he can afford from his income and given prices. It is expressed as P x . X +
Py .Y m. These combinations cost the consumer exactly his income or less than the income.
 Budget line is the graphical presentation of the whole collection of the combinations of the
two goods which costs the consumer exactly his income. It is downward sloping and a
straight line.
 Market Rate of Exchange (MRE) is the rate at which the market requires the sacrifice of
one good to obtain one extra unit of the other good. MRE also equals the ratio of market
price of good obtained to the market price of the good required to be sacrificed.
 Slope of budget line = MRE = Ratio of prices.
 Budget line shifts when any one or more of its determinants — income and prices of the
two goods — changes.
 Consumer equilibrium means the combination of the two goods, which consumer can
afford and which gives him maximum satisfaction he possibly can get.
 The main assumptions behind consumer's equilibrium are .
(1) The consumer is rational i.e. wants to reach as high an indifference cun./e as possible.
(2) Utility is expressed ordinaly, i.e. in terms of ranking.
(3) MRS decreases continuously as more of one good is consumed by willingly sacrificing the
other good, i.e. indifference curves are strictly convex.
(4) Utility is increasing function of consumption, i.e. a higher indifference curve represents a
higher utility level.
 There are two conditions of consumer's equilibrium
(1) MRS = MRE or MRS = Ratio of prices.
(2) MRS continuously falls.
 The two conditions expressed graphically are
(1) Slope of indifference curve = slope of budget line. or budget line is tangent
to the indifference curve.
(2) Indifference curve is strictly convex.
EXERCISES
MULTIPLE CHOICE QUESTIONS Il Markl
(Answers at the end of exercises)
Choose the correct alternative in the following questions.
I. The Indifference Curve Analysis is different from the Utility Analysis because the IC Analysis is based on
:
(a) Cardinal utility (b) Ordinal utility
(c) Law of diminishing marginal utility (d) Law of equi-marginal utility
2. Expressing choices in terms of first preference, second preference, third preference and so on is
expression in terms of :
(a) Diminishing marginal utility (b) Cardinal utility
(c) Monotonic preference (d) Ordinal utility
3. An indifference schedule is based on the assumption that :
(a) The consumer consumes only two goods.
(b) Preferences are ordinal.
(c) Marginal rate of substitution is decreasing.
(d) All the above
4. Monotonic preferences in the Indifference Curve Analysis means that :
(a) Total utility increases as quantity of goods with the consumer increases.
(b) (b) Total utility decreases as quantity of goods with the consumer decreases.
(c) Both (a) and (b).
(d) Neither (a) nor (b)
5. As we move along an indifference curve, each point to the right shows :
(a) Higher utility (b) Lower utility
(c) Same utility (d) Initially higher, then same and ultimately declines.
An indifference curve slopes downwards from left to right because :
(a) Marginal rate of substitution is declining.
(b) Consumer must give up some units of one good to obtain more units of the other good.
(c) (c) Both (a) and (b)
(d) None of the above (HOTS)
7. A typical indifference curve is downward sloping convex curve because as we move downwards along
the indifference curve, the slope of the curve:
(a) Decreases (b) Increases
(c) Unchanged (d) Initially increases, then decreases

8. An indifference curve to the right shows higher utility because of :
(a) Monotonic preferences (b) Cardinal preferences
(c) Ordinal preferences (d) None of the above
9. A consumer consumes only two goods X and Y. Let PX and P be their prices and Qx and Q the
quantities of these goods respectively. Let m be income. The budget constraint equation is :
(a) Px . Qx + Py. Qy = m (b) Px . Qx + Py .Qy ≤ cm
(c) Px . Qx + Py. Qy > m (d) None of the above
10. A consumer consumes only two goods X and Y. Let PX and P be their prices and Qx and Q . The
quantities of these two goods respectively. Let m be the income. The budget line equation is :
(a) Px . Qx + Py. Qy = m
(b) Px . Qx + Py. Qy ≥ m
(c) Px . Qx + Py. Qx < m
(d) Px . Qx + Py. Qx ≤ m
11. Slope of a budget line is:
(a) Increasing throughout (b) Decreasing throughout
(c) Constant throughout (d) Fluctuating throughout
12. A budget line can shift if:
(a) Price of the good on X axis changes. (b) Price of the good on Y axis changes.
(c) Income of the consumer changes (d) Any of the above
13. In the Indifference Curve Analysis, the consumer is in equilibrium when:

(a) Budget line is tangent to indifference curve.
(b) Indifference curve is convex.
(c) Both (a) and (b)
(d) None of the above (HOTS)
14. When price of one or both the goods consumer consumes falls, the consumer's utility level at
equilibrium in the IC analysis:
(a) Falls (b) Increases
(c) Remains unchanged (d) Uncertain
15. Suppose prices of only two goods the consumer consumes are doubled, and at the same time income is
also doubled, the consumer's utility level at equilibrium in the IC analysis:
16. Suppose prices of one of the two goods the consumer consumes falls and that of other rises, the
consumer's utility level at equilibrium in the IC analysis:
SHORT ANSWER QUESTIONS-I [3 Marks]
Answer the following questions in about 60 words.
1. Distinguish between cardinal utility and ordinal utility.
2. Explain the concept of Marginal Rate of Substitution.
3. Show how MRS is measured on an indifference curve. (HOTS)
4. Explain the concept of indifference map. Use diagram.
5. State three properties of an indifference curve.
6. Why is an indifference curve negatively sloped? Explain.
7. Why is an indifference curve strictly convex? Explain. (HOTS)
8. Why does a higher indifference curve represent a higher level of utility? Explain.
9. What is a budget set? Show it on a diagram.
10. Explain the concept of market rate of exchange.
11. What is budget line? State two alternative measures of its slope.
12. State the determinants of budget line. What happens when any one of the determinant changes?
13. Explain what is meant by 'consumer is rational'.
14. What is consumer's equilibrium? State its conditions under Indifference Curve Analysis.
SHORT ANSWER QUESTIONS-II [4 Marks]
1. Explain the concept of Marginal Rate of Substitution with the help of a schedule. (HOTS)
2. Explain the concept of Indifference Map. Use diagram.
3. Distinguish between budget set and budget line. Use diagram.
4. Explain the concept of budget line. Use diagram.
5. Explain how change in income affects the budget line. Use diagram.
6. Explain the effect of change in the price of a good on the budget line. Use diagram.
7. What is the effect of simultaneous and same percentage change in the prices of both the goods on the
budget line? Use diagram. (HOTS)
8. State the assumptions on which consumer's equilibrium in the Indifference curve analysis is based.
9. Explain any two assumptions the consumer's equilibrium is based in Indifference Curve Analysis. 10.
Explain why MRS must equal MRE when a consumer is in equilibrium.
11. Suppose MRS is greater than the ratio of prices. Explain how will a consumer reach equilibrium.
(HOTS)
12. Suppose MRS is less than the ratio of prices. What is likely to happen so that consumer's equilibrium is
restored? (HOTS)
LONG ANSWER QUESTIONS [6 Marks]

1. Explain the concept of Indifference Schedule and the elements on which the schedule is based.
2. Explain the concept of MRS with the help of an example and diagram.
3. Explain the concept of Indifference Map and the assumption about preferences on which it is based.
4. Explain three properties of indifference curve.
5. Distinguish between budget set and budget line and their equations. Use diagram.
6. Explain the effect of fall / rise in income of the consumer on the budget line. Use diagram
7. Explain the effect of the following on budget line : (a) Fall in price of good shown on the X-axis and (b)
Rise in the price of the good shown on the Y-axis.(HOTS)
8. Explain the assumptions on which the Indifference curve analysis is based.
9. Explain the conditions of consumer's equilibrium in the Indifference Curve Analysis. Use diagram.
10. Show taht two indifference curves cannot intersect each other.
SOME IMPORTANT QUESTIONS
1. Using indifference curve approach, explain the conditions of consumer's equilibrium.
2. Define budget set.
3. Explain the three properties of indifference curves.
4. Explain the concept of MRS by giving on example. What happens to MRS when consumer moves
downwards along the indifference curve? Give reasons for your answer.
5. Explain why is an indifference curve (i) downward sloping from left to right and (ii) convex.
6. Explain the conditions of consumer's equilibrium with the help of indifference curve analysis.
7. Explain the concepts of (i) MRS and (ii) budget line equation with the help of numerical examples.
8. A budget set is a collection of such bundles of goods that give same satisfaction. True or False? Give
reason.
Ans. False. A budget set is a collection of such bundles of goods which a consumer can afford, given income
and prices.
9. Explain the distinction between the equations of budget line and budget constraint.
10. A consumer consumes only two goods X and Y, both priced at ₹2 per unit. If a consumer chooses a
combination of two goods with Marginal Rate of Substitution equal to 2, is the consumer in
equilibrium? Why or why not? What will a rational consumer do in this situation? Explain.
VALUE BASED QUESTIONS
1. A consumer consumes only two goods. Consumer awareness programmes bring the consumer into a
better bargaining position. Explain how does it affect the budget line of the consumer. Use diagram.
2. A consumer is in equilibrium but has incomplete information about the market. Complete information
can bring him into a better bargaining position. Explain how will complete information influence the
consumer's equilibrium under Indifference Curve Analysis.
3. A consumer who is below the poverty line is in equilibrium. Taking a policy decision government
decides to grant cash transfers to the households below the poverty line. Show, with the help of the
Indifference Curve Analysis, that this consumer would be better of after cash transfer. Use diagram.
4. Welfare ofthe poorer sections ofthe society is a big priority. What possible step can the government take
to achieve this objective. Explain with the help of Indifference Curve Analysis. Use diagram.
Answer to the Multiple Choice Questions

1. (b) 2. (d) 3. (d) 4. (c) 5. (c) 6. (b) 7. (a) 8. (a) 9. (b) 10. (a) 11. (c) 12. (d)
13. (c) 14. (b) 15. (a) 16. (d)
CHAPTER: 7 DEMAND
Demand is one of the force determining market price. In market, demand for a good is
influenced by own price of the good and a host of other factors. The established inverse
relation between own price of the good and its demand is termed as Law of Demand.
7.1 INTRODUCTION
In Chapter 3, we studied about the central problems of an economy. We studied how these
problems arise. But how these problems are solved? In a free market economy, the economic
problems are solved by the automatic functioning of the price mechanism. What is a price
mechanism? It is a process of price determination which operates through the forces of demand and
supply. The price of a good or a service is determined when demand and supply of the good become
equal at a price commonly agreed between the buyers and sellers.
To study a price mechanism, therefore, it is necessary first to understand (a) the relation between
change in price and the consequent change in demand, and (b) the relation between change in price
and the consequent change in supply. Once we understand these two relations we can put them
together to study the process of determination of price. This divides our study into three parts : (a)
demand, (b) supply, and (c) price determination. In this chapter we will study about demand.
7.2 CONCEPTS
Good
The term 'good' is used for any commodity or service for which there is demand. Goods can be
'economic' and 'free'. An economic good is any good or service which must be paid for in money
or in other words, i.e., it is produced for sale in the market. Free goods are those which are in
unlimited supply and have no market price. Air, sunshine etc. are some examples of free goods. The
term 'good' in microeconomics means 'economic good' only. The study of free goods is outside the
scope of microeconomics.
Market
The term 'market for a good', in a wider sense, means an area in which buyers and sellers of
that good are in contact with one another. The range of this area may extend to the whole world.
The range depends on the nature of the good. The perishable goods normally have a shorter range.
Long-life goods may have a very wide range.
Price
The term price refers to the amount of money that has to be paid for a commodity or
service. Suppose you pay 50 to buy a book. 50 is the price of the book.
Demand
The demand for a good is defined as the quantity of that good a consumer or consumers
taken together are willing to buy at a particular price during a particular period of time.
Quantity, price, period of time and, above all, willingness to buy are the four characteristics of any
statement about the demand for a good. No statement about the demand for a good is complete
without these characteristics.
7.3 DETERMINANTS OF DEMAND

In this context a distinction is made between (i) demand by a single consumer and (ii) market
demand, i.e. demand by all the consumers of that good taken together. The factors that influence the
demand of an individual consumer also affect the market demand. But there are some additional
factors that influence the market demand. Let us explain the two situations separately.
7.3.1 Factors Influencing Demand for a Good by an Individual Consumer
Generally, the demand for a good by an individual consumer is said to depend on
(i) Income of the consumer, (ii) Own price of the good, (iii) Prices of other goods, (iv) Tastes and
preferences of the consumer.
(i) Income of the consumer
For studying the influence of income on demand, a distinction is made between (a) normal good
and (b) inferior good. The distinction is not based on the quality of the good but on the basis of
likings and dislikings for the good that develop with change in income levels. A consumer who likes a
good when his income was low may not like the same good when his income is high. For example, at
a low income level a consumer buys coarse cloth because he cannot afford fine cloth. At low income,
coarse cloth is a perfectly normal good for him. But when his income rises the consumer may reduce
or give up the consumption of coarse cloth and instead buy fine cloth. Now at higher income level,
coarse cloth becomes an inferior good.
We have given the above example to show that no good is inferior at all times and for all. It is the
income level that makes a good inferior for an individual. A good may be inferior for a consumer with
high income, but at the same time it is quite normal for the consumer with low income. So, whether a
good is inferior or normal does not depend on the quality or the utility content of the good but on the
income level of a consumer. With this background, we can now conveniently define normal and
inferior goods.
(a) Normal good : A good whose demand by a consumer rises with the rise in the income of
that consumer is called a normal good. For example, if a consumer buys more of toned milk for his
family as his income rises, then toned milk will be called a normal good. Demand for a normal good
falls with the fall in income.
(b) Inferior good : A good whose demand by a consumer falls with the rise in income of
that consumer is called an inferior good. For example, if a consumer reduces the consumption of
toned milk when his income rises, then toned milk is an inferior good for that consumer. Remember,
toned milk is not always an inferior good. At lower income levels it may be a normal good. Like this,
no good is either always normal or always inferior. It is the income level of the individual consumer
that makes a good normal or inferior for him. Demand for an inferior good rises with the fall in
income.
(ii) Own price of the good
Generally, with some exceptions the demand for a good rises with fall in price and falls with
the rise in price of that good. This is inverse relation between price and demand. This relationship
does not hold good in case of a Giffen good. In case of a Giffen good there is direct relation between
price and demand. (The explanation of a Giffen good is beyond the scope of the syllabus.)
(iii) Prices of other goods
Other goods for this purpose can be classified into three categories: substitutes, complementary
and unrelated. The likely effect on demand for the given good of change in price of some other good
is explained as follows:
The effect of change in price of a substitute good
Two goods are substitutes if one can be used in place of the other. These are also called
competitive goods because they compete with each other for demand in the market. Suppose we want
to examine the change in demand for tea on account of change in price of coffee. Suppose the price of
coffee falls. Now, what is likely to happen to the demand for tea? Since the relative price (i.e the
proportional price) of coffee is now lower, the consumer is likely to consume more coffee in place of
tea. The demand for tea is likely to fall. As such, with the fall in price of a substitute (coffee) the
demand for the given good (tea) falls. Again, with the rise in price of a substitute the demand for a
given good rises. So, there is a positive relation between the price of a substitute and the demand
for the given good.
More examples of substitute goods
 Apples and oranges
 Different vegetables
 Brands of readymade clothes
 Cola, orange, lemon
 Brands of toothpaste
Effect of change in price of a complementary good
Two goods are complementary to each other when they are used jointly. They are also called
joint goods. For example, tea and milk are complementary goods.
Suppose the price of milk rises. What is likely to happen to the demand for tea? Rise in the price
of milk reduces demand for milk. Since milk is used with tea the demand for tea is also likely to fall.
So, a rise in the price of a complementary good (milk) leads to fall in demand for the given good
(tea). Again, fall in price of a complementary good is likely to lead to rise in demand for the given
good. Thus there is an inverse relation between the price of a complementary good and demand for
the given good.
More examples of complements
 Tea leaves, milk, sugar
 Right shoe and left shoe
 Saree and blouse
 Salt and vegetables
 Shirt and trouser
 Sand and cement
Unrelated goods
If a good is neither substitute nor complementary of the given good, it is categorised as unrelated
good. For example, petrol and tea are unrelated goods. A change in the price of petrol has no direct
effect on demand for tea.
(iv) Tastes and preferences of the consumers
This is the basic factor behind the demand for a good by an individual consumer. Unless the
consumer has a taste for a good, he is not likely to buy that good howsoever cheap it is and
howsoever rich is the consumer. You will normally find that when fashions change the demand for old
fashioned goods declines very sharply, while the demand for latest fashion goods rises very sharply.
So, with the change in tastes and preferences, demand also changes.
7.3.2 Factors Influencing Market Demand for a Good
Market demand for a good is the sum of demands of all the consumers taken together for that
good. It can be defined as, the quantity of a good that all the consumers taken together, of that
good are willing to buy at a given price during a period of time.
Since the market demand is the sum of demands of individual consumers, it is obviously
influenced by all the four factors explained above that influence the demand of an individual
consumer. We can add two more factors in this list specific to market demand. These are :
(i) Population
More the population, more likely the number of consumers of a good. Not only the total population but its
composition, like age, also influences the demand for a good. It is because the needs of children, young and
the old, differ. Needs of male and female population also differ.
(ii) Distribution of income among people
In whose favour is the income distribution? Is it in favour of the rich or the poor? Is it in favour of
the young or the old? The needs of different groups differ. Clearly, if the income distribution is more
in favour of the rich, comforts and luxuries will be more in demand. If it is in favour of the poor,
necessities would be more in demand.
7.4 DEMAND SCHEDULE

(i) Of an individual consumer
A table showing different quantities of a good a consumer is willing to buy at different prices,
assuming no change in other factors influencing demand, is called a demand schedule of that
consumer. Take, for example, the following (Table 7.1)
Table 7.1
Demand Schedule of a Consumer for Good X
Price (₹ per unit) Demand (units)
5 100
4 200
3 300
2 400
The above schedule is drawn on the assumption that there is an inverse relation between price and
demand and that as price changes, there is no change in other factors influencing demand like income,
prices of other goods and tastes.
(ii) Of market
The market demand schedule for a good is merely the sum of demand schedules of individual
consumers of that good. Suppose there are only two consumers, A and B, of a good in the market. Let
their demand schedules be as follows (Table 7.2):
Table 7.2
Derivation of Market Demand Schedule
Price (₹ per unit) Demand by A Demand by B Market Demand (Units)
(Units) (Units) (A+B)
5 100 50 150
4 200 100 300
3 300 150 450
2 400 200 600
In Table 7.2, Column 4 gives market demand which is merely the sum of demands by A and B
shown in Columns 2 and 3 at different prices shown in Column 1. The market demand schedule
can now be defined as a table showing different quantities of a good all consumers, taken
together, of that good are willing to buy at different prices, assuming there is no change in other
factors influencing demand.
7.5 LAW OF DEMAND
The law of demand is an established law of economics. It indicates the generalised relationship
between change in price of a good and the consequent change in demand for that good.
Statement of the Law
The law of demand states that there is an inverse relation between change in price of a good
and the consequent change in demand for that good, assuming that there is
no change in all other factors influencing demand for that good. It implies that when price of a
good falls, the demand for the good rises, and when price rises the demand falls.
The above statement of the law is represented on a diagram as the downward sloping demand
curve from left to right. It is also called negatively sloped demand curve. (See Figures 7.1 and 7.2).
Demand schedules 7.1 and 7.2 are also based on this law.
Explanation of the Law
Why is demand more at a lower price? We will explain the inverse relation between price and
demand with the use of these two principles : (a) MU = Price and (b) the law of equi-marginal utility.
(a) On the basis of the MU = Price Principle
Given that a consumer purchases a good up to the point where marginal utility of the good
becomes equal to the price of that good.
MU = Price
Now, suppose that the price of the good falls, and therefore, it becomes lower than the MU. It
means that MU is now greater than price.
MU > Price
Since MU is greater than the price, it will induce the consumer to buy more units of the good. In
fact, the consumer must buy more in his natural endeavour to get maximum gain. It shows that when
price of a good falls, its demand rises. (The consumer will continue to buy more until MU falls
enough to be equal to price again).
(b) On the basis of the Law of Equi-Marginal Utility

The law states that a consumer is in equilibrium when the ratio of MU to price, in case of each
good consumed is the same. In a two goods, X and Y, case then a consumer is in equilibrium when.
M x MU y
=
Px Py
Given that the consumer is in equilibrium and price of X falls. This change disturbs the
equilibrium equality and converts it into the following inequality
M x MU y
>
Px Py
It means that, after fall in P x, MU of last rupee spent on X becomes greater than the MU of the last
rupee spent on Y. This induces the consumer to buy more of X by transferring expenditure from on Y.
This shows that when price of a good falls, its demand rises. (The consumer will go on buying
more of X till he reaches equilibrium again.)
7.6 DEMAND CURVE AND ITS SLOPE
A demand curve is simply the graphical representation of a demand schedule and carries the same
explanation and assumptions.
Slope of a curve is the ratio of change in the value of variable on the y-axis to change in value of
variable on the x-axis between two points of the curve. If the ratio has a negative value the curve is
downward sloping from left to right. If the ratio has a positive value the curve is upward sloping from
left to right.
In case of demand curve, price is shown on the Y-axis and quantity demanded is shown on the X-
axis. In case of a normal good, according to the Law of Demand, when price of a good changes, the
quantity demanded of good changes in opposite direction. When price falls demand rises. When price
rises demand falls. Since there is an inverse relationship between price and demand, the slope of
demand curve must be negative and demand curve slopes downwards from left to right.
7.6.1 Of an Individual
The following demand curve in Fig. 7.1 is based on Table 7.1, which shows the demand schedule
of a consumer.
What is the main characteristic of this demand curve D? It is downward sloping from left to right.
Why? Because there is inverse relation between price and demand. The demand curve is a straight
line. But it need not necessarily be a straight line always. It can be a hyperbola also (see Figure 7.2).
Whether a demand curve is a straight line or hyperbola, for a normal good it is generally downward
sloping.
We can now define a consumer's demand curve for a good. An individual's demand curve for a
good is the locus of points where each point shows the quantity of a good which a consumer is
willing to buy at a price during a given period of time, assuming no change in all other factors
influencing its demand. For example, point E on demand curve D shows that at price OP the
consumer is willing to buy OQ quantity of good.
7.6.2 Market Demand Curve

Market demand curve of a good can be derived by taking the horizontal sum of demand curves
of all the individual consumers of that good. Let us derive the 5 curve on the basis of data in Table
7.2. For this purpose, we first draw the individual demand curves of consumers A and B and then
take their horizontal sum. The market demand curve so derived is given in Figure 7.3.
Demand curves A and B are individual demand curves of consumers A and B. Demand curve M is
the market demand curve derived by taking the horizontal sum of demand curves A and B. For
example, at price OP the demand by A and B are respectively PQ A and PQB . The market demand at
the price is the sum of PQ A and PQB, i.e. PQM. Similarly, we can derive other points. By joining all
these points we get the market demand curve M.
We can now define a market demand curve for a good. Market demand curve for a good is the
locus of points where each point shows the quantity of a good all consumers of that good, taken
together, are willing to buy at a price during a period of time, assuming no change in all other
factors influencing demand. A typical market demand curve for a good is downward sloping from
left to right indicating the inverse relation between price and demand.
7.7 MOVEMENT ALONG THE DEMAND CURVE AND SHIFT OF DEMAND CURVE
7.7.1 Movement along the Demand Curve (Change in Quantity Demanded)
When demand of a good rises due to fall in the price of that good only, it is termed as extension of
demand. When demand falls due to rise in the price only, it is called contraction of demand. The
alternative term used for extension and contraction is 'Change in Quantity Demanded'. Graphically,
it means movement along the demand curve. Take, for example, Figure 7.4.
At price OP, the demand is PQ. When price falls to OP 1 demand rises to P1Q1. In this situation,
consumer moves from Q to Q1 downwards but remains on the same demand curve this is 'extension'.
When price rises to OP2, demand falls to P2Q2. Once again, the consumer moves along the same
demand curve to Q2 this is 'contraction'
7.7.2 Shift of the Demand Curve
(Change in Demand)
Meaning of 'Change in Demand'
Demand schedule is based on the assumption that when price changes, there is no change in all
other factors influencing the demand. What are these other factors? These are income, prices of the
related goods and tastes. Now, suppose any one of these factors, say income, changes while price
remains constant. Suppose, income of the consumer rises. If the good is normal, it will lead to rise in
demand. Such a change in demand is termed as change in demand and in the language of graph it is
termed as shift of demand curve.
Change in demand of a god is defined as change in demand due to change in the factor other
than the own price of good.
The terms used for such changes is 'increase' and ‘decrease’. If due to change in income, dema
more, it is expressed as increase in demand. If it is less it is expressed as decrease in demand.
Shift of Demand Curve
What happens to demand schedule or a demand curve in this situation? The demand schedule chang
the demand curve shifts. The old demand schedule and demand curve are no longer valid. Why so? It is
because a demand schedule or a curve is based on the assumption that there is no change in factors other
the price. So when a change occurs in any factor other than the price, the schedule or curve also changes
When demand increases, the demand curve shifts to the right. When demand decreases, the demand curv
shifts to the left. and 'decrease'.
In Figure 7.5, the original demand curve is D. On this demand curve, at price OP, quantity
demanded is PQ. When suppose the income rises, demand at the same price OP rises to PQ 1, which
must lie on a new demand curve D1 this is 'increase' in demand. When income falls demand curve
shifts to the left, i.e. to D2 this is 'decrease' in demand. It is assumed that good X is a normal good. In
case of an inferior good, opposite happens.
Specific Situations of Shift of Demand Curve
The demand for a good is said to shift when 'factors other than the own price of the good' change.
The specific situations of such shifts are summarised in the box given below :
Situations of Shift of Demand Curve of a Good
Increase in Demand Decrease in Demand

(Demand curve shifts to the right) (Demand curve shifts to the left)
Demand (Units)
Fig . 7.6 : Increase in demand
l. Rise in prices of substitutes.
2. Fall in prices of complements.
3. Rise in income (in case of normal good).
4. Fall in income (in case of inferior good).
5. Favourable change in tastes.
x
Demand (Units)
Fig. 7.7 : Decrease in demand
1. Fall in prices of substitutes.
2. Rise in prices of complements.
3. Fall in income (in case of normal good).
4. Rise in income (in case of inferior good).
5. Unfavourable change in tastes.
POINTS TO REMEMBER
 An economic good is one which must be paid for in money, or which is produced for sale
in the market.
 Market means an area in which buyers and sellers are in contact with one another.
 Price is the amount of money that has to be paid for a good.
 Demand for a good is the quantity of that good, consumers are willing to buy at a price
during a period of time.
 Demand for a good by an individual consumer is influenced by (1) income, (2) own price
of the good, (3) prices of related goods and (4) tastes and preferences.
 When income rises, demand for a normal good rises but demand for an inferior good falls.
 When price rises, demand for a good generally falls.
 When price of a substitute good falls, the demand for the given good falls.
 When price of a complementary good falls, the demand for the given good rises.
 Market demand for a good is the total demand by all the consumers of that good. In
addition to the four factors influencing demand by an individual consumer, market demand
is also influenced by (1) population and (2) distribution of income.
 A demand schedule shows different quantities of a good a consumer is willing to buy at different
prices. A market demand schedule of a good is the sum of demand schedules of individual
consumers of that good.
 A demand curve is the graphical representation of a demand schedule. An individual's demand
curve is the locus of points where each point shows the quantity of a good, which the consumer is
willing to buy at a price during a period of time.
 A market demand curve is the locus of points where each point shows the quantity of a good all
consumers of that good taken together are willing to buy at a price during a given period of time.
 The law of demand states that there is an inverse relation between a change in the price of a good
and the consequent change in the demand for that good, assuming no change in all other factors
influencing the demand.
 Shift in demand of a good is defined as change in demand due to change in the factor other than the
price of that good. The change in demand is expressed as increase and decrease. It is also termed as
the change in demand.
 Graphically, shift in demand means shift of demand curve. If there is increase in demand, the
demand curve shifts to the right. If there is decrease in demand, the demand curve shifts to the left.
 When demand of a good rises due to price only, it is called extension of demand. When demand falls
due to price only, it is called contraction of demand. Such change, extension of contraction is also
called Change in quantity demanded. In terms of curve, it means movement along the demand
curve.
EXERCISES
MULTIPLE CHOICE QUESTIONS [1 Markl
(Answers at the end of exercises)
Choose the correct alternative in the following questions.
1. A statement about demand of a good includes information about :
(a) Price (b) Quantity (c) Period of time (d) All the above
2. An "inferior" good is one which is :
(a) A low quality good (b) A low priced good
(c) Below the income status (d) All the above
3. When demand for one good falls due to rise in price of the other good, the two goods are likely to be :
(a) Complements (b) Substitutes (c) Competitive (d) Not related
4. "Change in quantity demanded" of a good is on account of change in :
(a) Price of the related good (b) Own price of the good
(c) Income of the buyer (d) Tastes
5. A demand curve "shifts" due to change in :
(a) Tastes (b) Income
(c) Price of the related goods (d) All the above
6. Downward sloping demand curve shows that :
(a) As price falls demand falls (b) As demand falls price falls
(c) As price rises demand falls (d) As price rises demand rises
7. Spot the inferior good •
(a) Wheat (b) Bajra (c) Rice (d) None of the above (HOTS)
SHORT ANSWER QUESTIONS-I [13 Marksl
1. State the factors on which demand of a good by an individual consumer depends. Explain one.
2. Explain any two factors affecting demand of a good by an individual consumer.
3. Distinguish between a normal good and an inferior good.
4. Explain how change in income affects the demand of a good.
5. Distinguish between substitute goods and complementary goods by giving examples.
6. Explain how distribution of income affects the demand for a good.
7. Define demand schedule. What is the main assumption behind this schedule?
8. Define demand curve. What is the main assumption behind this curve?
9. State the law of demand. Represent the same on a diagram.
10. Explain the difference between 'change in demand' and 'change in quantity demanded'.
11. What do you mean by 'increase' and 'decrease' of demand?
12. What do you mean by 'extension' and 'contraction' of demand?
13. Distinguish between 'extension' and 'increase' of demand.
14. Distinguish between 'decrease' and 'contraction' of demand.
15. Show increase and decrease of demand on a diagram.
SHORT ANSWER QUESTIONS-II [4 Marks]
1. State the factors influencing 'market demand' of a good. Explain any one.
2. State the factors influencing demand by an individual consumer. Explain any two.
3. Explain how prices of the related goods affect demand for a good.
4. Distinguish between a normal good and an inferior good. Give one example of an inferior good.
(HOTS)
5. Define a complementary good. How does change in price of one complementary good affects demand
for another complementary good? Give one example.
6. Define market demand. How do 'population' and 'distribution of income' affect market demand?
7. Define a demand schedule. Prepare a demand schedule on the basis of the law of demand.
8. Define and draw a demand curve. State the assumption behind this curve.
9. Explain the term 'shift of demand curve'. Use diagram.
10. Explain the term 'movement along the demand curve'. Use diagram.
1. Define demand. Explain the factors affecting demand by an individual consumer.
2. State the factors influencing market demand of a good. Explain any two.
3. What is market demand? Explain the process of deriving a market demand curve.
4.
Explain the distinction between 'shift in demand curve' and 'movement along the demand curve'. Use
diagram.
1. Define the market demand.
2. Why is a good called an inferior good?
3. When is a good called a normal good?
4. Explain the meanings of normal goods and inferior goods.
5. Distinguish between 'change in demand' and 'change in quantity demanded' of a commodity.
6. Define market demand. State the law of demand and the assumption behind it.
7. State three causes each for a rightward shift and a leftward shift of demand curve.
8. Explain the effect of increase in income on demand of a good.
9. Explain the effects of rise in prices of the related goods on demand of a good.
10. What is the relation between good X and Y in each case, if with the fall in price of X demand for good
Y (i) rises and (ii) falls? Give reasons. (HOTS)
11. Explain the law of demand with the help of a demand schedule.
12. Demand for a good increases with the increase in the income of its buyer. True or false? Give reason.
Ans. False. Demand increases only in case of a normal good.
13. If the good X and Y are substitutes, a rise in the price of X will result in a rightward shift in demand
curve of Y. True or False? Give reason.
Ans. True, because a rise in price of X makes Y relatively cheaper which leads to 'increase' in demand for Y.
14. How does change in price of a complementary good affect the demand for the given good? Explain
with the help of an example.
15. Distinguish between an inferior good and a normal good. Is a good which is inferior for one consumer
also inferior for all the consumers? Explain.
16. A and B are substitute goods. Explain the effect of rise in price of A on the demand for B.
17. A and B are complementary goods. Explain the effects of change in price of A on demand for B.
1. Below poverty line households are given cash grant by government every month for purchasing wheat,
a normal good. Explain its effect on demand for wheat by these households. Use diagram.
2. There is a mass campaign against consuming tobacco in the country. Explain, and show graphically, its
likely impact on market demand for tobacco.
3. Government aims at discouraging consumption ofjunk food but only through the market. What, any
one, option is available to the government to influence the market demand for junk food. Explain.
1. (d) 2. (c) 3. (a) 4. (b) 5. (d) 6. (c) 7. (d)
CHAPTER: 8 PRICE ELASTICITY OF DEMAND
The mathematical method of measuring the percentage change in demand caused by one percentage
change in own price of the good is Price Elasticity of Demand.
8.1 INTRODUCTION
Elasticity refers to degree of response. Elasticity of demand means degree of response of demand.
Demand responds to price, income, prices of related goods and tastes. Out of these factors tastes
cannot be expressed in numerical terms. So, elasticity of demand cannot be numerically expressed
with respect to change in tastes. Elasticities with respect to price of the given good, income and price
of the related good are termed as price, income and cross elasticities respectively. Income and cross
elasticities are beyond the scope of the book. Price elasticity of demand for a good is explained below.
8.2 CONCEPT OF PRICE ELASTICITY

8.2.1 Meaning
Price elasticity of demand (Ep) is a measure of degree of response of demand for a good to change i
price. By degree, here we mean the rate of change. Suppose E of a good is (-)2. (Minus sign refers to
inverse relation between price and demand.) It means that if price of a good changes by one percent,
demand for the good changes by 2 percent. Now we can define the Ep as a measure.
Ep measures the percentage change in quantity demanded of a good due to one percent
change in the price of that good.
For example, if E = (-) 3, it means that one percent fall in price leads to 3 percent rise in demand,
or one percent rise in price leads to 3 percent fall in demand.
8.2.2 Actual Value and Absolute Value
The difference is explained with reference to Ep of a 'normal' good only. The Giffen good case is
beyond the scope of this study.
In case of a normal good, there is inverse relation between price and demand. When price falls,
demand rises. Numerically, a price fall is a negative change, and a rise in demand a positive change.
The normal percentage method of calculating Ep is .
P ∆Q
EP ¿ Q × ∆ P
When price falls, ∆P has a negative sign and ∆Q has a positive sign. In the measure, P, Q and ∆Q
are positive, while ∆P is negative. It gives EP a negative (minus) value. This is the actual value of EP
Reading a value, ignoring minus sign attached to it, is called the absolute value. Suppose actual
value of E = -3. Its absolute value is 3. In the language of mathematics, the absolute value of -3 is
recorded as [-3]. (The two bars are called mods.)
Both, actual values and absolute values, are helpful in the study of E p. If the purpose is pure
calculation, actual value gives a correct picture (i.e. the sign indicates whether the good is a normal
good or a Giffen good). If the purpose is comparison of two or more EPS, the absolute value is useful.
ose, the Eps of goods X and Y are -2 and -3 respectively. These are actual values. But, on comparing
wo, -3 is taken to be greater than -2, because we have taken absolute values. Good Y is more elastic
use a one percent change in price bring a 3 percent change in demand for Y, while only 2 percent
ge in demand for X.
METHOD OF MEASUREMENT
e are three methods of measurement of Ep
ercentage change method, (ii) Geometric (or point) method and (iii) Expenditure method. We will
ain only the percentage change method. Geometric method and expenditure methods are beyond the
e of syllabus. (A brief introduction to these methods is given in appendix.)
Percentage Change Method
According to the percentage change method,
Percent change∈quantity demanded
EP = Percent change ∈ price
hat, in this method, numerator and denominator both are in percentages. It means that in whatever units
and demand are expressed, it is not going to affect the measure of EP. EP is thus independent of choice
ts. It is an important property of the method.
ose, when price of a good falls from 5 per unit to 4 per unit the demand for that good rises from 100
to 200 units. Let us present this data in the form of a table (8.1).
Table 8.1
Price per unit Qty. demanded
(₹) (Units)
5 (P1) 100 (Q1)
4 (P2) 200 (Q2)
∆Q
Now,percentage change in quantity demanded = Q × 100 ,
1
Where ∆Q = Q2 – Q1
∆P
entage change in price = P × 100 , Where ∆P = P2 – P1
1
∆Q
×100
Q1 ∆Q P 1 P1 ∆ Q
∴ E p= = × = ×
∆P Q1 ∆ P Q1 ∆ P
×100
P1
tituting the values given in table 8.1,
P1 ∆Q 5 100
Ep = Q × ∆ P = 100 × ¿ ¿
1
minus sign signifies inverse relation between price and demand. The numerical value 5 indicates that
price falls by I per cent demand rises by 5 per cent.
[While comparing two Eps minus sign should not be considered. It means that (-) 5 should be
taken as greater than (-) 4.]
8.3.2 Categorisation of the Numerical Values of E
Before we explain the second method of measuring E p, let us see that in how many categories the
measures of Ep are put. The numerical values are put into the following five categories. (Note that
while comparing Ep the minus sign is ignored) :
Value of Ep Category
EP = 0 Perfectly inelastic demand
EP < 0 Inelastic demand
EP = 0 Unitary elastic demand
EP > 0 Elastic demand
EP = ∞ (infinity) Perfectly elastic demand

Value of EP can vary from 0 to ∞. Conceptually, there are only three categories: elastic, inelastic and
unitary elastic.
The demand for a good is said to be elastic when E P is greater than 1; inelastic when E P is less
than l; and unitary elastic when EP = 1. (EP < 1 does not mean zero. EP = 0.9 is also EP < 1.)
EP = 0 is the of lower limit which means that change in price has no impact on demand. This is
why it is called perfectly inelastic demand.
EP = ∞ is the upper limit which means that a small change in price may lead to such a big change
in demand that it is difficult to find its exact numerical value.
EP = 1 means that one percent change in price leads to just one percent change in demand. Such a
demand is said to be neither elastic nor inelastic. It is called unitary elastic.
8.4 EP ON DEMAND CURVE (PERCENTAGE METHOD)

We can read EP , measured by the percentage method on a demand curve between two prices and
respective Price D quantities demanded at these prices. (It is different from geometric method of measu
Ep). Refer to the figure 8.1
n demand curve DD1, suppose initial price is OP1 and quantity demanded at this price is OQ 1. Further
ose that price falls to QP2 at which quantity demanded is OQ 2. We can read the required information for
ulating EP through the percentage method. The information is
Price Qty. demanded
OP1 OQ1
OP2 OQ2
∆P = P1 – P2 ∆Q = Q1 – Q2
Substituting the information in the percentage method, we get
P ∆q
EP = Q × ∆ p
O P1 Q1−Q 2
= OQ × P −P
1 1 2
bstituting the values, to be read from graph, we can find numerical value of E p. (This method is valid
when each of the price and quantity is positive, i.e. greater than zero).
PLE
to the figure 8.2
ng information when price changes from OP1 to OP2 and substituting in the method, we get:
p ∆ q OP 1 Q1−Q2 8 10
Ep= × = × = ×
q ∆ p OQ 1 P1−P2 20 ¿ ¿
hat the above result is valid when price changes from OP1 to OP2 If we take OP2 as the initial price and
s the changed price, the result would be different. Suppose we take OP2 as the original price and OP1 as
anged price, and calculate EP , we get.
OP 2 Q2−Q1 6
Ep= × = ×¿ ¿
OQ 2 P2−P1 30
This is the limitation of the percentage method. From the same data we get two results. This limitation
can be removed by using the arc method, the explanation of which is beyond the scope of syllabus.
The above application of the Percentage Method is related to a downward sloping straight line demand
curve. We can also apply the method to straight line demand curves having specific shapes. Given
below are two extreme cases :
) Demand curve parallel to the X-axis
Applying the percentage method between A p and B, we find :
OP Q1 −Q2
E P= × =∞ (∞)
OQ1 O
Such a curve is perfectly elastic demand o curve because Ep = ∞(infinity) between any
Demanded two points of this curve.
(2) Demand curve parallel to the Y-axis

Applying the percentage method between A and B, we find :
O P1 O
Ep= × =O
OQ P1−P2
Such a curve is perfectly inelastic demand curve because Ep = 0 between any two points of
this curve.
8.5 FACTORS DETERMINING EP

EP measures degree of response of demand for a good to change in price of that good.
Why is it that demand for one good is more elastic than the demand for another good? There are
many factors that influence the value of E of a good. Some of these are explained below :
How much necessary (or a matter of habit) is the good for the consumer?
re necessary the good for a consumer, less elastic is the demand for that good. It is because it is
icult to give up the consumption of a necessary good when its price goes high. For example, the demand
salt in a family is likely to be nearly perfectly inelastic.
e feeling of necessity is more a matter of habit. A rich man is habituated to the use of car. It is a
essity for him. Lower income group people also use cars, but not that frequently as rich people do. For
m, it may partly be a luxury. When price of car rises, demand for cars by rich people may fall at a much
er rate than the demand for cars by the lower income groups. Wheat is a bigger necessity than rice in
thern parts of India. Rice is bigger necessity than wheat in eastern parts of India.
How many close substitutes of a good?
e the number of close substitutes of a good, higher is likely to be the E P of that good. It is because a
umer can easily shift from one substitute to another in case of a price change. If there is no substitute of
od the consumer has no option but to buy the given good.
roportion of income spent on a good by a consumer.
e the proportion of income spent on a good, more is likely to be the E P of that good. It is because a
ge in price of a good, if a significant proportion is spen on that good, is likely to effect the total
nditure on that good significantly.
Time period
and for a product is likely to change at a greater rate over longer periods. For example, habits change
ly and over longer periods. If price of a good rises, the consumer may not reduce the consumption
ediately because he is habituated to that product. However, slowly and gradually over longer periods he
reduce the consumption. So, demand for a product is likely to be more elastic over longer periods.
he number of uses of a good
e the number of uses of a good, more likely is to be the E P of that good. It is because in case of price
ge a consumer can easily cut down or increase the uses.
How much high is the price of the good?
her the price of a good, higher is likely to be its elasticity. It is because a change in the price of a high
d good affects the total budget significantly. This compels the consumer to change his demand.
How much high is income of the consumer?
er the consumer is, more likely the demand for a good by him is less elastic. A rich consumer is not
y to reduce the demand for a good when its price goes high than a poor consumer.
NUMERICAL ILLUSTRATIONS
blem 1
onsumer buys 80 units of a good at a price of ₹ 4 per unit. When the price falls, he buys 100 units.
rice elasticity of demand is (-) 1, find out the new price.
Solution :
P ∆Q
Ep= ×
Q ∆P
¿
¿
∆ P=−1
New price = P + ∆P = 4 + (-1) = ₹3
Problem 2
A 5 percent fall in the price of X leads to a 10 percent rise in demand for X. A 2 per cent rise in
the price of Y leads to a 6 percent fall in demand for Y. Calculate the price elasticity of demand of X
and Y.
Solution:
10
EP of X = −5 =¿
−6
EP of Y = 2 =¿
Problem 3
A consumer buys 40 units of a commodity at a price of ₹5 per unit and his price elasticity of
demand is (-) 1.5. Calculate the amount he will buy at the price of ₹4 per unit of the commodity.
P ∆Q
Solution: Ep= ×
Q ∆P
¿
∆ Q=12
New Q = Q + ∆Q = 40 + 12 = 52 units.
Note : In this problem, we have taken minus sign into consideration both in case of E and AP.
Problem 4
A household increases its demand for a commodity from 40 units to 50 units when its price falls
by 10%. What is the price elasticity for the commodity?
Solution:
Q2−Q1 50−40
Percent change in Q = Q1
× 100=
40
× 100=25
Percentage change ∈Q 25
E P= = =¿
Percentage change∈P −10
Problem 5
A consumer spends 80 on a commodity when its price is ₹1 per unit and spends ₹96 when the
price is ₹2 per unit. What is the price elasticity of demand for the commodity?
Note : By dividing expenditure with the price we can get the quantity demanded.
Solution :
Given P Exp. Qd. (= Exp ÷ P)
1 80 80
2 96 48
P ∆Q 1 −32
E P= × = × =¿
Q ∆ P 80 1
POINTS TO REMEMBER
Demand elasticity means the degree of response of demand to change in the magnitude of a factor affecting
demand.
Ep measures the percentage change in demand due to one percent change in price.
According to the percentage change method, E equals percent change in demand divided by percent
change in price.
The demand is considered inelastic if Ep is less than one; unitary elastic if E is equal to one, and
elastic if E is greater than one.
Ep of a good is influenced by many factors (1) More necessary (or the matter of habit) the good, less the Ep .
(2) More the number of substitutes, higher the Ep . (3) More the proportion of income spent on a good,
more the Ep . (4) Longer the time period, more the Ep . (5) More the number of uses, more the Ep . (6) Higher
the price, higher the Ep' (7) Richer the consumer, less the Ep
EXERCISE
ULTIPLE CHOICE QUESTIONS [1 Mark
Answers at the end of exercises)
hoose the correct alternative in the following questions.
1. Price elasticity of demand measure shows :
(a) Response of price to change in demand
(b) Response of demand to change in price
(c) Degree of response of price to change in demand
(d) Degree of response of demand to change in price
. Price elasticity of demand (-3) means 3 percent fall in demand due to :
(a) 3 per cent fall in price (b) 3 per cent rise in price
(c) One per cent rise in price(d) One per cent fall in price
. Given values of price elasticities of demand, spot 'elastic' demand :
(a) -0.8 (c) - 1.0 (d) - 1.1
SHORT ANSWER QUESTIONS-I [3 Marks]
1. Explain the concept of price elasticity of demand.
2. What are the values attached to the 'elastic' and 'inelastic' demand and why?(HOTS)
3. What are the values attached to (a) perfectly elastic demand and (b) perfectly inelastic demand?
Explain the meaning of any one.
4. What is the relation between the price of a good and the expenditure on that good when (a) E P > 1 and
(b) EP < 1 ?
5. Represent EP on various points of a downward sloping straight line demand curve touching both the
axes.
6. Explain briefly any three factors influencing EP
7. Explain the relation between habit and E
SHORT ANSWER QUESTIONS-II [14 Marksl
1. Define EP . Explain the percentage change method of measuring E
2. Explain briefly any two factors determining E
3. Explain the relation between close substitutes of a good and E
I. Explain the percentage change method of measuring EP . Also give an example.
2. Explain any three factors determining EP
3. Explain the relation between time period and E with the help of an example.
APPLICATION QUESTIONS
I. Price of a good rises from ₹4 to ₹5 per unit. As a result its demand falls from 200 units to 100 units.
Calculate E
2. A consumer buys 50 units of a good at ₹10 per unit. At a price of < ₹8 per unit he buys 100 units. Find
out E
3. A 7% fall in the price of a good leads to 49% increase in demand of that good. Find out EP
(HOTS 4. EP of a
good is - 3. At a price of < ₹8 per unit a consumer buys 160 units of the good. How many units of the
good will the consumer buy when price falls to ₹6 per unit? (HOTS)
5. EP of a good is - 5. At a price ₹10 per unit consumer buys 200 units. At what price will he buy
100 units? (HOTS)
6. EP of a good is -4. When price of this good rises from ₹5 to ₹6 per unit, a consumer buys 40
units less. How many units did he buy at ₹5?
7. Given EP = -l, complete the following table : (HOTS)
Price Demand
(₹ per unit) (Units)
4 60
-- 90
Use percentage change method.
8. There are two goods A and B. The prices of both rise by 7 percent. As a result, demand for A falls by
10.5 percent, while there is no change in demand for B. Find out Ep of A and B. (HOTS)
9. Find out Ep by the percentage method :
Price ₹ Total expenditure (₹)
8 800
10 900
10. Calculate Ep
Price (₹) Demand (units)
4 125
5 100
11. Comment upon Ep when price falls from (a) ₹6 to ₹5, (b) ₹5 to ₹4 and (c) ₹4 to ₹3.
Price (₹) Demand

6 100
5 110
4 150
3 200
ANSWER
1. -2 2. -5 3. -7
4. 280 units 5. ₹ 11 6. 50
7. ₹ 2 8. Ep of A = -1.5, Ep of B = 0 9. -0.4
10. -0.8 11. (a) -0.6 (b) -2.27 (c) -1.33
1. What is meant by price elasticity of demand?
2. Explain the expenditure method of measuring price elasticity of demand of a commodity. When is the
demand said to be inelastic?
3. Mention any three factors that affect the price elasticity of demand of a commodity.
4. Give meaning of perfectly elastic demand and perfectly inelastic demand of a commodity.
5. Price elasticity of demand of a good is (-) 2. At a price of ₹ 10 per unit 40 units of this good are
bought. How many units will be bought at a price of ₹ 11 per unit? Calculate. (HOTS)Ans
P ∆Q
E P= ×
Q ∆P
¿
(-)80 = 10 ∆Q
∆Q = -8
New Q = Q + ∆Q = 40 + (-8) = 32 units.
6. At a price of ₹50 per unit the quantity demanded of a commodity is 1000 units. When its price falls by
10 percent, its quantity demanded rises to 1080 units. Calculate its price elasticity of demand. Is its
demand inelastic? Give reasons for your answer. (HOTS)
P ∆Q 500 80
Ans. Ep = Q × ∆ P = 1000 × −5 =¿
The demand is inelastic because the absolute value of elasticity is less than I (sign ignored).
7. When price of a good falls by 10 percent, its quantity demanded rises from 40 units to 50 units.
Calculate price elasticity of demand by the percentage method.
10
× 100
Ans. EP = % change i nQty . Demand 40 25
= = =¿
% change∈ price −10 −10
8. The quantity demanded of a commodity rises from 800 units to 850 units when its price falls from ₹20
per unit to ₹19 per unit. Calculate its elasticity of demand.
50
×100
% change∈Qd 80 0
Ans. EP = = =¿
% change∈ P −1
×100
20
9. Price elasticity of demand of a good is (—) l . At a given price the consumer buys 60 units of the good.
How many units will the consumer buy if the price falls by 10 percent
% change∈Q d
Ans. EP =
% change∈ P
% change∈Q d
(-)1 =
−10 %
. % change in Qd = + 10%.
Demand after price falls Q + 10% of Q = 60 + (10% of 60) = 66 units.
10. Price elasticity of demand of a good is (-) 2. The consumer buys a certain quantity of this good at a
price of ₹8 per unit. When the price falls he buys 50 percent more quantity. What is the new Price?
(HOTS)
% change∈Q d
Ans. EP =
% change∈ P
50 %
(-)2 = % change∈ P
50
% change in P = −2 =−25 %
New P = P + % change in P
= 8 + (- 25% change of 8) = 8 - 2 = ₹6 per unit.
11. Why is demand for water inelastic?
12. On the basis of the following schedule, calculate price elasticity of demand by the percentage method :
Price per unit (₹) Total expenditure
10 180
9 162
13. When price of a good is ₹13 per unit, the consumer buys 11 units of that good. When price rises to
₹15 per unit, the consumer continues to buy 11 units. Calculate price elasticity of demand.
P ∆ Q 13 0
Ans EP = × = × =0
Q ∆ P 11 2
14. When price of a good is ₹7 per unit a consumer buys 12 units. When price fails to ₹6 per unit he
spends ₹72 on the good. Calculate price elasticity of demand by using percentage method. Comment
on the likely shape of demand curve based on this measure of elasticity.
15. Ans. Price Demand
7 12
72
6 =12
6
P ∆Q
EP = ×
Q ∆P
7 0
¿ × =0
12 −1
The demand curve is parallel to the y-axis.
15. When price of a product doubles, its demand falls to half of what it was before the price change.
Calculate price elasticity of demand.
% change∈Qd −50 %
Ans. EP = = =¿
% change∈ P 100 %
16. Price elasticity of demand of a good is (-)l. When its price falls by one rupee, its demand rises from 16
to 18 units. Calculate the price before change.
P ∆Q
Ans, EP = ×
Q ∆P
¿
2P = 16 or P = 8(₹)
17. When price of a good falls from ₹15 per unit to ₹12 per unit, its demand rises by 25 percent. Calculate
price elasticity of demand.
% change∈Qd 25 25
= = =¿
Ans. EP = % change∈ P −3 ×100 −20
15
18. Price elasticity of demand of a good is (-)1. Calculate the percentage change in price that will raise
demand from 20 units to 30 units.
% change∈Qd
Ans. EP =
% change∈ P
10
×100
(-)1 = 20
% change∈ price
% change in P = -50% i.e. fall in price = 50%

19. Price elasticity of demand of two goods A and B is (-) 3 and (-) 4 respectively. Which of the two goods
has higher elasticity and why?
20. What will be the effect of 10 percent rise in price of a good on its demand if price elasticity of demand
is (a) zero, (b) -1, (c) - 2?
1. Some aerated drinks cause obesity. Government wants its consumption be reduced by 20 percent but
only through the market. Price elasticity of demand for these drinks is -2. Government imposes fresh
tax on these drinks to raise the market price. How much percent rise in price will be able to achieve
the objective? Calculate.
2. There is a vaccine which can prevent a serious disease. Market experts feel that its use can be
increased 5 times if its price falls to half. Calculated price elasticity of demand for the vaccine.
3. There is an item of consumption crucial for health of the people. Government decides to subsidize it.
After subsidy, government found that on an average a family is now spending more on this item.
Based on this information what can you say about price elasticity of demand of this item. Give reason.
4. A consumption good has harmful effects on health. Government wants to bring its consumption down
by imposing heavy tax on it. How much success government will be able to achieve will depend price
elasticity of demand. Explain how?
1. (d) 2. (c) 3. (d)
Understanding Based Questions from CBSE Examination Papers (Alongwith Answers) Based on
unit 2— Consumer's Equilibrium and Demand
1. When price of a product doubles, its demand falls to half of what it was before the price change.
Calculate price elasticity of demand.
% change∈Qd −50 %
Ans. EP = = =¿
% change∈ P 100 %
2. A consumer consumes only two goods A and B and is in equilibrium. Price of good A falls. Show that it
will lead to rise in demand for good A. Use Utility Analysis.
Ans. When consumer is in equilibrium:
M U A MU B
=
PA PB
When price of good A (PA) falls, then
M U A MU B
>
PA PB
Since per rupee marginal utility of A (MU A) is now higher than per rupee MU B, the consumer will
divert expenditure from good B to good A. This raises demand for good A.
3. Give meaning of an inferior good and explain the same with the help of an example.
Ans. When with the rise in income of a consumer, the consumer buys less quantity of a good, then that good
is an inferior good for that consumer. Suppose, when the consumer's income rises, he buys less of
coarse cloth and purchases more fine cloth, then for that consumer specifically coarse cloth is an
inferior good.
4. Explain the concept of MRS with the help of a numerical example. Also explain its behaviour along
the Indifference Curve.
Ans. Marginal Rate of Substitution (MRS) means the rate at which a consumer is willing to sacrifice quantity
of one good to obtain one more unit of the other good.
Let the two goods consumed be A and B. Suppose the following combinations of these two goods have
the same utility level for him:
Good A Good B MRS
1 8 --
2 4 4B : 1A
3 1 3B : 1A
The consumer is willing to sacrifice 4B to obtain second unit of A. For the third unit of A, he is willing
to sacrifice less because marginal utility of A decreases as he consumes more of A.
5. Explain the conditions of consumer's equilibrium under Indifference Curve analysis.
Ans. There are two conditions :
(i) MRS Ratio of prices
(ii) MRS continuously falls
Explanation :
(i) Let the two goods be X and Y. The first condition for consumer's equilibrium is that MRS
= PX /PY , Now suppose MRS is greater than P X/PY. It means that the consumer is willing to pay more for X
than the price prevailing in the market. As a result, the consumer buys more of X. This leads to fall in MRS.
MRS continues to fall till it becomes equal to the ratio of prices and the equilibrium is established.
(Or, alternatively in terms of when MRS < PX/PY)
(ii) Unless MRS continuously falls, the equilibrium cannot be established.
6. Distinguish between an inferior good and a normal good. Is a good which is inferior for one consumer also
inferior for all the consumers? Explain.
Ans. When with the rise in income of the consumer demand for a good increases, that good is a normal good
for that consumer. If with rise in income demand for the good decreases then that good is inferior for
that consumer.
A good is not necessarily inferior for all the consumers. A good which is inferior for a higher income
consumer may be a normal good for the lower income consumer. It is not the consumer but the income
level of the consumer which determines whether a good is normal or inferior.
7. Price of a good rises from 5 to 6 per unit but it had no effect on demand of that good. Calculate price
elasticity of demand of the good.
% change∈Qd 0
= =0 (Zero)
Ans. EP = % change∈ P 1
5 ×100
8. A consumer consumes only two goods. Explain consumer's equilibrium with the help of utility analysis.
Ans. Assuming that only two goods the consumer consumes are X and Y, the conditions of equilibrium are :
MU
x yMU
(i) P = P
x y
(ii) MU of a good falls as more of it is consumed
Explanation:
M U x MU y
(i) Suppose > The consumer will not be in equilibrium because per rupee MU
Px Py
of X is greater than per rupee MU of Y. This will induce the consumer to buy more of X by
reducing expenditure on Y. It will lead to fall in MUx and rise in MUy. This will continue
M U x MU y
till =
Px Py
(ii) Unless MU falls as more of a good is consumed the consumer will not reach equilibrium.
M U x MU y
Explanation based on < is also correct.
Px Py
6. A consumer consumes only two goods X and Y both priced at ₹3 per unit. If a consumer chooses a
combination of these two goods with Marginal Rate of Substitution equal to 3, is the consumer in
equilibrium? Give reasons. What will a rational consumer do in this situation?
Ans. Given Px = 3, Py = 3 and MRS = 3, A consumer is said to be in equilibrium when :
Px
MRS =
Py
3
Substituting values we find that : 3 >
3
Px
i.e. MRS >
Py
Therefore consumer is not in equilibrium.
Px
MRS > means that consumer is willing to pay more for one more unit of X as compared to
Py
what market demands.

The consumer will buy more units of X.
As a result MRS will fall due to the Law of Diminishing Marginal Utility.
Px
This will continue till MRS = and consumer is in equilibrium.
Py
7. A consumer consumes only two goods X and Y whose prices are ₹4 and ₹5 per unit respectively. If
the consumer chooses a combination of the two goods with marginal utility of X equal to 5 and that of
Y equal to 4, is the consumer in equilibrium? Give reasons. What will a rational consumer do in this
situation? Use utility analysis.
Ans. Given Px = 4, Py = 5 and MUx = 5, MUy = 4, a consumer will be in equilibrium when :
M U x MU y
=
Px Py
Substituting values, we find that

5 4 M U x MU y
> or >
4 5 Px Py
Since per rupee MUx is higher than per rupee MUy, consumer is not in equilibrium.
The consumer will buy more of X and less of Y. As a result MUx will fall and MUy will rise. The
M Ux
∧MU y
reaction will continue till P x and are equal and consumer is in equilibrium.
Py
8. Price elasticity of demand of good X is (-) 2 and of good Y is (-3). Which of the two goods is more
price elastic and why?
Ans. Good Y is more price elastic because one percent change in price of Y will lead to 3 percent change in
demand for Y. It is higher than the percentage change in demand for good X.
9. What will be the effect of 10 percent rise in price of a good on its demand if price elasticity of demand
is (a) zero (b) -1 (c) - 2?
Ans. (a) Zero percent or no change
(b) 10% fall
(c) 20% fall
10. Show that there is inverse relation between price of a commodity and its quantity demanded. Use
Utility Analysis.
Ans. Assuming that the consumer consumes only two goods X and Y and is in equilibrium.
M U x MU y
Then, =
Px Py
M U x MU y
Now suppose Px falls, then >
Px Py
Since per rupee marginal utility of X is greater than per rupee marginal utility of Y, the consumer will
buy more of X. It shows inverse relation between price of X and demand for X.
11. A consumer's income is ₹200. He spends it on purchase of good x and good y. Price of x and y are
₹40 and ₹20 per unit respectively. Answer the following questions :
(a) Write the equation of his budget line.
(b) Write two such combinations of x and y which lie on the budget line.
(c) Write two such combinations of x and y which are a part of his budget set but do not lie on his
budget line.
Ans. (a) 40x + 20y 200
(b) 1x + 8y, 2x + 6y
(c) 1x + 2y, 2x + 2y

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CHAPTER: 9 CONSUMER'S EQUILIBRIUM: INDIFFERENCE

6.1.1 Cardinal Utility vs. Ordinal Utility

 But since B lies on a lower IC as compared to C,

6.3.5 Shift of Budget Line

(2) Suppose price of X changes

) When more than one determinants change

6.4 CONSUMER'S EQUILIBRIUM

(c) Unchanged (d) Initially increases, then decreases

13. In the Indifference Curve Analysis, the consumer is in equilibrium when:

LONG ANSWER QUESTIONS [6 Marks]

Answer to the Multiple Choice Questions

7.3 DETERMINANTS OF DEMAND

7.4 DEMAND SCHEDULE

(b) On the basis of the Law of Equi-Marginal Utility

7.6.2 Market Demand Curve

Increase in Demand Decrease in Demand

8.2 CONCEPT OF PRICE ELASTICITY

tituting the values given in table 8.1,

EP = 0 Unitary elastic demand

EP > 0 Elastic demand

EP = ∞ (infinity) Perfectly elastic demand

8.4 EP ON DEMAND CURVE (PERCENTAGE METHOD)

(2) Demand curve parallel to the Y-axis

8.5 FACTORS DETERMINING EP

Price (₹) Demand

% change in P = -50% i.e. fall in price = 50%

(ii) MU of a good falls as more of it is consumed

Therefore consumer is not in equilibrium.

what market demands.

Substituting values, we find that

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