1 Economic Concepts · 1.1 Microeconomics: demand, production, markets and factor pricing
1.1.1 Demand: law of demand, determinants, utility and consumer equilibrium
Demand is the quantity a buyer is willing and able to buy at each price; it falls as price rises (law of demand), and a consumer is in equilibrium when the last rupee spent on every good gives the same marginal utility (or when MRS equals the price ratio).
- APPSC Paper I
- Advanced level
- 8 min read
- Free
Core facts
- Demand = desire + ability to pay + willingness to pay, always stated at a price and for a period of time.
- Law of demand (Marshall): other things being equal (ceteris paribus), quantity demanded varies inversely with price. Demand curve slopes downward from left to right.
- Demand function: Dx = f(Px, Py, Y, T, E…) – own price, prices of related goods, income, tastes, expectations, population, distribution of income.
- Movement along the curve (extension / contraction) = change in the good's own price only.
- Shift of the curve (increase / decrease) = change in any other determinant (income, tastes, prices of related goods).
- Market demand = horizontal sum of individual demands at each price.
- Utility = want-satisfying power of a good. Cardinal school (Marshall) measures it in "utils"; ordinal school (Hicks–Allen, 1934) only ranks it.
- Marginal utility (MU) = change in total utility from one more unit: MUₙ = TUₙ − TUₙ₋₁.
- Law of diminishing marginal utility (Gossen's first law): MU falls as more units are consumed. When MU = 0, TU is maximum; when MU is negative, TU falls.
- Law of equi-marginal utility (Gossen's second law; law of substitution): consumer equilibrium when MUx/Px = MUy/Py = MU of money.
- One good: equilibrium where MU = Price (in money terms).
- Consumer surplus (Marshall) = what the consumer is willing to pay − what he actually pays.
- Indifference curve (IC): combinations giving equal satisfaction; slope = MRSxy (marginal rate of substitution).
- Ordinal equilibrium: IC tangent to the budget line: MRSxy = Px/Py, and the IC is convex at that point.
- Exceptions to the law of demand: Giffen goods, Veblen (prestige) goods, expectation of further price rise, ignorance (price taken as a sign of quality), emergencies.
Explained
1. Movement versus shift.
| Change | What happens | Called |
|---|---|---|
| Own price falls | Move down the same curve | Extension of demand |
| Own price rises | Move up the same curve | Contraction of demand |
| Income rises (normal good) | Whole curve shifts right | Increase in demand |
| Price of a substitute falls | Curve shifts left | Decrease in demand |
Related goods: a rise in the price of a substitute (tea for coffee) raises demand for the good; a rise in the price of a complement (petrol for cars) lowers it. For an inferior good (coarse grain), a rise in income lowers demand.
2. Why the demand curve slopes down. (a) Diminishing marginal utility, (b) income effect (a lower price raises real income), (c) substitution effect (the good is now cheaper than its substitutes), (d) new buyers enter at lower prices, (e) the good is put to more uses.
3. Total and marginal utility.
Example 1. A consumer's total utility from successive apples is 10, 18, 24, 28, 30, 30, 28 utils. Find MU and the point of saturation. Solution. MU = 10, 8, 6, 4, 2, 0, −2. TU is highest (30) where MU = 0, at the 6th apple; the 7th gives negative MU. Answer: saturation at the 6th unit
4. Equilibrium with one good.
Example 2. In Example 1, take 1 util = ₹1 and the price of an apple = ₹4. How many apples are bought, and what is the consumer surplus? Solution. Buy while MU ≥ price: MU of the 4th apple = 4 = price, so 4 apples. Willing to pay 10 + 8 + 6 + 4 = 28; actually pays 4 × 4 = 16. Surplus = 28 − 16. Answer: 4 apples; consumer surplus ₹12
5. Equi-marginal utility with two goods.
Example 3. Px = ₹4, Py = ₹6, income ₹30.
| Unit | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|
| MUx | 20 | 16 | 12 | 8 | 4 |
| MUy | 30 | 24 | 18 | 12 | 6 |
Solution. MUx/Px = 5, 4, 3, 2, 1; MUy/Py = 5, 4, 3, 2, 1. Spending ₹30 with equal ratios: 3 units of X (₹12) and 3 units of Y (₹18); both ratios = 3. Total utility = 48 + 72 = 120, the highest any affordable bundle gives. Answer: 3 X and 3 Y
6. Market demand.
Example 4. Two buyers: qA = 20 − 2P and qB = 10 − P. Find market demand and the quantity at P = ₹4. Solution. Add horizontally: Q = 30 − 3P. At P = 4: 30 − 12. Answer: Q = 30 − 3P; 18 units
7. Indifference curve properties. (i) slope downward, (ii) convex to the origin (diminishing MRS), (iii) never intersect, (iv) a higher IC means higher satisfaction, (v) do not touch the axes (in the standard case).
8. Budget line. Px·X + Py·Y = M. Intercepts M/Px and M/Py; slope = −Px/Py. A rise in income shifts it parallel outward; a fall in Px swings it outward on the X-axis only.
Deeper
1. Price effect = substitution effect + income effect (Hicks; Slutsky's version holds the old bundle affordable).
| Good | Substitution effect | Income effect | Demand curve |
|---|---|---|---|
| Normal | Buys more when cheaper | Positive (reinforces) | Slopes down |
| Inferior (not Giffen) | Buys more | Negative but weaker | Slopes down |
| Giffen | Buys more | Negative and stronger | Slopes up |
So every Giffen good is inferior, but not every inferior good is Giffen. The Giffen case needs the good to take a large share of a poor household's budget (the classic example: bread for 19th-century British labourers).
2. Lines from ICs.
- Income consumption curve (ICC): traces equilibria as income changes; leads to the Engel curve. For an inferior good it bends backward.
- Price consumption curve (PCC): traces equilibria as one price changes; leads to the demand curve.
3. Criticisms of the cardinal approach. Utility cannot be measured in numbers; MU of money is not constant; goods are not independent (substitutes and complements). Hicks–Allen replaced it with ordinal ranking; Samuelson's revealed preference theory (1938) infers preference from observed choice without ICs.
4. Equilibrium and the market price.
Example 5. Demand Qd = 100 − 5P and supply Qs = 20 + 3P. Find the equilibrium price and quantity. Solution. 100 − 5P = 20 + 3P → 8P = 80 → P = 10; Q = 100 − 50. Answer: P = ₹10, Q = 50 If income rises and demand becomes Qd = 124 − 5P, then 8P = 104, P = 13, Q = 59: an increase in demand raises both price and quantity.
5. Consumer surplus with a linear demand curve is the triangle under the demand curve above the price line. With Qd = 100 − 5P (choke price ₹20) at P = ₹10: surplus = ½ × 50 × (20 − 10) = ₹250.
Common traps
- ✗ "A fall in the good's own price shifts its demand curve right." ✓ It causes a movement along the curve (extension).
- ✗ "Market demand is the vertical sum of individual demands." ✓ It is the horizontal sum (quantities added at each price).
- ✗ "TU is maximum when MU is maximum." ✓ TU is maximum when MU = 0.
- ✗ "All inferior goods are Giffen goods." ✓ All Giffen goods are inferior; only those with a dominant negative income effect are Giffen.
- ✗ "Consumer equilibrium: MUx = MUy." ✓ MUx/Px = MUy/Py (marginal utility per rupee).
- ✗ "Indifference curves are concave to the origin." ✓ They are convex (diminishing MRS).
- ✗ "Ordinal utility theory was given by Marshall." ✓ Marshall is cardinal; Hicks and Allen (1934) ordinal.
Quick revision
- Law of demand: price ↑ → quantity demanded ↓, ceteris paribus.
- Own price → movement; other factors → shift.
- Market demand: horizontal summation.
- MU = TUₙ − TUₙ₋₁; TU max when MU = 0.
- Gossen 1: diminishing MU; Gossen 2: equi-marginal.
- Equilibrium: MUx/Px = MUy/Py; one good: MU = P.
- Consumer surplus = willing to pay − actually paid.
- IC equilibrium: MRSxy = Px/Py; IC convex.
- Price effect = substitution + income effect.
- Exceptions: Giffen, Veblen, expectations.
Practise this topic. Questions on Demand, consumption & elasticity, with answers explained.
All Microeconomics: demand, production, markets and factor pricing notes · APPSC Paper I syllabus · APPSC Paper I Mock 1 with answers · Start free
Medha AI writes its own notes and checks them against the sources listed. Medha AI is an independent preparation service. It is not affiliated with, endorsed by or connected to APPSC, TSPSC, MPSC, UPSC or any other commission or government body.