5 Interesting Concepts of Economics in Real Life!

Demand Curve

It is the graphical representation showing the degree of response to demand & price of a product. It varies from person to person as people (Buyers) respond to an incentive of lower price by buying more and vice versa.

Law of Demand Curve:

It shows an “inverse relationship” exists between the price of a good and the quantity of a good which buyers are willing to purchase in a defined time period (while assuming all other things remain constant). Basically, when price falls, demand rises and vice versa. It is depicted by plotting Price on Y-axis and Quantity demanded on the X-axis of the graph.

Examples:

1. I still remember the time during Durga Puja. All relatives flock together at my place. This results in cooking too many and too much food items for which everyone keeps flooding the vegetable market now and then. As a result, the demand increases for vegetables/chicken/fish/mutton as a result, the price decreases.

2. My friend goes to have Beer at Easy Tiger, M.G Road every weekend and he gets 5 beers for Rs. 100 each. One Friday, he noticed that the Price went ↑ to Rs. 150 each bottle. Then he started ordering only 3 bottles. After a couple of months, the price of the beer went ↑ further to Rs. 200, now my friend started having only one bottle of beer. A further increase might make my friend shift to some other drink (if any substitute is available) buying 0 Beers.

The above example shows that the Demand Curve is always Downward Sloping. The more expensive a product gets (price↑) the less of it is demanded (quantity↓); the cheaper it is (price↓) the more of it is demanded by buyers (quantity↑).

Supply Curve

It is the graphical representation of the relationship between the price and the quantity of a product that a seller is willing and able to supply at the given period of time.

A “direct” relationship exists between the price and the quantity of a product that a supplier is willing and able to supply at the given period of time (while assuming all other things remain constant). Basically, when price increases, demand increases and vice-versa. This is referred to as the Law of Supply.

Suppliers are induced to produce more of a product when the prices go ↑ that they can generate more revenue.

Examples:

1. When a city becomes an industry hub, more & more people move to that city for opportunities. And the price of office spaces or residential spaces goes ↑ as the demand goes ↑.

2. My friend in college gave me a proposal that he will pay me Rs. 200 for each assignment that I would solve for him. I initially decided to do two assignments a month, earning Rs. 400. Now, he later said he will increase the pay by Rs. 300 each time I solve one of his assignments. Now that literally induced me to solve his assignments more than twice a month and make a good amount of cash out of it!

The above example shows an Upward Sloping Supply Curve. As the price goes ↑ the more of it is supplied (quantity↑); the cheaper it is (price↓) the less of it is supplied (quantity↓).

Price Elasticity of Demand

Price Elasticity is the measure of the percentage change in the quantity demanded of a particular good with respect to a percentage change in its price.

Formula for calculating PED: (%change in quantity demanded)/(% change in price)

Examples:

1. My uncle recently planned to buy Maruti Suzuki Baleno which costs around 7 Lakh rupees. But suddenly, the price of the car surged by 30% and therefore, my uncle decided not to buy it and switch to some other car.

Say, the bookings experienced a fall by 20%.

Price elasticity of the car = -20%/30% = -0.67

Thus we can say that for every percentage that the car price increases, the quantity of the car purchased/demanded decreases by 0.67 percentage. So now you might shift to another car that fits your budget within 7 Lakh.

2. Once I had a birthday party at my place. And I needed to buy 100 packets of potato Chips each costing Rs.10. Now I went to the mall and found out that the price of Chips has reduced from Rs. 10 to Rs. 9. So then, I bought 120 packets of chips given the low prices.

Therefore, the price elasticity of chips = dP/dQ * P/Q

= Change in Qantity Demanded/Change in Price * Initial Price/Initial Quantity Demanded

=20/1 * 10/100 = 2%

Thus we can say that the quantity demanded of Chips increases by 2% due to a fall in price by Rs.1.

Consumer & Producer Surplus

Consumer Surplus: refers to the difference between the price consumer is willing to pay & the price consumer actually pays.

Example:

Two months back I went to New Market at Esplanade in Kolkata to shop accessories before leaving for Bangalore. New Market is popular for cheap accessories & clothing. After struggling with several choices and vendors, I finally liked two earrings, which costs around Rs. 180. Now please understand the psychology of shopping here! The shopkeeper quoted me a price of Rs. 180 for both the earrings. Now, I have a budget of Rs. 200 to spend on two earrings, I am still inclined to lessen it further. So I quote the salesperson - Rs. 150 as the cost I am willing to pay for the earrings. Consequently, the salesperson and I got into some negotiation and we finally agreed to settle at Rs. 160.

So, my Consumer Surplus for the purchase of Saree amounts to Rs. (200-160) i.e. Rs. 40.

But, what I conveniently missed there was that a seller would not sell his product for a loss (in a general scenario). So, if the seller agreed to sell the earrings for Rs. 160 instead of its quoted price (Rs. 180) that must mean the Seller is gaining profits in the trade anyways. This concept is formally called as Producer Surplus.

Producer Surplus: refers to the difference between the price producer is willing to sell and the price producer actually sells for.

So, in my case, say the Producer was willing to sell the product at Rs. 140 initially but then he realized that consumers in the market are willing to purchase it for Rs. 180. So he quotes his earrings for Rs. 180. Now, even after bargaining, he received Rs. 160 from me, which is still more than what he was willing to sell it for. Hence his Producer surplus is Rs. (160-140) i.e. Rs 20.

Law of Diminishing Marginal Utility

The Law of Diminishing Marginal Utility suggests that as you consume/obtain more of a product, the marginal utility that the person derives from consuming each additional unit of that product declines.

Examples:

1. Sometimes, I forget drinking water the whole day while working and that makes me immensely thirsty. I practically rush home to drink a glass of water. To my notice, the first glass of water always gives me immense satisfaction. Now if drink another glass of water, this does not give me the same amount of satisfaction as the earlier glass had given me. This is because of the law of diminishing marginal utility. 

2. I really love eating Pizza. But I cannot eat more than three slices. The first slice of the Pizza gives the highest satisfaction/utility. Thereafter,  the satisfaction I derive from Pizza keeps decreasing, and ultimately I reach my saturation point after the third slice.

Credits:

https://www.quora.com/

The Altering Power of Income on Consumer Demands

Like everyone else, you go to work every day, do your job, and collect your paycheck at the end of every month! However, one of the months you suddenly noticed that the salary paid to you is significantly higher than usual. You've been given a raise! Now, since your income has increased, aren't you capable of spending more on goods or services than usual? This is referred to as an Income Effect. In other words, how changes in income affect the consumer decisions of purchasing any goods or services and ultimately, affecting the Demand.

Change in Income Influences Consumer Demands

The income effect principle implies how a consumer spends money influenced by an increase or decrease in his income. An increase in income results in demand for more goods and services and thus spends more money. A decrease in income results in the exact opposite. Businesses are generally affected by the effect when incomes are lower, and consequently, less spending occurs. But this is not the case always. 

The income effect can have both positive as well as negative effect on a business! 

For instance: A small-scale business that specializes in the production of goods that are purchased when incomes have decreased, it might see a boom in profits. Examples of such businesses include discount stores and retailers who sell goods in bulk. 

 

REF: https://www.youtube.com/watch?v=J6qBu0LreAI&t=377s

 

An additional factor to consider is the Substitution Effect, which occurs when the price for a product changes and consumers have an incentive to consume more of the good with a relatively lower price and less of the good with a relatively higher price.

 

Here Price plays a crucial role! 

The typical response to an increase in prices is that buyers choose to consume less of the products at higher prices.

So, how the change in Prices relate to Income? 

For Example: Consider the price of milk goes down by Rs.20. Now, the decrease in the price of milk increases the amount of money left with you that is also known as free money. This means you can either buy more milk, or other products. While higher prices make buyers feel like they have less money on hand, and therefore, causes them to buy less. On the other hand, lower prices make buyers feel a little content and cause them to purchase more. 

Another very important thing to consider is the vast inequality in the distribution of income that also has a power over Market Demand.

 

Effect of Income Inequality on Demand 

Higher income inequality means that the incomes of the rich keep increasing and those of the poor keep decreasing, which affects the overall demand and consumption of a product.

However, it also depends on the product. If it is an essential commodity which is available without any constraints in supply then there may not be any change in demand. For Example, edible salt. It is an essential commodity and perhaps difficult to replace in our daily life. The demand for salt does not go up when the consumer income goes up. Also, a decreasing income does not cut consumption since the supply is enough at a very stable inflation-adjusted price. An effect on demand might happen only if there is a severe shortage of supply due to which prices go up significantly.

Therefore, Demand does significantly depend on Income. Higher income means the more purchasing power. Therefore, with the increase in income people can afford to buy more. This is why an increase in income has a positive effect on the demand for a good.