Economics & Management

Course Code: NHS 201

Unit I (Part-II)

Offered to: B. Tech 2nd Year

Technology Branches: BE, FT, LT, PL, OT, CH, PT
Session: 2024-25
Semester: (IIIrd, Odd)

Course Instructor:
Ms. Sonal Mehrotra
Humanities Department, SoHSS,
HBTU, Kanpur.
Unit I: Introduction to Economics B.Tech 2nd: 2024-25

Unit-I: Introduction to Economics

(Part II)
Syllabus

Demand and supply, Consumer surplus and its applications

Introduction: Demand and supply

Definition: Demand refers to how much (quantity) of a product or service is desired by
buyers. The quantity demanded is the amount of a product people are willing to buy at a
certain price.
Demand for a commodity by a consumer is not the same thing as his desire to buy it.
A desire becomes a demand only when it is ‘effective’ which means that, given the price of
the good, the consumer should be both willing and able to pay for the quantity which he
wants to buy. Thus three things are essential for a desire to become effective demand.
 Desire for a commodity
 Willingness to pay
 Ability to pay for the commodity
For instance, demand for Mercedez Benz can be considered as demand only when it is
backed by desire, willingness and ability to pay.

Law of Demand
The consumer’s decisions are guided by several factors such as price, income, tastes and
preferences etc. Among the many factors affecting demand, price is the most significant
and the price-quantity relationship is given by the Law of Demand. It states that:
“The amount of quantity demanded increases as price falls and decreases as price rises,
other things being equal (Ceteris Paribus).”
1
Q
𝑃

The law indicates the inverse relation between the price of a commodity and its
quantity demanded in the market.
i. Normally, the consumer buys more of a good when its price falls and reduces the
quantity when its price increases.
ii. The quantity demanded must be related to the time interval over which it is
purchased. i.e., per day, per week, per month, or over some other period.
iii. The law assumes that the other factors affecting demand for a commodity such as
Income of the consumer, Tastes & Preferences, prices of related goods,
Demographic factors, Seasonal factors etc. remain the same in a given period.

Course Instructor: Ms. Sonal Mehrotra 2

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Three Alternative Ways of Expressing Demand

Demand for a good by an individual or the market as a whole is conventionally expressed

in three alternative forms, namely;
 A demand function
 A demand schedule
 A demand curve
Demand Function:
A demand function of an individual buyer is an algebraic form of expressing his demand
behavior. In it, the quantity demanded per period of time is expressed as a function of several
variables.
General form of the demand function is Dx=f (Px, Y, T)

In a demand function Dx=f (Px,Y,T), the dependent variable is Dx, i.e. the demand for a
commodity (a normal good).Px (price), Y (income) and T (tastes and preferences of a
consumer) are independent variables. In other words, the demand for a commodity is
dependent upon the mentioned three independent variables.
Example of a demand function for good X: Dx=2000–10Px
where, Dx denotes quantity demanded of good X,Px denotes the price of good X.

Demand Schedule:
A demand schedule is a tabular form of describing the relationship between quantities
demanded of a good in response to its price per unit, while all non-price variables remain
unchanged. A demand schedule has two columns, namely
 Price per unit of the good(Px)
 Quantity demanded per period (Dx)
The demand schedule is a set of pairs of values of Px and Dx. There are two types of
demand schedule, namely
 Individual demand schedule
 market demand schedule
Table: Individual Demand Schedule for Commodity X of individual A
Price per unit of Commodity Quantity Demanded of
X Commodity X (Units)
10 6000
20 5000
30 4000
40 3000
50 2000
60 1000

Course Instructor: Ms. Sonal Mehrotra 3

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
From individual demand schedules one may draw the market demand schedule.
Market demand schedule is the horizontal summation of individual demand schedules.
The illustration of market demand schedule is given as under assuming there are only 2
consumers (A&B) in the market (See Table)

Table: Market Demand Schedule for Commodity X

Per unit Price of Quantity Demanded of Quantity Demanded of Market

Commodity X Commodity X by Commodity X by
(Rs) Consumer–A (Units) Consumer–B (Units) Demand (Units)

PA QA QB QA+QB
10 6000 9000 15000
20 5000 8000 13000
30 4000 7000 11000
40 3000 6000 9000
50 2000 5000 7000
60 1000 4000 5000

Demand Curve: A demand curve is a graphic representation of the demand schedule. It is

a locus of pairs of prices per unit (Px) and the corresponding demand-quantities (Dx).

The figure shows the demand curve, where X-

axis measures quantity demanded and Y-axis
shows prices.

As the price increases from 10 to 60, the

quantity demanded declines from 6000 to 1000,
establishing a negative relation among the two.

Thus, this implies that the demand curve is

downward sloping.

Change in Demand
There are many factors other than price that affect demand of a commodity. These other
factors such as changes in consumer preferences, income levels, or the prices of related
goods bring change in location of the demand curve (i.e., its distance from the origin).
Hence, demand curve shifts outward or inward whereas the slope of the demand curve is
determined by its price.

Course Instructor: Ms. Sonal Mehrotra 4

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
In other words, demand of a commodity changes when there is
i. Movement along demand curve: a consumer moves from one point to another on
the same demand curve.
ii. Movement from one demand curve to the other: when the entire demand curve
shifts its position.
I. Movement along Demand Curve: A demand curve is drawn on the assumption that all
factors determining the demand behaviour of a consumer, other than the price of the
commodity itself, remain the same. When price of the commodity changes, the consumer
moves along the given demand curve and changes the quantity demanded of the
commodity.

 If the price decreases, the quantity demanded typically increases, leading to a

movement down the demand curve. (Also known as, expansion in demand)
 If the price increases, the quantity demanded usually decreases, resulting in a
movement up the demand curve. (Also known as, contraction in demand)
This behavior is consistent with the law of demand, which states that, all else being equal,
as the price of a commodity falls, the quantity demanded rises, and vice versa.

In the diagram, at price P1, the

quantity demanded is Q1. Now, if
price falls to P2, quantity
demanded rises to Q2. This
movement from A1 to A2 in
downward direction of the
demand curve is known as
expansion in demand.
However, if the price rises from P1
to P3, the quantity demanded falls
from Q1 to Q3. This movement
upward from A1 to A3 is known as
the contraction of demand.

II. Movement from One Demand Curve to the Other:

If the quantity demanded changes due to other factors other than price, the consumer
shifts from one demand curve to the other. This is known as shift in the demand curve.
This shift is due to the change in demand, which in turn is, due to change in
determinants of demand other than the price.
It is of two types:

Course Instructor: Ms. Sonal Mehrotra 5

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
i. Increase in demand or Rightward/Outward shift in demand curve: When the
consumer moves to the outer demand curve to the right. An increase in demand is
caused by a rise in income, a rise in the price of substitutes, a decrease in the price
of complementary goods, an increase in population, and when goods are
fashionable.
ii. Decrease in demand or Leftward/Inward shift in demand curve: When the
consumer moves to the inner demand curve to the left. A drop in demand is caused
by a drop in income, a drop in the price of substitutes, an increase in the price
of complementary goods, a drop in population, or when goods become out of style.

In the diagram, consider demand

curve DD’. At price P, the quantity
demanded is Q. Now, if the
consumer decides to buy more
quantity of a commodity, say Q1,
at the same price P, then this
movement from Q to Q1 is called
an increase in demand.
However, if the consumer decides
to buy less quantity of a
commodity, say Q2, at the same
price P, then this movement from
Q to Q2 is called a decrease in
demand.

Exceptions to the Law of Demand

The law of demand is widely applicable to a large number of goods. However, there are
certain exceptions to it on account of which a change in the price of a good does not lead
to a change in its quantity demanded in the opposite direction.
(a) Expected Change in the Price of a Good: When the price of a good is expected to
increase, consumers increase the demand-quantity so as to avoid paying a higher
price later. Similarly, when the price of a good is expected to fall, the consumers
postpone their purchases of it. So, we can say that, an expected change in its price
changes the demand in the same direction.
(b) The consumer may not consider a good as ‘normal’ or ‘superior’. There are four
types of such goods.
 Inferior Goods: An inferior good is one whose demand drops when people's incomes
rise. Inferior goods are the opposite of normal goods. When incomes are low,
inferior goods act as a more affordable substitute. Inferior goods consist of things
like generic products, used cars, pizza, discount clothing, traveling by bus rather and

Course Instructor: Ms. Sonal Mehrotra 6

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
canned foods, while normal goods include products such as fine-dine restaurants,
branded clothes and accessories, private cars or cabs, home services, technology
equipment etc. As consumers' incomes increase, they consume less inferior goods
and more normal goods.
 They are consumed generally by poor sections of the society or people with low
incomes. For example, with an increase in income, a typical farmer shifts his demand
from coarse grains to finer varieties of pulses. Also, when price rise the real income
of the consumer goes up. The consumer reduces demand of inferior good and buys
more of its substitute.
 Giffen Goods: A Giffen good is a low-income product whose demand rises when
the price rises and demand falls when the price falls. These are some special
varieties of inferior goods. These include bread, rice, wheat, bajra, cheaper
vegetable like potatoes etc. These are named after Sir Robert Giffen of Ireland. He
first observed that people used to spend more their income on inferior goods like
potato and less of their income on meat. But potatoes constitute their staple food.
 When the price of potato increases, after purchasing potato they did not have so
much to buy meat. So the rise in price of potato forced people to buy more potato
and thus raised the demand for potato. This is against the law of demand. This is
known as Giffen paradox. So giffen goods are products that people continue to buy
even at high prices due to low incomes and lack of substitute products.
All Giffen goods are inferior goods but not all inferior goods are Giffen goods.
 Ignorance: In some cases, the consumers suffer from the false notion that a higher
priced good is of better quality. This happens mainly in the case of those goods
where a typical consumer is not able to judge the quality easily. In such cases, the
sellers may be able to sell more not by lowering the price but by raising it.
 Veblen goods or luxury goods: Certain goods are meant for adding to one’s social
prestige. These form the part of ‘status symbol’ for showing that their user is a
wealthy or cultured person. The consumer considers it more desirable with high
social economic standing. For example: expensive diamond jewellery, luxury cars,
expensive watches, wines, carpets. Their demand falls, if they are inexpensive.
(c) Change in Fashion: Commodities for which the fashion is out are less in demand as
compared to commodities which are in fashion. In the same way, change in taste of
people affects the demand of a commodity. When a denim jeans replaces a regular
trousers, no amount of reduction in the price of the latter is sufficient to clear the
stocks. The denim jeans will have more customers even though its price may be
going up. The law of demand becomes ineffective.
(d) Complementary Goods: Law of demand is violated in the case of complementary
goods also. For example: if the price of the DVD player falls leading to increase in its
demand, in spite of rise in price of DVDs, their demand will increase.

Course Instructor: Ms. Sonal Mehrotra 7

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Determinants of Demand
Demand for a good by a consumer can vary in response to several factors such as its own
price, prices of other related goods, income of the consumer, tastes and preferences of
the consumer etc.
Symbolically, Dx=f(Px,PY,Y,T,…) where Px is the price per unit of good X, PY is the price of
the related goods, Y is the income of the consumer, T represents the tastes and
preferences of the consumer. The following are the leading determinants of demand -
(a) Price of the Commodity: The first determinant of the demand for a good is its own
price. The consumer compares the marginal utility expected from a good with its
price and decides whether it is worth buying or not. A fall in the price induces the
consumer to buy more of the good and an increase in the price causes a fall in
demand.
(b) Prices of Related Commodities: Prices of related commodities also affect the
demand of the commodity (say X). There are two ways in which a good can be
related to another good:
 Substitute goods: If the price of a substitute good, Y increases, the demand for
that good falls and the consumer wants to buy more of X instead. In contrast, if
the price of the substitute good falls the consumer increases the demand for that
good and hence wants to buy less of X. It has positive cross price effect.
 Complement goods: If the price of a complementary good, Y increase, the
demand for that good falls so does the demand of its complement X. In the same
way, a fall in the price of a complementary good causes an increase in the
demand for X. It has negative cross price effect.
(c) Levels of Income: The demand for a good is also affected by the levels of the
income of the consumer. With an increase in income the consumer wants to buy
more of a good. However, if the good is considered an ‘inferior’ one, he is expected
to reduce its demand when his income increases.
(d) Expected Change in Price: If price of a good is expected to increase, demand for that
good also increases and vice-versa. A consumer wants to buy a good before its price
goes up and will postpone its purchase if price is expected to fall.

(e) Other Factors: Other factors which affect the aggregate market demand for a good
include the size of population, the marketing and sale campaigns by the suppliers, the
‘selling expenses’ incurred by the sellers, the tastes and preferences of the buyers, and
distribution of income and wealth. For example, the richer sections are likely to spend a
smaller proportion of their incomes on basic necessities and a larger proportion on luxuries
and durable consumer goods.

Course Instructor: Ms. Sonal Mehrotra 8

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Meaning of Supply

Supply represents how much the market can offer.

The quantity supplied refers to the amount a good producer is willing to supply when
receiving a certain price. The supply of a good or service refers to the quantities of that
good or service that producers are prepared to offer for sale at a set of prices over a
period of time.
Law of Supply
The law of supply states that a firm will produce and offer to sell greater quantity of a
product or service as the price of that product or services rises, other things being
equal. There is direct relationship between price and quantity supplied.
It may be noted that at higher prices, there is greater incentive to the producers or firms
to produce and sell more. Other factors that determine supply are cost of production,
change of technology, price of related goods (substitutes and complements), government
policy prices of inputs, level of competition and size of industry, government policy, and
non-economic factors.
Q 𝑃
Thus ‘Ceteris Paribus’;
i. With an increase in the price of the goods, the producer is willing to offer more
goods in the market for sale.
ii. The quantity supplied must be related to the specified time interval over which it is
offered.
Three Alternative Ways of Expressing Supply
Supply of a good by an individual producer/firm or the market /industry as a whole is
conventionally expressed in three alternative forms, namely;
 A supply function
 A supply schedule
 A supply curve
Supply Function
A supply function of an individual supplier is an algebraic form of expressing his behavior
with regard to what he offers in market at the prevailing prices. In it, the quantity supplied
per period of time is expressed as a function of several variables.
General form of the supply function is Sx=f (Px, Cx, Tx)

Example of a supply function for good X is Sx=200+15Px

Sx denotes quantity supplied of good X, Px denotes the price of good X ,Cx represents cost
of production and Tx is technology of production.
Course Instructor: Ms. Sonal Mehrotra 9
Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Supply Schedule
A supply schedule is a tabular statement that shows different quantities or services that
are offered by the firm or producer in the market for sale at different prices at a given
time. It describes the relationship between quantities supplied of a good in response to
its price per unit, while all non-price variables remain unchanged. A supply schedule has
two columns, namely

 Price per unit of the good(Px)

 Quantity supplied per period(Sx)
The supply schedule is a set of pairs of values of Px and Sx. There are two types of supply
schedule, namely

 Individual supply schedule

 Market supply schedule

Table: Individual Supply Schedule for Commodity X

Price per unit of Quantity of Commodity

Commodity X (Units)
10 1000
20 2000
30 3000
40 4000
50 5000
60 6000

Individual supply schedule relates to the supply of a good or service by one firm at
different prices, other things remains constant or equal. The market supply schedule, on
the other hand, like market demand schedule is the sum of the amounts of good supplied
for sale by all the firms or producers in the market at different prices during a given time.
Let us assume, there are two producers for a good.
Table: Market Supply Schedule for Commodity X
Per unit Price of Quantity Supplied of Quantity Supplied of Market Supply
Commodity X by Commodity X by Commodity X by (Units)
producer A Producer A(Units) Producer B (Units) QA+QB
PX QA QB
10 1000 2000 3000
20 2000 3000 5000
30 3000 4000 7000
40 4000 5000 9000
50 5000 6000 11000
60 6000 7000 13000

Course Instructor: Ms. Sonal Mehrotra 10

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Supply Curve: The individual supply curve is a graphical representation of the information
given in individual supply schedule. The higher the price of the commodity or product, the
greater will be the quantity of supply offered by the producer for sale and vice versa,
other things remaining constant.

The figure shows the supply curve, where X-axis

measures quantity supplied and Y-axis shows
prices.

As the price increases from 10 to 60, the

quantity supplied rises from 1000 to 6000,
establishing a positive relation among the two.

Thus, this implies that the supply curve is

upward sloping.

Change in Supply – Increase/Decrease versus Expansion/Contraction in Supply

Note: The location of a supply curve (that is the distance from origin) is determined by
factors other than its own price, while its slope is determined by its price.

In other words, supply for a good changes when

 Movement along supply curve: a producer moves from one point to another on the
same supply curve
 Movement from one supply curve to the other: when the entire supply curve shifts
its position.
I. Movement along Supply Curve: An increase in price will increase the quantity supplied,
but a decrease in price will reduce the quantity supplied. The supply curve is positively
sloped-upward and to the right, as against the demand curve which is negatively sloped.
Contraction in the Supply: A reduction in quantity of supply on account of a decrease in
price is termed as ‘contraction’ in supply. In this case, the supplier moves downwards
along the supply curve.
Expansion in the Supply: An increase in the quantity of supply due to an increase in
price is termed as expansion in supply of that good. If the price of the good rises, the
supplier moves upwards along the supply curve and offers to sell more of the good.

Course Instructor: Ms. Sonal Mehrotra 11

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
In the diagram, at price P1, the
quantity supplied is Q1. Now, if
price falls to P2, quantity supplied
falls to Q2. This movement in
downward direction of the
supply curve is known as
contraction in supply.

However, if the price rises from

P1 to P3, the quantity supplied
increases from Q1 to Q3. This
upward movement is known as
Ex

the expansion of supply.

II. Movement from One Supply Curve to the Other: If the supply changes without change
in price, the supplier shifts from one supply curve to the other. Such a movement is called
increase or decrease in supply.
Increase in the Supply: When the producer moves to the outer supply curve to the right, it
is termed as ‘increase’ in supply. An increase in supply of a commodity may be brought due
to an increase in the number of producers, price of competing commodities, improvement
in technology, entry of new firms into the industry, increase in demand for the commodity,
change in goals of the firm, decrease in prices of factors of production, etc.
Decrease in the Supply: When the producer moves to the inner supply curve to the left, it
is termed as ‘decrease’ in supply. A decrease in the supply of a commodity may be a result
of a decrease in the number of producers, decline in technology, exit of some firms from
the industry, increase in costs of production etc.

In the diagram, consider supply

curve S1. At price P1, the quantity
demanded is Q1. Now, if the seller
decides to sell more quantity of a
commodity, say Q2, at the same
price P1, then this movement from
Q1 to Q2 is called an increase in
supply. (During sale offers)
However, if the seller decides to
sell less quantity of a commodity,
say Q3, at the same price P1, then
this movement from Q1 to Q3 is
called a decrease in supply.

Course Instructor: Ms. Sonal Mehrotra 12

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Exceptions to the Law of Supply
The law of supply states that the sellers are willing to sell more goods at a higher market
price of a commodity and vice-versa. Thus, there is a direct relationship between the price of
a commodity and its supply. However, there are some exceptions of law of supply. There are
certain circumstances under which the law of supply may not hold true. It means that the
price of the commodity and its supply may not move in the same direction. Thus, the
exceptions to the law of supply are as follows.
i. Expectation for future price rise: When the price of a good is expected to increase,
supplier decreases the supply quantity so as to create artificial scarcity and avoids
selling at lower prices in current period and sells more at even higher prices in
future period.
ii. Monopoly: The situation when there is only one seller of a service refers to
monopoly. The single seller is the price maker and has control over different prices.
The seller may not be willing to raise the supply even if the prices are going high,
hence it is an exception to the law of supply.
iii. Competition: When there is high competition in the market, the sellers may sell
goods in high quantities at low rates. It refers to a situation where the law of supply
does not hold.
iv. Perishable Goods: In case of perishable goods, like vegetables, fruits, etc., sellers
will be ready to sell more quantity even if the prices are falling. It happens because
sellers cannot hold such goods for long as these goods bear a risk of rotting. This is
an exception to the law of supply.
v. Legislation Restricting Quantity: Suppliers cannot offer to sell more quantities at
higher prices where the government has put regulations on the quantity of the good
to be offered or the price ceiling at which the good is to be offered in market.
Producers are unable to play with either of the factors on their own.
vi. Agricultural Products: Since the production of agricultural products cannot be
increased beyond a limit, the supply can also not be increased beyond this limit
even if the prices are higher; the producer is unable to offer larger quantities.
vii. Also, agriculture production depends on climatic conditions. If, due to unforeseen
changes in weather, the production of agricultural products is low, then their supply
cannot be increased even at higher prices.
viii. Rare goods (Artistic and Auction Goods): Rare, artistic, precious and auction articles
have limited supply. The supply of these goods cannot be increased even if the
prices or demand increases. For example, supply of rare articles like painting of
Mona Lisa cannot be increased, even if their prices are increased. It is also an
exception to the law of supply example.

Course Instructor: Ms. Sonal Mehrotra 13

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Determinants of Supply

At any point in time, the total quantity supplied of a good or service in the market is
influenced by number of factors. Some of the important factors include the following:

a. Costs of the Factors of Production: The cost of factor inputs such as land, labour,
capital, raw materials etc. influence the market supply of a product. For example, if
the price of labor goes up, then the supply quantity of the product will decline due
to higher labor cost.
b. Changes in Technology: The change in technology such as improved machinery,
method of organization and management helps the business units or firms to
reduce the cost of production. All this contributes significantly to increase the
market supply at given prices.
c. Price of Related Goods (Substitutes): Prices of related commodity also affect the
supply of the commodity (say X). If the price of a substitute good, Y increases, the
supply for that good (X) increases and the producer would shift the allocation of
resources to Y from X.
d. Change in the Number of Firms in the Industry (Market): A change in number of
firms in the industry (attracted by profits) also influences the market supply of a
good. For example, an increase in number of firms in the industry would increase
the quantity supplied of good over the range of prices.
e. Taxes and Subsidies: A change in government fiscal policy in terms of change in tax
rate or amount of subsidy may influence the supply of a good in the market. A
decrease/increase in the amount of tax/ subsidy on the good would allow firms to
offer larger amount of a good at a given range of prices.
f. Goal of a Business Firm: The goal of a business firm such as profit maximization,
sales maximization or both is responsible to influence the market supply of a good
or service. In case the firm is interested to maximize profit, the same may be
attained by decreasing the market supply of a good under certain conditions where
as goal of sales maximization will increase the supply.
g. Natural Factors: Natural Factors such as climatic changes, particularly in the case of
agricultural products influence its supply.
h. Changes in Producer or Seller Expectations: The supply curve is drawn for a certain
time period. If the expectations of the future prices change drastically in a market,
the firm would hold current production from the market in anticipation of higher
prices and thus influences supply of the good.

Course Instructor: Ms. Sonal Mehrotra 14

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Equilibrium of Demand and Supply
In economics, equilibrium is a state in which quantity demanded equals quantity
supplied. The demand and supply curve intersect each other at a point called point of
equilibrium. The market becomes stable. At equilibrium, every consumer who wishes to
purchase the product at the market price is able to do so, and the supplier is not left with
any unwanted inventory.
 The equilibrium quantity is the quantity at which demand equals supply.
 The equilibrium price is the price at which the demand is equal to supply.

In the diagram, P* is the

equilibrium price and Q* is the
equilibrium quantity. E is the point
of equilibrium.
At any price below P*, quantity
demanded Qd is greater than
quantity supplied Qs. A shortage of
supply exists.
At any price above P*, quantity
supplied Qs is greater than
quantity demanded Qd. A supply
surplus exists in the market.

The word equilibrium means balance. Equilibrium is the state in which market supply
and demand balance each other, and as a result prices become stable. Generally, an
over-supply of goods or services causes prices to go down, resulting in higher demand,
whereas an under-supply or shortage causes prices to go up, resulting in less demand. The
balancing effect of supply and demand results in a state of equilibrium.

Although the demand would be very high at lower prices, in practice, consumers may
never get the opportunity to buy the product at that low price because suppliers are not
willing to supply at that price. Similarly, although suppliers may be prepared to offer a
large amount for sale at a high price, they may not be able to sell it all because the
consumers are not willing to buy at that high a price. So, in order to satisfy both consumers
and suppliers, establishing equilibrium is necessary.

This can be better understood with demand and supply schedule for good X and analyzing
equilibrium position. Consider equilibrium price as Rs. 40 and equilibrium quantity as
9000 units.

Course Instructor: Ms. Sonal Mehrotra 15

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Table: Demand and Supply Schedule for Commodity X
Price per unit of Quantity Demanded of Quantity Supplied of Description
Commodity X PX Commodity X (Units) Qd Commodity X (Units) Qs

10 12000 3000 Excess Demand

20 11000 5000 Excess Demand
30 10000 7000 Excess Demand
40 9000 9000 Demand=Supply
50 7000 11000 Excess Supply
60 5000 13000 Excess Supply

Effect of Change in Demand and Supply on Equilibrium Price (or Market Price “Mp”)
Effect of Change in Demand on Mp

The equilibrium price will remain stable in the market as long as other factors that
influence demand and supply do not change. If any of these factors change, this will create
excess demand or excess supply and so initial equilibrium price will also change.

For example, a condition of drawing a demand curve is that level of income does not
change. If the level of income increases, there will be an increase in demand for a
commodity X at the existing market price. The demand curve will shift rightwards. Hence,
if the price remains the same, supply will be the same as before, and with increased
demand there will be a shortage, causing suppliers to raise the existing price.
In the graph, P is the equilibrium price
and Q is the equilibrium quantity. E is
the point of equilibrium. DD’ is the
initial demand curve and SS’ is the
supply curve.

Due to increase in income, demand

curve shifts from DD’ to D1D1’, causing
excess demand.

Due to the pressure of demand, the

price shifts from P to P1 and the
quantity supplied tends to expand.

E1 is the point of new equilibrium. The

new Equilibrium price is P1 and new
equilibrium quantity is Q1.

On other hand, if consumer’s level of income decreases, other things remaining constant,
the demand will decrease. The excess supply would cause existing price to fall.
* Notice that a change in conditions of demand does not cause changes in conditions of supply.

Course Instructor: Ms. Sonal Mehrotra 16

Unit I: Introduction to Economics B.Tech 2nd: 2024-25

Effect of Change in Supply on Mp

A shift in supply will also change equilibrium price. If supply determinants other than price
change, it will cause change in supply. For example, if there is an increase in supply due to
falling cost of production, the supply curve will shift outward (rightward). The equilibrium
price will fall.

Similarly, if there is a decrease in supply due to rising cost of production, the supply curve
will shift inward (leftward). The equilibrium price will rise.

In the graph, P is the equilibrium price

and Q is the equilibrium quantity. E is
the point of equilibrium. DD’ is the
demand curve and SS’ is the initial
supply curve.

Due to fall in cost of production, supply

curve shifts from SS’ to S1S1’, causing
excess supply.

Due to excess supply, the price reduces

from P to P1 and the quantity demanded
tends to expand.

E1 is the point of new equilibrium. The

new Equilibrium price is P1 and new
equilibrium quantity is Q1.

Consumer surplus and its applications

Alfred Marshall in his famous book “Principles of Economics” (first published in 1890)
introduced, among other things, the concept of Consumer surplus. Consumer surplus is also
known as Buyer surplus.
Let us consider a hypothetical market situation. Suppose there is a commodity ‘X’ in the
market, and consumer intends to participate in the market as a buyer. He is willing to pay
Rs. 50 for one unit of commodity X. However, as he enquires about its price from the seller,
he gets to know that the price of the commodity is Rs. 25. Here, the difference between the
two prices is Rs. 25. It is called consumer’s or buyer’s surplus. It measures the utility gain to
the group or individuals who purchased commodity X at Rs. 25.
Definition: Consumer’s Surplus is defined as the difference between what consumers are
willing to pay for a unit of the commodity and the amount the consumers actually pay for
that commodity.

Course Instructor: Ms. Sonal Mehrotra 17

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Consumers’ Willingness to pay can be read of as an individual or a market demand curve for
a product. Or we can say that the demand curve tells us the maximum price that consumers
would be willing to pay for any quantity supplied to the market.
Example: Consider four potential buyers (A, B, C and D) and their willingness to pay for a
good. The market price is Rs. 1200 at which sellers would sell.
Buyers Willingness to Pay Consumer’s
Surplus
A 2000 800
B 1700 500
C 1500 300
D 1200 0 Price
E 900
Table: Buyers with their willingness to pay

Commodity X

A earns consumer’s surplus of Rs. 800, since he was willing to pay Rs. 2000, but only had to
pay Rs. 1200. Similarly, B earns Rs. 500 of consumer’s surplus, and C earns Rs. 300 of
consumer’s surplus. Buyer D is willing to pay Rs. 1200 for a unit, but since the market price
is Rs. 1200, D gets no consumer’s surplus; hence he is the so-called "marginal" buyer.
The demand curve is stepped because we are considering only a small number of buyers.
In real markets, hundreds or thousands of buyers exists. Each step corresponds to one
potential buyer’s willingness to pay.
Consumer’s Surplus for a discrete and Non-discrete Good
A discrete good is one that can be bought and sold only in integer units. Consumer’s surplus
in this case will be given by the area below the demand curve and above the market price
line. In case of non-discrete goods, consumer surplus is found using a definite integral.

Course Instructor: Ms. Sonal Mehrotra 18

Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Change in Consumer Surplus due to change in Mp
It is often important to know how much the consumer’s surplus changes when the price
changes. There exists an inverse relationship between consumer’s surplus and the
price.
Now, consider Table showing five potential buyers of commodity X, listed in order of their
willingness to pay. How many of these five buyers will actually buy a unit of commodity?
It depends on the market price. At first, Mp =Rs. 30 and then it becomes Rs. 20.
Buyers Willingness to Pay CS1 CS2
A 59 29 39
B 45 15 25
C 35 5 10
D 25 5
E 10

The consumer surplus of each buyer is

shown at different Mp. At Mp=30, three
buyers A, B, C can buy a unit of a
commodity. At Mp=20, four buyers A, B, C
and D actually buy a unit of a commodity.

Effect of Price Changes on Consumer’s Surplus

 A rise in the market price of the commodity reduces consumer’s surplus.
 A fall in the market price of the commodity increases consumer’s surplus.
In the above case, Mp reduces. So, change in consumer’s surplus is given by an amount
equal to the sum of areas of Part I and II. Part I is the gain by Rs. 10 to A, B and C. Part II is
the gain by Rs. 5 to D who could not buy at Rs. 30 but bought the commodity X at Rs. 20.
The total increase in consumer’s surplus is Rs.35
Example
Let us consider demand function to be p=6-0.5x.
We need to calculate the loss in consumer’s
surplus when price rises from Re.1 to Rs.2.
At first, we plot the demand curve. When
p=1, x=10 and when p=2, x=8. The demand
curve will be downward sloping as shown in
the figure.
Loss in consumer’s surplus= Area abcd
=Area abce + Area ecd
= (8x1) + (1/2) x {10-8}x1
= 8+1
=Rs.9Instructor: Ms. Sonal Mehrotra
Course 19
Unit I: Introduction to Economics B.Tech 2nd: 2024-25
Producer Surplus
Similar to consumer surplus, producer surplus is the economic benefit to producers of
goods.
Definition: Producer surplus is defined as the difference between the amount the
producer is willing to sell goods for and the actual amount received by him when he
makes the trade. It exists if the market price of a good is higher than the price the
producer is willing to sell. Hence, it is shown graphically as the area above the supply
curve and the market price.
Example: If a seller would sell a good at Rs. 400, but the market price is Rs. 700, the
producer surplus is Rs.300.

A producer always tries to increase his

producer surplus by trying to sell more
and more at higher prices.
However, it is simply not possible to
increase the producer surplus
indefinitely because at higher prices
there might be very little or no demand
for goods.

Consumer surplus is a measure of consumer welfare. It shows consumer’s monetary gain

or marginal benefit. Producer surplus is a measure of producer welfare. It shows the cost
incurred by the producer on producing one additional unit of commodity. This cost is called
marginal cost or it can be deduced that, the price of a unit commodity along the supply
curve is called the marginal cost.

On plotting both the consumer and producer surplus together, we obtain the total surplus,
also known as total welfare or community surplus. It is used to determine the well-being of
the market. When all factors are constant, in a perfect market state, an equilibrium is
achieved. This state is also referred to as allocative efficiency – the marginal cost and
marginal benefit are equal.

E: It is the point of equilibrium at which

Total Surplus is maximum.

Total Surplus = Total Consumer Surplus +

Total Producer Surplus.

*********
Course Instructor: Ms. Sonal Mehrotra 20