Economics Basics: Theory of Consumer Behavior

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Economics Basics: Theory of Consumer Behavior

Consumer Budget :   A consumer having fixed budget to buy a set of goods is consumer’s budget. Its exchange value of a consumer for a set of product and a particular time.
Example: In case of Richa , her pocket money was Rs 2000 which was her monthly budget.

Budget Set:  Set of products or bundle of products which a consumer can exchange or get under restriction of his/her budget is called Budget set.

Example

In case of Richa : She prioritised as follows

  1. Get her spectacles.
  2. Transportation for 30 days.
  3. Buy 2 Book.
  4. Birthday of Brother will be settled in about Rupee 500.
  5. Go for a movie with two friends.

Other sets which Richa could have got in Rupee 2000 are as follows

  1. Get her spectacles.
  2. Transportation for 30 days.
  3. Buy 2 Book.
  4. Birthday of Brother will be settled in about Rupee 700.
  5. Go for a movie alone.

And many more such sets according to her preference under Consumer budget of Rupee 2000.

Rupee 2000 ≥ P1x1+p2x2+p3x3+pnxn in case of Richa

Where p1 , p2 till pn  are set of products and x1 , x2 till xn are cost for respective product.

Budget line:  The set of products or bundle of Products which are selected by consumers on line of Budget is called Budget line.

In case of Richa any number of variation of Richa’s selection of products which cost exactly equals to Rupee 2000 is budget line.

Capture

Challenges in Budget set

P1x1+P2x2+Pnxn > M

Change in Budget Set

P1x1+P2x2+Pnxn > M

P1x1+P2x2+Pnxn < M

Monotonic Preference

When a consumer get satisfied with one set of product more than other set of product in terms of volume as in 1 set volume is more and other is equal then this sort of preference is known as Monotonic Preference.

Price Ratio and slope of Budget line

Substitution Between Goods

Amount of goods consumer is willing to give up for another goods is substitution of goods.

Two sets of goods

Set 1:  (x1, x2)

Set 2:{ (x1+Δx1) + (x2+Δx2)} where Δx1 > 0 and Δx2 <0

Rate of substitution = Δx2/Δx1

Diminishing rate of Substitution:  Amount of goods x1 we are using more to respective decreasing of goods x2 is rate of substitution.

Indifference curve:  

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Economics Notes for Competitive Exams

Introduction to Economics

Economics is study of utilization of scarce resources to meet maximum utility.

Example:
Richa gets Rupee 2000 as Pocket money from her day. Resource is Rupee 2000.
Richa wants to go to movie which costs Rupee 300.
Richa wants to buy a book worth Rupee 400.
Richa spectacles got broken and that will cost 500.
Richa has planned a trip with friends which will cost Rupee 700.
Richa brothers Birthday comes in this month and a present may cost Richa Rupee 700.
Richa needs Rupee 300 for her monthly transportation.
So Richa expenditure is Rupee 2900 whereas her income is Rupee 2000.
Needs and wants which Richa will fulfill amongst all above needs is economics of Richa

What should Richa Do? Probably Richa will priorities-

  1. Get her spectacles
  2. Transportation for 30 days
  3. Buy 2 Book
  4. Birthday of Brother will be settled in about Rupee 500
  5. Go for a movie with two friends
    This will be economics of Richa!

Economics can be summarized as science through which-

  1. An individual understand his or her resources to maximize his well being (as he/she perceives it to be)
  2. A company uses its limited resources for profit maximization (Tangible and intangible)
  3. An industry uses its limited resources for gain of stakeholders.
  4. A country or a society uses its limited resources to meet its requirement of food, safety, growth or in short utility and may save for poor economical period.

Economics has further been divided in two parts.

  1. Micro Economics
  2. Macro Economics

Micro Economics

Micro means Small
Economics means:  study of utilization of scarce resources to meet maximum utility.

Study of Economical process or behavior of an individual, household, company or an Industry is Micro economics, salary, and cost of Production etc.

In case of Richa
If laborers who manufactures Spectacles will increase their labor charges then May be Richa will have to settle for lower quality of spectacle or she will have to reduce expenditure on other things, but increase in labor cost will be part of Microeconomics; it will be under control of manufacturer till a larger extent.

Microeconomics deals with factors like Demand , Supply , cost , Market , cost efficiency , product efficiency , distribution , supply , profit maximization , for an individual or household  a company or an industry.

Activities at Micro Economic level affects Macroeconomic environment of a country and then it becomes out of control of any individual or household or a company or an industry and becomes part of Macroeconomic factors.

Demand

Demand is an economical activity where exchange value of a Product or service is agreed upon or has willingness to get agreed upon.

We as an individual has too many needs and dreams but all those needs and dreams cannot be fulfilled because of difference in sum of cumulative exchange value of our labor to our needs or dreams.

Everything what we need or dream about is not demand. Unless and Until, We do not have exchange value for product or services which we need or dream about, it does not become demand in terms of economics.

Supply

Willingness of economic agents in providing Product or services in accordance with demand to marketplace is called as Supply.
Fundamental availability of Product or services in Market for consumer is Supply. You can also say availability at certain cost.
Sometimes you do not have enough water to die but that’s supply.

Who are Economic Agents?
Individual, House hold, company, consumer, supplier etc who all can be part of economical Process are Economic agents.
In Market Place General Theory states that When Price increases Demand decreases.

Cost

Exchange Value of a product which may keep flow of regeneration of product for market generally accessed in Local currency.

In case of Richa Need was of spending Rupee 700 for brother’s birthday but demand dropped down to Rupee 500 expenditure. Supply is Products available at Rupee 500.

Profit Maximization

It’s an economical phenomenon for an organization or a company where Maximum Profit in short term or long term on per unit sales cost is forecasted or determined.

Example:
Suppose in case of Richa Buyers of Glass can only Produce 1000 glasses at Rupee 500 but demand with him is of 1200 glasses per month. These are realized by Manufacturer after Richa bought Spectacles. To start producing more than 1000 spectacles he needs to install another Unit and cost of establishing new unit is Rs Rupee 1000000.
No what Price manufacturer should charge his consumers like Richa so that he may be able to sell 1000 glasses and create demand of 1000 glasses only.

Central Problem in an economy

As we know Economics is meeting maximum utility in limited Resources available, every economy faces central problem.

  1. What is produced and how much is produced?
  2. How are these being Produced?
  3. For whom these goods or services are being produced?

Production Possibility Frontier

As Richa was struggling to meet her utility similarly an economy on larger scale struggles to meet its utility for production of goods and services.
Combination of possibilities of production of goods or services under influence of limited resources is Production Possibility.
When larger economy prioritizes its production goal and targets then its Production possibility frontier.

For example:
As Iran sells oil and natural Gases to India in foreign exchange that is in Dollars, India has limitation of Purchasing Oil and Natural Gases. Whereas growing Indian economy needs Oil and Natural gases as primary source of Energy in all fields like-

  1. Transportation
  2. Electricity Production
  3. Cultivation

Now government has many options or sets of options of usage of Oil and Natural gas with following combinations

  1. All O&G given to transport department (Case 1)
  2. All O&G given Electricity Production department (Case 2)
  3. All O&G given to Agricultural department (Case 6)
  4. Transport department given 10% , Electricity production: 20% and Agriculture – 70% (Case 3)
  5. Transport department given 20% , Electricity production: 20% and Agriculture – 60% (Case 4)
  6. Transport department given 40% , Electricity production: 20% and Agriculture – 40% (Case 5)
  7. 50% oil to transport 60% Gas to transport; rest may be divided among Electricity production and Agriculture equally. (case 7)
    All above cases are to meet different production possibility objective and these cases are known as Production possibility Frontier

Organization of Economic Activities

  • Centrally Planned economy:  It’s an economic process where a product or service or resource is utilized to meet certain goal and objective of state or functionaries. Centrally Planned economy helps one set of economically activities or process over other.
    Example 1: May be during time of war government will want to use Iron ore to be used for manufacturing of artillery and arms rather than using them for manufacturing of Cars or Iron bars.
    Example 2: It becomes difficult for farmers to buy Diesel at Market price for cultivation or irrigation of land and if Land will not be cultivated then it will lead to inflation as food will not grow thus Government provides Diesel on subsidy to meet agricultural irrigation target.
  • Market Economy:  All economic activities which are governed through market. A market is free institution and it only accepts rule of Demand and supply in fare economic environment.

In a market determined system all goods and services comes at an exchange value generally accepted in society for utility and market policies are further governed on demand and supply. Price increases, if demand increases and price goes down if demand decreases.

Micro Economics

Macro means Large.
Economics means:  study of utilization of scarce resources to meet maximum utility.

Macroeconomics is study of overall behavior of economical phenomenon or activity on a larger scale like country or global.

It constitutes of National income, Inflation, Deflation, GDP, Employment rate, International Finance, International trade.

In case of Richa, She actually wanted to invest Rupee 700 on gift for her brother but her Economics forced her to settle for Rupee 500! Now appreciation in Dollar cost again decreased value what Richa could get in Rupee 500 in USA than that of in India.

Positive and Normative Economics:   As discussed in product possibility frontier that there are more than one ways of resource allocation for different industries and similarly there are more than one solution to an economic problem.

It’s important to understand which of economic activity will meet best possible economical viability and that is Positive Economics whereas Normative economics  we try to understand long term effect of that economical decision that is whether that economical decision taken was desirable or not.

Questions:

  1. Discuss central problem of Economics
  2. What do you mean by the production possibilities of an economy?
  3. What is production possibility frontier?
  4. Discuss the Subject matter of Economics?
  5. Distinguish Between a centrally planned economy and a market economy.
  6. What do you understand by Positive economic analysis?
  7. What do you understand by normative economic analysis?
  8. Distinguish between Microeconomics and Macroeconomics.
  9. What is Mixed economy?
  10. What is opportunity cost?

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