Monday, 18 January 2016

Consumer Equilibrium, indifference curve and consumer behaviour

It is assumed that consumers are constantly engaged in efforts to maximise their total utility. They always try to satisfy their needs through different combinations and choices of goods to maximise utility. So, the solutions that they find after making so many experiments and  decisions in maximising their satisfaction is known as the consumer equilibrium. It is arrived at with a set of indifference curves depicting their preferences for goods.

An indifference curve is a curve formed on a graph by connecting the points of different combinations of two commodities that a consumer regards as of equal value and are giving him equal satisfaction. The consumer regards any combination on that curve as of equal value and so he is indifferent to each of those combinations.

With a given income and the present ranges of prices, the consumer has to choose among various alternative combinations of goods and services to get utmost satisfaction and enjoy most of those goods and services. The manner in which he responds and the solution that he finds at a particular level with a given combination is his equilibrium.

Consumer equilibrium definition
Consumer equilibrium is a state of balance achieved by the consumer of goods and products that refers to the quantum of goods and services he can purchase within his given level of income and at the prevailing current prices.

Consumer Equilibrium is the point of balance at which stage, the consumer is able to get maximum satisfaction from a reasonable combination of multiple goods at their given prices and within his income. At this point, he is able to achieve maximum utility level and any shifts from that point will only diminish his satisfaction level.

Assumptions underlying Consumer's Equilibrium
The following are some of the assumptions that are implicit in studying the consumer equilibrium.

  • Consumer's income is given and he has to act within that income.
  • The prices are set and stable for the time being under study.
  • It is assumed that there are two goods X and Y and he has to choose various combinations of those two goods.
  • The indifference curve is the maximum possible level of satisfaction within his income selected from the indifference map or set of indifference curves.

Now, let us take an example. Suppose your income is $100 and you have to purchase two goods within that income. Let us assume that price of product X is $10 and that of product Y is $20. Now if you want to purchase only one commodity, then you can purchase either 10 units of X or 5 units of Y. But, you can't have only one item. You want to buy both items to maximise your satisfaction levels. So, you will try different combinations and the results are depicted through the indifference curves in the below indifference map.

In the above figure, X axis depicts product X and Y axis depicts product Y. At the right hand side  tip of each curves IC stands for indifference curve. So, there are four indifference curves drawn by us named IC1, IC2, IC3 and IC4. You will be able to notice that points on IC1, 2 and 3 fall within your income range. But IC4 is completely out of your income range as it is away and out of the price line. Price line AB is tangent to the indifference curve IC3 touching it at point E. So, point E can be considered as the consumer equilibrium point at which he is able to maximise his satisfaction levels by purchasing Q1 units of product X and Q2 units of product Y. Any other points on lower levels touching the price line will be of lesser satisfaction. Further, he is not spending his full income at those points. Points at higher levels do not touch the price line AB and so they are not in his income range.

So, consumer equilibrium is that point of level, where the consumer is able to maximise his satisfaction by spending his full income on those products in a better way. In practical life, there are so many products that the buyer purchases and it is a more complicated problem. The decision making ability of consumer shows his smartness and prudence in attaining consumer equilibrium.

Monday, 4 January 2016

Price fixing and factors determining price line

What is price fixation? 
Price fixing is the process of determining the price of a product for sale in market. It is believed that it is rather a kind of agreement between businessmen to buy or sell goods at a price not lesser than a particular price. It is applied for safeguarding their minimum profits by averting competition from rivals who may try to sell at lower prices for their selfish gains.

But, it is not a good practice and governments try to safeguard the interests of consumers by prohibiting unhealthy practices through enforcement of laws and other measures.

Let us now look at how prices of commodities are determined under normal market conditions.

How prices are determined?

  • Under normal circumstances, in healthy market conditions, prices are determined by the interaction of supply and demand forces.
  • Generally, the supplier or manufacturer fixes the price of his product after taking into account all his cost factors and then adding a margin of profit for himself.
  • So, the price is fixed at a rate which includes cost + profit. 
  • But, producers and / or suppliers may try to add a higher percentage of profit to the cost in fixing their prices.
  • So, the forces of supply and demand in the market come to our rescue in safeguarding the interests of consumers by settling at an equilibrium point of price.

Major factors influencing price determination
The following are some of the important factors affecting price determination.

Cost of production
Cost of production is the basic element of price. The producer of the product incurs some basic costs towards raw materials and ingredients involved in the production of his products. He further incurs the labour cost, the salaries of staff, rent of the building, any machinery and godowns involved in producing the product and other costs like electricity, stationery and depreciation of assets and tools used in producing the output. So all these elements constitute the cost of his product.
So, the producer or supplier fixes his price by summing up all these costs and dividing that total cost with the quantity that is produced at any period. This average cost should be fully realised by him from the buyers.

Competition in market
Competition in market from similar product dealers also influences the price. If there are many sellers of the same commodity, each one of them will try to maximise his sales by giving incentives to buyers. Buyers generally buy from a dealer who offers the products at comparatively lower prices. Even a small fraction of a currency unit charged lower can allure the buyers. So, the producer or supplier needs to pay attention to this factor of market competition in fixing his prices.

Value of product to the buyer
This is one more important element in fixing the price. The value that buyers attach to the product is a very sensitive part of price. Necessities like food grains, salt, sugar are more important for consumers. So, they cannot live without these products. The producer or supplier can fix the prices with some margins in such products without losing market.

The forces of supply and demand
The forces of demand and supply play major role in price determination. Buyers normally tend to purchase products at reasonably lower prices to get maximum satisfaction. Similarly sellers try to maximise their profits by selling things at higher prices. So, when both these forces interact, the buyers will restrict their purchases when the prices increase and increase their purchases when prices fall. Naturally, when there are no buyers at increased prices, the supplier is forced to decrease his price a little to attract buyers. When price falls the buyers will increase their demand. Similarly, when the prices fall too much, there will be excessive demand for products but the supplier may not have enough supply to meet their demand. Then, buyer will be willing to buy at an higher price. Thereby, the prices will increase. In this way, the price level settles at a point of equilibrium where quantity demanded and quantity supplied matchup. Price gets influenced in this way with the forces of supply and demand.

Government policies
Government can always try to regulate the prices through its policies and laws to safeguard the interests of consumers. So, the producers and sellers have to fix their prices in accordance with those policies and guidelines or else they may have to face legal proceedings and bans.

Saturday, 2 January 2016

Law of Demand, demand schedule and demand curve

The law of demand states the relationship between the price of a commodity and the quantity demanded of it. It studies and explains the spending and purchasing habits of consumers at any time.

Whereas suppliers of goods and services tend to increase supplies of their product into market as a result of the increase in prices, the consumers tend to react inversely. Consumers begin to shrink their demand for those goods and services whose prices begin to increase.

This decrease in demand happens because, consumers have to make purchases from within their own financial capacities. Naturally, they tend to curtail their purchases of costly items and shift their attention towards lower cost commodities.

The law of demand is based on this trend of the decreasing demand for goods and services whose prices are spiralling upwards. It assumes that other factors remaining same, changes in prices will result in changes in demand.

So, the law of demand and law of supply are inversely related to each other.

The law of demand definition
Law of demand states that, other factors remaining constant, as the price of a good or service increases, the consumer demand for it will decrease. So, according to this law of demand, the price of a commodity and quantity demanded are inversely related to each other. If the price rises, demanded quantity will decrease and if the price falls, demanded quantity will increase.

  • The demand for any commodity is expressed as at a given price and as at a particular time or for a given period of time.

What is demand schedule
Demand schedule is a chart showing various prices of the commodity and the quantities demanded of it at each price range.

Let me give an example here.
Suppose a consumer goes to purchase Sugar. He buys 5 kg sugar when the price is at Rs.30 per kg. Suppose the price increases to Rs.40. Then he will buy only 4 kg. and if the price further increases to Rs.50, he will be buying only 3 kg. As the price goes on increasing, he will go on decreasing his quantities of consumption. Or, conversely, when the prices fall, he will be increasing the quantities of his purchases. The same thing can be represented in the demand schedule as below.

Demand Schedule for Sugar                                                      
Price of sugar
Qty. of demand
5 kg
4 kg
3 kg

The above example is for a particular person's  individual demand. So, if we consider the demand of other people also for the commodity of Sugar, then it will be deemed as the total market demand for sugar. Suppose there are 10 people and each one demand various quantities at each price level. Then, you will have to add all the quantities demanded by all people for each price level to know the total demand at each price level. This is known as market demand for sugar. 

Demand Curve
A demand curve is a graph representing the relationship between price of a commodity and the quantity demanded by consumers at each price level of that commodity. It is a graphical representation of the demand schedule.

So, from the above figures of demand for sugar at different prices, we can prepare the demand curve as shown in the figure below.

Demand Curve for Sugar

In the above figure drawn with hand by me, the demand curve is the slant line at the top right hand corner of the image. It slants downwards because, with every increase in price the demand comes down.

Regarding factors affecting supply and demand, you may view for details at this link.