Theorizing Consumer Behaviour

1) When does the demand curve potentially slope upward?
– This happens when a consumer buys more of a good when its price rises-Case of Giffen goods
a. Economists use the term Giffen good to describe a good that violates the law of demand.
b. Giffen goods are goods for which an increase in the price raises the quantity demanded.
c. The income effect dominates the substitution effect.
d. They have demand curves that slope upwards.
2) How wages affect labour supply?
If the substitution effect is greater than the income effect for the worker, he or she works more.
If income effect is greater than the substitution effect, he or she works less.
3) How do interest rates affect household saving?
a. If the substitution effect of a higher interest rate is greater than the income effect, households save more.
b. If the income effect of a higher interest rate is greater than the substitution effect, households save less.

Richa Shukla
Globsyn Business School

Income Effect and Substitution Effect

• A price change has two effects on consumption.
– Income effect
– Substitution effect
• The Income Effect
– The income effect is the change in consumption that results when a price change moves the consumer to a higher or lower indifference curve.
• The Substitution Effect
– The substitution effect is the change in consumption that results when a price change moves the consumer along an indifference curve to a point with a different marginal rate of substitution

Richa Shukla
Globsyn Business School

Data say enough to silence any economic doomsayer

The world should not be worried about India’s medium to long term prospects as the nation’s economic fundamentals are sound and robust-

• India not a large borrower: $15 billion borrowing for a country with a $1 trillion GDP is not much
• Strong savings rate of 34.8%
• Investment rate of 35.9%
• Incremental Capital output ratio of 4% (better than China, 4.3%)
• Growth in export of 20%
• Strong growth in foreign exchange reserves at over $308 billion
• As per the projections, by 2022, India could be the world’s largest pool of trained manpower and leaders in industry and commerce, accounting for 10% of the world trade.

Source: The Chartered Accountant (Journal of the ICAI)

Richa Shukla

Globsyn Business School

Scarcity & Allocation

Teacher enters a class of 10 students with 10 chocolates (product is not scarce).
Teacher: How many chocolates does each one of you want?
It is found that 8 students prefer to have one chocolate each; and 2 students desire to have 2 chocolates each.
Thus total demand is 12 chocolates, whereas total supply is 10 chocolates (we see that chocolates have become a scarce product now because of excess demand as defined by student preference)
Teacher thinks….. “I have to devise an allocation mechanism for distributing chocolates. Let the mechanism be based on the concept of willingness to buy and ability to pay.”
Teacher: Whoever is willing to get chocolates have to appear for an examination, and that they are free to quit if chocolates are not strongly desired.
With this announcement two students quit as they were not willing to sit for an examination. Subsequently we are left with 10 chocolates and 8 students.

Key Takeaways:

• Individual preferences/desires make the availability of a product “limited in supply”
• For allocation of scarce product there ought to be an allocation mechanism such that who ever is willing to pay the market price for the product gets it (in the above case price is “to appear for an examination”) or there will not exist any systematized and regulated process of product distribution
• Allocation mechanism must be such that there is “continual adjustment of prices” (In the above case, if no one had left after “examination announcement” then the teacher would have to think for some add on strategies, i.e. some benchmarking in marks etc., till the point is achieved where total demand equals total supply)

Richa Shukla
Globsyn Business School