3 Marks Each

Question 13 Marks

Explain the exceptions to the law of demand.

Answer

As per the law of’ demand, when the price rises the demand falls and vice-versa. However, for some goods there are exceptions to this law.
Under this exception, when price of a good falls, its demand also falls instead of rising and vice-versa. Thus, change in price creates demand to change in opposite direction than that indicated in the law of demand.

Examples of such goods are:
$1.$ Prestigious goods:

Certain goods which are priced very high and are generally consumed by very rich people like, expensive jewelry, expensive cars, expensive mobile phones, etc. are considered prestigious goods.
Such goods are used by the rich as status symbols. Even if their price rises their demand expands instead of contracting.
On the other hand, if their price falls, the rich may contract their demand and avoid buying such goods with a mindset that a fall in price means that the good is losing its prestige and will now be in reach of even common people.
Examples of such products are Mercedes car, iPhone, etc.

$2.$ Extremely low-priced goods:

Certain goods are extremely low-priced. The consumer spends a very small proportion of his income on these products. For example, pins, stapler pins, toffee, etc.
Even if price of such goods rise consumer’s demand for these goods may not fall. Similarly, if their price falls, the consumer may not expand his demand as he may not need more of such goods than his actual need.

$3.$ Giffen goods $($Inferior goods$)$:

When price of certain goods namely inferior goods fall and the real income of a consumer rises he may reduce the consumption of such goods and substitute them with goods of superior quality.
It was Robert Giffen who made these observations and explained this concept. Hence, these goods i.e. inferior goods are also called Giffen goods. Such goods are necessary goods and are purchased by the low-income groups.

Example:

A person with low income purchases grains such as Jowar or Bajra for his daily diet. When the price of Jowar/Bajra falls drastically, the real income of the consumer tends to increase.
Hence, he will reduce consumption of such goods and will purchase more of wheat which is the superior good.
Another example is that of vegetable $($vanaspati$)$ ghee and pure ghee.

$4.$ Special preferences of people:
At times, people get very accustomed and used to certain goods. They cannot do with any other good. Even if there is some rise in the price of their preferred goods, their demand may not decrease.
Example:
A specific brand of Ketchup, tooth paste, shoes, etc.

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Question 23 Marks

Explain income elasticity of demand.

Answer

Meaning:

Income elasticity of demand is useful to measure changes in the demand for a commodity with respect to changes in the income of a consumer.
The extent (degree) of change in demand for a good because of a change in income of the consumer is called income elasticity of demand. It is denoted by $\varepsilon_y$.
Income elasticity $\left(\varepsilon_y\right)$=$\frac{Proportionate change in demand}{Proportionate change in price}$

Types/degrees of income elasticity of demand:
$1.$ Positive income elastic demand:

There are three degrees of in positive income elasticity of demand. They are:
$(A)$ Unit income elastic demand $\left(\varepsilon_y=1\right)$
$(B)$ Elasticity of demand greater than unity $\left(\varepsilon_y>1\right)$
$(C)$ Elasticity of demand less than unity $\left(\varepsilon_y<1\right)$
$2.$ Negative income elastic demand
$3.$ Zero income elastic demand

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Question 33 Marks

Explain expansion and contraction of demand along with diagram.

Answer

Increase/decrease in demand takes place when price is assumed constant and determinants other than price varies.
Keeping price as constant, if factors/determinants other than price vary there occurs increase/decrease in demand.
We take price which is an independent variable on $Y$-axis and demand on $X$-axis. So when price remains fixed i.e. constant, the demand $($on horizontal axis$)$ changes. This causes rightward/leftward shift in the demand curve $DD$.

Rightward shift:
Keeping price factor as constant, if demand increases due to any other factor, the demand curve will shift towards right which is called rightward shift in demand curve.
Leftward shift:
Keeping price factor as constant, if demand decreases due to any other factor, the demand curve will shift towards left which is called leftward shift in demand curve.
Let us take an example to understand the increase and decrease in demand:
The schedule $($table$)$ given below contains data of price of a commodity and its demand at various prices. Note that price $₹ 3$ is constant. A demand curve is plotted for the given data.
Increase and Decrease in Demand
The initial demand is represented by demand curve $D_1 D_1$. Here, at price of $₹ 3$ demand is $3$ units. This is plotted at point 'a' on $D_1 D_1$.
Increase in demand:
When price remains constant at $₹ 3$ but due to one or other factors demand increases to $5$ units, then the demand curve shifts to the right to $\mathrm{D}_3 \mathrm{D}_3$. This is indicated by rightward movement of demand curve from point ' $a$ ' to point ' $c$ '.
Decrease in demand:

- At constant price if the initial demand of $3$ units decreases to $1$ unit, the demand curve shifts leftward from point ' $a$ ' i.e. $D_1 D_1$ to point ' $b$ ' i.e. $\mathrm{D}_2 \mathrm{D}_2$.
- Thus, more than one demand curves are generated to depict increase or decrease in demand. A rightward shift of the demand curve shows increase. in demand and a leftward shift shows decrease in demand.

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Question 43 Marks

Define income effect and substitution effect.

Answer

$1.$ Income effect:
When the monetary income of the consumer remains constant, but price of the good falls then his real income rises. Real income means the purchasing power of money income. When real income rises, a consumer can buy more quantity of a good and therefore its demand may rise. This is known as income effect on demand.
$2.$ Substitution effect:

When price of the concerned good falls, it becomes relatively cheaper than its substitutes.
Hence, a consumer will reduce the consumption of substitute goods and increase the demand for the concerned good. This is called substitution effect.

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Question 53 Marks

Explain the concept of Giffen goods.

Answer

The demand for goods by individual and families are sometimes considered as backward.
The consumption of some goods is considered as backward too.
The consumers have no option but to buy such goods because of restricted income.
In such case, a decrease in price of these goods increases the real income and purchasing power of the consumer.
Therefore consumer can buy the high quality of goods.
They substitutes high quality goods for inferior goods .
It means that the reduction for them.
E.g. Jowar, Bajara, Rice of low quality, are inferior good.
These commodities are cheaper than high quality goods.
Therefore poor people buy these kind of commodities.
Suppose, a decreases in inferior good like jowar increases the demand for wheat.
Similarly a decrease in inferior goods like low quality of rice increases the demand for basmati rice.
We can say that decrease in price of inferior good reduces the consumption of inferior goods.
This concept was first introduced by Sir Robert Giffen.
Therefore these goods are known as Giffen goods.
The low of demand does not apply to Giffen goods.

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Question 63 Marks

Discuss the difference between expansion – constriction and increases – decreases in demand

Answer

Expansion – Contraction in Demand	Increase – Decrease in Demand
If all factors remain constant and price of commodity increases, the increase in demand is called expansion of demand. If the price of commodity increase and if demand decreases it is called contraction of demand.	If the price remains constant and other factors change, if there is increase in demand. It is called increase in demand. If demand decreases, it is called decrease in demand
Expansion and constriction of demand are caused by the change in price.	All the factors are constant expect price the change in demand is caused by change in other factors.
In expansion and contraction of demand, the movement is the same on demand curve. With expansion of demand, consumer moves from point above to point below on demand curve. When contraction of demand takes place, the movement is from downward to upward.	In increase and decrease of demand, demand curve changes. New demand curves are created when there is change in demand. In demand increase new demand curve moves on right side parallel to original demand curve. If demand decreases, a new demand curve parallel to original demand moves on left side parallel to the original demand curve.

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Question 73 Marks

Explain the assumptions of law of demand.

Answer

The following assumptions are made to prove the inverse relationship between price and demand.
Population is constant:

Population affects the demand. If population increases with an increase in price the demand does not contract.
Therefore the population is assumed to be constant.

Income of the consumer is constant :

Change in income changes the purchasing power which in turn affects the demand for a commodity.
E.g. the demand will not change when income increases with price.
Therefore the income is assumed to be constant.

Taste and preferences of the consumer is constant :

The taste and preferences of the consumer can affect the demand.
The consumer does not increase the demand for a commodity with a fall in price if the commodity is outdated.
Therefore preferences of the consumer are assumed to be constant.

Price of substitutes and complementary goods are constant :

Price of substitutes and complementary goods are constant :
The price of substitutes and complementary goods affect the demand for a good.
E.g. when the demand for a potato increases with a fall in price of potato the price of other vegetables are constant.
Similarly, the demand for car will not increases if the price of petrol increases with a fall in price of car, therefore price of substitutes and complementary goods are assumed to be constant.

No speculation about future prices :

The current demand does not increases with a fall in price because there is a possibility of further reduction of price in future.
Therefore we assume that there is no speculation of future prices.

The quality of goods in constant :

If the quality changes with a change in price the law of demand does not work.
E.g. if the quality of $T.V.$ increase with a price, the demand of $T.V.$ is not affected.

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Question 83 Marks

Explain the meaning of income effect and substitution effect.

Answer

Points	Income Effects	Substitute Effects
Meaning	The monetary income of consumer is constant if price of commodity decreases, the real income of the consumer increase and his purchasing power increases. Thus, the resulting demand is called income effect. On the contrary, if the price of the commodity goes up, the real income of the consumer decreases purchasing power deceases and as a result demand decreases.	When the price of a commodity decrease it becomes cheaper than its substitute. The consumer decreases his purchase of substitutes and increases his demand of the original commodity. On the other hand, if price of commodity goes up, it become dearer than its substitutes. Thus, its demand decrease. This is called substitute effect.
Example	A consumer spends $50$ on sugar when the price of sugar is $Rs.10,$ he is able to buy $5\ k.g.$ sugar. Now the price goes down to Rs.8. Now he has to spend $40$ for $5\ k.g.$ of sugar. Now, he can buy more	If all other cold drinks remain unchanged in price and the price of Pepsi decreases, the demand of Pepsi sugar with $10$ spent by him. This is income effect.
Effects	Sugar with $10$ spent by him. This is income effect. Income effect can be positive or negative.	This effect is always positive.

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Question 93 Marks

Calculation the elasticity of demand by using total outlay method. The demand for A commodity is $100$ units when unit price is $Rs. 10$. If the price increases to $5$ demand reduces to $300$ units. Calculate the elasticity of demand.

Answer

Price of $A$	Demand for $A$	Total cost
$10 5$	$100 300$	$1000 1500$

The change in price from $10$ to $5$, increases the total cost from $Rs. 1000$ to $1500.$
Therefore demand is elastic.

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Economics 3 Marks Each

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