Question

1. Producers are motivated to increase the price of a product when it looks favorable to increase profit and have more money available for additional production, but why must they always be cautious when committing additional resources to increased production in response to an initially favorable consumer response to a higher price for their product?

2. What is a budget constraint, and what restrictions does it place on consumers?

3. Our text, other texts, and various economists loosely claim that extreme cases can “qualify” as perfectly inelastic demands, but is this true in the real world? Why or why not?

4. Briefly describe one example of the law of diminishing marginal utility from your own life.

5. What role do time and substitutes play in determining whether or not a good faces a more elastic demand or a more inelastic demand?

Answer 1

1) It is generally seen that when there are favourable conditions in the market, for eg there are signs that price of a particular commodity may increase in near future, producers might start increasing the price of their goods and start investing more in that product . This is a good idea from producers side of view as this will maximise their profit.

But while doing so he should be cautious , he must also analyse the price and demand of substitute goods which might diminish the demand of the product , also this increased price may not necessarily motivate consumer to buy more , instead discourage him to use that product, leading to decreased demand and stockpiling of goods.

2) Budget constrain in economics means combination of all goods and services that consumer can get to satisfy his needs within his limited income . We all face budget constrain, this happens because we have limited income and we have to satisfy ourself within this range.

Budget constrain limits the consumers capability to buy something. It puts limits on commodities that he can avail to maximise his satisfaction.

Budget constrain is guided by increase and decrease in income. The more the income ,the more the purchasing power and less the budget constrain on the consumer and vice versa.

3) Perfectly inelastic demand is a situation where the demand of goods do not change at all no matter how much there is increase in price.

Now this situation rarely exist in real world because upto some extent consumer may be willing to pay the increased price but if it continues to exist , then due to budget constraint he may decrease his consumption. For eg salt is inelastic good but if there will be exponential increase in its price, consumers may decrease their consumption.

However in some extreme cases, the essential goods may show perfectly inelastic demand. Suppose there is some natural calamity, war or any other extreme, people will be willing to buy essential goods no matter what the price is. Because those goods are necessary for their survival and they will pay anything they have for it.

4) Law of diminishing marginal utility states that every additional unit that we consume reduces the level of satisfaction that if gives. Provided that the consumption is continuous.

However , it does not apply to giffens goods ( essential goods) and veblen goods ( luxury goods) .

Suppose you love chocolates, and you start consuming it daily, you will observe that the level of satisfaction decreases with each additional unit you consume. Showing law of diminishing marginal utility.

5) Substitutes play an important role in determining the demand of goods to be elastic or more inelastic . If substitutes are available people can easily switch to them with increase in price of one good. Eg with rise in price of tea people can switch to coffee.

Time also determines the demand to be elastic or inelastic. If people have more time, they can look for more alternatives. Also with time, people's preferences tend to change , making demand elastic or inelastic.