 In the previous class we were discussing about the fundamental loss of demand and supply and how that in the market the equilibrium that is achieved between demand and supply is the best way to allocate the resources and we saw how a particular quantity is demanded or supplied changes with price and the extent to which certain goods and services are sensitive to changes in prices is measured by the elasticity and we saw some goods which are very critical are in elastic which means they are insensitive to changes in price while goods that have substitutes are more sensitive to changes in price and that explain the price elasticity of demand which is the changes in demand with changes in price and we assumed that the income is constant and we saw different relationships of demand and supply with changes in price how there is an elastic demand in elastic demand and an elastic supply and in elastic supply but the price elasticity of demand is mainly affected by three factors one is the availability of substitutes availability of substitutes this is probably the most important factor that influences the elasticity of a good or a service in general if there are more substitutes then more elastic will the demand be because there are more number of substitutes for example if the price of let us say a cup of coffee went up by 5 rupees then we have an alternate beverage for an early morning which is tea as a result of which since the price is increased the price of coffee is increased we will naturally see a shift from consumers who are willing to replace their morning cup of coffee with tea and this means that coffee is an elastic good because an increase in the price of coffee has cost a decrease in the demand for coffee because consumers have shifted from coffee to tea because tea is a good substitute for coffee. So you can understand how availability of substitutes will make a particular product elastic or in elastic in this case coffee is more elastic because there is an alternate substitute that is available now in the same example if the price of caffeine which is a critical input to coffee where to go up as a whole then we would probably see very little changes in the conception of coffee or tea because there are very few substitutes to caffeine and let us assume that consumers are not willing to give up their caffeine intake no matter what the prices then if the prices of caffeine went up and consumers are not willing to give up their intake of caffeine in the morning then caffeine becomes an in elastic product because of its lack of substitutes there is no substitute to caffeine intake in coffee. So you will understand that while a product within an industry in this case coffee within the hot beverages industry is elastic due to the fact that that particular product has more number of substitutes the industry itself tends to be in elastic because caffeine's price increase hardly affects the industry because caffeine has no substitute usually unique goods for example let us say diamonds are in elastic because they have very few substitutes so availability of substitutes is one important factor that determines the elasticity of a particular product or service the second factor that affects the price elasticity of demand is the amount of income that is available the amount of income that is available to be spent amount of income to spend this factor affecting the demand elasticity refers to the total that a person can spend on a particular good or service let us for example say the price of a can of coke is rupees 5 and that every month I had allocated 20 rupees or every day I had allocated 20 rupees so that I could buy four cans of coke every day now if there is a sudden increase in the price of coke from 5 rupees to 10 it means that with this 20 rupees I can just have two cans of coke as against the initial four that I used to have every day so if there is an increase in price and that there is no change in the amount of income that is available to spend on this particular good there will be an elastic reaction in demand and it is this elastic reaction this makes this demand more sensitive because a change in price in this case is not supported by a change in equal amount of income that is available on hand so that the amount that is consumed is also the same so this explains in the absence of any increase in the disposable income that is available for the for conception of a particular good or service a change in price makes the demand more change in price of a particular product or service makes the demand more elastic. The third factor is time now time is also an influential factor when we talk about the price elasticity of demand now let us say if the price of a train ticket let us say I am I am a regular train commuter and the price of the train tickets went up by 5 rupees a trip so if as since I am a daily train commuter and there are very few substitutes that are available for me I can probably afford to absorb this increase in the train fare so that for at least in the short term I start using the train even at these increased prices now for this short term it is inelastic but that does not mean that it is inelastic forever now if I find that over a period of time that I cannot afford to spend this additional 5 rupees every day then I would shift to an alternate transport mechanism probably I could I would use a bicycle for my daily commute so the price elasticity of the train travel to me becomes elastic over a period of time so time is again a third important factor that determines the price elasticity of demand if the length of time is beyond my affordable limits then the demand for that particular product or service becomes elastic the what we saw before was the price elasticity of demand or price elasticity of supply which just measured the change in the quantity demanded or supplied with the degree of change in the quantity that is demanded or supplied with changes in price the next thing that we would like to see now is income elasticity of demand what we saw before was if price increases and income remains the same then the demand will decrease this is for the non-critical goods then it also follows that if there is an increase in income if there is an increase in income demand tends to increase as well demand also increases with increases in income the degree to which an increase in income will cause an increase in demand is called the income elasticity of demand so the percentage increase in income percentage demand increase the degree to which a particular product or service is demanded with increases in income is the income elasticity of demand just as we had a ratio to measure the price elasticity the income elasticity of demand can be measured this way it can be the income elasticity of demand let us say I call it EDY will be the quantity demanded new minus the old quantity at previous income levels divided by the old quantity minus my new income different the incremental income my old income so if I need to express income elasticity of demand I am just trying to see how much of the increase in quantity that is demanded how much it has increased as a proportion to the increase in income that I have received now if income elasticity of demand is greater than 1 then the demand for the item is considered to have a high income elasticity high income elasticity and if it is less than 1 the demand is considered to be income in elastic so if income elasticity of demand is less than 1 then it is income elastic luxury items usually have a higher income because the moment the income increases we do not have to really for feet a luxury requirement because our income also has increase so typically you will find that you know luxury items are having high income elasticity for example if I just received a pay hike and with my initial pay hike I mean with my initial pay I could just afford one at trip to visit my parents every month and because of this new pay increase which let us say the pay increases rupees 10000 and my original pay was let us say 80000 rupees a month and this hike of 10000 has made it possible for me to make two trips to visit my parents and we can measure the income elasticity of demand and we will find that it is greater than 1 because there is an increase in the income which has resulted in increase in the demand for an air travel that I make now my original quantity the new quantity in this case the number of trips that I can make is 2 as against the one that I used to do my new income is 70000 per month my old income is 70000 so in this case the income elasticity is greater than 1 and is very highly income elastic now there is also another question are there chances where despite increase in income will demand decrease because income elasticity means it assumes that an increase in income will cause an increase in the demand for a particular product but will demand decrease if income increases yes why because let us for example take the case of inferior goods not necessarily inferior let us say I buy DVDs regularly and when my income level was x I used to buy a regular DVD and now if my income has increased to let us say x plus delta x and because of this increase in income it does not mean that I can buy two DVDs but instead if I decide to migrate from a regular DVD to a Blu-ray DVD let us for example take then here is a case where despite increase in the income that is available on hand that is a reduction in the demand for the regular DVDs that I usually buy now products for which the demand decreases as income increases will hence have an income elasticity less than 0 so income elasticity will be less than 0 if increase in income results in decrease in demand now income elasticity will be 0 basic critical necessities it means that there is no change in demand despite increase in income and for such products you will have an income elasticity 0 now what we saw just now was as I said the fundamental law of demand and supply and how the demand and supply of products and services change with price and the behavior of consumers with respect to changes in price and how that causes a change in the product change in the quantity that is demanded by a consumer and we measured that by trying to measure the sensitivity of the demand curve or the supply curve with prices to see whether a particular good or a service is elastic or inelastic both from changes in price perspective as well as changes in income perspective so this in essence captures the relationship between a quantity demanded and price between the quantity supplied and price and how that in a market economy that the supply and demand always works together in achieving an equilibrium state where there is an equilibrium price and an equilibrium quantity now we need to understand another broad concept of utility concept of utility the focus of economics as a subject of study as I said before is to understand the problem of scarcity and the problem of fulfilling the unlimited wants of human kind with limited and scarce resources that are available because of scarcity economies need to allocate the resources that are available the limited resources that are available very efficiently the very fundamental principle that underlies the law of demand and supply is the concept of utility which is which reflects or which represents the advantage or the fulfillment a person receives from consuming a particular good or experiencing a particular service so at a very broad level utility means it tries to measure the extent of fulfillment a consumer has in consuming a product or experiencing a service how individuals and economies aim to gain optimal satisfaction in dealing with scarcity is what utility is all about utility tries to explain how individuals societies and economies try to gain that optimal fulfillment or that optimal satisfaction in dealing with resources that are very scarce since we are talking about fulfillment and satisfaction it becomes very relative as a result of which utility is kind of an abstract concept it is not very concrete or an observable quantity it cannot be quantified the units to which we assign utility is very arbitrary because it is very relative it has a relative value but one thing that we need to understand is the total utility is the aggregate sum of the satisfaction the fulfillment or the benefit that an individual gains from consuming a given amount of goods or services in an economy it is that aggregate sum which constitutes the total utility so the amount of a persons total utility the total utility hence corresponds to the persons level of conception total utility hence corresponds to the persons level of conception which means the more a person consumes the larger is his or her utility total utility so more conception more total utility and in this case total utility means the satisfaction level while marginal utility is a little different from total utility marginal utility represents the additional satisfaction or the amount of utility that is gained from each extra unit of conception so marginal utility is that delta satisfaction with an extra unit of conception although total utility usually increases as we consume more and more of a particular good or experience more and more of a particular service the marginal utility usually decreases with each additional unit of conception this explains the law of diminishing marginal utility this is because although total utility usually increases with more and more of conception the marginal utility decreases with each additional conception because there is a certain threshold for satisfaction as a result of which a consumer will no longer receive the same amount of pleasure from consuming the same product once the consumer has crossed the threshold in other words the total utility will increase at a rate which is slower in pace as an individual increases the quantity consumed so you keep increasing the quantity that you are consuming the rate at which the total utility increases keeps decreasing this explains the law of diminishing marginal utility which means total utility will increase at a slower rate with increase in quantity consumed I will just give a small example for you to understand let us for let us take chocolate as an example and that I am able to attach some quantifiable variable just to give you the total utility that can be quantified now the number of chocolates number of chocolates marginal chocolate utility total utility total chocolate utility every product every service has its own utility so in this case we are talking about the chocolate utility now let us say I did not consume any chocolate the marginal chocolate utility is 0 the total chocolate utility is also 0 let us say I had one chocolate and if I need to express the utility in numbers let us say one chocolate means 70 in terms of its marginal utility 70 the total utility that I have gained by consuming one chocolate is also 70 0 plus 70 let us say I decide to have one more and I have already had one chocolate now I have decided to have one more the marginal utility will not be the same 70 let us say it is 10 while the total utility is 70 plus 10 I decide to take one more chocolate the marginal utility is 5 the total utility is 85 I decide to have one more marginal utility is 3 the total utility is 88 now why is this happening the pleasure of each additional chocolate bar will be less than the pleasure that I would have received from eating the one before probably because I have a sense of feeling full or I have eaten too many sweets for that particular day beyond the threshold so this table shows that the total utility will increase at increasing levels of conception but you will find that this increase in this example is at rate slower than the previous conception levels so I had 1 plus from 1 to 2 to 3 to 4 the total utility keeps increasing but at a slower rate why because the marginal utility keeps dropping down because it was 70 by the next three chocolate bars put together the aggregate marginal utility is 18 the law of diminishing marginal utility in this case helps economists to understand the law of demand and the negative sloping demand curve actually it is this marginal utility the diminishing marginal utility explains the negative demand slope why because the less of something you have the more satisfaction you gain from each additional unit you consume the marginal utility you will gain from that product is therefore higher and it is because of this higher marginal utility you are willing to pay more it gives you a higher willingness to make to pay more for a particular product and that is why you find that prices are lower at a higher quantity demanded because your additional satisfaction diminishes as you demand more so this explains the negative slope of a demand curve the reason is because the less of something you have the more satisfaction the less you have something more is the satisfaction you gain from each additional unit you consume more satisfaction from each additional unit and it is because of this higher marginal utility you are willing to pay more and this explains the negative slope in the demand curve in order to determine what a customers or a consumers utility and total utility are in fact that is a very challenging subject economists turn to consumer behavior which means a consumer demand theory which studies consumer behavior and satisfaction it is always a customer or a consumer is assumed to be a rational thinker so a customer is a rational thinker and economists assume since the consumer is rational he will try to maximize his or her total utility so a rational customer maximizes total utility now what do I mean by this since a customer a sensible customer is assumed to be rational economists assume that he or she will always try to maximize total utility and it is this rational thinking that influences economists decision making now why is that every consumer tries to maximize total utility the example that we took the example of chocolate instead of spending all my money on three chocolate bars which we saw gave me a total utility of 85 if I had just purchased one chocolate bar which gave me a total utility of 70 and perhaps a glass of milk that gives me a total utility of 50 this combination 70 with from chocolate and 50 from a glass of milk gives me an aggregate utility of 120 at the same cost of purchasing three chocolate bars which gave me an aggregate value of 85 this explains the rational behavior of customer who tries to always maximize the total utility and it is this behavior of customers and their and their constant endeavor to maximize the total utility that influences economic decision making it always tries to maximize the end users total utility and that governs consumer behavior and economic decision making and that is the reason why markets behave differently for different types of products different types of services and different types of consumers so far I have given you a very brief overview on the principles of supply and demand and the relationship with price elasticity of supply and demand both price elasticity as well as income elasticity and how a concept of utility forms the fundamental of economic decisions to handle the complex issue of allocating scarce resources to a diverse set of needs of the end user and all of this happens in a given market space an additional dimension that can be brought into this is the type of market in which all of this happens so the last topic for this class would be to understand different types of markets the first one would be a monopoly as the name very clearly suggests it means that there is only one producer one producer or one seller and typically a monopolistic market is characterized by high entry barriers entry barriers are very high and monopolistic market could be for different reasons could be economic political or social if the government decides that it needs to control critical services then it would decide that it is going to be the only producer or the only seller of such critical services and that you see in services like power electricity which is by and large controlled by the government or for example in Saudi Arabia the entire oil industry is controlled by the government because for them oil is critical to the economy so a monopolistic market is one in which there is only one player as a result of which it is that producer or seller who will control the prices and typically it is the government which invariably is that one seller because it would like to control the critical services in a nation the next type of market is an oligopoly in which few firms a handful of firms control supply and by controlling supply it also controls the price of the product there would be no change there would be no differences in the products in oligopoly you would find that the products are almost identical and there is a lot of interdependence between the players in the oligopolistic market the classic example could be the cement industry there is hardly any difference in the end product but we will find that the cement industry in our country is oligopolistic which is just controlled by a very few players and we usually call this as cartilization of the industry so what will happen if let us say if there are only three cement manufacturers and one decides to reduce the price to gain market share there is very limited option for others to differentiate because the products are identical they also will reduce the prices so a reduction in price by one player in the oligopolistic market will force the other players to also reduce their prices on the other hand there is also the downside to it where such cartils also engage in collusion where they consciously take a decision to increase the price and we saw very recently in the cement industry how this cartil actually increased the they colluded together and increases increased the price of the cement and an industry also will undergo consolidation and if an industry undergoes consolidation then it is moving towards an oligopolistic market where the more and more different companies different firms in an industry gets consolidated the more and more it is approaching an oligopolistic market because from a stage where there are more number of firms in the market it it gets reduced to just a handful of firms so an oligopolistic market is just characterized by very few firms and typically you would see this in products and services that are very identical it has both advantages as well as disadvantages the third type of market is perfect competition perfect competition embraces free market theory many buyers and sellers and typically the entry barriers are not that high so more number of buyers can get into a perfect perfectly competitive market where the law of demand and supply operates theoretically freely because there is a number of choice for the seller because in a perfect competition in a perfect market the presence of substitutes is also high substitutes meaning the presence of an alternate supplier is very high and typically you see a perfect competition in the mobile telephony or in the fast-mover fast in the FMCG is the fast-moving consumable goods or air travel very recently in the busy routes so there is more choice in a perfect competition where the free market theory ensures that the end user has more choice and a perfect market is something that allows choice for customers make sure that the law of demand and supply operates freely so you have three different types of market each of them having their own advantages and disadvantages and if you take a nation's economy usually you will have all these three types of markets but usually you will find either a market to be monopolistic or perfect competition very rarely you would find more number of markets that are of oligopolistic in nature so what we have seen in the last few classes is to understand a country's economic landscape and how as a national output of a country is measured by way of its GDP and how behavior of consumers with respect to the quantity that a particular consumer or group of consumers demand or supply or supply and how that changes with price as we saw the law of demand and law of supply and how the fundamental to all of this comes from the concept of utility which characterizes the economic principle of a rational customer who wants to maximize the total utility based on which resources are allocated and all of this happens in markets which are of three different types this constitutes the economic landscape now while all of this happens within a given market space we also need to understand that there are factors outside the market that are very important that shapes the way in which markets perform now what we saw before was various internal dynamics of a market that determines at what price a particular quantity is supplied what price a particular quantity is demanded and these are all invariably interlinked within the market space when we go beyond the market space we need to understand there are some external factors that will also in equal force change the way in which markets operate as a result of which prices can go up and down now what are these external forces these external forces some of some of the examples are could be the availability of money itself money available in market interest rates or exchange rate or how the availability of money changes interest rates or the availability of money how would how does it impact inflation so we need to understand that these external factors are equally important when it comes to shaping the way in which a market performs and these external factors are controlled by policy makers how they are controlled could be either in fiscal policy making or in monetary policy making there are two main policy making tools fiscal policy monetary policy so next class we will understand what fiscal policy is all about what monetary policy is all about and what are the different tools that monetary policy makers use and how in fiscal policy the government encourages the government is the one that actually is responsible for stimulating demand so next class we will understand fiscal policy monetary policy and how these important variables that I mentioned before the flow of money interest rate inflation exchange rate how all of these are interlinked and in the process all of this will change the way in which the market as a whole performs so we will see this in next class thank you.