Desarrollar la descripción del caso de uso 111

3.2 Effect of subsidy on consumer surplus

The concept of consumer surplus is of prime importance in understanding the benefits of subsidy and other related measured adopted to enhance consumers' welfare. Subsidy is the monetary help given by the government to reduce the high cost of production so that it may be possible for the producer to sell his commodity at a lower price and still make profit. With subsidy, the firm produces at a lower unit cost and therefore sells at a lower price than the actual price of the commodity thus raising demand and consumers surplus.

Let us illustrate the effect of a subsidy on consumer surplus using Fig. 5.3.

With the subsidy, the firm's supply curve moves downwards to the right of the old supply curve On the old supply curve S_o, OQ₀ amount of the commodity is sold at OP₀ price on the demand curve D. The consumers surplus is the difference between OQ_oAD - OQ₀AP_o

= DAP_o. However, after the amount of AB subsidy, the price falls to OP₁ and the quantity supplied increased to OQ₁). With the subsidy, consumer's purchasing power increases as a result of price reduction, thus increasing consumer surplus to DBP₁ (OQ₁BD - OQ₁BP₁). Thus the net gain in consumer surplus as a result of the subsidy is P_oABP₁, which is the difference between DBP₁ and DAP_o

4.0 Conclusion

The behavior of consumer's is consistence with maximization of utility based on the available income and prices of the goods and services he consumes. Consumer surplus is a measure of the benefits derived from a purchase in excess of the price that is paid. This concept is based on the assumption that the satisfaction that consumers derive from any given commodity is more than the price they actually pays for the commodity instead of doing without it. Though there are some criticisms and difficulties in measuring consumer surplus, this concept is of great practical importance in economic theory.

5.0 Summary

This unit has taken through the concept of consumer surplus using two important measures- cardinal utility and indifference curve approaches. We defined consumer surplus as the excess of the price, which a consumer would be willing to pay rather go without the commodity over that, which he actually pays. We observed that the magnitude of consumer surplus can be related to the total utility derived from consuming a given commodity. When the total utility is high consumers would be willing to offer higher prices than do without the commodity while the reverse is the case for a commodity that gives lower utility to the consumer. We finally considered the effect of subsidy and other related measured adopted to enhance consumers' welfare on consumer surplus.

6.0 Tutor Marked Assignment

Question: a) Define consumer surplus. b) With the aid of a diagram, explain the concept of consumer surplus in terms of indifference curve.

7.0 References and further readings

Ryan, C. A. and Holley, H. U. (1986) Principles of Microeconomics. South-Western Publishing Company, Cincinnati, Ohio. Pp.170.

Koutsoyiannis, A. (1979). Modern Microeconomics. (Second Ed.) Macmillan Publishers Ltd. London and Basing stoke. Pp.32-35.

Truent, L.J and Truent, 0.8. (1987). Microeconomics. Times Morror / Mosby College publishing, Sr. Louis, Toronto, Sant Clara. Pp. 446-447

Jhingan, M. L. (1997). Mtcroeconomic Theory. (Fifth Ed.) Vrinda Publications (P) Ltd., Myur Vihar, India. Pp. 193-201

UNIT SIX: PRINCIPLES OF DEMAND Table of contents

1.0Introduction 2.0 Objectives

3.1 The law of demand 3.2 Individual demand 3,3 Market demand

3.4 Change in quantity demanded and change in demand 4.0 Conclusion

5.0 Summary

6.0 Tutor-marked assignments 7.0 References and further reading 1.0 Introduction

Demand is basic to the study of economics. Economics view demands as desires to consume at certain prices, not needs or wants that can be quantified. For these needs or wants to become demands, they must be viewed as what people will actually do when confronted with different set of prices. This is planned expenditure backed up by purchasing power. Demand in economic refer to the desire to obtain goods or services and the willingness and ability to pay for them. Thus, by demand we refer to effective demand, that is, demand backed up by ability to pay. We can therefore define demand as the list of the quantities a person is willing to buy at a given price in a given period of time.

2.0 Objectives

After going through the content of this unit, you should be able to 1. Define demand and state the law of demand

2. Compare individual and market demand

3. List the various determinants of demand

4. Illustrate with the aid of a diagram the effect of changes in price and income on the demand curve.

3.1 Individual demand

The principal assumption upon which the theory of consumer behavior and demand is built is: a consumer attempts to allocate his limited money income among available good and services so as to maximize his satisfaction. Demand results from people’s desire to use goods and services. But to be able to translate this desire into demand, the individual must be able to back it up with money. For an individual to be able to satisfy his desire, he must get the product, and to get the product he must pay its price. How much of a commodity an individual will buy depends on his personal preference, taste, income, price of the good and price of related good. Initially we want to focus on what happens when the price of a good or service changes relative to the price of other goods or services. Holding constant all the other factors that affect demand, the law of demand state that the quantity demanded of a good or service is negatively related to its price. An individual tends to buy more units of good when the price is lower, and he decreases his purchases when price increases. This particular behavior of the individual is understandable and rational if other determinants of demand are held constant. A person can buy more goods at a lower price because his purchasing power has increased. For example, when one kg of meat wan N200.00, a consumer with N600.00 could buy 3kg.

however, if the price increased to N350.00 the buyer cannot even get two kg for his N600.00 (income effect). Also if the price of a commodity increases relative to the price of a substitute, the consumer may be forced to increases his demand for the substitute and thereby decreasing the quantity of the costly product (substitution effect).

The list of quantities demanded at various alternative prices is called demand schedule. A hypothetical demand schedule is presented in Table 6.1. The table shows the quantities of

coke demanded per day at various prices all other determinants of demand being kept constant.

Exercise 6.1: State the law of demand. Why does the demand curve of a normal good