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FBM 1101 PRINCIPLES OF ECONOMICS

Lecture 3 CONCEPT OF DEMAND

What is demand in economics?

People require goods and services in an economy to satisfy their wants. All goods
and services have wants satisfying capacity which is known as “UTILITY” in economics.
Utility is highly subjective concept; it is different from person to person. Utility (level of
satisfaction) is measured by means of introspection. By demand for goods and services,
economists essentially mean is willingness as well as ability of the consumer in procuring and
consuming the goods and services.

Thus, demand for a commodity or service has two key components (a) desire for a
commodity to satisfy a want of the consumer (b) capability of the consumer to pay for the
good or service. In nutshell therefore we can state that -

When desire is backed by willingness and ability to pay for a good or service then it
becomes Demand for the good or service. Conceptually, demand is nothing but consumer’s
readiness to satisfy desire by paying for goods or services. A desire accompanied by ability
and willingness to pay makes a real or effective demand.

Demand for a good/service is defined as the quantity of a commodity a consumer is
willing & able to purchase at a given price at a given point of time.

Significance of the concept of demand

Demand is one of the most important decision making variables in the present
globalised, liberlised and privatized economy. Under such type of an economy consumers
and producers have wide choice. There is full freedom to both the buyers and sellers in the
market. Therefore demand reflects the size and pattern of the market. The future of a
producer is dependent upon the well analysed consumer’s demand. Even the firm does not
want to make profit as such but want to devote for ‘customer services’ or ‘social
responsibilities’. That is also not possible without evaluating the consumer’s tastes,
preferences, choice etc. All these things are directly built into the economic concept of
demand.

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quality etc. packaging. Demand schedule for mango is presented below. Any rise or fall in demand for the product has to be to find out reasons and revised production plans. The market system works in an orderly manner because it is governed by certain Fundamental Laws of Market known as Law of Demand and Supply. Demand analysis has profound significance to management for day to day functioning and expansion of the business. market mechanism and working of the price system. Thomas Carlyle. teach a parrot to say demand and supply.” The most important function of microeconomics is to explain the laws of demand and supply. other things being equal is called individual demand. It represents a functional relationship between price and quantity demanded. Thus the short term and long term decisions of the management are depend upon the trends in demand for the product. The laws of demand and supply plays very important role in economic analysis. Individual Demand Schedule can also be defined as a statement showing the varying quantities of a commodity that would be purchased by consumer at varying prices at a given time. Individual Demand Schedule The various quantities of a commodity that a consumer would be willing to purchase at all possible prices in a given market at a given point in time. Price per fruit (Rs) Quantity demanded (Nos) 10 2 8 4 6 5 2 . The demand and supply forces determine the price of goods and services in the market. the famous 19th century historian remarked “It is easy to make parrot learned in economics. FBM 1101 PRINCIPLES OF ECONOMICS The survival and the growth of any business enterprise depend upon the proper analysis of demand for its product in the market. Individual demand schedule is merely a list of prices together with the quantities that will be purchased by a consumer. technology or change in advertisement.

market demand schedule can be worked out at each price level as indicated in the last column of the table. consumer is willing to purchase more mangoes. viz. 10 per fruit is 7 mangoes and so on. FBM 1101 PRINCIPLES OF ECONOMICS 5 7 4 8 3 10 2 12 At price Rs 10 per mango. 4 per kg. It is horizontal summation of the demand of individual consumer at each unit price. Given the individual demand schedules. consumer is willing to purchase only 2 mangoes. 3 . As the price/ mango start decreasing. Market Demand Market demand is the sum of the demand of all the consumers in a market for a given commodity at a specific point of time.. A. with individual demand schedules as presented in the Table below. Price / fruit A B C Market demand 10 2 5 0 7 8 4 7 0 12 6 5 9 0 14 5 7 10 0 17 4 8 14 1 23 3 10 16 1 27 2 12 20 2 34 Consumer C is not willing to buy mangoes for any price higher than Rs. Assume that in a market there are only three consumers. B and C. The market demand at Rs.

autonomous and derived demand. while the goods that are required to produce other goods have derived demand. is a derived demand. The goods. Demand curve slopes downward from left to right. KINDS OF DEMAND 4 . FBM 1101 PRINCIPLES OF ECONOMICS Demand curve The graphical representation of demand schedule (i. It shows there is inverse relationship between price and quantity demanded of a commodity. Consumer goods are the examples here. pesticides.. The diagrammatic representation of the Demand Curve can be as follows: Autonomous Demand and Derived Demand On the basis of dependency of demand of a good on the demand of other goods.e. which is called derived demand. Demand curve is obtained by plotting a demand schedule on a graph with quantity demanded on X axis and price of commodity on Y axis. for it is linked with the demand for agricultural products. The demand for fertilizers. whose demand is not linked with the demand of other goods are supposed to have autonomous demand. quantity and price) is called a demand curve. It has a negative slope. Thus the goods which are demanded for their own sake have autonomous demand. The demand for certain goods is related with the demand for other goods. etc. we have two types of demand.

Cross Demand: It refers to various quantities of a good or service that a consumer would be willing to purchase not due to changes in the price of the commodity under consideration. ceteris paribus. Depending on how demand of goods varies in accordance with change in the income of the consumers. phone etc b) Inferior Goods. necessities like bread are often inferior goods. Example. ceteris paribus.Goods for which an increase in income leads to a decrease in demand and a decrease in income leads to an increase in demand. FBM 1101 PRINCIPLES OF ECONOMICS 1.A luxury good means an increase in income causes a bigger percentage increase in demand.cars. HD TV’s would be a luxury good. 2. 3. but due to changes in price of related commodities. Income Demand: It refers to various quantities of a good or service that a consumer would be willing to purchase at different levels of income. there are three types of goods: a) Normal goods. For example. 5 . computers. For example. Price Demand: It refers to various quantities of a good or service that a consumer would be willing to purchase at all possible prices in a given market at a given point in time.Goods for which an increase in income will cause demand to rise and a decrease in income causes demand to fall. c) Luxury good.

e. Tea & Coffee.) pen and ink. Joint Demand Certain commodities are to be used together to satisfy a particular want (e. e. FBM 1101 PRINCIPLES OF ECONOMICS There are two types of related goods.g. LAW OF DEMAND The law of demand explains the functional relationship between the quantity demanded of a commodity and its unit price. if the price of a commodity falls. Composite Demand A commodity can be put to several uses and that commodity may be demanded to satisfy any one or more of such uses. Q  1/ P 6 . its quantity demanded will decline. Law of demand states that other things remaining constant. the quantity demanded of it will rise and if the price of a commodity rises.g.) Electricity may be demanded for several of the household. the demand for such commodities is known as composite demand (e.g.g. Similarly. petrol and coal have composite demand. industrial and decorating purposes.Substitute goods & complementary goods. TV and DVD player. Complementary Goods are goods which are used together. Substitute goods are goods which are alternatives. The demand for such commodities is known as joint demand.

Demand Function As per the law of demand. The demand . Price of the commodity. and Px is the price of X. Example: 7 . the larger is the quantity demanded for a particular good. Level of income of the households. the larger the average money income of the household. iii. which is independent variable.price relationship can be both linear and non-linear. the demand for a commodity depends upon the money income of the household. other things being equal. Price of related commodities. Determinants of Demand/ Factors affecting demand i. ii. These goods are called inferior goods. In most cases. When goods are substitutes. 'a' is intercept and 'b' quantifies the relationship between Dx and Px.The demand for a product is inversely proportional to its price. It implies that a rise in price of a commodity brings about a fall in its purchase and vice versa.Other things being equal. Law of demand was propounded by Alfred Marshal. a rise in the price of one will cause the demand of the other to fall. FBM 1101 PRINCIPLES OF ECONOMICS Demand varies inversely with the price. there are certain commodities for which quantities demanded decrease with an increase in money income. demand is function of price provided other things remain constant Dx = f (Px) Where Dx is demand for commodity X. However. The demand function if considered as linear or straight line function can be expressed in the form of following equation: Dx = a + bPx Where a and b are constants. The tendency of the consumer is to buy more quantities of a commodity at a lower price than what he buys at a higher price. which is dependent variable. a rise in the price of one commodity will result in a rise in demand for the other commodity.When commodities are complements.

toffees etc will be more. Tastes and preference of consumers. salt. 8 . Extension of demand means buying more quantity of commodity at a lower price. while contraction of demand indicates buying less at higher price. Movement along the Demand Curve It refers to change in the quantity demanded due to change in price. Extension and contraction of demand represent the “change in quantity demanded”. This is purely a price resulted phenomenon of demand changes for a commodity. while other factors influencing demand are assumed to be at fixed level. Goods which are more in fashion command higher demand than goods which are out of fashion. the demand for spectacles.The demand for a commodity also depends upon tastes and preferences of consumers and changes in them over a period of time. b) Composition of population: If there are more old people in a region. v. The commodity for which the demand increases with an increase in the money income is called superior goods. Similarly. Other factors a) Size of population: generally. walking sticks. greater is the demand for commodities in general. FBM 1101 PRINCIPLES OF ECONOMICS rice. The downward movement from O to A is extension. etc will be high. public transport etc. if the population consists of more children. iv. It can be either extension or contraction of demand. baby foods. larger the size of the population of a country or a region. demand for toys. Example: clothing. while the upward movement from O to B contraction. The terms extension and contraction refer to the movement on the same demand curve.

As against extension and contraction of demand. Increase in demand means more demand at the same price or same demand at higher price. decrease in demand means less demand at the same price or same demand at lower price. FBM 1101 PRINCIPLES OF ECONOMICS Shifts in the Demand Curve It refers to change in demand not due to change in price but due to change in the values of other variables influencing demand. D1D1 is the new demand curve representing increases in demand. When there is an increase in demand. 9 . increase and decrease in demand result in the shifting of the demand curve. the demand curve shifts upwards to the right side of the initial demand curve DD. It can increase or decrease or decrease in demand. On the other hand.

Shifters of the demand curve  Price of the related goods  Income of the consumers  Tastes and preference of the consumers  Population  Advertisement and Publicity etc Why does the demand curve slope downward from Left to Right? The downward sloping nature of demand curve is explained by 3 reasons: 1. Law of Diminishing Marginal Utility Law of Diminishing Marginal Utility states that “As a consumer consumes more and more units of a specific commodity. H. Therefore. Substitution Effect As the price of one good falls. Gossen. Therefore. D2D2 is the demand curve representing decrease in demand. assuming other alternative products stay at the same price. Income Effect- Assuming that money income is fixed. a rise in price will reduce real income and force consumers to cut back on their demand. 2. demand will rise. FBM 1101 PRINCIPLES OF ECONOMICS The decrease in demand is indicated by the shift of the demand curve towards left downwards to the initial demand curve. it becomes relatively less expensive. and consumers will switch from the expensive alternative to the relatively cheaper one. what consumers can buy with their money income . 3. and. at lower prices the good appears cheaper. consumers can buy more from the same money income.that is. at a lower price. Conversely. ceteris paribus.rises and consumers increase their demand. real income . the utility from the successive units goes on diminishing”. a German economist 10 . as the price of a good falls.Mr.

ceteris paribus. It is the position of consumer’s equilibrium or maximum satisfaction. If the consumer is forced further to take a glass of water. n = Number of units 5th glass 42 0 of consumption 6th glass 39 -3 The utility goes on diminishing with the consumption of every successive glass water till it drops down to zero. MU can be calculated 3rd glass 40 8 as: MUn = TUn – TUn-1 Where: MUn = Marginal utility from nth unit. If he takes second glass of water after that. the more we have of a thing. Alfred Marshal restated this law as: “The additional benefit which a person derives from an increase of his stock of a thing diminishes with every increase in the stock that already has”. 4th glass 42 2 TUn = Total utility from n units.Additional utility derived 2nd glass 32 12 from the consumption of one more unit of the given commodity. A rational consumer will stop taking water at the point at which marginal utility becomes negative even if the good is free.Total satisfaction obtained from the consumption of all possible units of 1st glass 20 20 a commodity. Units Total Utility Marginal Utility Total utility . the utility of the third glass will be less than that of second and so on. The glass of water gives him immense pleasure or we say the first glass of water has great utility for him. This is the point of satiety. a man is very thirsty. It is because the edge of his thirst has been blunted to a great extent. In short. the utility will be less than that of the first one. the less we want still more of that. He goes to the market and buys one glass of sweet water. FBM 1101 PRINCIPLES OF ECONOMICS Later on. TUn-1 = Total utility from n – 1 units. 11 . Suppose. or to be more precise. Explanation and Example of Law of Diminishing Marginal Utility: This law can be explained by taking a very simple example. it leads to disutility causing total utility to decline. Marginal utility . If he drinks third glass of water. The marginal utility will become negative.

This phenomenon says that rise in price is followed by an extension of demand. So quantity demanded of these goods falls with fall in their price. utility will be high and the consumer will be prepared to pay more for the commodity. the consumer will buy more units of that commodity only when its price falls. while a fall in price is followed by a reduction in demand for the good. This is known as ‘snob appeal’/ Veblen effect. Goods having Prestige value: A few goods like diamonds etc are purchased by the rich and wealthy sections of society. So when price of these goods falls. where. 12 . Giffen Goods (Inferior Goods): This phenomenon which is explained below was given by Sir Robert Giffen. 2. which is contrary to the fundamental law of demand. The higher the price of the diamond. If the price of this good rises they will become so poor that they were found to spend less on other items and buy more potatoes in order to get a minimum diet and keep themselves alive. When less units are available. potato. FBM 1101 PRINCIPLES OF ECONOMICS The law of demand is based on the law of Diminishing Marginal Utility. Price expectation: When the consumer expects that the price of the commodity is going to fall in the near future. So the law of demand does not hold good here. which induces people to purchase items of conspicuous consumption. the marginal utility of that commodity continues to decline. came to be known as Giffen Paradox. 1. the higher its prestige value.. According to this law. the consumers think that the prestige value of these goods comes down. they do not buy more even if the price is lower. This proves that the demand will be more at a lower price and it will be less at a higher price. Robert Giffen of Scotland observed in the 19th century (1840s) that poor people spent the major portion of their income on a staple item. Upward-sloping demand curve. That is why the demand curve is downward sloping. the law of demand does not hold good. 3. Exceptions to the law of Demand Following are the exceptional cases. viz. It was named after him as Giffen paradox. Such a commodity is also known as Veblen good (named after the economist Thorstein Veblen) whose demand rises (falls) when its price rises (falls). The prices of these goods are so high that they are beyond the reach of the common man. Therefore. when a consumer buys more units of a commodity.

medicine. ELASTICITY OF DEMAND The law of demand says that demand varies inversely with the price. Alfred Marshall developed the concept of elasticity of demand which measures the responsiveness of quantity demanded to changes in price. What is not known is the extent by which quantity demanded is responsive to changes in price. 5. From the law of demand. Fear of Shortage: When people feel that a commodity is going to be scarce in the near future. FBM 1101 PRINCIPLES OF ECONOMICS On the other hand. 𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅 P = 𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇 𝒕𝒉𝒆 𝒄𝒐𝒎𝒎𝒐𝒅𝒊𝒕𝒚 13 . In fact elasticity of demand is the rate at which quantity demanded changes because of change in price. rice. other things being equal. they will buy more even if the price is higher. To be more precise. Elasticity of demand indicates the degree of relation between quantities demanded changes because of change in price. when they expect further rise in price of the commodity. elasticity of demand is defined as “the relative change in the quantity demanded to the relative change in the price”. Types of Elasticity of Demand There are three types of elasticities of demand 1) Price Elasticity of Demand (P) It is a measure of change in quantity of a commodity demanded in response to change in the price of that commodity. the law of demand is not applicable as the demand for such necessary goods does not change with the rise or fall in price. Shows how much & as to what extent the quantity demanded will change in response to change in factors affecting demand. etc. Basic necessities of life: In case of basic necessities of life such as salt. 4. they buy more of it even if there is a current rise in price. we know the direction in which quantity and price are moving.

tastes. 𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅 I = 𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒊𝒏𝒄𝒐𝒎𝒆 𝒐𝒇 𝒕𝒉𝒆 𝒄𝒐𝒏𝒔𝒖𝒎𝒆𝒓 Engel Curve 14 . price of substitutes.. are kept at constant level. price of the commodity. preferences.. when other factors influencing demand viz. etc. FBM 1101 PRINCIPLES OF ECONOMICS Elasticity along a linear demand curve 2) Income Elasticity of Demand (I) It measures the responsiveness of demand due to changes in the income of the income of the consumers in terms of percentage.

illustrate the relationship between consumer demand and household income. Engel curves for normal goods slope upwards – the flatter the slope the more luxurious the good. In contrast. Engel curves for inferior goods have a negative slope.e. increase in income causes a bigger percentage increase in demand. FBM 1101 PRINCIPLES OF ECONOMICS Engel Curves. Normal goods have a positive income elasticity of demand so as consumers' income rises more is demanded at each price i. These may be substitutes or complements. It is the ratio of percentage change in quantity demanded of commodity (X) and percentage change in price of related commodity (Y). I > 1. 3) Cross elasticity of demand Demand for one good (X) is also influenced by the price of other related good (Y). and the greater the income elasticity. there is an outward shift of the demand curve (I > 0). In case of luxury goods. Inferior goods have a negative income elasticity of demand meaning that demand falls as income rises (I < 0). 𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅 𝒐𝒇 𝒄𝒐𝒎𝒎𝒐𝒅𝒊𝒕𝒚 (𝑿) CP = 𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇 𝒓𝒆𝒍𝒂𝒕𝒆𝒅 𝒄𝒐𝒎𝒎𝒐𝒅𝒊𝒕𝒚 (𝒀) 15 . named after 19th Century German statistician Ernst Engel.

1) Perfectly Elastic Demand (Ep = ) A slightest change in price of a commodity leads to an infinite change in quantity demanded. 16 . It is mostly a theoretical concept. FBM 1101 PRINCIPLES OF ECONOMICS In case of substitutes. Car and Petrol) and hence it is negative. DEGREES OF ELASTICITY OF DEMAND Based on the magnitudes of elasticity of demand. In case of complementary goods (Tea and Sugar) the rise in price of one commodity brings about the fall in the demand of the other (Eg. The demand in such a situation is said to be perfectly elastic. (Tea and Coffee) the cross elasticity of demand is positive and large. The demand is hypersensitive and the elasticity of demand is infinite. Here the demand curve will be a horizontal line parallel to X-axis. it can be categorized into five degrees as given below.

Elasticity of demand is greater than unity. A lesser proportionate change in the price of a commodity is followed by a larger proportionate change in the quantity demanded. FBM 1101 PRINCIPLES OF ECONOMICS 2) Perfectly inelastic demand (EP = 0) It is the situation in which change in price of a commodity leaves the demand unaffected. The price of the commodity may increase or decrease. The case of perfectly inelastic demand is also a theoretical concept. The demand here is insensitive. Elasticity of demand is zero. 17 . The demand curve is vertical to X axis. 3) Relatively Elastic demand (EP > 1) Demand is said to be elastic when percentage change in quantity demanded is larger than the percentage change in price. but the quantity demanded remains the same.

5) Unitary elastic demand (EP = 1) When a given proportionate change in price results in the same proportionate change in the quantity demanded of commodity. Elasticity of demand is one. Elasticity of demand is less than unity. the demand is said to be unitary elastic. FBM 1101 PRINCIPLES OF ECONOMICS 4) Relatively Inelastic demand (EP < 1) It means that large proportionate change in the price of a commodity is followed by a smaller proportionate change in the quantity demanded. 18 .

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