Professional Documents
Culture Documents
qGrowth of population
qGovernment policy
qClimatic conditions
q Income distribution
qExpected change in price
qFuture expectation about income etc.
DEMAND DETERMINANTS
There are three kinds of demand relations which are usually studied under demand
analysis such as: Price Demand, Income Demand and Cross Demand.
Price Demand: Price demand studies how demand for a commodity ( Dx) changes with
respect to change in price(Px) , ceteris paribus (other things remaining the same).
Dx= f (Px)
Income Demand: Income Demand examines how demand for commodity ( Dx) changes as a
result of change in income of the consumer(Y) , other things remaining the same.
Dx= f (Y)
Cross Demand: Cross demand studies how quantity demand of a commodity ( Dx) changes
as a result of change in price of its related goods ( PR ), ceteris paribus . Cross demand
function can be denoted as follows:
D x= f ( P R )
LAW OF DEMAND
Demand Curve
0 Quantity demand
Exceptional Demand Curves/
Exception to Demand curve or Law of Demand
Exceptional Demand Curves contd.
q Giffen goods,
q conspicuous consumption
q conspicuous necessities,
q expected changes in price,
q extraordinary situations like natural disasters, famine, riots etc
Exception to Demand curve contd.
Giffen goods:
In case of certain inferior goods called Giffen goods, when the price falls, quite
often less quantity will be purchased than before because of the negative
income effect and people’s increasing preference for a superior commodity
with the rise in their real income. Few examples of giffen goods are cheap
potatoes, coarse cloth, coarse grain, etc.
Conspicuous consumption:
Some expensive commodities like diamonds, expensive cars, exorbitantly
high priced mobile phones etc., are used as status symbols to display one’s
wealth or , to distinguish oneself from average people. The more expensive
these commodities become, the higher their value as a status symbol and
hence, the greater the demand for them. Law of demand does not apply here.
Conspicuous necessities:
certain things become necessities of modern life. These are purchased even if
their prices rise. E.g. TV, refrigerators, mobile phones, automobiles.
Exception to Demand curve contd.
Extraordinary situations:
War, famines, riots, natural calamities are extra ordinary situations when
people’s behavior becomes abnormal. Law demand does not apply in
abnormal situations.
ELASTICITY OF DEMAND
P
D
0 Q1 Q2 Quantity Demand
PRICE ELASTICITY OF DEMAND (cntd.)
ELASTIC DEMAND
When the proportionate
change in demand is more
Price than the proportionate
changes in price, it is known
as relatively elastic demand.
E.g. luxury goods
0 Q1 Q2 Quantity demanded
PRICE ELASTICITY OF DEMAND (cntd.)
P1 D
0 Q1 Q2 Quantity Demand
PRICE ELASTICITY OF DEMAND (cntd.)
INELASTIC DEMAND
W h e n t h e
proportionate change
Price in demand is less than
D the proportionate
Inelastic demand curve changes in price, it is
k n ow n a s re l at i ve l y
P2 inelastic demand. e.g.
necessities, electricity
P1 etc.
Q1 Q2 Quantity Demanded
O
PRICE ELASTICITY OF DEMAND (cntd.)
0 Q Quantity Demanded
,
or,
or,
Where
o High Income Elasticity (ey > 1 ) indicates that a proportionate change in quantity
demanded is more than proportionate change in money income. E.g. luxuries
o Income elasticity less than unity / Low Income Elasticity (eY < 1 ) indicates that
a proportionate change in quantity demanded is less than proportionate
relative change in money income. e.g. necessities
q Negative income elasticity (eY < 0 ) [in case of inferior goods] indicates that less
is bought at higher incomes and more is bought at lower incomes.
,
or,
or,
Where
qPositive Cross elasticity of demand (eAB > 0 ) when the goods A and B are
substitutes] e.g. Coca cola and Pepsi, Chinese mobile phones and smart phones.
q Negative Cross elasticity of demand (eAB < 0 ) [when the goods A and B are
complementary] e.g. vehicle and petrol
Where,
eP is price elasticity of demand
Q is quantity demanded (initial)
P is price of the commodity (initial)
dQ is change in quantity demanded
dP change in price
GEOMETRIC OR POINT METHOD contd.
Price
A
P2 C
dP
P1 D
E
dQ
B
O Q1 Q2 Demand
GEOMETRIC METHOD contd.
d
P
r A e=
8
i
c e>1
e
c e=1
e<1 d
e=0
B Demand
0
SUPPLY
Determinants of Supply
qPrice of the product
qState of technology
qPrices of relevant resources
qPrices of alternative goods
qProducer expectations
qNumber of producers/sellers in the market
LAW OF SUPPLY
Law of supply states that normally, the quantity supplied varies directly with its
price, other things constant.
In other words , law of supply states that lower the price, the smaller the
quantity supplied and higher the price, the greater the quantity supplied.
Supply Curve
Supply curve is the graphical representation of the relationship between supply of a
commodity (Dx) and its price (Px) .
Supply Curve
0 Supply
Equilibrium price a EQUILIBRIUM PRICE
commodity is determined
at point(E) where market
demand is equal to
market supply. S(P)
Price
At price P 2 , supply is
more demand and thus Surplus
P2
there is surplus in the
market. Price will fall E
causing supply to fall and Pe
demand to rise. Price P1
will continue to fall until Shortage
it reaches equilibrium
price Pe at which
Demand=Supply D(P)
( Equilibrium point E). 0 Q1 Qe Q2
Demand Demand/Supply
=
Supply
At P1, demand is more than supply and as such there is shortage in the market. Price
will raise causing demand to fall and supply to rise. Price will continue to rise until it
reaches equilibrium price at which Demand=Supply ( Equilibrium point E).