Concept of demand

Demand indicates the quantities that consumers are both willing and able
to buy per time period at each possible price, other things constant.
Demand function
A demand function exhibits a functional relationship between demand and
its determinants. Symbolically, Qx=f(Px, Py, I, T, Tn, N, M)
Where, Qx= Demand
Px = Price of the commodity X,
Py= Price of related commodity Y,
I = Consumer’s income
T=Tastes and Preferences of the consumer
Tn=Taxation
N = Number of Consumers
M=Consumer’s expectations
Law of demand
Law of demand is advocated by Dr. Alfred Marshall. The law says that
quantity demanded varies inversely with price, other things constant. In
other words, the higher the price, the smaller the quantity demanded; the
lower the price, the greater the quantity demanded.
What explains the law of demand? Or why is more demanded at a lower
price?

• Substitution effect of a price change: - when price of a good falls, that

good becomes cheaper compared to other goods. So consumers tend
to substitute that good for other goods. As a result more is demanded
at a lower price.
• Income effect of a price change:- A fall in price of a good increases
consumer’s real income and thereby consumers tend to purchase
more.

The relation between price and demand can be expressed through Demand
schedule and demand curve.

• Demand Schedule is table showing the relation between the price of a

good and the quantity that consumers are willing and able to buy per
time period, other things constant.

The demand schedule for Pizza

Price per Pizza(Rs.) Quantity Demanded per

Week(in Lakh units)
Rs.150 8
Rs.120 14
Rs.90 20
Rs.60 26
Rs.30 32

MICRO ECONOMICS (GE-1) S.K.MISHRA

 • Demand Curve is a curve showing the relation between the price of a
good and the quantity consumers are willing and able to buy per
period, other things constant. The demand curve slopes downward,
reflecting the law of demand.

Demand Curve for Pizza

200.00
Price per unit of pizza(Rs.)

150.00

100.00

50.00

0.00
0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00
Quantity demanded for Pizza per week(lakhs)

Exceptions to the law of demand:-

Demand curve may not be negatively sloped in following cases.

• Conspicuous consumption/consumption of prestigious goods(snub

appeal)
• Giffen goods/staple goods
• Speculation and expectation
• Psychological bias

MICRO ECONOMICS (GE-1) S.K.MISHRA

Distinction between demand and quantity demanded

Demand indicates the entire relationship between price and quantity

demanded as represented by the demand curve or the demand schedule.
Quantity demanded indicates the amount of a good that consumers are
willing and able to buy per period at a particular price, as reflected by a
point on a demand curve.

Distinction between Individual demand and Market demand

Individual demand indicates a relation between the price of a good and the
quantity purchased by an individual consumer per period, other things
constant. In other words, it is the demand of an individual consumer.
Market demand indicates a relation between the price of a good and the
quantity demanded by all consumers in the market during a given period,
other things constant. In other words, it is the sum of the individual
demands in the market.

Derivation of individual and market demand curves

Individual demand curve is a curve relating the quantity of a good that a

single consumer will buy to the price of that good. Market demand curve
relates the quantity of a good that all consumers in a market will buy to its
price. It can be derived as horizontal summation of the individual demand
curves of all consumers in a particular market.

MICRO ECONOMICS (GE-1) S.K.MISHRA

Shifting of the demand curve
It implies movement of the demand curve right or left resulting from a
change in one of the determinants of demand other than price of the good.

Variables that can affect market demand are (1) the money income of
consumers, (2) prices of other goods, (3) consumer expectations, (4) the
number or composition of consumers in the market, (5) Consumer tastes,
and (6) advertising outlays or expenditures. How do changes in each affect
demand?
Changes in consumer income- goods are classified into two broad
categories, depending o how demand responds to changes in money income.
The demand for normal good increases as money income increases, so the
demand curve shifts rightward. On the other hand, demand for inferior good
decreases as money income increases, so the demand curve shifts leftward.
Examples of inferior goods include low quality food grains, used furniture,
and used clothing. As money income increases, consumers tend to switch
from these inferior goods to normal goods such as better quality food grain,
new furniture, and new clothing.
Change in the prices of other goods- Other goods may be related goods or
unrelated goods. Related goods can be substitute good or complement good.
Two goods are considered substitutes if an increase in the price of one shifts
the demand for the other rightward and conversely, if a decrease in the price
of one shifts the demand for other leftward. Examples of substitutes include
pizza and sandwiches, coke and pepsi, private and public transportation.
Goods used in combination are called complements. Examples include coke
and pizza, milk and cookies, computer software and hardware, airline
tickets and rental cars. Two goods are considered complements if an
increase in the price of one decreases the demand for the other, shifting the
demand curve leftward.
Change in consumer expectations- consumer expectations about factors
that influence demand can be income or price. A change in consumers’
income expectations can shift the demand curve. For example, a consumer
MICRO ECONOMICS (GE-1) S.K.MISHRA
who learns about a pay rise might increase demand well before the rise
takes effect. Likewise, a change in consumers’ price expectations can shift
the demand curve. For example, if consumers come to know that home
prices will climb next month, some will increase their demand for housing
now, shifting this month’s demand for housing rightward. On the other
hand, if housing prices are expected to fall next month, some consumers will
postpone purchases, thereby shifting this month’s housing demand
leftward.
Changes in the number and composition of consumers- If the number of
consumers changes, the demand curve will shift. For example, if the
population grows, the demand for pizza will shift rightward. Even if the total
population remains unchanged, demand could shift with a change in the
composition of the population. For example, an increase in the teenage
population could shift pizza demand rightward. A baby boom would shift
rightward the demand for baby food.
Changes in consumer tastes- by taste we mean our likes and dislikes as a
consumer. As our tastes change demand changes, causing a shift in the
demand curve. For example, although pizza is popular, some people just
don’t like it, and those who are lactose intolerant can’t stomach the cheese
topping. Thus most people like pizza but some don’t.
Changes in expenditure on advertising- a change in firm’s expenditure on
advertising and promotion may change demand and a shift in the demand
curve.
Changes in taxation policy - Tax is a compulsory payment from a person
to the public authority or government to fund the public expenditure. An
increase in tax rate may reduce the demand and vice versa.
State of economic activities- a growth in economic activities may increase
the demand for both consumer good and capital goods, shifting the demand
curve rightward. On the other hand, a slowdown in economic activities may
reduce the demand for both consumer goods and capital goods, shifting the
demand curve leftward.

Distinction between change in demand and change in quantity

demanded
A change in one of the determinants of demand other than price causes a
change in demand, a shift in the demand curve. A change in price, other
things constant, causes a change in quantity demanded, a movement along
a demand curve.

MICRO ECONOMICS (GE-1) S.K.MISHRA

Elasticity of demand
By elasticity we mean sensitivity of one variable to another. Elasticity of
demand measures the degree of responsiveness of quantity demanded for a
product to change in different demand determinants, namely price of the
commodity, money income of the consumer, prices of the related goods,
advertisement expenditure. Accordingly, we have (A) Price Elasticity of
Demand, (B) Income Elasticity of Demand, (C) Cross or Cross-price
Elasticity of Demand, and (D) Advertisement or Promotional Elasticity of
Demand.

Price Elasticity of Demand

It measures the consumer’s responsiveness to a change in price. It is

calculated as the percentage change in quantity demanded divided by the
percentage change in price. Symbolically, Ep = ∆q/∆p × p/q. However,
different formulas are prescribed depending on the magnitude of change in
Quantity demanded and price. These are as follows.

Ep = dq/dp × p/q (Point formula-when the change

is very small)

Or

Ep = ∆q/(q + qˈ)/2 ÷ ∆p /(p + pˈ)/2 (Arc formula-when the change is

large)

Categories of Price Elasticity of Demand

The value of price elasticity varies between zero and infinity.

If Ep = 0, the demand is perfectly inelastic

If Ep = 1, the demand is unit elastic

If Ep = ∞, the demand is perfectly elastic

If 0 < Ep < 1, the demand is inelastic

If 1 < Ep < ∞, the demand is elastic

MICRO ECONOMICS (GE-1) S.K.MISHRA

Determinants of Price Elasticity of Demand

Several factors influence the price elasticity demand for a good.

• Availability of substitutes- The greater the availability of substitutes,

the more elastic is the demand to a price change and vice versa.
• Share of the consumer’s budget spent on the good- goods claiming
larger share of the consumer’s budget have more elastic demand than
the goods claiming small share in consumer’ budget.
• Length of adjustment period- the longer the period of adjustment, the
more elastic is the demand to a price change and vice versa.
• Nature of goods- Necessities have less elastic demand whereas
comforts and luxuries have more elastic demand.
• Number of uses- Goods having more number of uses have more elastic
demand than the goods with less number of uses.
• Possibility of postponement of consumption- Goods whose consumption
can be postponed have more elastic demand than the goods whose
consumption cannot be postponed.

MICRO ECONOMICS (GE-1) S.K.MISHRA

Income Elasticity of Demand (EI): It measures how responsive quantity
demanded is to a change in consumer income. It is calculated as the percentage
change in quantity demanded divided by the percentage change in income that
caused it. Symbolically,

EI = dQ/dI × I/Q (Point formula-when the change is very small)

Or

EI = ∆Q/(Q + Qˈ)/2 ÷ ∆I /(I + Iˈ)/2 (Arc formula-when the change is large)

The value of EI is positive for normal goods and negative for inferior goods.

Cross or Cross-Price Elasticity of Demand (EC or EXY): it measures the

responsiveness of quantity demanded for one good to changes in price of another
good. It is calculated as the percentage change in the quantity demanded for one
good divided by the percentage change in the price of another good. Symbolically,

EC or EXY = dQx/dPy × Py/Qx (Point formula-when the change is very small)

Or

EC or EXY = ∆Qx/ (Qx + Qxˈ)/2 ÷ ∆Py / (Py + Pyˈ)/2 (Arc formula-when the
change is large)

The value of EC or EXY is positive for substitutes, negative for complements

and zero for unrelated goods.

Advertisement or Promotional Elasticity of Demand (EA): It measures the

sensitivity of sales (Quantity demanded) to changes in expenditure for advertising
and promotion. It is calculated as the percentage change in quantity demanded
divided by the percentage change in advertisement expenditure. Symbolically,

EA = dQ/dA × A/Q (Point formula-when the change is very small)

Or

EA = ∆Q/(Q + Qˈ)/2 ÷ ∆A /(A + Aˈ)/2 (Arc formula-when the change is large)

MICRO ECONOMICS (GE-1) S.K.MISHRA