Demand Theory

What Is Demand Theory?

Demand theory is an economic principle relating to the relationship between consumer
demand for goods and services and their prices in the market. Demand theory forms the basis
for the demand curve, which relates consumer desire to the amount of goods available. As
more of a good or service is available, demand drops and so does the equilibrium price.

Understanding Demand Theory

Demand is simply the quantity of a good or service that consumers are willing and able to buy
at a given price in a given time period. People demand goods and services in an economy to
satisfy their wants, such as food, healthcare, clothing, entertainment, shelter, etc. The demand
for a product at a certain price reflects the satisfaction that an individual expects from
consuming the product. This level of satisfaction is referred to as utility and it differs from
consumer to consumer. The demand for a good or service depends on two factors: (1) its
utility to satisfy a want or need, and (2) the consumer’s ability to pay for the good or service.
In effect, real demand is when the readiness to satisfy a want is backed up by the individual’s
ability and willingness to pay.

Demand theory is one of the core theories of microeconomics. It aims to answer basic
questions about how badly people want things, and how demand is impacted by income levels
and satisfaction (utility). Based on the perceived utility of goods and services by consumers,
companies adjust the supply available and the prices charged.

Built into demand are factors such as consumer preferences, tastes, choices, etc. Evaluating
demand in an economy is, therefore, one of the most important decision-making variables that
a business must analyze if it is to survive and grow in a competitive market. The market system
is governed by the laws of supply and demand, which determine the prices of goods and
services. When supply equals demand, prices are said to be in a state of equilibrium. When
demand is higher than supply, prices increase to reflect scarcity. Conversely, when demand is
lower than supply, prices fall due to the surplus.

The Law of Demand and the Demand Curve

The law of demand introduces an inverse relationship between price and demand for a good
or service. It simply states that as the price of a commodity increases, demand decreases,
provided other factors remain constant. Also, as the price decreases, demand increases. This
relationship can be illustrated graphically using a tool known as the demand curve.

The demand curve has a negative slope as it charts downward from left to right to reflect the
inverse relationship between the price of an item and the quantity demanded over a period of
time. An expansion or contraction of demand occurs as a result of the income effect or
substitution effect. When the price of a commodity falls, an individual can get the same level
of satisfaction for less expenditure, provided it’s a normal good. In this case, the consumer can
purchase more of the goods on a given budget. This is the income effect. The substitution
effect is observed when consumers switch from more costly goods to substitutes that
have fallen in price. As more people buy the good with the lower price, demand increases.

Meaning of Demand in economics:

The demand for the commodity can be described as its quantity at which consumer is willing
and able to purchase or consume a given commodity during a given period of time.
So, the commodity can be said as demanded when

 A consumer possesses the willingness to buy it

 Possesses the ability to purchase or consume it
 And it is related to a given period of time.

According to Prof. Bober

“By demand, we mean the various quantities of a given commodity or service which consumers
could buy in a given period of time at various prices or at various incomes or at various prices of
related goods.”
According to Ferguson
“Demand refers to the quantities of a commodity that the consumers are able and willing to
buy at each possible price during a given period of time, other things being equal.”

Demand Schedule
In economics, a demand schedule is a table that shows the quantity demanded of a good or
service at different price levels. A demand schedule can be graphed as a continuous demand
curve on a chart where the Y-axis represents price and the X-axis represents quantity.

Understanding Demand Schedule

A demand schedule most commonly consists of two columns. The first column lists a price for
a product in ascending or descending order. The second column lists the quantity of the
product desired or demanded at that price. The price is determined based on research of the
market.

When the data in the demand schedule is graphed to create the demand curve, it supplies a
visual demonstration of the relationship between price and demand, allowing easy estimation
of the demand for a product or service at any point along the curve.
Determinants of Demand
It refers to the factors which influence the demand for a particular commodity for a given
period of time.
In other words, these factors directly or indirectly affect the demand for the commodity in the
market. An organization should understand the impact of these determinants of the demand.
Some of these are explained as under:
1) The Price of the commodity:
It is the most important determinant. It affects the demand for goods at a large extent. As the
law of demand, there is an inverse relationship between the price of commodity and Qd. the
Qd increases with a reduction in price, assuming other things constant and vice versa.
For example
A consumer prefers to make bulk quantity purchases when prices are less and makes fewer
purchases when prices are high.

2) The income of consumers:

Income is another main determinant which represents the purchasing power of the consumer.
When income increases, the consumer starts purchasing more which results in more demand
and vice versa while other factors remain constant. Income and demand are directly related to
each other in case of normal and superior goods.
For example:
Suppose if the salary of Mr A has increased, then he can purchase some luxury items such as
television, air conditioners, and accessories.
The relationship between income and different types of goods can be discussed as under:
Normal or Consumer goods:
These refer to the goods which are consumed by all the people in society on a daily basis such
as soaps, toothpaste, grains, clothes, etc. As the income increases, the Qd of consumer goods
increases but up to a certain limit, other things remain the same.
Inferior goods:
Inferior goods are those whose demand decreases when income increases and vice versa. For
example, public transportation, generic grocery products, and kerosene, etc.
However, the goods are not always inferior or normal goods as inferior goods are normal goods
for the people having a low level of income. Therefore, we can say that the level of income
creates the perception of goods i.e normal or inferior.
3) The Price of related goods:
Demand for a given commodity can be influenced by the price of related goods. These related
goods can be classified as:
Substitute goods:
Substitute goods are those which can be used in place of each other for the satisfaction of some
want e.g. tea and coffee, coke and limen Soda etc. There is a direct relationship between the
price of substitute goods and given commodity, other things remain constant and vice versa. It
implies as the price of substitute goods increases, the Qd for given commodity starts increasing.
For example, If the price of coke increases, it will result in more Qd for Limca as the Limca will
become cheaper as compared to coke. Thus the price of substitute goods directly affects the Qd
for the given commodity.
Complementary goods:
 complementary goods are those which are used together to satisfy a specific need such as cars
and petrol, shoes and polish, pencils and erasers etc. there is a negative relationship between
prices of complementary goods and Qd of the given commodity. It implies that as the price of
complementary goods rises, the Qd for given commodity starts declining, other things being
constant and vice versa.
For example, as the price of shoes starts increasing, the Qd for polish starts decreasing as it will
become expensive when used together. So, the demand for a given commodity is inversely
affected by the price of complementary goods.
4) Tastes and preferences:
Tastes and preferences have a great impact on the demand for the given commodity. These are
highly influenced by the change in trends, fashion, lifestyle, sex, age, religious values, standard
living, customs and common habits. Any change in these factors results in a change in tastes
and preferences of consumers. Consumers switch over to new products in place of old ones for
their consumption.
Also, the sex ratio, habits and age influences the demand for the product in a particular area.
For example, if the number of females is more as compared to males in a specific area, the
demand for feminine products will be more in that area such as makeup kits and cosmetics
material.
5) Expectations of consumers:
If the price of the product is expected to rise in future, the consumers demand more to store it
in the short run. For example, if it is expected that the prices of petrol and diesel will increase
by next week, the demand for petrol and diesel would increase in present.
Similarly, if there is an expectation that the prices of products will fall in future, the consumers
would delay the purchases of that product. Thus, price expectations also make a significant
impact on the demand of buyers.
6) Growth of population: 
The size of the population determines aggregate demand in the country. More the growth of
population more will be the demand and vice versa. Thus, the growth of population is directly
related to demand of the commodities. For example, if the population in an economy is more,
there will be more demand for food grains, pulses and other consumer goods.
7) Distribution of National Income:
 The market demand is highly influenced by the distribution of national income. The even
distribution of national income creates a market demand for necessities goods and on the other
hand, uneven distribution of national income creates a demand for luxury goods.
8) Credit availability:
The easy access to credit affects the demand for the given commodity at a large extent. It
boosts up the demand in the economy as the consumers with a low level of income can afford
expensive products such as consumer durables in instalments.
It increases the customer base for the business. Thus, most firms use this method to increase
demand and sales of its products such as washing machines, refrigerators, LED Television and
luxury cars etc.
9) Taxation and subsidies:
These refer to one of the major factors to affect the demand for commodities. Govt policy
influences the demand through tax rates and subsidies in the market. For example, if the tax
rate on a specific product is high, it will increase the price of the product. This would result in
fall in the demand for that particular product and vice versa.
Similarly, the subsidies lower the price of the product and lead to more demand for the product
in the market. Thus, low tax rates and more subsidies boost up the demand in the market and
vice versa.
10) Climatic conditions:
The demand for some products varies with the climatic conditions of a specific area. For
example, tea and coffee are more demanded in winter season whereas ice cream is more
demanded in the summer season. Similarly, there are some specific products such as umbrella
which are highly demanded in hilly areas as compared to plains. Thus, consumers demand
different products under different climatic conditions.
Conclusion
Apart from the factors discussed above, there may be more determinants affecting the demand
of a particular commodity. To be precise, some factors are important for one commodity and
others could be for other commodities. Therefore, the importance of different factors varies
with the buyers.
What Affects Demand?
There are various factors that drive demand, including cost, income, preference and more.
These factors also affect consumers’ purchase decisions. Here are the fundamental
determinants of demand:
 Cost of a good or service. The law of demand states that, with all factors remaining constant,
the number of products or services consumers will buy is based on the price. That means people
will purchase less when the price of a certain product increases. On the other hand, consumers
will buy more when the price decreases.
 Income of buyers. Income gives consumers buying power. A decrease in income leads to lower
demand. However, an increase in income does not always lead to buying more of a particular
commodity. Additionally, satisfaction decreases as a person consumes more of a single product
or service, as stated by the Law of Diminishing Marginal Utility.
 Cost of related goods or services. There are two types of related costs to consider. First, the
cost of a complementary good or service purchased along with a particular item. For example,
pancakes and maple syrup or chips and dip. When the price of complementary goods falls, the
demand increases. Second, the cost of substitutes bought instead of a product. For example,
substituting Coke for Pepsi or choosing a store-brand item over a name-brand. In this case, an
increase in the price of substitutes increases demand for the good or service.
 Tastes or preferences. Changes to consumer desires will affect demand. For instance, if
consumer preference is in favor of a certain product, the quantity demanded increases.
Likewise, if their taste goes against a good or service, the amount demanded falls.
 Expectations. People’s subjective evaluations of value for a certain good or service can affect
their purchase decisions. Expectations often refer to whether a buyer thinks the prices of a
product will rise or fall in the future. For instance, present demand for a certain product tends to
increase if consumers expect it to be more expensive in the future.

Assumptions of Law of Demand

Law of Demand can operate and remain valid only if certain things like income, population size,
climate, consumer's tastes and expectations, etc., are assumed to remain constant or equal. In
other words, there is a need for an assumption or a consideration that these things do not
change at all under any circumstances.
The six basic assumptions of law of demand are as follows:
1. No change in the income
The first assumption regarding the law of demand to operate is that the income of the
consumer must remain same or should not change (i.e. neither rise nor fall).
Income is assumed to remain constant, since, its rise may lure the consumer to buy more goods
and raise demand despite an increase in the commodity prices.
2. No change in size and composition of the population
The second assumption for the law of demand to function is that the size and composition of
the total population of a country should not change. In other words, the population must
neither increase nor decrease.
Here, it is assumed that the population size and its composition must remain constant because
a rise in the number of people would also increase demand for commodities even when their
prices are higher and vice-versa.

3. No change in prices of related goods

The third basic assumption of the law of demand considers that the Prices of Related Goods
(i.e. Substitute Goods and Complementary Goods) don't change and remains same.
Here, it is assumed that the Prices of Substitute Goods (like Tea and Coffee) and
Complementary Goods (e.g. Petrol and Cars) should not change. It is considered so, since, a
change in consumer's liking or choice makes the law of demand stand invalid and inapplicable.
4. No change in consumer's taste, preference, etc.
The fourth assumption of the law of demand considers that the taste, preference, habit,
fashion, etc., of the consumer, should remain unchanged. That is, there should not arise a
newer choice or change in the mood to try something different.
Here, it is assumed that the consumer's taste, preference, habit, style, so on., should not
change because it breaks the functionality or validity of the law of demand.
5. No expectation of a price change in future.
The fifth basic assumption of Demand Law to remain valid is not to expect any future
possibilities regarding a change or fluctuation in the prices of commodities.
Here, it is assumed not to keep any expectation of future price change because it will affect the
current demand of goods.
For example, if people are expecting a rise in the future prices of some goods, then the current
demand for such goods will also increase and vice-versa.
6. No change in the climatic conditions
The sixth assumption of the law of demand is that the weather conditions or climate of a region
or geographical area should remain same and not alter at all.
There is a need to assume the climate to stay unchanged because a seasonal shift changes the
essential needs of people.
For example, the demand for umbrellas is high mostly during a rainy season and low during
other seasons.
Hence, to allow the law of demand to operate smoothly the climate should also be considered
to remain constant.

Elasticity
What Is Elasticity?
Elasticity is a measure of a variable's sensitivity to a change in another variable, most
commonly this sensitivity is the change in quantity demanded relative to changes in other
factors, such as price. In business and economics, price elasticity refers to the degree to which
individuals, consumers, or producers change their demand or the amount supplied in response
to price or income changes. It is predominantly used to assess the change in
consumer demand as a result of a change in a good or service's price.

How Elasticity Works

When the value of elasticity is greater than 1.0, it suggests that the demand for the good or
service is more than proportionally affected by the change in its price. A value that is less than
1.0 suggests that the demand is relatively insensitive to price, or inelastic.

Inelastic means that when the price goes up, consumers’ buying habits stay about the same,
and when the price goes down, consumers’ buying habits also remain unchanged.

If elasticity = 0, then it is said to be 'perfectly' inelastic, meaning its demand will remain
unchanged at any price. There are probably no real-world examples of perfectly inelastic
goods. If there were, that means producers and suppliers would be able to charge whatever
they felt like and consumers would still need to buy them. The only thing close to a perfectly
inelastic good would be air and water, which no one controls. 

Elasticity is an economic concept used to measure the change in the aggregate quantity
demanded of a good or service in relation to price movements of that good or service.
A product is considered to be elastic if the quantity demand of the product changes more than
proportionally when its price increases or decreases. Conversely, a product is considered to be
inelastic if the quantity demand of the product changes very little when its price fluctuates.

For example, insulin is a product that is highly inelastic. For people with diabetes who need
insulin, the demand is so great that price increases have very little effect on the quantity
demanded. Price decreases also do not affect the quantity demanded; most of those who need
insulin aren't holding out for a lower price and are already making purchases.

On the other side of the equation are highly elastic products. Spa days, for example, are highly
elastic in that they aren't a necessary good, and an increase in the price of trips to the spa will
lead to a greater proportion decline in the demand for such services. Conversely, a decrease in
the price will lead to a greater than proportional increase in demand for spa treatments.

Types of Elasticity or measurement of demand elasticity

Elasticity of Demand
The quantity demanded of a good or service depends on multiple factors, such as price,
income, and preference. Whenever there is a change in these variables, it causes a change in
the quantity demanded of the good or service.

Price elasticity of demand is an economic measure of the sensitivity of demand relative to a

change in price. The measure of the change in the quantity demanded due to the change in
the price of a good or service is known as price elasticity of demand.

Income Elasticity
Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain
good to a change in real income of consumers who buy this good, keeping all other things
constant. The formula for calculating income elasticity of demand is the percent change in
quantity demanded divided by the percent change in income. With income elasticity of
demand, you can tell if a particular good represents a necessity or a luxury.

Cross Elasticity
The cross elasticity of demand is an economic concept that measures the responsiveness in
the quantity demanded of one good when the price for another good changes. Also called
cross-price elasticity of demand, this measurement is calculated by taking the percentage
change in the quantity demanded of one good and dividing it by the percentage change in the
price of the other good.
Price Elasticity of Supply
Price elasticity of supply measures the responsiveness to the supply of a good or service after a
change in its market price. According to basic economic theory, the supply of a good will
increase when its price rises. Conversely, the supply of a good will decrease when its price
decreases.

We can further classify these elastic and inelastic types of demand into five categories.

Perfectly Elastic Demand 

When there is a sharp rise or fall due to a change in the price of the commodity, it is said to be
perfectly elastic demand.  In perfectly elastic demand, even a small rise in price can result in a
fall in demand of the good to zero, whereas a small decline in the price can increase the
demand to infinity.  However, perfectly elastic demand is a total theoretical concept and
doesn’t find a real application, unless the market is perfectly competitive and the product is
homogenous.   The degree of elasticity of demand helps to define the slope and shape of the
demand curve. Therefore, we can determine the elasticity of demand by looking at the slope of
the demand curve.  A Flatter curve will represent a higher elastic demand. Thus, the slope of
the demand curve for a perfectly elastic demand is horizontal.
Perfectly Inelastic Demand
A perfectly inelastic demand is the one in which there is no change measured against a price
change. Like perfectly elastic demand, the concept of perfectly inelastic is also a theoretical
concept and doesn’t find a practical application. However, the demand for necessity goods can
be the closest example of perfectly inelastic demand. The numerical value obtained from the
PED formula comes out as zero for a perfectly inelastic demand.  The demand curve for a
perfectly inelastic demand is a vertical line i.e. the slope of the curve is zero. 
Relatively Elastic Demand

Relatively elastic demand refers to the demand when the proportionate change in the demand
is greater than the proportionate change in the price of the good. The numerical value of
relatively elastic demand ranges between one to infinity. In relatively elastic demand, if the
price of a good increases by 25% then the demand for the product will necessarily fall by more
than 25%. Unlike the aforementioned types of demand, relatively elastic demand has a practical
application as many goods respond in the same manner when there is a price change.  The
demand curve of relatively elastic demand is gradually sloping. 
Relatively Inelastic Demand
In a relatively inelastic demand, the proportionate change in the quantity demanded for a product is
always less than the proportionate change in the price. For example, if the price of a good goes down by
10%, the proportionate change in its demand will not go beyond 9.9%, if it reaches 10% then it would be
called unitary elastic demand. The numerical value of relatively inelastic demand always comes out as
less than 1 and the demand curve is rapidly sloping for such type of demand. 

Unitary Elastic Demand

When the proportionate change in the quantity demanded for a product is equal to the proportionate
change in the price of the commodity, it is said to be unitary elastic demand. The numerical value for
unitary elastic demand is equal to 1. The demand curve for unitary elastic demand is represented as a
rectangular hyperbola. 

Factors Affecting Demand Elasticity

There are three main factors that influence a good’s price elasticity of demand.

Availability of Substitutes
In general, the more good substitutes there are, the more elastic the demand will be. For
example, if the price of a cup of coffee went up by $0.25, consumers might replace their
morning caffeine fix with a cup of strong tea. This means that coffee is an elastic good because
a small increase in price will cause a large decrease in demand as consumers start buying more
tea instead of coffee.

However, if the price of caffeine itself were to go up, we would probably see little change in
the consumption of coffee or tea because there may be few good substitutes for caffeine.
Most people, in this case, might not willingly give up their morning cup of caffeine no matter
what the price. We would say, therefore, that caffeine is an inelastic product. While a specific
product within an industry can be elastic due to the availability of substitutes, an entire
industry itself tends to be inelastic. Usually, unique goods such as diamonds are inelastic
because they have few if any substitutes.

Necessity
As we saw above, if something is needed for survival or comfort, people will continue to pay
higher prices for it. For example, people need to get to work or drive for a number of reasons.
Therefore, even if the price of gas doubles or even triples, people will still need to fill up their
tanks.

Time
The third influential factor is time. For instance, if the price of cigarettes goes up to $2 per
pack, someone with a nicotine addiction with very few available substitutes will most likely
continue buying their daily cigarettes. This means that tobacco is inelastic because the change
in price will not have a significant influence on the quantity demanded. However, if that
person who smokes cigarettes finds that they cannot afford to spend the extra $2 per day and
begins to kick the habit over a period of time, the price of cigarettes for that consumer
becomes elastic in the long run.
What Is Inelastic?
Inelastic is an economic term referring to the static quantity of a good or service when its price
changes. Inelastic means that when the price goes up, consumers’ buying habits stay about the
same, and when the price goes down, consumers’ buying habits also remain unchanged.

Inelasticity of Demand
An inelastic product, on the other hand, is defined as one where a change in price does not
significantly impact demand for that product.

Should demand for a good or service be static when its price or other factor changes, it is said
to be inelastic. In other words, when the price changes or consumer's incomes change, they
will not change their buying habits. Inelastic products are necessities and, usually, do not have
substitutes they can easily be replaced with. Since the quantity demanded is the same
regardless of the price, the demand curve for a perfectly inelastic good is graphed out as a
vertical line.

For businesses, there are many advantages to price inelasticity. For example, they have greater
flexibility with prices because demand remains basically the same, even if prices increase or
decrease. If the business raises its prices up or down, consumers' buying habits will remain
mostly unchanged. This can impact demand and total revenue for a business in a couple of
different ways.

First, a business may have less overall revenue. If the price for an inelastic good is decreased
and the demand for that good does not increase, this would result in a decrease in revenue.
For this firm, there is no beneficial outcome in reducing the price of its goods.

Second, a business may experience more overall revenue. If the price for an inelastic good is
increased and the demand for that good stays the same, the total revenue will increase
because the quantity demanded has not changed.

Normally, a price increase does, in fact, lead to a decrease in quantity demanded (even if it is
small). So, businesses that deal with inelastic goods are generally able to increase their prices,
sell a little less, and still make higher revenues. They tend to be protected against economic
downturns and better able to maximize profits. 

Determinants of Elasticity of Demand

Apart from the price, there are several other factors that influence the elasticity of demand.
These are:
 Consumer Income: The income of the consumer also affects the elasticity of demand.
For high-income groups, the demand is said to be less elastic as the rise or fall in the
price will not have much effect on the demand for a product. Whereas, in case of the
low-income groups, the demand is said to be elastic and rise and fall in the price have a
significant effect on the quantity demanded. Such as when the price falls the demand
increases and vice-versa.
 Amount of Money Spent: The elasticity of demand for a product is determined by the
proportion of income spent by the individual on that product. In case of certain goods,
such as matchbox, salt a consumer spends a very small amount of his income, let’s say
Rs 2, then even if their prices rise the demand for these products will not be affected to
a great extent. Thus, the demand for such products is said to be inelastic. Whereas
foods and clothing are the items where an individual spends a major proportion of his
income and therefore, if there is any change in the price of these items, the demand will
get affected.
 Nature of Commodity: The elasticity of demand also depends on the nature of the
commodity. The product can be categorized as luxury, convenience, necessary goods.
The demand for the necessities of life, such as food and clothing is inelastic as their
demand cannot be postponed. The demand for the Comfort Goods is neither elastic nor
inelastic. As with the rise and fall in their prices, the demand decreases or increases
moderately.
 Whereas the demand for the luxury goods is said to be highly elastic because even with
a slight change in its price the demand changes significantly. But, however, the demand
for the prestige goods is said to be inelastic, because people are ready to buy these
commodities at any price, such as antiques, gems, stones, etc.
  Several Uses of Commodity: The elasticity of demand also depends on the number of
uses of the commodity. Such as, if the commodity is used for a single purpose, then the
change in the price will affect the demand for commodity only in that use, and thus the
demand for that commodity is said to be inelastic. Whereas, if the product has several
uses, such as raw material coal, iron, steel, etc., then the change in their price will affect
the demand for these commodities in its many uses. Thus, the demand for such
products is said to be elastic.
 Whether the Demand can be Postponed or not: If the demand for a particular product
cannot be postponed then, the demand is said to be inelastic. Such as, Wheat is
required in daily life and hence its demand cannot be postponed. On the other hand,
the items whose demand can be postponed is said to have elastic demand. Such as the
demand for the furniture can be postponed until the time its prices fall.
 Existence of Substitutes: The substitutes are the goods which can be used in place of
one another. The goods which have close substitutes are said to have elastic demand.
Such as, tea and coffee are close substitutes and if the price of tea increases, then
people will switch to the coffee and demand for the tea will decrease significantly.
Whereas, if there are no close substitutes for a product, then its demand is said to be
inelastic. Such as salt and sugar do not have their close substitutes and hence lower is
their price elasticity.
 Joint Demand: The elasticity of demand also depends on the complementary goods, the
goods which are used jointly. Such as car and petrol, pen and ink, etc. Here the elasticity
of demand of secondary (supporting) commodity depends on the elasticity of demand
of the major commodity. Such as, if the demand for pen is inelastic, then the demand
for the ink will also be less elastic.
 Range of Prices: The price range in which the commodities lie also affects the elasticity
of demand. Such as the higher range products are usually bought by the rich people,
and they do not care much about the change in the price and hence the demand for
such higher range commodities is said to be inelastic.

Also, the lower range commodities have inelastic demand because these are already low priced
and can be bought by any sections of the society. But the commodities in middle range prices
are said to have an elastic demand because with the fall in the prices the middle class and the
lower middle class are induced to buy that commodity and therefore the demand increases. But
however, if the prices are increased the consumption reduces and as a result demand falls.

Thus, these are some of the important determinants of elasticity of demand that every firm
should understand properly before deciding on the price of their offerings.
What is Supply?
 Supply is an economic term that refers to the amount of a given product or service that
suppliers are willing to offer to consumers at a given price level at a given period. Supply is
a fundamental economic concept that describes the total amount of a specific good or service
that is available to consumers. Supply can relate to the amount available at a specific price or
the amount available across a range of prices if displayed on a graph. This relates closely to
the demand for a good or service at a specific price; all else being equal, the supply provided
by producers will rise if the price rises because all firms look to maximize profits.

Understanding Supply
Supply and demand trends form the basis of the modern economy. Each specific good or
service will have its own supply and demand patterns based on price, utility and personal
preference. If people demand a good and are willing to pay more for it, producers will add to
the supply. As the supply increases, the price will fall given the same level of demand. Ideally,
markets will reach a point of equilibrium where the supply equals the demand (no excess
supply and no shortages) for a given price point; at this point, consumer utility and producer
profits are maximized.

Law of Supply
The law of supply is the microeconomic law that states that, all other factors being equal, as
the price of a good or service increases, the quantity of goods or services that suppliers offer
will increase, and vice versa. The law of supply says that as the price of an item goes up,
suppliers will attempt to maximize their profits by increasing the number of items for sale.

The law of supply is one of the most fundamental concepts in economics. It works with the law
of demand to explain how market economies allocate resources and determine the prices of
goods and services.

Supply Curve
The supply curve is a graphic representation of the correlation between the cost of a good or
service and the quantity supplied for a given period. In a typical illustration, the price will
appear on the left vertical axis, while the quantity supplied will appear on the horizontal axis.

Supply schedule

Supply schedule is a chart that shows how much product a supplier will have to produce to
meet consumer demand at a specified price based on the supply curve. In other words, it’s
basically a supply graph in spreadsheet form listing the quantity that needs to be produced at
each product price level.
Assumptions

The assumptions of the law of supply are as under:

 No change in cost of production

It assumed that there is no change in cost of production because of the profit decreases with
the increase in cost of production and it causes the decrease in supply. If price of a commodity
decreases and cost of production also decreases, at the same time, the quantity supplied does
not decrease and profit remains constant.

 No change in technology
It is also assumed that technique of production does not change. If better methods of
production are invented, profit increases at the previous price. The sellers increase supply and
law of supply does not operate.

 No change in climate
It is also assumed that there is no change in climatic situation. For example, at any place flood
or earth quake occurred. The supply of goods decreases at that place at previously prevailing
price.

 No change in prices of substitutes

If the prices of substitutes of a commodity fall then the tendency of consumers diverts to
substitutes therefore, the supply of a commodity falls without any change in price.

 No change in natural resources

If the quantity of natural resources (minerals, gas, coal, oil etc) increases, the cost of production
decreases. It causes to increase in quantity supplied.

 No change in price of capital goods

The capital goods are raw material, machinery, tools etc. The cost of production increases due
to increase in prices of capital goods. It can lead to decrease in quantity supplied.

 No change in political situation

The amount of investment is affected by the change in political situation of a country. The
production of goods decreases due to decrease in investment.
  No change in tax policy
It is also assumed that the taxation policy of government does not change. The increase in taxes
effects the investment and production and supply of goods decreases.

Determinants of Supply

 Price of a good: Other things remain constant when the relative price of a commodity is
high, it is supplied in great quantity, as firm produces the commodity to earn profit and
the profit of the firm increases with an increase in its price.
 Price of related goods: When the price of other goods, i.e. competing or
complementary goods rise, it becomes comparatively profitable to the firm to produce
and offer the other good than the good in question. For instance: A farmer produces
two crops tea and coffee and if the price of tea increases, then in such a situation, it will
be more profitable for the farmer to produce more tea. Therefore, the farmer may shift
his resources from the coffee production to that of tea. In this way, the supply of tea
may increase and coffee will fall.
 Price of inputs: The price of factors of production (inputs), i.e. land, labor, capital,
entrepreneur also affects the supply of the commodity, in a way that if there is an
increase in the price of a factor of production, then the cost of producing a commodity
which uses that particular factor in excess will be more in comparison to the commodity,
which uses the same factor in less quantity.
 State of the art technology: Innovations in the product, usually make the product better
than before, and also better than its competitors, with the limited resources which the
company possess. Thus the company will increase the supply of the products with state
of the art technology and reduce the supply of the product which is displaced.
  Taxes and subsidies: Goods and services tax is levied on goods, which increases the
overall cost of production and so the supply of the commodity will increase only when
the price of the commodity rises. Conversely, government subsidies usually decrease
the cost of production and hence it is beneficial to the firm to increase the supply of
goods.
 Nature of competition: When there is a cut-throat competition between firms in the
market, the firm wants to increase their share to the maximum, for which they supply
more of the commodity. Further, when there is a new entry to the industry, it also
increases the supply of the existing goods in the market.
 Firm’s business objective: The primary objective of the firm, i.e. profit maximization or
sales maximization or the combination of the two, also influence the market supply of
the commodity. So, when the firm wants to increase the profit, it will decrease the
supply of the commodity, which can help the firm in increasing the price when there is a
high demand for it. In contrast, when the firm wants to increase its sales, it will simply
raise the supply.
Static Economics

In economics, the concept of static refers to a situation where there is a movement. But this
movement is continuous, certain, regular and constant. Static economics does not deal with the
unexpected changes. It studies only the expected economic activities. 

According to Prof. Stigler:  “The stationary state is an economy in which the tastes,
resources and technology do not change through time.” Static economic analysis is also known
as a timeless economy. The pricing of commodities is an important example of static economy.
Here we suppose that the price is determined by the forces of demand and supply which
belong to the same time period. Price, demand and supply refer to the same time period.

Importance of Static Economics:

Static economics occupy an important role in economics. According to Prof. Harrod, “Statics will
remain an important part of the whole economics.”

 It is the simple and easy method of economic analysis. It is easier to understand and
economical in thought.
 It is the basis of the principle of free trade. The principle of free trade which was favored
by classical economists like Adam Smith is an integral part of static economics.
 Robbins’ definition is also the subject matter of static economics. Robbins defined
economics as a science which studies human behavior as a relationship between ends
and scarce means which have alternative uses. This definition is a part of static
economics.
  Static economics gives knowledge of the conditions of equilibrium. It tells that price is
determined where demand for the supply of goods is equal. Similarly, income is in
equilibrium where planned investment and planned savings are equal.

Limitations of Static Economic Analysis:

Constancy of Variables:
Prof. Clark and Stigler have assumed many economic variables as constant. They are
population, quantity of capital, natural resources, techniques of production, habits and
fashions, etc. We know that these economic factors change in reality. So static economic
analysis is far from reality.

Unrealistic Assumptions:
Static analysis is based on unreal assumptions like perfect competition, perfect mobility, perfect
knowledge, full employment, etc. These assumptions are far from the real world. That is why
Prof. Hicks said, “Stationary state in the end is nothing but an evasion.”

It ignores Time Element:

Another shortcoming of the static analysis is that it studies a timeless economy. But in reality,
many changes occur with the passage of time. Therefore, it gives a narrow explanation of
economic problems.

It does not Explain the Path of Equilibrium:

Static analysis explains only the final state of equilibrium. And comparative statics compares
only the two final equilibrium states. It does not show how this new equilibrium has been
reached. Though comparative static economic analysis has many drawbacks, yet it occupies an
important role in economics.

Dynamic Economics:
The concept of dynamics is derived from Physics. It refers to a state where there is a change
such as movement.

According to Prof. Harrod, “Economic dynamics is the study of an economy in which rates of

output are changing.”

Dynamic economics is becoming more and more popular since 1925. Though the principles
advocated by Clark and Aftalian were dynamic in nature yet their main purpose was to explain
the business fluctuations. After 1925, dynamic economics became popular not only in business
fluctuations but also in the determination of income and growth models.
The following points explain the scope and importance of dynamic economics:
 Study of Time Element:
Time element occupies an important role in dynamic economics. Economic problems
concerning continuous change of economic variables and path of change can be studied
only in dynamic economics.

 Trade Cycles:
Theories of trade cycles have been advocated only through the introduction of dynamic
economics. Theories of trade cycles are based on dynamic economics as they refer to the
fluctuations of the different time periods.

 Basis of many Economic Theories:

Dynamic economics has an important place in economics because many economic theories are
based on it. For example, saving and investment theory, theory of interest, effect of time
element in price determination, etc. are based on dynamic economics.

 More Flexible Approach:

Dynamic analysis is more flexible. Models regarding the possibilities of economic change can be
development in dynamic analysis. That is why it has been found a useful mode of study.
Dynamic economics is also useful in solving the problems of economic planning, economic
growth and trade cycles.

 Realistic Approach:
Dynamic economic analysis is nearer to the reality. In a real world, economic variables like
national income, consumption, etc. change irregularly and uncertainly. Moreover, economic
variables of the previous period also affect the present economy. And time clement occupies an
important role in economic analysis.

Limitations of Dynamic Economics:

Dynamic economic analysis has its shortcomings too. It is difficult to understand.
Its main limitations are the following:

 Complex Approach:
Dynamic economic analysis is a complex approach for the study of economic variables because
it is based on time element. To find solutions of various problems, we have to make use of
mathematics and economics which is beyond the understanding of a common man.

 Not Fully Developed:

Many economists like Samuelson and Harrod, have developed dynamic approach of economic
analysis. They have developed their theories through dynamic analysis. But this mode of
economic analysis has not been fully developed. The reason is that factors affecting economic
variables change very soon. Dynamic approach is not developing at the speed at which
economic factors change.