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2. Theory of Demand

INTRODUCTION
Demand and supply are two forces which help the market economy to function. In a competitive
market prices of goods and services are determined by the help of demand and supply. The prices
in turn influence demand and supply of goods and play an important role in allocation of
resources in a market economy.
It is necessary to know the meaning of demand before discussing the law of demand.
Generally people refer to the wants or desire for a thing is demand. But mere desire for a thing is
not demand in economics. In economics only the effective desires are called demand. Effective
desires refers three things. (a) the desire for the commodity (b) willingness to buy and (c) the
purchasing power to buy .The demand also connected with price over a given period of time.

The term demand is defined in different economist in different ways from time to time.
Some of the important definitions are given below

According to Hanson “By demand, we mean the quantity of a commodity that will be
purchased at a particular price and not merely the desire of a thing”.

According to Chapman “Demand is the quantity of expression of preferences”.

TYPES OF DEMAND
1. Price Demand : Price demand refers to the various quantizes of the commodity when the
consumer will buy per unit of time and at certain price. There is inverse relationship between
price and quantity demanded. D = f(p)
2. Income Demand : Income demand shows the relationship between the income of the
consumer and quantity demanded. There is a positive relationship between income and
quantity demanded. In case of normal goods there is positive relationship and incase of
inferior goods there is inverse relationship between income and quantity demanded.
3. Cross Demand : Cross demand refers to the relationship between quantity demanded of good
‘x’ and price of related good ‘y’ other things being constant. From cross demand we mean the
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change in the quantity demanded of a commodity without any change in its price but due to
the change in the prices of related goods.
4. Direct and Indirect Demand : The demand for consumer goods which satisfy the human
want directly is called direct demand. On the other hand the demand for …producer goods
which satisfy the human want indirectly is called indirect demand.
5. Joint Demand and Composite Demand : If the demand for one commodity leads to the
demand for other is called joint demand. For an example the demand for motor bike and
petrol are joint demand. On the other hand, demand is said to be composite when a thing is
demanded for the more purposes. The demand for electricity and coal is composite as they
are used for several purposes.
6. Alternate Demand : When the demand is fulfilled in alternate way is called alternate demand.
Let us consider the demand for light. It has an alternate demand.
7. Direct and Derived Demand : Certain goods which satisfy our wants directly are called to
have direct demand. The demand for consumer goods are called direct demand. On the other
hand the goods and services which fulfill our wants indirectly are called derived demand.
Demands for producer goods are called derived demand.
8. Competitive Demand : Demand for substitutes is known as competitive demand i.e. the
demand for one commodity reduces the demand for other commodity. For example the
demand for vegetable oil and that of butter oil are the competitive demand.

THE LAW OF DEMAND

THE LAW OF DEMAND
The law of demand expresses the functional relationship between price and quantity demanded.
According to the law of demand other things being equal, if a price of a commodity falls, the
quantity demanded of it will rise, and if price of the commodity rises., the quantity demanded will
fall. Thus according to the law of demand there is inverse relationship between price and quantity
demand other things remaining the same.

It can be expressed as
Dx = f(Px, Py, Y, T)
Px = Demand for x
Py = Price of Y
Y = Income of the consumer
T = Taste

Assumption : According to Stigler and Boulding, the law of demand is based on the following
assumptions.
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1. There should be no change in the income of the consumer.

2. There should be no change in the taste and preference of the consumer.
3. Price of related commodities should remain unchanged.
4. The commodity in question should be normal.
5. There should not be any changes in the size of the population.
6. There should be perfect competition in the market

Demand schedule and demand curve : The law of demand can be explained through a demand
schedule and a demand curve. A demand schedule is presented in table 1. Demand schedule can
be individual demand schedule or market demand schedule. Considering other things being equal
individual demand schedule refers to the commodities demanded by the consumer at various
price.

Demand schedule of an individual consumer

Price(Rs) Quantity Demanded (Unit)

10 5
8 8
6 12
4 15
2 20
From the above table it is seen that as price per unit say (x) goes on falling, the quantity demand
goes on increasing. When the price of good (x) is 10 quantity demanded is 5 units. As such when
price fall to Rs.8 the quantity demanded increases to 8 units.

We can convert this demand schedule in to a demand curve by graphically plotting the various
price-quantity combinations. and this has been done in fig.1. In fig.1, OX axis measures the
different quantities of goods (x )and OY axis price per unit of good x .
FIGURE1
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By joining the various combination points we get a curve DD, which is known as demand curve.
This is the demand curve is a graphic statement on presentation of qualities of a good demanded
by the consumer at various possible prices in a period of time.

Market Demand : The market demand is the sum of total of demand of all consumers in the
market for a commodity at various prices. So we can have market demand for a commodity by
adding up the quantities demanded of the commodity at various prices. Suppose there are three
consumers in the market A, B and C of commodity (x) whose demand schedule are given in the
table 2 :
PRICE QD by A QD by B QD by C Market Demand
10 0 5 10 15
8 5 10 15 30
6 10 20 25 55
4 15 25 30 70
5 20 30 35 85

QD = Quantity Demanded

By adding up the quantities demanded of the commodity by three consumers at various prices we
get the market demand schedule tab.2.

The market demand curve is the horizontal summation of all individuals demand for the
commodity. This can be shown in the diagram given below.
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The FIGURE 2(A), 2(B), 2(C) shows the individual demand curve, D 1D1, D2D2, D3D3 are the
demand curves for consumer A, B and C, the market demand curve DD. It is assumed that there
are three consumers in the market facing same price of the commodity but they purchase
according to their individual requirements.
A + B + C = Market Demand
Reasons for the law of demand. Why does demand curve slope down: So far as the law of
demand is concerned it states there is inverse relationship between price and quantity demanded.
Now the important question is why the demand curve slopes downward to right. In other words,
why the law of demand decrease by describing price demand relationship is valid. There are
several reasons responsible for the inverse price demand relationship which have been explained
as under.

Income effect: when price of a commodity falls money income remaining constant real income
increases. The consumer can buy more quantity of the commodity with his given income. If the
consumer chooses to buy the same amount of the commodity as before some money will be left
with him because he has to spend less on the commodity due to its lower price. This increase in
real income induces the consumer to buy more of that commodity. This is called income effect.

Substitution effect : Another important reason why the consumer consumes more when price fall
in substitution effect. When price of a commodity falls, it becomes relatively cheaper than its
substitutes . This indicates the consumer to substitute the commodity when price has fallen for
other commodities which have now becomes relatively dearer. For instance, tea and coffee are the
substitute goods. If the price of tea goes down, the consumer may substitute tea for coffee,
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although price of coffee remain same. Therefore, with fall in price the demand will increase due
to unfavorable substitution effect.

Law of diminishing marginal utility : The law of demand can be derived from the law of
diminishing marginal utility. The law of marginal utility states that as the consumer consumes
one goods after another the utility derived from each successive unit goods are decreasing. It
means as the price of the commodity falls, consumer purchases more of the commodity so that
marginal utility from the commodity falls to be equal to the reduced price and vice versa.

New Consumers : When a price of a commodity falls the consumer who were not consuming the
commodity before will start purchasing the commodity. As a result the total demand in the
market goes up.

Psychological Effects : When the price of the commodity falls, people favour to buy more which
is natural and psychological. Therefore the demand increases with the fall in prices.

Exceptions to the law of demand :

Law of demand is generally behaved to be valid in most of the situations. But there are some
situations when the law does not work.

Article of distinction : Veblen Effect: One exception to the law of demand is associated with the
name of the economist Veblen who prepared the …doctrine….of conspicuous consumption.
According to him “Articles of distinction command more demand when their prices are high.
Article of distinction include jewellery, diamonds, costly carpets etc. the rich people demand
more of such commodities when their prices are high”. If the prices of these commodities goes
down, they no longer remain the article of distinction and so have less demand.

Giftin goods : Robert Giftin pointed out another exception to the law of demand. He observed in
Britain when the prices of bread went up people purchased more bread and not less of it. The
reason given for this is that these British workers consumed a diet of mainly bread and when the
price of bread went up they were compel to spend more on given quantity of bread. Therefore
they could not afford to purchase as much meat as before. Thus they substituted even bread for
meat. Such goods are considered as Giften good and there is direct relationship between price
and quality demanded.
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War or Emergency : During the period of war if there is fear of shortage people may start
buying for holding and building stocks, even at high prices, they will buy less at low prices.

Ignorance: Sometimes people buy more of a commodity at a higher price out of their ignorance.
Therefore irrational consumer generally buy at higher price.

Purchase in anticipation : Sometimes people buy more at a higher price to earn more profit in
the future.

Determinant of Demand :
The law of demand states other things remains constant more is demand at lower price and less is
demanded at higher price. But when there is change in these other things, the whole demand
schedule or demand curve undergoes a change. The following are the factors which determine
demand for goods.

Taste and preference of the consumer : Taste and preference of the consumer is one of the
important determinant of demand. Taste and preference include fashion, habits, customs,
advertisements, climate and new invention etc. The price remaining constant if there is change in
taste and preference of the consumer there will be changes in demand.

Income of the consumer : The demand for goods also depends upon income of the people. The
greater the income of the people the greater will be their demand for goods. Generally there is
direct relationship between income of the consumer and his demand. The demand for normal
goods rises, with an increase in income and falls with a fall in income. But incase of an unfair
good when the income increases the demand for these goods becomes less. On the other hand
when the income falls the demand for inferior goods increases.

Changes in the prices of related goods : The demand for good is also affected by the prices of
other goods, especially those which are related to it as substitutes or components. When we draw
the demand curve or demand schedules we generally assumes the prices of related goods remain
constant. Therefore when the prices of related goods, substitute or complements change, the
whole demand curve. would change its position, it will shift upward or downward as the case
may be. When the rise in prices of a good causes increase in demand for another good the two
goods are called substitute goods. On the other hand, the goods which are complementary with
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each other, rise in price of any of them will lead to the decrease in the demand for other goods
and cause a leftward shift in its demand curve. The goods which are complementary with each
other, the change in the price of any of them would affect the demand of other.

The number of consumer in the market : The increase or decrease in consumer also influence
the demand of a product in the market. The greater number of consumer of a good, the greater the
market demand for it. Now the question arises an what factors the number of goods depends. If
the consumer substitutes one goods for another, then the number of consumers of that good which
has been substituted by the other will decline and for the good which has been used in its place,
the number of consumer will increase. Sometimes also the seller may succeed in finding out new
markets for his good and as a result the market for his good expands. Another important factor
which increase the consumers in the market is population grown. Increase in population leads to
an increase in demand for all types of goods.

Distribution of wealth : The amount demanded of a commodity is also influenced by the

distribution of wealth in the society. If there is an equal distribution of income in the society, the
demand will be higher and incase of inequality demand will be less.

Government Policy : Govt. policy is also responsible to influence the demand for the
commodity. The government imposes taxes on various commodities which lead to an increase in
the price of the commodities. As a result the demand goes down.

Change in demand and change in quantity demanded :

Change in demand is a multi valued function. The change in demand occurs when other non price
factors change, price remain same. In case of change in demand we have a separate demand
schedule which may shift the demand curve to the left or right. So we have to …move from one
demand curve to another demand curve. Change in demand can be increase in demand where
price remain constant but there is increase in demand. On the other hand decrease in demand is
said to occur when there exists less demand at same price and same demand at less price. This is
shown in the diagram below. In fig 3 when price was OP the quantity demanded was Oq
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Fig.3
But price has remained constant , quantity demanded has increased to . There is rightward
shift of the demand curve. In the second situation price is same op but there is reduction in
demand from oq to oq2. This situation may happen after other things did not remain same. On the
other hand change in quantity demanded in a single valued function depending only on price. It
occurs when price exchanges other non-price factors remain constant. We mark as the same
demand curve turn left to measured along a demand curve only. It should be remembered that
extension and extraction in the demand takes place as a result of change in the price alone when
other determinants of demand such as tastes, …income, propensity to consume and prices of the
related goods remain constant. It is shown in the diagram given below.

Fig 4
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It will be seen in fig.4 that when price of the good is op, the quantity demand is Oq. Now if, price
of the goods falls to , the quantity demanded increases from to , on the other hand if

price of the good rise from op to op2 the quantity demanded falls to

DEMAND FUNCTION

The general demand function

Qd = f(Px, I, Pr, T, A)
Px = Price of the commodity x
I = Income of the individual
Pr = Prices of related commodities
T = Taste and preference of the consumer
A = Advertising expenditure

But in many cases we assume other things remain constant, the demand is only a function of
price. So the demand function Qd = f(Px)

As we know there is inverse Relationship between price and quantity demanded, so when we
express their relationship in a curve we get a downward slopping demand curve. Thus the demand
curve is graphic representation of demand function with price as the only independent variable.
But the level of position of demand have depend on other factors which are hold constant. When
there is change in other determining factors the whole demand curve will shift.
But the demand function Qd = f(Px) is a general function, if we want to estimate demand
for a commodity we require a specific from of the demand function. It can be written as Qd = a –
b Px. It is a linear form
Where a is a constant intercept term on the X axis and b is the coefficient showing the slope of
the demand curve.
Numerical Example.
. Gurgling Springs, Inc. is a bottler of natural spring water distributed throughout the

New England states. Five-gallon containers of GSI spring water are regionally promoted

and distributed through grocery chains. Operating experience during the past year

suggests the following demand function for its spring water.

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Ans.

Q = 250 - 100P + 0.0001Pop + 0.003I + 0.003A

where Q is quantity in thousands of five-gallon containers, P is price (Rs), Pop is

population, I is disposable income per capita (Rs), and A is advertising expenditures (Rs).

P = $4, Pop = 4,000,000 persons, I = $50,000 and A = $400,000

Q = 250 – 100 (4) + 0.0001(4,000,000) + 0.003($50,000) + 0.003($400,000)

Q = 250 – 400 + 400 + 150 + 1200

Q = 1600
When price is Rs 4 the quantity demanded is 1600.

According to the law of demand other thing remaining constant more is demanded at

lower price and less is demanded at higher price. So price is the only determinant of

demand other factor remain constant.

So Q = f (P)

If price falls to Rs3

Q = 250 – 100 (3) + 0.0001(4,000,000) + 0.003($50,000) + 0.003($400,000)

Q = 250 – 300 + 400 + 150 + 1200

Q = 1700

If price rises up to Rs5

Q = 250 – 100 (5) + 0.0001(4,000,000) + 0.003($50,000) + 0.003($400,000)

Q = 250 – 500 + 400 + 150 + 1200

Q = 1500.

If we plot this on a diagram we will find the demand curve. In the diagram presented

below OX axis represents the quantity demanded and OY axis represents Price. When
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price is Rs3 the quantity demanded is 1700. When price is Rs5 the demand is 1500. If

price falls to Rs4 the demand again goes up to 1600.

Price Quantity demanded

3 1700

4 1600

5 1500

Calculate the quantity demanded at prices of Rs5, Rs4, and Rs3.

Q = 250 – 100 (5) + 0.0001(4,000,000) + 0.003($50,000) + 0.003($400,000)

Q = 250 – 500 + 400 + 150 + 1200

Q = 1500.

At a price 4

Q = 250 – 100 (4) + 0.0001(4,000,000) + 0.003($50,000) + 0.003($400,000)

Q = 250 – 400 + 400 + 150 + 1200

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Q = 1600

At price 3

Q = 250 – 100 (3) + 0.0001(4,000,000) + 0.003($50,000) + 0.003($400,000)

Q = 250 – 300 + 400 + 150 + 1200

Q = 1700

Calculate the prices necessary to sell 1,250, 1,500, and 1,750 thousands of five-

gallon containers.

Q = 250 – 100 p + 0.0001(4,000,000) + 0.003(Rs50,000) + 0.003(Rs400,000)

1250 = 250 – 100p+ 400 + 150 + 1200

100p = 250 + 400 + 150 + 1200 – 1250

100 P = 750

P = $ 7.5
So if Q = 1250. P = $7.5

If Q = 1500
Q = 250 – 100 p + 0.0001(4,000,000) + 0.003(Rs50,000) + 0.003(Rs400,000)

1500 = 250 – 100p+ 400 + 150 + 1200

100p = 250 + 400 + 150 + 1200 – 1500

100 P = 500

P=$5
If Q = 1750
Q = 250 – 100 p + 0.0001(4,000,000) + 0.003(Rs50,000) + 0.003(Rs400,000)

1750 = 250 – 100p+ 400 + 150 + 1200

100p = 250 + 400 + 150 + 1200 – 1750

100 P = 250

P = $ 2.5
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Glossary.
Quantity Demanded. Quantity demanded is the amount of a good, service, or resource that
people are willing and able to buy during a specified period at a specified price

Law Of demand. Other things remaining the same,

• If the price of the good rises, the quantity demanded of that good
decreases.
• If the price of the good falls, the quantity demanded of that good
increases.
Demand. Demand is the relationship between the quantity demanded and the price of a good

when all other influences on buying plans remain the same .

Demand Schedule. Demand schedule is a list of the quantities demanded at each different price
when all the other influences on buying plans remain the same

Demand Curve. Demand curve is a graph of the relationship between the quantity demanded of
a good and its price when all other influences on buying plans remain the same.
Market demand Curve. The market demand curve is the horizontal sum of the demand curves

.
of all buyers in the market
Change in demand. Change in demand is a change in the quantity that people plan to buy

when any influence other than the price of the good changes. A change in demand means that

there is a new demand schedule and a new demand curve .

Substitute good. A substitute is a good that can be consumed in place of another good
Demand Function. The functional relationship between quantity demanded and its determinates

1. OBJECTIVE QUESTION
(a) What do you mean by demand ?
(b) What is a demand schedule ?
(c) What is the shape of the demand curve ?
(d) What is the law of demand ?
(e) What is change in demand ?
(f) State the function affecting the demand ?
(g) What do you mean by substitute goods ?
(h) What is the different determinants of demand ?
(i) What is an individual demand schedule ?
(j) Give an exception to the law of demand ?

2. LONG TYPE QUESTION

(a) State and illustrate the law of demand giving its assumptions and limitations.
(b) Briefly explain the law of demand? Why does it slopes down ward?
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(c) Define demand? What are the different determinants of demand?