L4 - ECO101 - Demand Theory

Chapter 3: Demand Theory
Dr. Saima Khan (SaKn)
ECO 101: Introduction to Microeconomics
Department of Economics, School of Business,

North South University
Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 1 / 31

Introduction
Markets - Demand vs Supply
Markets - Any place where buyers and sellers come together

(e.g. New Market, Bashundhara City, Facebook marketplace,
Daraz, Amazon)
Demand Side - Buying side of the market.
Supply Side - Selling side of the market.

Introduction
Defining Demand
Demand is defined as:

the willingness and ability to buy a good
at a given price
in a given period of time.

Introduction
Is this Demand?
Case 1: Demand for Indian Coffee Makers?

Anna goes to the market to buy a coffee maker. She has decided to set
aside BDT 3,000 for this item. She goes to the market and finds many
coffee maker models ranging in price between BDT 2,400 to BDT 2,900.
But all the models are made in India and she would rather buy a coffee
maker made in China. Would you say Anna has demand for a Indian coffee
makers?

Introduction
Is this Demand?
Case 2: Demand for NordVPN

Russ would like to download a NordVPN app in his phone. How-
ever the apps cost about USD 5 per month, and when converted
to Taka, that’s a lot of money. Would you say Russel has a de-
mand for NordVPN?

Introduction
Is this Demand?
Case 3: Flying Home

A friend tells you that she flies home to see her mother only
once a year. You ask why. She says, “Because the price of the
ticket to fly home is BDT 8, 000.” She then adds, “If the price
were, say, BDT 4, 500 instead of BDT 8, 000 I would fly home
twice a year instead of once.”

Introduction
Law of Demand
Law of Demand
Negative or Inverse Relationship between Price & Quantity
Demanded, ceteris paribus (all else remains unchanged).

Introduction
Law of Demand - Underlying Rationale
So why is the demand curve downward sloping? How can we justify

the law of demand? Why the negative relationship?
Income Effect
Substitution Effect

Law of Demand
Income Effect
Say Price of Nescafe Coffee increases; i.e. PNC ↑ from $2 to $4.
Say you have $10 to spend per day

I When PNC = $2, you could buy 5 units of good X.
I When PNC = $4, you can now buy 2.5 units of good X.
Since the same amount of cash, $10, now buys less of good X,
you FEEL POORER.
So now you are willing to buy less of good X; i.e. QNC ↓ .
Essentially, the price change affects your REAL INCOME (your

income’s purchasing power) - this is why we call it the Income
Effect.
Law of Demand
Substitution Effect
Say Price of Nescafe Coffee increases; PNC ↑ .
Now, other coffee brands (e.g. MacCoffee) look cheaper

compared to Nescafe;
I MacCoffee and Nescafe are substitute goods - one can be
replaced for the other and they serve the same purpose;
So you switch from the more expensive Nescafe to the cheaper
substitute = MacCoffee;
I Thus, you buy less Nescafe coffee; i.e. quantity demanded of
Nescafe falls - QNC ↓ .
Thus price change makes you switch to cheaper substitutes; this

is the SUBSTITUTION EFFECT.
Law of Demand
Another Explanation: Diminishing Marginal Utility

When you consume more and more in a given period of time,
I You get less utility from each additional unit.
If getting less satisfaction, willing to pay less for each additional
unit.
I Initially, for the first unit, willing to pay a lot.
I As consume more, for the nth unit, willing to pay much less.
So as consume more - QNC ↑ , willingness to pay decreases
WTPNC ↓ - so P has to decrease PNC ↓ to get the consumer
to buy more.
I Thus the negative relationship between Price & Quantity
Demanded.
Law of Demand
Individual versus Market Demand
Individual Demand
I price & quantity demanded relationship for ONE buyers.
I e.g, Rashed’s the demand for tehari from Tehari House.
Market Demand
I Price & quantity demanded relationship for ALL buyers.
I Obtained by adding quantity demanded at each price.

Market Demand
Deriving the Market Demand
How to get the market demand curve?

I Get this by adding up individual demand curves for Rashed,
Samira, Omar and all other buyers.
I Obtained by adding quantities demanded at each price for each
buyer.

Market Demand
Deriving Market Demand Curve (contd)
Let’s take a simple example - say there are only 2 people in the
economy.
How to get their Market Demand for Coffee?

Market Demand
Quantity Demanded vs Demand
Change is Quantity Demanded

I This is Movement ALONG the curve (see graph).
I Caused by a PRICE CHANGE.

Demand-Shift Factors
Change in Demand
Change in Demand
I The curve SHIFTS (see graph).
I Caused by non-price factors (e.g change in tastes, income
change etc).
I more/less is bought at EACH and EVERY price.

Change in Demand - Shift Factors
So, what are the non-price factors that shift the demand curve?
SHIFT factors include
I Income (normal versus inferior goods)
I Price of related goods (substitutes versus complements)
I Preferences/change in tastes and fashion
I Number of buyers
I Expectation of future prices

Shift Factor - Income (Normal Goods)
Normal Goods - as income increases, you buy more of this good.

I e.g. cake, shoes, clothes, holidays, schools, TV, phone, dining
out, cosmetics.

Shift Factor - Income (Normal Goods)

Let’s look at how change in income affects demand for a normal
good.
I As income increases, people go on more holidays to Bangkok;
I People buy more flight tickets at each and every price;
I Demand for Bangkok flights increases; demand curve shifts
outwards from D1 to D2 .

Shift Factor - Income (Inferior Goods)
Inferior Goods - as income increases, you buy less of this good.

I e.g. inferior quality rice, coffee from roadside store.

Shift Factor - Income (Inferior Goods)
Let’s examine how a change in income affects DEMAND for an

inferior good.
I As income increases, people move away from ”unsmart” phones;
I So, people buy less “un-smart” phones at each and every price;
I Demand for “un-smart” phones decreases; demand curve shift
inwards from D1 to D2 .
Shift Factor - Income (Neutral Goods)
Neutral Goods; as income increases/decreases, you continue to

buy the same amount of this good.
e.g. toothpaste; necessities (cotton/gauze/paracetamol);
mosquito bat.
How does the demand curve shift when income increases, for
neutral goods like toothpaste?

Prices of Related Goods (Substitutes & Complements)
Substitute goods - goods that can be replaced for each other;

they serve a similar purpose.
I examples: iced tea & freshly squeezed orange juice; chotpoti &
fuchka; shingara & samosa.
Complements - goods that have to be used together;
I examples: milk powder & sugar; cereal & milk; phone & phone
charger.

Prices of Related Goods: Substitutes
How does changing price of Netflix subscription affect demand

for Amazon Prime Video?
I Say Netflix ↑ the price of monthly subscriptions from $9 to $15;
I A lot of consumers now decide to switch away from Netflix to
Amazon Prime Video (whose price is still unchaged at $10);
I People now buy more Prime Video subscription at each & every
price;
I Demand for Prime Video increases; demand curve for prime
videos shifts outwards from D1 to D2 .
Prices of Related Goods: Complements
How does change in price of printers affect demand for printer

cartridges?
I Say there is a supply chain disruption ⇒ price of printers ↑.
I People now buy less printers & so they need less printer
cartridges paper ;
I Thus, people buy less A4 cartridges at each & every price;
I Demand for cartridges decreases; demand curve shifts inwards
from D1 to D2 .
Shift Factor - Change in Preferences
Change in preferences/ fashion trends (e.g. tiktok trends) often

affect demand for some goods
I e.g. organic food, vegan cakes, golden coffee (coffee with
turmeric), cruelty free cosmetics.

Shift Factor - Change in Preferences (contd)
Let’s say a lot of influencers start promoting protein shakes as a

quick and easy way to lose fat and gain muscles.
As the videos go viral, people buy more protein shakes at each &
every price;
Demand for protein shakes increases; thus demand curve for
protein shakes shifts outwards from D1 to D2 .
Shift Factor - Market Size (Number of Buyers)
Change in population size in an area can affect market demand

for a good.
I examples - change in migration, changing birthrate/death rate,
war, natural disasters.

Shift Factor - Market Size (contd)
Say a country opens its borders to migrant workers;

New migrants into the country buy more and more SIM cards at
each & every price;
Demand for local SIM cards increases; its demand curve shifts

Shift Factor - Expectation of Future Prices
Say, with Ramadan approaching, people expect date prices to ↑;

So, to avoid more expensive dates in Ramadan, people bring
forward their purchase of dates;
They buy more dates NOW at each & every price;
Demand for dates increases; thus demand curve for dates shifts
Practice Questions
Due to a bumper crop this year, consumer income increased.

Thus many people chose to switch from ”mota chaaler bhat” to
Basmati rice. Explain, with a labelled diagram, how the demand
for ”mota chaaler bhat” will be affected.
Recently the price of HP computers have gone down. How will
this affect the demand for Dell computers? Justify with a
labelled diagram.
The owner of Gemini Super Store stocks all kinds of snacks. He
sees that K&K has lowered the price of their tea bags and tea
leaves. Thus he decides to stock more biscuits in his store.
Explain why he took this decision with the aid of a labelled
diagram.

L4 - ECO101 - Demand Theory

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Chapter 3: Demand Theory

Dr. Saima Khan (SaKn)

ECO 101: Introduction to Microeconomics

Department of Economics, School of Business,

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 1 / 31

Markets - Demand vs Supply

Markets - Any place where buyers and sellers come together

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 2 / 31

Demand is defined as:

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 3 / 31

Case 1: Demand for Indian Coffee Makers?

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 4 / 31

Case 2: Demand for NordVPN

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 5 / 31

Case 3: Flying Home

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 6 / 31

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 7 / 31

Law of Demand - Underlying Rationale

So why is the demand curve downward sloping? How can we justify

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 8 / 31

Say Price of Nescafe Coffee increases; i.e. PNC ↑ from $2 to $4.

Say you have $10 to spend per day

So now you are willing to buy less of good X; i.e. QNC ↓ .

Essentially, the price change affects your REAL INCOME (your

Say Price of Nescafe Coffee increases; PNC ↑ .

Now, other coffee brands (e.g. MacCoffee) look cheaper

Nescafe falls - QNC ↓ .

Thus price change makes you switch to cheaper substitutes; this

Another Explanation: Diminishing Marginal Utility

So as consume more - QNC ↑ , willingness to pay decreases

WTPNC ↓ - so P has to decrease PNC ↓ to get the consumer

Individual versus Market Demand

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 12 / 31

Deriving the Market Demand

How to get the market demand curve?

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 13 / 31

Deriving Market Demand Curve (contd)

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 14 / 31

Quantity Demanded vs Demand

Change is Quantity Demanded

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 15 / 31

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 16 / 31

Change in Demand - Shift Factors

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 17 / 31

Shift Factor - Income (Normal Goods)

Normal Goods - as income increases, you buy more of this good.

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 18 / 31

Shift Factor - Income (Normal Goods)

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 19 / 31

Shift Factor - Income (Inferior Goods)

Inferior Goods - as income increases, you buy less of this good.

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 20 / 31

Shift Factor - Income (Inferior Goods)

Let’s examine how a change in income affects DEMAND for an

Shift Factor - Income (Neutral Goods)

Neutral Goods; as income increases/decreases, you continue to

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 22 / 31

Prices of Related Goods (Substitutes & Complements)

Substitute goods - goods that can be replaced for each other;

Dr. Saima Khan (NSU) ECO 101 - Introduction to Microeconomics 23 / 31

Prices of Related Goods: Substitutes

How does changing price of Netflix subscription affect demand