LESSON – 2 THEORY OF DEMAND

Q. 1
What are the reasons for the downward slopping demand curve?

Negatively slopping demand curve or inverse relationship between price and quantity
demanded can be explained in terms of the following factors:

Law of Diminishing Marginal Utility:

The law of DMU states that as we consume more and more units of a commodity, the
utility derived from each successive unit goes on decreasing.
A consumer will maximise his satisfaction when,
marginal utility of the commodity = price of the commdity
So the consumer will buy more units of the commodity when price falls, because
marginal utility from additional units falls

Income effect:

The income effect shows the change in the purchase of a commodity due to a change in
the real income of the consumer resulting from change in price of the commodity.
A fall in price will result in increase in the purchasing power (real income) of the
consumer. As a result he can purchase more of the given commodity with the same
money income or he can buy the same amount of the commodity and at the same time
he will be able to save money.

Substitution Effect:

The substitution effect refers to the effect that a change in relative price of substitute
goods has on the quantity demanded of a commodity. If there is a fall in the relative
price of X in terms of Y, commodity X becomes relatively cheaper and the consumer
will increase his demand for X and vice-versa.

Increase in number of consumers:

When price of a commodity falls, many new consumers who were not able to buy it
earlier, can purchase it now. It also leads to increase in quantity demanded by the
existing consumers due to income and substitution effects.

1
Several uses of a commodity:

Some commodities like milk, electricity, steel etc. have several uses. Some of them are
more important while others are less important. When price of such goods increase, they
can be used to the most important purpose and therefore a small quantity will be
demanded. But when price falls, the commodity can be put to less important uses also
leading to an increase in demand.

Q. 2
Explain the exceptions to the law of demand.

The law of demand may not operate in certain special circumstances. A rise in price
may increase the demand and a fall in price may decrease the demand. In these cases the
demand curve will slope upward, showing a positive relationship.

An exceptional Demand Curve

Giffen Goods:

Named after Sir Robert Giffen. He has observed that when price of a very inferior good
rises, the real income of the consumers falls. The poor people are forced to cut down
their purchases on other superior commodities and demand more of this commodity.
The consumer spends a large part of his income on these commodities. For example
maize and jawar, etc.
On the other hand if price of these goods decrease, he will be able to spend more on
superior goods and reduce consumption of inferior goods.
Here, income effect is more powerful than substitution effect.

2
Articles of snob appeal:

Veblen has termed some goods as goods of ‘conspicuous consumption’. Some people
may consume a very expensive commodity as status symbol or as a source of display of
richness. In this case its price and demand may move in the same direction. For
example, diamond ornaments or expensive cars etc.

Expectations regarding future price:

If price of a commodity is rising today and is expected to rise more in future, people
will buy more today even at the existing higher price. They will do this to avoid the
pinch of higher price in future.
Similarly, if they expect a fall in price in future, they will postpone their purchase even
at a lower price at present.

Emergencies:

During emergencies like war, natural calamities etc, people buy and hoard goods even at
higher prices in fear of shortage and insecurity in future.

Quality – price relationship:

Veblen has indicated the fact that some consumers assume that high priced goods are of
higher quality. In such cases more of the goods are demanded at higher prices. For
example, some people like ‘Lux Supreme’ having a higher price than ordinary ‘Lux”
having a lower price even though the two brands are almost of same quality.

Change in fashion:

If a commodity is in fashion, consumers will buy it even when price is rising. And if a
commodity goes out of fashion, consumers will not purchase it even at a lower price.

Q. 3
What do you mean by change in quantity demanded?

When the quantity demanded of a commodity changes (rise or fall) due to a change in
its own price, keeping other determinants (price of related goods, income of the
consumer, taste and preference pattern, speculation of future price etc.) constantn it is
known as change in quantity demanded.

3
There are two types of change in quantity demanded:

Extension of demand:
It means more quantity is demanded with the fall in price, other factors remaining
constant.

Contraction of demand:
It means less quantity is demanded with the rise in price, other factors remaining
constant.

A1 to A2: Extension of demand

A1 to A3: Contraction of demand

Q. 4:
What do you mean by change in demand?

When the quantity purchased changes (rise or fall) due to a change in factors (price of
related goods, income of the consumer, taste and preference pattern, speculation of
future price etc.) keeping the price of the commodity constant, it is known as change in
demand.
There are two types of change in demand:

Increase in demand:
It refers to a situation when the consumers buy larger quantity of a commodity at the
same price level due to change in other factors like:
 Increase in price of substitute goods.
 Fall in the price of complementary goods.
 Increase in consumer’s income.
 Favourable changes in consumer’s taste and preferences.
 Speculation of rise in price in near future.
 Favourable govt policy of tax and subsidy.
 Equitable income distribution.
4
Decrease in demand:

It refers to a situation when the consumers buy lesser quantity of a commodity at the
same price level due to change in other factors like:
(Opposite to the above points.)

A1 to A2: Increase in demand

A1 to A3: Decrease in demand

Q. 5
Differentiate between movement and shift in demand curve.

Movement / change in quantity demanded Shift / change in demand

 It indicates a change in quantity  It indicates a change in the whole

demanded due to a change in its own
price, keeping other determinants
constant.
 It shows an upward or downward
movement from one point to another
along a particular DD curve.
 It leads to extension / expansion or
contraction of demand.
demand schedule due to a change in
other determinants, at the same price
level. Like - price of related goods,
income of the consumer, taste and
preference pattern, speculation of future
price etc.
 It shows a rightward or leftward shift of
the whole DD curve.
 It leads to increase or decrease in
demand.

5
 A1 to A2: Extension of demand
A1 to A2: Increase in demand
A1 to A3: Contraction of demand
A1 to A3: Decrease in demand

Q. 6:
Distinguish between extension of demand and increase in demand.

Extension / Expansion of demand Increase in demand

i) It means more quantity is demanded i) It means more quantity is demanded due to
with fall in price of the commodity, favourable change in other factors at the
keeping other factors constant. same price:
 Increase in consumer’s income.
 Increase in price of substitute goods.
 Fall in the price of complementary goods.
 Favourable changes in consumer’s taste and
preferences.
 Speculation of rise in price in near future.
 Favourable govt policy of tax and subsidy.
 Equitable income distribution.

ii) It shows a downward movement on ii) It shows a rightward shift of the DD curve.
the same DD curve.
iii) Numerical representation. iii) Numerical representation.

P (₹) Q (Kg) P (₹) Q (Kg)

20 100 20 100
15 150 20 150

6
iv) iv)

Q. 7:
Differentiate between contraction of demand and decrease in demand.
Opposite to the previous answer

Q. 8:
Explain the reasons for decrease in demand / leftward shift in demand curve.

 Fall in income of the consumers

 Fall in price of substitute goods
 Rise in price of complementary goods
 Unfavourable change in taste and preference
 Speculation of fall in price in near future
 Unfavourable govt policy of tax and subsidy
 Decrease in population (for mkt demand)
 Unequal distribution of income (for mkt demand)
DIAGRAM

Q. 9:
Explain the reasons for increase in demand / rightward shift in demand curve.
Opposite to the previous answer
----------------------------------------------------------------------------------------------------------