Unit 2 – Demand, Supply, Equilibrium and Elasticity

• The Basic Decision-Making Units

• The Circular Flow of Economic Activity - Demand and Supply
• Input Markets and Output Markets
• Needs, Wants and Demand
• Goods, Services, Products and Commodity
• Difference between Goods and Services
• Types of goods related to income

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 Unit 2 – Demand, Supply, Equilibrium and Elasticity
• Demand and Quantity Demanded
• Law of Demand
• Demand Function
• Demand Equation
• Demand Schedule
• Draw a Demand Curve
• Why does a demand curve slope downward to the right?
• Exceptions to the Law of Demand
• Determinants of Demand or Factors that shift the Demand Curve
• Movement along a Demand Curve and Shift in a Demand Curve
• Market Demand
• Deriving market demand from the individual demand curves

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 Unit 2 – Demand, Supply, Equilibrium and Elasticity
• Supply and Quantity Supplied
• The Law of Supply
• The Supply Function and Supply Equation
• The Supply Schedule and Supply Curve
• Draw a Supply Curve
• Determinants of Supply or Shift in a Supply Curve
• Movement along a Supply Curve and Shift of a Supply Curve
• The invisible hand
• Laissez-faire
• Equilibrium and Types of Equilibrium
• Determination of Equilibrium of demand and supply
• Excess Supply or Surplus and Excess Demand or Shortage

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 Unit 2 – Demand, Supply, Equilibrium and Elasticity

• Elasticity
• Price Elasticity of Demand
• Other Elasticities - Income elasticity of demand and Cross Price Elasticity
• The Price Elasticity of Demand and Its Determinants
• Price Elasticity and Total Revenue

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 Unit 2 - Introduction
• Goods and services usually referred to as ‘commodities’ are produced by firms
while household individuals are the consumers of the commodities. Firms are the
‘sellers’ while households are the ‘buyers’. Sellers and buyers exchanges goods
and services for money in a place called ‘market’. There are different types of
market, we have the physical market where sellers and buyers interact, we have
the market through intermediaries such as the banks and finance institutions and
we also have market over telephone, internet, and emails orders. Basically the
sellers (supply) and the buyers (demand) interaction in the market form the
‘market force’. Market force is the forces of demand and supply which determines
the quantity of goods and services as well as their prices. Price is defined as the
rate at which a commodity is exchanged for money or other units of exchange.
Price tends to rise when there is little supply of goods and services. We refer to
this situation as ‘scarcity’. When there is plentiful supply (by competing firms-
supply) then we have ‘excess’ of goods in the market. This usually brings the price
down. Therefore, “Price determination” is one of the core focuses of
microeconomics.

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 Unit 2 - Introduction
• Quantity of a commodity purchased by an individual or family or group of
people at different prices at a given time and place is known as the demand
for such commodity. With this definition, there is a link between the various
commodities and households’ purchase. Households in various places are
the consumer of firms’ commodity; they therefore behave in a predictable
habitual pattern such that increases in prices of commodity are responded to
by the consumer. Usually consumer tends to buy less when there is an
increase in the price of a commodity but buy more when there is a decrease
in the commodity price. It can be inferred that price and quantities are
inversely related. In other words, quantity demanded will decrease when
there is a rise in price and it increases when there is a fall in price. In
essence, price affects quantity demand for a commodity. It should be recall
that in the last unit, we understand that income of households also
determines what they consume. Whatever quantity they wish to demand for
is regulated by their limited resources to purchase. However, price and
income are not the only factor that can affect quantity demanded. One other
factor earlier mentioned is the preference of households. Therefore some
factors affecting demand for a commodity.
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 Unit 2 - Introduction
• Relationship between price and quantity demanded is referred to as
demand. The opposite of this is what is known as supply. The
relationship between the price and quantity of a good offered to the
market for sale is known as supply. In the last section, discussion on
quantity of commodity demanded and factors that can reduce or
increase quantity demanded by households are discussed. The effects
of price on the demand curve known as ‘movement on the demand
curve’ as well as the effects of other factors which are known as ‘the
shift on the demand curve’ were explored. Similarly under this unit, a
link between supply and price; supply curve and factors that can cause
a movement on the curve and or a shift on the curve shall be
discussed.

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 Unit 2 - Introduction
• Market operation obviously depends on interaction between demand
and supply. This interaction leads to price determination in a free
perfect competitive market. If the consumers are willing to buy more
that is there is increase in demand in the market, it should follows that
producers shall be willing to produce and supply more to the market.
In the short run, the price may rise as the demand increase before the
producers are able to increase supply. After increased supply to the
market and the market is flooded with the goods, price falls and
demand rises again as this will encourage buyers to buy more.
Consequently, price coordinates the quantity demanded and quantity
supplied.
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 Unit 2 - Introduction
• The law of demand states that the higher the price the lower the
quantity consumers will purchased. However, the response of the
quantity supply or demanded to changes in price is unknown.
Therefore, we tend to ask the question of how much will the quantities
demanded react to price? This question is answered by elasticity.
Elasticity is a concept that is used to quantify the response in one
variable when there is change in another variable. Knowing the size
and magnitude of this reaction is very imperative. Therefore we shall
be examining price elasticity of demand, simply put; elasticity is a
ratio of percentage change in demand and price.

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 Unit 2 - Introduction
• In the previous unit we discussed on demand and its different elasticities as
well as their determinants. In this unit we shall continue our discussion on
supply and market price. Recall that the law of demand states that the higher
the price the lower the quantity consumers will purchased while law of
supply states that the higher the price the higher the quantity the supplier
will be willing to supply to the market. However, the response of the
quantity supply or demanded to changes in price is unknown. Therefore, the
question of how much the quantity demanded will react to price or how
much the quantity supplied will react to price is answered by elasticity.
Recall again that we defined Elasticity has a concept that is use to quantify
the response in one variable when there is change in another variable.
Consequently knowing the size and magnitude of these reactions is very
imperative. Therefore we shall be examining elasticity of supply and other
important elasticity.

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 Objectives of Unit 2

• At the end of the unit you should be able to -

• Concepts of The Basic Decision-Making Units
• Design The Circular Flow of Economic Activity
• Analyze the Input Markets and Output Markets
• Define Needs, Wants and Demand
• What do you mean by Goods, Services, Products and Commodity
• Show the Difference between Goods and Services
• Explain different Types of goods and Services

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 Objectives of Unit 2
• Show the difference between Demand and Quantity Demanded
• Draw a Demand Curve form hypothetical demand schedule.
• Why does a demand curve slope downward to the right?
• Are there any Exceptions to the Law of Demand?
• Point out Determinants of Demand or Factors that shift the Demand Curve
• Relate the Movement along a Demand Curve and Shift in a Demand Curve
• Define Market Demand and Deriving market demand from the individual
demand curves
• Produce a Supply Curve from a Hypothetical Supply Schedule
• Illustrate the Determinants of Supply or Shift in a Supply Curve
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 Objectives of Unit 2
• Describe the Movement along a Supply Curve and Shift of a Supply Curve
• Define The invisible hand
• Define Laissez-faire
• Explain the Equilibrium and Types of Equilibrium
• Examine the Equilibrium of demand and supply
• Explain the Excess Supply or Surplus and Excess Demand or Shortage
• Define Elasticity and Price Elasticity of Demand
• Calculate Price Elasticity of Demand on a Linear Demand Curve
• Explain Income elasticity of demand and Cross Price Elasticity
• Discuss The Determinants of Price Elasticity of Demand
• Correlate the Price Elasticity of Demand and Total Revenue

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 The Basic Decision-Making Units
• A firm is an organization that transforms resources (inputs) into
products (outputs). Firms are the primary producing units in a
market economy.
• An entrepreneur is a person who organizes, manages, and
assumes the risks of a firm, taking a new idea or a new product
and turning it into a successful business.
• Households are the consuming units in an economy.

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The Circular Flow of Economic Activity - Demand and Supply

• The circular flow of

economic activity shows
the connections between
firms and households in
input and output markets.
• Payments flow in the
opposite direction as the
physical flow of resources,
goods, and
services(counterclockwise).

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 Input Markets and Output Markets
• Output, or product markets are the markets in which goods and services are
exchanged.
• Input markets are the markets in which resources—labor, capital, and land—
used to produce products, are exchanged. The inputs into the production process.
Land, labor and capital are the three key factors of production.
• Input markets include:
• The labor market, in which households supply work for wages to firms that
demand labor.
• The capital market, in which households supply their savings, for interest or for
claims to future profits, to firms that demand funds to buy capital goods.
• The land market, in which households supply land or other real property in
exchange for rent.

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 Needs, Wants and Demand
• Needs are the essential things to fulfill the states of deprivation for our survival.
Needs can be basically divided into Physical Needs, Social Needs, and Individual
Needs. In ancient times the three basic needs of the man are food, clothing and
shelter but with the passage of time, education and healthcare also became
integral, as they improve the quality of life.
• Physical needs include the basic human requirements such as air for breathing,
food, water, clothing, and shelter.
• Social needs are the requirement for belongings and affection from friends and
family.
• Individual needs can be varied depending on each person’s perception,
knowledge, and environment.

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 Needs, Wants and Demand
• Wants are the satisfiers of needs. Specific products have the ability of satisfy
specific wants. A want is a product desired by a customer that is not required for
us to survive. So, want is the complete opposite of need, which is essential for our
survival. In economics, wants are defined as something that a person would like
to possess, either immediately or at a later time. Simply put, wants are the desires
that cause business activities to produce such products and services that are
demanded by the economy. They are optional, i.e., an individual is going to
survive, even if not satisfied. Further, wants may vary from person to person and
time to time. We all know that human wants are unlimited while the means to
satisfy those wants are limited. Hence, all the wants of an individual cannot be met
and they must seek for alternatives. For example, you need to write, for this your
choice will be the best pen. For write is your needs but the best brand of pen is
your wants.

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 Needs, Wants and Demand
• Economists use the term demand to refer to the amount of some good or service
consumers are willing and able to purchase at each price. Demand is based on needs and
wants—a consumer may be able to differentiate between a need and a want, but from an
economist’s perspective, they are the same thing. Demand is also based on ability to pay.
If you can’t pay for it, you have no effective demand. Demands are wants for specific
products. They are backed by willingness and ability to buying power. Wants backed by
money and willingness to spend the money become demand.
• Demand = Want + Willingness to Purchase + Purchasing Ability
• For example, You need BMW car and you have the buying power, is your demand.
• As an example, many people would wish to buy a BMW car which is a want to satisfy the
need of transportation. But only few can afford to buy BMW cars and since the
purchasing power is not present it does not count as demand for BMW cars.

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 Goods, Services, Products and Commodity
• Goods: All tangible things which possess utility and which can satisfy human needs and
wants.
• Services: All activities and processes , which are intangible and performed to satisfy
human needs and wants.
• Products: Goods or services available in the market for sale.
• Commodity : A commodity is a product or resource that has identical or similar
properties and value as another item. This means commodities are interchangeable.
Commodities are often raw or generic materials that help manufacturers provide a service,
such as when a manufacturer uses iron to create different products. Other examples of
commodities include crude oil, gold and wheat.
• Commodity includes:
• Agricultural; such as cotton or wool;
• Metals; like gold, silver, or aluminum;
• Energy sources; namely oil, gas, and electricity.

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 Difference between Goods and Services
Goods
Goods are tangible
They can be seen and touched
Goods can be stored
There is a time gap between the production
and consumption
Production and distribution are separated
from consumption
Goods are things or material
Transfer of ownership is possible
Example, Table, books, pen, etc.
Services
Services are intangible
They can not be seen and touched. But they
can be felt.
Services can not be stored
There is no time gap.
Services are produced, distributed and
consumed simultaneously
Services are activities or processes
Ownership can not be transferred
Example, Teaching, health services,
hospitality, etc.
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 Types of goods related to income
• Inferior good:
• Goods for which demand decreases as consumer’s income rises.
• Has negative “income elasticity” .
• Normal good:
• Goods for which demand increases with rise in consumer ‘s income.
• Has positive “income elasticity”.
• Superior good:
• That tends make up a larger proportion of consumption with rise in income.
• Has elasticity , which is both positive and greater than 1.
• It might be a luxury good that is not purchased at all below a certain level of
income, e.g., a penthouse, a luxury car.
• Luxury good: Superior good.

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 Types of Goods - Related to Price
• Ordinary good:
• goods for which quantity demanded increases as the price falls and, quantity demanded
decreases as the price increases under ceteris paribus
• Giffen good:
• A special type of inferior goods for which demand increases with increase in
prices.
• Example, inferior staple foods
• Veblen good (or ostentatious goods):
• Veblen goods are goods for which increased prices will increase quantity demanded.
• Purchased as a symbol of status

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 Types of Goods - Related to Price
• Necessity good – something needed for basic human existence, e.g. food, water,
housing, electricity. Though this becomes a subjective term, is electricity a
necessity? Is broadband internet a necessity?
• Comfort good – a good which isn’t a necessity, but gives enjoyment/utility, e.g.
subscription to Netflix or take-away food. A comfort good may become a luxury.
• Complementary Goods. Goods which are used together, e.g. TV and DVD
player.
• Substitute goods. Goods which are alternatives, e.g. Pepsi and Coca-Cola.

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 Types of Goods - Related to Consumption Ability

• Rival good (or rivalrous good):

• Goods whose consumption by one consumer prevents simultaneous
consumption by other consumers.
• For example, cars, and clothing.
• Nonrival good:
• May be consumed by one consumer without preventing simultaneous
consumption by others,
• e.g. television and radio shows.

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 Types of Goods - Related to Consumption Ability

• Excludable good:
• whose consumption can be prevented. E.g. rental accommodations
• Non-excludable good:
• it is not possible to prevent an individual from enjoying the benefits of it. Examples:
Water flowing in a river,, fresh air.
• Public good:
• goods that are non-excludable as well as non-rival.
• It is not possible to exclude individuals from the consumption of such goods.
• Private good:
• goods that are both excludable and rival.
• Example: Car owned by an individual.

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 Economic goods and free goods
• Free goods
• Those goods that exist in plenty
• One can have as much of them as one can without any payment.
• e.g., air, sunshine, etc.
• Economic goods
• Those goods which are scarce and which can be obtained only after making payment for them.
• Most of the things a man needs to satisfy his wants fall in this group.
• Quasi-public good – goods which have some of the characteristics of non-rivalry and non-
excludability, but not 100%. For example, interest is mostly very cheap to access. Once
provided, you can access most website – though some websites may charge to view (e.g.
newspapers).
• Merit goods. Goods which people may underestimate benefits of. Also often has positive
externalities, e.g. education. See: Merit goods.
• Demerit goods. Goods where people may underestimate the costs of consuming it. Often has
negative externalities, e.g. smoking, drugs. See: Demerit goods.

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 Consumption goods and capital goods
• Consumption goods are those goods which yield satisfaction directly.
• They are used by the consumers to satisfy their wants directly, e.g., food, clothing, pen, ink,
etc.. They are also called goods of the first order.
• Capita goods are those goods which help us to produce other goods,
• For example, tools, machines, etc. They are also called Producers’ goods or Goods of Second
Order.
• They satisfy wants only indirectly, because they help in producing goods which in turn satisfy
our wants directly.
• Intermediate goods are goods which are in between the consumption goods and capital
goods.
• They are the raw materials used in the production of the final consumption goods.
• For example, milk as a raw material is used to prepare Paneer, butter, etc.

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 Consumption goods and capital goods
• Material goods. The example of material goods are land, buildings, cash, etc.
• Non-material goods : Various kinds services .
• They are not tangible but and can be transferred. For example, The goodwill of
a business.
• Transferable and non-transferable goods
• Most material can be transferred to other and thus their ownership can be
changed.
• e.g. land, building, etc.
• Non-transferable goods
• which are non-tangible and can not be transferred to other like skill,
intelligence, etc.

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 Consumption goods and capital goods
• Personal and Impersonal goods.
• Personal goods refer to the personal qualities of a person,
• e.g., his ability and skill. They are non-material and exist inside him. They are
also called internal goods.
• Impersonal goods
• Those goods that are not personal. They are external and lie outside a person.,
• e.g. land , building, etc. These are also called external goods.
• intangible - you can't touch, manufacture or store services
• perishable - they are performed in the moment and finished when they are over
• inconsistent - not able to be repeated exactly between services (changes in time,
location, resources, conditions, and so on)

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 Services
• There are three main types of services, based on their sector: business services, social
services and personal services.
• Business Services
• A business service is a service in which another business is the consumer. These services
allow a business to operate and best serve its customers.
• Examples of business services include:
• Banking; technology support
• human resources; transportation
• public relations; legal representation
• Manufacturing; marketing; Security; insurance

• Businesses pay for these services, which keep them in business. They are not receiving a
product that they can keep; as soon as they stop paying for the service, it stops.

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 Services
• Social Services
• Social services benefit society as a whole. They're paid for by taxes and nonprofit
organizations rather than direct transactions.
• Here are examples of social services:
• fire service; police
• Education; social work
• food subsidies; foster care; animal welfare
• You may notice that items like "education" appear in both goods and services. A
teacher standing in front of the class educating you is a service; the education you
receive as a result is a good.

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 Services
• Personal Services
• Most business-to-customer services are categorized under personal services. Customers
pay money to a business or individual and receive a service in exchange.
• Examples of personal services include:
• doctor's visits; haircuts; pedicures; legal advice
• Surgery; house cleaning; babysitting; therapy sessions
• food delivery
• Like in all services, personal services are intangible, perishable and inconsistent. For
example, you can pay a doctor to perform a medical procedure, but you are not buying the
doctor. When they are finished with the procedure, the transaction is complete.

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 Demand and Quantity Demanded
• Market prices are determined via demand and supply. If the demand for a product
is more than the supply, the prices seem to go up. If the supply of the product is
more than the demand, the prices go down. This simple economic principle is easy
to understand, but what is the definition of demand is something to ponder.
• Demand is a principle of economics that captures the consumer's desire to buy the
product or service and as the price the consumers are willing to pay and ability or
affordability to pay for that product or service. On the other hand, Demand
indicates how much of product consumers are desire to buy the product or
service the consumers are both willing and able to buy at each possible price
during a given period, other things remaining constant. If we keep all other factors
constant, the demand should go up as the prices go down, and the demand should
go down as the prices go up.

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 Demand and Quantity Demanded

• Three characteristics of demand - desire, ability, and willingness

• Economists use the term demand to refer to the amount of some good
or service consumers are willing and able to purchase at each price.
Demand is based on needs and wants—a consumer may be able to
differentiate between a need and a want, but from an economist’s
perspective, they are the same thing. Demand is also based on ability
to pay. If you can’t pay for it, you have no effective demand. What a
buyer pays for a unit of the specific good or service is called the price.
The total number of units purchased at that price is called the quantity
demanded.

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 Quantity Demanded
• Quantity demanded is an economic measurement of demand for
goods or services over a period of time. The quantity demanded
represents the amount (number of units) of a product that a
household would buy in a given period of time at current market price.
Or Quantity demanded represents exact quantity (how much) of a
good or service is demanded by consumers at a particular price.
Quantity demanded may differ even at the same price due to various
factors such as economic recession, change in the customer
preference, or the availability of a substitute product.

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 Law of Demand
• The law of demand states that, if all other factors remain equal, the higher the
price of a good, the less people will demand that good.
• In other words, the higher the price, the lower the quantity demanded. The amount
of a good that buyers purchase at a higher price is less because as the price of a
good goes up, so does the opportunity cost of buying that good. As a result, people
will naturally avoid buying a product that will force them to forgo the
consumption of something else they value more.

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 Law of Demand
Explain inverse relationship between in
quantity demanded and price of a
commodity

Higher the price, lower would be the

quantity demanded

Price and quantity demanded are

negatively related

This law is only qualitative statement not

quantitative statement

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 Law of Demand
• According to the law of demand other things being equal, if the price
of a commodity falls, the quantity demanded rise and if the price of
commodity rises, its quantity demanded falls.
Quantity
When price demanded
goes up inverse relationship goes up
between quantity
demanded and
price
Quantity
demanded When price
goes down goes Down

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 Demand Function
• Demand Function is a comprehensive formulation which specifies the factors that influence the
demand for the product.
• Demand function states the relationship between the demand for a product and its determinants.
• Individual Demand Function, 𝐷 = 𝑓 𝑃
Where D= Demand, P= Price, F= Function
Market demand, 𝐷𝑥 = 𝑓(𝑃𝑥 , 𝑃𝑦, 𝑀, 𝑇, 𝐴, 𝑈)
Where, Dx = Quantity demanded for Commodity x
𝑓 = Functional relation
𝑃𝑥 =Price of commodity x
𝑃𝑦 =Price of commodity y which are substitutes or complemantary
𝑀 = Money income of consumer.
𝑇 = Taste and preference of a consumer
𝐴 = advertisement effect
𝑈 = Unknown variable

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 Demand Equation
• The hypothetical demand equation is, Qd = a – b𝑃𝑋
Where,
Qd = Quantity demanded
a = Intercept
b = Slope
𝑃𝑋 = Price
• To draw a schedule we need a specific demand equation. The linear demand
equation is -
Qd = 500 – 10 Px

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 Demand Schedule
• The tabular statement of price-quantity relationship between
two variables is called demand schedule. If we put the different
values of price in the above equation then we get the different
values of quantity demanded, which we put a table this is called
the demand schedule.
Combinations Price Quantity of Demand Calculation
A 40 100 500-10X40
B 30 200 500-10X30
C 20 300 500-10X20
D 10 400 500-10X10
E 0 500 500-10X0

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 Draw a Demand Curve
• Horizontal axis measures quantity 50
demanded, vertical axis measures price.

Price
When the price 40 units then the quantity
demanded 100 units and so on. D
40
• The demand curve is a graphic statement
or presentation of quantities of a
commodity, which will be demanded by 30
the consumer at various possible prices at
a given period of time. Demand curve
does not tell us the price. It only tells us
how much quantity of goods would be 20
purchased by the consumer at various
possible prices.
• Along with the demand curve DD the 10
price and quantity demanded are
negatively related, so the demand curve is Quantity
D
downward sloping. 0
100 200 300 400 500 600 700

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 Why does a demand curve slope downward to the right ?
• The Seven major causes of downward sloping demand curve are as follows:
• 1. Law of Diminishing Marginal Utility
• The law of demand relies upon the law of diminishing marginal utility. According to the law of diminishing
marginal utility, as consumers buy more units of a commodity, the marginal utility of that commodity
continues to decline. Therefore, consumers will buy more units of commodities only when the price of that
product begins to fall. The utility will be high when fewer units are available and consumers will be prepared
to pay more for that commodity. This proved that there will be higher demand when the price falls and lower
demand when the price rises. This is why the demand curve is sloping downwards.
• 2. Price Effect
• Every commodity has certain consumers, when the price of the commodity falls, new consumers start
consuming it, as a result, demand increases. On the other hand, with the increase in the price of the
commodity, many consumers will either reduce or stop its consumption, and as a result, demand decreases.
Therefore, due to the price effect, the demand curve slopes downward when consumers consume more or less
of the commodity.

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 Why does a demand curve slope downward to the right ?
• 3. Income Effect
• When the price of a commodity decreases, the real income of the consumer increases because he has to spend
less in order to buy the same quantity of that good. On the contrary, When the price of a commodity increases,
the real income of the consumer decreases. This is termed as income effect. Under the influence of the income
effect, with a fall in price, the consumer will buy more units of that commodity and also spend a portion of
income in buying other commodities. For example, with the fall in the price of milk, he will buy more of it
but at the same time, he will increase the demand for other commodities. On the contrary, with an increase in
the price of the milk, he will reduce its demand. The income effect of change in the price of the commodity
being positive, the demand curve slopes downward.
• 4. Income Group
• There are different people in different income groups in every society but the majority of the people fall in the
low-income group. The downward sloping of the demand curve also relies on the income group of the people.
Ordinary people buy more when the price of the commodity falls whereas they buy less when the price rises.
The rich do not affect the demand curve as they are well capable of buying more commodities even at high
prices.

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 Why does a demand curve slope downward to the right ?
• 5. Different Uses of Certain Goods
• The different uses of certain goods and services are also accountable for negative sloping demand curves. With the
increase in the price of such goods, they will be used only for more important uses and accordingly the demand for
such goods will fall. On the other hand, with a fall in price, they will put to various other uses, and accordingly, their
demand will rise.
• 6. Substitution Effect
• The substitution effect is another reason for the downward sloping demand curve. With a fall in the price of the
commodity, and the price of its substitutes remaining the same, the consumer will buy more units of that commodity.
As a result, demand will increase. On the other hand, with a rise in the price of the commodity, and the price of its
substitutes remaining the same, the consumer will buy fewer units of that commodity. As a result, demand will
decrease. For example, as the price of tea declines, and the price of coffee being unaffected, the demand for tea will
rise, and conversely with an increase in the price of the tea in the market, its demand will fall.
• 7. Tendency to Satisfy Unsatisfied Wants.
• There is always a human tendency to satisfy unsatisfied wants. Each and every person has some unsatisfied wants.
When the price of goods, such as apples, falls, the consumer will buy more of that commodity as he wants to satisfy
his unsatisfied wants. As a consequence of this habit of humans, the demand curve slopes downward to the right.

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 Exceptions to the Law of Demand
• The law of demand holds true in most cases. The price keeps fluctuating until an
equilibrium is created. However, there are some exceptions to the law of demand. These
include the Giffen goods, Veblen goods, possible price changes, and essential goods. Let
us discuss these exceptions in detail.
• Giffen Goods
• Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are
goods that are inferior in comparison to luxury goods. However, the unique characteristic
of Giffen goods is that as its price increases, the demand also increases. And this feature is
what makes it an exception to the law of demand.
• The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a
staple in the Irish diet. During the potato famine, when the price of potatoes increased,
people spent less on luxury foods such as meat and bought more potatoes to stick to their
diet. So as the price of potatoes increased, so did the demand, which is a complete
reversal of the law of demand.

47
 Exceptions to the Law of Demand
• Veblen Goods
• The second exception to the law of demand is the concept of Veblen goods. Veblen
Goods is a concept that is named after the economist Thorstein Veblen, who
introduced the theory of “conspicuous consumption”. According to Veblen, there
are certain goods that become more valuable as their price increases. If a product
is expensive, then its value and utility are perceived to be more, and hence the
demand for that product increases.
• And this happens mostly with precious metals and stones such as gold and
diamonds and luxury cars such as Rolls-Royce. As the price of these goods
increases, their demand also increases because these products then become a status
symbol.

48
 Exceptions to the Law of Demand
• The expectation of Price Change
• In addition to Giffen and Veblen goods, another exception to the law of demand is
the expectation of price change. There are times when the price of a product
increases and market conditions are such that the product may get more expensive.
In such cases, consumers may buy more of these products before the price
increases any further. Consequently, when the price drops or may be expected to
drop further, consumers might postpone the purchase to avail the benefits of a
lower price.
• For instance, in recent times, the price of onions had increased to quite an extent.
Consumers started buying and storing more onions fearing further price rise,
which resulted in increased demand.
• There are also times when consumers may buy and store commodities due to a
fear of shortage. Therefore, even if the price of a product increases, its associated
demand may also increase as the product may be taken off the shelf or it might
cease to exist in the market.
49
 Exceptions to the Law of Demand
• Essential or necessary products and services:
• One more exception case for the law of demand is the essential or necessity goods
and products. Individuals will keep on purchasing necessities, for example,
medications or essential staples like salt, rice, and sugar, regardless of whether the
cost increases. The costs of these items don’t influence the quantity demanded.
• Change in income:
• There will be a change in the behavioural purchase of goods and services
according to the changes in personal income. Assuming that a family’s personal
disposable income increases, they might buy more items independent of the rise in
their cost, in this way increasing the quantity demanded of the item. Essentially,
they may defer purchasing an item regardless of whether its cost lessens, assuming
their personal disposable income has decreased. Henceforth, a change in an end
consumer’s income may likewise be an exemption for the law of demand.
50
 Exceptions to the Law of Demand
• Luxury goods:
• The consumption of luxury goods and services doesn’t cease even if the price of a
certain product or service increases. For example, gold, real estate, etc.
• Consumers negligence:
• At certain times, the consumers are unaware of the price changes that take place in
the market. At these times, the end consumers may end up paying more than the
maker price.
• Effect of demonstration:
• Middle-income consumers tend to imitate or copy the upper-middle-class
consumer behaviors and may tend to purchase the same products or services of the
upper-middle class.

51
 Exceptions to the Law of Demand

• Changes in taste, preferences, and fashionable products:

• Consumers’ changes in taste and preferences in fashionable products
don’t change the quantity demanded with an increase in price rise as
the consumers are willing to spend more on these products and
services.
• Trading in stock exchanges:
• The law of demand won’t hold good in the speculation market.
According to the law of demand, an increase in price will reduce the
demand, but in the case of speculation and trading, people will buy
more stocks even though there is an increase in the price of the stocks.
52
 Determinants of Demand
• Prices of Goods
• Income of Consumer
• Prices of Related Goods
• Population
• Tastes, Habit
• Expectation about future prices
• Climatic Factors
• Demonstration Effect
• Distribution of national income

53
 Determinants of Demand – Factors that shift the Demand Curve
• Change in Consumer Income
• When there is an increase in income, demand for most goods increases. If there is a
decrease in income, demand for most goods decreases.
• The exception to this rule is called inferior goods, because people buy less of them as
their income rises.
• Change in Consumer Tastes
• If consumers like a product more based on advertising or experience in using the good,
demand increases. If consumers like a good less over time, demand decreases.
• Change in the Price of a Substitute
• If the price of a substitute good increases, this will increase demand for the original good.
• For example, if the price of Coca Cola increases, the demand for Pepsi Cola might
increase.
• If the price of a substitute good decreases, this will result in a decrease in demand for the
original good.
• For example, if the price of Coca Cola decreases, the demand for Pepsi Cola will
decrease.

54
 Determinants of Demand – Factors that shift the Demand Curve
• Change in the Price of a Complementary Good
• If the price of a complementary good increases, this will decrease demand for the original
good.
• For example, if the price of camera film sharply rises, the demand for cameras will
decrease.
• If the price of a complementary good decreases, this will result in an increase in demand
for the original good.
• For example, if the price of CD players decreases, the demand for CD’s will increase.
• Change in Consumers’ Price Expectations
• Consumers’ expectations about the future price of a good influence demand. If consumers
expect the price to increase, they try to buy more now, before the price rises.
• Change in the Number of Consumers in the Market
• If there is an increase in the number of consumers in the market, this will result in an
increase in demand. If there is a decrease in the number of consumers, this will result in a
decrease of demand.

55
 Shifts in Demand
4.00
3.50
3.00
Demand price 2.50
A B
2.00
1.50
C D
1.00
E F
0.50
D1 D2
0.00
10 20 30 40 50 60 70 80
Quantity of pecans per day

56
 Movement along a demand curve
• Keeping all other things remaining the same, when there is a change in demand of a
commodity due to change in price, it is referred to as the change in quantity demanded. It
is shown as a movement along the demand curve when expressed graphically. There are
two forms of movement in a demand curve: extension or downward and contraction or
upward.
• Upward movement of a demand curve
• When the price of the commodity rises, the quantity demanded falls. It leads to the
upward movement of the demand curve. It is also known as contraction of demand.
• Downward movement of a demand curve
• When the price of the commodity falls, the quantity demanded rises. It leads to the
downward movement of the demand curve. It is also known as expansion of demand.

57
Movement along a demand curve –
Diagrammatically Analysis
• When price rises from OP to OP 2 demand falls
from OQ to OQ2. This is known as contraction of
demand.
• When price falls from OP to OP 1 demand rises
from OQ to OQ1. This is known as expansion of
demand.

58
 Movement along a Demand Curve and Shift in Demand a Curve

Basis for
Movement in Demand Curve Shift in Demand Curve
Comparison
The shift in the demand curve is when, the
Movement in the demand curve is when the
price of the commodity remains constant,
commodity experience change in both the
Meaning but there is a change in quantity demanded
quantity demanded and price, causing the
due to some other factors, causing the
curve to move in a specific direction.
curve to shift to a particular side.
What is it? Change along the curve. Change in the position of the curve.
Determinant Price Non-price
Indicates Change in Quantity Demanded Change in Demand
Demand Curve will move upward or Demand Curve will shift rightward or
Result
downward. leftward.

59
Movement along a Demand Curve and Shift in Demand a Curve

60
 Market Demand
• Demand for a good or service can be defined for an individual
household, or for a group of households that make up a market.
• Market demand may be defined as the sum of all the quantities of a
good or service demanded per period by all the households buying in
the market for that good or service.

61
Deriving market demand from the individual demand curves

P P P
$3.50 DA $3.50
DB $3.50 DC
$1.50 $1.50 $1.50
0 0
4 8 Qd 3 Qd 0
4 9 Qd
Price
Market Demand
$3.50

$1.50

0
8 20 Qd
62
 Supply and Quantity Supplied
• A firm’s decision about what quantity of product to supply depends
on:
• The price of the good or service
• The cost of producing the product which depends on:
• The price of required inputs (land, labor, capital)
• The technologies to be used to produce the product
• The prices of related products
• The amount of a particular product that a firm would be willing and
able to offer for sale at a particular price during a given time period.

63
 The Law of Supply

• The positive relationship between price and quantity of a good

supplied. An increase in market price will lead to an increase in
quantity supplied, and a decrease in market price will lead to a
decrease in quantity supplied, other things remaining the same.
• A supply schedule is a table, or chart, showing how much of a product
firms will supply at different prices.
• A supply curve is a graph illustrating how much of a product a firm
will supply at different prices.

64
 Supply Function and Supply Equation

Supply Function : Supply has a functional relationship with price.

So we can say,
Qs= f(p), Other things are remaining the same.
Supply Equation : A hypothetical supply equation is –
Qs= - c + dp
A numerical supply equation is -
Qs= - 5 + 2p

65
 The Supply Schedule
Supply schedule represents the relation between prices and
quantities that people are willing to produce and sell.

Suppose the following is the supply schedule of apples.

Combinations Price(per dozen) Tk. Quantity supplied (in dozen)
A 7 9
B 6 7
C 5 5
D 4 3
E 3 1

66
 Draw a supply curve
• It will be seen that when price is as high as Tk. 7 per dozen, as many
as 9 dozen apples are offered for sale. As the price falls, the amount
supplied decreases. When the price is as low as Tk. 3 only 1 dozen
apples are offered for sale. This means that as price falls quantity of
supply is contracted, and as price rises the quantity of supply is
extended. This is the law of supply.

67
 Draw a supply curve
• The supply schedule given above can be represented in the form of
supply curve. The following curve represent the supply curve of apple.
In this diagram, quantities supplied are measured along X axis, and
prices along Y axis, SS is the supply curve. When the price of apple is
7 Tk. per dozen, the producer wish to supply 9 dozens of apple per
week, which represent the point A. As the price falls to 6 Tk. per
dozen, the producer wish to supply 7 dozens of apple per week, which
represent the point B. Finally, when the price is 3 Tk. Per dozen, the
producer wish to supply 3 dozens of apple per week, which represent
the point E. We add through to the point A, B, C, D, and E, we get a
supply curve named SS´.

68
 Draw a supply curve

• The following curve represent

the supply curve.
• Conclusion : Along with the
supply curve SS, the price and
quantity supplied are positively
related, so the supply curve is
upward sloping.

69
 Determinants of Supply or Shift in a Supply Curve
• 1.Price of the Good/ Service
• 2. Price of Related Goods
• 3. Price of the Factors of Production
• 4. State of Technology
• 5. Government Policy
• 6. Number of sellers
• 7.Expectation for future prices
• 8. Natural conditions
• 9. Transportation conditions

70
Determinants of Supply or Shift in a Supply Curve

1. Price of the Good/ Service

The most obvious one of the determinants of supply is the
price of the product/service. With all other parameters being
equal, the supply of a product increases if its relative price is
higher. The reason is simple. A firm provides goods or services
to earn profits and if the prices rise, the profit rises too.
2. Price of Related Goods
Let’s say that the price of wheat rises. Hence, it becomes more
profitable for firms to supply wheat as compared to corn or
soya bean. Hence, the supply of wheat will rise, whereas the
supply of corn and soya bean will experience a fall.

71
Determinants of Supply or Shift in a Supply Curve
3. Price of the Factors of Production
Since most private companies’ goal is profit maximization. Higher
production cost will lower profit, thus hinder supply. Factors
affecting production cost are: input prices, wage rate, government
regulation and taxes, etc.
4. Technology:
Technological improvements help reduce production cost and
increase profit, thus stimulate higher supply
5. Government Policy
Commodity taxes like excise duty, import duties, GST, etc. have a
huge impact on the cost of production. These taxes can raise overall
costs.

72
 Determinants of Supply or Shift in a Supply Curve
Hence, the supply of goods that are impacted by these taxes
increases only when the price increases. On the other
hand, subsidies reduce the cost of production and usually lead to
an increase in supply.
6. Number of sellers:
More sellers in the market increase the market supply.

7. Expectation for future prices:

If producers expect future price to be higher, they will try to hold
on to their inventories and offer the products to the buyers in the
future, thus they can capture the higher price.

73
Determinants of Supply or Shift in a Supply Curve

• 8. Natural conditions
• The supply of certain products is directly influenced by climatic
conditions. For instance, the supply of agricultural products
increases when the monsoon comes well on time.
• 9. Transportation conditions
• Better transport facilities result in an increase in the supply of
goods. Transport is always a constraint to the supply of goods. This
is because goods are not available on time due to poor transport
facilities

74
 Determinants of Supply or Shift in a Supply Curve
The shift in supply curve is when, the price of the commodity
remains constant, but there is a change in quantity supply due to
some other factors, causing the curve to shift to a particular side.
A shift takes place in supply curve due to the increase or decrease
in supply, which is shown in Figure.

75
Determinants of Supply or Shift in a Supply Curve
In Figure, an increase in supply in indicated by the shift of the
supply curve from S1 to S2. Because of an increase in supply,
there is a shift at the given price OP, from A1 on supply curve S1
to A2 on supply curve S2. At this point, large quantities (i.e. Q2
instead of Q1) are offered at the given price OP.

76
 Movement along a Supply Curve
• Movement along Supply Curve is when the commodity experience
change in both the quantity supply and price, causing the curve to move
in a specific direction.
In Figure, quantity supplied at price OP1 is OQ1. When the price rises
to OP2, the quantity supplied also increases to OQ2, which is shown by
the upward movement from A1 to A2 (it is pointed by the direction of
the arrow between A1 to A2) This upward movement is known as the
expansion of supply.

77
Movement along a Supply Curve and Shift of
a Supply Curve

78
 The invisible hand
• Adam Smith – one of the first economists wrote about ‘The invisible
hand of the price mechanism’
• That scarce resources would be allocated most efficiently by people
pursuing their own self-interests
• Those who could afford to pay, would have and those who could not
would go without
• The market would reach an equilibrium point where the amount of a
good or service demanded at a given price would exactly equal the
amount supplied

79
 Laissez-faire
• The concept of laissez-faire in economics is a staple of free-market
capitalism. The theory suggests that an economy is strongest when the
government stays out of the economy entirely, letting market forces
behave naturally.
• In laissez-faire policy, the government’s role is to protect the rights of
the individual, rather than regulating business in any way. The term
‘laissez-faire’ translates to ‘leave alone’ when it comes to economic
intervention. This means no taxes, regulations, or tariffs. Instead, the
market should be completely free to be led by the natural laws of
supply and demand.

80
 Equilibrium and Types of Equilibrium
• The term ‘ equilibrium’ has often to be used in economic analysis. Equilibrium
means a state of balance between to forces. When forces acting in opposite
directions are exactly equal, the object on which they are acting is said to be in a
state of balance.
• Types of equilibrium :
• Stable equilibrium : There is stable equilibrium, when the object concerned, after
having been disturbed, tends to resume its original position. Thus, in the case of a
stable equilibrium, there is a tendency for the object to revert to the old position..
• Unstable equilibrium : The equilibrium is unstable when a slight disturbance
evokes further disturbance, so that the original position is never restored. In this
case, there is a tendency for the object to assume newer and newer positions once
there is departure from the original position.

81
 Equilibrium and Types of Equilibrium
Neutral equilibrium
It is neutral equilibrium when the disturbing forces neither bring it back
to the original position nor do they drive it further away from it. It rests
where it has been moved. Thus, in the case of a neutral equilibrium, the
object assumes once for all a new position. after the original position is
disturbed.

82
 Determination of Equilibrium of demand and supply

Equilibrium means the state of balance between two

forces. The market equilibrium means the state of
balance between demand and supply. The market
equilibrium comes at that price and quantity where the
forces of demand and supply are in balance. At the
equilibrium price, the amount that buyer want to buy
is just equal to the amount that sellers want to sell. The
reason we call this an equilibrium is that, when the
forces of demand and supply are in balance, there is
no reason for price to rise or fall, as long as other
things remain unchanged.

83
 Determination of Equilibrium : Numerical and Graphical

Numerical Analysis : The following table shows the numerical

analysis of equilibrium of demand and supply
Quantity demanded Quantity supplied
Price (per gallon)
(millions of gallons) (millions of gallons)
$1.00 800 500
$1.20 700 550
$1.40 600 600
$1.60 550 640
$1.80 500 680
$2.00 460 700
$2.20 420 720

84
 Determination of Equilibrium : Numerical and Graphical

• Graphical Analysis: Demand and Supply for Gasoline. The demand curve (D) and
the supply curve (S) intersect at the equilibrium point E, with a price of $1.40 and a
quantity of 600. The equilibrium is the only price where quantity demanded is equal
to quantity supplied. At a price above equilibrium like $1.80, quantity supplied
exceeds the quantity demanded, so there is excess supply. At a price below
equilibrium such as $1.20, quantity demanded exceeds quantity supplied, so there is
excess demand.
• In the figure, the equilibrium price is $1.40 per gallon of gasoline and the equilibrium
quantity is 600 million gallons. If a market is at its equilibrium price and quantity,
then it has no reason to move away from that point. However, if a market is not at
equilibrium, then economic pressures arise to move the market toward the equilibrium
price and the equilibrium quantity. At any above-equilibrium price, the quantity
supplied exceeds the quantity demanded. We call this an excess supply or a surplus.
85
Determination of Equilibrium : Numerical and Graphical

86
 Excess Supply or Surplus and Excess
Demand or Shortage
• With a surplus or excess supply, gasoline accumulates at gas
stations, in tanker trucks, in pipelines, and at oil refineries. This
accumulation puts pressure on gasoline sellers. If a surplus remains
unsold, those firms involved in making and selling gasoline are not
receiving enough cash to pay their workers and to cover their
expenses. In this situation, some producers and sellers will want to cut
prices, because it is better to sell at a lower price than not to sell at all.
So, if the price is above the equilibrium level, incentives built into the
structure of demand and supply will create pressures for the price to
fall toward the equilibrium.

87
 Excess Supply or Surplus and Excess
Demand or Shortage
When the price is below equilibrium, there is excess demand, or a
shortage—that is, at the given price the quantity demanded, which has
been stimulated by the lower price, now exceeds the quantity supplied,
which had been depressed by the lower price. In this situation, eager
gasoline buyers mob the gas stations, only to find many stations running
short of fuel. Oil companies and gas stations recognize that they have an
opportunity to make higher profits by selling what gasoline they have at
a higher price. As a result, the price rises toward the equilibrium level.

88
 Elasticity
• Basic idea:
Elasticity measures how much one variable responds to changes in
another variable.
• One type of elasticity measures how much demand for your
websites will fall if you raise your price.
• Definition:
Elasticity is a numerical measure of the responsiveness of Qd or Qs
to one of its determinants.

89
 Price Elasticity of Demand

Price elasticity Percentage change in Qd

of demand =
Percentage change in P

• Price elasticity of demand measures how much Qd responds to a

change in P.
• Loosely speaking, it measures the price-sensitivity of buyers’ demand.

90
 Price Elasticity of Demand
• Along a D curve, P and Q move in opposite directions, which would
make price elasticity negative. We will drop the minus sign and report
all price elasticities as positive numbers.
P
P2
P1
D

Q
Q2 Q1

91
 Price Elasticity of Demand
• Example
15%
• Price elasticity of demand equals = 1.5
10%
P rises P
by 10%

P2
P1
D
Q
Q falls
by 15% Q2 Q1

92
 Calculating Percentage Changes
Standard method
of computing the
Demand for percentage (%) change:
your websites
P end value – start value
x 100%
start value
B
$250
A Going from A to B,
$200 the % change in P equals
D
($250–$200)/$200 = 25%
Q
8 12

93
 Calculating Percentage Changes
Problem:
The standard method gives
Demand for different answers depending
your websites on where you start.
P
From A to B,
B P rises 25%, Q falls 33%,
$250
A elasticity = 33/25 = 1.33
$200
From B to A,
D
P falls 20%, Q rises 50%,
Q elasticity = 50/20 = 2.50
8 12

94
 Calculating Percentage Changes
• So, we instead use the midpoint method:

end value – start value

x 100%
midpoint
▪ The midpoint is the number halfway between
the start & end values, the average of those
values.
▪ It doesn’t matter which value you use as the
“start” and which as the “end” – you get the
same answer either way!

95
 Calculating Percentage Changes
• Using the midpoint method, the % change
in P equals

$250 – $200
x 100% = 22.2%
$225
▪ The % change in Q equals
12 – 8
x 100% = 40.0%
10
▪ The price elasticity of demand equals
40/22.2 = 1.8

96
 Five different classifications of Price
Elasticity of Demand
• The price elasticity of demand is closely related to the slope of the
demand curve.
• Rule of thumb:
The flatter the curve, the bigger the elasticity.
The steeper the curve, the smaller the elasticity.
• Five different classifications of D curves

97
“Perfectly inelastic demand” (one extreme case)
Price elasticity % change in Q 0%
=0
of demand = % change in P = 10%

D curve: P
D
vertical
P1
Consumers’
price sensitivity: P2
none
P falls Q
Elasticity: by 10% Q1
0 Q changes
by 0%
98
“Inelastic demand”
Price elasticity % change in Q < 10%
= = <1
of demand % change in P 10%

D curve: P
relatively steep
P1
Consumers’
price sensitivity: P2
relatively low D
P falls Q
Elasticity: by 10% Q1 Q2
<1
Q rises less
than 10%
99
“Unit elastic demand”
Price elasticity % change in Q 10%
= = =1
of demand % change in P 10%

D curve: P
intermediate slope
P1
Consumers’
price sensitivity: P2
intermediate D

P falls Q
Elasticity: by 10% Q1 Q2
1
Q rises by 10%

100
“Elastic demand”
Price elasticity % change in Q > 10%
= = >1
of demand % change in P 10%

D curve: P
relatively flat
P1
Consumers’
price sensitivity: P2 D
relatively high
P falls Q
Elasticity: by 10% Q1 Q2
>1
Q rises more
than 10%
101
“Perfectly elastic demand” (the other extreme)
Price elasticity % change in Q any %
= = = infinity
of demand % change in P 0%

D curve: P
horizontal
P2 = P1 D
Consumers’
price sensitivity:
extreme
P changes Q
Elasticity: by 0% Q1 Q2
infinity
Q changes
by any %
102
 Elasticity of a Linear Demand Curve

P The slope
200% of a linear
$30 E = = 5.0 demand
40%
curve is
67% constant,
20 E = = 1.0
67% but its
elasticity
40%
10 E = = 0.2 is not.
200%

$0 Q
0 20 40 60

103
 Other Elasticities - Income elasticity of demand
• Income elasticity of demand: measures the response of Qd to a change in
consumer income

Income elasticity Percent change in Qd

=
of demand Percent change in income

• Recall from Chapter 4: An increase in income causes an increase in

demand for a normal good.
• Hence, for normal goods, income elasticity > 0.
• For inferior goods, income elasticity < 0.
104
 Other Elasticities - Cross-price elasticity of demand

• Cross-price elasticity of demand:

measures the response of demand for one good to changes in the price of
another good

Cross-price elast. % change in Qd for good 1

=
of demand % change in price of good 2
• For substitutes, cross-price elasticity > 0
(e.g., an increase in price of beef causes an increase in demand for chicken)
• For complements, cross-price elasticity < 0
(e.g., an increase in price of computers causes decrease in demand for software)

105
 The Price Elasticity of Demand and Its
Determinants
• Availability of Close Substitutes
• Necessities versus Luxuries
• Definition of the Market
• Time Horizon
• Demand tends to be more elastic:
• the larger the number of close substitutes.
• if the good is a luxury.
• the more narrowly defined the market.
• the longer the time period.

106
 Price Elasticity and Total Revenue
• Continuing our scenario, if you raise your price
from $200 to $250, would your revenue rise or fall?
Revenue = P x Q
• A price increase has two effects on revenue:
• Higher P means more revenue on each unit you sell.
• But you sell fewer units (lower Q), due to Law of Demand.
• Which of these two effects is bigger? It depends on the
price elasticity of demand.

107
 Price Elasticity and Total Revenue
Price elasticity Percentage change in Q
=
of demand Percentage change in P

Revenue = P x Q
• If demand is elastic, then
price elast. of demand > 1
% change in Q > % change in P
• The fall in revenue from lower Q is greater
than the increase in revenue from higher P,
so revenue falls.

108
 Price Elasticity and Total Revenue
Elastic demand increased
(elasticity = 1.8) revenue due
P to higher P lost
If P = $200, revenue
due to
Q = 12 and lower Q
$250
revenue = $2400.
$200
If P = $250, D
Q = 8 and
revenue = $2000.
When D is elastic, Q
8 12
a price increase
causes revenue to fall.
109
 Price Elasticity and Total Revenue
Price elasticity Percentage change in Q
=
of demand Percentage change in P

Revenue = P x Q
• If demand is inelastic, then
price elast. of demand < 1
% change in Q < % change in P
• The fall in revenue from lower Q is smaller
than the increase in revenue from higher P,
so revenue rises.
• In our example, suppose that Q only falls to 10 (instead
of 8) when you raise your price to $250.

110
 Price Elasticity and Total Revenue
Now, demand is
increased
inelastic:
revenue due
elasticity = 0.82 P to higher P lost
If P = $200, revenue
Q = 12 and due to
$250 lower Q
revenue = $2400.
If P = $250, $200
Q = 10 and D
revenue = $2500.
When D is inelastic, Q
a price increase 10 12
causes revenue to rise.
111