You are on page 1of 46

slide 1

slide 1
 The Law of Demand states that the demand
for a commodity increases when its price
decreases and falls when its price rises, other
things remaining constant.
 It states the nature of relationship between
the quantity demanded of a product and the
price of the product.

Demand Function = Qx = f(Px)


.
slide 2
A demand curve is a locus of point
showing various alternative price-
quantity combinations.
OR
The demand curve for any good shows
the quantity demanded at each price,
holding constant all other determinants
of demand.

slide 3
The DEPENDENT variable is the quantity
demanded.
The INDEPENDENT variable is the good’s own price.
Demand

1) Substitution Effect : When the


price of a commodity falls, prices of its
substitution remaining constant, then
the substitute become relatively
costlier i.e. the commodity whose price
has fallen becomes relatively costlier.
The increase in demand on account of
this factor is known as substitution
effect.

slide 5
2) Income Effect : When the price of a
commodity falls, other things remaining
the same, then the real income of the
consumer increases. The increase in
demand on account of an increase in
real income is known as the income
effect.

slide 6
(a) Expectations regarding further prices:
When consumer expect a continuous
increase in the price of durable
commodity ,they buy more of it despite the
increase in its price with a view to avoiding
the pinch of a much higher price in future.
(b) Status Goods: The law of does not apply
to the commodities which are used as a
status symbol for enhancing social prestige
or for displaying wealth and riches. For e.g.
gold.
(c) Giffen Goods: If the price of giffen goods
increases, (price of its substitute remaining
constant), its demand increases instead of
decreasing because ,in case of these
goods, income effect of price rise is greater
than the substitution effect.
slide 7
Shift in the Demand Curve

A change in any variable other than


price that influences quantity
demanded produces a shift in the
demand curve or a change in demand.

slide 8
Factors that shift the demand curve
include:

• Change in consumer income

• Consumer preferences

• Prices of related goods


Shift in the Demand Curve

This demand curve has shifted to the right.


Quantity demanded is now higher at any
given price. slide
10
 Demand is a function of own-price, income,
prices of other goods, and tastes.
 The demand curve shows demand as a
function of a good's own price, all else
constant.
 Changes in own-price show up as
movements along a demand curve.
 Changes in income, prices of substitutes and
complements, and tastes show up as shifts in
the demand curve.

slide
11
The degree of responsiveness of
demand to the change in its
determinants, is called elasticity of
demand.
It is the measurement of the
percentage change in one variable that
results from a 1% change in another
variable.
 Price elasticity

 Cross-elasticity

 Income elasticity
Price elasticity of demand is a measure of how
much the quantity demanded of a good responds
to a change in the price of that good.
Percentage Change in Quantity
Ep =
Percentage Change in Price

Change in Quantity
Quantity
Ep =
Change in Price
Price
P
a
25 b
30

Q
40 24

Ep = (24/40) ÷ (5/30) = 3.6


A price elasticity of 3.6 means that
for each one percent change in
price the quantity demanded will
change by 3.6 percent.
 Perfectly Inelastic
Quantity demandeddoes not respond to price
changes.
 Perfectly Elastic
Quantity demanded changes infinitely with any
change in price.
 Unit Elastic
Quantity demanded changes by the same percentage
as the price.
 Elasticity is less than 1
Quantity demanded changes less as
compared to the change in price.

 Elasticity is grater than 1


Quantity demanded changes more as
compared to the change in price.
Demand

slide
21
Demand

slide
22
Demand

slide
23
slide
24
 Arc elasticity
 Point Elasticity
The measure of elasticity of demand
between any two finite points on a
demand curve is known as arc
elasticity.

Q2 − Q1 P2 − P1
Ep = ÷
(Q1 + Q2 ) / 2 ( P1 + P2 ) / 2
Price
Μ

Α
20
Β
10

43 75 Quantit
y
 Point Elasticity on a linear demand
curve
 Point Elasticity on a non-linear demand
curve
 Point elasticity is the elasticity of demand at a
finite point on a demand curve, e.g., at a point A or
B on the linear demand curve in contrast to the arc
elasticity between points A and B.

 Ep = AN
AM

 Ep = Lower segment
Upper segment
Μ
Price

Ν
Quantity
Draw a tangent AB on the demand
Price curve at point R
D
ep = Lower Segment Slope of AB = OB/OA
Upper Segment
A
Ep = (OB/OA)* (RN/RM)

As triangle AOB, AMR and NRB are


similar (OB/OA)= (NB/RN)
R
M Ep = (NB/RN)*(RN/RM)
D = NB/RM

Again NB/RM = RB/AR


Ep = RB/AR
B
O Ep = Lower Segment
N Upper Segment
Quantity Demanded
1. Availability of Substitutes: The higher the
degree of closeness of the substitutes, the greater the elasticity of demand
for the commodity.
2 .Nature of Commodity: Luxury and necessities.
Demand for luxury goods is more elastic than the demand for necessities
3. Weightage in the Total
Consumption: If proportion of income spent on a commodity
is large, its demand will be more elastic.
4.Time Factor in adjustment of
Consumption Pattern: The longer the
time available, the greater the price-elasticity.

5. Range of Commodity Use: The wider


the range of the uses of a product, the higher
the elasticity of demand for the decrease in
price.
 Income elasticity of demand measures how much
the quantity demanded of a good responds to a
change in consumers’ income.

 Itis computed as the percentage change in the


quantity demanded divided by the percentage
change in income.
Income elasticity of demand =
Percentage change in quantity demanded
Percentage change in income
 Goods consumers regard as necessities
tend to be income inelastic
• Examples include food, fuel, clothing,
utilities, and medical services.
 Goods consumers regard as luxuries tend
to be income elastic.
• Examples include sports cars, furs, and
expensive food.
The cross-elasticity is the measure of
responsiveness of demand for a
commodity to the changes in the price
of its substitutes and complementary
goods.
 The formula for measuring cross-elasticity of
demand for tea (et,c ) and the same for coffee
(ec,t ) is given below:

et,c = Percentage change in demand


for tea (Qt)
Percentage change in price of coffee (Pc)
= Pc . ∆Qt
Qt ∆ Pc
ec,t = Pt . ∆Qc
Qc ∆Pt
Demand

A measure of utility, or satisfaction derived


from the consumption of goods and services,
that can be measured using an absolute
scale. Cardinal utility exists if the utility
derived from consumption is measurable in
the same way that other physical
characteristics--height and weight--are
measured using a scale that is comparable
between people.
slide
40
Demand

 A method of analyzing utility, or satisfaction


derived from the consumption of goods and
services, based on a relative ranking of the
goods and services consumed. With ordinal
utility, goods are only ranked only in terms of
more or less preferred, there is no attempt to
determine how much more one good is
preferred to another.

slide
41
Demand

A consumer may not be able to tell that an


ice-cream give 5 utils and chocolate gives 10
utils.But he or she can always tell whether
chocolate gives more utility or less utility than
ice-cream.

slide
42
Demand

1. Rationality: It is assumed that the consumer


is a rational being in the sense that he satisfies
his wants in the order of their preference. That
is, he or she buys that commodity which yields
the highest utility.
2. Limited money income: Consumer has a
limited income to spend on the goods.
Limitedness of income, along with utility
maximization objectives makes choice
between goods inevitable.

slide
43
3. Maximization of satisfaction: Every rational
consumer intends to maximize his/her satisfaction
from his/her given money income.

4.Utility is cardinally measurable: The


cardinalists have assumed that utility is cardinally
measurable and that utility of one unit of a
commodity equals the money which consumer is
prepared to pay it or 1 util=1 unit of money.

5.Diminishing marginal utility: Following law of


diminishing marginal utility, it is assumed that the
utility gained from the successive units of a
commodity consumed decreases as a consumer
larger quantity of a commodity.

slid
6.Constant marginal utility of money: The cardinal utility
approach assumes that the marginal utility of money
remains constant whatever the level of a consumer’s
income.
7.Utility is additive : Cardinalists assumed not only that
utility is cardinally measurable but also that utility derived
from various goods and services consumed by a consumer
can be added together to obtain the total utility.