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Dr. GOPALAKRISHNA B.V. Faculty in MBA, SDM, Mangalore
In the ordinary parlance demand means desire or willingness for a commodity. But in Economics terminology demand backed up by enough money to pay for the goods demanded. Demand is the Desire or want backed up by money. Therefore, demand means desire backed by the willingness to buy a commodity and the purchasing power to pay. Harvey – demand in economics is the desire to posses something & the willingness & ability to pay a certain price in order to possess it”. Stonier & Hague – demand in economics means demand backed up by enough money to pay for the good demanded”. Benham – “demand for a thing at a given price is the amount of it which will be bought per unit of time at that price”.
1. Demand is a desire or want backed up by
money – desire + purchasing power 2. Demand is always related to price and time – it is an relative concept. Demand for a commodity should always have a reference to price and time. Example – demand for grapes by a household at a price of Rs 10/kgs or 20 kgs/ per week. 1. Demand may be viewed Ex-Ante or Ex-post Ex-ante means intended demand Ex-post – what is already purchased.
Demand has the following four characteristics
1. Price – demand is always related to price. It is
meaningless to say that the demand for refrigerator in the market is one thousand. The person must state the price at which the consumer is prepared to purchase the said quantity of the commodity. 2. Time – demand always means demand per unit of time, per day, per week, per month or per year. 3. Market – demand is always related to the market. Market here simply refers to the contact between buyers and sellers. There is no need for definite geographical area. 4. Amount – demand is always a specific quantity which a consumer is willing to purchase. It is not
Law of Demand
• The law of demand is one of the fundamental
laws of economics. • 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. • The law of demand – states, there is an inverse relationship between the price and quantity of demand. • The law holds under the condition (based on assumption) i.e., other things remain constant
Law of demand is based on certain assumptions
1. There is no changes in consumers’ taste and preferences. 2. Consumer’s Income remain constant 3. Price of other goods should not be change (prices of substitutes and complementary goods) 4. There should be no substitute for the commodity. 5. The commodity should not confer any distinction. 6. The demand for the commodity should be continuous. 7. No changes in weather condition
Law of Demand…….
• These factors remain constant only in
the Short Run – in the long run they tend to change. • The law of demand is based on the Law of Diminishing Marginal Utility . It can be illustrated through a demand schedule, a demand curve and a demand function.
• Demand Schedule is a table or statement
showing how much of a commodity is demanded in a particular market at different prices. • Alfred Marshall was the first economist developed the techniques of price theory – it is a list of price and quantities. • A Demand Schedule may be
– 1. Individual Demand Schedule – 2. Market Demand Schedule
Demand scheduled is a list of quantities of a commodity purchased by a consumer at different prices Demand Schedule
Individual Demand Schedule
Market Demand Schedule
Individual Demand – • refers to the demand for a commodity from the individual point of view – a family, household or person. • Individual demand is a single consuming entity’s demand D = f (P). Market Demand – • Refers to the total demand of all the buyers taken together. • Market demand is an aggregate of the quantities of product demanded by all the individual buyers at a give price.
• How much quantity the consumers in
general would buy at a given period of time. • Market demand is more important from the business point of view – sales depend on the market demand – business policy and planning are base on the market demand – price are determined on the basis of market demand. Dx = f (Px, Py, M, T, A, U)
Dx = f (Px, Py, M, T, A, U) Dx = Quantity demanded for commodity x f = functional relationship Px = Price of commodity x Py = Prices of related commodities M = The money income of the consumer T = the taste of the consumers A = the advertisement effect U = unknown variable
Individual Demand Schedule
Table. 1 Demand for Oranges by Individual A Price of Oranges (Rs) Quantity demanded of oranges (dozen)
Table 2. Market Demand Schedule for orange
Price of Oranges (Rs. Per dozen Quantity demanded of Oranges by consumers (dozens) Market Demand or Oranges (dozens)
A 1 3 7 11 13
B 0 1 2 4 6
C 3 6 9 12 14
D 0 4 7 10 12
10 9 8 7 6
4 14 25 37 45
Horizontal Summation: From Individual to Market Demand
Why does the demand curve slope downwards
• Demand curves slope downwards
from left to right. • This is because of the inverse relationship between the price and quantity demanded. • But the question is why do people demand more if prices come down ? • This is because of the following reasons -
A downward sloping demand curve
• A demand curve must look like
this, i.e., be negatively sloped.
price demand quantity demanded
Reasons for downward sloping
demand curve from left right
1. The operation of law of diminishing marginal utility. 2. Substitution effect. 3. Income effect 4. New consumers enter to market 5. Several uses/multiple uses 6. Psychological effects
1. The operation of law of diminishing marginal utility The law of demand is based on the law of diminishing marginal utility. If consumer’s uses more and more units of a commodity the utility derived from each and successive units goes on decreasing. It means as the price of the commodity falls consumer purchases more of the commodity and hence his marginal utility will diminishes. 2. Substitution effect Substitution effect also leads to the demand curve to slope downwards from left to right. As the price of a commodity falls, prices of its substitute goods remains the same and consumer will buy more of that commodities.
3. Income effect The fall in the price of a commodity is equivalent to an increase in the income of the consumer. After falling prices, - he has spend less money for purchasing the same amount of commodity as before. A part of this money can be used for purchasing some more units of that commodity. Similarly, if the price increases, the consumer’s income effect reduced and he has to curtail his expenditure on the commodity. 4. New consumers When the price of commodities falls new consumer can enter into market. For example computer sets, laptops, mobile, refrigerators, washing machines etc – falling prices even the poor people can also buying these goods.
5. Several uses Some commodities can be put to several uses which lead to downward slope of the demand curve. When the price of such commodities goes up they will be used for important purposes. When price falls, the commodities will be uses for various purpose – For example electricity/power 6. Psychological effects When the price of a commodity falls, people favour to buy more which is natural & psychological entity. Therefore, the demand increases with the fall in prices.
Exception to the Law of Demand
• Law of demand is only a general statement
telling that prices and quantities of a commodities are inversely related. • There are certain peculiar cases – law of demand will not hold good. • Certain cases with the increases in price quantity demand also increases and with the fall in price quantity demand also falls. • In such a case demand curves slopes upward from left to right. • Robert Giffen was the first person to expose this rare occasion, which is known as Giffen Paradox.
Prices of Commodities
Q1 Quantity of Demanded
Factors influences on exception to the law of demand
1. 2. 3. 4. 5. 6. 7. Prestige goods (Veblen effects). Giffen effects or Paradox. Speculative goods. Scarcity and Inflation. Ignorance of the people Demand for necessaries War or emergency
1. Prestige Goods
• Articles of prestige value Snob appeal or
articles of conspicous consumption – only by rich people – costlier price – diamond, gold etc. • Veblen in his doctrine of conspicuous consumption and hence this effect is called Veblen Effect. • When prices of such goods rise, their snob appeal increases and they are purchase in larger quantities. • On the other hand, as the price of Veblen goods falls, their capacity to perform the function of ostentation diminishes.
in the speculative market, particularly in stocks
2. Speculative goods
and shares, more will be demanded when the prices are rising and less will be demanded when the price declines. People tend to buy more shares, bond & debentures when their prices are rising in the hope that making profits in future and they can reduces buying prices are falling.
Robert Giffen is an Irish economist of 19th century
3. Giffen Effect or Giffen Paradox
– discovered Giffen Paradox. People were so poor that they spent a major part of their income on Potatoes and a small part on meat. When the price of potatoes rose, they had to economise on meat even to maintain the same consumption of potatoes.
4. Demand for Necessaries
The law of demand does not apply in the case of necessaries of life – food, clothing and shelter Irrespective of price changes, people have to consume the minimum quantities of necessary commodities.
5. Scarcity and Inflation
The law of demand cannot apply in the case of acute scarcity/shortage of commodities. People buying more out of panicky when prices are rising. Even at the time of hyper-inflationary situation people will try to purchase more commodities even there is higher prices of commodities.
6. Consumer’s ignorance Sometimes, people buy more of a commodities at a higher price out of sheer of ignorance. 7. War or emergency During the period of war, if there is fear of shortage, people may start buying for hoarding & building stocks even at higher prices. On the other hand, if there is depression, they will buy less at low prices.
Changes in Demand curve
Changes in demand curve takes place in two ways –
1. 2. Extension and Contraction demand Increase and decrease demand
1. Extension and contraction demand A movement along a demand curve takes place when there is a change in the quantity demanded due to change in the commodity’s own price and not due to any other factor. 2. Increase and decrease demand When demand changes due to changes in other factors such as tastes & preferences, income of consumers, prices of the related good (substitutes and complementary) etc – it is called as increase & decrease demand
1. Extension and contraction demand
A movement along a demand curve takes place when there is a change in the quantity demanded due to change in the commodity’s own price and not due to any other factor.
P P1 D O M2 M M1 Quantity Demanded
Contraction demand Expansion demand
When the price of the commodity is
OP, the quantity demanded is OM. If the price of the good falls from OP to OP1 quantity demanded increases from OM to OM1 is called as expansion demanded. While, on the other hand, when the price of good rises from OP to OP2 quantity demand decreases from OM to OM2, thus situation is called as contraction demand.
2. Increased and decreased demand When demand changes due to changes in other factors such as tastes & preferences, income of consumers, prices of the related good (substitutes and complementary) etc – it is called as increased & decreased demand. Due to changes in other factors, if the consumers buy more goods it is called increased demand. On the other hand, if the consumers buy less goods it is called decreased demand
Figure. 1 Y D D1 D1 A P B Y
D1 D O Q Increased Demand Q1 X O Q1 Q
Quantity of Demanded Decreased Demand
Figure 1 – original demand curve is DD,
the price is OP and quantity demanded is OQ. Due to change in the conditions of demand (income, taste & price of substitute & complementary) the quantity demand increases from OQ to OQ1 – this is called as increased demand. Figure. 2 - Where OP is the original price of OP and the OQ is the quantity demand. Due to fall in (other factors) quantity demand decreases to OQ1 – this situation is called as decreased demand.
Determinants of demand Demand may change not only because of a change in price but also due to other factors. These factors such as tastes & habits of the people, income of the consumers, weather conditions, size of population & substitution goods etc are leads to changes in demand ( non-price factors) either rightward or leftward directions.
Factors determines the demand for a commodities are –
1. Price of the commodity 2. Income of the consumers 3. Tastes & preferences of the consumers 4. Prices of related goods 5. Advertisement & sales propaganda 6. Consumers expectations 7. Changes in size of population 8. Changes in weather condition 9. Prosperity and depression 10.Distribution of income and wealth
1. Price of the Commodity • There is a close relationship between the quantity demanded and the price of the product. • Normally a larger quantity is demanded at a lower price and vice-versa. • There is inverse relationship between the price and quantity demanded. 2. Income of the Consumer • The ability to buy/purchasing power a commodity depends upon the income of the consumer. • When the income of the consumers increases, they buy more and when income falls they buy less.
3. Tastes and Preferences of the Consumers • The demand for a product depends upon tastes and preferences of
• • • • •
the consumers. Demand for several products like ice-cream, chocolates, beverages and so on depends on individual’s tastes. People with different tastes and habits have different preferences for different goods. A Strict Vegetarian – no demand for meat at any price. Non-Vegetarian – liking chicken even at high price. Smokers and Non-smokers.
• • • • • •
4. Prices of Related Goods Related goods are generally substitutes and complementary goods. The demand for a product is also influenced by the prices of substitutes and complements. Substitute commodities – examples – Tea and Coffee, Jower and Bajra, Pear and Beans, Ground nut and Til-oil. Demand for a commodity depends on the relative price of substitutes. Complementary goods – satisfy one wants – two or three goods are needed in combination – Joint Demand Example Car and Petrol, Pen and Ink, Tea, Sugar and Milk, Shoes and socks, Sarees and Blouse, Gun and Bullets etc
5.Advertisement and Sales Propaganda • In modern time, the preferences of consumers can be altered by advertisement and sales propaganda. • Advertisement helps in increasing demand by informing the potential consumers. • Advertisement are given in various means such as news papers, radio, television. 6. Consumer Expectations • Changes in future expectation are also influence to changes in demand. • If consumer expects as rise in prices he may buy large quantities of that commodity and vice versa. • Expectation of rising income – tend to increase his current consumption.
7. The Growth of Population • The growth of population is also another important fact that affects the market demand. • When population increases demand also increases irrespective of the price level. • Similarly, composition of population of population also brings about change in demand. • If the population consists – more of babies – then demand for baby food, toys, feeding bottles will increases.
8. Changes in weather condition Demand for a commodity may change due to a change in climatic conditions. For example, during summer demand for cool drinks, ice-creams cotton clothes, fan, cooler etc increases. While, during winter and rainy seasons demand for woolen clothes, rain-coats, umbrella increases. 9. Prosperity & depression Demand for goods increases during the period of prosperity and decreases during depression without any reference to price. 10. Distribution of income and wealth When income wealth is equally distributed the demand will increase more than it is unequally distributed.
The law of demand explains the direction of change in
Elasticity of Demand
demand due to change in the price. But it does not tell us the rate at which demand changes due to changes in price. Elasticity of demand explains the relationship between a change in price and consequent change in amount demanded. The concept of elasticity of demand was introduced by Marshall –“Elasticity of demand shows the extent of change in quantity demanded to a change in price”. In other words, “The elasticity of demand in a market is great or small according as the amount demanded increases much or little for a given fall in the price & diminishes much or little or a give rise in price.
Ed = Percentage Change in Quantity Demanded Percentage Change in Price = Change in Quantity Demanded Quantity Demanded Initially = Where
Change in Price Initial Price
∆Qd = Change in Quantity Demanded ∆P = Change in Price
Elasticity of Demand
Cross Elasticity of Demand
1. Price elasticity of demand Marshal was the first economist to define price elasticity of demand. Price elasticity of demand measures changes in quantity demanded to a change in price. It is the ratio of percentage change in quantity demanded to a percentage change in price.
Percentage change in quantity demand ____________________________________ Price Elasticity Percentage change in price
2. Income elasticity of demand Income elasticity of demand shows the change in quantity demanded as a result of change in income. Income elasticity of demand may be stated as ratio of change in the quantity demanded of a good due to changes in the income of the country.
Percentage change in quantity demanded
_________________________________ Percentage change in income
3. Cross Elasticity of Demand
A change in the price of one commodity leads to a
change in commodity. demand. Ec the quantity demanded This is called as cross of another elasticity of
Percentage change in quantity demanded of X
Percentage change in price of Y
∆ QX Py ∆ PY Qx
∆ Qx = Change in quantity demand for commodity X ∆ Py = Change in price of commodity Y Py = Price of commodity Y Qx = Quantity demand for commodity X
Kinds of price elasticity of demand
• Marshal was the first economist, developed concept of price elasticity of demand. of demand is not • Price elasticity may be more for certainsame for all the commodities. It goods and less for
some other goods. • The price elasticity of demand is classified into five kinds. 1. Perfect elastic demand 2. Perfect inelastic demand 3. Unit elasticity of demand 4. Relatively elastic demand 5. Relatively inelastic demand
1. Perfectly elastic demand
When a small change in price leads to an
infinitely large change in quantity demanded. For example a small rise in price will cause the quantity demanded of the commodity falling infinitely, while a small fall in price will cause substantial increases in price of commodity. ed = ∞
2. Perfectly inelasticity of demand In this case even a large change in price of commodity leads to no changeYin quantity demanded. Ed = 0 D
D O M Quantity of Demand X
3. Unit elasticity of demand
The change in demand is exactly equal to
the change in price. When both are equal the elasticity is said to be unitary. Ed = 1
P1 D O M M1 Quantity of Demand
4. Relatively more elastic demand
It refers to that situation where a proportionate
change in the quantity demanded is much greater than the proportionate change in price. In other words, it refers to that situation where a small proportionate fall in price of a commodities is followed by a large proportionate increase in its Y D quantity demanded and vice versa. Ed > 1.
P P1 D X Quantity Demand
5. Relatively less elastic demand
It refers to that situation where the proportionate
change in the quantity demanded is much less than the proportionate change in price. In other words, it refers to that situation where a great proportionate fall in price of a commodities followed by a small proportionate changes in quantity demanded. Y Ed < 1. D
P1 D O M M1 Quantity Demand X
Table - Types of Price Elasticity of Demand
Sl No. Types of PED Numerical Expression 1. 2. 3. 4. 5. Perfectly Elastic Perfectly Inelastic Unit Elastic Relatively Elastic Relatively Inelastic ∞ 0 1 >1 <1 Description Shape of Curves Infinite Zero One More than One Less than One Horizontal Vertical Rectangular Hyperbola Flat Steep
Types of Price Elasticity of Demand
D4 = ∞ D3 = > 1 D D4 D2 = 1 D1 = < 1 D5 = 0
D2 D5 D1
Measurement of elasticity of demand • For practical purposes, it is not enough to know whether the demand is elastic or inelastic. • It is more useful to find out the extent to which demand is elastic or inelastic. • Generally four methods are to measure elasticity of demand. 1. Percentage method 2. Total outlay method 3. Point method 4. Arc method
1. Percentage method This measured by dividing the percentage change in quantity demanded in response to percentage change in price. Percentage method are also called as ratio method.
Percentage method = % Change in Qty Demanded % Change in Price
It is also called as formula method or coefficient of price elasticity of demand. All the five types of price elasticity of demand can be illustrated.
D4 = ∞ D3 = > 1 D D4 D2 = 1 D1 = < 1 D5 = 0
D2 D5 D1
2. Total expenditure/outlay/revenue method This method was given by Alfred Marshall. Elasticity of demand can be measured on the basis of
change in total outlay/expenditure of a consumer due to change in the price of a commodity.
Total Revenue/total outlay = Price X (Quantity
purchase or sold). This can know only whether elasticity is equal to one, greater than one or less than one. (ep = 1) Unit elasticity
Relatively more elasticity (ep = > 1) Relatively less elasticity ( ep = < 1)
Ed = > 1
Ed = 1 P2 P4 Ed = < 1 O E3 E4 E2 X
• Total outlay is measured in X axis and
price is shown in Y axis. • When price falls from P1 to P2, total expenditure remains the same. Therefore, elasticity is equal to one. Ed = 1 • When price falls to P4 total expenditure decreases from E2 to E4, hence elasticity is less than one. Ed = < 1 • When price decreases from P3 to P1 total outlay increases from E3 to E2 – in this case, elasticity is greater than one. Ed = > 1 • This method which is also known as total revenue method simply classifies demand into three types. It does not help us to measure elasticity in numerical terms.
3. Point method • This method was also suggested by Alfred Marshall. • According to this method, a straight line demand curve joining the two axes and measure the elasticity between two points. • Point method refers to conditions where the changes in prices as well as changes in quantities demanded are very small. • In this method, consider do not large changes in price or quantities in the calculation of elasticity's of demanded. • Point-Elasticity Formula
Q 1 – Q0 Q0 P 1 – P0 P0
∆ Q/Q0 ∆ P/P0
ep = ∞ ep > 1
ep = 1
ep < 1
ep = 0 0 Quantity Demanded B
4. Arc Method • Arc elasticity of demand is the measurement of elasticity of demand when large changes in price or quantities are considered. • Point elasticity measures only minute changes, where as arc elasticity is used to calculate elasticity over a substantial range of price changes. Original Quantity – New Quantity • Original Quantity + New Quantity Arc elasticity = Original Price – New Quantity Original Price + New Quantity
• Arc-Elasticity Formula∆
– Q1 – Q0 Q1 + Q0
P1 – P0 P1 + P0
Draw a tangent AB on the demand curve at point R ep = Lower Segment Upper Segment S Slope of AB = OB/OA Ep = (OB/OA)* (RN/RM) As triangle AOB, AMR and NRB are similar (OB/OA)= (NB/RN) Ep = (NB/RN)*(RN/RM) = NB/RM Again NB/RM = RB/AR Ep = RB/AR
B N Quantity Demanded
Ep = Lower Segment Upper Segment
Factors determines elasticity of Demand
1. Nature of the commodities 2. Availability of substitutes 3. Variety of uses 4. Joint Demand 5. Deferred Consumption 6. Income groups 7. Proportion of income spent 8. Level of prices 9. Time factor
• • • • • •
1. Nature of the commodity The elasticity of demand for any commodities depends upon the nature of commodities – necessary, comfort or luxury. The demand for necessaries like – food, salt, cloths, maches etc – inelastic in nature. Luxuries commodities like – diamond, gold, silver more elastic in nature. 2. Availability of substitutes Commodities having substitutes have more elastic in nature. When the change in the price of one commodity, the demand for its substitute is immediately affected. If the commodity has no substitutes than elasticity is inelastic in nature.
3. Variety of uses
• The demand for a commodity having variety of
uses is more elastic in nature– coal, milk, steel and electricity etc. If there is a slight fall in the price of coal, its demand will increase & which can be uses for various purposes. • For example, electricity is a multiple use commodity – a fall in its price will result in a substantial increase in its demand – people may use it for cooking, iron, heater etc. • On the other hand, a rise in its price will result in restricting its consumption to the most essential uses. For example, people may use it for lighting purposes only.
4. Joint Demand • There are certain commodities which are jointly demanded – for example petrol & car, pen & ink, bread & jam etc. • The elasticity of demand of the second commodity depends upon the elasticity of demand of the major commodity. • It the demand for cars is less elastic, the demand for petrol will also be less elastic. • On the other hand, if the demand for bread is elastic, the demand for jam will also be elastic.
5. Postponement of the consumption
• When the demand for a commodity is postponable, its • • • •
demand is more elastic than that of the commodities which cannot be postponed.. The consumption of T.V. sets, VCR, DVDs, refrigerator, washing machine etc. can be postponed, if their price goes up. But the consumption of medicine, salt, food etc cannot be postponed even if its price rises. If the price of any of these articles rises, people will post-pone their consumption. As a result, their demand will decrease and vice-versa. 6. Habits of the people People who are habituated to the consumption of a particular commodity like tea, coffee, cigarette, wine of a particular brand – demand is generally inelastic. What ever the price of particular commodities, habitant use of it.
• • • • • •
7. Consumer’s income The elasticity of demand also depends upon the income. Persons who belong to the higher income group, their demand for commodities is less elastic. On the other hand, the demand of persons in lower income groups is generally elastic. A rise or fall in the price of commodities will reduce or increase the demand on their part. 8. Proportion of income spent If a consumer spends a very small part of his income on goods like newspapers, salt, matchbox etc, the demand for them will be inelastic. On the other hand, consumer spends a larger part of his income like, T.V sets, refrigerators, washing machine, the demand of them is elastic.
9. Level of prices • The level of prices also influences the elasticity of demand for commodities. • When the price level is high, the demand for commodities is elastic and when the price level is low, the demand is less elastic. 10. Time factors • Time factor plays an important role in influencing the elasticity of demand for commodities. • The shorter the time in which the consumer buys a commodities the lesser will be the elasticity of demand for that product. • On the other hand, the longer the time which the consumer takes in buying a commodities, the higher will be the elasticity for that product.
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