Chapter 3

Demand

The Law of Demand 

The law of demand holds that other things equal (Cetris Paribus), as the price of a good or service rises, its quantity demanded falls. The reverse is also true: as the price of a good or service falls, its quantity demanded increases.

Demand Curve & Demand Schedule
Demand Schedule

The demand curve has a negative slope, for general goods

Types of Demand 
        

Individual Demand Market Demand Joint Demand Composite Demand Autonomous Demand Regular Demand Irregular Demand Negative Demand Artificial Demand Unwholesome Demand

Elasticity ² the concept  

The responsiveness of one variable to changes in another When price rises, what happens to demand? Ans. Demand falls But!...How much does demand fall?  

If price rises by 10% - what happens to demand? We know demand will fall But« more than 10% or less than 10%? 

Thus Elasticity measures the extent to which demand will change

Types of Elasticity
3 basic types used: 
 

Price elasticity of demand Income elasticity of demand Cross elasticity

Price Elasticity 

Price Elasticity of Demand The responsiveness of demand to changes in price i.e. % Change in Quantity Demanded % Change in Price When % change in demand is greater than % change in price ² elastic demand When % change in demand is less than % change in price ² inelastic Demand When % change in demand is equal to % change in price ² Unit elastic demand

Business Application of Price Elasticity 
 

If demand is price elastic: Increasing price would reduce Total Revenue (% Qd > % P) Reducing price would increase Total Revenue (% Qd > % P)

Cont.. 
 

If demand is price inelastic: Increasing price would increase Total Revenue (% Qd < % P) Reducing price would reduce Total Revenue (% Qd < % P)

Income Elasticity 

Income Elasticity of Demand The responsiveness of demand to changes in income of the consumer i.e. % Change in Quantity Demanded % Change in Income When % change in demand is greater than % change in income ² elastic demand When % change in demand is less than % change in Income ² inelastic Demand When % change in demand is equal to % change in Income ² Unit elastic demand  

Normal Good ² demand rises as income rises and vice versa Inferior Good ² demand falls as income rises and vice versa A positive sign denotes a normal good A negative sign denotes an inferior good 



Cross Elasticity 

The responsiveness of demand of one good to changes in the price of a related good ² either substitute or a complement % Change in Q of A % Change in Price of B  

Goods which are complements: Cross Elasticity will have negative sign (inverse relationship between the two) Goods which are substitutes: Cross Elasticity will have a positive sign (positive relationship between the two)

Importance of Elasticity    

Relationship between changes in price and total revenue Importance in determining what goods to tax (tax revenue) Importance in analysing time lags in production Influences the behaviour of a firm

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