Topics

Law of Demand
The shape of demand curve
Difference between change in quantity demanded and change in
demand.
Shift of demand curve
Demand determination through Income Consumption Curve
Substitutes and Complements
Engel Curve: Normal good and Inferior good
Income and Substitution Effect for Normal Good
Income and Substitution Effect for Inferior Good
Shape of demand curve for giffen good
Market Demand Curve
 Law of Demand
Other things unchanged, as price rises,
the quantity demanded decreases, and as
price falls, the quantity demanded
increases; the relationship between price
and the quantity demanded is negative.
 Ceteris Paribus Assumption
Ceteris paribus is a Latin term that means
all other thing being equal.  For a demand
curve to be accurate the ceteris paribus
assumption must be in place.  So when
there is a change in price there is a
movement along the demand curve. This
is called a change in quantity demanded.
 The Law of Demand

Price Quant. A
P1

Price
B
P2

Q1 Q2
Quantity
DEMAND SCHEDULE DEMAND CURVE
Make a demand curve in your notes based
on the following demand schedule:
Demand for Cotton Shirts
Price Quantity
Tk 500 70,000
Tk 1000 60,000
Tk 1500 50,000
Tk 2000 40,000
Tk 2500 30,000
Tk 3000 20,000
The Reasons Behind the Law of
Demand
• The price a consumer pays for a good is,
in fact, the opportunity cost of having it
• The principle of diminishing marginal utility
• Income and substitution effects
• Movement along the demand curve is a result in a
consumer changing their behavior based on a change in
price.
• Increase in quantity demanded is demonstrated by
moving down the demand curve
• Decrease in quantity demanded is demonstrated
by moving up the demand curve
• Why can’t a change in demand from
other factors be demonstrated
by moving along the
demand curve?
 Individual Consumer’s Demand
QdX = f(PX, I, PY, T)
QdX = quantity demanded of commodity X
by an individual per time period
PX = price per unit of commodity X
I = consumer’s income
PY = price of related (substitute or
complementary) commodity

T= tastes of the consumer

 QdX = f(PX, I, PY, T)

QdX/PX < 0
QdX/I > 0 if a good is normal
QdX/I < 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements
 Linear Demand Function

QX = (a0 + a1N + a2I + a3PY + a4T) + a5Px

PX Intercept:
a0 + a1N + a2I + a3PY + a4T

Slope:
QX/PX = a1

QX
 Slope as a Rate of Change
If x and y are related by the equation y = mx + b, where m and b are constants
with m not equal to zero, then x and y are linearly related. If (x1, y1) and (x2,
y2) are two distinct points on this line, then the slope of the line is

y2  y1 y
m 
x2  x1 x
This ratio is called the rate of change of y with respect to x. Since the slope
of a line is unique, the rate of change of two linearly related variables is
constant. Some examples of familiar rates of change are miles per hour
and revolutions per minute.
 Changes in Demand versus
Changes in Quantity Demanded

• A change in price, ceteris paribus, results in a

change in quantity demanded; that is a
movement along the curve not a change in
demand.

• A change in demand (curve) results from

changes in factors other than price. Such
changes cause shifts of the demand curve.
 MOVEMENT ALONG A DEMAND CURVE
VERSUS SHIFT BETWEEN DEMAND CURVES
D1
An increase in income
D0
Price per Quart

D2
C
A decrease in income
$1.30

F
1.10

D1
D2 D0
Quantity Demanded in Billions of Quarts per year
C op yri ght  2000 by Harc ourt, Inc . Al l ri ght s rese rved.
 Changes in Demand
When any factor that influences buying plans other
than the price of the good changes, there is a change
in demand for that good.

Six main factors that change demand are:

1. The prices of related goods

2. Expected future prices
3. Income
4. Expected future income
5. Population
6. Preferences
 Shifting the Demand Curve
Income Consumer Expectations
Changes in consumers incomes
affect demand. A normal good is a Whether or not we expect a good to
good that consumers demand more increase or decrease in price in the
of when their incomes increase. An future greatly affects our demand for
inferior good is a good that that good today.
consumers demand less of when
their income increases.
Population Consumer Tastes and
Advertising
Changes in the size of the Advertising plays an important role in
population also affects the demand many trends and therefore
for most products. influences demand.
For increase in:

• preferences — D shifts rightward

• population — D shifts rightward
• expected future prices — D shifts rightward
• income (normal good) — D shifts rightward
• income (inferior good) — D shifts leftward
For increase in:

• price substitute — D shifts rightward

(A substitute is a good that can be used in place of
another good.)

• price complement — D shifts leftward

(A complement is a good that is used in conjunction
with another good.)
Demand determination through Income
Consumption Curve
Clothing
(units per
month) Assume:
•I = $20
10 •PC = $2
•PF = $2, $1, $.50

6 A
U1 D
5 Three separate
B
indifference curves
4 U3
are tangent to
each budget line.
U2

Food (units
per month)
4 12 20
 Effect of a Price Change
Clothing The price-consumption
(units per curve traces out the
month) utility maximizing
market basket for the
various prices for food.

6 A
Price-Consumption Curve
U1 D
5
B
4 U3

U2

Food (units
4 12 20 per month)
 Demand Curve
Price
of Food
Individual Demand relates
E the quantity of a good that
$2.00
a consumer will buy to the
price of that good.

G
$1.00
Demand Curve
$.50 H

Food (units
4 12 20 per month)
 Individual Demand
The
The Individual
Individual Demand
Demand Curve
Curve

• Two Important Properties of Demand

Curves

1) The level of utility that can be

attained changes as we move
along the curve.
 Individual Demand
The
The Individual
Individual Demand
Demand Curve
Curve

• Two Important Properties of Demand

Curves
2) At every point on the demand curve,
the consumer is maximizing utility by
satisfying the condition that the MRS of
food for clothing equals the ratio of the
prices of food and clothing.
 Effect of a Price Change
Price When the price falls: Pf/Pc & MRS also fall
of Food
E
$2.00

•E: Pf/Pc = 2/2 = 1 = MRS

•G: Pf/Pc = 1/2 = .5 = MRS
G •H:Pf/Pc = .5/2 = .25 = MRS
$1.00
Demand Curve
$.50 H

Food (units
4 12 20 per month)
 Effects of Income Changes
Clothing
Assume: Pf = $1
(units per
month) Pc = $2
I = $10, $20, $30

Income-Consumption
Curve
7 D An increase in income,
U3
with the prices fixed,
5 U2 causes consumers to alter
B their choice of
3 market basket.
A U1

Food (units
4 10 16 per month)
Effects of Income Changes
Price An increase in income,
of from $10 to $20 to $30,
food with the prices fixed,
shifts the consumer’s
demand curve to the right.

E G H
$1.00

D3
D2
D1

Food (units
4 10 16 per month)
 Individual Demand
• Income Changes
– The income-consumption curve traces out
the utility-maximizing combinations of food
and clothing associated with every income
level.
 Individual Demand
• Income Changes
– An increase in income shifts the budget line to
the right, increasing consumption along the
income-consumption curve.
– Simultaneously, the increase in income shifts
the demand curve to the right.
 Individual Demand
Normal
Normal Good
Good vs.
vs. Inferior
Inferior Good
Good
• Income Changes
– When the income-consumption curve has a
negative slope:
• The quantity demanded decreases with income.
• The income elasticity of demand is negative.
• The good is an inferior good.
 Individual Demand
• Engel Curves
– Engel curves relate the quantity of good
consumed to income.
– If the good is a normal good, the Engel curve
is upward sloping.
– If the good is an inferior good, the Engel curve
is downward sloping.
 Market Demand
From
From Individual
Individual to
to Market
Market Demand
Demand

• Market Demand Curves

– A curve that relates the quantity of a good that
all consumers in a market buy to the price of
that good.
 Summing to Obtain a
Market Demand Curve
Price
5 The market demand
curve is obtained by
summing the consumer’s
4 demand curves

3
Market Demand
2

1
DA DB DC

0 5 10 15 20 25 30 Quantity
 Market Demand
• Two Important Points

1) The market demand will shift to

the right as more consumers enter
the market.

2) Factors that influence the

demands of many consumers will
also affect the market demand.
Horizontal Summation: From
Individual to Market Demand