BASIC ELEMENTS OF SUPPLY AND

DEMAND # 3
 THEORY OF DEMAND
 Theory of demand establishes relationship between
the quantity demanded of a commodity and its price.

 CONSUMER`S BEHAVIOUR
 Two theories
 1)Marshallian utility approach
 2)Hicksian indifference curve analysis
 MARGINAL UTILITY

 The change in the total utility resulting from a one-unit

change in the consumption of a commodity per unit of time.
 OR
 The addition made to the total utility by the consumption of
the last unit considered just worthwhile.

 Marginal utility (MU) = Change in the total utility

 ------------------------------------------
 Change in quantity consumed
 MARGINAL UTILITIES OF RELATED
GOODS
 Substitutes : They are capable of satisfying
same want, e.g., tea and coffee

 Complementary : They are such goods

which are wanted together for the
satisfaction of a want,e.g.paper, pen and ink
for writing.
DEMAND
LAW OF DEMAND

ELASTICITY OF
DEMAND
 MEANING OF DEMAND
 Power to purchase a product
and
Willingness to
purchase it
 LAW OF DEMAND

Price( per egg) Quantity demanded

80 2

70 3
60 4
50 5
40 6
 D

Price
80

70

60

50

40
D

2 3 4 5 6

Qd (Eggs)
 ASSUMPTIONS OF THE LAW
OF DEMAND
 1- INCOME REMAINS CONSTANT

 2- HABITS AND FASHION SHOULD NOT

CHANGE

 3- PRICE OF RELATED GOODS SHOULD REMAIN CONSTANT

 4- NO CHANGE IN FUTURE CIRCUMSTANCES

 5- WEATHER AND POPULATION SHOULD REMAIN

CONSTANT

 6- DISREGARDING NEW SUBSTITUTES

 LIMITATIONS
 1) VERY HIGH- PRICED PRODUCTS

 2) VERY LOW- PRICED PRODUCTS (INFERIOR

GOODS)

 3) IGNORENCE OF THE CONSUMER

 4) INCREASE IN THE MARGENAL UTILITY OF

THE CONSUMER
 FACTORS AFFECTING THE
DEMAND CURVE
 1) Average income
 2)Size of the market
 3)Prices and availability of related goods.
 4)Tastes and preferences.
 5)Special influences(umberallas)
 CHANGES IN DEMAND
 1) EXTENSION AND CONTRACTION OF
DEMAND

 2) RISE AND FALL OF DEMAND

 EXTENSION AND
CONTRACTION OF DEMAND

P Qd
P Qd

B 5 10
A 10 5

B 5 10 A 10 5
 D

P
R 10
I
C
E 5

0
5 10

Qd
 RISE OF DEMAND

P Qd
P Qd

A 10 5
A 10 5
OR

C 10 8 A 12 5
 Rise of Demand

D/

B
12
D

P A C
R 10
I
C D/
E D

0
5 8

Qd
 FALL OF DEMAND

P Qd
P Qd

A 10 5
A 10 5
OR

B 10 2 C 8 5
 Fall of Demand

D/

P A
R 10
I
C 5
D
E
D/

0
2 5

Qd
 CAUSES OF RISE AND FALL OF
DEMAND
 1) CHANGES IN INCOME
 2) CHANGES IN TASTE AND FASHION
 3) CHANGES IN WEATHER
 4) CHANGES IN POPULATION
 5) CHANGES IN THE QUANTITY OF MONEY
 6) CHANGES IN DISTRIBUTION OF INCOME
 7) RATE OF ECONOMIC GROWTH
 8) DISCOVERY OF A SUBSTITUTE
 9) CHANGES IN THE PRICE OF SUBSTITUTE
 10) CHANGE OF TASTE
 THE SUPPLY SCHEDULE
 The supply schedule relates the quantity supplied
of a good to its market price, other things constant.
input prices, prices of related goods, and
government policies)
 SUPPLY CURVE

 It shows the relationship between quantity supplied

and prices. There exists a positive relationship
between these two. (table, diagram)
 EQUILIBRIUM OF SUPPLY AND
DEMAND

 A market equilibrium comes at the price at which

quantity demanded equals quantity supplied. At
that equilibrium, there is no tendency for the price
to rise and fall .The equilibrium price is also called
the market –clearing price.
 EFFECT OF A SHIFT IN SUPPLY
AND DEMAND
 If Demand rises…. D curve shift right…Price
 Quantity

 If demand falls….D curve shift left….Price

 Quantity

 If supply rises….S curve shift right….Price

 Quantity
 If supply falls…. S curve shift left….Price
 Quantity