Lecture # 4

Theory of Demand
 TOPICS

 Definition of Demand

 Law of Demand

 Determinants of demand

 Extension and Contraction in Demand

 What is Demand
 Demand in common language means the desire for an object
 the word ‘demand’ can be used in a variety of senses, which often
causes misunderstanding and errors of analysis.
 The demand becomes effective only it if is backed by the
purchasing power in addition to this there must be willingness to
buy a commodity
 So Demand is a desire backed by ability and willingness to pay
for a product at a particular price per unit time.
 Demand is a desire……..Ability to pay……..Willing to pay
 Particular Price
 Per Unit time
Example: The demand of family for milk @ Rs.120 per liter is 20
liters per week.
 Demand is the quantity of a good or service that
customers are willing and able to purchase during a
specified period under a given set of economic
conditions.

 The time frame, might be an hour, a day, a month or a

year.
 Demand Schedule

Price (Rs) Demand (X)

25 2

20 4

15 6

10 8

5 10
 Demand Curve
30

25

20

15
Price

Price

10

0
2 4 6 8 10

Quantity Demanded
 Law of Demand

 The law of demand explains the behaviour of consumers, either a

single consumer/household or all the consumers collectively.
 Law of demand shows the relation between price and quantity
demanded of a commodity in the market.
 “ If other things donot change people buy more of good when its
price falls and less of it when its price rises”
 A decrease in the price of a good, all other things held constant,
will cause an increase in the quantity demanded of the good.
 An increase in the price of a good, all other things held constant,
will cause a decrease in the quantity demanded of the good.
Price (Rs) Demand(X)

25 2

20 4

15 6

10 8

5 10
 Law of Demand
30

25

20
Price

15

10

0
2 4 6 8 10
Demand
Assumptions of Law of demand

 This is no change in consumers taste and preferences.

 Income of consumer should remain constant.
 Prices of other goods/Substitues should not change.
 The demand for the commodity should be continuous
 People should not expect any change in the price of the
commodity (No expectation of further rise in price)
 Weather do not change
EXCEPTIONS

Precious goods

Hoarding

Ignorance
Factors Affecting Demand or Determinants of Demand:
Price of the Commodity:
 The most important factor-affecting amount demanded is the price of the
commodity.
 The amount of a commodity demanded at a particular price is more properly
called price demand.
 The relation between price and demand is called the Law of Demand.
 It is not only the existing price but also the expected changes in price, which
affect demand.
Income of the Consumer:
 The second most important factor influencing demand is consumer income.
 In fact, we can establish a relation between the consumer income and the
demand at different levels of income, price and other things remaining the same.
 The demand for a normal commodity goes up when income rises and falls
down when income falls.
Prices of related goods:
The demand for a commodity is also affected by the changes in prices of the related
goods also.
Population:
 Increase in population increases demand for necessaries of
life.
 The composition of population also affects demand.
 Composition of population means the proportion of young and
old and children as well as the ratio of men to women.
 A change in composition of population has an effect on the
nature of demand for different commodities.

Expectations regarding the future prices:

 If consumers expect changes in price of commodity in future,
they will change the demand at present even when the present
price remains the same.
 Similarly, if consumers expect their incomes to rise in the near
future they may increase the demand for a commodity just now.
Tastes of the Consumers:
 The amount demanded also depends on consumer’s taste. Tastes
include fashion, habit, customs, etc.
 If the taste for a commodity goes up, its amount demanded is
more even at the same price. This is called increase in demand.
The opposite is called decrease in demand.

Wealth:
 The amount demanded of commodity is also affected by the
amount of wealth as well as its distribution.
 The wealthier are the people; higher is the demand for normal
commodities.
 If wealth is more equally distributed, the demand for necessaries
and comforts is more. On the other hand, if some people are rich,
while the majorities are poor, the demand for luxuries is generally
higher.
Climate and weather:

If weather chages, demand will change

Extension and Contraction in Demand
The extension/contraction in demand is change in demand due to
price only.
Extension of demand. There is extension of demand for a
commodity when there is decrease in the price of that commodity.
When price is 15 dollars the demand is 50 kilograms. When price
comes down to 10 dollars there is extension in demand fro m 50
to 60 kilograms.

Price Demand

15 50 kg

10 60
Contraction of demand
There is contraction of demand for a commodity when there is
increase in the price of commodity.
When price is 10 dollars per kilogram the demand is 40
kilograms. When price increases to 20 dollars there is
contraction of demand from 40 to 30 kilograms.

Price Demand

10 40 kg

20 30
 Shifts in demand
 The position of the demand curve will shift to the left or
right following a change in an underlying determinant of
demand.
 It shifts due to changes in others factors than price
 Increases in demand are shown by a shift to the right in the
demand curve.
 This could be caused by a number of factors, including a
rise in income, a rise in the price of a substitute or a fall in
the price of a complement.
 A shift in demand to the right means an increase in the
quantity demanded at every price.
 For example, if drinking cola becomes more fashionable
demand will increase at every price.
PRICE (£) ORIGINAL Qd NEW Qd

110 0 100

100 100 200

90 200 300

80 300 400

70 400 500

60 500 600

50 600 700

40 700 800

30 800 900
Decrease in demand
Demand can decrease and cause a shift to the left of the
demand curve for a number of reasons, including a fall in
income, assuming a good is a normal good, a fall in the price of
a substitute and a rise in the price of a complement.

For example, if the price of a substitute, such as

orange, falls, then less cola is demanded at each price, as
consumers switch to the substitute.
PRICE (£) ORIGINAL Qd NEW Qd

110 0

100 100

90 200 100

80 300 200

70 400 300

60 500 400

50 600 500

40 700 600

30 800 700
 References
Salvatore, D. (2004). Managerial Economics in a
Global Economy, 5th Edition. South-Western
Publishing Co

https
://www.economicsonline.co.uk/Competitive_markets/De
mand_shifts.html

http
://www.managedstudy.com/micro/extension-and-contract
ion-of-demand.htm