Unit - 2

Managerial Economics
Unit - 2
Theory of Demand and Supply
By Dr. Sharif Mohd.
Introduction to Managerial Economics Centre for Distance and Online Education

 Demand:
• Demand simply means a consumer’s desire to buy goods and services without any hesitation and pay the
price for it. In simple words, demand is the number of goods that the customers are ready and willing to
buy at several prices during a given time frame
• “ Demand means effective desire or want for a commodity which is backed up by the ability (purchasing
power) and willingness to pay for it”.
• Demand = Desire + Ability to pay + Willingness to spend+Time+Price.
• Dx=f(Px, Py, Pz, B, A, E, T, U).
• Where Dx= Demand for item; Px= Price of Goods; Py= Price of Substitute; Pz= Price of Complements;
B= Income of consumers; A= Advertisement expenditure; E=Price expectation of consumers; T= Taste
and preferences; U = all other factors.
2. Demand Theory and Supply Centre for Distance and Online Education
Types of Demand
Price Demand
Income Demand
Cross Demand
Direct Demand
Derived Demand
Joint Demand
Composite Demand
 Determinants of Demand
1. Price of the Commodity
2. Income of the consumers
3. Price of the related goods
4. Change in the distribution of income and wealth
5. Change in fashion, taste, habit and custom
6. Change in population
7. Govt. policy
8. Climate and weather condition
9. Future expectation
10. Propensity to consume
11. Liquidity of wealth assets
12. Advertisement
13. Introduction of new products
14. Increase in money supply
❏ Law of Demand:
● “ Other things being equal, the higher the price of a commodity, the smaller is
the quantity demanded and lower the price, larger the quantity demanded”.
❏ Factors behind Law of demand

● Substitution effect
● Income effect
● Utility Maximising behaviour
● Extension of demand: Extension of demand is the increase in demand due to

the fall in price, all other factors remaining constant.
● Contraction of demand: Contraction of demand is the fall in demand due to the
rise in price, all other factors remaining constant.
BASIS FOR MOVEMENT IN DEMAND

SHIFT IN DEMAND CURVE
COMPARISON CURVE
Meaning Movement in the demand The shift in the demand curve is when,
curve is when the commodity the price of the commodity remains
experience change in both the constant, but there is a change in
quantity demanded and price, quantity demanded due to some other

factors, causing the curve to shift to a
causing the curve to move in a
particular side.
specific direction.
BASIS FOR MOVEMENT IN DEMAND

SHIFT IN DEMAND CURVE
COMPARISON CURVE
What is it? Change along the curve. Change in the position of the curve.
Determinant Price Non-price
Indicates Change in Quantity Change in Demand

Demanded
Result Demand Curve will move Demand Curve will shift rightward or leftward.
upward or downward.
❏ Movement in Demand Curve

● Upward Movement: Indicates contraction of demand, in essence, a fall in demand is
observed due to price rise.
● Downward Movement: It shows expansion in demand, i.e. demand for the product or
service goes up because of the fall in prices.
❏ Shift in Demand Curve
● Rightward Shift: It represents an increase in demand, due to the favourable change in
non-price variables, at the same price.
● Leftward Shift: This is an indicator of a decrease in demand when the price remains
constant but owing to unfavourable changes in determinants other than price.
a). Movement in Demand Curve b). Shift in Demand Curve
● Therefore, with the overall discussion, you might have understood, that a
movement and shift in the demand curve are two different changes.
● Movement in the curve is caused by the variables present on the axis, i.e. price and
quantity demanded.
● On the flip side, a shift in the curve is because of the factors which are other than
those present on the axis, such as competitors price, taste, expectations and so on.
Elasticity of Demand
❏ Elasticity of Demand:
● Elasticity is the measurement of the percentage change of one economic variable in
response to a change in another.
● An elastic variable is one which responds more than proportionally to changes in other
variables Elasticity is an economic concept used to measure the change in the aggregate
quantity demanded for a good or service in relation to price movements of that good or
service.
Price Elasticity:
Price Elasticity of Demand A measure of the relationship between a change in the quantity
demanded of a particular good and a change in its price. Price elasticity of demand is a term in
economics often used when discussing price sensitivity. The formula for calculating price
elasticity of demand is: Ep=% change in Q.D/% Change in P
Degrees of Price Elasticity of Demand
Methods of Measuring Price Elasticity
Percentage Method Point Method Arc Method Total Outlay Method
1. Percentage Method:
● The price elasticity of demand is measured by its coefficient Ep. This coefficient Ep
measures the percentage change in the quantity of a commodity demanded resulting from
a given percentage change in its price: Thus
● Where q refers to quantity demanded, p to price and ∆ to change. If E p> 1, demand is
elastic. If Ep < 1, demand is inelastic, it Ep = 1 demand is unitary elastic.
(i) Suppose the price of commodity X falls from Rs. 3 per kg. to Re. 1 per kg. and its quantity demanded
increases from 30 kgs. to 50 kgs. Then
❏ The Point Method:
● Prof. Marshall devised a geometrical method for measuring elasticity at a point on the
demand curve.
● If the price falls from PB(=OA) to MD(=OC). the quantity demanded increases from
OB to OD. Elasticity at point P on the RS demand curve according to the formula is:
● Ep = ∆q/∆p x p/q
● Where ∆ q represents changes

in quantity demanded, ∆p
changes in price level while p
and q are initial price and
quantity levels.
● ∆ q = BD = QM
● ∆p = PQ
● p = PB
● q = OB
● We arrive at the conclusion that at the mid-point on the demand curve the
elasticity of demand is unity.
● Moving up the demand curve from the mid-point, elasticity becomes
greater.
● When the demand curve touches the Y-axis, elasticity is infinity. Any point
below the mid-point towards the X-axis will show elastic demand.
● Elasticity becomes zero when the demand curve touches the X-axis.
The Arc Method:
● We have studied the measurement of elasticity at a point on a demand curve. But when
elasticity is measured between two points on the same demand curve, it is known as arc
elasticity.
● In the words of Prof. Baumol, “Arc elasticity is a measure of the average
responsiveness to price change exhibited by a demand curve over some finite stretch of
the curve.”
● Any two points on a demand curve make an arc. The area between P and M on the
DD curve in figure is an arc which measures elasticity over a certain range of
price and quantities. On any two points of a demand curve the elasticity
coefficients are likely to be different depending upon the method of computation.
Point Price (Rs.) Quantity (Kg)
P 8 10
M 6 12
● If we move from P to M, the elasticity of demand is:
● If we move in the reverse direction from M to P, then
The Total Outlay Method:
● Marshall evolved the total outlay, total revenue or total expenditure method as a
measure of elasticity.
● By comparing the total expenditure of a purchaser both before and after the change
in price, it can be known whether his demand for a good is elastic, unity or less
elastic.
● Total outlay is price multiplied by the quantity of a good purchased:
● Total Outlay = Price x Quantity Demanded.
2. Income elasticity: Income elasticity of demand refers to the sensitivity of the quantity
demanded for a certain good to a change in real income of consumers who buy this good,
keeping all other things constant.
The formula for calculating income elasticity of demand is the percent change in quantity
demanded divided by the percent change in income.
3. The cross elasticity: The cross elasticity of demand is an economic concept that
measures the responsiveness in the quantity demanded of one good when the price for
another good changes.
Also called cross-price elasticity of demand, this measurement is calculated by taking
the percentage change in the quantity demanded of one good and dividing it by the
percentage change in the price of the other good.
Use or Role of Elasticity of Demand in Business Decisions

1. Price Distribution
2. Public Utility pricing
3. Joint Supply
4. Super markets
5. Use of Machine
6. Factor Pricing
7. International trade
8. Shifting of Tax Burden
9. Taxation Policy
Supply
● The fundamental economic concept that states the total amount of a specified
product or service that is available to customers is known as ‘supply.’
● It is very closely related to and goes hand in hand with demand. When supply
exceeds demand for a product or service, the prices of said product fall.
● This is known as the law of supply and demand. Their relationship highly
affects the price of goods and is a very important topic in the field of
economics.
The various types of supply
1. Market supply
2. Composite supply
3. Long-term supply
4. Joint supply:
5. Short-term supply
6. The various types of supply
Law of Supply:
● Law of supply states that other factors remaining constant, price and
quantity supplied of a good are directly related to each other.
● In other words, when the price paid by buyers for a good rises, then
suppliers increase the supply of that good in the market.
● Description- Law of supply depicts the producer behavior

at the time of changes in the prices of goods and services.
When the price of a good rises, the supplier increases the
supply in order to earn a profit because of higher prices.
● The above diagram shows the supply curve that is upward
sloping (positive relation between the price and the
quantity supplied). When the price of the good was at P3,
suppliers were supplying Q3 quantity. As the price starts
rising, the quantity supplied also starts rising.
● When college students learn that computer engineering jobs pay more than
English professor jobs, the supply of students with majors in computer
engineering will increase.
● When consumers start paying more for cupcakes than for donuts, bakeries
will increase their output of cupcakes and reduce their output of donuts in
order to increase their profits.
● When your employer pays time and a half for overtime, the number of
hours you are willing to supply for work increases.
Price, Quantity Demanded, and Quantity Supplied

Price (per gallon) Quantity demanded (millions of gallons) Quantity supplied (millions of gallons)
$1.00 800 500
$1.20 700 550
$1.40 600 600
$1.60 550 640
$1.80 500 680
$2.00 460 700
$2.20 420 720
Rising costs:
If costs rise, less can be
produced at any given
price, and the supply curve
will shift to the left.
Falling costs:
If costs fall, more can be
produced, and the supply
curve will shift to the right.
● Any change in an underlying determinant of supply, such as a change

in the availability of factors, or changes in weather, taxes, and
subsidies, will shift the supply curve to the left or right.

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Managerial Economics

By Dr. Sharif Mohd.

Introduction to Managerial Economics Centre for Distance and Online Education

❏ Factors behind Law of demand

● Extension of demand: Extension of demand is the increase in demand due to

BASIS FOR MOVEMENT IN DEMAND

quantity demanded and price, quantity demanded due to some other

BASIS FOR MOVEMENT IN DEMAND

Determinant Price Non-price

Indicates Change in Quantity Change in Demand

❏ Movement in Demand Curve

a). Movement in Demand Curve b). Shift in Demand Curve

Degrees of Price Elasticity of Demand

Methods of Measuring Price Elasticity

Percentage Method Point Method Arc Method Total Outlay Method

❏ The Point Method:

● Where ∆ q represents changes

The Arc Method:

Point Price (Rs.) Quantity (Kg)

● If we move from P to M, the elasticity of demand is:

● If we move in the reverse direction from M to P, then

The Total Outlay Method:

Use or Role of Elasticity of Demand in Business Decisions

The various types of supply

● Description- Law of supply depicts the producer behavior

Price, Quantity Demanded, and Quantity Supplied

$1.00 800 500

$1.20 700 550

$1.40 600 600

$1.60 550 640

$1.80 500 680

$2.00 460 700

$2.20 420 720

● Any change in an underlying determinant of supply, such as a change

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