Eco 123 - 100 Demand and Supply

2.
THEORY OF DEMAND
ECO 100: MICROECONOMICS
1
Meaning of Demand
 The word 'demand' is so common and

familiar with every one of us that it
seems superfluous to define it. The need
for precise definition arises simply
because it is sometimes confused with
other words such as desire, wish, want,
etc.
 Demand in economics means a desire to
possess a good supported by willingness
and ability to pay for it.
2
Meaning of Demand
 If your have a desire to buy a certain

commodity, say a car, but you do not
have the adequate means to pay for it, it
will simply be a wish, a desire or a want
and not demand.
 Demand is an effective desire, i.e., a
desire which is backed by willingness
and ability to pay for a commodity in
order to obtain it.
3
In the words of Prof. Hibdon;
"Demand means the various quantities of
goods that would be purchased per time
period at different prices in a given
market".
4
Characteristics of Demand
There are thus three main

characteristic's of demand in
economics.
(i) Willingness and ability to pay.
Demand is the amount of a commodity
for which a consumer has the
willingness and also the ability to buy.
5
(ii) Demand is always at a price.

If we talk of demand without reference to
price, it will be meaningless. The
consumer must know both the price and
the commodity. He will then be able to
tell the quantity demanded by him.
(iii) Demand is always per unit of time.
The time may be a day, a week, a
month, or a year.
6
Example:
 For instance, when the milk is selling at
the rate of $15.0 per liter, the demand for
a buyer of milk is 10 liters a day. If we do
not mention the period of time, nobody
can guess as to how much milk we
consume? It is just possible we may be
consuming ten liters of milk a week, a
month or a year.
7
 Summing up, we can say that by
demand is meant the amount of the
commodity that buyers are able and
willing to purchase at any given price
over some given period of time.
 Demand is also described as a schedule
of how much a good people will
purchase at any price during a specified
period of time.
8
Law of Demand
Definition and Explanation of the Law

 The demand for a commodity is related
to price per unit of time.
 It is the experience of every consumer
that when the prices of the commodities
fall, they are tempted to purchase more.
9
Law of Demand
 Commodities and when the prices rise,

the quantity demanded decreases.
There is, thus, inverse relationship
between the price of the product and the
quantity demanded.
 The economists have named this inverse
relationship between demand and price
as the law of demand.
10
Statement of the Law
According to Prof. Samuelson:
"The law of demand states that people will
buy more at lower prices and buy less at
higher prices, other things remaining the
same".
E. Miller writes:
 "Other things remaining the same, the
quantity demanded of a commodity will be
smaller at higher market prices and larger
at lower market prices".
11
 "Other things remaining the same, the
quantity demanded increases with every
fall in the price and decreases with every
rise in the price".
In simple we can say that when the price
of a commodity rises, people buy less of
that commodity and when the price falls,
people buy more of it ceteris paribus
(other things remaining the same).
12
 Or we can say that the quantity varies

inversely with its price. There is no doubt
that demand responds to price in the
reverse direction but it has got no
uniform relation between them.
 If the price of a commodity falls by 1%, it
is not necessary that may also increase
by 1%.
13
 The demand can increase by 1%, 2%,

10%, 15%, as the situation demands.
 The functional relationship between
demanded and the price of the
commodity can be expressed in simple
mathematical language as under:
Qdx = f (Px, M, Po, T,..........)
14
 Qdx = A quantity demanded of

commodity x.
 f = A function of independent variables
contained within the parenthesis.
 Px = Price of commodity x.
 Po = Price of the other commodities.
 T = Taste of the household.
15
 The bar on the top of M, Po, and T means that
they are kept constant.
The demand function can also be symbolized as
under:
Qdx = f (Px) ceteris paribus
Ceteris Paribus. In economics, the term is used
as a shorthand for indicating the effect of one
economic variable on another, holding constant
all other variables that may affect the second
variable.
16
Schedule of Law of Demand
Price 100 80 60 40 20 10
Qty 5 7 10 15 20 30
17
Law of Demand Curve/Diagram
 Demand curve is a graphic
representation of the demand schedule.
According to Lipsey:
 "This curve, which shows the relation
between the price of a commodity and
the amount of that commodity the
consumer wishes to purchase is called
demand curve".
18
19
 In the figure (4.1), the quantity.

demanded of shirts in plotted on
horizontal axis OX and "price is
measured on vertical axis OY. Each
price- quantity combination is plotted as
a point on this graph. If we join the price
quantity points a, b, c, d, e and f, we get
the individual demand curve for shirts.
20
 The DD/ demand curve slopes

downward from left to right. It has a
negative slope showing that the two
variables price and quantity work in
opposite direction.
 When the price of a good rises, the
quantity demanded decreases and when
its price decreases, quantity demanded
increases, ceteris paribus.
21
Assumptions of Law of Demand
There are three main assumptions of the
Law:
 (i) There should not be any change in the
tastes of the consumers for goods (T).
 (ii) The purchasing power of the typical
consumer must remain constant (M).
 (iii) The price of all other commodities
should not vary (Po).
22
Example of Law of Demand
 If there is a change, in the above and

other assumptions, the law may not hold
true.
 For example, according to the law of
demand, other things being equal
quantity demanded increases with a fall
in price and diminishes with rise to price.
23
 Now let us suppose that price of tea
comes down from $40 per unit to $20
per unit.
 The demand for tea may not increase,
because there has taken place a change
in the taste of consumers or the price of
coffee has fallen down as compared to
tea or the purchasing power of the
consumers has decreased, etc., etc.
24
 From this we find that demand responds

to price inversely only, if other thing
remains constant.
 Otherwise, the chances are that, the
quantity demanded may not increase
with a fall in price or vice-versa.
 Demand, thus, is a negative relationship
between price and quantity.
25
 In the words of Bilas:

 "Other things being equal, the quantity
demanded per unit of time will be
greater, lower the price, and smaller,
higher the price".
26
Limitations/Exceptions of Law of
Demand
Though as a rule when the prices of normai
goods rise, the demand them decreases but
there may be a few cases where the law may
not operate.
(i) Prestige goods:
There are certain commodities like diamond,
sports cars etc., which are purchased as a
mark of distinction in society. If the price of
these goods rise, the demand for them may
increase instead of falling.
27
Demand
(ii) Price expectations: If people expect a
further rise in the price particular
commodity, they may buy more in spite
of rise in price. The violation of the law in
this case is only temporary.
(iii) Ignorance of the consumer: If the
consumer is ignorant about the rise in
price of goods, he may buy more at a
higher price.
28
Demand
(iv) Giffen goods: If the prices of basic
goods, (potatoes, sugar, etc) on which
the poor spend a large part of their
incomes declines, the poor increase the
demand for superior goods, hence when
the price of Giffen good falls, its demand
also falls. There is a positive price effect
in case of Giffen goods.
29
Importance of Law of Demand
(i) Determination of price. The study of

law of demand is helpful for a trader to
fix the price of a commodity.
 He knows how much demand will fall
by increase in price to a particular level
and how much it will rise by decrease
in price of the commodity.
30
 It helps the management in deciding
whether how much increase or decrease
in the price of commodity is desirable.
(ii) Importance to Finance Minister. The
study of this law is of great advantage to
the finance minister.
 If by raising the tax the price increases to
such an extend than the demand is
reduced considerably.
31
 And then it is of no use to raise the tax,

because revenue will almost remain the
same.
 The tax will be levied at a higher rate
only on those goods whose demand is
not likely to fall substantially with the
increase in price.
32
(iii) Importance to the Farmers. Goods

or bad crop affects the economic
condition of the farmers.
 If a goods crop fails to increase the
demand, the price of the crop will fall
heavily.
 The farmer will have no advantage of the
good crop and vice-versa.
33
Individual's and Market Demand
for a Commodity
Individual's Demand for a Commodity
"The individuals demand for a commodity
is the amount of a commodity which the
consumer is willing to purchase at any
given price over a specified period of
time".
 The individual's demand for a commodity
varies inversely price ceteris paribus.
34
Individual's and Market Demand
for a Commodity
 As the price of a goods rises, other
things remaining the same, the quantity
demanded decreases and as the price
falls, the quantity demanded increases.
35
Market Demand for a Commodity
 The market demand for a commodity is

obtained by adding up the total quantity
demanded at various prices by all the
individuate over a specified period of
time in the market.
 It is described as the horizontal
summation of the individuals demand for
a commodity at various possible prices
in market.
36
Market Demand Curve
 Market demand curve for a Commodity

is the horizontal sum of individual
demand curves of ail the buyers in a
market. This is illustrated with the help of
the market demand schedule given
above.
37
Market Demand Curve
38
Market Demand Curve
 The market demand curve DD/ for a
commodity, like the individual demand
curve is negatively sloped, (see figure
4.2).
 It shows that under the assumptions
(ceteris paribus) other things remaining
the same, there is an inverse
relationship between the quantity
demanded and its price.
39
Market Demand Curve
 At price of $10, the quantity demanded

in the market is 40 thousand units.
 At price of $2.0. it increases to 180
thousand units. In. other words, the
lower the price of the good X, the greater
is the demand for it ceteris paribus
40
Movement Vs Shifts of Demand
Curve
Changes in demand for a commodity can
be shown through the demand curve in
two ways:
(1) Movement Along the Demand Curve
and
(2) Shifts of the Demand Curve.
41
(1) Movement Along the Demand
Curve
Demand is a multivariable function.
 If income and other determinants of
demand such as tastes of the
consumers, changes in prices of related
goods, income distribution, etc., remain
constant and there is a change only in
price of the commodity, then we move
along the same demand curve.
42
Curve
 In this case, the demand curve remains
unchanged. When, as a result of change
in price, the quantity demanded
increases or decreases, it is technically
called extension and contraction in
demand.
 The demand curve, which represents
various price quantity has a negative
slope.
43
Curve
Whenever there is a change in the
quantity demanded of a good due to
change, in its price, there is a movement
from one point price quantity
combination to another on the
same demand curve.
 Such a movement from one point price
quantity combination to another along
the same demand curve is shown in
figure (4.3).
44
Curve
45
Curve
 Here the price of a commodity falls from
$8 to $2. As a result, therefore, the
quantity demanded increases from 100
units to 400 units per unit of time.
 There is extension in demand by 300
units.
 This movement is from one point price
quantity combination (a) to another point
(b) along a given demand curve.
46
Curve
 On the other hand, if the price of a good
rises from $2 to $8, there is contraction
in demand by 300 units.
 We, thus, see that as a result of change
in the price of a good, the consumer
moves along the given demand curve.
The demand curve remains the same
and does not change its position.
47
Curve
 The movement along the demand curve
is designated as change in quantity
demanded.
48
(2) Shifts in Demand Curve
 Demand, as we know, is determined by

many factors. When there is a change in
demand due to one or more than one
factors other than price, results in the
shift of demand curve.
 For example, if the level of income in
community rises, other factors remaining
the same, the demand for the goods
increases.
49
 Consumers demand more goods at each

price per period of time (rise or Increase
in demand).
 The demand curve shifts upward from he
original demand curve indicating that
consumers at each price purchase more
units of commodity per unit of time.
50
 If there is a fall in the disposable income

of the consumers or rise in the prices of
close substitute of a good or decline in
consumer taste or non-availability of
good on credit, etc, etc., there is a
reduction in demand (fall or decrease in
demand).
51
 The fall or decrease in demand shifts the

demand curve from the original demand
curve to the left.
 The lower demand curve shows that
consumers are able and willing to buy
less of the good at each price than
before.
52
Px Qx Rise in Qx Fall in Qx
12 100 300 50
6 250 500 200
4 500 600 300
53
54
2) Shifts in Demand Curve
 In this figure, (4.4) the original demand

curve is DD/.
 At a price of $12 per unit, consumers
purchase 100 units. When price falls
to$4 per unit, the quantity demanded
increases to 500 units per unit of time.
55
 Let us assume now that level of income

increases in a community.
 Now consumers demand 300 units of the
commodity at price of $12 per unit and
600 at price of $4 per unit.
 As a result, there is an upward shift of
the demand curve DD2.
56
 In case the community income falls,
there is then decrease in demand at
price of $12 per unit.
 The quantity demanded of a good falls to
50 units.
 It is 300 units at price of $4 unit per
period of time. There is a downward shift
of the demand to the left of the original
demand curve.
57
Summing Up:
(i) Extension in demand is due to reduction in
price.
(ii) Increase in demand occurs due to changes
in factors other than price.
(iii) Contraction in demand is the result of a rise
in the price commodity.
(iv) A decrease in demand follows a change in
factors other than price.
58
(v) Changes in demand both increase

and decrease are representing shifts in
the demand curve.
(vi) Changes in the quantity demanded
are represented by move along the
same demand curve.
59
Determinants of Demand
 While explaining the law of demand, we

have stated that, other things remaining
the same (ceteris paribus), the demand
for a commodity inversely with price per
unit of time. The other things, have an
important bearing on the demand for a
commodity.
60
(i) Changes in population: If the

population of a country increase on
account of immigration or through high
birth rate or on account of these factors,
the demand for various kinds of goods
will increase even the prices remains the
same. The demand curve will shift
upward to the right.
61
(ii) Changes in tastes: Demand for a

commodity may change due to changes
in tastes and fashions. For example,
people develop a taste for coffee. There
is then a decrease in the demand for tea.
The de curve for tea shifts to the left of
the original demand curve.
62
(iii) Changes in income: When the income of

consumers increases generally leads to an
increase in the demand for some commodities
and a decrease in the demand for other
commodities.
 For example, when income of people
increases, they begin to spend money on
those which were previously regarded by them
as luxuries, or semi-luxuries and reduce the
expenditure on inferior goods.
63
 Take the case of a man whose income

has increased from $1000 to $20,000
per month. His consumption of wheat will
go down because he now spends more
money on the superior food such as
cake, fish, daily products, fruits, etc., etc.
64
(iv) Changes in the price of substitutes:

if the price of a particular commodity
rises, people may stop further purchase
of that commodity and spend money on
its substitute which is available at a
lower price. Thus we find, a change in
demand can also be brought about by a
change in the price of the substitute.
65
(v) Changes in the state of trade: The total

quantity of goods demanded is also affected
by the cyclical fluctuations in economic
activities. If the trade is prosperous, the
demand for raw material, machinery, etc.,
increases. If on the other hand, the trade
period is dull, the demand for, producer's
goods will fail sharply as compared to the
demand for consumer goods.
66
(vi) Climate and weather conditions:

The climate and weather conditions have
an important bearing on the demand of a
commodity. For instance, the consumer's
demand for woolen clothes increases in
winter and decreases in summer.
67
Slope of the Demand Curve
Demand Curve is Negatively Sloped

 The demand curve generally slopes
downward from left to right. It has a
negative slope because the two
important variables price and quantity
work in opposite direction.
68
 As the price of a commodity decreases,

the quantity demanded increases over a
specified period of time, and vice versa,
other , things remaining constant.
 The fundamental reasons for demand
curve to slope downward are as follows:
69
(i) Law of diminishing marginal utility:

The law of demand is based on the law
of diminishing marginal utility.
 According to the cardinal utility
approach, when a consumer
purchases more units of a commodity,
its marginal utility declines.
70
 The consumer, therefore, will purchase

more units of that commodity only if its
price falls.
 Thus a decrease in price brings about an
increase, in demand. The demand curve,
therefore, is downward sloping.
71
(ii) Income effect: Other things being

equal, when the price of a commodity
decreases, the real income or the
purchasing power of the household
increases.
 The consumer is now in a position to
purchase more commodities with the
same income.
72
The demand for a commodity thus
increases not only from the existing
buyers but also from the new buyers
who were earlier unable to purchase at
higher price.
 When at a lower price, there is a greater
demand for a commodity by the
households, the demand curve is bound
to slope downward from left to right.
73
(iii) Substitution effect: The demand

curve slopes downward from left to right
also because of the substitution effect.
 For instance, the price of meat falls and
the prices of other substitutes say poultry
and beef remain constant.
74
 Then the households would prefer to

purchase meat because it is now
relatively cheaper.
 The increase in demand with a fall in the
price of meat will move the demand
curve downward from left to right.
75
SUPPLY THEORY
Meanings of Supply and Stock

 Supply is of the scarce goods. It is the
amount of a commodity that sellers are
able and willing to offer for sale at
different price per unit of time.
 “Supply is a schedule of the amount of
a good that would be offered fore sale at
all possible price at any period of time;
e.g., a day, a week, and so on”.
76
 "Stock is meant the total quantity of a
commodity this exists in a market and
can be offered for sale at a short notice".
Distinction Between Supply and Stock
 Supply refers to that quantity of the
commodity which is actually brought into
the market for sale at a given price per
unit of time.
77
 While Stock is meant the total quantity
of a commodity this exists in a market
and can be offered for sale at a short
notice.
 The supply and stock of a commodity in
the market may or may not be equal if
the commodity is perishable, like
vegetables, fruits, fish, etc; then the
supply and stock is generally the same.
78
 But in case of a product find that the
price of his product is low as compared
to its cost of production, he tries to
withhold the entire or a part of a stock.
 In case of a favorable price, the producer
may dispose of large quantities or the
entire stock of his commodity; it will all
depend upon his own valuation of the
commodity at that particular time.
79
Law of Supply
 There is direct relationship between the
price of a commodity and its quantity
offered fore sale over a specified period
of time.
 When the price of a goods rises, other
things remaining the same, its quantity
which is offered for sale increases as
and price falls, the amount available for
sale decreases.
80
Law of Supply
 This relationship between price and the

quantities which suppliers are prepared
to offer for sale is called the law of
supply.
 The law of supply, in short, states that
ceteris paribus sellers supply more
goods at a higher price than they are
willing at a lower price.
81
Law of Supply
Px 4 3 2 1
Qx 100 80 60 40
 In the table above, the produce are able and willing

to offer for sale 100 units of a commodity at price of
$4. As the price falls, the quantity offered for sale
decreases. At price of $1, the quantity offered for
sale is only 40 units.
82
Law of Supply Curve/Diagram
83
Formula for Law of
Supply/Supply Function
 The supply function can also be expressed in symbols.
 QxS = Φ (Px Tech, Si, Fn, X,........)
 Here:
 Qxs = Quantity supplied of commodity x by the producers.
 Px = Price of commodity x.
 Tech = Technology.
 S = Supplies of inputs.
 F = Features of nature.
 X = Taxes/Subsidies.
 = Bar on the top of last four non-price factors indicates
that these variables also affect the supply but they are held
constant.
84
Law of Supply
 The law of supply is based on a moving

quantity of materials available to meet a
particular need. Supply is the source of
economic activity.
 Supply, or the lack of it, also dictates
prices.
 Cost of scarce supply goods increase in
relation to the shortages.
85
Law of Supply
 Supply can be used to measure

demand.
 Over supply results in lack of customers.
 An over supply is often a loss, for that
reason.
 Under supply generates a demand in the
form of orders, or secondary sales at
higher prices.
86
Law of Supply
 If ten people want to buy a book, and

there's only one book, the sale will be
based on the level of demand for the
book. The supply function requires more
books, which generates more production
to meet demand.
87
Assumptions to the Law of
Supply
(i) Nature of Goods.
 If the goods are perishable in nature
and the seller cannot wait for the rise in
price.
 Seller may have to offer all of his
goods at current market price because
he may not take risk of getting his
commodity perished.
88
(ii) Government Policies.
 Government may enforce the firms and
producers to offer production at
prevailing market price.
 In such a situation producer may not be
able to wait for the rise in price.
89
(iii) Alternative Products.
 If a number of alternative products are
available in the market and customers
tend to buy those products to fulfill their
needs, the producer will have to shift to
transform his resources to the production
of those products.
90
(iv) Squeeze in Profit.
 Production costs like raw materials, labor
costs, overhead costs and selling and
administration may increase along with
the increase in price.
 Such situations may not allow producer
to offer his products at a particular
increased price.
91
Importance of Law of Supply
(i) Supply responds to changes in prices

differently for different goods,
depending on their elasticity or
inelasticity.
 Goods are elastic when a moderate
change in price leads to a large
change in the quantity supplied.
92
 In contrast, goods are inelastic when a

change in price leads to relatively no
response to the quantity supplied.
 An example of an elastic good would be
soft drinks, whereas an example of an
inelastic service would be physicians'
services.
93
 Producers will be more likely to want to
supply more inelastic goods such as
gas because they will most likely profit
more off of them.
(ii) Law of supply is an economic principle
that states that there is a direct
relationship between the price of a
good and how much producers are
willing to supply.
94
(iii) As the price of a good increases, suppliers
will want to supply more of it. However, as the
price of a good decreases, suppliers will not
want to supply as much of it.
 to produce a good, the incentive of profit must
be greater than the opportunity cost of
production, the total cost of producing the
good, which includes the resources and value
of the other goods that could have been
produced instead.
95
(iv) Entrepreneurs enter business ventures

with the intention of making a profit.
 A profit occurs when the revenues from
the goods a producer supplies exceeds
the opportunity cost of their production.
 However, consumers must value the
goods at the price offered in order for
them to buy them.
96
 Therefore, in order for a consumer to be

willing to pay a price for a good higher
than its cost of production, he or she
must value that good more than the
other goods that could have been
produced instead.
 So supplier's profits are dependent on
consumer demands and values.
97
However, when suppliers do not earn

enough revenue to cover the cost of
production of the good, they incur a loss.
 Losses occur whenever consumers
value a good less than the other goods
that could have been produced with the
same resources.
98
Determinants of Supply
(i) Technology changes. Technology helps a

producer to minimize his cost of production.
(ii) Resource supplies. The producer also has
to pay for other resources such as raw
materials and labor. if his money is short on
supplying a certain number of products
because of an increase in resource supplies,
then he has to reduce his supply.
99
(iii) Tax/ Subsidy. A producer aims to

maximize his profit, but an increase in
tax will only increase his expenses,
decreasing his capacity to buy resource
supplies and forcing him to reduce his
supply.
100
(iv) Price of other goods produced.

 A producer may not only produce on product
but other products as well.
 A producer's money is limited and if he
increases his supply in one product, he would
have to decrease his supply in the other
product, no unless his sales increase.
101
Change in supply vs Change in
quantity supplied
Movement Along with the Same Supply
Curve
102
Movement Along with the Same
Supply Curve
 In the above figure (5.2) at price "aT"
($3.00), "aT" 50 units quantity is
supplied. When price rises to dL ($7.0),
the quantity supplied by the producers
increases to OL (110 units). The change
in quantity supplied at varying prices is
referred as movement along the same
supply curve.
103
Shifts in Supply Curve
Price Quantity Rise in Supply Fall in Supply
50 200 320 140
40 160 200 100
30 100 150 70
20 39 100 15
104
105
 In the figures (5.3) SS/ in the original

supply curve S2S2 to the right of the
original supply curve shows an increase
in the quantity supplied at each price.
S3S3 supply curve to the left of original
supply curve to the left of original supply
curve indicates a decrease in supply at
each price over a specified period of
time
106
ELASTICITY OF DEMAND
 The law of demand is straight forward. It

tells us when the price of a good rises,
its quantity demanded will fall, all other
things held constant.
 The law does not indicate as to how
much the quantity demanded will fall with
the rise in price or how much responsive
demand is to a rise price.
107
ELASTICITY OF DEMAND
 The economists here use and measure

the quantity demanded to a change in
price by the concept of elasticity of
demand.
 Price elasticity of demand measures
the degree of responsiveness of the
quantity demanded of a good to a
change in its price. It is also defined as:
108
Price elasticity of demand
 "The ratio of proportionate change in

quantity demanded caused by a given
proportionate change in price".
 Price elasticity of demand is computed
by dividing the percentage change in
quantity demanded of a good by the
percentage change in its price.
109
Ed = Percentage Change in Quantity Demanded

Percentage Change in Price
Ed = %∆Q
%∆P
110
 The price elasticity of demand tells us

the relative amount by which the quantity
demanded will change in response to a
change in the price of a particular good.
For example, if there is a 10% rise in the
price of a tea and it leads to reduction in
its demanded by 20%, the price elasticity
of demand will be:
111
Ed = -20
+10
Ed = -2.0
112
Degrees of Elasticity of Demand
 We have stated demand for a product is

sensitive or responsive to price change.
The variation in demand is, however, not
uniform with a change in price.
 In case of some products, a small
change in price leads to a relatively
larger change in quantity demanded.
113
Elastic and Inelastic Demand
 For example, a decline of 1% in price leads to
8% increase in the quantity demanded of a
commodity. In such a case, the demand is
said to be elastic.
 There are other products where the quantity
demanded is relatively unresponsive to price
changes. A decline of 8% in price, for
example, gives rise to 1% increase in quantity
demanded. Demand here is said to be
inelastic.
114
Elastic and Inelastic Demand
 The terms elastic and inelastic demand

do not indicate the degree of
responsiveness and unresponsiveness
of the quantity demanded to a change in
price.
 The economists therefore, group various
degrees of elasticity of demand into
five categories.
115
(1) Perfectly Elastic Demand
 A demand is perfectly elastic when a
small increase in the price of a good its
quantity to zero.
 Perfect elasticity implies that individual
producers can sell all they want at a
ruling price but cannot charge a higher
price. If any producer tries to charge
even more, no one would buy his
product.
116
 People would prefer to buy from another

producer who sells the good at the
prevailing market price of $4 per unit.
 A perfect elastic demand curve is
illustrated in figure below, it is horizontal
indicating that each quantity is sold at
the same price.
117
118
 It shows that the demand curve DD/ is a
horizontal line which indicates that the
quantity demanded is extremely
(infinitely) response to price.
 Even a slight rise in price (say $4.02),
drops the quantity demanded of a good
to zero. The curve DD/ is infinitely
elastic. This elasticity of demand as such
is equal to infinity.
119
(2) Perfectly Inelastic Demand
 When the quantity demanded of a good

dose not change at all to whatever
change in price, the demand is said to
be perfectly inelastic or the elasticity of
demand is zero.
120
 For example, a 30% rise or fall in price

leads to no change in the quantity
demanded of a good.
Ed = 0
30%
Ed = 0
121
122
 In figure 6.2 a rise in price from OA to

OC or fall in price from OC to OA causes
no change (zero responsiveness) in the
amount demanded.
Ed = 0
Δp
Ed = 0
123
(3) Unitary Elasticity of Demand
 When the quantity demanded of a good

changes by exactly the same percentage
as price, the demand is said to has a
unitary elasticity.
 For example, a 30% change in price
leads to 30% change quantity demand
= 30% / 30% = 1.
124
 One or a one percent change in price

causes a response of exactly a one
percent change in the quantity demand.
125
126
 In the figure DD/ demand curve with unitary

elasticity shows that as the price falls from OA
to OC, the quantity demanded increases from
OB to OD. On DD/ demand curve, the
percentage change in price brings about an
exactly equal percentage in quantity at all
points a, b.
Ed = %∆q
%∆p
Ed = 1
127
(4) Elastic Demand
 If a one percent change in price causes
greater than a one percent change in quantity
demanded of a good, the demand is said to be
elastic.
 Alternatively, we can say that the elasticity of
demand is greater than one. For example, if
price of a good change by 10% and it brings a
20% change in demand, the price elasticity is
greater than one.
128
(4) Elastic Demand
Ed = 20%
10%
Ed = 2
129
(4) Elastic Demand
130
(4) Elastic Demand
 In figure (6.4) DD/ curve is relatively

elastic along its entire length.
 As the price falls from OA to OC, the
demand of the good extends from OB to
ON i.e., the increase in quantity
demanded is more than proportionate to
the fall in price.
131
(4) Elastic Demand
Ed = %∆q
%∆p
Ed > 1
132
(5) Inelastic Demand
 When a change in price causes a less

than a proportionate change in quantity
demand, demand is said to be inelastic.
 The elasticity of a good is here less than
I or less than unity. For example, a 30%
change in price leads to 10% change in
quantity demanded of a good, then;
133
Ed = 10%
30%
Ed = 1
3
Ed < 1
134
135
 In figure (6.5) DD/ demand curve is

relatively inelastic. As the price fall from
OA to OC, the quantity demanded of the
good increases from OB to ON units.
 The increase in the quantity demanded
is here less than proportionate to the fall
in price.
136
 NOTE: It may here note that the slope of

a demand curve is not a reliable
indicator of elasticity. A flat slope of a
demand curve must not mean elastic
demand. Similarly, a steep slope on
demand curve must not necessarily
mean inelastic demand.
137
 The reason is that the slope is expressed
in terms of units of the problem.
 If we change the units of problem, we can
get a different slope of the demand curve.
 The elasticity, on the other hand, is the
percentage change in quantity demanded
to the corresponding percentage change
in price.
138
Measurement of Price Elasticity
of Demand
There are three methods of measuring
price elasticity of demand:
(1) Total Expenditure Method.
(2) Geometrical Method or Point
Elasticity Method.
(3) Arc Method.
139
(1) Total Expenditure
Method/Total Revenue Method
 The price elasticity can be measured by
noting the changes in total expenditure
brought about by changes in price and
quantity demanded.
(i) When with a percentage fall in price,
the quantity demanded increases so
much that it results in the increase in
total expenditure, the demand is said to
be elastic (Ed > 1).
140
141
 The figure (6.6) shows that at price of
$20 per pen, the quantity demanded is
ten pens, the total expenditure OABC
($200).
 When the price falls down to $10, the
quantity demanded of pens is thirty. The
total expenditure is OEFG ($300).
142
 Since OEFG is greater than OABC, it
implies that change in quantity
demanded is proportionately more than
the change in price.
 Hence the demand is elastic (more than
one) Ed > 1.
143
(ii) When a percentage fall in price, raises
the quantity demanded so much as to
leave the total expenditure unchanged,
the elasticity of demand is said to be
unitary (Ed = 1).
144
145
 The figure (6.7) shows that at price of
$10 per pen, the total expenditure is
OABC ($300). At a lower price of $5, the
total expenditure is OEFG ($300).
 Since OABC = OEFG, it implies that the
change in quantity demanded is
proportionately equal to change in price.
So the price elasticity of demand is equal
to one, i.e., Ed = 1.
146
(iii) When a percentage fall in price
raises the quantity demanded of a good
so as to cause the total expenditure to
decrease, the demand is said to be
inelastic or less than one, i.e., Ed < 1.
147
148
 In the fig (6.8) at a price of $5 per pen
the quantity demanded is 50 pens.
 The total expenditure is OABC ($300).
 At a lower price of $2, the quantity
demanded is 100 pens.
149
 The total expenditure is OEFG ($200).
Since OEFG is smaller than OABC, this
implies that the change in quantity
demanded is proportionately less than
the change in price. Hence price
elasticity of demand is less than one or
inelastic.
150
NOTE:
 As the demand curve slopes downward,
therefore, the coefficient of price
elasticity of demand is always
negative. The economists for
convenience sake, omit the negative
sign and express the price elasticity of
demand by positive number.
151
(2) Geometric Method/Point
Elasticity Method
 "The measurement of elasticity at a point
of the demand curve is called point
elasticity".
 The point elasticity of demand method is
used as a measure of the change in the
quantity demanded in response to a very
small changes in price.
152
(2) Geometric Method/Point
Elasticity Method
 The point elasticity of demand is defined
as:
"The proportionate change in the quantity
demanded resulting from a very small
proportionate change in price".
153
(i) Elasticity on a Linear Demand
Curve
 The price elasticity of demand can also
be measured at any point on the
demand curve.
 If the demand curve is linear (straight
line), it has a unitary elasticity at the mid
point. The total revenue is maximum at
this point.
154
Curve
 Any point above the midpoint has an
elasticity greater than 1, (Ed > 1). Here,
price reduction leads to an increase in
the total revenue (expenditure).
 Below the midpoint elasticity is less than
1. (Ed < 1). Price reduction leads to
reduction in the total revenue of the firm.
155
Curve
156
Curve
 The formula applied for measuring the
elasticity at any point on the straight line
demand curve is:
Ed = %∆q X p
%∆p q
157
 In the figure (6.9) AG is the linear
demand curve (1). Elasticity of demand
at its mid point D is equal to unity. At any
point to the right of D, the elasticity is
less than unity (Ed < 1) and to the left of
D, the elasticity is greater than unity (Ed
> 1).
158
Curve
(1) Elasticity of demand at point D =
= DG = 400 = 1 (Unity).
DA 400
(2) Elasticity of demand at point E =
= GE = 200 = 0.33 (<1).
EA 600
159
Curve
(3) Elasticity of Demand at point C =
= GC = 600 = 3 (>1).
CA 200
(4) Elasticity of Demand at point C is
infinity.
(5) At point G, the elasticity of demand is
zero.
160
Curve
 Summing up, the elasticity of demand is
different at each point along a linear
demand curve. At high prices, demand is
elastic. At low prices, it is inelastic. At the
midpoint, it is unit elastic.
161
(ii) Elasticity on a Non Linear
Demand Curve
 If the demand curve is non linear, then
elasticity at a point can be measured by
drawing a tangent at the particular point.
 This is explained with the help of a figure
given below:
162
Demand Curve
163
Demand Curve
 In figure 6.10, the elasticity on DD/
demand curve is measured at point C by
drawing a tangent. At point C:
Ed = BM = BC = 400 = 2 (>1).
MO CA 200
 Here elasticity is greater than unity. Point
C lies above the midpoint of the demand
curve DD/.
164
Demand Curve
 In case the demand curve is a
rectangular hyperbola, the change in
price will have no effect on the total
amount spent on the product.
 As such, the demand curve will have a
unitary elasticity at all points.
165
(3) Arc Elasticity
 Normally the elasticity varies along the

length of the demand curve.
 If we are to measure elasticity between
any two points on the demand curve,
then the Arc Elasticity Method, is used.
 Arc elasticity is a measure of average
elasticity between any two points on the
demand curve.
166
(3) Arc Elasticity
 It is defined as:
"The average elasticity of a range of
points on a demand curve".
 Arc elasticity is calculated by using the
following formula:
Ed = ∆q X P1 + P2
∆p q1 + q2
167
(3) Arc Elasticity
Here:
 ∆q denotes change in quantity.
 ∆p denotes change in price.
 q1 signifies initial quantity.
 q2 denotes new quantity.
 P1 stands for initial price.
 P2 denotes new price.
168
(3) Arc Elasticity
169
(3) Arc Elasticity
 In this fig. (6.11), it is shown that at a

price of $10, the quantity of demanded of
apples is 5 kg. per day.
 When its price falls from $10 to $5, the
quantity demanded increases to 12 Kgs
of apples per day.
 The arc elasticity of AB part of demand
curve DD/ can be calculated as under:
170
(3) Arc Elasticity
Ed = ∆q X P1 + P2
∆p q1 + q2
Ed = 7 X 10 + 5 = 7 X 15 = 7 X 15 = 21
5 5 + 12 5 17 5 17 17
= 1.24
The arc elasticity is more than unity.
171
Income Elasticity of Demand
 Income is an important variable affecting

the demand for a good.
 When there is a change in the level of
income of a consumer, there is a change
in the quantity demanded of a good,
other factors remaining the same.
172
 The degree of change or responsiveness

of quantity demanded of a good to a
change in the income of a consumer is
called income elasticity of demand.
 Income elasticity of demand can be
defined as:
173
"The ratio of percentage change in the

quantity of a good purchased, per unit of
time to a percentage change in the
income of a consumer".
 The formula for measuring the income
elasticity of demand is the percentage
change in demand for a good divided by
the percentage change in income.
174
Ey = Percentage Change in Quantity

Percentage Change in Income
Ey = ΔQ X Y
ΔY Q
175
 Let us assume that the income of a

person is $4000 per month and he
purchases six CD's per month. Let us
assume that the monthly income of the
consumer increase to $6000 and the
quantity demanded of CD's per month
rises to eight.
176
The elasticity of demand for CD's will be

calculated as under:
 ΔQ = 8 - 6 = 2
 ΔY = $6000 - $4000 = $2000
 Original quantity demanded = 6
 Original income = $4000
177
Ey = ΔQ / ΔY x Y / Q
= 2 / 200 x 4000 / 6 = 0.66
 The income elasticity is 0.66 which is

less than one.
178
 When the income of a person increases,

his demand for goods also changes
depending upon whether the good is a
normal good or an inferior good.
 For normal goods, the value of elasticity
is greater than zero but less than one.
179
 Goods with an income elasticity of less

than 1 are called inferior goods.
 For example, people buy more food as
their income rises but the % increase in
its demand is less than the % increase in
income.
180
Cross Elasticity of Demand
 The concept of cross elasticity of
demand is used for measuring the
responsiveness of quantity demanded of
a good to changes in the price of related
goods.
 Cross elasticity of demand is;
"The percentage change in the quantity of
one good as a result of the percentage
change in the price of another good".
181
Exy = % Change in Quantity of Good X

% Change in Price of Good Y
 The numerical value of cross elasticity

depends on whether the two goods in
question are substitutes, complements
or unrelated.
182
Types and Example:

(i) Substitute Goods.
 When two goods are substitute of each
other, such as coke and Pepsi, an
increase in the price of one good will
lead to an increase in demand for the
other good. The numerical value of
goods is positive.
183
 For example there are two goods. Coke

and Pepsi which are close substitutes.
 If there is increase in the price of Pepsi
called good y by 10% and it increases
the demand for Coke called good X by
5%, the cross elasticity of demand would
be:
184
Exy = %ΔQx / %ΔPy = 0.2

 Since Exy is positive (E > 0), therefore,
Coke and Pepsi are close substitutes.
185
(ii) Complementary Goods.

 However, in case of complementary
goods such as car and petrol, cricket bat
and ball, a rise in the price of one good
say cricket bat by 7% will bring a fall in
the demand for the balls (say by 6%).
186
 The cross elasticity of demand which are

complementary to each other is,
therefore, -6% / 7% = -0.85 (negative).
187
(iii) Unrelated Goods.

 The two goods which a re unrelated to
each other, say apples and pens, if the
price of apple rises in the market, it is
unlikely to result in a change in quantity
demanded of pens. The elasticity is zero
of unrelated goods.
188
Determinants of Price Elasticity
of Demand
 The price elasticity of demand is not the
same for all commodities. It may be or
low depending upon number of factor.
These factors which influence price
elasticity of demand, in brief, are as
under:
189
of Demand
(i) Nature of Commodities.
 In developing countries of the world, the
per capital income of the people is
generally low. They spend a greater
amount of their income on the purchase
of necessaries of life such as wheat,
milk, course cloth etc.
190
of Demand
 They have to purchase these

commodities whatever be their price.
 The demand for goods of necessities is,
therefore, less elastic, and or sometimes
inelastic. The demand for luxury goods,
on the other hand is greatly elastic.
LESS ELASTIC = INELASTIC
191
of Demand
(ii) Availability of Substitutes.
 If a good has greater number of close
substitutes available in the market, the
demand for the good will be greatly
elastic.
 If the price of Coke rises, people will
switch over to the consumption of Pepsi,
which is its close substitute. So the
demand for Coke is elastic.
192
of Demand
(iii) Proportion of the Income Spent on
the Good.
 If the proportion of income spent on the
purchase of a good is very small, the
demand for such a good will be inelastic.
 For example, if the price of a box of
matches or salt rises by 50%, it will not
affect the consumers demand for these
goods.
193
of Demand
 The demand for salt, maker box
therefore will be inelastic.
 On the other hand, if the price of a car
rises from $6 to $9 and it takes a greater
portion of the income of the consumers,
its demand would fall.
 The demand for car is, therefore, elastic.
194
of Demand
(iv) Time.
 The period of time plays an important
role in shaping the demand curve. In the
short run, when the consumption of a
good cannot be postponed, its demand
will be elastic.
195
of Demand
 In the long run if the rise price persists,
people will find out methods to reduce
the consumption of goods.
 So the demand for a good in the, long
run is elastic, other things remaining
constant.
196
of Demand
 For example if the price of electricity
goes up, it is very difficult to cut back its
consumption in the short run.
 However, if the rise in price persists,
people will plan substitution gas heater,
fluorescent bulbs etc. so that they use
less electricity.
197
of Demand
 So the electricity of demand will be
greater (Ed = > 1) in the long run than in
the short run.
(5) Number of Uses of a Good.
 If a good can be put to a number of
uses, its demand is greater elastic (Ed >
1).
198
of Demand
 For example, if the price of coal falls, its
quantity demanded will rise considerably
because demand will be coming from
households, industries railways etc.
(6) Addition. If a product is habit forming
say for example, cigarette, the rise in its
price would not induce much change in
demand. The demand for habit forming
good is, therefore, less elastic.
199
of Demand
 (7) Joint Demand. If two goods are
Jointly demand, then the elasticity of
demand depends upon the elasticity of
demand of the other Jointly demanded
good.
 For example, with the rise in price of
cars, its demand is slightly affected, then
the demand for petrol will also be less
elastic.
200
Importance of Elasticity of
Demand
(i) Importance in taxation policy.
 As regards its practical advantages, the
concept has immense importance in the
sphere of government finance.
 When a finance minister levies a tax on
a certain commodity, he has to see
whether the demand for that commodity
is elastic or inelastic.
201
Demand
 If the demand is inelastic, he can
increase the tax and thus can collect
larger revenue. But if the demand of a
commodity is elastic, he is not in a
position to increase the rate of a tax.
 If he does so, the demand for that
commodity will be, calculated and the
total revenue reduced.
202
Demand
(ii) Price discrimination by
monopolist.
 If the monopolist finds that the demand
for his commodities is inelastic, he will at
once fix the price at a higher level in
order to maximize his net profit. In case
of elastic demand, he will lower the price
in order to increase, his sale and derive
the maximum net profit.
203
Demand
 Thus we find that the monopolists also
get practical advantages from the
concept of elasticity.
(iii) Price discrimination in cases of
joint supply.
 The concept of elasticity is of great
practical advantage where the separate,
costs of Joint products cannot be
measured.
204
Demand
 Here again the prices are fixed on the
principle. "What the traffic will bear" as is
being done in the railway rates and
fares.
(iv) Importance to businessmen.
 The concept of elasticity is of great
importance to businessmen. When the
demand of a good is elastic, they
increases sale by towering its price.
205
Demand
 In case the demand' is inelastic, they are
then in a position to charge higher price
for a commodity.
 (v) Help to trade unions. The trade
unions can raise the wages of the labor
in an industry where the demand of the
product is relatively inelastic.
206
Demand
 On the other hand, if the demand, for
product is relatively elastic, the trade
unions cannot press for higher wages.
(vi) Use in international trade.
 The term of trade between two countries
are based on the elasticity of demand of
the traded goods.
207
Demand
(vii) Determination of rate of foreign
exchange.
 The rate of foreign exchange is also
considered on the elasticity of imports
and exports of a country.
208
Demand
(viii) Guideline to the producers.
 The concept of elasticity provides a
guideline to the producers for the
amount to be spent on advertisement.
 If the demand for a commodity is elastic,
the producers shall have to spend large
sums of money on advertisements for
increasing the sales.
209
Demand
(ix) Use in factor pricing.
 The factors of production which have
inelastic demand can obtain a higher
price in the market then those which
have elastic demand.
 This concept explains the reason of
variation in factor pricing.
210

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2.

ECO 100: MICROECONOMICS

 The word 'demand' is so common and

 If your have a desire to buy a certain

There are thus three main

(ii) Demand is always at a price.

Definition and Explanation of the Law

 Commodities and when the prices rise,

 Or we can say that the quantity varies

 The demand can increase by 1%, 2%,

 Qdx = A quantity demanded of

 In the figure (4.1), the quantity.

 The DD/ demand curve slopes

 If there is a change, in the above and

 From this we find that demand responds

 In the words of Bilas:

(i) Determination of price. The study of

 And then it is of no use to raise the tax,

(iii) Importance to the Farmers. Goods

 The market demand for a commodity is

 Market demand curve for a Commodity

 At price of $10, the quantity demanded

 Demand, as we know, is determined by

 Consumers demand more goods at each

 If there is a fall in the disposable income

 The fall or decrease in demand shifts the

6 250 500 200

4 500 600 300

 In this figure, (4.4) the original demand

 Let us assume now that level of income

(v) Changes in demand both increase

 While explaining the law of demand, we

(i) Changes in population: If the

(ii) Changes in tastes: Demand for a

(iii) Changes in income: When the income of

 Take the case of a man whose income

(iv) Changes in the price of substitutes:

(v) Changes in the state of trade: The total

(vi) Climate and weather conditions:

Demand Curve is Negatively Sloped

 As the price of a commodity decreases,

(i) Law of diminishing marginal utility:

 The consumer, therefore, will purchase

(ii) Income effect: Other things being

(iii) Substitution effect: The demand

 Then the households would prefer to

Meanings of Supply and Stock

 This relationship between price and the

 In the table above, the produce are able and willing

 The law of supply is based on a moving

 Supply can be used to measure

 If ten people want to buy a book, and

(i) Supply responds to changes in prices

 In contrast, goods are inelastic when a

(iv) Entrepreneurs enter business ventures

 Therefore, in order for a consumer to be

However, when suppliers do not earn

(i) Technology changes. Technology helps a

(iii) Tax/ Subsidy. A producer aims to

(iv) Price of other goods produced.

Price Quantity Rise in Supply Fall in Supply

50 200 320 140

40 160 200 100