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# THEORY OF DEMAND

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• The demand of a commodity (Dx) is a function of the price of the good x with other factors such as the price of related goods (Pr), the income (Y), the population (P), wealth (W) and so on being constant. In other words, Dx = f(Px; W_; Y_; T_; Pr_; etc.) where '_' denotes 'constant'.

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• ### THEORY OF DEMAND

1. 1. THEORY OF “DEMAND”
2. 2. INTRODUCTION • How much to produce and what price to charge? • Factors determining demand for a product. • Explores the relationship between price and demand for a product. • Examines likely impact of the potential factors that influence its demand.
3. 3. WHAT IS DEMAND? The quantity of a product consumers are willing and able to buy at different prices in a specified time period. Types of Demand -Direct and derived demands -Individual and market demand -Recurring and replacement -Complementary and competing -New and replacement demands
4. 4. DETERMINANTS OF DEMAND • • • • • • • • • Price of Product Income of Consumer Price of Related Good Tastes and Preferences Advertising Consumer’s expectation of future Income and Price Growth of Economy Seasonal conditions Population
5. 5. DEMAND SCHEDULE • It shows the price and output relationship. • Tabular representation of price and demand.
6. 6. DEMAND CURVE • The geometrical representation of demand schedule is called the demand curve.
7. 7. LAW OF DEMAND • As the price of a good rises, quantity demanded of that good falls. • As the price of a good falls, quantity demanded of that good rises. • Ceteris paribus.
8. 8. DEMAND FUNCTION • When we express the relationship between demand and its determinant mathematically, the relationship is known as demand function. • The demand for product X can be written in functional form as- Dx= f (Px, Y, Po, T, A, Ef, N )
9. 9. EXCEPTIONS TO THE LAW OF DEMAND • • • • • • Inferior Goods Snob Appeal Demonstration Effect Future Expectation of Prices Insignificant proportion of income spent Goods with no Substitutes
10. 10. CHANGE IN DEMAND VS. CHANGE IN QUANTITY DEMANDED • A shift of the entire demand curve to a new position is called change in demand. • Changes in non-price determinants of demand.
11. 11. QUANTITY DEMANDED • Fluctuations in price, another determinant of demand, cause movement along the demand curve.
12. 12. Why the demand curve slope downwards? • • • • • Law of diminishing marginal utility. Income effect. Substitution effect. New consumers. Multiple use of commodity.
13. 13. ELASTICITY OF DEMAND • Elasticity of demand is defined as the responsiveness of the quantity of a good to changes in one of the variables on which demand depends Price of the commodity  Income of the Consumer  Various other factor DEFINATION-’’The elasticity of demand measures the response of the demand for the commodity to change in price”.
14. 14. PRICE ELASTICITY OF DEMAND • The price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. Percentage change in quantity demanded Price elasticity of demand = Percentage change in price
15. 15. PRICE ELASTICITY OF DEMAND Point Definition Arc Definition EP EP Q/Q P/P Q P P Q Q2 Q1 P2 P 1 P2 P Q2 Q1 1
16. 16. Perfectly Inelastic Demand: Elasticity Equals 0 city of Demand Price Demand \$5 4 1. An increase in price . . . 0 Quantity 100 2. . . . leaves the quantity demanded unchanged. Copyright©2003 Southwestern/Thomson Learning
17. 17. Inelastic Demand: Elasticity Is Less Than 1 Price \$5 4 1. A 22% increase in price . . . Demand 0 90 100 Quantity 2. . . . leads to an 11% decrease in quantity demanded.
18. 18. Unit Elastic Demand: Elasticity Equals 1 Price \$5 4 Demand 1. A 22% increase in price . . . 0 80 100 Quantity 2. . . . leads to a 22% decrease in quantity demanded. Copyright©2003 Southwestern/Thomson Learning
19. 19. Elastic Demand: Elasticity Is Greater Than 1 Price \$5 4 Demand 1. A 22% increase in price . . . 0 50 100 Quantity 2. . . . leads to a 67% decrease in quantity demanded.
20. 20. Perfectly Elastic Demand: Elasticity Equals Infinity Price 1. At any price above \$4, quantity demanded is zero. \$4 Demand 2. At exactly \$4, consumers will buy any quantity. 0 3. At a price below \$4, quantity demanded is infinite. Quantity
21. 21. INCOME ELASTICITY • The degree of responsiveness of the demand for the commodity to a change in the income of the consumer. • It is defined as Ratio of percentage change in the quantity demanded of a commodity to the percentage change in the income of consumer
22. 22. INCOME ELASTICITY • Negative ( inferior commodities ) • Zero ( neutral commodities ) • Greater than zero but less than 1( normal commodities ) • Greater than unity ( Luxurious commodity )
23. 23. INCOME ELASTICITY • Point Definition EI • Arc Definition EI Q/Q Q I I/I I Q Q2 Q1 I 2 I1 I 2 I1 Q2 Q1
24. 24. Cross Elasticity of Demand (CED) • Cross price elasticity (CED) measures the responsiveness of demand for good X following a change in the price of good Y (a related good) • CED = % change in quantity demanded of product A % change in price of product B • With cross price elasticity we make an important distinction between substitute products and complementary goods and services.
25. 25. Substitutes Price of Two Weak Substitutes Good S Demand + Goods S and T are weak substitutes A rise in the price of Good S leads to a small rise in the demand for good T P2 P1 tea and coffee Quantity demanded of Good T
26. 26. - Complements Price of Two Close Complements Good X Goods X and Y are close complements A fall in the price of good X leads to a large rise in the demand for good Y Petrol and petrol car Demand P1 P2 Quantity demanded of Good Y
27. 27. Goods with zero cross-price elasticity of demand . INDEPENDENT Price of Demand Good A Goods A and B have no relationship. P1 A fall in the price of good A leads to no change in the demand for good B P2 Therefore the cross-price elasticity of demand is zero salt! P3 Quantity demanded of Good B