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MICRO ECONOMICS
MODULE 1
DEMAND ANALYSIS
Dr. Kushwinder Kaur ,
Assistant Professor
DDE, Kurukshetra University
Meaning of Demand
 Demand is defined as the consumer’s willingness
and ability to pay for a good or service per unit of
time at a particular price
 Demand of a consumer/household for a particular
good or service is Individual demand and
summation of individual demand is called as
market demand
DEMAND FUNCTION
 A demand function for a good expresses a causal
relationship between quantity demanded of the
good and its own price. In other words, it is a
functional relationship between demand and
price.
 If the good is X , Qx is quantity demand and Px is
the price of good X then the general form of the
demand function will be
Qx = f( Px )
Law of Demand
 The law states that “other factors remaining the
same”, price and quantity demand of any good and
service are inversely related to each other. When the
price of a good increases, the demand for the same
good will fall and vice-versa.
 “Other factors remaining same” means the factors
other than its price do not change i.e. income, the
prices of substitutes and complements, consumer
tastes and preferences and expectations of future
prices etc. remain the same.
Law of Demand
Let demand function be:
Qx = f( Px, Pr, I,T, E, Y) where
Qx= quantity demanded of good X
Px= Price of good X
Pr= Price of related goods
I= Income of the consumer
T= Tastes and preferences of the consumer
E= Expectations of price changes
Y= any other changes (economic, social, demographic
factors etc.)
Demand Schedule and Demand Curve
 The relationship between the price of a good and
the quantity demanded is given by the demand
schedule.
 A demand curve / schedule shows the
relationship between price and demand over a
hypothetical range of prices.
Demand Schedule and Demand Curve
Why does demand curve slope downwards?
Causes of downward sloping of demand curve:
 Law of diminishing marginal utility and equi-
marginal utility
 Price effect
 Income effect
 Substitution effect
 Different uses of the good
Exceptions to the Law of Demand
Situations under which the law of demand may not hold
true i.e. demand increases with increase in price and it
falls with fall in price:
 Articles of distinction like costly jewelery
 Expectations of price changes
 Ignorance
 Emergency situation like war, floods, droughts etc.
 Giffen goods
Elasticity of demand
 Proportionate change in quantity demanded of a good due
to proportionate change in each of the determinants
affecting its demand (its price or income of the consumer
or price of related goods) keeping others as constant.
Ed =
proportionate change in quantity demanded
proportionate change in its determinant
=
∆q
∆p
x
p
q
where ∆ denotes a change and p , q are initial price
and quantity respectively
Types of Elasticity of demand
 Main three types of elasticity of demand
are:
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
Price Elasticity of demand
1. Price elasticity of demand (Ep)– It is the degree of
responsiveness of quantity demanded of a good due to a change in its
own price, other things remaining the same.
 Ep = -
percentage change in quantity demanded of a good
percentage change in its price
=
∆q
∆p
x
p
q
where ∆ denotes a change and p , q are initial price and quantity
respectively.
Negative sign is ignored due to inverse relationship between price and
demand
Price elasticity of demand - Types
Price elasticity of demand is of five types:
a) Relatively elastic demand (Ed >1): If a change in the price will lead to a
larger percentage/proportionate change in the quantity demanded. A
good with a price elastic demand has a relatively flat demand curve
Price elasticity of demand - Types
b) Unitary elastic demand (Ed =1): If a change in price leads to the same
percentage/proportionate change in the quantity demanded. The demand curve
for a good with a unit price elastic demand is a rectangular hyperbola
Price elasticity of demand - Types
c) Relatively inelastic demand (Ed <1): If a change in the price leads to a
smaller percentage/proportionate change in the quantity demanded. A good
with a price inelastic demand has a relatively steep demand curve
Price elasticity of demand - Types
Two Extreme cases:
d) Perfectly elastic demand (Ed=∞): if a small fall in price increases the
quantity demanded infinitely or with a small rise in price, quantity
demanded becomes zero. A good with a perfectly price inelastic demand
has a vertical demand curve.
Price elasticity of demand - Types
e) Perfectly inelastic demand (Ed=0): a change in price will not lead to
any change in the quantity demanded. A good with a perfectly price
inelastic demand has a vertical demand curve
Income Elasticity of demand
2. Income elasticity of demand (Ey) – It measures the percentage
change in a consumer's purchase of a good as a result of a percentage
change in her/his income, others things like price of the good or related
goods, taste of the consumers etc., remaining the same.
Ey =
Percentage change in quantity demanded
Percentage change in income of consumer
=
∆q
∆y
.
y
q
where ∆ denotes a change and y , q are initial income and
quantity respectively
Cross Elasticity of demand
3. Cross elasticity of demand (Ec) – when a price change of a good
leads to a change in demand for another good, other things remaining the
same. It is measured as:
Ec =
Percentage change in quantity demanded of good A
Percentage change in price of good B
=
∆Q𝑎
∆𝑃𝑏
x
𝑃𝑏
Qa
where ∆ denotes a change
Qa = initial quantity demanded of good A
Pb = initial price of good B
If Ec>0 then goods are substitutes
If Ec<0 then goods are complements
If Ec=0 then goods are independent
Measurement of elasticity of demand
Four methods to measure elasticity of demand are:
 1. Total outlay method
 2. Flux’s percentage method
 3. Point method
 4. Arc elasticity of demand
Measurement of elasticity of demand
 1. Total Expenditure method: In this method, Ed is
measured on the basis of change in total expenditure
(T.E) in response to a change in price.
• If T.E before and after the price change remains same
then Ed = 1(Unitary elastic demand)
• If T.E increases with fall in price and decreases with
rise in price then Ed>1(Elastic demand)
• If T.E decreases with fall in price and increases with
rise in price then Ed>1(inelastic demand)
Measurement of elasticity of demand
OX-axis shows T.E
OY-axis shows Price
Measurement of elasticity of
demand
 2. Percentage method:
Ep= -
percentage change in quantity demanded of a good
percentage change in its price
=
∆q
∆p
x
p
q
where
∆q = change in quantity demanded
∆p = change in price
p = initial price
q = initial quantity
Measurement of elasticity of demand
 3. Point method: Also called as geometric method, it
measures elasticity at any point on a demand curve as the
ratio of its lower segment to the upper segment.
Ed =
lower segment of demand curve
upper segment of demand curve
Measurement of elasticity depends upon the nature of
demand curve.
Measurement of elasticity of demand
 Linear demand curve
Measurement of elasticity of demand
 Non-linear demand curve : a tangent is drawn at the point
at which Ed is to be measured and lower segment is
divided by upper segment.
At point R:
Ed =
𝑅𝑇′
𝑅𝑇
Measurement of elasticity of demand
 4. Arc elasticity of demand: Under this method, Ed is
measured by using average of initial of price and new
price and the initial quantity and new quantity demanded
i.e.
 Ed =
𝑄−𝑄1
(𝑄+𝑄1)
2
𝑃−𝑃1
(𝑃+𝑃1)
2
where
Q = initial quantity, Q1 = new quantity
P = initial price, P1 = new price

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BA-I Economics (Demand Analysis)_1590144618.pdf

  • 1. MICRO ECONOMICS MODULE 1 DEMAND ANALYSIS Dr. Kushwinder Kaur , Assistant Professor DDE, Kurukshetra University
  • 2. Meaning of Demand  Demand is defined as the consumer’s willingness and ability to pay for a good or service per unit of time at a particular price  Demand of a consumer/household for a particular good or service is Individual demand and summation of individual demand is called as market demand
  • 3. DEMAND FUNCTION  A demand function for a good expresses a causal relationship between quantity demanded of the good and its own price. In other words, it is a functional relationship between demand and price.  If the good is X , Qx is quantity demand and Px is the price of good X then the general form of the demand function will be Qx = f( Px )
  • 4. Law of Demand  The law states that “other factors remaining the same”, price and quantity demand of any good and service are inversely related to each other. When the price of a good increases, the demand for the same good will fall and vice-versa.  “Other factors remaining same” means the factors other than its price do not change i.e. income, the prices of substitutes and complements, consumer tastes and preferences and expectations of future prices etc. remain the same.
  • 5. Law of Demand Let demand function be: Qx = f( Px, Pr, I,T, E, Y) where Qx= quantity demanded of good X Px= Price of good X Pr= Price of related goods I= Income of the consumer T= Tastes and preferences of the consumer E= Expectations of price changes Y= any other changes (economic, social, demographic factors etc.)
  • 6. Demand Schedule and Demand Curve  The relationship between the price of a good and the quantity demanded is given by the demand schedule.  A demand curve / schedule shows the relationship between price and demand over a hypothetical range of prices.
  • 7. Demand Schedule and Demand Curve
  • 8. Why does demand curve slope downwards? Causes of downward sloping of demand curve:  Law of diminishing marginal utility and equi- marginal utility  Price effect  Income effect  Substitution effect  Different uses of the good
  • 9. Exceptions to the Law of Demand Situations under which the law of demand may not hold true i.e. demand increases with increase in price and it falls with fall in price:  Articles of distinction like costly jewelery  Expectations of price changes  Ignorance  Emergency situation like war, floods, droughts etc.  Giffen goods
  • 10. Elasticity of demand  Proportionate change in quantity demanded of a good due to proportionate change in each of the determinants affecting its demand (its price or income of the consumer or price of related goods) keeping others as constant. Ed = proportionate change in quantity demanded proportionate change in its determinant = ∆q ∆p x p q where ∆ denotes a change and p , q are initial price and quantity respectively
  • 11. Types of Elasticity of demand  Main three types of elasticity of demand are: 1. Price elasticity of demand 2. Income elasticity of demand 3. Cross elasticity of demand
  • 12. Price Elasticity of demand 1. Price elasticity of demand (Ep)– It is the degree of responsiveness of quantity demanded of a good due to a change in its own price, other things remaining the same.  Ep = - percentage change in quantity demanded of a good percentage change in its price = ∆q ∆p x p q where ∆ denotes a change and p , q are initial price and quantity respectively. Negative sign is ignored due to inverse relationship between price and demand
  • 13. Price elasticity of demand - Types Price elasticity of demand is of five types: a) Relatively elastic demand (Ed >1): If a change in the price will lead to a larger percentage/proportionate change in the quantity demanded. A good with a price elastic demand has a relatively flat demand curve
  • 14. Price elasticity of demand - Types b) Unitary elastic demand (Ed =1): If a change in price leads to the same percentage/proportionate change in the quantity demanded. The demand curve for a good with a unit price elastic demand is a rectangular hyperbola
  • 15. Price elasticity of demand - Types c) Relatively inelastic demand (Ed <1): If a change in the price leads to a smaller percentage/proportionate change in the quantity demanded. A good with a price inelastic demand has a relatively steep demand curve
  • 16. Price elasticity of demand - Types Two Extreme cases: d) Perfectly elastic demand (Ed=∞): if a small fall in price increases the quantity demanded infinitely or with a small rise in price, quantity demanded becomes zero. A good with a perfectly price inelastic demand has a vertical demand curve.
  • 17. Price elasticity of demand - Types e) Perfectly inelastic demand (Ed=0): a change in price will not lead to any change in the quantity demanded. A good with a perfectly price inelastic demand has a vertical demand curve
  • 18. Income Elasticity of demand 2. Income elasticity of demand (Ey) – It measures the percentage change in a consumer's purchase of a good as a result of a percentage change in her/his income, others things like price of the good or related goods, taste of the consumers etc., remaining the same. Ey = Percentage change in quantity demanded Percentage change in income of consumer = ∆q ∆y . y q where ∆ denotes a change and y , q are initial income and quantity respectively
  • 19. Cross Elasticity of demand 3. Cross elasticity of demand (Ec) – when a price change of a good leads to a change in demand for another good, other things remaining the same. It is measured as: Ec = Percentage change in quantity demanded of good A Percentage change in price of good B = ∆Q𝑎 ∆𝑃𝑏 x 𝑃𝑏 Qa where ∆ denotes a change Qa = initial quantity demanded of good A Pb = initial price of good B If Ec>0 then goods are substitutes If Ec<0 then goods are complements If Ec=0 then goods are independent
  • 20. Measurement of elasticity of demand Four methods to measure elasticity of demand are:  1. Total outlay method  2. Flux’s percentage method  3. Point method  4. Arc elasticity of demand
  • 21. Measurement of elasticity of demand  1. Total Expenditure method: In this method, Ed is measured on the basis of change in total expenditure (T.E) in response to a change in price. • If T.E before and after the price change remains same then Ed = 1(Unitary elastic demand) • If T.E increases with fall in price and decreases with rise in price then Ed>1(Elastic demand) • If T.E decreases with fall in price and increases with rise in price then Ed>1(inelastic demand)
  • 22. Measurement of elasticity of demand OX-axis shows T.E OY-axis shows Price
  • 23. Measurement of elasticity of demand  2. Percentage method: Ep= - percentage change in quantity demanded of a good percentage change in its price = ∆q ∆p x p q where ∆q = change in quantity demanded ∆p = change in price p = initial price q = initial quantity
  • 24. Measurement of elasticity of demand  3. Point method: Also called as geometric method, it measures elasticity at any point on a demand curve as the ratio of its lower segment to the upper segment. Ed = lower segment of demand curve upper segment of demand curve Measurement of elasticity depends upon the nature of demand curve.
  • 25. Measurement of elasticity of demand  Linear demand curve
  • 26. Measurement of elasticity of demand  Non-linear demand curve : a tangent is drawn at the point at which Ed is to be measured and lower segment is divided by upper segment. At point R: Ed = 𝑅𝑇′ 𝑅𝑇
  • 27. Measurement of elasticity of demand  4. Arc elasticity of demand: Under this method, Ed is measured by using average of initial of price and new price and the initial quantity and new quantity demanded i.e.  Ed = 𝑄−𝑄1 (𝑄+𝑄1) 2 𝑃−𝑃1 (𝑃+𝑃1) 2 where Q = initial quantity, Q1 = new quantity P = initial price, P1 = new price