Demand all concepts

1. Demand
 Demand is defined as that want, need or desire which is backed by
willingness and ability to buy a particular commodity, in a given period of
time.
 Demand is the quantity of a commodity which consumers are willing to
buy at a given price for a particular unit of time.
 Demand is a effective desire, as it is backed by willingness to pay and
ability to pay.

2. Types of Demand
• Direct and Derived Demand
• Recurring and Replacement Demand
• Complementary and Competing goods
• Individual and Market demand

3. Determinants of Demand
Following are the factors which determine the demand for any product.
 Price of the product
 Income of the consumer
 Price of related goods
 Taste and Preferences
 Advertising
 Consumer’s Expectation of future Income and Price
 Population
 Growth of Economy

4. Demand Function
When we express the relation between demand and its determinants
mathematically, the relationship is known as demand function. Thus it can be
said that demand for a product X (Dx) is a function of:
Price of the product X (Px)
Income of the consumer (Y)
Price of related goods (Po)
Taste and Preferences (T)
Advertising (A)
Consumer’s Expectation of future Income and Price (Ef)
Population and Growth of Economy (N)
Dx = f(Px, Y, Po, T, A, Ef, N)

5. Law of Demand
The Law of Demand states that other things remaining constant,
(ceteris paribus) when price of a commodity raises, the demand for
the commodity falls and when the price of the commodity falls, the
demand for that product raises.
This states that, demand for the product is inversely proportional to
its price. The demand function can be illustrated as following to
illustrate law of demand:
Dx = f (Px)
The other factors remain constant only in the short run. In long run
they tend to change. The Law of demand therefore, holds only in the
short run.

6. Characteristics of Law of
Demand
Inverse Relationship
The relationship between price and quantity demanded is inverse that is, if
price raises demand falls and vice versa
Price An Independent Variable And Demand A Dependent Variable:
It is the effect of the price on demand which is examined, and not the effect of
demand on price. When the price increases, the demand decreases and vice
versa. In the other words, in the law of demand price is regarded as an
independent variable and demand as dependent variable.
Other Things Remains the Same
The law of demand assumes that other things remain the same. In the other
words, there should be no change in other factors influencing demand except
price

7. Reasons behind Law of
Demand
This law can be understood with the help of substitution effect, income effect
and Law of diminishing marginal utility, new consumers and different uses of
the commodity.
Substitution Effect:
when the price of the commodity falls, it become more easily affordable and
thus more attractive to the consumer; as also, its substitute become more
expensive, assuming that its price has not changed. The consumer tries to
substitute this particular commodity for other commodities. As a result,
demand for the commodity raises. On the contrary, when price of this
commodity raises, other substitutes become less expensive.

8. Income Effect:
we know that demand depends upon the income of the consumer and law
of demand assumes that income is given. When price of a particular
commodity falls, the consumer’s real income raises, though money remains
the same. Thus, with fall in the price of the commodity, income remaining
the same, purchasing power of the individual raises, including the consumer
to buy more of that commodity.

9. Law of Diminishing Marginal Utility:
The purchase of a commodity involves a sacrifice. The sacrifice is measured
by the price paid. The consumer will never pay for a commodity more than
the money value of its marginal utility to him. But the larger the amount of a
commodity purchased, the less is the marginal utility. Therefore, the
consumer will not buy a large quantity unless the price is low.
This follows from Law of diminishing utility
Qty. of Apples Marginal Utility (Paisa)
1 100
2 80
3 50
From the table it is clear that the household derives utility worth 100p. From
the first apple consumed 80p. from the second apple and 50 paisa from the
third.
If the price of apples is 100p. each, he will buy only one. If the price is 80 p.
he will buy two. When price falls, the consumer increases his purchase for
thereby he increases his total utility. In other words, more apples will be
demanded at lower price. This clearly shows the dependence of the law of
the demand upon the law of diminishing marginal utility and also the
downward slope of demand curve.

10. New Consumers:
New buyers may buy the commodity with a fall in its price. The lower price
would tend to attract those people with lower incomes who felt that they could
not afford it at the higher price. A fall in price thus tends to attract new buyers
and induce the old buyers to buy more. For example, transistors have become
cheaper and even poor people can easily buy transistors. Thus, the demand for
transistors has gone up with a fall in their price. The opposite would happen for
a rise in price.
Different Uses of the Commodity:
Commodities have many uses. If their price rises, they are used only for more
important purposes. As a result their demand will go down. On the opposite,
when the price is reduced, they will be put to various uses and their demand will
rise.
For example: With the increase in the electricity charges, power will be used
primarily for domestic lighting, but if the charges are reduced, people will use
power for cooking, fans, heaters, etc.

11. Exceptions to Law of
Demand
Giffen Goods:
The case of Giffen goods needs a little bit of story telling! In early Ireland, it
was observed that the poor population consumed two goods: meat (which
was costly) and bread (which was cheap). A very strange phenomenon was
observed when the price of bread was increased, it made a large drain on the
resources of the poor people and raise their marginal utility of money to such
an extent that they focused to curtail their consumption of meat and buy
more of bread, which was still the cheapest food. This implied that quantity
demanded of bread (an inferior good) increases with increase in its price.
These are special type of inferior goods.

12. Snob Appeal or Veblen Goods or Social Status Goods: Veblen goods
have snob value, for which the consumer measures satisfaction
derived not by their utility value, but by social status.
Demonstration Effect: Demonstration effect is the influence on a
person’s behavior by observing the behavior of others. Demand for
most of the items of luxury is governed by demonstration effect.
Fashion is one such incidence.
Future expectation of prices: Panic buying is when people increase the
purchase of goods with the expectation that prices will rise more in
the future.
Insignificant Proportion of Income spent: Things of very low value and
limited use like salt and matchbox do not show any impact of price on
their demand.

13. Goods with no substitute:
Those goods which have no substitute, such as life saving drugs, petrol and
diesel, people have no option but to buy them, whatever be the price; hence
demand does not show any effect of price rise.
Emergencies: The law of demand does not apply in situation of emergencies like
war, famine etc. in such period, household behave in an abnormal way. They
Accentuate scarcities and induce further price rises by making increased
purchase even at higher prices.
Consumer’s Psychological Bias or Illusion:
Sometime consumers develop a false idea that a high-priced commodity is of
better quality. When the price of such a commodity falls, they feel (illusion) that
its quality has also deteriorated and, therefore, they do not buy it.

14. Demand Schedule
Demand schedule is the list or tabular statement of the different
combinations of price and quantity demanded of a commodity.
Point on Demand Price (Rs per cup) Demand (‘000 cups)
A 15 50
B 20 40
C 25 30
D 30 15
E 35 10
F 40 5

15. Demand Curve
The demand curve shows the relationship between price of a good and the
quantity demanded by consumers, ceteris paribus. It is a graphical
presentation of demand schedule.
Demand Curve
D
D
d
a
Quantity
Price
0
15
30
15 50
Linear Demand Curve
D
D
d
a
Quantity
Price
0
15
30
15 50

16. Shift in Demand Curve
The movement along the same demand curve is known as a
contraction or expansion in quantity demanded, which occurs due to
rise or fall in the price of the commodity.
Whereas, a shift of demand curve due to a change in any of the factors
other than price such as income, taste and preferences, or price of
other goods, is known as change in demand

17. Demand Schedule for coffee with
increased Income.
Point on
Curve
Price
(Rs per cup)
Demand (‘000
cups) Monthly
Income (Rs.
20,000)
Demand (‘000
cups) Monthly
Income (Rs.
30,000)
A 15 50 60
B 20 40 50
C 25 30 40
D 30 15 25
E 35 10 15

18. Change in demand
Price
Quantity
0
25
20 30 40
D
D
D1
D1
D2
D2
Demand curve shifts to the right if income
rises and shifts to the left if income falls,
ceteris paribus.

19. Supply
Demand and supply are like two side s of a coin or two blade of
scissors. Just like demand indicates the willingness of the purchaser to
buy a particular commodity, supply means willingness of the firm to
sell a particular commodity.
Supply refers to the quantities of a good or service that
the seller is willing and able to provide at a price , at a
given point of time, ceteris paribus.

20. Determinats of Supply
• Price of the commodity
• Cost of production
• State of Technology
• Number of Firms
• Government Policies

21. Supply Function
When we express mathematically the relation between supply (dependent
variable) and its determinants (independent variables), the functional
representation is termed as supply function. Thus supply of a product X (Sx)
is a function of:
I. Price of the commodity (Px)
II. Cost of production (C)
III. State of Technology (T)
IV. Number of Firms (N)
V. Government Policies (G)
Sx = (Px, C, T, G, N)

22. Law of Supply
The Law of Supply states that other things remaining the same, the
higher the price of a commodity, the greater is the quantity supplied.
The logic is easy to understand Price of the product is the revenue to
the supplier; therefore higher price means greater revenue to the
supplier and hence greater is the incentive to supply.

23. Supply Schedule
Supply schedule of a commodity is a list or a tabular statement of different
combinations of price and quantity supplied of that commodity.
Point on Supply Curve Price (Rs. Per cup) Supply (‘000 cups per
month)
A 15 10
B 20 15
C 25 30
D 30 45
E 35 60

24. Supply Curve
Supply curve is the graphical presentation of the supply schedule. It represents
the quantities supplied of a commodity at different price level. Like a demand in
order to derive the supply curve for an individual firm, we plot quantity
supplied on the horizontal axis and price on the vertical axis.
S
S
a
d
10 45
Quantity
p
r
i
c
e
0
15
30
10 45
Quantity
p
r
i
c
e
0
15
30
Supply Curve Linear Supply Curve
a
d
S
S

25. Shifts in Supply Curve
Change in quantity supplied refers to movements along the same supply curve
due to change in the price of the commodity.
However when change in supply is associated with change in factors like cost
of production, technology, etc., it causes a shift of the supply curve upwards or
downwards.
Price
Quantity
0
25
20 30 40
S1 S
S2
S1 S
S2
Change in Supply

26. Elasticity of demand
The elasticity of demand explains the quantitative aspect of the price-
demand of change relationship. The elasticity of demand is the ratio of
change in quantity demanded due to the change in the variables
affecting demand. These variables can be:
 Price of the product
 Income of the buyer
 The price of the related goods
 Advertisement
 Future expectation of prices
The degree of responsiveness of demand to the change in its
determinants is called elasticity of demand.

27. According to Prof. A.Cairncross
“The elasticity of demand for a commodity is the rate at
which the quantity bought changes as the price
changes.”
According to Prof. Eastham
“The elasticity of demand is the measure of the
responsiveness of quantity demanded to a change in
price”

28. Difference between Law of Demand and Elasticity of
demand
Basis of Difference Law of Demand Elasticity of Demand
• Meaning • If the other things remain
constant, when the price
increases demand decreases
and vice versa is known as
law of demand.
• The measurement of change
in quantity demanded of a
good due to change in price is
known as elasticity of demand.
• Nature • Law of demand is qualitative
in nature
• Elasticity of demand is
quantitative in nature
• Relationship • Law of demand specifies the
inverse relationship between
demand and price
• Elasticity of demand specifies
positive, negative & zero
relationship
• Factors affecting • Law of demand studies the
main factor, related to price
affecting the demand
• Elasticity of demand studies
the factors affecting demand
related to price, income,
substitutes, advertisement, etc

29. Kinds/Types of Elasticity of Demand
The demand of the commodity is influenced by many factors. In
practice, the effect of only those factors on elasticity of demand is
measured which have significant effect on the demand of the
commodity.
On this basis, elasticity of demand classified as under:
• Price elasticity of demand
• Income elasticity of demand
• Cross elasticity of demand

30. Price Elasticity of Demand
Price elasticity of demand measure the proportionate
change in quantity demanded of a commodity to a given
change in its price.
Price is considered to be the most important among all
independent variable that affect the demand of any
commodity. That is way price elasticity is usually denoted
as -℮p or simply as ℮

31. Types/Degrees of Price Elasticity of
Demand
Different commodities respond differently to changes in
their price. A price change has relatively less impact on
quantity demanded of a necessity than it has on the
quantity demanded of a luxury. In fact, it is the nature of
the commodity which is responsible for different elasticity
of demand in case of different commodities.
a. Perfectly elastic demand
b. Absolutely inelastic demand
c. Unit elasticity of demand
d. Relatively elastic demand
e. Relatively inelastic demand

32. Perfectly Elastic Demand
When no reduction in price is needed to cause an increase
in quantity demanded.
℮=∞
Price
Quantity demanded
For ex: Imaginary Goods

33. Perfectly Inelastic Demand
Where a change in price, however large, cause no change in
quantity demanded.
℮ = o
Price
Quantity demanded
For ex: Salt

34. Unit elasticity of Demand
Where a given proportionate change in price causes an
equally proportionate change in quantity demanded.
℮ = 1
Price
Quantity demanded
For Ex: Cloths

35. Relatively elastic Demand
Where a change in price causes a more than proportionate
change in quantity demanded.
℮ > 1
Price
Quantity demanded
For Ex: Car

36. Relatively Inelastic Demand
Where a change in price causes a less proportionate change
in quantity demanded.
℮ < 1
Price
Quantity demanded
For Ex: Tea

37. Methods of Measuring Price
Elasticity of demand
• Ratio or Percentage Method
• Arc Elastic Method
• Total Outlay Method

38. The proportionate measure of elasticity has some distinct advantage
over the other measures. This method allows comparison of changes
in two qualitatively different variable, namely changes in physical
units (demand) and changes in monetary units (price). It is also
helpful in deciding how big a change in price and quantity is:
Q2 – Q1/ Q1
℮p = ----------------
P2 – P1 / P1
Where,
Q1 = Original quantity demanded
Q2 = New quantity demanded
P1 = Original price level
P2 = New Price level

39. Test yourself
Suppose quantity demanded of coconut is initially 800
units at a price of Rs. 10 and increase to 1000 units
when price to Rs. 8. Calculate price elasticity of demand
of coconut

40. Q2 – Q1/ Q1
℮p = ----------------
P2 – P1 / P1
200 2
℮p = ------ / ----
800 10
= - 1.25
Since value of ℮p > 1, therefore it can be said that
demand for coconut is relatively elastic.

41. Arc Elasticity Method
When price elasticity is to be found between two points on demand
curve, the problem arises which price and quantity (old figures i.e. Q1
& P1 or new Figures Q2 & P2) should be taken as base. Moreover
measuring price elasticity at a single point does not represent full arc
between two points. Therefore to avoid confusion and to have full
representation of complete arc between Q1P1 and Q2P2, average of
two prices and two quantities are taken as base. Therefore, under arc
elasticity method, price elasticity of demand between two points on
demand curve is calculated.

42. Q1 - Q2 P1 + P2
℮p = ------------ * -------------
Q1 + Q2 P1 - P2
Where,
Q1 = Quantity demanded before price change
Q2 = Quantity demanded after price change
P1 = Price before change (old Price)
P2 = Price after change (new Price)

43. Total Outlay Method
Price elasticity can also be measured on the basis of change in the
total outlay (total expenditure by consumer)
Where, Total outlay = Price * Quantity
However, by this method we can only say whether a good is elastic or
inelastic, we cannot find out the exact numeric elasticity. We can
explain this concept with the help of the examples:

44. A)
When as a result of change in price of a good, the total outlay on the
remains the same, the price elasticity for the good is said to be unity.
Price/kg of
Apples (P)
Quantity (kg)
Demanded (D)
Total Outlay
P Q TO = P * Q
12 10 120
10 12 120
For e.g. table shows that when price of the apple is Rs.12 per kg, demand
is 10kg i.e. total outlay of Rs.120/-. when price falls to Rs. 10 per kg,
demand increase to 12kg, again a total outlay is Rs. 120/-. Here price of
apple falls but the total outlay remain same, therefore demand is said to
be unitary elastic

45. B)
When as a result of increase in the price of good, total outlay on the goods
falls or when as a result of decrease in price, the total expenditure made on
the good increases, we say price elasticity of demand is greater then unity.
Price/kg of
Apples (P)
Quantity (kg)
Demanded (D)
Total Outlay
P Q TO = P * Q
12 10 120
10 14 140
For e.g. As a fall in price of apple from Rs.12 to Rs.10 per kg, the total
outlay on apple increases from Rs.120 to Rs.140, indicating elastic demand
for apples.

46. C)
When as a result of increase in price of a good, the total outlay made on the
good increases or when as a result of decrease in price, the total outlay made
on the good falls, we say that price elasticity of demand is less than unity.
Price/kg of
Apples (P)
Quantity (kg)
Demanded (D)
Total Outlay
P Q TO = P * Q
12 10 120
10 11 110
For e.g. As a fall in price of apple from Rs.12 to Rs.10 per kg, the total
outlay falls from Rs.120 to Rs.110 indicating inelastic demand.

47. Relationship between Price
Elasticity and Revenue
A firm which wants to maximize its total revenue would certainly want to
know whether increasing or decreasing price of its product will increase its
revenue or not. This decision should be based on the price elasticity of the
product of the firm. Decision should be based upon following rules:
If Ep>1, then decreasing the price will increase the revenue
Price Quantity demanded Total outlay
P Q TO = P * Q
12 10 120
10 14 140
8 20 160
Here, Ep> 1, the firm is maximizing it revenue as its decreasing price,
because the percentage change in the quantity demanded is more than the
percentage change in the price.

48. Price Quantity demanded Total outlay
P Q TO = P * Q
8 12 96
10 11 110
12 10 120
If Ep< 1, then increasing the price will increase its revenue.
Here, Ep<1, and firm is maximizing its revenue as it increase the price,
because the percentage change in the quantity demanded is less than the
percentage change in price.

49. Factors determining Price Elasticity of
Demand
1. Nature of the Commodity: the demand for necessities is generally
about price inelastic because the consumption of the necessary
articles (e.g., salt or wheat) does not change much with a change in
price. Demand for comforts and luxuries like T.V, CD players, etc. is
relatively more elastic.
2. Availability of Substitutes: one of the most important
determinants of elasticity of demand for a commodity is the
availability of close substitute. The higher the degree of closeness of
the substitutes, the greater the elasticity of demand for the
commodity. For example, coffee and tea may be considered as close
substitute for each other. If the price of the coffee rises, we may
curtail its purchase and take to tea and vice versa.

50. 3. Number of uses: if a commodity can be put to more than one
use, it would be relatively price elastic. Consider electricity, it is used for
various purposes; when it is relatively cheap, it is used for all possible
purposes, otherwise its use is restricted to the most immediate purpose.
On a contrary, consider an item like calculator, or life saving drugs,
which have only one use. Demand for such goods would thus be
relatively price inelastic.
4. Proportion of income spend on the commodity: The
greater the proportion of income spend on purchasing a commodity,
the more sensitive would be to price, due to the income effect.
5. Time: demand for any commodity is usually more price elastic in the
long run. The reason is simple; consumers take time to adjust their
consumption pattern to accommodate substitute in their consumption
bundles. A shift from petrol driven automobiles to CNG driven ones is
the typical example.

51. 6.Durability of the commodity: perishable commodities
like eatables are relatively price inelastic in comparison to
durable items like consumer electronic appliances, cars,
etc.
7. Items of addiction: items of intoxication and addiction
are relatively price inelastic. Consider the example of
cigarettes, if their price rises, smokers may not be able to
promptly cut down their consumption of cigarettes and
may thus not respond instantly to an increase in price.

52. Income Elasticity of Demand
Income is the important determinant of demand of commodities. A
higher income implies more purchasing power generating to higher
demand for commodities, while low income means less purchasing
power generating lower demand for commodities.
Income elasticity may be defined as the degree of responsiveness of
quantities demanded to a given change in the income.
According to Prof. Waston, “ Income elasticity of demand is the rate
of change of quantity with respect to change in income, other
determinants remaining constant.”

53. Proportionate change in the quantity demanded
℮i = -------------------------------------------------------------
Proportionate change in Income
Q1 – Q2/ Q1
℮i = -------------
I1 – I2/ I1
Here,
Q = Quantity demanded
I = Income of the consumer

54. Types of Income Elasticity of
Demand
1. Zero Income elasticity of demand: If the change in income will have no
effect on the quantities demanded, then it is zero income elasticity of
demand. Such goods are known as neutral goods. For e.g., salt, medicine,
match box, etc.
Quantity demand
Income

55. 2. Positive Income elasticity of demand: If the demand of the
commodity increases with an increase in the income of the
consumers and decreases on the fall in the income of its consumers,
then it is positive income elasticity of demand. A good that has
positive income elasticity is regarded as a normal good. Example are
clothes, jewellery, etc.
3. Negative Income Elasticity: If the increase in the income of
consumer decreases the demand for the commodity, and the
decrease in the income of the consumer increase the demand for the
commodity, then it is negative income elasticity of demand. A good
that has negative income elasticity of demand is regarded as inferior
good. Typical example would be inferior of cereals; a consumer
would switch over consumption to superior quality with increase in
income.

56. Importance of Income elasticity of
demand
The income elasticity of demand has important implication for short-term
operation and a long-run strategic planning.
1. Management of the firm that supply products with higher income elasticity
of demand will anticipate rapid growth of the sales as economy grows.
2. The firm that supply products with relatively low income elasticity of
demand will anticipate stability in their sales. As management of such
firms cannot expect sales increase as the economy grows.
3. If a product is regarded as an inferior good by market as a whole, the firm
must expect the quantity demanded of the product to decline as economy
grows as income rise.
So, the knowledge of income elasticity can thus be useful in forecasting
demand, when a change in personal income is expected, other things
remaining the same. It also helps in avoiding over production or under
production.

57. ENGEL CURVE
An curve is the function relating the quantity purchased of a
commodity to the level of money income. In other words, the income-
demand curve showing the relationship between money income and
demand is known as Engel Curve.
Engel curve is termed after Ernst Engel (1821 – 96), a famous Germen
statistician who first made extensive studies of the relationship
between income and consumption.

58. Luxurious
Goods
Inferior
Goods
Quantity
Demanded
Quantity
Demanded
I
N
C
O
M
E
I
N
C
O
M
E
Necessary
Goods
Quantity
Demanded
I
N
C
O
M
E
In first figure Engel curve is showing the relationship between income and
demand in case of necessities. Here Engel curve is mainly flat.
In second figure Engel Curve showing relationship between income and
demand in case of luxury goods. Demand for such goods increase rapidly with
the increase in income.
In third figure Engel curve relevant for income-demand relationship in case of
inferior goods.

59. Cross Elasticity of Demand
When the demand of two commodities is related with one another so that
the change in price of one commodity change the demand of other
commodity, it is called cross elasticity of demand.
It may be defined as responsiveness of a demand for a commodity due to
change in the price of a related commodity.
If there are two commodities X and Y, then cross elasticity of demand X with
respect of Y can be obtained by the following formulae:
Proportionate change in quantity demanded of commodity X
℮c = ---------------------------------------------------------------------------
---
Proportionate change in Price of commodity Y

60. Qx1 – Qx2/ Qx2 + Qx1
℮c = ----------------------------
Py1 – Py2/ Py2 + Py1
Here,
℮c = Cross elasticity of demand
Qx1 = Demand of X before change in price of Y
Qx2 = Demand of X after change in price of Y
Py1 = Original Price of Y
Py2 = Change price of Y
• CROSS ELASTICITY WILL HAVE POSITIVE SIGN IF TWO GOODS ARE
SUBSTITUTES
• CROSS ELASTICITY WILL HAVE NEGATIVE SIGN IF TWO GOODS ARE
COMPLEMENTARY

61. Elasticity of Supply
There is only one type of identifiable elasticity of supply measuring the
responsiveness of market supply to change in the price of the product. The
elasticity of supply, Es, is measured by using the formulae.
percentage change in quantity supplied
Es = ___________________________________________
percentage change in price
Supply curves normally slope upward from left to right, elasticity of supply
is usually positive.