The document discusses theories of demand, including the definition of demand, factors that influence demand, and the law of demand. It also covers elasticity of demand, indifference curves, budget lines, and welfare analysis. Specifically, it defines demand as the quantity of a good consumers are willing and able to buy at a given price. It also explains that the law of demand states that as price increases, demand decreases, and vice versa.

1. Unit‐1
Theory of demand, Elasticity of
demand
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2. Theory of demand
• Demand is the quantity of a good or service that consumers
are willing and able to buy at a given price in a given time period
• Demand is different to desire! Effective demand is when a desire to
buy a product is backed up by an ability to pay for it
• Latent demand exists when there is willingness to buy among
people for a good or service, but where consumers lack the
purchasing power to be able to afford the product.
• Derived Demand
• The demand for a product X might be connected to the demand for
a related product Y – giving rise to the idea of a derived demand.
For example, demand for steel is strongly linked to the demand for
new vehicles and other manufactured products, so that when an
economy goes into a recession, so we expect the demand for steel
to decline likewise.
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3. Theory of demand
Factors influencing demand
• Price of the good
• Prices of related goods
• Income of the people
• Tastes of consumers
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4. Theory of demand
The Law of Demand : There is an inverse
relationship between the price of a
good and demand.
• As prices fall, we see an expansion of
demand.
• If price rises, there will be
a contraction of demand.
• Ceteris paribus assumption: Many
factors affect demand, but in demand
curve, economists assume all factors
as constant except the price
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Qty
Price Higher prices lead to
contraction of demand
Lower price lead to
expansion of demand
Demand curve

5. Theory of demand
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There are two reasons why more is demanded as price falls:
1. The Income Effect: when the price of a good falls, the consumer
can maintain the same consumption for less expenditure resulting
in increased income (saving) due to less expenditure. Some of the
increase in income (saving) is used to buy more of this product.
2. The Substitution Effect: When the price of a good falls the
product becomes cheaper than an alternative item then some
consumers switch their spending from the alternative good or
service to the product thereby increasing the demand.
Ref: Engineering Economics by R Panneerselvam , PHI

6. Law of demand & supply
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Ref: Engineering Economics by R Panneerselvam , PHI
Price
Demand curve Supply curve
Qty
When price is decreased, the demand
increases and its supply decreases . It is due
to the reason that at lower prices, producers
restrain from releasing more quantities of the
product in the market.
The point of intersection of the supply curve
and demand curve is known as the equilibrium
point. And the price at that point is called the
equilibrium point price.
demand and supply of a product are interdependent and they
are sensitive with respect to the price of that product.

7. Elasticity of Demand
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elastic of demand =( change in demand/ average demand) / (
change in price/ average price)
Ref: Engineering Economics by R Panneerselvam , PHI
Elastic demand
Price
In elastic demand
Price

8. Indifference curves
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An indifference curve is a curve showing
combination of two goods that give the
consumer equal satisfaction and utility.
In other words it is loci of combination
(bundle) that give equal satisfaction to
the customer
Each point on an indifference
curve indicates that a consumer is
indifferent between the two and all points
give him the same utility.
Ref: Engineering Economics by R Panneerselvam , PHI
Qty of of product A
Qty of product B

9. Indifference curves
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Ex. In a observation over a group it has
been observed that following combination
of Apples and bananas provide same utility
Bananas
Apples
CombinationApples Bananas
C1 22 17
C2 14 20
C3 10 26
C4 9 41
C5 7 80
C1
C2
C3
Diminishing marginal utility : The indifference curve is convex due to
diminishing marginal utility. When one has a certain no. of bananas –
that is all one want to eat in a period. Extra bananas give very little
utility, so one may give up a lot of bananas to get something else.

10. Indifference curves
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Indifference curves have the following properties:
1. An indifference curve slopes down.
2. An indifference curve gets flatter as we move right along the
curve.
3. An individual is better off when he or she’s on an indifference
curve that lies farther up and to the right.
•The slope of the indifference curve is known as the marginal rate of
substitution(MRS). MRS tells the marginal utility the individual will
gain (or lose) from moving up or down on the indifference curve

11. Indifference curves
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•Marginal utility is simply the benefit the person gains from consuming
an additional unit of a good
•The MRS is always negative for the same reason that indifference curves
are convex
Ex. A hungry person eating a Dosa finds the first one amazing, the
second one filling, the third one hard to eat, and the fourth one
may be nausea-inducing – Decreasing value or utility or
satisfaction

12. Budget lines
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A budget line shows the combination of goods that can be afforded
with your current income
An individual doesn't just have one indifference curve – they will
have an similar curve at different level of income. and a new income
may mean there is no "optimal" point on the original indifference
curve.
Banana
Apple
Banana
Apple Income consumption curv
Banana
Apple

13. Welfare Analysis
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Economic welfare is the total benefit available to society from an
economic transaction or situation.
Economic welfare is also called community surplus. Welfare is
represented by the area shown by colors in the diagram, which is
made up of the area for consumer surplus (Green), and the area
for producer surplus (blue).
Qty
Price
Consumer
surplus
Producer
surplus
S
D

14. Welfare Analysis
Consumer surplus / Producer surplus
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Consumer surplus is derived whenever the price a consumer
actually pays is less than they are prepared to pay
Producer surplus is the additional benefit to producers, in terms
of profit, gained when the price they receive in the market is more
than the minimum they would be prepared to supply for.
Qty
Price
Consumer
surplus
D
P
Q Qty
Price
Producer
surplus
D
P
Q
S

15. Welfare Analysis
Consumer surplus / Producer surplus
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Economic welfare is also called community surplus. Welfare is
represented sum of consumer surplus & producers surplus
If we consider govt revenue also,
at equilibrium Welfare = CS + PS + GR
Where CS is consumer surplus, PS is producer surplus, Gr is
Government revenue
Welfare analysis considers whether economic decisions by
individuals,/ organizations/ government increase or decrease
economic welfare.
• Note that an increase in market price decreases CS & increases PS
• So an increase in market price does not necessarily have a negative
impact on the economy