Law of demand, elasticity of demand, exceptions to law of demand

1. Determinants of Demand

2. Price Number of
buyers
Determinants of
Demand
Prices of other
goods
Income
Expectations
about future
Quality
Taste Supply

3. Thank you

4. LAW OF DEMAND

5. Law of Demand
 Definition: The law of demand states that other
factors being constant (cetris peribus), price and
quantity demanded of any good and service are
inversely related to each other.
 When the price of a product increases,
the demand for the same product will fall and vice
varsa.

8. Assumptions
 Tastes and preferences of the consumers remain
constant
 No change in the Income of the consumer
 Prices of related goods (substitudes or
complementary) does not change
 Consumers do not expect any change in the prices in
near future.
 No. of buyers should not change drastically

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11. Elasticity – the concept
The responsiveness of one variable to
changes in another
When price rises, what happens
to demand?
Demand falls
BUT!
How much does demand fall?

12. Elasticity – the concept
If price rises by 10% - what happens to
demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent to
which demand will change

13. Elasticity
Price Elasticity of Demand
The responsiveness of demand
to changes in price
Where % change in demand
is greater than % change in price –
elastic
Where % change in demand is less
than % change in price - inelastic

14. Elasticity
The Formula:
Ped =
% Change in Quantity Demanded
___________________________
% Change in Price
If answer is between 0 and 1: the relationship is inelastic
If the answer is above 1 : the relationship is elastic

15. Elasticity
Price
Quantity Demanded
D
If the firm
decides to
decrease price
to (say) 3, the
degree of price
elasticity of the
demand curve
would determine
the extent of the
increase in
demand and the
change therefore
in total revenue.
5
100
3
140
Total Revenue

16. Elasticity
Price (£)
Quantity Demanded
10
D
5
5
6
% Δ Price = -50%
% Δ Quantity Demanded = +20%
Ped = -0.4 (Inelastic)
Total Revenue would fall
Producer decides to lower price to attract sales
Not a good move!

17. Elasticity
Price (£)
Quantity Demanded
D
10
5 20
Producer decides to reduce price to increase sales
7
% Δ in Price = 30%
% Δ in Demand = + 300%
Ped = 10 (Elastic)
Total Revenue rises
Good Move!

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19. Income elasticity of Demand

20. Elasticity
Income Elasticity of Demand:
The responsiveness of demand
to changes in incomes
Normal Good – demand rises
as income rises and vice versa
Inferior Good – demand falls
as income rises and vice versa

21. Elasticity
Income Elasticity of Demand:
A positive sign denotes a normal good
A negative sign denotes an inferior
good

22. Elasticity
 For example:
 Yed = 0.6: Good is an inferior good but inelastic – a
rise in income of 3% would lead to demand falling
by 1.8%
 Yed = 0.4: Good is a normal good but inelastic –
a rise in incomes of 3% would lead to demand rising
by 1.2%
 Yed = 1.6: Good is a normal good and elastic –
a rise in incomes of 3% would lead to demand rising
by 4.8%
 Yed = 2.1: Good is an inferior good and elastic –
a rise in incomes of 3% would lead to a fall in demand of
6.3%

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24. Cross elasticity of demand

25. Elasticity
Cross Elasticity:
The responsiveness of demand
of one good to changes in the price of
a related good – either
a substitute or a complement
Xed =
% Δ Qd of good t
__________________
% Δ Price of good y

26. Elasticity
Goods which are complements:
Cross Elasticity will have negative sign
(inverse relationship between the two)
Goods which are substitutes:
Cross Elasticity will have a positive
impact on sale of the substitute
product (positive relationship between
the two)

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28. Agree / Disagree with the statements
 1. Any value of price elasticity of demand which is
equal to one indicates elastic demand.
 2. When income elasticity of demand is negative, the
good is a necessity.
 3. Cross elasticity of demand between two substitutes
is positive.
 4. Dairy products and steel in India are substitute
products.
 5. Discuss the income elasticity of demand for the
following products-
 Jewellery
 Fresh vegetables

29.  1. Agree
 2.Agree
 In economics a necessity good is a type of normal
good like any other normal good, when income rises,
demand rises. But the increase for a necessity good is
less than proportional to the rise in income, so the
proportion of expenditure on these goods falls as
income rises. This observation for food is known
as Engel’s law. The income elasticity of a necessity
good is thus between zero and one.

30.  Necessity goods are goods that we cannot live without
and will not likely cut back on even when times are
tough, for example food, power, water and gas.
 The more necessary a good is, the lower the price
elasticity of demand, as people will attempt to buy it
no matter the price.
 3. Agree
 Complementary goods have a negative cross-price
elasticity: as the price of one good increases, the
demand for the second good decreases.

31.  Substitude goods have a positive cross-price elasticity: as
the price of one good increases, the demand for the
other good increases.
 Independent goods have a cross-price elasticity of zero:
as the price of one good increases, the demand for the
second good is unchanged.
 4. Disagree
 5. Positive
 6. Negative

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