Lecture3 - Demand

7/30/2019 Lecture3 - Demand

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THEORY OF DEMAND

Dr. Rakesh Kumar Sharma

Assistant Professor

School of Behavioral Sciences & Business Studies

Thapar University, Patiala



Meaning

The term ‘Demand’ is used in economics in a specialsense. Ordinary the term Desire, Want &lled demDemand used interchangeably. But in Economics all

three terms have different meaning. If you desire topurchase Color TV but don’t have enough money withyou. Then this desire will remain wishful thinking. It willnot be demand. And inspite of having sufficient moneyyou don’t want to spend it on color TV . Then this desirewill called want and not demand. Only when you areready to spend necessary money to realise your Demand.



Meaning of Demand

Meaning and Definition of Demand According to Benham: “The demand for anything, at a given price,

is the amount of it, which will be bought per unit of time, at thatprice.”

According to Bobber, “By demand we mean the various quantities

of a given commodity or service which consumers would buy in onemarket in a given period of time at various prices.”

Requisites:

a. Desire for specific commodity.

b. Sufficient resources to purchase the desired commodity.

c. Willingness to spend the resources.d. Availability of the commodity at

(i) Certain price (ii) Certain place (iii) Certain time.



Kinds of Demand1. Individual demand

2. Market demand

3. Income demand

- Demand for normal goods (price –ve, income +ve)

- Demand for inferior goods (eg., coarse grain)

4. Cross demand

- Demand for substitutes or competitive goods (eg.,tea & coffee,bread and rice)

- Demand for complementary goods (eg., pen & ink)

5. Joint demand (same as complementary, eg., pen & ink)

7. Direct demand (eg., ice-creams) 8. Derived demand (eg., TV & TV mechanics)

9. Competitive demand (eg., desi ghee and vegetable oils)

10.Demand of unrelated goods



FACTORS AFFECTING DEMAND 1. Prices of Goods

2.Income of Consumer

3.Prices of Related Goods

4.Population

5.Tastes,Habit

6.Expectation about future prices

7.Climatic Factors

8.Govt. Policy

9.Distribution of national income



Demand Schedule

Demand Schedule: a tabular presentation showing different quantities of acommodity that would be demanded at different prices.

Types of Demand Schedules

Individual Demand schedule Market Demand Schedule

Price A

1 50

2 40

3 30

4 20

Price A B C M.S

1 50 45 40 135

2 40 30 38 108

3 35 20 30 85

4 20 15 25 60



Demand Curve

The Graphical Representation of Demand Schedule is called a Demand Curve. It is of two

types:

Types of Demand Curve

Y Y

Price Less Flatter Price More Flatter

O Demand X O Demand X

Individual DC Market DC



Figure 2.1 Market demand for tomatoes

Demand, the assumed inverse relationship between price and quantity purchased, can be

represented by a curve that slopes down toward the right. Here, as the price falls from

$11 to zero, the number of bushels of tomatoes purchased per week rises from zero to

110,000.



Figure 7.2 Market demand curve

The market demand curve for Coke, D A+B, is obtained by summing the quantities that

individuals A and B are willing to buy at each and every price (shown by the individual

demand curves D A and DB).



Demand Curve

Movement along demand curve Vs. Shift in demand curve:

Distinction between change in quantity demanded and change in

demand.

A. Change in quantity demanded – When quantity demandedchanges ( rise or fall ) as a result of change in price alone, otherfactors remaining the same.

Contraction/fall in quantity demanded Extension/Rise in quantity demanded

The change is depicted/ represented by the movement

up or down on a given demand curve. This does notrequire drawing a new demand curve.



Figure 2.2 Shifts in the demand curve

An increase in demand is represented by a rightward, outward, shift in the demand curve,

from D1to D2. A decrease in demand is represented by a leftward, or inward, shift in the

demand curve, from D1 to D3.



The Law of Demand

Prof. Samuelson: “Law of demand states that people will buy more at lower priceand buy less at higher prices, others thing remaining the same.”

Ferguson: “According to the law of demand, the quantity demanded varies inverselywith price”.

Chief Characteristics:

1. Inverse relationship.

2. Price independent and demand dependent variable.

3. Income effect & substitution effect.

Assumptions:

No change in tastes and preference of the consumers.

Consumer’s income must remain the same.

The price of the related commodities should not change.

The commodity should be a normal commodity



The Law of Demand

EXPLAINERS:

Why demand curve slopes downwards?

1. Income effect

2. Substitution effect

3. Diminishing Marginal Utility

4. Different uses

5. Size of consumer

6. Psychological effects



Law of Demand Exceptions:

• Inferior goods

• Articles of snob appeal. (exception: Veblen goods, eg., diamonds)

• Expectation regarding future prices (shares, industrial materials)

• Emergencies

• Ignorance

• Change in fashion, habits, attitudes, etc..

Importance:

• Price determination.

• To Finance Minister

• To farmers• In the field of Planning.



The Law of Demand

P

Q

A

B

P

Q

D1 D2

CHANGE IN PRICE=

change in quantity

demanded

CHANGE IN OTHER=

change in demand

P1

P2

Q1 Q2



The Law of Demand

P

Q

D1 D2

CHANGE IN OTHER=

change in demand



Determinants of Demand

Things other than price that cause the wh

curve to shift

Increase: shift to the right

Decrease: shift to the left



Determinants of Demand

Change in consumer tastes

Change in people’s income

normal goods

inferior goods



What Happens to Demand if…?

SITUATION: You’re the owner of a hot dog making

company:

(a) people change their preference from

hamburgers to hot dogs?





company:

(b) U.S. negotiates a deal w/ China to trade

hot dogs for egg rolls?





company:

(c) the price of ground beef plummets?





company:

(d) the minimum wage rises?





company:

(e) the MWU threatens a strike if owners

fail to meet their demands?





company:

(f) unemployment hits an all-time high?





company:

(g) the price of buns increases due to a

wheat shortage?



Elasticity of demand Definition: “Elasticity of demand is defined as the responsiveness of the quantity

demanded of a good to changes in one of the variables on which demanddepends.”

These variables are price of the commodity, prices of the related commodities,income of the consumer & other various factors on which demand depends. Thus,we have Price Elasticity, Cross Elasticity, Elasticity of Substitution & IncomeElasticity. It is always price elasticity of demand which is referred to as elasticityof demand

A.Price Elasticity Measures how much the quantity demanded of a good changes when its price

changes.

Or

It may be defined as “Percentage Change in Quantity demanded over percentagechange in price”



Factors affecting Elasticity of Demand

1. Availability of substitutes

2. Postponement of consumption

3. Proportion of expenditure (needles: inelastic; TV: elastic)4. Nature of the commodity (necessity vs. luxury; durability/reparability eg., shoes)

5. Different uses of the commodity (paper vs. ink)

6. Time period (elastic in the long term)

7. Change in income (necessaries: inelastic; milk and fruit for a rich man)

8. Habits9. Joint demand

10. Distribution of income

11. Price level (very costly & very cheap goods: inelastic)



Price Elasticity Price Elasticity

• Elastic Demand or more than 1 – When quantity demanded responds greatlyto price changes

• Inelastic Demand or less than 1 – When quantity demanded responds littleto price changes.

• Unitary Elastic – When quantity demanded responds equally to the pricechanges.

• Perfectly inelastic or 0 elastic demand

• Perfectly elastic or infinite elastic demand

Economic factors determine the size of price elasticity for individual goods.Elasticity tends to be higher when the goods are luxuries, when substitutesare available and when consumer have more time to adjust their behavior.



Calculating Price Elasticity

PED = % Change in Qty Demanded

% Change in Price

Points to Remember:

• We drop the minus sign from the numbers by treating all %changes as positive. That means all elasticity’s are positive,

even though prices and quantities move in the oppositedirection because of the law of downward sloping demand.

• Definition of elasticity uses percentage changes in price anddemand rather than actual changes. That means that achange in the units of measurement does not affect theelasticity. So whether we measure price in Rupees or paisa,the price elasticity stays the same.



Some business applications of

Price Elasticity• Price discrimination• Public utility pricing (electricity, railway)• Joint supply (wool and mutton)

• Super markets• Use of machines (lower cost of production for elastic)• Factor pricing (workers producing inelastic demand

products)• International trade (devalue when exports are price-

elastic)• Shifting of tax burden (shift commodity tax when

demand is inelastic)• Taxation policy



Elasticity & Revenue:

• When demand is price inelastic, marginal revenue is negative anda price decrease reduces total revenue.

• When demand is price elastic, marginal revenue is positive and aprice decrease increases total revenue.

• In the borderline case of unit elastic demand, marginal revenue is 0and a price change leads to no change in the total revenue.

B. Income Elasticity of Demand: Is the degree of responsiveness of quantity demanded of a good to a small change in the income of the consumer.

• If the proportion of income spent on a good remains the same asincome increases, then income elasticity for the good is equal toone.

• If the proportion spent on a good increases, then the income

elasticity for the good is greater than one.• If the proportion decreases as income rises, then income elasticity

for the good is less than one.



Income elasticity

Types:• Zero• Negative• Positive (i) low (ii) unitary (iii) high

Empirical evidence suggests that income elasticity falls as incomerises.

Income elasticity and business decisions1. If ei is >0 but <1, sales will increase but slower than the general

economic growth;

2. If ei is >1, sales will increase more rapidly than general economicgrowth

Corollary: in a growing economy while farmers suffer as theirproducts have low income elasticity, industrialists gain as theirproducts have high income elasticity.



Cross Elasticity: A change in the demand for onegood in response to a change in the price of another good represents cross elasticity of demand of the former good for the latter good.

• If two goods are perfect substitutes for each othercross elasticity is infinite and if the two goods aretotally unrelated, cross elasticity between them iszero.

• Goods between which cross elasticity is positive

can be called Substitutes, the good betweenwhich the cross elasticity is negative are notalways complementary as this is found when theincome effect on the price change is very strong.



Degrees of Elasticity of

Demand

1. Perfectly Elastic

2. Perfectly Inelastic

3. Unitary Elastic 4. Relatively more elastic

5. Relatively less elastic



1. Perfectly Elastic

dO X

Y

p

d1

Ed = ∞

2 P f tl I l ti



2. Perfectly Inelastic

p1

OX

Y

p

d

Ed = 0

3 U it El ti



3. Unitary Elastic

p1

OX

Y

p

d1

Ed = 1

d



4. Relatively more

Elastic

p1

OX

Y

p

d1

Ed > 1

d

5 R l ti l l



5. Relatively less

Elastic

p1

OX

Y

p

d1

Ed < 1

d



Figure 7.3 Elastic and inelastic demand

Demand curves differ in their relative elasticity. Curve D1 is more elastic than curve D2, in

the sense that consumers on curve D1 are more responsive to a given price change (P2 to

P1) than are consumers on curve D2.



Figure 7.4 Changes in the elasticity coefficient

The elasticity coefficient decreases as a firm moves down the demand curve. The upper half

of a linear demand curve is elastic, meaning that the elasticity coefficient is greater than

one. The lower half is inelastic, meaning that the elasticity coefficient is less than one. This

means that the middle of the linear demand curve has an elasticity coefficient equal to one.



Figure 7.8 Network effects and demand

As the price falls from P3 to P2, the quantity demanded in the short run rises from Q1 to Q2.

However, sales build on sales, causing the demand in the future to expand outward to, say,

D2. The lower the price in the current time period, the greater the expansion of demand in

the future. The more the demand expands over time in response to greater sales in the

current time period, the more elastic is the long-run demand.



Methods of measurement of

Elasticity1. Percentage or Proportionate Method = Percentage change in demand or; Percentage change in price = Proportionate change in demand

Proportionate change in price 2. Total Outlay (Expenditure) Methods TO=TQ * P ; where, TO=total outlay; TQ=total quantity; P=price of the

commodity

3. Geometric (Point) method – at any given point onthe curve

= lower segment of demand curve upper segment of demand curve



Figure 3.4 Maslow’s hierarchy of needs

The pyramid orders human needs by broad categories from the most prepotent needs on

the bottom to lesser and lesser prepotent needs as an individual moves up the pyramid.

According to Maslow, an individual can be expected to satisfy her needs in the order of

their prepotence, or will move from the bottom of the pyramid through the various levels

to the top, so long as the individual’s resources to satisfy her needs last.



Figure 3.5(a) Demand, price, and need

satisfaction

The extent to which needs are satisfied

depends, in the economists’ view of the world,on

the nature of the need’s demand and its price.

Physiological needs may indeed be more

completely satisfied than other needs, but

that may only be because physiological needs

have relatively low prices (panel (a)). But

then, as shown in this figure (panel (b)), the

price of the means of satisfying physiological

needs might be higher than the prices of the

means of satisfying safety and love needs.

Lecture3 - Demand

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