Page 1 THEORY OF DEMAND P. Bharathi Page 2 What is Demand? The willingness to buy a good or service...

THEORY OF DEMANDTHEORY OF DEMAND

P. BharathiP. Bharathi

What is What is Demand?Demand?• The willingness to buy a good or The willingness to buy a good or

service at all pricesservice at all prices

• What is the law of Demand?What is the law of Demand?

• If nothing else changes, the quantity If nothing else changes, the quantity demanded of a demanded of a

good or service is greater at lower good or service is greater at lower prices than higher.prices than higher.

Determinants of Determinants of DemandDemand

• Prices of other goods ( substitute or Prices of other goods ( substitute or complementary)complementary)

• Outlook (consumer expectation of Outlook (consumer expectation of future income and prices)future income and prices)

• Income (normal goods versus inferior Income (normal goods versus inferior goods)goods)

• Number of potential customers (pop. Number of potential customers (pop. of market)of market)

• Tastes (or fashions)Tastes (or fashions)

Reasons for inverse relation between Reasons for inverse relation between price & demandprice & demand

1.1. Income EffectIncome Effect –current buyers buy more. –current buyers buy more.

2. 2. Substitution EffectSubstitution Effect– new buyers now purchase.– new buyers now purchase.

3. 3. Diminishing Marginal UtilityDiminishing Marginal Utility - because buyers - because buyers of successive units receive less marginal utility,of successive units receive less marginal utility,

they will buy more only when the price is lowered.they will buy more only when the price is lowered.

Rs.54321

……a specified time a specified time periodperiod……other things remaining other things remaining constantconstant

P QD

1020355580

Price decreasesPrice decreases;; QD increasesQD increasesConsumers Consumers “willingness to buy”“willingness to buy”

Rs.5Rs.5

Rs.Rs.44

Rs.Rs.33

Rs.Rs.22

Rs.Rs.11

D

0 10 20 35 55 80Quantity Demanded

GRAPHING GRAPHING DEMANDDEMAND

PP

QQoo

Rs5Rs5

44

33

22

11

PP QQDD

$5$544332211

10102020353555558080

Price of CornPrice of Corn

Quantity of CornQuantity of Corn

CORNCORN

10 20 30 40 50 60 70 10 20 30 40 50 60 70 8080

5555

PP

QQoo

Rs.5Rs.5

44

33

22

11

PP QQDD

Rs.5Rs.544332211

10102020353555558080



CORNCORN

10 20 30 40 50 60 70 10 20 30 40 50 60 70 8080


3535

PP

QQoo

Rs.5Rs.5

44

33

22

11

PP QQDD

Rs.5Rs.544332211

10102020353555558080



CORNCORN

10 20 30 40 50 60 70 10 20 30 40 50 60 70 8080


PP

QQoo

Rs.5Rs.5

44

33

22

11

PP QQDD

Rs.5Rs.544332211

10102020353555558080



CORNCORN

10 20 30 40 50 60 70 8010 20 30 40 50 60 70 80


PP

QQoo

Rs.Rs.55

44

33

22

11

PP QQDD

Rs.5Rs.544332211

10102020353555558080



CORNCORN

1010 20 30 40 50 60 70 20 30 40 50 60 70 8080


PP

QQoo

Rs.5Rs.5

44

33

22

11

PP QQDD

Rs.5Rs.544332211

10102020353555558080

DD



CORNCORN

10 20 30 40 50 60 70 8010 20 30 40 50 60 70 80


…a specifiedspecified time periodtime period……other things remaining other things remaining constantconstant

Price decreasesPrice decreases;; QD increasesQD increases

Rs.5

Rs.4

Rs.3

Rs.2

Rs.1

DD

0 10 20 35 55 80Quantity DemandedQuantity Demanded

““C”C”

Rs.3Rs.3 Rs.3Rs.3 Rs.3Rs.3++ ++

3535 3939 2626

Rs.3Rs.3

100100

FromFrom “individual”“individual” demand todemand to “market”“market” demanddemand

[Total][Total]

““A”A” ““B”B”

DD DD DD DD

==

And, what if the price of this product drops from Rs.3 to Rs.2?And, what if the price of this product drops from Rs.3 to Rs.2?

Individual Demand and Market DemandIndividual Demand and Market Demand

Rs.2Rs.2

4040

Rs.2Rs.2

4545

Rs.2Rs.2

3030

Rs.2Rs.2

115115

““Market Demand”Market Demand”

QDQD22QDQD11

PricePrice

QDQD

InverseInverse relationshirelationshipp

Rs.10Rs.10

DD

Change in QDChange in QD1. 1. Price changePrice change2. 2. MovementMovement [up/down the demand curve][up/down the demand curve]3. 3. Point to pointPoint to point [along the curve] [along the curve]

Rs.8Rs.8

““Demand Shifters”Demand Shifters”

1.1.TasteTaste2.2.IncomeIncome3.3.Market SizeMarket Size4.4.Expectations of consumers Expectations of consumers

about future price, Income, about future price, Income, availability of goodavailability of good

5.5.Prices of related goodsPrices of related goods

ComplementComplement[[iinnvveerrssee]]

ButterButter

DD11 DD22

PP

SubstituteSubstitute

[[DirectDirect]]

CoffeeCoffee

DD11

DD22

PP

BreadBread

PP11

QDQD11 QDQD22

PP22

DD


PP

DD33 DD11 DD33

QDQD33 QDQD11 QDQD22


ELASTICITY OF DEMANDELASTICITY OF DEMAND “ “ The degree of responsiveness of change The degree of responsiveness of change

in demand to a change in price ”in demand to a change in price ”Importance of Elasticity of demand:Importance of Elasticity of demand:• Determination of price under monopoly, Determination of price under monopoly, • Determination of price under Determination of price under

discriminating monopolydiscriminating monopoly• Determination of price of product mix,Determination of price of product mix,• Determination of price of public utilities, Determination of price of public utilities, • Determination of international trade Determination of international trade

policypolicy

Type of elasticity of demand:Type of elasticity of demand: Income elasticity of Demand:Income elasticity of Demand: The degree of The degree of

responsiveness of change in demand to a responsiveness of change in demand to a change in income change in income

Type of Income Elasticity of Demand: Type of Income Elasticity of Demand: – ZeroZero– NegativeNegative– PositivePositive

Price Elasticity of Demand:Price Elasticity of Demand: The degree of responsiveness of change in The degree of responsiveness of change in

demand to a change in price demand to a change in price Methods of Measuring Price Elasticity:Methods of Measuring Price Elasticity:

» Total outlay or expenditure Total outlay or expenditure methodmethod

» Point MethodPoint Method» Arc MethodArc Method

Cross Elasticity of Demand: Cross Elasticity of Demand: The degree of responsiveness of The degree of responsiveness of

change in demand for good ‘B’ to a change in demand for good ‘B’ to a change inprice of good ‘A’change inprice of good ‘A’

Type of Cross elasticity of demand:Type of Cross elasticity of demand:– Zero,Zero,– Negative, Negative, – Positive: Positive:

a) >1 (b) <1, (c) =1a) >1 (b) <1, (c) =1– InfinitiveInfinitive

Factors governing the elasticity of Factors governing the elasticity of demand:demand:

• Number and closeness of substitutesNumber and closeness of substitutes• Significance of commodity in budgetsSignificance of commodity in budgets• Degree of necessity of goodsDegree of necessity of goods• Habits and temperaments of Habits and temperaments of

consumerconsumer• Number of the use of commodityNumber of the use of commodity• Period of time for demandPeriod of time for demand

Factors influencing demand:Factors influencing demand:

– Number of consumersNumber of consumers– Price levelPrice level– Availability of substitutesAvailability of substitutes– Distribution of wealthDistribution of wealth– TasteTaste– FashionFashion– Possibility of change in pricePossibility of change in price– ClimateClimate– AdvertisementAdvertisement

Page 1 THEORY OF DEMAND P. Bharathi Page 2 What is Demand? The willingness to buy a good or service...

Documents

Transcript of Page 1 THEORY OF DEMAND P. Bharathi Page 2 What is Demand? The willingness to buy a good or service...