economics demand sep 2010

8/8/2019 Economics Demand Sep 2010

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Supply and demand are the forces

that make market economies work.

A marketis a group of buyers and

sellers of a particular good or

service.

Modern microeconomics is about

supply, demand, and market

equilibrium.

MARKETS


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MEANING OF DEMAND

The demand for a commodity is the

amount of it that a consumer will

purchase or will be ready to take off

from the market at various given prices

at a given moment of time


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MEANING OF DEMAND

People demand goods because they have utility

or want satisfying powerTo create demand the good should have

utility, and the person should have the desire,

willingness and ability to buy the good


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DEMAND

Quantitydemandedis the amount of a

good that buyers are willing and able to

purchase.

Law of Demand

The law of demandstates that, other things

equal, the quantity demanded of a good

falls when the price of the good rises &

vice-versa.


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The Demand Schedule: The

Relationship between Price and

Quantity Demanded

Demand Schedule

The demand scheduleis a table that

shows the relationship between the

price of the good and the quantity

demanded.


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The demand schedule:The demand for potatoes (monthly)

The demand schedule:The demand for potatoes (monthly)


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The Demand Curve: The

Relationship between Price and

Quantity Demanded

Demand Curve

The demandcurveis a graph of the relationship

between the price of a good and the quantitydemanded.

A demand schedule or demand curve does nottell what the price is, it only tells how muchquantity will be purchased a various prices.


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20

40

60

80

100

Quantity (tonnes: 000s)

Price( R

sper

kg)

Price

(Rs per kg)

20

4060

80

100

Market demand

(tonnes 000s)

700

500350

200

100

A

BC

D

E

Point

A

B

C

D

E

Demand


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LAW OF DEMAND

As price of a good or service goes down the

quantity consumers wish to buy will increase

and when price goes up the quantity demanded

decreases, other factors remaining constant

Inverse price demand relationship hence the

downward slope of the demand curve


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LAW OF DEMAND

Why do buyers purchase a greater quantity at lower pricesand vice-versa?

The substitution effect

The income effect

The Substitution Effect

The change in the quantity demanded of a good that resultsbecause buyers switch to substitutes when the price of the

good changes

The Income effect

The change in the quantity demanded of a good that results

because a change in the price of a good changes the buyerspurchasing power(their real income)


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The Income Effect

Income effect is negative for inferior goods

In case price of an inferior good accounting for a

considerable proportion of total consumption falls

consumers real income increases: they become

relatively richer

So they substitute superior good for the inferior

ones i.e. reduce the consumption of inferior goods

So income effect on demand for inferior goods

becomes negative


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CHIEF CHARACTERISTICS OF

LAW OF DEMAND

Inverse relationship

Price ,independent variable, demand

dependent variable Other things constant

Reasons underlying the law of

demand- income effect & substitutioneffect


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DETERMINANTS OF DEMAND

Price of the commodity- negative or inverse

relationship

Taste & preferences of the consumers

Money Income of the people

Change in the prices of related goods

Advertising & demand

Number of consumers in the market

Demonstration effect Consumer expectations with regard to future

prices

Income distribution


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Price of related commodities: When change in price of the other commodity

leaves the amount demanded of the commodityunder consideration unchanged we say the twocommodities are unrelated, otherwise they are

related Substitutes-when price of one & quantity

demanded of the other move in same directione.g. apples & pears, rail & road transport, tea &coffee

Complements-when price of one & quantitydemanded of the other move in the oppositedirection e.g. bread & butter, pen & ink, tea &sugar


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Income of the household The quantity demanded of a good &

income of household move in the same

direction

In case of goods like foods, vegetables,

fruits etc after a certain level of income

any further increase in income may leave

amount demanded unchanged Inferior goods- amount demanded

decreases with increase in income

increases with decrease in income


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INCOME OF THE HOUSEHOLD

For income demand analysis goods & services can be

grouped into four categories:Essential consumer goods: food grains, salt, oils, cooking

fuels, minimum clothing & housing

Demand increases with increase in income only up to a

certain limitInferior goods: e.g. bajra, bidis, kerosene stove, travelling by

bus etc

Demand decreases with the increase in income of the

consumerNormal goods: demand increases with increase in income

Prestige or luxury goods: consumed mostly by the rich e.g.

luxury cars, designer jewelry, costly cosmetics, antiques etc

Demand arises only beyond a certain level of income


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Market Demand versus Individual

Demand

Market demand refers to the sum of

all individual demands for aparticular good or service.

Graphically, individual demand

curves are summed horizontally toobtain the market demand curve.


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Change in quantity

demanded & shift in demand

Change in Quantity Demanded

Movement along the demand curve.

Caused by a change in the price of

the product.


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0

D

Price of Ice-CreamCones

Quantity of Ice-Cream Cones

A tax that raises the

price of ice-cream

cones results in a

movement along thedemand curve.

A

B

8

1.0

Rs2.

0

4

Changes in Quantity

Demanded


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Shifts in the Demand Curve

Consumer income

Prices of related goods

Tastes

Expectations

Number of buyers


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Figure 3 Shifts in the Demand Curve

Price of

Ice-CreamCone

Quantity of

Ice-Cream Cones

Increase

in demand

Decrease

in demand

Demand curve, D3

Demand

curve, D1

Demandcurve, D2

0


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Shifts in the Demand Curve

Consumer Income

As income increases the demand for anormal goodwill increase.

As income increases the demand for

an inferior goodwill decrease.


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Rs3.02.50

2.001.501.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of lowquality rice

Quantity of

low quality

rice0

Decrease

in demand

An increase

in income...

D1D2

Consumer Income

Inferior Good


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Predicting and Explaining Changes in

Prices and Quantities

Distinguishing Between

A change in the quantity demanded A movement along the demand curve that

occurs in response to a change in price

A change in demand A shift of the entire demand curve


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Table: Variables That Influence

Buyers

Copyright2004 South-Western


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Exceptions to the law of demand

Expectations regarding future prices

Status goods

Giffen goods: named after Robert Giffen

Giffen goods may be any inferior commoditymuch cheaper than its superior substitutes

consumed by poor households as an essential

consumer good

If price of such goods increases its demandincreases instead of decreasing e.g. bajra


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ELASTICITYOF DEMAND

Generally, elasticity is a measure of the sensitivity

of one variable to another.

It tells us the percentage change in one variable in

response to a one percent change in another

variable.


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ELASTICITYOF DEMAND

Law of demand indicates only the direction of

change in quantity demanded to a change in

price ; it does not tell by how much the demand

will change due to price change

This is provided by the concept of elasticity of

demand

Elasticity of demand also called price elasticityof demand relates to the responsiveness of

quantity demanded of a good to the change in its

price


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ELASTICITYOF DEMAND

Price elasticity = percentage change in quantity

demanded/percentage change in price

The percentage change in a variable is theabsolute change in the variable divided by the

original level of the variable.

Price elasticity

= change in quantity demanded/quantity demandedChange in price/price


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ELASTICITYOF DEMAND

So the price elasticity of demand is also:

P

Q

Q

P

P/P

Q/QEP

=

=

Interpreting Price Elasticity of Demand Values

1) Because of the inverse relationship

between Pand Q; EP

is negative.

2) If EP > 1, the percent change in quantity is

greater than the percent change in price. We say

the demand isprice elastic.


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Price Elasticities of Demand

DP*

= -EP

Quantity

Price Infinitely Elastic Demand


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Price Elasticities of Demand

Q*

0EP=

Quantity

Price Completely Inelastic Demand


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P

QO 40

20

D

100

8

a

Unit elastic demand (PD = 1)Unit elastic demand (PD = 1)

b

Elastic demandElastic demand


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P(Rs)

Q (millions of units per period of time)

0

b

a

D

5

4

10 20

Elastic demandElastic demand

Inelastic demandInelastic demand


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P(Rs)

Q (millions of units per period of time)

0

c

a

D

8

4

15 20

Inelastic demandInelastic demand

Determinants of price


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Determinants of price

elasticity of demand

The number & closeness of

substitutes

The share of the commodity in the

buyers budget

Nature of the commodity

Number of uses a commodity can

be put to

Habit forming characteristics

Time period


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Types of income elasticity

Zero income elasticity- change in income has no

effect on demand e.g. salt

Negative income elasticity- increase in income may

lead to reduction in quantity demanded e.g. biris , low

quality cereals

Positive income elasticity- increase in income leadsto increase in demand. Most of the goods are in this

category. Such goods are called positive goods e.g.

luxury goods have elasticity more than unity


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Income Elasticity of Demand

Income elasticity of demand for aproduct X is

Ey =

change in demand of X/original demand

Change in income/original income

Income elasticity is positive for normal

goods but negative for inferior goods


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Cross Elasticity of Demand

Cross elasticity is the measure of

responsiveness of demand for a commodity tothe changes in the price of its substitutes and

complementary goods

Ec = proportionate change in demand for

product A / proportionate change in price of

product B

To take the example of tea and coffee, the cross

elasticity of demand for coffee(Qc) with respect

to price of tea(Pt):

Ec,t = change in Qc / original Qc

change in Pt/ original Pt


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Cross Elasticity of Demand.

The same formula is used to measure the cross

elasticity of demand for complementary goods

Demand for complementary goods has negative

cross elasticity while for substitutes it is positive Greater the cross elasticity, closer the

substitutes

Higher the negative cross elasticity higher the

degree of complementarity

economics demand sep 2010

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