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CHAPTER 2 2.1 DEMAND

CLASSIFICATION OF GOODS AND SERVICES Conventional perspective 1. Free goods Goods offered by nature. It has unlimited supply, zero production cost, no price tag and no opportunity cost. Examples are air, rainwater, sunlight etc. 2. Economic goods Physical goods made by man. It has limited supply, price tag, involves production cost, and opportunity cost. Examples are pen, textbook, VCD, scooter etc. 3. Public goods A good or service that allows the entire community to enjoy the benefits. It has the feature of non-excludability, where the consumption of a good by one person will not prevent others from enjoying it. Examples of public goods are streetlights, public parks and recreation, roads, etc. 4. Services Intangible goods, which cannot be seen or touched. Examples are education, health care, security, etc. Types of goods a. Inferior goods b. Necessity goods c. Normal goods d. Luxury goods Related goods a. Substitute goods goods that serve as an alternative to each other b. Complementary goods goods that must be used together Islamic perspective Concept of goods a) b) c) Al-Tayyibat - good, clean and pure things - the ethical and spiritual values of consumer goods Al-Rizq Tarafiah - Godly sustenance, Divine bestowal, or Heavenly gifts - Allah is the only Sustainer and Provider for all creatures - Goods which cause wastage/extravagance - FORBIDDEN

Classification of goods based on hierarchy of needs 1. Dharuriyah - Goods which fulfill our basic needs e.g. food, shelter, clothes 2. Hajiyah - Goods that enhance the quality/comfort of life e.g. TV, car, telephone

3. Kamaliyah - Goods that contribute towards the perfection of life e.g. bungalow, luxury car, jewelleries.

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2.2 DEFINITION OF DEMAND AND LAW OF DEMAND Definition The desire to purchase a good, plus the willingness and the ability to pay for that good at a given time. Law of demand An inverse relationship between quantity demanded and its price. Ceteris paribus; when P , Qd and vice versa. (P and Qd are negatively related) 2.3 INDIVIDUAL DEMAND AND MARKET DEMAND Individual demand Demand schedule It shows the quantities that a consumer is willing to buy at different prices. P of apple (RM) 1 2 3 4 5 6 Qd of apple (unit) 25 23 18 15 10 8

Demand curve It illustrates the quantity purchased at different price level. P of apple
Demand curve is downward sloping from left to right

D Qd of apple Market demand Definition It is the horizontal summation of all the individual demand in the market at certain price level and certain time period. Demand schedule P of apple (RM) 1 2 3 4 5 6 Ms A 25 23 18 15 10 8 Qd of apple (unit) Ms B Ms C 20 26 17 22 15 16 12 14 8 11 6 7 Market

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Demand curve P of apple

Market demand curve is flatter and wider

D (market) Qd of apple 2.4 CHANGE IN QUANTITY DEMANDED VS CHANGE IN DEMAND

Change in quantity demanded Imply movement along the same demand curve An increase in Qd (extension) or decrease in Qd (contraction) The changes in Qd is due to the change in its own price Price

D Quantity demanded
Q

Change in Demand Imply a shift of the entire demand curve Shift to the right (Increase in demand) or shift to the left (Decrease in demand) The changes in demand is due to the factors other than its own price Price

D0
Q0 Q

D
Q1

D1 Quantity demanded

2.5

DETERMINANTS OF DEMAND Factors that influence demand are; 1. The price of related goods a. Substitute goods - If the P coke , Qd pepsi (positively related) b. Complementary goods If the P car , Qd petrol (negatively related) 2. Income

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a. Normal goods If income , demand for normal goods b. Inferior goods If income , demand for inferior goods
3. Taste and preference 4. Festive seasons 5. Size of population 6. Government policies a. Taxes on imported goods b. Subsidies on locally produced goods 7. Expectation If one expects the P of car to in the future, the Qd car will now. 2.6 EXCEPTIONAL DEMAND The law of demand always holds for normal goods. Other type of goods may exhibit the opposite of what the law says. An exceptional demand curve can be regressive at higher prices (P , Qd ) or regressive at lower prices (P , Qd ). 1. a. Luxury goods Regressive at higher prices An expensive good is perceived as having higher quality and show prestige. Price
Against the law of demand (P , Qd )

Follow the law of demand (P , Qd )

Quantity demanded b. Expectation If expect the P of shares to further, the demand for share now.

2. a. Giffen goods Regressive at lower prices A Giffen good is an inferior good whose demand declines as real income rises due to the decrease in price. Price
Follow the law of demand (P Qd ) ,

Against the law of demand (P , Qd )

Quantity demanded b. Expectation If expect the P of shares to further, the demand for share now

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2.7

INTER-RELATED DEMAND 1. Joint demand It applies to the demands for complementary goods. When the demand for radiocontrol cars increases, the demand for batteries will also increase. 2. Competitive demand It applies to the demands for substitute goods. When the demand for Air Asia flights increases, the demand for Malaysian Airline flights will decrease. 3. Derived demand The demand for factors of production is derived from the demand for its output. The demand for more bricks is caused by the demand for more condominiums. 4. Composite demand It refers to goods with multipurpose products. Example, rubber is used to make shoes, tyres, household products etc.

2.8

ELASTICITY OF DEMAND Definition A general concept that can be used to quantify the response in one variable when another variable changes. Types of elasticity Price elasticity Cross elasticity Income elasticity I. Price elasticity ( p) To measure the responsiveness of quantity demanded to changes in its own price

Formula

p = =

% Qd %P Q1 - Q0 Q0

percentage change in quantity demanded percentage change in price P0 - P0 Q Q

P1

P P

where ; Q1 = new quantity Q0 = original quantity Reason

P1 = new price P0 = original price

The reason to compute price elasticity is to find out the sensitiveness of market demand toward changes in price. The degrees of price elasticity measure this sensitiveness.

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Degrees of price elasticity Degree Description Value of coefficient P Elastic % Qd > % P 1 < p < P Q Q P Inelastic % Qd < % P P Q Q P Unitary % Qd = % P P Q Q P Perfectly elastic Any increase in P will cause the Qd to be 0. Price is fixed Slope of demand curve

0 < p < 1

p = 1

p =

P Q Q P

Perfectly inelastic

Any change in P will not change the Qd. Qty demanded is fixed.

p = 0

P Q

FACTORS INFLUENCING PRICE ELASTICITY OF DEMAND 1. Availability of substitutes Demand is more elastic when more substitutes for the product are available 2. Relative importance of the item in the budget Demand is more elastic when the item takes a more significant portion of the consumers budget 3. Time frame Demand becomes more elastic over longer time period. More time to find

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information and substitutes 4. The degree of necessity or luxury Demand is less elastic when the item is considered necessity goods 5. Consumption habit / Brand loyalty Demand is less elastic when the item is consumed habitually or loyally.

II.

Cross elasticity ( c) To measure the responsiveness of quantity demanded to changes in the price of other goods.

Formula

c =

% Qdx % Py Q1x - Q0x Q0x

percentage change in quantity demanded of good x percentage change in price of good y P0y = - P0y Qx Qx

P1y

Py Py

where ; Q1 = new quantity of good x Q0 = original quantity of good x Reason

P1 = new price of good y P0 = original price of good y

The reason to compute cross elasticity is to identify the relationship between good x and good y given that there is a change in the price of good y. Relationship between goods Value of coefficient Positive Negative Zero Relationship Substitute Complementary Not related Description Py , Qy ; Qx Py , Qy ; Qx Py , Qy ; no change in Qx

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Income elasticity ( i) To measure the responsiveness of quantity demanded to changes in income.

III.

Formula

i = =

% Qd %I Q1 - Q0 Q0

percentage change in quantity demanded percentage change in income I0 - I0 Q Q

I1

I I

where ; Q1 = new quantity Q0 = original quantity Reason

I1 = new income I0 = original income

The reason to compute income elasticity is to identify the type of goods being demanded given that there is a change in income. Type of goods Value of coefficient Positive i > 1 Positive i 1 Zero i = 0 Negative Type Luxury goods Normal goods Necessity goods Description I , big in Qd I , small in Qd I , no change in Qd I , Qd

Inferior goods

2.9

PRICE ELASTICITY AND TOTAL REVENUE Total Revenue (TR) = Price (P) x Quantity (Q) When demand is elastic ; % Qd > % P P , Qd : TR P , Qd : TR When demand is inelastic ; % P > % Qd P , Qd : TR P , Qd : TR When demand is unitary ; % P = % Qd P , Qd : TR unchanged

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ESSAY QUESTIONS
a) b) c) d) e) Briefly explain any two (2) types of goods from Islamic perspective. Distinguish between changes in quantity demanded and changes in demand. Explain any four (4) factors that influence the demand for a product. Using appropriate diagrams, explain the 5 degrees of price elasticity of demand. Explain any four (4) factors that influence the price elasticity of demand. [4 m] [10 m] [10 m] [10 m] [10 m]

STRUCTURE QUESTIONS
CONCEPT OF DEMAND 1. Show diagrammatically the effect of each of the followings has on the demand for My Vi cars. (a) the announcement of easy loan scheme to purchase a car.

(b) a special promotion by the Proton Savvy producers.

(c) a special package price offer by Perodua for the purchase of My Vi.

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(d) Indicate whether the following statement is True or False i. ii. iii. iv. v. Contraction and extension refers to the changes in Demand A shift of demand curve to the right is probably caused by the increase in income The demand for luxury good is an upward sloping curve An exceptional demand curve violates the law of demand Consumption habit causes the demand to be more elastic

PRICE ELASTICITY OF DEMAND 2. The data below shows the relationship between the price of good A and quantity demanded of good A, B, C , and the level of income. Price of A 1 2 3 4 Good A 50 40 30 20 Quantity demanded Good B 25 30 35 40 Good C 20 20 20 20 Income 1000 750 500 250

(a) Calculate the price elasticity of demand for good A when its price decreases from RM 3 to RM 2 . What is the degree of elasticity?

(b) Calculate the cross elasticity for good B when the price of A increases from RM 2 to RM 4. What is the relationship between good A and B ?

(c) The relationship between good A and good C is __________________

(d) Calculate income elasticity for good B when income rises from RM 750 to RM 1000. What is the type of good B ?

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