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 special

sense. Ordinary the term Desire, Want &lled dem Demand used interchangeably. But in Economics all three terms have different meaning. If you desire to purchase Color TV but dont have enough money with you. Then this desire will remain wishful thinking. It will not be demand. And inspite of having sufficient money you dont want to spend it on color TV . Then this desire will called want and not demand. Only when you are ready 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 that price. According to Bobber, By demand we mean the various quantities of a given commodity or service which consumers would buy in one market 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 Demand
1. 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 a commodity that would be demanded at different prices.

Types of Demand Schedules

Individual Demand schedule Price A 1 2 3 4 50 40 30 20

Market Demand Schedule Price A B C M.S 1 2 3 50 40 35 45 30 20 40 38 30 135 108 85

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

Individual DC

Market DC

Y Price

Less Flatter

Y Price

More Flatter

Demand

Demand

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, DA+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 DA 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 demanded

changes ( rise or fall ) as a result of change in price alone, other factors 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 not require 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 price and buy less at higher prices, others thing remaining the same. Ferguson: According to the law of demand, the quantity demanded varies inversely with price. Chief Characteristics: Inverse relationship. Price independent and demand dependent variable. Income effect & substitution effect.

1. 2. 3.

Assumptions:
No change in tastes and preference of the consumers. Consumers 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
P1 A

P
B
D1 D2

P2
Q1

Q CHANGE IN PRICE= change in quantity demanded

Q2

Q CHANGE IN OTHER= change in demand

The Law of Demand

P

D1

D2

Q CHANGE IN OTHER= change in demand

Determinants of Demand

Things other than price that cause the who curve to shift Increase: shift to the right Decrease: shift to the left

Determinants of Demand

Change in consumer tastes

Change in peoples income

normal goods

inferior goods

What Happens to Demand if?

SITUATION: Youre the owner of a hot dog making company:

(a) people change their preference from hamburgers to hot dogs?

What Happens to Demand if?

SITUATION: Youre the owner of a hot dog making company:

(b) U.S. negotiates a deal w/ China to trade hot dogs for egg rolls?

What Happens to Demand if?

SITUATION: Youre the owner of a hot dog making company:

(c) the price of ground beef plummets?

What Happens to Demand if?

SITUATION: Youre the owner of a hot dog making company:

(d) the minimum wage rises?

What Happens to Demand if?

SITUATION: Youre the owner of a hot dog making company:

(e) the MWU threatens a strike if owners fail to meet their demands?

What Happens to Demand if?

SITUATION: Youre the owner of a hot dog making company:

(f) unemployment hits an all-time high?

What Happens to Demand if?

SITUATION: Youre the owner of a hot dog making company:

(g) the price of buns increases due to a wheat shortage?

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 demand depends. 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 & Income Elasticity. It is always price elasticity of demand which is referred to as elasticity of 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 percentage change in price

Elasticity of demand

Factors affecting Elasticity of Demand

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

Availability of substitutes Postponement of consumption Proportion of expenditure (needles: inelastic; TV: elastic) Nature of the commodity (necessity vs. luxury; durability/reparability eg., shoes) Different uses of the commodity (paper vs. ink) Time period (elastic in the long term) Change in income (necessaries: inelastic; milk and fruit for a rich man) Habits Joint demand Distribution of income Price level (very costly & very cheap goods: inelastic)

Price Elasticity

Price Elasticity Elastic Demand or more than 1 When quantity demanded responds greatly to price changes Inelastic Demand or less than 1 When quantity demanded responds little to price changes. Unitary Elastic When quantity demanded responds equally to the price changes. 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 substitutes are 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 elasticitys are positive, even though prices and quantities move in the opposite direction because of the law of downward sloping demand. Definition of elasticity uses percentage changes in price and demand rather than actual changes. That means that a change in the units of measurement does not affect the elasticity. 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 priceelastic) Shifting of tax burden (shift commodity tax when demand is inelastic) Taxation policy

Elasticity & Revenue:

When demand is price inelastic, marginal revenue is negative and

a price decrease reduces total revenue. When demand is price elastic, marginal revenue is positive and a price decrease increases total revenue. In the borderline case of unit elastic demand, marginal revenue is 0 and 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 as income increases, then income elasticity for the good is equal to one. 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 income rises.

Income elasticity and business decisions 1. 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 economic growth Corollary: in a growing economy while farmers suffer as their products have low income elasticity, industrialists gain as their products have high income elasticity.

 Cross Elasticity: A change in the demand for one good 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 other cross elasticity is infinite and if the two goods are totally unrelated, cross elasticity between them is zero. Goods between which cross elasticity is positive can be called Substitutes, the good between which the cross elasticity is negative are not always complementary as this is found when the income 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

Y Ed = p

d1

2. Perfectly Inelastic
Y
p1 p

Ed = 0

3. Unitary Elastic
Y
p1 p

Ed = 1

d1

4. Relatively more Elastic

Y
p1 p

Ed > 1

d1

5. Relatively less Elastic

Y
p1 p

Ed < 1

d1

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 Elasticity

1. 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 on

the curve = lower segment of demand curve upper segment of demand curve

Figure 3.4 Maslows 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 individuals 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 needs 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.