LAW OF DEMAND

LAW OF DEMAND
 - law states that , other things being equal,
the quantity demanded of a commodity
increases when its price falls and decreases
when its price rises.

 Dx=f(Px, pr, y,T, U …..)

 Pr
 Y
 T
 U constant
ASSUMPTIONS

 “Ceteris paribus”- other things being equal

 No change in income
 No change in taste and preferences
 No change in size of population
 No change in price of related goods
 No substitutes are available
Price of milk Quantity demanded
5 10
4 12
3 15
2 20
1 30
 Law of demand can be illustrated
numerically through a demand schedule and
graphically through a demand curve.
MAIN POINTS OF LAW OF
DEMAND
 Inverse relationship :
 law of demand operates on the principle of
inverse relationship between price and
quantity demanded . More of one will results
in lesser of other.
 Qualitative and not quantitative :
 law of demand makes a qualitative
statement. It indicates the direction of
change in the amount of quantity demand
and nothing about the magnitude of upward
or downward change
 No proportional change :
 no proportional relationship between price
and quantity demanded. E.g.: if price
increases by 10 percent, demand can reduce
by 5 percent or 95 percent
 Comparison with the game of see saw :
 demand and quantity act as if they are two
ends of a see saw, if one goes up other will
go down or vice versa
 One sided approach :

 it only explains the effect of change in

quantity with the change in price , but
neglects to explain the effect of change in
price with the change in quantity
CAUSES OF OPERATION OF LAW
OF DEMAND
 Why does demand curve slopes downwards

 Law of diminishing marginal utility :

 The concept explains as the stock of things
increases, the marginal utility other things
remaining the same, decreases.
 when , the quantity offered for sale
increases ,the marginal utility derived from
it reduces, consequently the price which a
consumer willing to pay also decreases.
 Income effect:
 a fall in the price of a commodity results in
the rise in consumer income. Therefore
purchases more of it
 Where as a rise in the price of commodity
will reduce income of a consumer, forced
him to purchase less of it,
 When price falls quantity demanded will
increase and vive versa , resulting in
downward sloping of the curve
 Substitution effect :
 the fall in the price of a commodity (the price of
substitute remaining the same ) makes its more
attractive to the consumer resulting in extension
of demand.
 Eg: with the fall in price of tea, the price of
coffee remaining the same, tea will be
substituted for coffee, makes it more attractive
 New buyers :
 when the prices of a commodity falls the demand
for it increases two folds
 a) the existing buyer will buy more
 b) new buyers also started buying this product
 Different uses:

 many goods have several uses, some are

more important than others, when the price
of a product is high , the use will be
restricted to more important purposes
 but when the price falls the consumer will
use the product for less important purposes
also , hence will result in extension of
demand.
EXCEPTIONS OF THE LAW OF
DEMAND
Reasons for upward sloping demand curve
 Ignorance:
 consumer perception that high price goods
are of superior quality.
 When price increases consumer buy more of
it sue to ignorance effect .
 Producers of cosmetics product like face
creams, powders etc have experienced it
 Speculative effect :
 when the price of a commodity increases
consumer buy more of it due to anticipation
or speculation of further rise in price,
 When price falls , consumers may not react
to it immediately and hence buy the same
quantity , waiting for prices to decrease
more
 Giffen’s paradox :
 in case of giffen goods ( named after sir Robert
Giffen), a fall in price of an inferior(giffen good)
goods tends to reduce its demand , and a rise in
price of it will tend to increase its quantity
demanded.eg: staple food stuffs like cheap
potatoes , cheap bread, vegetable ghee etc.

 Fear of shortage :
 people may buy more of a commodity at a higher
price if they fear of a shortage in near future
 Happens in the times of war and inflation
 Prestigious goods :
 Articles of snob appeal: goods of status symbol ,
which increases social prestige, people measure
the desirability of a good by its use not by its
price
 Diamonds, jewellery, big cars etc.

 Necessities :
 commodities which have become a necessity due
to its constant use .
 Eg: television sets, washing machines,
refrigerators , cooking gas etc
IMPORTANCE OF THE LAW OF
DEMAND
 Useful for the seller or manufacturer :
 while fixing the price of a commodity the
seller is faced with the problem like – how
much his sale falls when he raises his price ?
Or how much his sales expand with fall in
price.
 Price determination:
 a monopolist with the help of law of demand
can predict how much his quantity fall or
increase with the rise or fall of price
 To the finance minister:
 while fixing taxes for the commodity, a
finance minster can look into the situation of
demand schedule

 To the farmers :
 good or bad crop will effect the economic
condition of the economy, if there is a good
crop and demand for its remain same there
will be reduce price
CHANGEIN
DEMAND CURVE
CHANGES IN DEMAND- MOVEMENT
ALONG THE DEMAND CURVE AND
SHIFT IN THE DEMAND CURVE
 Extension and contraction of demand
(movement along the demand curve )

 Increase or decrease of demand (shift in

demand curve )
CHANGE IN QUANTITY DEMANDED-
MOVEMENT ALONG THE DEMAND CURVE
 When the quantity demand changes(rise or
fall) due to change in price ,while others
factors remain the same, it is known as
change in quantity demanded.
 2 types:
 Extension and contraction of demand .
 Extension or contraction is strictly related
with the price component, other things
remain the same
EXTENSION OF DEMAND
 When the quantity demanded of a commodity
rises due to fall in its price , other things
remaining the same, it is called as rise in
quantity demanded or extension of demand
 Other things remaining the same, a fall in
price will result in higher quantity demanded,
it is known as extension of demand.

 Movement along the demand curve from point

A to point B
CONTRACTION OF DEMAND
 Contraction of demand or fall in demand
refers to a fall in quantity demanded of a
commodity as a result of rise in its price ,
others things remaining the same.

 Other things remaining the same , a rise in

price will result in fall in quantity
demanded , known as contraction of demand
 Movement from point B to A along the same
curve
 A movement down a demand curve is called
as rise in quantity demanded or extension of
demand.

 A movement up the demand curve is called

as fall in quantity demanded or contraction
of demand.
CHANGE IN DEMAND- SHIFT IN
DEMAND
 Increase or decrease in demand
 When the amount purchased of a commodity
rises or fall because of factors others than
price of a commodity it is known as change
in demand.

 If the change in demand is due to the change

in any factor other than the price of a
commodity like income, taste , fashion etc it
is known as increase or decrease of demand
INCREASE IN DEMAND
 When the consumer buy a larger amount of a
commodity at the same price.
 When the quantity demanded rises due to
change in income, fashion, taste, population
it is increase in demand
 Method:
 Same price, more demand
DECREASE IN DEMAND
 When the consumer buys a smaller quantity
at the same price
 When irrespective of price demand of a
commodity falls due to change in income,
taste or fashion, it will be decrease in
demand

 method :
 Same price, less demand
Extension of demand / Increase in demand /
contraction of demand decrease in demand

Changes in Changes in
price, other Changes in other factors,
factors demand price factor will
remaining the remain the
same same

Diagrammatic representation of changes in demand

DISTINCTION BETWEEN EXTENSION OF DEMAND
AND INCREASE IN DEMAND (EOD AND IID)
 Extension of demand is larger quantity being
purchases due to fall in prices of a
commodity and increase in demand refers to
more being purchased at the same price.
 EOD is due to fall in own price of a
commodity , IID refers to change in other
factors
 Extension simply involves a downward
movement along the same demand curve ,
increase is the right ward shift in the entire
demand curve .
DISTINCTION BETWEEN CONTRACTION
AND DECREASE IN DEMAND (COD &DID)
 COD is fall in quantity purchased due to rise
in prices, DID means smaller quantity is
purchased at the same price.
 COD is due to rise in its own prices, DID is
due to changes in any other factor.
 COD is upward shift along the same demand
curve, DID is inward shift in the entire
demand curve
CASE OF US SNACK CAKE
INDUSTRY
FOR CLASS DISCUSSION : HOW DOES
RECESSION OR SLOWDOWN AFFECT
MARKET DEMANDS?- CHANGE IN DEMAND
CURVE
 Consumer psychology
 Vanity (COSMETICS, MANICURE, HAIR DYE
ETC)
 Real estate
 Electronics
 Luxury cars
 Travel and tourism
 Restaurant business(habit factor)
NUMERICAL
 Raj Kumar & co. , the cabinet maker has
estimated the following demand function for the
steel cabinets produced by them :
 Qd=1500-0.03P+0.09AE
 Qd= quantity demanded
 P= average price
 AE= advertising expenditure
 All date are on quarterly basis . The firm’s
currently spend 10,000 per quarter on advertising.
 Give graphical representation assuming price
variable values to be Rs 10,000, Rs 9000, Rs
8000,Rs 7000, Rs 6000
QUESTIONS ?
 Identify the influencing factors to market
demand of 1) ice cream 2) sugar 3)ball pen
4) designer jeans

 The price of gold increases. Will this affect

the demand for gold? How
 Is there any difference of expression
between increase in demand and rise in
demand for godrej hair dye.
 ELASTICITY
OF
DEMAND AND ITS
MEASUREMENT
ELASTICITY OF DEMAND
 Elasticity of demand measures the
responsiveness of the quantity demanded of
a good, to change in it price , price of other
goods and changes in consumer income.

 Degree of responsiveness of quantity

demanded of a commodity to change in
any of its determinants.
 Elasticity of demand = % change in quantity
demanded/ % change in determinants of
demand
TYPES OF ELASTICITY OF
DEMAND
 Price elasticity of demand

 Income elasticity

 Cross elasticity
 Arc elasticity and
 Advertisement elasticity
PRICE ELASTICITY OF DEMAND
 Degree of responsiveness of quantity
demanded of a commodity in response to
change in its price.

 Price elasticity is defined as the ratio of the

percentage change in demand to the
percentage change in its price

 E= %change in quantity demanded / % change

in price of a product or
 E=∆Q/Q X P/∆P
ELASTICITY
Price of apple Quantity demanded
20(p1) 100 (q1)
21(P2) 96(q2)

∆ p= p2-p1= 1 ∆q= q2-q1=-4

e-= ∆q/q* p/ ∆ p

e= - 0.8
Due to inverse relationship, coefficient of price elasticity of demand is
usually negative
DEGREE OF PRICE ELASTICITY
 Unit elasticity of demand( e=1)
 Elastic demand( e> 1)
 Inelastic demand(e<1)
 The numeric value of price elasticity ranges from
zero to infinity
 Change in demand is not equal to change in price
 When a small change in price may lead to a bigger
change in quantity demanded , the demand is
said to be elastic.

 Or in elastic
5 DEGREE OF ELASTICITY'S OF
DEMAND
 Perfectly elastic demand :

 A situation in which a small change in price

will cause an infinite large change in
demand .
 A small rise in price of the commodity,
consumer stops buying it.
 Numerical coefficient = infinty

 Case of theoretical extremity , hardly

encountered in practice.
 Perfectly in elastic demand :

 Absolute no change in demand as a result of

change in price.
 Demand remains same irrespective of change
in price
 Numerical coefficient- 0

 A theoretical consideration rather than a

practical phenomenon.
 Unitary elastic demand :

 A situation where a demand changes in exact

proportion to change in price
 Demand curve will take the shape of a
rectangular hyperbola
 Numerical coefficient = 1
 More elastic demand ( relatively elastic
Demand) :

 A situation where a change in demand is

more than the proportional change in price.
 Demand curve is more flatter and horizontal

 ∆Q/Q > ∆P/P

 Elasticity is > 1
 Less elastic demand ( relatively Inelastic
Demand) :

 Situation in which a change in demand is less

than the proportionate change in price
 Valid for necessity goods

 ∆Q/Q < ∆P/P

 Elasticity is less than 1

Numerical values terminology Description
E= infinity Perfect elastic Consumer have
indefinite demand at a
particular price and
none at slightly higher
price
E= 0 Perfectly inelastic Demand remain
unchanged, what ever
be the price
e=1 Unitary elastic Quantity change by
exactly the same
percentage as price
E>1 Relatively elastic Quantity demanded
changes by larger
E<1 Relatively inelastic Quantity demanded
changes by smaller
PRICE ELASTICITY FOR FOOD
ITEMS
Elasticity of demand e>1 Inelastic demand e<1
Cheese Bread
Frozen peas Milk
Meat Sugar
Potatoes
Vegetables
Chicken

Source: Annual report of national food survey committee, 2001

MEASUREMENT OF PRICE
ELASTICITY
 Measurement of elasticity of demand is used
to find out whether price elasticity of
demand is
 Unitary
 Greater than unity
 Less than unity
METHODS
 Percentage method/ proportional method:

 Measured by the ratio of percentage change in

quantity demanded to percentage change in price
of this commodity.
 Percentage change in demand/ percentage in price

 Coefficient of price elasticity of demand is

always negative (-) because of inverse
relationship between price and demand
 Proportionate method is used when changes in
price and demand are very small
 Point method :
 Used to find the elasticity at a particular
point on the demand curve
 Also known as geometrical method

 E= lower sector of demand curve / upper

sector of demand curve
 If lower sector>upper sector, E>1
 If lower sector = upper sector, E= 1
 If lower sector < upper sector , E<1
 Arc method :

 Point method is used when the changes are

small,
 where as arc method is used when the
changes in price and demand are large
EARC= ∆q / ∆P * p1+p2/q1+q2
NUMERICAL
 Initial price is 100 and 1000 units are
demanded. New price is 120 and 800 units
are demanded.

 Calculate :
 Point elasticity

 Arc elasticity
 Total expenditure method ;
Price Quantity Total
expenditure
5 20 100
4 26 104

p q TE
5 20 100
4 25 100

p q TE
5 20 100
4 22 88
 Total expenditure method ;
 Also known as unity method
 Three measure of elasticity of demand –
greater than unity: when total expenditure
increase with a fall in price and decreases
with rise in price E>1
 equal to unity: when the total expenditure
remains the same, whether the price rises or
fall E=1
 less than unity : when total expenditure
decreases with a fall in price E<1
 Major drawback of total expenditure method
is –

 It does not measure the elasticity of demand

in numeric values

 It only classifies it into unity , less than

unity, more than unity
FACTORS DETERMINING PRICE
ELASTICITY OF DEMAND
 Nature of the commodity :

 either the good is a necessity, comfort or

luxury
 Demand for necessity will be less elastic
 Demand for luxury will be more elastic
 Substitutes :
 Commodities having substitutes are more
elastic

 Variety of uses :
 demand for goods like milk, coal , electricity
is more elastic
 If price of coal falls, its demand for all
quarters will increase
 Postponement of the use :
 commodities whose consumption can be
deferred have an elastic demand.

 Demand for construction houses have elastic

demand , demand for goods like meals have
inelastic demand
 Range for prices :

 very high and very low prices tend to be

inelastic , middle range are more elastic
because a rise or fall in price will affect the
demand of a large number of person
 Time factor :
 the shorter the time the lesser will be the
elasticity of demand , the longer the time
the higher will be elasticity of demand

 Results in discovery of new products ,

substitutes , change in habits, consumer
adjustments to new products
 Durability of goods :
 When goods are durable like scooter, t.v ,
car etc , the demand is inelastic
 Because people dnt buy more when price
fall
 Classes of buyer :
 wealthy and well to do people have
inelastic demand , a change in price will not
affect much of the quantity demanded

 People of middle class have more elastic

demand , a change in price will bring larger
change in demand
PRICE ELASTICITY – A HARVARD
STUDY
 ..\..\price_elasticity_of_demand_handout.pd
f
INCOME ELASTICITY OF DEMAND
 Income elasticity measures the
responsiveness of quantity demanded of a
commodity to changes in the income of a
consumer
 Measures the rate at which the quantity
bought changes, with the change in income
other things remaining the same
 E= percentage in quantity demanded /
percentage in income

 E= %∆Q/%∆Y
KINDS OF INCOME ELASTICITY
 Positive income elasticity : (E>0)
 When the quantity demanded of a
commodity increases with the increase in
income , elasticity is said to be positive

 Valid for normal goods

 Negative income elasticity : (E<0)
 When the amount demand decreases with
the rise in income

 Valid for giffen or inferior goods

 Zero income elasticity : (E=0)

 When the demand for a commodity does not

respond to change in income

 Valid for goods which are very basic and low

price goods – salt , sugar , newspaper etc
UNITARY INCOME ELASTICITY
 % change in demand is equal to % change in
income.

 E=1
 Income elasticity greater than one
 % change in quantity demanded is greater
than % change in income
 E>1

 Income elasticity less than one

 % change in quantity demanded is less than %
change in income
 E<1
APPLICATION OF INCOME
ELASTICITY
 Long term business planning ( demand for
comforts and luxury have high income
elasticity, prospects for long term growth is
high

 Market strategy

 Housing development strategies(housing

development requirements can be predicted
and construction work )
COMBINED EFFECT OF
ELASTICITY'S OF DEMAND
 Panavision, a TV manufacturing company, is
planning to increase the price of its television
sets by 10 per cent next year. The economic
report of the country has forecasted rise in per
capita income by 5% during this period.
 Panavision economic advisor has estimated
price elasticity for the TV set at -1.4 and
income elasticity at 2.2. The Panavision
currently sells 50,000 TV sets. Give the forecast
for the sales. Is it advisable to raise the price of
TV sets as has been decided in this case when
each TV set is currently priced at Rs. 10,000.
COMBINED EFFECT
 Q2= Q1[1+ ep(%∆P) + em(%∆M)]

 Q1- initial quantity demanded

 Q2- estimated demand quantity
 P- price
 M- income
 Ep- price elasticity of demand
 Em- income elasticity of demand.
CROSS ELASTICITY OF DEMAND
 When the demand for a commodity changes
with the change in price of a related good

 The rate at which the quantity demanded of

commodity X changes with the change in the
price of commodity Y
 E XY= % change in the quantity demanded of
X/% change in the price of Y
TYPES OF CROSS ELASTICITY OF
DEMAND
 Positive cross elasticity :

 When increase in the price of one product

will result in the increase in the demand for
other good
 Substitutes goods have said to have positive
cross elasticity
 Negative cross elasticity :
 When increase in the price of one product
will result in fall in the demand for other

 Complementary goods
 Zero cross elasticity :

 When change in price of one product will

cause no change in the price of other
product

 Valid for independent goods/ unrelated

goods
 APPLICATION OF CROSS
ELASTICITY
Fare Daily no of passengers

Rail bus Rail bus

Before fare change 45 40
45 40
After fare change 45 35 45 35

Cross elasticity helps to determine competitive prices

Cross elasticity of demand for a train service from station A to B is the

rate of change in the number of train tickets sold on that route in
relation to the percentage change in prices of bus service for the same
route.

If the bus fare reduced from 40 to 30 , calculate the cross elasticity of

rail demand.
IMPORTANCE OF ELASTICITY OF
DEMAND IN MANAGERIAL ECONOMICS
 Managerial use of price elasticity of demand
 Income elasticity

 Cross elasticity
USE OF PRICE ELASTICITY
 Determination of price under monopoly
 Basis of price determination
 Price determination of joint products
 Determination of wages (demand for lb is
elastic or inelastic , if dd is elastic strikes ,
lock outs will not help in raising wages )
 Advantage to finance minister
 Determination of price for public utilities
(electricity , post and telegraph , railways
etc )
 Distribution of burden of taxes
 International trade
IMPORTANCE OF INCOME
ELASTICITY
 Knowledge of nature of good :
 differentiate between essential and non
essential goods, commodities with high
elasticity are luxuries, commodities of basic
nature are for necessities
 Helpful in business research :
 Helpful in calculating income sensitivity (%
change in rupee expenditure as a result of %
change in income )
 Importance in production planning :
elasticity help in calculating the demand and
supply elasticity's and hence helpful in
planning for production
IMPORTANCE OF CROSS
ELASTICITY
 Classification of commodities :
 Substitute goods : cross elasticity is positive
 Complementary goods : cross elasticity is
negative
 Independent goods :cross elasticity is zero
 Helpful to define industry :
 commodities who have good substitutes
available tend to have higher cross elasticity,
firms producing substitutes will
automatically tend to have higher cross
elasticity
ADVERTISING ELASTICITY OF
DEMAND
 Qx=f(A)
 Qx= demand of the product
 A= advertisement expenditure
 AED is useful in determining the optimum
level of advertisement expenditure
 It is essential for competitive advantage
 AE is defined as the ratio of proportionate
change in sales to the proportionate change
in advertising expenditure
 eA= ∆Q/ ∆A*A/Q
DEGREE OF ADVERTISEMENT
ELASTICITY
 E=0, when sales does not respond to increase
in expenditure
 E=infinity , when sales respond up to infinity
with a small change in expenditure
 E=1, when sales increases in same proportion
with increase in expenditure
 E = greater than unity , when sales increases
by a higher proportion than expenditure
 E= less than unity, when sales increases in
less proportionate manner
FACTORS AFFECTING
ADVERTISEMENT ELASTICITY
 The level of total sales

 Cumulative effect of past advertisement

 Advertisement by rival firms

 Other factors (nature of the product,
consumer income , taste and preferences
etc
NUMERICAL
 An initial advertisement expenditure of
50,000 , the demand for a firm’s product is
80,000 units. When the advertisement
expenditure budget increased to 60,000, the
sale volume increased to 90,000 units.

 Calculate advertisement elasticity .

 0.63
MINI CASE – VCD RENTALS
 According to a chamber of commerce study in
Mumbai , VCD rental market , the price elasticity
of the demand for VCD rental is 0.7. A 10% rise in
rentals implies a decline the demand for VCDs on
rental by 7%. That means , the demand for VCD’s
on rental is inelastic.
 Based on this information , the owner of Andheri
music stores, a B.com , graduate increased the
rentals by 25% in order to enhance its total
revenue.
 Contrary to his expectations , the store’s total
revenue decreased, in consequence.
 Solve the mystery?
MINI CASE 2
 Adam, the owner of an ice-cream centre,
near university campus, was also a part time
student of management studies in commerce
college. After having studies the theory of
price elasticity of demand, he thought the
demand for ice cream should be price
elastic.
 For an experiment, he announced special
reduced price for ice cream cone in second
week of august under independence
anniversary week.
MINI CASE 2
 He observed the following sales outcome .
 Adam worked out price elasticity coefficient in
this case as
 E= ∆q/ ∆p*p/q= 500/1*5/1000= 2.5
 Finding demand elasticity above unity , he
inferred that price reduction led the total sales
revenue to increase. This outcome encouraged
him to reduce the price permanently in
October on a permanent basis to Rs. 4.50. to
his utter surprise , he found that average
weekly sales revenue rather decline to Rs.4770
MINI CASE 2
August price Total sales Total sales
revenue
1st week Regular , Rs. 5 1000 5000
2nd week Special , Rs. 4 1500 6000

What happened with Adam, where he went wrong. Give your

interpretation about the case??