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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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DETERMINANTS OF DEMAND
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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DETERMINANTS OF DEMAND
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