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 Demand1. Individual demand2. 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) 6. Composite demand (eg., coal & electricity) 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.Demonstration Effect 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 Market Demand Schedule

Price A

1 50

2 40

3 30

4 20

Price

A B C M.S

1 50 45 40 135

2 40 30 38 108

3 35 20 30 85

4 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

Y Y Price Less Flatter Price More Flatter

O Demand X O Demand X

Individual DC Market DC

Figure 2.1 Market demand for tomatoesDemand, the assumed inverse relationship between price and quantity purchased, can berepresented by a curve that slopes down toward the right. Here, as the price falls from $11to zero, the number of bushels of tomatoes purchased per week rises from zero to 110,000.

Figure 7.2 Market demand curveThe market demand curve for Coke, DA+B, is obtained by summing the quantities thatindividuals A and B are willing to buy at each and every price (shown by the individualdemand 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 curveAn 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 thedemand 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:

1. Inverse relationship.

2. Price independent and demand dependent variable.

3. Income effect & substitution effect. Assumptions: No change in tastes and preference of the consumers. Consumer’s 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

Law of Demand Exceptions:• Inferior goods• Articles of snob appeal. (exception: Veblen goods, eg.,

diamonds)• Expectation regarding future prices (shares, industrial materials)• Emergencies• Quality-price relationship• Conspicuous necessities.• Ignorance• Change in fashion, habits, attitudes, etc..

Importance:• Price determination.• To Finance Minister• To farmers• In the field of Planning.

Market Research and Law of Demand1. The more confidence a person has in price information as a

predictor of quality, the more likely he’ll be to choose a high-priced, rather than a low-priced item.

2. A person who perceived himself as experienced in purchasing a product will generally choose a low-priced item, but an inexperienced person will select a high-priced one.

3. A person who selects a high-priced item will (i) believe it’s more difficult to judge product quality, and (ii) feel he has less ability to make accurate quality judgments than one who chooses a low-priced item.

4. A person who purchases a high-priced product would perceive large quality differentials. He would also feel that it is risky and uncertain to go in for a low-priced product.

5. Business executives also disbelieve that the consumer is rational. (Eg., Yale – the under priced lock)

6. Purchasing behavior of the consumer is mostly repetitive.

The Law of Demand

P

Q

A

B

P

Q

D1D2

CHANGE IN PRICE=

change in quantity demanded

CHANGE IN OTHER=change in demand

P1

P2

Q1 Q2

The Law of Demand

P

Q

D1D2

CHANGE IN OTHER=change in demand

Determinants of Demand

Things other than price that cause the whole curve to shift

Increase: shift to the rightDecrease: shift to the left

Determinants of Demand

Change in consumer tastes

Change in people’s income

normal goods

inferior goods

What Happens to Demand if…?

SITUATION: You’re the owner of a hot dog making company:

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

What Happens to Demand if…?

SITUATION: You’re 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: You’re the owner of a hot dog making company:

(c) the price of ground beef plummets?

What Happens to Demand if…?

SITUATION: You’re the owner of a hot dog making company:

(d) the minimum wage rises?

What Happens to Demand if…?

SITUATION: You’re 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: You’re the owner of a hot dog making company:

(f) unemployment hits an all-time high?

What Happens to Demand if…?

SITUATION: You’re the owner of a hot dog making company:

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

Elasticity of demand 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”

Factors affecting Elasticity of Demand1. Availability of substitutes

2. Postponement of consumption3. Proportion of expenditure (needles: inelastic; TV: elastic)4. Nature of the commodity (necessity vs. luxury;

durability/reparability eg., shoes)5. Different uses of the commodity (paper vs. ink)6. Time period (elastic in the long term)7. Change in income (necessaries: inelastic; milk and fruit for a rich

man)8. Habits9. Joint demand10. Distribution of income11. 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 ElasticityPED = % 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 elasticity’s 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 price-

elastic)• 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 decisions1. 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

dO

X

Y

p

d1

Ed = ∞

2. Perfectly Inelastic

p1

OX

Y

p

d

Ed = 0

3. Unitary Elastic

p1

OX

Y

p

d1

Ed = 1

d

4. Relatively more Elastic

p1

OX

Y

p

d1

Ed > 1

d

5. Relatively less Elastic

p1

OX

Y

p

d1

Ed < 1

d

Figure 7.3 Elastic and inelastic demandDemand curves differ in their relative elasticity. Curve D1 is more elastic than curve D2, inthe 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 coefficientThe elasticity coefficient decreases as a firm moves down the demand curve. The upper halfof a linear demand curve is elastic, meaning that the elasticity coefficient is greater thanone. The lower half is inelastic, meaning that the elasticity coefficient is less than one. Thismeans that the middle of the linear demand curve has an elasticity coefficient equal to one.

Figure 7.8 Network effects and demandAs 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 inthe future. The more the demand expands over time in response to greater sales in thecurrent time period, the more elastic is the long-run demand.

Methods of measurement of Elasticity1. 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) MethodsTO=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 Maslow’s hierarchy of needsThe pyramid orders human needs by broad categories from the most prepotent needs onthe 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 oftheir prepotence, or will move from the bottom of the pyramid through the various levelsto the top, so long as the individual’s resources to satisfy her needs last.

Figure 3.5(a) Demand, price, and need satisfactionThe extent to which needs are satisfied depends, in the economists’ view of the world, onthe nature of the need’s demand and its price. Physiological needs may indeed be morecompletely satisfied than other needs, but that may only be because physiological needshave relatively low prices (panel (a)). But then, as shown in this figure (panel (b)), theprice of the means of satisfying physiological needs might be higher than the prices of themeans of satisfying safety and love needs.