The Basics of Demand,

7/30/2019 The Basics of Demand,

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The Basics of Demand,Supply and Equilibrium

Dr. Prerna Jain


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Demand

Demand is defined as the want whichis backed by willingness and ability tobuy a particular commodity in a given

period of time.

Quantity demanded (Qd)

Amount of a good or serviceconsumers are willing and able topurchase during a given period oftime


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Types of Demand

When a commodity is

demanded for its own sakeby the final consumer, it isknown as consumer goodand its demand is deriveddemand. Ex: TV,refrigerator, computer andeatables.

A final consumer is onewho derives satisfactionfrom a good without anyfurther value addition.

Derived Demand

When a commodity is

demanded for using iteither as a raw material oras an intermediary forvalue addition in any othergood or in the same good,it is known as a capitalgood and its demand is

derived demand.

Direct Demand


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Recurring Demand

Consumable goods have

recurring demand, i.e.,they are consumed atfrequent intervals, like youeat food twice a day

Replacement Demand

Goods like TV, cars,

furniture and houses areall examples of durableconsumer goods. They arepurchased to be used for along period of time. Butthey wear and tear overtime due to use or

obsolescence oftechnology; thus they needreplacement.


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ComplementaryDemand

Goods which create jointdemand arecomplementary goods;

therefore demand for onecommodity is dependentupon demand for the otherone

Competing Demand

Goods that compete witheach other to satisfy anyparticular want are called

substitutes.


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Individual Demand

Demand for an individualconsumer is normallyexpressed as individual

demand and the theory ofdemand is based onindividual demand.

Market Demand

Demand by all theconsumers for its productis known as market

demand.


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Determinants of Demand

Price of the product Normally, price has anegative effect on demand.

Income of the consumer Normally, incomebears a positive relationship with demand.Normal goods have a positive relation whereasinferior goods have negative relation.


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Price of related goods If price of a commodityincreases, its demand falls, but when demand foranother product also falls as a consequence torise in price of this commodity such goods are

complementary to each other (car and petrol).

On the other hand when demand for anothercommodity rises as a consequence of increase inprice of this commodity, they are substitutes (tea

and coffee). Thus an increase in the price of a commodity

increases the demand for its substitute andreduces the demand for its complement.


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Tastes and Preferences Tastes and preferenceshave such effect that in spite of a fall in price,demand may not increase if the good has goneout of fashion and in spite of increase in price,

demand may not decrease because of theproduct being in fashion.


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Advertising Advertising has gained remarkableground as a determinant of demand, especially inthe modern age of cut throat competition amongbrands.

Consumers expectation of future income andprice.

Population

Growth of economy


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Demand Function

Demand function

DX = f (Px, Y, Po, T, A, Ef, N)


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Milestones on the Road to

Theory of Demand and Supply Antoine- Augustin Cournot was the first scholar

to bring out the Law of Demand in 1838, but histheory could not gain popularity as it was in puremathematical terms with which the then students

of economics was unfamiliar.

In 1844 Dupuit drew the first demand curve andcalled itthe curve of consumption.

The law of demand was discovered a few years

later and given its first application by lardner in1850 to explain transportation services.


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Fleeming Jenkin was the first scholar to draw thedemand and supply curves together to explainthe determination of price in 1870. Jenkin alsowas the first to use theories of demand and

supply to make predictions about the effects oftaxes. Alfred Marshall is recognised as the firstperson to present complete and modernexplanation of demand and supply theory

through his monumental treatise to economics Principles of Economics.


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Generalized Demand Function

Qd = abP + cY + dPo + eT + fA+ gN

b, c, d, e, f, &g are slope parameters

Measure effect on Qdof changing one of thevariables while holding the others constant

Sign of parameter shows how variable isrelated to Qd

Positive sign indicates direct relationship Negative sign indicates inverse relationship


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Law of Demand

A decrease in the price of a good, all other thingsheld constant, will cause an increase in thequantity demanded of the good.

An increase in the price of a good, all otherthings held constant, will cause a decrease in thequantity demanded of the good.


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Reasons Behind Law of

Demand Price Effect: This explains why a fall in price

results in rise in demand and vice versa. Somecommodities may have multiple uses, likeelectricity, milk, coal, steel, etc. A fall in the price

of such a commodity would induce a consumer toput it to alternative uses, like electricity can beused for lighting, cooling, cooking, runningmachines, etc.


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Substitution Effect: When the price of acommodity falls, it becomes more easilyaffordable and thus more attractive to theconsumer; as also its substitute become more

expensive, assuming that its price has notchanged. The consumer tries to substitute thisparticular commodity for other commodities. As aresult, demand for the commodity rises.


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Income effect demand depends upon theincome of the consumer and law of demandassumes that income is given. When price of aparticular commodity falls, the consumers real

income rises, though money income remains thesame. Thus, with fall in the price of thecommodity, income remaining the same,purchasing power of the individual rises, inducing

the consumer to buy more of that commodity.


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Exceptions to the Law of

Demand Giffen Goods: In Ireland it was observed that the

poor population consumed two goods: meat(which was costly) and bread (which was cheap).A very strange phenomenon was observed when

the price of bread was increased, it made a largedrain on the resources of the poor people thatthey were forced to curtail their consumption ofmeat and buy more of bread which was still the

cheapest food. This implied that quantitydemanded of bread (an inferior good) increasedwith increase in its price. Sir Robert Giffen wasthe first to give an explanation to this situation


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Hence, such goods which display direct pricedemand relationship are called giffen goods.These goods are considered inferior by theconsumer, but they occupy a significant place in

the individuals consumption basket. It sohappens that people in this case, with the rise ofprice of that good (bread) are forced to reducetheir purchase of other expensive goods (say,

meat) and increase the purchase of that good(bread) in larger quantity to supplement thereduction in luxury food items. Hence thesegoods are those on which major portion ofincome is spent, hence they are termed as giffen.


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Snob Appeal There are certain goods whichhave snob value, for which the consumersmeasures the satisfaction derived not by theirutility value, but by social status. The consumers

of this particular commodity want to show it offto others, and as a result they buy less of it at alower prices and more at higher prices.

Demonstration Effect: When a persons behaviour

is influenced by observing the behaviour ofothers, this is known as demonstration effect.Fashion is one such incidence. In such a caseprice is not a governing parameter and goods are

bought even though prices are rising.


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Future expectation of prices

Goods with no substitutes Those goods whichhave no substitute, such as life saving drugs,petrol and diesel, people have no option but tobuy them, whatever be the price


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Graphing Demand Curves

A point on a demand curve showseither:

Maximum amount of a good that will be

purchased for a given price

Maximum price consumers will pay for aspecific amount of the good


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Graphing Demand Curves

Change in quantity demanded

Occurs when price changes

Movement along demand curve

Change in demand

Occurs when one of the other variables,or determinants of demand, changes

Demand curve shifts rightward orleftward


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Change in Quantity Demanded

Quantity

Price

P0

Q0

P1

Q1

An increase in price

causes a decrease in

quantity demanded.


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Change in Quantity Demanded

Quantity

Price

P0

Q0

P1

Q1

A decrease in price

causes an increase in

quantity demanded.


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Changes in Demand

Change in Buyers Tastes

Change in Buyers Incomes

Normal Goods Inferior Goods

Change in the Number of Buyers

Change in the Price of RelatedGoods

Substitute Goods

Complementary Goods


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Change in Demand

Quantity

Price

P0

Q0 Q1

An increase in demand

refers to a rightward shift

in the market demand

curve.


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Change in Demand

Quantity

Price

P0

Q1 Q0

A decrease in demand

refers to a leftward shift

in the market demand

curve.


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Supply

Supply refers to the quantities of a good orservice that the seller is willing and able toprovide at a price, at a given point of time andvice versa.


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Supply

Six variables that influence QsPrice of good or service (P)

Input prices (PI)

Prices of goods related in production (Pr)Technological advances (T)

Expected future price of product (Pe)

Number of firms producing product (F)

Generalized supply function

( , , , , , )s I r eQ f P P P T P F


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Generalized Supply Function

k, l, m, n, r, & s are slope parameters

Measure effect on Qsof changing one of thevariables while holding the others constant

Sign of parameter shows how variable isrelated to Qs

Positive sign indicates direct relationship Negative sign indicates inverse relationship

s I r eQ h kP lP mP nT rP sF


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Generalized Supply Function

Variable Relation to Qs Sign of SlopeParameter

P

Pe

F

PI

Pr

Direct

Direct

Direct

Inverse

Inverse

Inverse for substitutes

k = Qs/ P is positive

l = Qs/ PI is negative

m = Qs/ Pr is negativem = Qs/ Pr is positive

r = Qs/ Pe is negative

s = Qs/ F is positive

Direct for complements

n = Qs/ T is positiveT


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Graphing Supply Curves

A point on a supply curve shows either:

Maximum amount of a good that will beoffered for sale at a given price

Minimum price necessary to induce producersto voluntarily offer a particular quantity forsale


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Graphing Supply Curves

Change in quantity supplied

Occurs when price changes

Movement along supply curve

Change in supply Occurs when one of the other variables, or

determinants of supply, changes

Supply curve shifts rightward or leftward


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Law of Supply

A decrease in the price of a good, all other thingsheld constant, will cause a decrease in thequantity supplied of the good.

An increase in the price of a good, all other

things held constant, will cause an increase in thequantity supplied of the good.


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Change in Quantity Supplied

Quantity

Price

P0

Q0

P1

Q1

An increase in price

causes an increase in

quantity supplied.


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Changes in Supply

Change in Production Technology

Change in Input Prices

Change in the Number of Sellers


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Change in Supply

Quantity

Price

P0

Q1Q0

An increase in supply

refers to a rightward shift

in the market supply curve.


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Change in Supply

Quantity

Price

P0

Q1 Q0

A decrease in supply refers

to a leftward shift in the

market supply curve.


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Market Equilibrium

Market equilibrium is determined atthe intersection of the marketdemand curve and the market supply

curve.

The equilibrium price causes quantitydemanded to be equal to quantity

supplied.


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Market Equilibrium

Quantity

Price

P

Q

D S


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Market Equilibrium

Quantity

Price

P0

Q0

D0 S0

Q1

P1

D1

An increase in demandwill cause the market

equilibrium price and

quantity to increase.


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Market Equilibrium

Quantity

Price

P1

Q1

S0

Q0

P0

D0D1

A decrease in demandwill cause the market

equilibrium price and

quantity to decrease.


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Market Equilibrium

Quantity

Price

P0

Q0

D0 S0

Q1

P1

An increase

in supply

will cause

the marketequilibrium

price to

decrease and

quantity toincrease.

S1


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Market Equilibrium

Quantity

Price

P1

Q1

D0

Q0

P0

A decrease in

supply will

cause the

marketequilibrium

price to

increase and

quantity todecrease.

S1 S0

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