3 demand theory

• Concepts of Demand and

Supply: Individual and Market

Demand and Supply• Demand and Supply

Curves, Schedules and Factors

Affecting Demand and Supply Movements along Demand/Supply Curves

and their Shifts

In This Lecture…..

• Concepts, Types and Measurements of

and Factors affecting Elasticity of Demand

and Supply• Producer’s Surplus• Consumer’s Surplus• Effects of Government

Intervention, Effects of Price Ceiling and Price

Floor and Dead Weight Loss • Concepts of Externalities

In This Lecture…..

DemandA Definition

Demand refers to the quantity

of the commodity which the

consumer is willing to buy at

a particular price during a

particular time period.

Want, Desire, Demand

• Desire to have a RR, but do not have enough money – wishful thinking

• In spite of having the money you do not want to spend on RR – want

• Your desire to have a RR with the ability and willingness to pay for it combined together will be - demand

Factors determining Demand & Demand Function

• Dx = f (Px, PR,Y, T, E)

Dx = Demand for commodity X

Px = Price of commodity X

PR= Price of related goods

(Substitute and Complementary)

Y = Income of the consumers

T = Taste and preference

E = Expectations of the buyers

Demand and Prices of Other Goods

• Substitute Goods : These are those goods which are an alternative to one another in consumption eg. Tea or coffee, Pepsi or Coca cola

• A fall in the price of substitute good say Y, leads to a fall in the quantity demanded of good X and vice versa

• Complementary Goods : They are those goods which are jointly used or consumed together to satisfy a want eg. Tea and sugar, bread and butter.

• A fall in the price of complementary good say Y, leads to a rise in the quantity demanded of good X and vice versa

Demand and Income of the consumer

• If X is a Normal Good, then with the increase n the income, consumer buys more of the good. It has positive income effect.

• If X is an Inferior Good, then with the increase n the income, consumer buys less of the good. Eg. Coarse Grains. It has negative income effect.

Factors determining Market Demand & Demand Function

• Dx = f (Px, PR,Y, T, E, N, Yd, A)

Dx = Demand for commodity X

Px = Price of commodity X

PR= Price of related goods

Y = Income of the consumers

T = Taste and preference

E = Expectations of the buyers

N = Population

Yd= Income distribution

Law of Demand

There is an inverse relationship between the price of a commodity and the quantity demanded of that commodity.

Dx = f (Px), ceteris peribus where, Dx = quantity demanded of good X

Px = price of the good XAs the price of a good rises, the quantity demanded of the good falls, and as the price of a good falls, the quantity demanded of the good rises, ceteris paribus.

Price

Quantity

Ceteris Paribus

A Latin term meaning “all other things constant” or “nothing else changes.”

Assumptions of the Law of Demand* Price of related goods is constant* The income of the consumers remain

unchanged.* Consumers tastes and preferences remains same.* Expectations of the customers is constant* Number of population remains same.* All the units of the goods are homogenous.* Commodity should be normal good.

Demand Schedule

Demand Schedule : It’s a tabular representation showing the different quantities of a good that the consumers are willing to pay at different levels of prices during a given period of time.

A demand schedule is the numerical representation of the law of demand.

Demand Curve

Demand Curve : It’s a graphical

representation of the demand schedule showing the different quantities of a good that the consumers are willing to pay at different levels of prices during a given period of time.

Demand Schedule

Downward Slopping Demand Curve

The graphical representation of the demand

schedule and law of demand.

Demand - Schedule and Graph

Why Demand Curve always Slopes Downwards?

* Law of Diminishing Marginal Utility

As a consumer consumes more and more of a same commodity at a point of time, the utility derived from each additional unit consumed goes on declining / the consumer is willing to pay less for more units of a good. This shows inverse relationship between price and quantity demanded.

Why Demand Curve always Slopes Downwards?

* Substitution Effect

When the price of a good falls, consumer buys less of the substitute goods and more of the good whose price has fallen. This shows inverse relationship between price and quantity demanded.

Why Demand Curve always Slopes Downwards?

* Income Effect

With the fall in the price of a good, the real income or the purchasing power of the consumer rises and he demands more of the good. This shows inverse relationship between price and quantity demanded.

Why Demand Curve always Slopes Downwards?

* New Consumers Creating Demand

As price of a commodity falls, a new consumer class appears who can now afford the good. Thus, the demand increases.

Why Demand Curve always Slopes Downwards?

* Different Uses

With the fall in the price of a good, it is put to various uses and demand for that commodity increases and vice versa. Eg. Milk can be used for making butter, cheese, curd and drinking purposes etc.

Exceptions to the Law of Demand* Giffen Goods

It is an inferior good like jowar, bajra that is consumed by low-paid wage earners who spend a large proportion of their income to buy it.

In this case, as the price of giffen good decreases, the low-paid wage earners shift to better quality good as their real purchasing power has increased thereby deceasing the demand for the giffen good.

It is named after Sir Robert Giffen (1837-1910)

Exceptions to the Law of Demand* Goods of Status

Precious goods like diamonds, gold, silver – higher the price higher will be its demand.

It is also known as Veblen goods / prestigious goods.

It is named after Thorstein Veblen (1857-1929)

Exceptions to the Law of Demand* Expectation of price rise in future

If the price of a commodity rises and the consumer expects further rise in price, it leads to an increase in the demand for that commodity and vice versa. Eg. Shares.

Exceptions to the Law of Demand* Demonstration Effect / Keeping up with Jones

If people are buying the goods by imitating the consumption pattern of the higher income group – the demand will be higher even at higher price.

Exceptions to the Law of Demand* Emergency

In case of emergency like war, curfew, drought or famine, the law of demand does not hold.

RECAPFactors determining Demand & Demand

Function

• Dx = f (Px, PR,Y, T, E)

Dx = Demand for commodity X

Px = Price of commodity X

PR= Price of related goodsY = Income of the consumersT = Taste and preferenceE = Expectations of the buyers

Demand and Prices of Other Goods

• Substitute Goods : These are those goods which are an alternative to one another in consumption eg. Tea or coffee, Pepsi or Coca cola

• A fall in the price of substitute good say Y, leads to a fall in the quantity demanded of good X and vice versa

Price price

of D of D’

Coffee D’ Coffee D

O O

Quantity demanded Quantity demanded

of tea of tea

(a) Fall in the price of substitute (b)Rise in the price of substitute

• Complementary Goods : They are those goods which are jointly used or consumed together to satisfy a want eg. Tea and sugar, bread and butter.

• A fall in the price of complementary good say Y, leads to a rise in the quantity demanded of good X and vice versa

Price priceof D of D’Butter D’ Butter D

O O Quantity demanded Quantity demanded

of bread of bread

(a) Fall in the price of (b) Rise in the price of complementary complementary

Demand and Income of the consumer

• If X is a Normal Good, then with the increase n the income, consumer buys more of the good. It has positive income effect.

• If X is an Inferior Good, then with the increase n the income, consumer buys less of the good. Eg. Coarse Grains. It has negative income effect.

Price price

D D’

D’ D

O O

Quantity demanded Quantity demanded

of Normal Good with of Inferior Good with

a rise in income of a rise in income of

the consumer the consumer

Demand and Consumer’s TastePrice price

D D’

D’ D

O O

Quantity demanded Quantity demanded

with an unfavourable with a favourable

change in consumer’s change in consumer’s

taste taste

Demand and Expectations of BuyersPrice price D D’ D’ D

O O Quantity demanded Quantity demanded

when consumers when consumers expect the price expect the price to fall in near future to rise in near future

Factors determining Market Demand & Demand Function

• Dx = f (Px, PR,Y, T, E, N, Yd, A)

Dx = Demand for commodity X

Px = Price of commodity X

PR= Price of related goodsY = Income of the consumersT = Taste and preferenceE = Expectations of the buyersN = Population

Yd= Income distributionA = Age and Sex composition of

Population

Individual Demand and Market Demand

• Individual Demand :-

It means quantity demanded of a good by

an individual consumer at various prices

per time period.

• Market Demand :-

It is the aggregate of the quantities

demanded by all consumers in the market

at different prices per time period.

Market Demand Schedule

Market Demand Schedule : It’s a tabular representation showing the different quantities of a good that the consumers in the market are willing to pay at different levels of prices during a given period of time.

Market Demand Curve

Market Demand Curve : It’s a graphical representation of the market demand schedule showing the different quantities of a good that the consumers in the market are willing to pay at different levels of prices during a given period of time.

Derivation of Market DemandSchedule

Derivation of Market DemandCurve

Change in Quantity Demanded (movement) vs. Change in Demand (shift) of Demand Curve

• Change in Quantity Demanded / Movement along the demand curve

It is caused by the change in the price of good other things remaining constant.

* Expansion of Demand : It refers to rise in

demand due to the fall in price of the good.

* Contraction of Demand : It refers to fall in

demand due to the rise in price of the good.

Contd.

Expansion of Demand Contraction of DemandPrice Price

P P1

P1 P

O O

Q Q1 Q1 Q

Quantity Demanded Quantity Demanded

• Shift / Increase or Decrease in Demand

It is caused by changes in factors other than price of the good like

consumer’s income

price of related goods

consumer’s taste and preferences

consumer’s expectations etc.

Contd.

* Increase in Demand : It refers to more demand at a given price or same demand at higher price. It is indicated by the rightward shift in the demand curve. It is due to

- increase in the income of the consumers- increase in the price of substitute goods- decrease in the price of complementary goods- favorable change in customer’s taste- consumer’s expectation of rise in price of the good in near future

Contd.

* Decrease in Demand : It refers to less demand at a given price or same demand at lesser price. It is indicated by the leftward shift in the demand

curve. It is due to

- decrease in the income of the consumers

- decrease in the price of substitute goods

- increase in the price of complementary goods

- unfavorable change in customer’s taste

- consumer’s expectation of fall in price of the

good in near future

Contd.

Price

P

D1

D

O Q Q1 Qx

Quantity Demanded

Increase in demand

Contd.

Price

P D

D1

O Q1 Q Qx

Quantity Demanded

Decrease in demand

Difference in the Causes of Shift in the Demand Curve

Increase in Demand (Upward or Rightward shift in Demand)

Decrease in Demand (Downward or Leftward shift in

Demand)

1. Increase in the income of the consumers.

1. Decrease in the income of the consumers.

2. Increase in the price of substitute goods.

2. Decrease in the price of substitute goods.

3. Fall in the price of complementary goods.

3. Rise in the price of complementary goods.

4. Favorable change in the taste and preferences of the customers

4. Unfavorable change in the taste and preferences of the customers

5. Consumer’s expectation of rise in the price of goods in near future

5. Consumer’s expectation of fall in the price of goods in near future

Difference between Increase in Demand and Expansion of Demand

Increase in Demand Expansion of Demand

•It refers to shift in demand curve.

•There is a rightward shift in the demand curve.•It is due to:-

- increase in consumer’s income

- increase in the price of substitute goods

- fall in the price of complementary goods

- favorable change in consumer’s

taste

- consumer’s expectation of rise in the

price in near future

•It refers to movement along a demand curve.•The consumers move to the right on the same demand curve.•It is due to the fall in the price of the commodity.

Contd.

Increase in Demand Expansion of Demand•It is defined as a rise in demand at the same price of a commodity or same demand at higher price.•Graphical presentation:-Price

D D1

P

O Q Q1

Quantity

•Numerical example:-

Px Qx

3 90

3 80

•It is defined as rise in demand due to fall in price of the commodity.• Graphical Presentation :-Price

P

P1 D

O Q Q1

Quantity

•Numerical Example :-

Px Qx

3 90

4 80

Difference between Decrease in Demand and Contraction of Demand

Increase in Demand Expansion of Demand

•It refers to shift in demand curve.

•There is a leftward shift in the demand curve.•It is due to:-

- decrease in consumer’s income

- decrease in the price of substitute goods

- rise in the price of complementary goods

- unfavorable change in consumer’s

taste

- consumer’s expectation of fall in the

price in near future

•It refers to movement along a demand curve.•The consumers move to the left on the same demand curve.•It is due to the rise in the price of the commodity.

Contd.

Increase in Demand Expansion of Demand•It is defined as a fall in demand at the same price of a commodity or same demand at lower price.•Graphical presentation:-Price

D1 D

P

O Q1 Q

Quantity

•Numerical example:-

Px Qx

3 90

3 100

•It is defined as fall in demand due to rise in price of the commodity.• Graphical Presentation :-Price

P1

P D

O Q1 Q

Quantity

•Numerical Example :-

Px Qx

3 90

2 100