THEORY OF DEMAND P Bharathi Page 1

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THEORY OF DEMAND P. Bharathi Page 1

What is Demand? • The willingness to buy a good or service at all prices • What is the law of Demand? • If nothing else changes, the quantity demanded of a good or service is greater at lower prices than higher. Page 2

Determinants of Demand • Prices of other goods ( substitute or complementary) • Outlook (consumer expectation of future income and prices) • Income (normal goods versus inferior goods) • Number of potential customers (pop. of market) • Tastes (or fashions) Page 3

Reasons for inverse relation between price & demand 1. Income Effect –current buyers buy more. 2. Substitution Effect– new buyers now purchase. 3. Diminishing Marginal Utility - because buyers of successive units receive less marginal utility, they will buy more only when the price is lowered. Page 4

Consumers “willingness to buy” P Rs. 5 4 3 2 1 Price decreases; QD increases D Rs. 5 QD 10 20 35 55 80 Rs. 4 Rs. 3 Rs. 2 Rs. 1 0 10 20 35 55 80 Quantity Demanded …a specified time period …other things remaining constant Page 5

GRAPHING DEMAND Price of Corn CORN P $5 4 3 2 1 QD 10 20 35 55 80 P Rs 5 4 3 2 1 o 10 20 30 40 50 60 70 80 Quantity of Corn Q Page 6

GRAPHING DEMAND Price of Corn P Rs. 5 CORN P QD Rs. 5 10 4 20 3 35 2 55 1 80 4 3 2 1 o 55 10 20 30 40 50 60 70 80 Quantity of Corn Q Page 7

GRAPHING DEMAND Price of Corn P Rs. 5 CORN P QD Rs. 5 10 4 20 3 35 2 55 1 80 4 3 2 1 o 10 20 30 40 50 60 70 80 35 Quantity of Corn Q Page 8

GRAPHING DEMAND Price of Corn P Rs. 5 CORN P QD Rs. 5 10 4 20 3 35 2 55 1 80 4 3 2 1 o 10 20 30 40 50 60 70 80 Quantity of Corn Q Page 9

GRAPHING DEMAND Price of Corn P Rs. 5 CORN P QD Rs. 5 10 4 20 3 35 2 55 1 80 4 3 2 1 o 10 20 30 40 50 60 70 80 Quantity of Corn Q Page 10

GRAPHING DEMAND Price of Corn CORN P QD Rs. 5 10 4 20 3 35 2 55 1 80 P Rs. 5 4 3 2 1 o D 10 20 30 40 50 60 70 80 Quantity of Corn Q Page 11

Price decreases; QD increases D Rs. 5 Rs. 4 Rs. 3 Rs. 2 Rs. 1 0 10 20 35 55 80 Quantity Demanded …a specified time period …other things remaining constant Page 12

Individual Demand Market Demand D “C” “B” “A” D “Market Demand” D D Rs. 3 +Rs. 3 = Rs. 3 Rs. 2 35 40 39 45 30 [Total] 100 115 26 From “individual” demand to “market” demand And, what if the price of this product drops from Rs. 3 to Rs. 2? Page 13

D Change in QD Rs. 10 1. Price change 2. Movement [up/down the demand curve] 3. Point to point [along the curve] Inverse Price relationship Rs. 8 QD 1 QD 2 QD Page 14

“Demand Shifters” 1. Taste 2. Income 3. Market Size 4. Expectations of consumers about future price, Income, availability of good 5. Prices of related goods Page 15

“Demand Shifters” D 1 D 2 P Substitute [Direct] Coffee D 1 D 2 P P 1 D P 2 Complement [ i n v ers e] Butter QD 1 QD 2 Bread Page 16

“Demand Shifters” D 1 D 3 P QD 3 QD 1 QD 2 Page 17

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ELASTICITY OF DEMAND “ The degree of responsiveness of change in demand to a change in price ” Importance of Elasticity of demand: • Determination of price under monopoly, • Determination of price under discriminating monopoly • Determination of price of product mix, • Determination of price of public utilities, • Determination of international trade policy Page 19

Type of elasticity of demand: Income elasticity of Demand: The degree of responsiveness of change in demand to a change in income Type of Income Elasticity of Demand: – Zero – Negative – Positive Price Elasticity of Demand: The degree of responsiveness of change in demand to a change in price Methods of Measuring Price Elasticity: » Total outlay or expenditure method » Point Method » Arc Method Page 20

Cross Elasticity of Demand: The degree of responsiveness of change in demand for good ‘B’ to a change inprice of good ‘A’ Type of Cross elasticity of demand: – Zero, – Negative, – Positive: a) >1 (b) <1, (c) =1 – Infinitive Page 21

Factors governing the elasticity of demand: • • • Number and closeness of substitutes Significance of commodity in budgets Degree of necessity of goods Habits and temperaments of consumer Number of the use of commodity Period of time for demand Page 22

Factors influencing demand: – – – – – Number of consumers Price level Availability of substitutes Distribution of wealth Taste Fashion Possibility of change in price Climate Advertisement Page 23

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