MODULE II

THE CONCEPT OF DEMAND

AND ELASTICITY OF DEMAND
Demand
“demand is desire backed by willingness to pay
and ability to pay”
A wish to have a commodity does not
become demand. A person should have
desire for a commodity with willingness
to pay and ability to pay for it. Thus
desire become demand when;
desire for the commodity
Willingness to pay
Ability to pay
Demand for a commodity
“demand for a commodity is the quantity of
that commodity which consumers will be
willing to buy in a given period of time at a
given price.”

Product
Price
place
period
Types of demand
Individual demand : It can be defined as the
quantity of a commodity that an individual
consumer is willing to buy in a given period
of time at a given price.
House hold demand : it is the quantity of
commodity that a household is willing to buy
in a given period of time at a given price
Market demand : it is the quantity of
commodity that all consumers in a market
will be willing to buy in a given period of time
at a given price.
Determinants of Demand
✔ Price of the commodity
✔ Price of the substitutes
✔ Income of the consumer
✔ Tastes and Preferences
✔ Credit facility and Rate of interest
✔ Trade cycles
✔ Distribution of National Income
✔ Money supply
✔ Seasonal effect
Law of demand
Generally commodities are demanded at
different quantities at different prices. A
person demands more at a lower price and
less at a higher price. In economics, the
relation of price to demand or sale is known
as the Law of Demand.
The Law of Demand states that higher the
price and lower the demand and vice versa,
while other things remaining the same.There
is an inverse relationship between price and
demand.
Exception to the Law of Demand
a) Giffen’s goods (inferior goods).
Sir Robert Giffen observed that if the price
of a commodity, consumed mostly by poor
households as a necessary item,increases,
its demand increases instead of decreasing.
This phenomenon is known as Giffen’s
paradox. Giffen’s goods are inferior goods
b) Status symbol goods or prestige goods
Conti…
c) Expectation regarding price
variation.
d) Demand for necessaries like rice,
medicines
e) Change in fashion
f) Special occasions
g) Brand loyalty
h) Ignorance of consumers
i) Emergencies
Demand funtion
Demand function expresses the relationship between
quantity demanded for a commodity and its
determinants. Demand function can be expressed in
the form of an equation as follows:
Da = f(Pa, Pr, Y ,T…..) where
Da = demand for commodity ‘a’
Pa = price of commodity ‘a’
Pr = price of related commodities
Y = consumers income
T = taste and preference etc…
Demand schedule
Demand schedule is a list or table which
showing various prices of a commodity and
the quantities demanded by consumers at
these prices. For example
PRICE OF SUGARE QUANTITY DEMANDED
60 (Rs/kg) 5 (in kg)
65 4
70 3
75 2
80 1
Household demand schedule and curve
A household demand schedule is a table
which shows different prices and
corresponding quantity demanded of a
particular household product.
A demand schedule can be presented in the
form of a graph which is called demand
curve. The demand curve slopes downwards
from left to right (negative slope). It shows
the inverse relatinship between price and
quantity demanded
 9
price Demand Curve
8
7
6
5
0 10 15 20 25 30
Quantity Demanded
Why the demand curve slopes downwards?

1. Income Effect
2. Price Effect

3. Substitution Effect
4. Diminishing Marginal Utility
5. Alternate use of Commodity
The Market Demand and Market
Demand Curve
Market demand is the quantity of a commodity
that all consumers in a market will be willing
to buy in a given period of time at a given
price.
Market demand schedule is a list or table
showing the various prices of a commodity
and the quantities demanded at those prices
by the entire market.
The graphical representation of MDS is Market
Demand Curve
 Factors determining market demand
i. Price of the commodity
ii. Price of the substitutes
iii. Number of households in the market
iv. Income of the house holds
v. Tastes and preferences of households
vi. Rate of interest
vii. Business conditions
viii. Distribution of income
ix. Money supply
 Movement Along Demand Curve & Shift in
Demand Curve
In economic theory, change in demand studied under
two head, that is;
A) Change in demand due to change in price
B) Change in demand due to change in non-price
factors like income, taste,preference etc
Changes in demand of a commodity caused by
changes in price is referred as expansion or
contraction of demand and changes in
demand caused by factors other than price
is referred as shift in demand or increase or
decrease in demand
Expansion and Contraction of Demand
The most important factor determining
the demand for a commodity is its price.
When the price of a commodity falls, the
consumer moves down the demand
curve and buys more. This is called
expansion of demand.
When the price rises, the consumer
moves up the demand curve and buys
less, this is called contraction of
demand.
 Expansion and Contraction of Demand
Y
P1 a

b
P

c
P2

0 N
N1 N2
X
Shift in demand (increase/decrease)
• Variations in quantity demanded of a
commodity caused by changes in factors
other than its price is known as shift in
demand. Shift in demand can be either
increase or decrease in demand
• This may be due to increase or decrease in
income, change in taste or preference,
availability of substitutes etc…
• This may be rightward shift or leftward shift
 Y SHIFT IN DEMAND

PRICE D D1
D2

D1
D
D2

O N2 N N1 X
QUANTITY
ELASTICITY OF DEMAND
Elasticity of demand means the degree of
responsiveness of demand of a commodity
due to changes in its various determinants.
The law of demand explains the inverse
relationship between price and quantity
demanded.
But the law does not say ‘how much quantity’
changed due to change in price. This defect
of law of demand is explained by the concept
of elasticity of demand
Price Elasticity of Demand
Price elasticity of demand is defined as the
degree of responsiveness of quantity
demanded of a commodity in response to
change in its price.
In other words, price elasticity of demand
refers to ratio of the percentage change in
the quantity demanded of a commodity to a
given percentage change in its price.
Price elasticity measures the degree at which
demand responds to price.
 percentage change in quantity demanded
ep = percentage change in price
or
change in quantity demanded X 100
= original quantity
change in price
original price X 100
example
The demand for a commodity was 100
units when the price was Rs 10. the
demand for it increased to 120 units
when the price was reduced to Rs 9.
measure the elasticity of demand.
ep =
P = original price
Q = original quantity
Conti…
 Degree of Price Elasticity
Theoretically, there are five category of
price elasticity
I. Perfectly Elastic Demand
II. Perfectly Inelastic Demand
III. Unitary elastic Demand
IV. Relatively Elastic Demand
V. Relatively Inelastic Demand
Perfectly Elastic Demand
This is the situation where a small change in
price causes a substantial change in quantity
demanded. A slight change in price causes an
infinite increase in demand and vice versa.
Y
D ep = ∞
price

o X
Quantity demanded
Perfectly Inelastic Demand
This is the situation where changes in price
cause no change in quantity demanded. This
D
is another situation where Y
there is non-responsiveP1
or inelastic to price P
changes. P2
Ep = 0
o M X
Unitary Elastic Demand
This is the situation where change in the price
causes proportionate change in quantity
demanded. In this case elasticity will be
equal to one or Y
D
unity. The curve is
ep = 1
Known as P
rectangular P1 D
hyperbola.
N N1 X
Relatively Elastic Demand
This is the situation when a given
proportionate change in price causes more
proportionate change in quantity demanded.
For eg, 8% change Y
D
in price
P ep >1
causes 20%
P1
change in D
demand.
O N1 X
N
Relatively Inelastic Demand
In this situation a proportionate change in
price, causes lesser proportionate change in
quantity dmanded. Y D
for eg, 15% change P
in price causes 8% ep <1
change in demand. P1
D
the demand curve
O N N1 X
will be steep.
Factors affecting price elasticity of
demand
Nature of the commodity

Alternative use of the commodity

Availability of substitutes
Price
Income

Time period
 Measurement of price elasticity
I. Proportional or Percentage Method
under this method elasticity is measured by
using the following formula.
ep =
If price elasticity is equal to one, it is unitary
elastic demand. If elasticity is less than one, it
is relatively inelastic demand and more than
one relatively elastic demand. Infinite
elasticity shows perfectly elastic demand and
elasticity zero shows perfectly inelastic
demand.
ll.Expenditure Method
Under this method total expenditure incurred
on commodity changes as a result of change
in price which reflect the quantity
demanded. Consider the following table
PRICE QUANTITY TOTAL EXPENDITURE
DEMANDED

18 3 P X Q =54 e>1
15 4 P X Q = 60 e=1
12 5 P X Q = 60 e=1
9 6 P X Q = 54 e<1
Conti…
If total expenditure increases, elasticity is
greater than 1
If total expenditure decreases, elasticity is less
than one.
If total expenditure remains constant, elasticity
is equal to one.
It should be noted that we are considering
changes in total expenditure caused by
changes in price and changes in quantity
demanded.
lll. Geometric Method (point / straight
line method)
Under this method elasticity is calculated by
taking in to account each point of change.
The demand curve should be a straight line
with downward sloping. The curve extended
to touch X axis and Y axis. Then point marked
on this curve dividing in to two segments i e
upper segment and lower segment. Elasticity
can be calculated by dividing lower segment
by the upper segment.
Cont….

ep = lower segment
upper segment
Y A Ep = ∞

B
ep = >1

ep = 1
price C

D
ep = <1

E ep = 0
O X
INCOME ELASTICITY OF DEMAND
The degree of responsiveness of quantity
demanded due to the change in income
of consumers is described as income
elasticity of demand.
It is the ratio of percentage change in
quantity demanded to percentage
change in income.
ey = percentage change in quantity demanded
percentage change in income
 CLASSIFICATION OF INCOME ELASTICITY
I. Zero income Elasticity : this is the situation
where changes in income do not lead to any
change in quantity demanded. Salt,
matches
II. Negative Income Elasticity : under this,
demand for a commodity decreases as a
result of change in income . Inferior goods
III. Positive Income Elasticity : this is the
situation where changes in income lead to
increase in quantity demanded. Consumer
goods
CROSS ELASTICITY
Percentage change in quantity demanded of a
commodity due to change in the price of the
related commodity is cross elasticity of
demand.
Related commodity may be complementaries
or substitutes. Tea and coffee are substitutes
and petrol and scooter are complementaries.
When the price of tea increases, demand for the
coffee increases due to substitution effect.when
price of the petrol increases, demand for the
scooter decreases due to non-affordability.
IMPORTANCE OF ELASTICITY OF DEMAND

TO THE GOVERNMENT
IN PRICING

TO THE MONOPOLIST
IN INTERNATIONAL TRADE