Hypotheses

Theory of Demand and Its • Economists have hypotheses about how changes in
each independent variable affect the amount demanded
Application (i.e., the dependent variable).

Dr. Muhammad Shahadat Hossain Siddiquee

Professor, Department of Economics
University of Dhaka
Contact E-mail: [email protected]
Cell: +8801719397749

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The ‘Standard’ Model of Demand The Demand Curve

• The DEPENDENT variable is the amount demanded. • The demand curve for any good shows the quantity demanded at
• The INDEPENDENT variables are: each price, holding constant all other determinants of
-the good’s own price demand.
-the consumer’s money income • The DEPENDENT variable is the quantity demanded.
-the price of other goods • The INDEPENDENT variable is the good’s own price.
-preferences

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Demand for Tea The Law of Demand

• The law of demand says that a decrease in good’s own price will
result in an increase in the amount demanded, holding constant
all other determinants of demand.
• Law of demand says that demand curves are negatively
sloped.

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1
The Law of Demand Related Goods and Services
• The law of demand states that • Substitutes are goods that can serve as replacements for one another;
there is a negative, or inverse when the price of one increases, demand for the other goes up.
relationship between the Perfect substitutes are identical products.
quantity of a good demanded
and its price.
• Complementary are goods that ‘go together’; a decrease in the price
of one results in an increase in demand for the other, and vice versa.
• This means that demand curves
slopes downward.

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The Demand Curve Shift of Demand vs. Movement Along

a Demand Curve
ANNA'S DEMAND • A change in demand is not the same as
a change in quantity demanded.
SCHEDULE FOR
TELEPHONE CALLS
QUANTITY
• In this example, a higher price causes
PRICE DEMANDED
lower quantity demanded.
(PER (CALLS PER
CALL) MONTH)
$ 0 30
0.50 25 • Changes in determinants of demand,
3.50 7 • The demand curve is a graph illustrating other than price, cause a change in
7.00 3 how much of a given product a household demand, or a shift of the entire
10.00 1
would be willing to buy at different prices. demand curve, from DA to DB.
15.00 0

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A Change in Demand Versus a Change

Related Goods and Services
in Quantity Demanded
• Normal Goods are goods for which demand goes up • When demand shifts to the right, demand
when income is higher and for which demand goes increases. This causes quantity demanded
to be greater than it was prior to the shift,
down when income is lower. for each and every price level.

• Inferior Goods are goods for which demand falls

when income rises.

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2
A Change in Demand Versus a Change From Household Demand to Market
in Quantity Demanded Demand
• To summarize: • Assuming there are only two households in the market, market
demand is derived as follows:
Change in price of a good or service
leads to

Change in quantity demanded

(Movement along the curve).

Change in income, preferences, or

prices of other goods or services
leads to

Change in demand
(Shift of curve).

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The Impact of a Change in Income The Concept of Elasticity

• Higher income decreases the demand • Higher income increases the • Elasticity is a measure of the responsiveness of one
for an inferior good demand for a normal good variable to another.
• The greater the elasticity, the greater the
responsiveness.

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The Impact of a Change in the Price of

Price Elasticity
Related Goods
• Demand for complement good (ketchup) shifts
left
• The price elasticity of demand is the percentage
change in quantity demanded divided by the percentage
change in price.

• Demand for substitute good (chicken) shifts

right

• Price of hamburger rises

• Quantity of hamburger
demanded falls
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3
Price Elasticity of demand Classifying Demand as Elastic or
Inelastic
• Demand is elastic if the percentage change in quantity
Percentage change in quantity demanded demanded is greater than the percentage change in
ED = price.
Percentage change in price
E>1

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Sign of Price Elasticity Classifying Demand as Elastic or

Inelastic
• According to the law of demand, whenever the price • Demand is inelastic if the percentage change in
rises, the quantity demanded falls. Thus the price quantity demanded is less than the percentage change in
elasticity of demand is always negative. price.

• Because it is always negative, economists usually state

the value without the sign. E<1

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What Information Price Elasticity of Elastic Demand

Demand Provides?
• Price elasticity of demand gives the exact quantity • Elastic Demand means that quantity changes by a
response to a change in price. greater percentage than the percentage change in price.

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4
Inelastic Demand Calculating Elasticity of Demand

• Inelastic Demand means that quantity doesn't change • To determine elasticity, divide the percentage change in quantity
much with a change in price. demanded by the percentage change in price.

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Defining Elasticities Perfectly Inelastic Demand Curve

• When price elasticity is between zero and -1 we say demand is
inelastic.

Perfectly inelastic
demand curve
• When price elasticity is between -1 and
- infinity, we say demand is elastic.

• When price elasticity is -1, we say demand is unit elastic.

0
Quantity
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Elasticity Is Independent of Units Perfectly Elastic Demand Curve

• Percentages allow us to have a measure of responsiveness that is

independent of units.
• This makes comparisons of responsiveness of different goods
easier.

Perfectly elastic
demand curve

0
Quantity
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5
Demand Curve Shapes and Elasticity Cross Elasticity of Demand (CPed) + = Substitutes
• Perfectly Elastic Demand Curve
– The demand curve is horizontal, any change in price • Substitutes:
can and will cause consumers to change their – With substitute goods such as brands of razors, an increase
consumption. in the price of one good will lead to an increase in demand
for the rival product
• Perfectly Inelastic Demand Curve
– Weak substitutes – inelastic CPed
– The demand curve is vertical, the quantity demanded
– Close substitutes – elastic CPed
is totally unresponsive to the price. Changes in price
have no effect on consumer demand.
Cross price elasticity will be positive for Substitutes
• In between the two extreme shapes of demand curves
are the demand curves for most products.
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Determinants of the Price Elasticity of Cross Elasticity of Demand (CPed) -

Demand = Complements
• Price elasticity of demand depends on: • Complements:
– How many substitutes there are – Goods that are in complementary demand
– How well a substitute can replace the good or – Weak complements – inelastic CPed
service under consideration – Close complements – elastic CPed
– The importance of the product in the consumer’s
total budget
The cross price elasticity of demand for two
– The time period under consideration
complements is negative

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Cross Elasticity of Demand Substitutes

+
• Cross price elasticity (CPed) measures the
responsiveness of demand for good X following a
change in the price of good Y (a related good)

• CPeD = % change in qty D of product A

% change in price of product B

• With cross price elasticity we make an important

distinction between substitute products and
complementary goods and services.
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Complements - Calculate the CPeD and state whether the goods are
complements or substitutes?

1. A 10% rise in the price of fish may cause demand for

chicken to increase by 2%.
2. The fall in the price of paper by 20% causes the
demand for pens to increase by 5%.
3. A 20% rise in the price of ice cream causes demand
for sweets to increase by 4%.
4. A 12% fall in the price of air fares leads to a 30% rise
in the demand for foreign holidays.
5. A 10% rise in bikes will leave the demand for cheese
unaffected.

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Goods with zero cross-price elasticity Answers…

of demand (INDEPENDENT)
• A 10% rise in the price of fish may cause demand for chicken to increase by
2%.
+2/+10 = +0.2
• The fall in the price of paper by 20% causes the demand for pens to
increase by 5%.
+5/-20 = -0.25
• A 20% rise in the price of ice cream causes demand for sweets to increase
by 4%.
+4/+20 = +0.2
• A 12% fall in the price of air fares leads to a 30% rise in the demand for
foreign holidays.
+30/-12 = -2.5
• A 10% rise in bikes will leave the demand for cheese unaffected.
0/+10 = 0

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Get your calculators ready

CPeD
=
% change in qty D of product A
% change in price of product B

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