Ch 3 – Theory of Demand

DEMAND ANALYSIS
Meaning & Definition of Demand

Demand
• Desire
• Purchasing power.
• Willingness to spend
• Time period

Demand for a commodity refers to the quantity, which a consumer wishes to purchase at a given period of
time.
Or
Demand is the desire for a commodity, which is backed by purchasing power and willingness to spend it at a
given period of time.

6 Important points to remember about DEMAND:

1. Demand is always measured in units.

2. Demand is a microeconomics concept (which deals with human behaviour).
3. We demand a commodity because it carries some satisfaction power to it known as Utility.
4. Every consumer is a rational (Normal thinking, Wise & Judicious) human being and wants to get
maximum satisfaction at minimum prices.
5. Demand is a flow concept. It has some time dimension attached to it. It may be calculated for a given
period of time i.e., few hours, few weeks or few months etc.
6. There must be some relationship between the price and quantity demanded of the commodity.

DIFFERENCE BETWEEN DEMAND AND DESIRE

A Desire is a wish for a commodity not backed by purchasing power. Hence, there is no relationship
between desire and price of the commodity. For ex., A poor man wishes to buy a luxury car.
Demand is a wish for a commodity, which is backed by purchasing power and willingness to spend it.
Thus, there is an inverse relationship between demand & price of the commodity. For ex., A Rich man wishes
to buy a luxury car.

Functional Relationship between Demand & Factors affecting Demand

Dx = ƒ (Px, Y, Pr, T, U)
Where, Dx = Demand of a commodity.
ƒ = functional relation
Px = price of commodity
Pr = price of related goods
T = taste & preferences
U = Miscellaneous
Y = Income
Factors Affecting Demand
1. PRICE OF A COMMODITY (P)
• Impact:-
When price of a commodity rises, consumer tends to demand less and vice versa, i.e., price and demand
are inversely related to each.
1
P∝𝐷
• Schedule:-
Px Qx
Px↑ Qx 10 20 ↓
Px↓ Qx 8 30 ↑

• Curve:-

𝑌2 −𝑌1 Δ𝑦
=
𝑋2−𝑋1 Δ𝑥
Price

ΔY

ΔX D
O
Qty dd.

2. RELATED GOODS (R):- (Cross Price Effect)

Substitute Goods Complementary Goods

2(a). SUBSTITUTE GOODS

• Meaning:
It refers to those commodities, which can be replaced for one another with equal ease and comfort. It is
so because when price of one commodity rises, the demand for its substitute also rises, i.e., they have
positive cross price effect.

• Example:-
Pepsi – Coke, Ball pen – Gel pen, Lays – bingo.

• Impact:-
When price of substitute goods rises, it has a positive impact on other commodities, i.e., with increase in
price of commodity, the demand for its substitute also rises.

Schedule:-
Coke Pepsi
Px Qx Py Qy
10 30 10 15
10 20 9 25
 • Curve:-

Due to fall in the price of

its substitute good

Price of coke
D

D’
O
Qty dd. of coke

2(b) COMPLEMENTARY GOODS (Joint Demand)

• Meaning:-
These goods are demanded jointly, i.e., one commodity is of no use without the availability of the other
commodity. There exists a negative relation b/w price of the commodity and the demand of its
complementary goods.
• Example:-
Car-petrol, Inverter – battery, pen – ink, lens – frame.
• Schedule:-
Car Petrol
Px Qx Py Qy
3Lac 30 50 200
3Lac 35 40 300
• Curve:-
Due to fall in the price of
its complementary good
Price of car

D’

O
Qty dd. of car

• Distinction between Substitute Goods & Complementary Goods:-

Basis Substitute Goods Complementary Goods
1. Meaning Those goods which can be exchanged Those goods which are demanded jointly
with other commodities and still the or together. Without one, the other is of no
utility is almost same. use.
 These goods have +ve relation.
2. Relation These goods have -ve relation.
Price (x) Quantity (y)
10 20 Price (x) Quantity (y)
3. Schedule 12 24 10 30
12 20
Pepsi & Coke
4. Example Car & Petrol

3. INCOME OF THE CONSUMER

Income of a consumer and demand for a commodity are directly associated and move in the same
direction. But it is not so far with every commodity as there are some exceptions to this.
• Inferior Goods
• Necessity Goods
3(a).Normal Commodity
It refers to those commodities which are demanded in routine life of consumer and have a positive income
effect. Income of the consumer and demand for normal goods are directly associated.
Example
Clothes, Slippers, TV, Fan etc

Curve

3(b) Inferior Commodity

It refers to those lower quality commodities, which do not have any close and cheap substitute and
thus, have negative income effect.
Income of the consumer and demand for inferior goods are inversely associated and moves in
opposite direction. It happens because as income of the consumer rises, then the consumer will divert
its demand towards a better substitute.

Example
Ration rice, Coarse grains, double-toned milk etc
Curve
3(c) Necessary Commodity
It refers to those commodities, which are essential for human existence and it is very difficult to survive
in the absence of these commodities. With a fluctuation in income of consumer, the demand for such
goods remains constant, i.e., these commodities have no income effect.
Example
Salt, Essential Medicine, school uniform etc.

Curve

Important Note : Inferior good and Normal Good are not categories of goods rather these classification
depends upon the INCOME of the consumer and it is the consumer who is to decide whether he counts a
given good as a inferior good or normal good.

4. TASTE AND PREFERENCES OF THE CONSUMER

Generally, a consumer demands more of a commodity for which he has a favourable taste and preference.
He would demand less of that commodity for which his taste and preference is favourable.
Eg: In modern times, youngsters have developed demand for pizzas and burgers in comparison to home
cooked food and thus, demand for such fast foods have increased.
5. MISCELLANEOUS
There are certain other factors which affect the demand for a commodity like weather conditions,
composition of population, distribution of income, budget policies, etc.

Law of Demand
Law of Demand states, “other things being constant, a rational consumer tends to demand more at a lesser price
and vice versa”. It means demand of commodity has an inverse relationship with price of the commodity. The
other things which are constant here are:
(a) Price of Related commodity
(b) Income of a consumer
(c) Taste and preferences
Assumptions of Economic Analysis:
1. Ceteris Paribus means other things are constant.
Qx = f (Px, Pr, Y, T, U)
2. Rational consumer who wants to maximize his wants with given income.
Individual Demand Schedule
The tabular representation of law of demand is known as individual demand schedule. It shows quantity
demanded by an individual at various levels of prices.
Individual Demand Curve:
The graphical representation of individual demand schedule is known as individual demand curve.

MARKET DEMAND

Meaning: Total demand made by all the consumers in a market for a commodity at various levels of prices in a
given period of time is known as market demand.
Symbolically, it can be written as:-
Market demand = ∑ 𝐼𝑛𝑑𝑖𝑣𝑖𝑑𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑

Market Demand Schedule

Px Q1 Q2 Q3 Q4 Market
Demand
10 100 110 50 60 410
20 90 105 45 50 370
30 80 100 40 40 330
40 70 92 38 30 290
Factors affecting Market Demand.
1. Price of commodity.
2. Related goods
3. Income
4. Taste and preferences.
(as explained earlier)
5.Size of population.
Increase in population depicts higher no. of buyers for commodity. Thus, implying increase in market demand
and vice versa.
6.Distribution of income.
Market demand is also influenced by the distribution of income in the society.
If distribution of income increases any inequality in income, the demand for luxury goods and inferior goods
will also increase and if distribution of income leads to equality in income, then the demand for normal goods
may rise.

MOVEMENT ALONG THE DEMAND CURVE

OR
CHANGE IN QUANTITY DEMANDED
It is based on law of Demand, which states that demand of the commodity fluctuates due to the fluctuation in
price of the commodity.
The fluctuation in demand due to the fluctuation in price of the commodity is known as movement along the
demand curve. It may be of two types:
1. Expansion in Demand.
2. Contraction in Demand.

SHIFT IN DEMAND CURVE

OR
CHANGE IN DEMAND
It is based on factor other than price, if demand fluctuation due to the fluctuation in factors other than price,
then it is known as shift in demand curve.
It may be of two types:
1. Increase in Demand
2. Decrease in Demand

Shift in the Demand curve

Causes of rightward shift in demand curve.
* Increase in income of the consumer.
* Increase in the price of substitute goods.
* Decrease in the price of complementary goods.
* Favourable taste and preferences.
* Favourable weather condition.
* Increase in population.
* Favourable budget policies.
Causes of leftward shift in demand curve.
* Fall in the income of a consumer.
* Decrease in the price of substitute goods.
* Increase in the price of complementary goods.
* Decrease in population.
* Unfavourable taste and preferences.
 * Unfavourable weather conditions.
* Unfavourable budget policies.

Q Write the difference between Expansion in demand and Increase in Demand.

Q Write the difference between Contraction in demand and Decrease in Demand.
Q Write the difference between change in demand and change in quantity demanded.
Exceptions to the law of demand are as follows:-
1. Giffen Good
In case of certain inferior goods (giffen goods), when price falls, their demand may not rise because the
consumer will divert their purchasing power to purchase other superior goods. As a result, demand for
such inferior goods whose price has fallen also falls. Such inferior goods are known as giffen goods.
[This fact was analayzed by Sir Robert Giffen]
1. Goods expected to become scarce or costly in future
Such goods are purchased by households in increasing quantity, even when price are rising.
2. Goods of Ostentation (Prestige value goods)
Such type of goods are purchased not because of their intrinsic value [face value] but because of status
and prestige value. Eg: In case of diamond jewellery when it is sold at a lower price, it sells poorly but if
offered at 5 times the price, it sells quite well.
3. Necessities
In case of necessity goods, the quantity demanded remains constant with fluctuation in prices, i.e., it has
no tendency to change due to change in price and thus, the demand curve is vertical and parallel to y-
axis.
4. Ignorance
In case of ignorance of facts a consumer might purchase more, even at higher prices. Eg: A foreigner
might buy Indian goods in India at a higher price due to lack of knowledge of the buyer about the
product.

5. Emergency
In case of emergencies like famine and war, the commodities are demanded even at a higher price, as the
entire situation creates emergency for the consumers. Eg: During the high level of pollution during
Diwali, 2016, the purifying masks were demanded more even at a higher price.

Causes behind Law of Demand.

1. Income effect.
2. Substitution effect.
3. Law of Diminishing Marginal Utility.
4. Number of consumers.
5. Diverse uses of commodity.
As we know, inverse relationship exists between price of the commodity and demand of that commodity. Now,
a question arise why there is inverse relationship exist between them.
(a) Income effect
Fall in the price of commodity increases the real income of the consumer. Real income refers to the
purchasing power, which allows the consumer to demand more of the commodity and this increase in
demand is due to the rise in real income, which is known as the income effect.

Money Px Qx
Income
1000 100 10
1000 50 20
(b) Substitution effect
Fall in the price of a commodity makes it cheaper in comparison to its dearer substitute. So, the
consumer withdraws money from the dearer substitute in order to purchase some additional units of the
cheaper substitute. This effect of substituting one commodity with another commodity is known as
substitution effect.

Price Effect = Income Effect + Substitution Effect

(c) Law of Diminishing Marginal Utility

According to Alfred Marshall, the demand curve can be derived with the help of law of diminishing
marginal utility. According to him, as we keep on consuming successive units of a commodity, marginal
utility derived from every successive units keeps on falling. It implies that initial units provide greater
satisfaction and hence commands higher price, whereas greater units provide lesser satisfaction and
commands lesser price.
(d) Additional consumer / Number of consumers
When price of commodity falls, two effects are quite possible:
* New consumers, i.e. people who were not able to afford it previously starts demanding it at a lower
price.
* Old consumers of the same commodity start demanding more by spending the same amount of money.
(e) Different (Diverse) uses of commodity
Commodity having diverse uses, with a fall in price are used in various different ways and with a rise in
price of such commodities, the various uses of the commodity is cut down and gets restricted. Hence,
lesser quantity is demanded.