CHAPTER-2, DEMAND AND LAW OF DEMAND

Demand for a commodity refers to the quantities of a commodity which the consumers are willing and
able to purchase at various possible prices during a particular period of time.

➢ Desire backed by the willingness and ability to purchase a commodity is a demand or effective
desire. Example- the desire to own a car becomes a demand when it is accompanied by a willingness
and ability to spend that money to purchase the car.
➢ Demand is always related to a particular price. Consumers are willing to purchase a specific
quantity at a particular price. Example- A consumer may buy 3 shirts if the price is Rs 500, 2 shirts if
the price is Rs 800, none at all if the price is Rs 1200.
➢ Demand is a flow concept, with reference to a particular time period and expressed per unit of
time. If we say, the demand for cars is 200, it is meaningless. To be meaningful, we have to specify
whether demand for cars is 200 per week, per month or per year

Types of Demand
1. Individual Demand and Market Demand:

Individual Demand refers to the quantities of the commodity which an individual consumer is willing and
able to purchase at various prices during a particular period of time. Eg, Quantity of Milk purchased by a
household per day. Individual Demand is the same as Household Demand.

Market Demand refers to the total quantity of the commodity that all households are willing and able to
purchase at various prices during a given period of time. Market Demand is total Quantity of milk purchased
by all households at a given price per day.

2. Ex ante Demand and Ex Post Demand:

Ex ante Demand is planned or desired demand. Ex ante Demand refers to the quantity of goods that
consumers are wanting or willing to purchase during a specific period.

Ex post Demand refers to the quantity that consumers actually purchase during a specific period.

Ex ante demand is not always the same as Ex Post Demand. Consumers may end up buying more or lesser
quantity of goods than they had actually planned or desired to buy.

3. Joint Demand refers to the demand for two or more goods which are used jointly or demanded
together. Example- Car and petrol, Pen and paper, Bread and Butter. A rise in price of cars would lead to a
fall in the demand for cars and fall in demand for petrol

4. Derived Demand: The demand for a commodity that arises because of the demand for some other
commodity is called Derived Demand. It generally relates to demand for factors of production. Example-.
Demand for bricks, cement etc. is derived from demand for more buildings

5. Composite Demand: Demand for goods which have multiple uses is called Composite Demand. A
commodity has composite demand when it can be put to several alternative uses. Example- Steel can be
used to make vehicle bodies, utensils, construction etc. Electricity has domestic and commercial use for
lighting, heating, cooking etc.
DETERMINANTS/FACTORS AFFECTING DEMAND

1. Price of the commodity: Also called Price Demand. It refers to different quantities of a commodity that
are purchased at different possible prices. Normally there is an inverse relationship between price and
quantity demanded of the commodity. Lower the price, higher the quantity demanded and higher the price,
lower the quantity demanded. Basis of Law of Demand. Example- a consumer purchases more quantity of
apples as the price of apples falls.

2. Income of the consumer: The functional relationship between demand for a commodity and the income
of the consumer is called Income Demand. It shows how much quantity of a commodity a consumer will buy
at different levels of his income. Generally, this relationship is direct, i.e. the demand for the commodity
rises with increase in income, as in case of normal goods, example- clothes, refrigerator, TV. However, this is
not always the case.

Income Demand is discussed on the basis of three types of goods:

i.Normal Goods (NG): are those goods the demand for which increases with increase in income of the
consumers and decreases with fall in income. Direct or Positive relationship between income of
consumer and quantity demanded. Articles of comfort and luxury also fall under normal goods. Example-
clothes, refrigerator, TV, etc.
ii.Inferior Goods (IG): are those goods the demand for which falls with increase in income of the
consumer. Inverse relationship between income of consumer and quantity demanded of inferior goods as
consumers shift to superior products with increase in income beyond a certain level. Example- At lower
levels of income, a consumer will purchase more coarse cereals like Jowar, maize and the quantity
demanded will increase upto a certain level of increase in income. However, with further increase in
income, the demand for Jowar (inferior good) falls, as consumers substitute it with superior goods like
wheat, rice.
iii.Inexpensive Goods of Necessities (IN): In case of Inexpensive Goods of Necessities, quantity demanded
increases with increase in income up to a certain level and thereafter remains constant irrespective of
the income level. E.g. salt, matchbox etc.

3. Consumers’ Tastes and Preferences: depend upon change in fashion, lifestyle, social customs, new
trends, advertisements etc. Due to this, demand for goods change as people like to keep up with modern
trends. Example- Demand for health foods, bicycles has increased with the general awareness to eat healthy
and to be fit.
4. Prices of Related Goods:

i) Substitute or Competitive Goods satisfy the same type of needs and hence can be used in place of one
another. E.g. Tea and Coffee, Pepsi and Coke. There is a direct, positive relationship between the demand
for a product (Tea) and the price of its substitute (Coffee)

ii) Complementary Goods are complementary to one another, i.e. they are used jointly and demanded
together, e.g. Car and Petrol. An increase in the price of one, decrease the demand for the complement.
There is an inverse, negative relationship between the demand for a good (Car) and the price of its
complement (Petrol).

5.Consumers’ Expectations: about future prices, change in income, availability of goods etc determine
demand in the current period.

If consumers expect a price rise in a commodity in future, they will purchase large quantities today to avoid
buying at higher price in future. If consumers expect their income to rise, they will increase spending and
buy more commodities in anticipation of increase in income. If consumers expect certain goods to be
scarcely available in future, due to strike, crop failure etc. the current demand for such goods would
increase

6.Consumer-Credit Facilities: If consumers are able to easily borrow from banks, they would be tempted to
purchase certain goods. E.g. Demand for cars increases with increase in availability of car loans.

7.Demonstration Effect: refers to the tendency of people to emulate the consumption style of friends,
neighbours etc. Example- Demand for high-end cell phones, cars etc. to emulate higher standards of living
demonstrated by others

Additional Factors Affecting Market Demand:

8.Size and Composition of Population: Larger the population size, larger the number of consumers.
Composition of population like, adults, children, male, female, old, young etc. affects the demand because
types of goods demanded by each segment of population is different. E.g. A younger population in urban
India will want more western, modern clothes. This is the demographic effect on market demand for
different goods.

9.Distribution of Income: If income is unequally distributed, wealth is concentrated in the hands of a smaller
percentage of population and there will be higher demand for luxury items like LED TV, high-end cars etc. If
income is evenly distributed, there will be more demand for necessities and not luxury goods

10.Climatic Factors: Different goods are required for different climates. Market Demand for air-
conditioners, cold drinks, Fans etc. increases in summer months. Market Demand for warm clothes, heaters
etc. increase in winter months

11.Government Policy: If Govt. increases taxes, like VAT, sales tax etc (now GST). the prices of the
commodities increase and market demand falls. If govt. wants to give a boost to say cement industry, it
spends more on construction of roads, bridges etc. which increases the demand for commodities like
cement required for construction.
LAW OF DEMAND: states that other things remaining equal, the quantity demanded of a commodity
increases when its price falls and decreases when its price rises

Assumptions: other things remaining unchanged, means ceteris paribus order.

1. There should be no change in consumer’s income

2. There should be no change in consumer’s tastes and preferences
3. Prices of related commodities should be unchanged
4. The commodity should be a normal good
5. Size of Population should not change
6. Distribution of income should not change
7. There should be no expectations of future change in prices

Individual Demand Schedule: is a table which shows various quantities of a commodity demanded at
different prices by a household during a given time period

Individual Demand Schedule for Apples

Price (₹ per kg) Quantity demanded (kg per week)

100 1
90 2
80 3
70 4
In the above schedule, a household purchases 1kg at ₹100 and 4kgs when price falls to ₹70. It shows larger
quantity of apples are bought as the price falls.

Individual Demand Curve- shows different quantities of a good a consumer is willing to buy at different
prices during a given period of time

Price of apples is on the Y-axis and Quantity on the X-axis. DD is the Demand curve, which slopes downwards
from left to right depicting inverse relationship between price and quantity demand
Market Demand Schedule: is a table which shows various quantities of a commodity that all the households
(consumers) are willing to purchase at different prices during a given time period

Market Demand Schedule for Apples

Price (₹ Quantity demanded by A (kg Quantity demanded by B (kg Total Market Demand (A+B)
per kg) per week) per week) (kg per week)
100 1 2 1+2=3
90 2 3 2+3=5
80 3 4 3+4=7
70 4 5 4+5=9

Market Demand Schedule is drawn up by adding the quantity demanded of individual consumers A and B at
different prices. As per the above schedule, consumer A demands 1kg while consumer B demands 2kg
therefore the market demand for apples at ₹100 is 1kg+2kg=3kg. As price falls to ₹70, the market demand
increases to 4kgs+5kgs=9kgs. Market Demand Schedule shows the Inverse relationship between price and
quantity demanded of a commodity.

Demand Curve and its derivation – is the graphic presentation of the Demand Schedule showing different
quantities demanded at different prices over a given time period. It is always drawn on the ceteris paribus
order

2. Derivation of Market Demand curve from Individual demand Curves: Market Demand curve shows
different quantities of goods all consumers in the market are willing to buy at different prices during a
specified period of time. It is the horizontal summation of the demand curves of all the households.

Price of apples is on Y-axis and Quantity on X-axis. DDA is demand curve of consumer A and DDB is demand
curve of consumer B.

DDM is drawn by aggregating DDA and DDB, i.e. by adding the two curves horizontally because the quantity
demanded is shown on the X-axis. DDM is the Market Demand curve, which, like the individual demand
curve, also slopes downwards from left to right depicting inverse relationship between price and quantity
demanded.
REASONS FOR DOWNWARD SLOPE OF DEMAND CURVE (Explanation of the Law of Demand)

The negative slope of the Demand curve or inverse relationship between price and quantity demanded is
due to the following factors:

1. Law of Diminishing Marginal utility: As the amount consumed of a commodity increases, the utility
derived by the consumer from the additional units goes on decreasing. Hence the marginal utility
falls with an increase in consumption. A utility maximising consumer will be in equilibrium when he
consumes that much quantity of a commodity such that the marginal utility of the commodity
equals its price.
Marginal Utility of a commodity= Price of the commodity or MUx = Px
Hence a consumer would purchase a larger quantity of the commodity only when the price falls
because MU falls with every additional unit.
2. Income Effect: A change in demand on account of change in real income due to change in price of
a commodity is known as Income Effect. The price change has the effect of change in purchasing
power which affects the quantity demanded by the consumer. Suppose a consumer spends ₹ 200 on
buying apples. He can buy 2 kg of apples when the price is ₹ 100 per kg. If the price falls to ₹ 80 per
kg, consumer spends₹ 160 on 2 kg of apples and is able to save₹ 40 at this lower price of apples. The
consumer may use this saving of ₹ 40 to buy more quantities of the apples. Hence a fall in the price
of a commodity results in increased purchasing power of the given money income or increase in
real income of the consumer

3. Substitution Effect: is the effect that a change in relative prices of substitute goods has on the
quantity demanded of the commodity. When the price of a commodity falls and the prices of the
substitutes remain unchanged, it becomes relatively cheaper compared to its substitutes. Hence
demand for the relatively cheaper commodity increases.

Example- If the price of coffee falls , price of tea remaining unchanged, consumers would shift from
tea to coffee and there would be an increased demand for coffee

The sum total of Income effect and Substitution effect is called Price Effect (In fact, both occur
simultaneously)

Price Effect= Income Effect + Substitution Effect

4. Increase in number of consumers: A fall in the price of a commodity leads to increase in the quantity
demanded from existing consumers, due to income and substitution effects. Simultaneously, when
the price falls, many new consumers can afford the commodity now and the quantity demanded
increases due to this.
Example: when price of apple falls from 100 to 70, more consumers can afford It now than at earlier
prices. Due to this, the demand for apples goes up.

5. Several Uses of a Commodity: There are many goods like Steel, aluminium, electricity, milk which
have multiple uses. When the prices are high, these commodities will be used for important purposes
only, hence a small quantity will be demanded. When the price falls, the commodities can be used for
less important uses also and the quantity demanded increases. Example- When the price of
electricity is high, it will be used for lighting, but when the price falls, it will also be used for cooking
EXCEPTIONS TO THE LAW OF DEMAND/REASONS FOR UPWARD SLOPING DEMAND CURVE:

1. Giffen Goods: are those inferior goods on which the consumer spends a large part of his income
and the demand for which falls with a fall in their price.
Example- Coarse cereals like maize and jowar are consumed by poor consumers. If the price of
maize falls, the consumer’s real income rises, due to which the consumer may be able to purchase
superior cereals like wheat. This would lead to an increase in quantity demanded of wheat and a
decrease in quantity demanded of maize. Hence when the price of inferior foods like jowar, falls,
consumers tend to spend less on them and switch over to superior foods like wheat.

If the price of inferior foods like jowar, rises, there is a fall in consumer’s real income, due to which
consumer is required to reduce consumption of superior foods like wheat and increase purchase of
jowar instead, as intake of a particular quantity of food is essential for survival

Therefore, where the consumer spends a bulk of income on purchasing inferior food items, the
demand falls with a fall in price and increases with an increase in price

2. Articles of Snob Appeal: (Veblen goods) (Goods of Conspicuous consumption)

Goods like Diamonds, High-end watches, cars like Rolls Royce, Jaguars etc. which serve as Status
Symbol, increase social prestige, display of wealth and richness, are demanded by wealthy
consumers, because these goods satisfy the rich persons desire for distinction as they give their
owner a sense of superiority and higher prestige due to their exclusivity and high prices. These are
also called Veblen Goods or Goods of Conspicuous consumption. Higher the price, greater the
exclusivity and prestige value. Hence at higher prices, the demand for such goods may increase

3. Expectations about Future Prices: In case of rising prices, consumers will buy more quantities and
store it for future use, even at existing high prices to avoid the burden of further rise in prices. In
case of falling prices, consumers will postpone purchases even at existing low prices, to take
advantage of still lower prices in future. Hence demand increases if prices are expected to rise and
falls if prices are expected to fall in future

4. Emergencies: In times of war, strikes, famine etc. consumers buy and hoard goods even at high
prices as they anticipate shortage of goods. During times of depression they will buy less at low
prices as they expect prices to fall further in future.

5. Quality-Price Relationship: Some consumers take price as an index of quality. They assume that
high priced goods are of high quality and low priced goods are of comparatively inferior quality.
Hence more goods of the superior brand are demanded at a higher price by such consumers as
compared to demand for lower priced brands. This is called Veblen effect. Example- They will buy
more ‘Lux Supreme’ at a higher price, as they feel it has a higher quality as compared to other low-
priced brands of soap

6. Change in Fashion: When a commodity is out of fashion, consumers will not buy it even if it is
offered at lower prices. Example- There will be almost no demand for clothes which have gone out
of fashion, even if these are offered at very low prices
Factors that cause shift of Increase in demand/ Rightward Decrease in demand /
demand curve shift Leftward shift
Income Increase in Income Decrease in Income
Price of the substitutes Rise in Price of the substitutes Fall in Price of the substitutes
Price of complementary goods Fall in Price of complementary Rise in Price of complementary
goods goods
Tastes and preferences Favourable change in Tastes and Unfavourable change in Tastes
preferences and preferences
Price expectations Expectations of rise in price Expectations of fall in price
Population Increase in population Decrease in population

MOVEMENT ALONG THE DEMAND CURVE- SHIFT IN DEMAND CURVE- CHANGE IN DEMAND:
CHANGE IN QUANTITY DEMANDED:
When the quantity demanded of a commodity rises When the quantity demanded of a commodity rises
or falls due to a change in its own price, other or falls due to a change in other determinants of
determinants of demand (like income, taste, prices demand (like income, tastes, prices of related
of related goods) remaining the same, it is called goods), it’s own price remaining the same, it is
change in quantity demanded called change in demand of the commodity.

A Movement downwards on a particular demand A rightward shift in the Demand Curve indicates
curve is called rise in quantity demanded or Increase in Demand. Consumers purchase a larger
Expansion of Demand. quantity at the same price.

A Movement upwards on a particular demand A leftward shift in the Demand Curve indicates
curve is called fall in quantity demanded or Decrease in Demand. Consumers purchase a
Contraction of Demand. smaller quantity at the same price.
Quantity demanded is on X-axis. Price is on Y-axis. Quantity demanded is on X-axis. Price is on Y-axis.

If the price of the commodity falls from OP₁ to OP₂, A rightward shift in the Demand Curve from D₁D₁ to
the quantity demanded rises from OQ₁ to OQ₂. The D₂D₂ indicates Increase in Demand. Consumers
purchase a larger quantity at the same price. It may
downward movement on demand curve DD from A₁
also mean that consumers demand the same
to A₂ is Expansion of Demand. quantity at a higher price.
If the price of the commodity rises from OP₁ to A leftward shift in the Demand Curve from D₁D₁ to
OP₃, the quantity demanded falls from OQ₁ to OQ₃. D₃D₃ indicates Decrease in Demand. Consumers
The upward movement on demand curve DD from purchase a smaller quantity at the same price. It
A₁ to A₃ is Contraction of Demand. may also mean that consumers demand the same
quantity at a lower price.

Expansion of Demand Contraction of Demand

Larger quantity demanded due to a fall in price, Smaller quantity demanded due to a rise in price,
other things remaining the same other things remaining the same

Larger quantity demanded due to a fall in price, Indicated by Upward Movement along the Demand
other things remaining the same Curve (draw applicable Diagram)

GRAPH GRAPH

Increase in Demand Decrease in Demand

Graph Graph
Larger Quantity is purchased due to change in Smaller quantity is purchased due to change in
other factors (like income, tastes, prices of related other factors (like income, tastes, prices of related
goods), its own price remaining unchanged goods), its own price remaining unchanged

Consumers demand a larger quantity at the same Consumers demand a smaller quantity at the same
price. price.

A rightward shift in the Demand Curve indicates A leftward shift in the Demand Curve indicates
Increase in Demand (draw applicable Diagram) Decrease in Demand (draw applicable Diagram)
 Cross Demand or Cross Price Effect: is the functional relationship between price of a commodity and the
demand for a related commodity. It shows the way a demand for a product is affected by a change in price
of another related product. (Explain Substitute and complementary goods as above, briefly with diagram
and examples)

i) Substitute or Competitive Goods Demand for Tea is on X-axis and Price of Coffee is on Y-axis. If price of coffee
increases from OP₀ to OP₁, (price of tea being unchanged), demand for tea will increase from OQ₀ to OQ₁, as
many consumers will shift to drinking tea, as it has become relatively cheaper. Here the demand for tea has
increased not due to a fall in its own price, but due to the increase in price of coffee, its substitute. The
demand curve KL is positive, upward sloping indicating that demand for tea varies directly with a change in
price of coffee

ii) Complementary Goods Demand for Cars is on X-axis and Price of Petrol is on Y-axis. If price of Petrol increases
from OP₀ to OP₁, (price of cars being unchanged), demand for cars will decrease from OQ₀ to OQ₁, alongwith
decrease in demand for petrol. The demand curve HR is negative, downward sloping indicating that demand
for cars varies inversely with a change in price of petrol

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