Theory Of Demand
Introduction
• A market economy functions through:» Demand» Supply.
• Market is an arrangement by which buyers and sellers contact each other to make any transaction.
• People demand goods because they satisfy their wants.
• The amount of satisfaction which a person derives from consuming a commodity is called as Utility.
• The greater the utility he expects from the commodity, the greater his desire for that commodity
Definition of Demand
“ Quantities of a good or services that people are
ready to buy at various prices within some given
time period, other factors besides price held
constant.”
it Implies:• The consumers have a desire to purchase• Ability to pay for the goods and services.
• Sometimes the quantity demanded is not necessarily equal to quantity bought by the consumer.
• It is flow concept i.e- its measured by the amount the consumers wish to buy per unit of time.
The Law of Demand
The Law of Demand -
“It expresses the functional relationship
between price and quantity demanded.”
• There is an inverse relationship between price and
quantity demanded, If the other things being equal
Other things –
Taste or preferences
Income
Price of related goods.
Demand Curve
Demand Curve:
It is graphic statement or presentation of quantities demanded
by the consumer at various possible prices in a period of time.
(Demand curve does not tell us the price of the product)
Price (Rs)
Quantity Demanded (Units)
5 2
4 3
3 4
2 6
1 10
Y D
2 3 4 6 100
1
2
3
4
5
6PRICE & DEMAND
QUANTITY
PR
ICE
Market Demand
Market Demand:
It is sum total of demands of all consumers in the market
for a commodity at various prices.
Price QD1 QD2 QD3 MD
1 16 11 15 42
2 11 7 12 30
3 7 5 10 22
4 4 4 7 15
5 2 3 5 10
6 1 2 2 5
P
O a1 b1 c1 Q
Reason for the Law of Demand
Income Effect:– With the fall in price of commodity the
consumer can buy more of the commodity with his given income.
– Fall in prices leads to consumers purchasing power to increase.
Substitution Effect:– When the price of commodity falls it becomes
relatively cheaper than other commodities.– So consumer substitute the commodity and the
quantity demanded rises.
No of consumer Increases:– Fall in prices leads more number of consumer
to demand the commodity and hence rise in quantity demanded.
Why does the demand curve slope downwards?
Exception to The Law of Demand
1. Veblen Effect: Conspicuous Consumption» Goods having prestige value» Some consumers measure the utility of a
commodity by its price i.e greater the price , greater the utility.
2. The Giffen Case: » When the price of essential goods
increases, it demands also increases.» A fall in its price, quantity demanded
decreases.
3. Speculative Market» Rise in prices is followed by larger
purchases and fall in price by smaller purchases.
Factors determining Demand
1. Tastes and Preferences of the consumers: Goods for which the tastes and preferences are
greater , the demand would be large and demand curve will lie at a higher level.
Consumers tastes keeps on changing and as result there is a change in demand for them.
2. Income of the people: Greater the income greater the demand
(purchasing power)• Change in income also lead to change in
demand curve for Normal and Inferior Goods
Normal and Inferior Goods
Effect of Increase in Incomeon Demand for a Normal Good
O Q Q’
P
D
D
D’
D’
D’
D’
D
D
P
QQ’
Effect of Increase in Incomeon Demand for a Inferior Good
Factors determining Demand
3. Changes in the prices of the related GoodsDemand for goods also changes with the change in prices of “other” goods
a) Substitute Goods – Different goods that, at least partly, satisfy the sameneeds of the consumers and, therefore, can beused to replace one another.
– The rise in prices causes the increase in demand of another goods
– Good A is a substitute of Good B if a rise / fall in the price of good B causes increase / decrease in the demand for good A respectively.
Substitute Goods
OQ Q’
P
Quantity Demanded
D
D
D’
D’
Rightward Shift with rise in price of Substitute goods
Leftward Shift with fall in price of Substitute goods
OQQ’
Quantity Demanded
P
D
D
D’
D’
Factors determining Demand
b) Complementary Goods –
Goods whose use is interrelated with the use of an
associated or paired good such that a demand for one (tyres) generates demand for the other (gasoline).
– The change in prices causes the change in demand of another goods
– Good A is complement of Good B if a rise / fall in the price of good B causes decrease / increase respectively in the demand for good A
Complementary Goods
OQ Q’
P
Quantity Demanded
D
D
D’
D’
OQQ’
Quantity Demanded
P
D
D
D’
D’
Leftward Shift- Rise in price ofcomplementary goods
Rightward Shift- Fall in price of complementary goods
Factors determining Demand
4. The Number of Consumers in the Market. Greater the number of consumers of a good, greater
the market demand Increase in consumers is dependent upon growth in
population and exploration of new markets
5. Consumer Expectations Demand is dependent upon what is the consumer
expectation about the future. If buyers are expecting the price to increase in future,
the current demand increases.
6. Income Distribution Distribution of income in the society also effects
demand If distribution is equal, the propensity to consume of
the society would be high, so demand would be high.
Movement along Demand curve
Extension or Contraction in Demand:
• When the quantity demanded rises/ falls as a result of changes in price and we move along a given demand curve.
• The other determinants remain constant. (Demand curve remain the same)
• Extension : When quantity demanded rise due to fall in price.
• Contraction: When quantity demanded fall due to rise in prices.
Movement along Demand curve
As a result of changes in price of a good the consumers move along the given demand curve.The demand curve remains the same and does not change its position.A shift in demand curve happen by change in factors other than in its own price.
MO
P
P’
P”
NL
Expansion
Contraction
Shifts in Demand
Shift in Demand curve:
When the demand changes due to the factor other than price.
a) Increase in Demand:
With the other factor increasing say income, it will cause a shift in demand curve.
The consumers demand more of the commodity than before
Q1 Q3Q2
P1
P2
P3
D
D D’
D’
Shifts in Demand
B) Decrease in Demand:
It there are adverse changes in the factors
It will cause a shift in demand curve to the left
The consumers demand less of the commodity than before
Q1Q3 Q2
P1
P2
P3
D
DD’
D’
Demand Function
Qd = f ( Px, I, Pr, T, A)
Where Px = Own price of the commodity X I = Income of the Individual Pr = Prices of related commodities T = Tastes and preferences of the individual consumer A = Advertising expenditure made by the producers of the
product
Keeping other factor as constant
Qd = f (Px)
It implies that quantity demanded of good X is function of its own price. Otherdeterminants remaining constant
Demand Function
• The level / position of demand curve depends on the other factors
• To show how much quantity demanded changes with a unit change in price
Qd = a- bPx
where a= Constant intercept term on the X- axisb = Co-efficient showing the slope of the demand curvePx = Independent VariableQd = Dependent variable
Theory Of Supply
SUPPLY
• Supply refers to the schedule of the quantities of a good that the firms are able and willing to offer a various prices.
How much of a commodity the firms are able to
produce depends on:
– The resources available – Technology they employ– Profits they expect to make
Definition of Supply
“ Quantities of a good or services that people are ready to sell at various prices within some given time period, other factors besides price held constant.”
• Sometimes the quantity supplied is not necessarily equal to quantity actually sold by the consumer.
• It is flow concept i.e- its measured by the amount of a commodity that the firm produces and offer for sale in the market per period of time.
Supply Function
Qs = S ( Px, F1, Pr, W,E )
Where Px = Own price of the commodity X F1= Price of Inputs Pr = Prices of other products related in
production W = Weather, strikes and other short –run
forces E = Firms expectation about future prospects
for prices, cost, sales and state of economy Keeping other factor as constant
Qs = f (Px)
Supply Function
• The level / position of supply curve depends on the other factors
• To show how much quantity supply changes with a unit change in price
Qs = a + bPx
where
a= Constant intercept term on the X- axis
b = Co-efficient showing the slope of the supply curve
The Law of Supply
The Law of Supply –
“It expresses the functional relationship between
price and quantity demanded.”
There is an direct relationship between price and
quantity supplied, If the other things being equal
Supply Curve
Supply Curve:
It is graphic statement or presentation of quantities
supplied by the firm at various possible prices in a period
of time.
Price (Rs)
Quantity Supplied (Units)
500 100
510 150
520 200
530 225
540 275
Y
100 150 200 225 250 275470
480
490
500
510
520
530
540
550
560Price & Supply
QUANTITY
PR
ICE
Reason for the Law of Supply
Why does the Supply curve slope Upwards?
• Firms are driven by profit motive
– Higher the price of the product, more profitable to produce them.
– Greater the incentives of the firm to produce– It also depends upon possibilities of substitution– More production also leads to more profits
Factors determining Supply
1. Production Technology
2. Price of Inputs
3. Prices of Related products
4. Number of producers (or firms)
5. Future price expectations
6. Taxes and Subsidies
Shifts in Supply
Shift in Supply curve:
When the Supply changes due to the factor other than price.
a) Increase in Supply:
With the increase in other factor
The producers supply more of the commodity
Q1 Q3Q2
P1
P2
P3
SS’
Shifts in Supply
B) Decrease in Supply :
It there are adverse changes in the factors
It will cause a shift in Supply curve to the left
The producers supply less of the commodity
Q1 Q3Q2
P1
P2
P3S
S’
Market Equilibrium
S
Q
P
D
Q1
P1
Surplus
Shortage
Equilibrium Price: The price that Qd = QsEquilibrium Quantity:
The amount that people are willing to buy and seller are willing to offer.Shortage: Qd > QsSurplus: Qd < Qs
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