CONCEPT OF DEMAND

Demand refers to the amount of products or services that consumers wish to purchase at any given
price level. The mere desire of a consumer for a product is not demand. Demand includes the
purchasing power of the consumer to acquire a given product at a given period. The desire which is
backed by willingness to pay and ability to pay is called demand in economics. In other words, it’s
the amount of products or services that consumers are willing and able to purchase.
Demand Function:
Functional relationship between demand and its determinants is known as demand function.
It is expressed in algebraically form as:
Qx = f ( Px, Y, T, Pr, Pe,Gp, ……..)
Px = Price of x goods
Y= Income of the consumer
T = taste and preference of consumer
Pr = Price of related goods ( Price of substitutes and complementary goods)
Pe = Price expectation Gp = Government policy
1
Types of Demand function
1. Linear demand function: If the slope of the
demand curve remains same throughout its
length is called linear demand function.

Qd = a + bPx
-

2. Non Linear demand function: If the slope of the

demand curve changes all along the demand
curve is called non linear demand function.

Qd = aPxb

2
• Factors affecting the Demand/ Determinants of Demand
• Price of the goods/services
• Income of the consumer
• Price of the related goods
• Government policy
• Price expectation
• Taste and preference of consumer
• Advertisement
• Size of population
• Climate and weather

3
Types of Demand
The demand can be classified on the following basis:
• Price Demand: The demand associated with the change in price of the commodity is called
price demand. The price demand means the amount of commodity a person is willing to
purchase at a given price. While studying the demand, we often assume that the other factors
such as income of the consumer, their tastes, and preferences, the prices of other related goods
remain unchanged. There is a negative relationship between the price and demand Viz. As the
price increases the demand decreases and as the price decreases the demand increases.

4
Income Demand:  The demand associated with the change in income of the consumer is called income
demand. The income demand refers to the willingness of an individual to buy a certain quantity at a given
income level. Here the price of the product, customer’s tastes and preferences and the price of the related
goods are expected to remain unchanged. There is a positive relationship between the income and demand
in the case of normal and superior goods. But there is negative relationship between income and demand
for inferior goods.

5
• Cross Demand:  The demand associated with the change in price of the related goods is
called cross demand. It is one of the important types of demand wherein the demand for a
commodity depends not on its own price, but on the price of other related products is called as
the cross demand. Such as with the increase in the price of coffee the consumption of tea
increases, since tea and coffee are substitutes to each other. Also, when the price of cars
increases the demand for petrol decreases, as the car and petrol are complimentary to each
other.

6
• Derived Demand: Labourers and raw materials which are demanded to produce the final
product is known as derived demand.

• Individual Demand and Market Demand: The individual demand refers to the demand for
goods and services by the single consumer, whereas the market demand is the demand for a
product by all the consumers who buy that product. Thus, the market demand is the aggregate
of the individual demand.

7
Introduction to the Law of Demand:
The law of demand is one of the important laws in economics. The law of demand expresses a
relationship between the quantity demanded and its price. It may be defined in Marshall’s words
as “the amount demanded increases with a fall in price, and diminishes with a rise in price”. 
In short other thing remaining same, opposite relationship between price and quantity demanded is
called law of demand.
These assumptions are:
(i) There is no change in the tastes and preferences of the consumer;
(ii) The income of the consumer remains constant;
(iii) There is no change in customs;
(iv) There should not be change in price of related goods;
(v) No change in government policy;
(vi) No change in price expectation
(vii) There should not be any change in the quality of the product; and

8
9
The above table shows that when the price of say, orange, is Rs. 5 per unit, 100 units are demanded. If
the price falls to Rs.4, the demand increases to 200 units. Similarly, when the price declines to Re.1,
the demand increases to 600 units.
In the figure, point P of the demand curve DD1 shows demand for 100 units at the Rs. 5. As the price
falls to Rs. 4, Rs. 3, Rs. 2 and Re. 1, the demand rises to 200, 300, 400 and 600 units respectively.
This is clear from points Q, R, S, and T. When we join all these points then we get downward sloping
curve which is known as demand curve. This curve shows inverse relation between price and quantity
demanded.
Movement Along Demand Curve:
It is the state of increase or decrease in quantity demanded of a commodity due to fall or rise in price
level but all other determinants of demand remaining same is known as movement along demand
curve.
When price decrease, demand increases which is known as extension in demand. When price increases,
demand decreases which is known as contraction in demand. Moving from A to B is known as
extension and moving from A to C is known as contraction in demand.

10
Contraction in
demand

Extension in demand

11
Shift in demand curve:
When the initial demand curve shift either rightward or leftward from its initial position due to change
in determinants of demand except the price of the commodity is called shift in demand curve.
When demand curve shift rightward from its initial position due to change in determinants of
demand except price is called increase in demand.
Causes of rightward shift:
1. Increase in prices of substitutes,
2. Increase in income,
3. Favorable change in taste and preference,
4. Increase in population,
5. Increase in advertisement,
6. Increase in government expenditure, money supply,
7. Decrease in prices of complementary goods and taxes
Causes of leftward shift:
1. Decrease in prices of substitutes,
2. Decrease in income,
3. Unfavorable change in taste and preferences

12
4. Decrease in population,
5. Decrease in advertisement,
6. Decrease in government expenditure or money supply
7. Increase in prices of complementary goods and taxes
Fig:

Decrease in Demand
Increase in Demand

13
Causes of Downward Sloping Demand Curve:
1. Income Effect
2. Substitution Effect
3. Law of Diminishing Marginal Utility
4. Entry of New Consumer
5. Multiple uses

Exception of Law of Demand:

6. Giffen Goods
7. Change in Income of the consumer
8. Future Expectation about Prices
9. Ignorance of consumer
10. Emergencies
11. Change in Fashion and Tastes & Preferences
14
Supply:
Supply refers to the quantity of a commodity that a firm is willing to sell and able to sell at
various market prices under the given periods of time is called supply. Other things remaining
same there is positive relationship between price and quantity supply. Positive relationship
between price and quantity supplied is called law of supply. Law of supply can be shown with
the help of following table and figure.
This law can be explained with the help of a supply schedule as well as by a supply curve based
on an imaginary figures and data.
.

15
Here, in this diagram the supply curve SS is sloping upward. It suggests with the supply schedule,
that the market supply tends to expand with the rise in price and vice-versa. Similarly, the upward
slopping curve also shows positive relationship between price and supply.
Supply Function:
Functional relationship between supply and its determinants is known as supply function.
It is expressed in algebraically form as:
Qx = f ( Px, Pf, T, Nf, Pe,Gp, ……..)
Px = Price of x goods
Pf= Price of factors of production
T = Technology
Nf = Number of firms
Pe = Price expectation
Gp = Government policy

16
Factors affecting the Supply/ Determinants of Supply
Price of the goods/services
Number of firms
Government policy
Price expectation
Objective of firm
Technology
Price of inputs
Development of infrastructure
Natural factors

17
Movement Along Supply Curve:
It is the state of increase or decrease in quantity supplied of a commodity due to rise or fall in
price level but all other determinants of supply remaining same is known as movement along
supply curve.
When price increases, supply also increases which is known as extension in supply. When price
decreases, supply also decreases which is known as contraction in supply. Moving from A to
B is known as extension and moving from B to A is known as contraction in demand.

18
 SHIFT IN SUPPLY CURVE

When the initial supply curve shift either rightward or leftward from its initial position due to change in
determinants of supply except the price of the commodity is called shift in supply curve. When
supply increases supply curve shift rightward and when supply decreases supply curve shift leftward ,

19
Determination of Equilibrium Price:
In a free market economy, prices are determined by the forces of demand and supply. Demand alone
can’t determine the price. Similarly supply alone also can’t determined the price. Price of the
commodity is determined where demand is equal to supply. Equilibrium price is the price at which
the quantity of a commodity that consumers are willing to buy equals the quantity of that commodity
that suppliers are willing to sell. Therefore
• At Equilibrium, Demand = Supply

Price Quantity demanded of Quantity supplied of

chocolates chocolates
2 100 20
4 80 40
6 60 60
8 40 80
10 20 100

20
21
 E
P0 0

22
Question: Suppose there are 1000 identical individuals in the market for commodity X,
each with a demand function given by QDx = 12 – 2 Px and 100 identical producers of
commodity X, each with a supply function given by QSx = 20 Px. Find.
(i) Market demand and market supply function
(ii) Graph the market demand and market supply and show the equilibrium.
(iii) Determine the equilibrium price and quantity mathematically.
(iv) What would be the effect on the new equilibrium price and quantity if government imposes
tax on seller of this product.
Solution:
(v) Market demand function is QDx = 1000(12 – 2 Px ) = 12000- 2000Px
Market supply function is QSx = 100x20 Px = 2000Px
(ii.) Price QDx QSx
2 8000 4000
3 6000 6000
4 4000 8000
23
 Y

S
4
E
3

Price
2
D
o X
4000 6000 8000
Equilibrium price and quantity are achieved when
Quantity
QDx = QSx
12000- 2000Px = 2000Px
Then Px = 3
Putting the value of Px = 3 in demand and supply equation then
QDx = 12000- 2000Px = 12000- 2000x3 = 6000
QSx = 2000Px = 2000x3 = 6000
24
25
26
27
 Elasticity of Demand
Other things remaining same, elasticity of demand is used to measure proportionate
change in quantity demanded of a commodity in response to the proportionate change
in determinants of demand like price of the commodity or income of the consumer or
price of the related goods etc.
There are following types of elasticity of demand.

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertisement elasticity of demand

Price Elasticity of Demand

Other things remaining same, price elasticity of demand is used to measure
proportionate change in quantity demanded of a commodity in response to the
proportionate change in price of the commodity.
In price elasticity of demand we take absolute value i.e. we
ignore negative sign while analyzing.
(i) When Ep>1 : Demand is said to be elastic
(ii)When Ep< 1: Demand is said to be inelastic
(iii)When Ep = 1: Unitary elastic demand
(iv)When Ep = 0 : Perfectly inelastic demand
(v) When Ep = Infinite: Perfectly elastic demand
1. Perfectly Elastic Demand:
When a very small change in price brings infinite change in quantity is said to be perfectly elastic
demand. In perfectly elastic demand, a small rise in price results in fall in demand to zero, while a
small fall in price causes increase in demand to infinity. In such a case, the demand is perfectly
elastic or ep =
2. Perfectly Inelastic Demand:
Whatever be the change in price of the commodity but demand remaining same is said to be
perfectly in elastic demand. In this situation ep =0
3. Relative elastic Demand:
When the proportionate change in quantity demanded is greater than proportionate change in price is
said to be relative elastic demand. In this situation Ep>1
4. Relative Inelastic Demand:
When the proportionate change in quantity demanded is smaller than
proportionate change in price is said to be relative inelastic demand. In this
situation 0<Ep<1
5. Unitary elastic Demand:
When the proportionate change in quantity demanded is exactly equal to the
proportionate change in price is said to be unitary elastic demand. In this situation
Ep=1
Measurement of Price Elasticity of Demand:
1. Point Method:
When there is small change in price and quantity demanded then we use point method to
measure price elasticity of demand. With the help of the point method, it is easy to point out
elasticity at any point along a demand curve. Mathematically we use following formula to
measured price elasticity of demand.

36
Graphically we use following formula to measured price elasticity of demand when demand
curve is linear.

Suppose that the straight line demand curve CD . Five points L, M, N, P and Q are taken on
this demand curve. The elasticity of
demand at each point can be measured
with the help of the above formula.
Let point N be in the middle of the
demand curve. So elasticity of demand at
point.

37
When demand curve is non linear then we adopt following steps to measure elasticity of demand.
 We have to draw a tangent line from any particular point where we want to measure elasticity of demand.
 After drawing the tangent line, we have to draw a perpendicular line from that point to x axis.
 Then we have to measure the distance between perpendicular line to tangent line intersected to X axis and
the distance between perpendicular line to origin.

38
Total Expenditure/ Outlay Method:
This method was given by Marshall. It evaluates elasticity on the basis of a change in
consumer’s total expenditure (i.e. price multiplied by quantity) on the product as price of the
product changes (See Table-5.3). It has three types i.e. elasticity of demand greater than one,
elasticity of demand equal to one and elasticity of demand less than one.

39
40
3. Arc Elasticity Method:
When there is large change in price, we use arc method to measure price elasticity of demand.
Arc elasticity is the elasticity at the mid-point of an arc of a demand curve (Watson).
The arc elasticity method is based upon average price and average quantity in place of initial
price and initial quantity respectively. In Figure-5.4, points A and B on the demand curve Dd
represent new and initial points with the price levels as P2 and P1 and quantity levels as Q2 and
Q1 respectively.

41
42
 Examples
1. The demand for the commodity is Q=2000 – 30 P. The commodity is initially priced at Rs. 20 per
unit. Compute the price elasticity of demand. If the objective is to total revenue should the price be
increased or decreased? Why?

2. Suppose a college decides to raise the tuition fee from Rs. 3000 per month to Rs. 4000 per month
of MBS students. The number of students getting admission is 5000. The price elasticity of
demand for the students is 0.2.
(a) find out the number of students getting admission after the increase in tuition fee.
(b) Find out total revenue before and after the increase in tuition fee.
(c) Explain whether the increase in tuition fee is wise decision or not.
 Solution
1.
We have given demand function Q = 2000 – 30P.

When price is Rs. 20 then Quantity Q = 2000 – 30x20 = 1400

Now differentiating demand function with respect to P
Then

Here price elasticity demand value is less than one, which shows demand is inelastic demand. Hence firm should increase price
in order to raise total revenue.
 Solution 2:

Here initial number of students (Q1) = 5000

Initial tuition fee of students (P1) = 3000
Final tuition fee of students (P2) = 4000
Price elasticity of demand (Ep) = -0.2
Number of students after increase in tuition fee (Q2) =?
Hence total number of students after increase in tuition fee is 4667.
(b) Totalincome before increase in tuition fee
i.e. TR1 = P1 x Q1 = 3000 x 5000 = 15000000

Total income after increase in tuition fee

i.e. TR2 = P2 x Q2 = 4000 x 4667 = 18668000

(c) Increase in tuition fee is wise decision for the college because total income of
the college increases than before.
Income Elasticity of Demand
– Income elasticity of demand measures how much the quantity demanded of
a commodity changes due to a change in income of the consumer.
– It is computed as the percentage change in the quantity demanded divided
by the percentage change in income.

47
How to analyze income elasticity of demand

(i) If Ey<0, commodity is inferior

(ii) If 0<Ey<1, commodity is necessity
(iii) If Ey>1, commodity is luxurious/superior
Types of Income Elasticity of Demand
1. Zero income elasticity of demand ( EY=0)
If the quantity demanded for a commodity remains constant with any rise or fall in income of
the consumer then it is said to be zero income elasticity of demand. For example: In case of
basic necessary goods such as salt, kerosene, electricity, etc. there is zero income elasticity of
demand.

50
2. Negative income elasticity of demand ( EY<0)
If there is inverse relationship between percentage change in income of the consumer and
percentage change in quantity demanded for the commodity, then it is known as negative
income elasticity of demand. That is, quantity demanded for a commodity decreases with the
rise in income of the consumer and vice versa, it is said to be negative income elasticity of
demand.

51
3. Income elasticity greater than unity (EY > 1)
If the percentage change in quantity demanded for a commodity is greater than percentage
change in income of the consumer, it is said to be income elasticity of demand greater than
unity. For example: When the consumer’s income rises by 3% and the demand rises by 5%, it
is the case of income elasticity greater than unity.

52
4. Income elasticity less than unity (EY < 1)
If the percentage change in quantity demanded for a commodity is lower than percentage
change in income of the consumer, it is said to be income elasticity of demand less than unity.
For example: When the consumer’s income rises by 10% and the demand rises by 6%, it is the
case of income elasticity less than unity.

53
5. Income elasticity equal to unity (EY = 1)
If the percentage change in quantity demanded for a commodity is equal to percentage change
in income of the consumer, it is said to be income elasticity of demand equal to unity. For
example: When the consumer’s income rises by 5% and the demand rises by 5%, it is the case
of income elasticity equal to unity.

54
• Cross-price elasticity of demand
– It measures of how much the quantity demanded of one
good responds to a change in the price of another good,
computed as the percentage change in quantity
demanded of the first good divided by the percentage
change in the price of the second good
%change in quantity demanded of good 1
Cross - price elasticityof demand 
%change in price of good 2

55
How to analyze cross elasticity of demand

(i) If Ec<0, Goods are complementary

(ii) If Ec= 0, commodity is neutral
(iii) If Ec>0, Goods are substitutes
1. Positive cross elasticity of demand: When there is positive relationship between proportionate
change in quantity demanded of one commodity and proportionate change in price of another
commodity is called positive cross elasticity of demand. Cross elasticity of demand is positive
in the case of substitutes goods. For e.g. when price of fanta rises then quantity demanded of
sprite also rises and vice versa.

58
2. Negative cross elasticity of demand: When there is negative relationship between
proportionate change in quantity demanded of one commodity and proportionate change in
price of another commodity is called negative cross elasticity of demand. Cross elasticity of
demand is negative in the case of complementary goods. For e.g. when price of petrol rises
then quantity demanded of motorcycle falls and vice versa.

59
2. Zero cross elasticity of demand: When there is no relationship between proportionate change
in quantity demanded of one commodity and proportionate change in price of another
commodity is called zero cross elasticity of demand. Cross elasticity of demand is zero in the
case of neutral goods. For e.g. when price of car falls then there is no change in quantity
demanded of tomato.

60
Elasticity of Supply:
Elasticity of is used to measure proportionate change in quantity supplied due to certain
proportionate change in price. In other words, it is used to measure of the degree of change in
the quantity supplied of a product in response to a change in its price.

61
less

62
63
 DETERMINANTS OF ELASTICITY OF
DEMAND
• Availability of Close Substitutes: If close substitutes goods are available demand is
elastic otherwise inelastic.
• Necessities versus Luxuries: For necessary goods demand is inelastic and for
luxurious goods demand is elastic.
• Time Period: For short time demand is inelastic and for long time demand is elastic.
• Possibility of postponement: If yes elastic and if no inelastic.
• Level of income : for higher income level people demand is inelastic but for lower
income level people demand is elastic.
• Proportion of income spend for purchase of goods: If less proportion of income is
spend for purchase goods demand is inelastic and if more proportion of income spend
to purchase goods demand is elastic. 64
 Examples
1. DDC has introduced different products like milk, ghee, curd, paneer etc. as joint product since 2010. The figures
of total quantity of these product in 2016 1nd 2017 are given below.
Product 2016 2017
Price (Rs. Per unit) Demand (Rs. Per unit) Price (Rs. Per unit) Demand (Rs. Per unit)

Milk 50 400000 45 600000

Ghee 300 40000 280 56000

Curd 70 100000 100 90000

Paneer 150 2000 180 1900

a. Compute price elasticity of demand for the product of DDC by proportion method
b. Suppose that you are appointed as a marketing manager in 2018. The board of director of DDC
assigned you to revise existing prices in order to increase total revenue in 2018 on the basis of price
elasticity of demand. How do you revise prices of each product of DDC to meet goal? Explain with
proper reasons?
c. How price elasticity of demand useful to (i) Price discrimination (ii) Pricing of inputs?
b. In order to increase TR, I suggest to decrease the price of milk and ghee because
these goods are elastic demand because their value is more than one. But in order
to increase TR, I suggest to increase the price of curd and paneer because these
goods are inelastic demand because their value is less than one

c. Price elasticty of demand is useful to price discrimination. Producer charges higher

price in inelastic market and lower price in elastic market for the same product.
Producer can not pay higher price for the input if producer is producing elastic
product but producer can pay higher price for the input if producer is producing
inelastic product.
 USES OF PRICE ELASTICITY OF DEMAND IN BUSINESS
DECISION MAKING
• Product pricing : If elastic low price and if inelastic high price
• Pricing of joint products: low price for elastic and high price inelastic product
• Demand forecasting: elastic then increase in future production and inelastic then
not to increase future production.
• Price Discrimination: low price in elastic market and high price in inelastic market
• Pricing of inputs: firm can pay higher price for input if firm is producing inelastic
product but firm can not pay higher price for input if firm is producing elastic
product
• Useful in International Trade: country can get benefit for international trade when
export is inelastic and import is elastic
• Useful in formulation of government tax policies: elastic then government can not
impose high tax but if inelastic then government can impose high tax 69
 USES OF INCOME ELASTICITY OF DEMAND IN BUSINESS
DECISION MAKING
– To know the stage of trade cycle: when income elasticity value is increasing
then economy is moving toward recovery or prosperity. when income elasticity
value is decreasing then economy is moving toward recession or depression.
– Marketing Activities: when the coefficient of income elasticity of demand
increasing firm can adopt the sufficient promotional and marketing activities
and ……
- Classification of Goods: if Ey<0, commodity is inferior, if 0<Ey<1,
commodity is necessity and if Ey>1, commodity is luxurious/superior

70
 USES OF CROSS ELASTICITY OF DEMAND
IN BUSINESS DECISION MAKING
1. Classification of goods: If Ec<0, Goods are complementary, If Ec= 0,
commodity is neutral and If Ec>0, Goods are substitutes
2. Classification of markets If Ec=∞, market is perfectly competitive, If Ec = 0,
market is monopoly and If 0<Ec<∞, market is imperfect market.
3.Determination of pricing policy: Large firms produce different related goods.
Cross elasticity of demand helps to decide whether to increase price of related
product or not.

71