Theory of Demand

Presented by
Farzana Yeasmin
Assistant Professor
Department of Agricultural Economics
Bangladesh Agricultural University, Mymensingh-2202
 Demand
• Three necessary conditions for demand:
1. Desire to purchase a good
2. Ability to buy that good
3. Willingness to pay for the good
• Demand: Other things remaining the same, the demand for a good is the quantity of
the good that consumers are willing and able to buy at each possible prices over a
given period of time.

• Quantity Demanded: It refers to the quantity of the good or commodity that

consumers are willing and able to buy at given possible prices within a given period
of time.
 The Law of Demand

• The law of demand states that there is an inverse relationship

between price and quantity demanded. Other things remaining same,
when the price of a good falls, the quantity demanded will rise.
Conversely, when the price of a good rises, the quantity demanded
will fall.

• Demand thus is a function of price, i.e., it varies with price and can be
expressed as D= f (P). Here D is demand and P is price.
 Exceptions to the law of demand

§ Scarcity: In times of scarcity although prices are rising, yet people tend to buy more of the

scarce good and keep them.

§ Necessaries of life: Certain commodities are essentials and people must consume them at

all costs.

§ Ignorance: Sometimes consumer's buy more goods at high prices out of sheer ignorance.

§ Self display: Things which are used for self display, as in the case of certain commodities if

the price rises demand for such commodities may increase instead of decreasing.

§ Giffen's Paradox: It is said that Giffen's paradox provides an important exception to the

law of demand
Giffen Paradox:

Sir Robert Giffen was the first to discover this paradox so it is called Giffen's Paradox.
It is said that when the price of Giffen goods or inferior goods, falls, the demand for
such goods also falls and demand rise with a rise in their prices. It is just contrary to
what the law of demand lays down.
Explanation:

He observed that when the price of bread increased, then the low-paid British wage
earners bought more of bread and not less. Since, the wage earners diet was mainly
bread, with the increase in price they were forced to cut down their consumption of
meat and other expensive food items. Thus to maintain their food intake, they bought
bread even at higher prices. This phenomena was referred to as ‘Giffens Paradox’.
Demand for Giffen goods varies directly with price and thus is an exception to the law
of Demand.
 Demand Schedule
Demand Schedule: Demand Schedule shows the list of the quantities of a commodity demanded by a
consumer at different prices at a certain time in a tabular form.
A market demand schedule on the other hand, shows the quantity demanded of the market for a
commodity at different prices at a certain time.

Wheat
Individual Demand Schedule Market Demand Schedule
August 31,2013 August 31, 2013

Price per quintal Demand (q) Price per quintal Demand (q)
1250 1.0 1250 100
1200 1.5 1200 150
1150 2.0 1150 200
1100 3.0 1100 300
 Demand Curve

• Demand curve: The demand curve of a good shows the quantity

demanded of the good at each price over a period of time, ceteris
paribus.
• The demand curve is a graphical presentation of demand schedule, i.e,

quantities of a good which will be demanded by the consumer at

various possible prices at a given moment of time.

• The demand curve is downward sloping due to the law of demand.

 Demand Curve

We can understand this inverse relationship using the following individual

demand schedule:
 Demand Curve
• This graph also shows the demand curve falling as the price reduces. The downward

sloping of this curve explains the law of demand. Furthermore, its rightward shift with
falling prices indicates increasing demand.

• A similar market demand curve showing demands of various commodities of the same

kind will also look the same. This indicates that a demand curve is always downward
sloping. The extent to which a curve slopes might differ but its downward direction is
inevitable.

• Such downward sloping of demand curves from left to right explains the law of demand.

This happens because of the inverse relationship between price and demand.
 Why does demand curve slope downwards?

• The following are some of the causes explaining why demand curves always slope
downwards:
1) The law of diminishing the marginal utility

• According to this principle, the marginal utility of a commodity reduces when the
quantity of goods is more. Consequently, when the quantity is more, the prices will
fall and demand will increase. Hence, consumers will demand more goods when
prices are less. This is why the demand curve slopes downwards.
 Why does demand curve slope downwards?
2) Substitution effect

Consumers often classify various commodities as substitutes. For example, many

Bangladeshi consumers may substitute coffee and tea with each other for various
reasons. When the price of coffee rises, consumers may switch to buying tea more as
it will become relatively cheaper.

Economists refer to this as the substitution effect. Hence, if the price of tea reduces,
its demand will increase and the demand curve will be downward sloping.
 Why does demand curve slope downwards?

3) Income effect

According to this principle, the real income of people increases when the prices of
commodities reduce. This happens because they spend less in case of falling prices
and end up with more money. With more money, they will, in turn, purchase more
and more. Therefore, the demand increases as prices fall.
 Why does demand curve slope downwards?

4) New buyers
Whenever the price of a commodity decreases, new buyers enter the market and start
purchasing it. This is because they were unable to purchase it when the prices were high
but now they can afford it. Thus, as the price falls, the demand rises and the demand
curve becomes downward sloping.
5) Old buyers
This rule is basically a corollary of the new buyers rule. When the price of a commodity
decreases, the old buyers can afford to buy even more quantities of it. As a result, this
results in demand increasing and the demand curve slopes downwards.
 Factors affecting demand/ Determinants of Demand

The following are the factors which determine demand for goods.

i) Change in real income vii) Changes in the price of the commodity

ii) Change in the level and distribution of income viii) Change in savings
iii) Change in tastes preferences and fashion ix) Change in asset preferences
iv) Climate or weather changes x) Conditions of trade
v) Changes in the size and composition of xi) Expectations or anticipation
population
xii) Price of related goods
vi) Changes in money supply
 Factors affecting demand/ Determinants of Demand

The following causes bring about changes in demand and also explain how
demand will be affected by the following factors.

i) Change in real income: In times of technical progress, there is a large output of cheap goods.
The purchasing power of money increases or, real income increases. The demand schedule have

to be recast, because less money will be needed to purchase the same quantity of goods, and the

savings so made will find outlet in the purchase of other commodities. Some goods may be

eliminated from consumption and instead entirely now goods purchased; demand for some goods

will decrease and that for other increase.

 Factors affecting demand/ Determinants of Demand

ii) Change in the level and distribution of income: Through the instrument of public
finance, e.g. by taxing the rich and spending the funds so obtained on the poor, wealth is
redistributed. There is a transfer of spending power. This is bound to affect demand. Demand
for those goods will increase which are purchased by a class whose spending power has
increased, and vice-versa.

iii) Change in tastes preferences and fashion: We see that increasing habit of taking tea has
decreased the demand for milk. Change in the mode of dress means a change in the demand for
dress materials. When some goods go out of fashion, they will be less in demand, even though
they may become cheap.
 Factors affecting demand/ Determinants of Demand

iv) Climate or weather changes: It is obvious that demand for a commodity must change with
the change in season.

v) Changes in the size and composition of population: If for instance, the commonwealth
countries and America allow a free entry to India. We can expect emigration from India. If
India is stick to their own mode of living in food and dress in their new homes, demand for
such things will be crated there.

vi) Changes in money supply: When there is inflation, the additional money will add to the
purchasing power of the community, the price will rise. People will have to readjust their
expenditure, demand for certain things will be reduced and for other stimulated.
 Factors affecting demand/ Determinants of Demand

vii) Changes in the price of the commodity: Obviously, demand is decisively affected
by the change in the price of commodity concerned. There is inverse relation between
price and the quantity demanded.

viii) Change in savings: Demand for goods is affected by a change in consumer’s

propensity to save. Large saving means less money available for purchase of goods.

ix) Change in asset preferences: It is quite obvious that if a consumer develops

marked liquidity preference, his demand for goods will decrease, because he prefers to
keep with him ready cash instead of buying things.
 Factors affecting demand/ Determinants of Demand

x) Conditions of trade: Demand for everything is greater in a boom even though the
prices are rising. On the other hand, in times of depression, there is a general
slackening of the demand.

xi) Expectations or anticipation: If prices are expected to rise in future, the demand
for goods will increase now in the present. Similarly, expectations of rising incomes
will restrain current purchase and postpone purchases to a future favorable situation.
 Factors affecting demand/ Determinants of Demand

xii) Price of related goods:

Substitutes: When a decline in price of one good results in a decline in the demand for
another, they are substitute. e.g. tea and coffee, increase in the consumption of one will
lead to a decrease in the demand for the other.

Complements: Two goods are complements if the price of one and the demand for
other are inversely related. Increased demand for one will augment that for other e.g.
Horse and carriage, if the price of carriage will falls, the demand for horses rises.

Joint demand: The increase in the demand for the ultimate object, e.g. the house will
increase the demand for everything needed in building a house.
 Factors affecting demand/ Determinants of Demand

xii) Price of related goods:

Composite supply: e.g. light obtained from electricity, gas or kerosene, choosing of
anyone of them will reduce the demand for the others.

Composite demand: e.g. water required for drinking, washing, bathing. Any extension
or contraction of its used will correspondingly change the demand.

Thus, the demand for a commodity does not depend only on its own price but the prices
of other goods too.
 Extension and Contraction of Demand

• When as a result of changes in price, the quantity demanded rises or

falls, extension or contraction in demand is said to have taken place.

• Therefore, in economics, the extension and contraction in demand are

used when the quantity demanded rise or falls as a result of changes in
price and we move along a given demand curve.
 Extension and Contraction of Demand

• Extension and contraction in the demand takes place as a result of

changes in the price alone when other determinants of demand such as
tastes, income, propensity to consume and prices of the related goods
remain constant.

• These other factors remaining constant means that the demand curve
remains the same, that is, it does not change its position; only the
consumer moves downward or upward on it.
 Extension of demand and contraction of demand
• Whenever demand changes on account of changes in price, it is called extension and
contraction in demand.
• A downward movement indicating a fall in price and expansion of demand, and an upward
movement indicating rise in price and contraction of demand.
 Increase in demand and decrease in demand

• When demand changes due to the factors other than price, there is shift in the
whole demand curve.

• Apart from price, demand for a commodity is determined by incomes of the

consumer, their tastes & preferences, price of related goods etc. Thus, when there
is any change in these factors, it will cause a shift in the demand curve.

• When there is shift in the whole demand from left to the right it is called increase
in demand and when there is shift in the whole demand from right to the left it is
called decrease in demand curve.
 Increase in demanded and decrease in demand

• When the change in demand is owing to changes in other factors like income, fashion, population etc.,
we call it rise and fall in demand or increase and decrease in demand.
• We take in account other factors, i.e. size of family, increase or decrease in income, change in fashion
and style, the government policies etc.
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