Unit 2

What is Demand?
Demand for a product or service exists when three conditions are met:
Desire :- The consumer must want the product.
Willingness to Pay:- The consumer must be ready to pay for it.
Ability to Pay :- The consumer must have enough money to afford it.
So, demand = Desire + Willingness to Pay + Ability to Pay
Concept of Demand and Demand Analysis
Demand refers to the quantity of a good or service that consumers are willing and able to
purchase at different prices during a given period.
Types of Demand
Price Demand :- Demand changes based on the price of a product. Dx=f(Px)
Dx stands for Demand for commodity'X'
F' denotes functional relationship and
Px denotes price of X
Income Demand :- Demand changes based on consumer income.
Dx=f ( y)
Dx stands for Demand for good 'X'
Y' denotes income of a consumer and
F' denotes a functional relationship.
Cross Demand :- Demand for a product changes due to changes in the price of related goods
(substitutes or complements).
Dx=f ( py)
Dx stands for Demand for commodity 'X'
PY' denotes a price of 'y'commodity
F' denotes a functional relationship.
Derived Demand :- Demand for one good arises due to demand for another (e.g., demand
for steel due to demand for cars).
Joint Demand :- Demand for goods that are used together (e.g., cars and petrol).
DEMAND FUNCTION
The demand function is a mathematical expression showing therelationship between the
quantity demanded of a commodity and the factors that determine it. It is expressed as follows:
Dx = f(Px, P1, P2, ..., Pn, Y, T)
Where:
Dx = Demand for Good X
Px = Price of Good X
P1, P2, ..., Pn = Prices of substitutes and complements
Y = Income of the consumer
T = Tastes of the consumer
f = Functional relationship that determines the quantity demanded
Here, demand is a dependent variable, whereas prices, income, and tastes of the consumer are
independent variables.
Determinants of Demand
Price of the Product – Higher price lowers demand, and vice versa.
Consumer Income – Higher income increases demand for normal goods but decreases demand
for inferior goods.
Price of Related Goods – Substitutes and complementary goods affect demand.
Consumer Preferences – Trends, fashion, and advertisements influence demand.
Future Expectations – If prices are expected to rise, current demand may increase.
DETERMINANTS OF DEMAND
There are a number of factors that determine the demand for a good. A demand function
shows the factors that determine the demand for a good. The following are some of the
important factors that determine demand.
1) PRICE OF THE COMMODITY: The demand for a commodity is inversely related to its price.
If the price of a commodity decreases, its demand will increase, and vice versa. The demand for
any good depends on its price. More will be demanded at a lower price and vice versa.
2) PRICES OF SUBSTITUTES AND COMPLEMENTARIES:
Demand is also influenced by changes in the prices of related goods, either substitutes or
complementaries. Prices of substitutes influence the demand for a commodity up to a certain
extent. For instance, an increase in the price of coffee leads to an increase in the demand for
tea. In the case of substitutes, there exists a positive relationship between the price and the
quantity demanded of the substituted good.
Automobiles and diesel are complementary goods. In the case of complementaries, there exists
a negative relationship between the price and the quantity demanded.
3) INCOME OF THE CONSUMER:
Income of the consumer is another important determinant. An increase in the income of a
consumer leads to an increase in his purchasing power or quantity demanded. Whenever the
income of a consumer increases, other things remaining the same, the demand for normal
goods increases, but the demand for inferior goods decreases.
4) TASTES AND PREFERENCES:
Demand for a commodity may change due to a change in tastes, preferences, and fashion.
Tastes vary from person to person and do not remain the same forever. An increase in the use
of trousers reduced the demand for dhotis due to a change in fashion. Advertisements also
influence the demand for a particular commodity.
5) POPULATION:
The size of the population of a country is another important determinant of demand. In other
words, a change in the size of the population will affect the demand for certain goods. For
instance, the larger the population, the more the demand for certain goods like food grains,
clothes, etc.
6) TECHNOLOGICAL CHANGES:
Due to technical progress, new discoveries enter the market. As a result, old goods are
substituted by new goods. For instance, the demand for 'cell phones' reduced the demand for
'landline' phones.
7) CHANGE IN WEATHER:
Demand for a commodity may change due to a change in climatic conditions. For instance,
during summer, the demand for cool drinks, cotton clothes, and air-conditioners increases.
During winter, the demand for woolen clothes increases.
8) STATE OF BUSINESS:
During the period of prosperity, demand for commodities will expand, and during a depression,
demand will contract.
Law of Demand
Prof. Marshall defines the law of demand as, "The amount demanded increases with a of the fall
in price and diminishes with a rise in price when other thing remain the same".
So, the law of demand explains the relationship between the price and quantity demanded of a
commodity. -Demand varies with price; in other words, if the price is low demand will be high
and if the price is high demand will be low.

Assumptions of the Law of Demand:

1)No change in the income of the consumer.
2)No change in the tastes and preferences of the consumer.
3)No change in the price of substitutes and complementary goods.
4)No new substitutes are discovered.
5)No expectation of future price changes.
Exceptions to the Law of Demand:
that are rarely purchased or consumed (like luxury items), the law may not apply as individuals
may derive consistent utility from each unit due to its infrequent use.

Giffen goods: These are inferior goods for which demand increases as the price increases, due
to the income effect outweighing the substitution effect. Eg:Ragee,jowar,Bajra, Broken rice etc.
Veblen goods( Prestigious goods)These are luxury goods where demand increases as price
increases, due to the perceived prestige or status.Eg: Diamond, precious stones, costly furniture
etc.
Necessities: In cases where a good is a necessity, price changes may not significantly affect the
quantity demanded.Eg : tobacco products, haircuts, water, and electricity.
Ignorance of price changes: If consumers are unaware of price changes, they may not change
their demand in response.Eg: War.
SPECULATIVE EFFECT: If the price of a commodity increases, then the consumer will buy
more of it, if it is expected to increase still further. Thus an increase in price may not be
accompanied by a decrease in its demand which is contrary to the law of demand. For instance
it takes place in the market for stocks and shares.
ILLUSION: Some times, consumers develop a false idea that a high priced good will have a
better quality instead of a low priced good. If the price of such a good falls, they feel that it's
quality also deteriorates and they do not buy, which is contrary to the law of demand.
It is to be noted, that in case of inferior goods, prestigious goods, expectations about future
price changes and illusion of high price goods possessing high quality, the law of demand will
not apply.
Limitations
The different limitations and drawbacks of the law of demand in economics include the
following:
• They do not hold true in every situation. In events such as war, depression, demonstration
effect, Giffen paradox, speculation, ignorance effect, and necessities of life. For example, if
there is an anticipation of war, citizens will start buying their required stocks and store them for
use at the time of war, even if the prices of those goods keep on increasing. Thus, this is an
exception to the law of demand as even with the increase in prices of the goods, demand for
and for those goods will not decrease in a war situation.
• There are assumptions of the law of demand. If any assumptions do not hold, then the law of
demand will not be applicable in those cases.
Elasticity of Demand
Meaning of Elasticity of Demand
In Economic Theory, the concept of Elasticity of Demand plays a significant role. Elasticity
of demand refers to the percentage change in quantity demanded in response to the percentage
change in one of the variables on which demand depends. These variables include the price of
the commodity, prices of related goods, income of the consumer, tastes and preferences of the
consumer, etc. The percentage change in quantity demanded, divided by the percentage
change in any one of the variables on which demand depends, represents Elasticity of Demand.
Elasticity of demand varies from person to person, place to place, time to time, and
commodity to commodity. For instance, rice, salt, vegetables, etc., do not show significant
changes in the quantity demanded even after a rise in the price of these goods. Similarly, there
will be a greater change in the quantity demanded of refrigerators, air coolers, TVs, washing
machines, etc., with a small fall in their prices. The concept of elasticity demand was first
introduced by COURNOT' and MILL in a rough form. Later it was developed in a scientific
manner by ALFRED MARSHALL.
MARSHALL'S DEFINCATION: According to Marshall, "The elasticity of Demand in a market is
great or small according as the amount demanaded increases much or little for a given fall in
price",
According to Mrs. Joan Robinson, "The Elasticity of Demand at price or at any output is the
proportional change of amount purchased in response to a small Change in price, divided by the
proportional change in price".

(Elasticity of Demand means the degree of sensitiveness or responsivness of demand to a

change in its price)
TYPES OF ELASTICITY OF DEMAND
Elasticity is a tool by which we measure the degree of the dependent variable responsiveness to
a change in an independent variable. For example, price of the commodity ,income of
consumer, prices of substitutes and complementaries are independent variables and the
quantity demanded of the commodity is dependent variable.
The concept of Elasticity of demand explains how much or to what extent a change in any one
of the independent variables leads to a change in the dependent variable.
In this connection, we can learn three types of elasticities.
1. Price Elasticity of demand (Ep)
2. Income Elasticity of demand (Ey)
3. Cross Elasticity of demand (Ec)
PRICE ELASTICITY OF DEMAND
Price elasticity of demand is the responsiveness of quantity demanded of a good to a change in
the price of that commodity.
Price elasticity of demand, its various forms, various methods of measurements, factors that
determine it and its importance are going to be discussed in this section.
1) TYPES OF PRICE ELASTICITY OF DEMAND.
If the price of a commodity increases, its quantity demanded will fall. The rate of change
in demand is not always proportionate to the rate of change in price. For some commodities, a
smaller change in price leads to a greater change in quantity demanded. In such a case, the
demand is elastic. On the other hand, even a greater change in price may lead to only a smaller
change in the quantity demanded. In such a case, we say that the demand is inelastic. They are
as follows:
A)Perfectly Elastic Demand (Ed = )
B)Perfectly Inelastic Demand (Ed = 0)
 ●

C) unitary elastic demand (Ed=1)

D) Relatively elastic demand (Ed>1)
E) Relatively Inelastic demand (Ed<1)
2. CROSS ELASTICITY OF DEMAND:
Cross elasticity of demand (XED) is an economic concept that measures the responsiveness in
the quantity demanded of one good when the price of other goods changes. Also called cross-
price elasticity of demand, this measurement is calculated by taking the percentage change in
the price of the other good.
3. INCOME ELASTICITY OF DEMAND:

Income elasticity of demand measures the responsiveness in the quantity demand for a good or
service when the real income of the consumers is changed, keeping all the other variables
constant. The formula for calculating income elasticity of demand is percent change in quantity
demanded divided by the percent change in income. This concept helps us to find whether a
good is necessity or luxury.
Utility analysis
WHAT IS UTILITY?
Utilities refer to essential services and tools that support both daily living and system
functionality. In the context of public utilities, these include services such as electricity, water,
gas, sewage, waste management, and telecommunications, all of which are vital for homes,
businesses, and communities to function smoothly.
Types of Utilities
Form Utility
This utility is created by converting raw materials into finished products that meet consumer
needs. For example, turning cotton into clothing adds form utility.
Time Utility
This refers to making goods and services available at the time they are needed or desired by
consumers, such as offering seasonal products or 24-hour services.
Place Utility
Place utility is created by ensuring that products are available at locations convenient for
consumers. For instance, placing products in online stores or in easily accessible physical
locations adds place utility.
Possession Utility
This occurs when ownership or access to a product is made easier, often through financial
options like leasing or installment payments, allowing consumers to acquire what they need
more easily.
The concept of utility was introduced to social thoughts by Benham in 1789 and to economic
thoughts by Jevons in 1871. In a general sense, utility is the “want satisfying power” of a
commodity. In economic sense, utility is a psychological phenomenon; it is a feeling of
satisfaction, pleasure, happiness, or well-being which a consumer derives from the consumption
or possession of a commodity. As regards the measurement of utility, there are two different
approaches:
1. Cardinal Utility 2. Ordinal Utility

1) CARDINAL UTILITY
Utility is cardinal in the sense that utility is a measurable and quantifiable entity. The numbers
1, 2, 3, 4, etc., are cardinal numbers. According to the concept of cardinal utility, the utilities
derived from the consumption of commodities can be expressed in terms of numbers such as 1,
2, 3, 4, and so on. For example, a person can say that he derives utility equal to 10 utils from
the consumption of 1 unit of commodity A and 5 utils from the consumption of 1 unit of
commodity B. Since he can express his satisfaction quantitatively, he can easily compare
different commodities and express which commodity gives him better utility or satisfaction and
by how much. Alfred Marshall followed this approach.
2) ORDINAL UTILITY
Utility is ordinal in the sense that utilities derived from the consumption of commodities cannot
be measured, much less compared. The numbers 1st, 2nd, 3rd, 4th, etc., are ordinal numbers.
The ordinal numbers are ordered or ranked. It means the utilities obtained by the consumer
from different goods can be arranged in a serial order such as 1st, 2nd, 3rd, 4th, etc. Modern
economists, like J.R. Hicks and R.J.D. Allen, have used the ordinal approach.
LAW OF DIMINISHING MARGINAL UTILITY
The law of diminishing marginal utility was originally explained by Hermann Heinrich Gossen in
1854. Hence, it is called Gossen’s first law. But Alfred Marshall popularized this law and
analyzed it in a scientific manner.
Definitions of the Law
 “The additional benefit which a person derives from a given increase of his stock of a thing
diminishes with every increase in stock that he already has.” – Alfred Marshall
The law of diminishing marginal utility is an economic principle that states that the
additional satisfaction gained from consuming more of a good or service decreases as
consumption increases.
The first unit of a product typically provides the highest satisfaction. As consumption
continues, the marginal utility of each subsequent unit diminishes.
While total utility may still increase with each unit consumed, it does so at a decreasing rate
because the extra satisfaction from each new unit is lower than the previous one.
Imagine you’re eating slices of pizza. The first slice might give you great satisfaction (high
marginal utility), but as you eat more, each additional slice is less enjoyable. By the fourth or
fifth slice, you might not feel much satisfaction at all, and eventually, you may feel no benefit or
even discomfort.
This law helps explain why consumers tend to buy a variety of goods instead of just consuming
one thing. It also influences pricing, product variety, and consumption patterns.
LIMITATIONS (OR EXPECTATIONS):
The following are the limitations or expectations to the law:

(i) Suitable units: The units of commodity consumed must be of suitable size. The unit must not
be too small or too big. Otherwise, the law will not operate.

(ii) Similar units: All the units of the commodity must be of the same quality. If they differ in
quality, the law will not hold good.

(iii) Period of consumption: Consumption must be made continuously or within a reasonable

period of time. If a person takes oranges one after the other, the law will definitely operate; but if
he takes one orange in the morning, another in the evening, the law will not hold good.

(iv) Character of the consumer: There should be no change in the character of the consumer. If
any change takes place as in the place of a drunkard, the law will not hold good.

(v) Rare collections: The law does not apply to rare collections like ancient coins or rare stamps.

(vi) Stock of other people: Pigou points out that the utility of a commodity sometimes depends
on stock possessed by other people. Suppose in an aristocratic locality every family maintains
two cars. The family which has only one car desires another car. If it purchases another car, the
second car gives more utility than the first one.