Unit 1(4th

Topic)
Determinants of demand and Law of Demand

Dr. Anand Gupta

DEMAND
 Demand for a commodity refers to the desire to buy a
commodity backed with sufficient purchasing power and the
willingness to spend.
 For Example: You desire to have a Car, but you do not have
enough money to buy it. Then, this desire will remain just a
wishful thinking, it will not be called demand.
 Demand for a commodity refers to the quantity of the
commodity which a consumer is willing and able to purchase at
any Price and a Specific time period.
 Law of Demand
 The Law of Demand States that, other things being constant
(Ceteris Paribas), the demand for a good extends with a
decrease in price and contracts with an increase in price.
 Acc. to Dr. Marshall, “The law of demand states that amount
demanded increases with a fall in price & diminishes with a
rise in price.”
 In other words, there is an inverse relationship between
quantity demanded of a commodity and its price.
 The term other thing being constant implies that income of the
consumer, his taste and preferences and price of other
related goods remains constant.
Assumptions of Law of Demand
No change in the income of the consumer.
No change in the price of related goods.
There should be no expectation of any change in the future
price of the commodity.
Consumer tastes, preferences & choices remains constant
No Substitutes for the commodity are available.
There is no change in the distribution of incme and wealth of
the community.
Demand Schedule & Demand Curve
Demand Schedule is that schedule which expresses the relation between different
quantities of the commodity demanded at different price.

According to Samuelson, “The table relating to price and quantity demanded is called the
demand schedule.

Demand Curve is simply a graphic representation of demand schedule.

According to Leftwitch, “The Demand Curve represents the maximum quantities per unit
of time that consumer will take at various prices.

Demand Schedule and Demand Curve are of two types

1)Individual Demand Schedule & Individual Demand Curve
2)Market Demand Schedule & Market Demand Curve
Individual Demand Schedule & Individual Demand Curve
• It is defined as the table which shows quantities of a given commodities which an
individual consumer will buy at different possible prices at a given time.
• Individual demand curve is a curve that shows different quantities of a
commodity demanded by an individual consumer.
• The slope of an individual demand curve is downward from left to right that
indicates the inverse relationship of demand with price.

Price. (in Quantity

Rs.) Demanded of
commodity x (in
units)
5 1
4 2
3 3
2 4
1 5
Market Demand Schedule & Market Demand Curve
 Market demand schedule shows total demand of all the consumers in
the market at different prices of the commodity.
 Market demand curve is a curve that represent the aggregate demand of
all the consumers in the market at different prices of a particular
commodity
Price Individual Demand (in units) Market Demand (in
(Rs.) units) {DA + DB}

Household A Household B
(DA) (DB)
5 1 2 1 +2 = 3
4 2 3 2+3=5
3 3 4 3+4=7

2 4 5 4+5=9
1 5 6 5 + 6=11
Why does demand curve slope downward

 Law of Diminishing Marginal Utility

 Income Effect

 Substitution Effect

 New Buyers

 Different Uses
Demand Function
Demand Function shows the relationship between demand for a commodity
and its various determinants.
It shows how demand for a commodity is related to, say price of the
commodity or income of the consumer or other determinants.
It is Expressed as: Dx = f (Px, Pr, Y, T, E)

Here, Dx: Quantity Demanded of commodity X

Px : Price of the Commodity X
Y : Consumer’s Income
T : Consumer’s Taste & Preferences
E: Consumer’s Expectations
N : Population Size
Yd : Distribution of Income
Exception to the Law of Demand
In certain cases, the demand
curve slopes up from left to right,
i.e., it has a positive slope.

Under certain circumstances,

consumers buy more when the
price of a commodity rises, and
less when price falls. Many causes
are attributed to an upward
sloping demand curve.
Exception to the Law of Demand

1) Articles of Distinction: This exception was first of all

discussed by Veblen. According to him, articles of distinction
have more demand only if their prices are sufficiently high.

Diamond, jewellery, etc; have more demand because their

prices are abnormally high.

If their prices fall, they will no longer be considered as articles of

distinction and so their demand will decrease.
Exception to the Law of Demand
2) The Giffen Goods
A study of poor farmers of Ireland by Sir Giffen in the 19th century
revealed that the major portion of their income was spent on potatoes
and only a small amount was spent on meat.
Potatoes were cheap but meat was costly. When the price of potatoes
tend to increase consumption of meat was curtailed to economies their
expenditure and as a result of this they saved money and spent more on
potato to meet their food deficiency.
In this way quantity purchase rises even when prices of potatoes rises.

Giffin goods are highly inferior goods, showing a very high negative
income effect
Exception to the Law of Demand
3) Highly Essential Good: In case of certain highly essential items such as life-
saving drugs, people buy a fixed quantity at all possible price. Heart patients will
buy the same quantity of ‘medicine’ whether price is high or low. Their response to
price change is almost nil.
4) Emergencies: During emergencies such as war, natural calamity- flood, drought,
earthquake, etc., the law of demand becomes ineffective. In such situations, people
often fear the shortage of the essentials and hence demand more goods and services
even at higher prices.
5) Bandwagon Effect: (The bandwagon effect is a psychological phenomenon in
which people do something primarily because other people are doing it).
This is the most common type of exception to the law of demand wherein the
consumer tries to purchase those commodities which are bought by his friends,
relatives or neighbors.
. For example, if the majority of group members have smart phones then the
consumer will also demand for the smart phone even if the prices are high.
6) Speculative Effect
Determinants of Demand / Factors Affecting Demand

1) Price of the Commodity: The law of demand states that other things being constant
the demand of the commodity is inversely related to its price. It implies that rise in
price of commodity brings about a fall in its purchase and vice versa.
Determinants of Demand / Factors Affecting Demand
2) Price of Related Goods: Demand for a commodity is also influenced
by change in price of related goods. These are of two types:

a)Substitute Goods: These are the goods which can be substituted for
each other, such as tea and coffee, or ball pen and ink pen.
In case of such goods, increase in the price of one causes increase in the
demand for the other and decrease in the price of one causes decrease in
the demand for the other.

b) Complementary Goods: Complementary goods are those which

complete the demand for each other, and therefore, demanded together.
For Example Pen and ink, Car and Petrol.
In case of complementary goods, a fall in the price of one causes
increases in the demand for the other and rise in the price of one causes
decrease in the demand for others.
Determinants of Demand / Factors Affecting Demand

3) Income of the Consumer: The ability to buy a commodity

depends upon the income of the consumer. When the income
of the consumer increases, they buy more and when the
income falls they buy less.

4) Expectations: If the consumer expects that price in future will

rise, he will buy more quantity in present, at the existing price.
likewise, if he hopes that price in future will fall, he will buy less
quantity in present, or may even postpone his demand.
Determinants of Demand / Factors Affecting Demand

5) Taste and Preferences: Taste and preferences include

fashion, custom etc. Taste and preferences can be influenced
by advertisement, change in fashion, climate, new inventions,
etc.
Other thing being equal, demand for those goods
increases for which consumer develop tastes and preferences.
Contrary to it, if a consumer has no taste or preference for a
product, its demand will decrease.
Determinants of Demand / Factors Affecting Demand
6) Population Size: Demand increases with the increase in population
and decreases with decrease in population.
Composition of population (male, female ratio) also affects the
demand.
E.g. Female population increases, demand for goods meant for women
will go up.

7) Distribution of Income: if income is equally distributed, there will be

more demand. If income is not equally distributed, there will be less
demand.
In case of unequal distribution, most will not have enough money to
buy things.
Increase In Demand
Increase and decrease in demand are referred to change in demand due to
changes in various other factors such as change in income, distribution of income,
change in consumer’s tastes and preferences, change in the price of related goods,
while Price factor is kept constant Increase in demand refers to the rise in demand
of a product at a given price.
Decrease In Demand
Extension and Contraction of
Demand
• The variations in the quantities demanded
of a product with change in its price, while
other factors are at constant, are termed
as expansion or contraction of demand.

• Expansion of demand refers to the period

when quantity demanded is more because
of the fall in prices of a product. However,
contraction of demand takes place when
the quantity demanded is less due to rise
in the price o a product.

• For example, consumers would reduce

the consumption of milk in case the prices
of milk increases and vice versa.
Elasticity of Demand
Elasticity of Demand
The ratio between proportional change in one
variable due to proportional change in another
variable.

Elasticity of demand measures the degree of change

in demand of a commodity in response to a change
in the price of the commodity, or change in the
income of the consumer or change in the prices of
related goods.
Cont….
Definition Elasticity of Demand

Dr. Marshall, “Elasticity of demand may be defined

as the percentage change in the quantity demanded
divided by the percentage change in the price.
According to Boulding, “Price elasticity of demand
measures the responsiveness of the quantity
demanded of a good to the change in its price”
A. Price elasticity of demand
Degrees of Price Elasticity of Demand
A change in demand is not always equal to the
change in price. A small change in price may lead
to a great change in demand is called the case of
elastic. On the other hand a big change in price
lead to a small change in demand is the case of
inelastic demand.

There is 5 degree of price elasticity of demand.

Degrees of Price Elasticity of Demand
1. Perfectly Elastic
Demand
A situation in which a small
change in price will cause
an infinitely large change
in demand. In this case, a
small fall in price leads to
an unlimited extension of
demand.
Degrees of Price Elasticity of Demand

2. Perfectly Inelastic
Demand
A situation in which there
is no change demand as a
result of change in price.
Degrees of Price Elasticity of Demand
3. Unitary Elastic
Demand
A situation where
demand changes in exact
proportion to the change
in price. If the price
becomes double, the
demand falls by half and
if the price falls by half,
demand become double.
Degrees of Price Elasticity of Demand
4. More Elastic
Demand
A situation in which
change in demand is
more than the
proportionate change
in price. In this case,
elasticity is said to be
greater than unity or E
>1
Degrees of Price Elasticity of Demand
5. Less Elastic
Demand
A situation in which the
change in demand is
less than proportionate
change in price. In this
case, elasticity of
demand is said to be
less than unity or E <
1.
Measurement of Price Elasticity of
Demand

The measurement of elasticity of demand is to know

whether price elasticity of demand (a) Unitary or (b)
Greater than unity or (c) Less than unity. There are five
methods of the measurement of price elasticity of
demand.

1. Total Expenditure Method

2. Percentage Method or Proportionate Method
3. Point Method
4. Arc Method
5. Revenue Method
1.Total Expenditure Method

According to this
method there can
be three measures
of elasticity of
demand

Greater than unity (

E > 1)
Equal to unity
( E = 1)
Less than unity
( E < 1)
Total Expenditure Method
2. Percentage Method
Percentage change in demand is divided by percentage change in price
2. Percentage Method
3. Point Method
This method is used to find out the elasticity of demand at a
particular point on a demand curve.

Lower Sector of demand curve

E at point =
Upper Sector of demand curve

Linear and Non-linear demand curves

Linear Demand Curve
Non Linear Demand Curve
4. Arc Method

In this method, we make

use of the mid points
between the old and the
new figures in the case of
both prices and demand.
Determinants of price elasticity
Nature of commodity
Substitutes
Varity of Uses
Postponement of the use
Range of prices
Proportion of the income spent on a commodity
Habits & Fashion
Time factor
Classes of buyers
 B. Income elasticity of demand

Income elasticity of demand is the rate at which quantity

bought changes, as a result of change in the income of the
consumer, other things being equal.

Kinds of Income Elasticity:

Positive, Negative and Zero Income Elasticity
Positive Income Elasticity
Negative Income Elasticity
Zero Income Elasticity
 Degree of Income Elasticity

1. Equal to Unity: - Ey =100% /100% = 1

2. More than Unity: - Ey = 200%/100%=2(greater than unity)

3. Less than Unity: - Ey = 50%/100%=1 (less than unity)

A good is a normal good if income elasticity > 0.

A good is an inferior good if income elasticity < 0.
 C. Cross Elasticity of Demand

Cross elasticity of demand is the

rate at which quantity bought of x
commodity changes, as a result of
change in price of y commodity,
other things being equal.
 Kinds of Cross-price elasticity

1. Positive Cross Elasticity With the

rise or fall in the price of commodity
the quantity demanded of the related
commodity increase or decrease
accordingly, then the cross elasticity
of demand is positive, cross-price
elasticity is positive if and only if
the goods are substitutes.
 Kinds of Cross-price elasticity
Negative Cross Elasticity When
with a rise in the price of a
commodity, the demand for
related good decrease, and with a
fall in the price of a commodity,
the demand for other related
good increase, then the cross
elasticity of demand is said to be
negative. cross-price elasticity is
negative if and only if the goods
are complements.
Kinds of Cross-price elasticity
Zero Cross Elasticity
When with the change in
prices there is no change
in commodity
Importance of Elasticity of
Demand
Managerial uses of price determination
Wage determination
Advantage to Finance Minister
Determination of Prices of Public Utility
Distribution of Burden of taxes
International trade
Demand Forecasting
Consumer Equilibrium- IC