CHAPTER-3

Theory of Demand
Highlights of Content (i) (ii) (iii) (iv) (v) (vi) 2. Meaning of demand Factors affecting demand Law of demand Extension v/s increase in demand Normal, Inferior & Giffen goods Types of demand Market Demand Curve : The graphic presentation of market demand schedule is called market demand curve.

THEORY OF DEMAND Desire:- It means wish of a person to have a commodity but doesn't have enough money to buy a commodity. Want:- It means desire to have a commodity and also have enough money to buy a commodity but not ready to spend it. Demand : The demand for a particular good refers to the quantity of that good that a person is willing to buy at particular price within a given period of time.

Conditions for demand to take place : or Elements of demand 1. 2. 3 4. Desire for the good Purchasing power to buy the good. Readiness to spend the money Availability of the good in the market at particular price at particular time Demand function OR Write the factors influencing demand OR Determinants of Demand :A Demand function explains the relationship between the demand for a commodity and the factors affecting demand. These factors are also called determinant of demand. They are : Dx = f (Px, Y, T, Pr, .., ..) 1. 2. 3. 4. 5. 6. 7. Price of the commodity itself (P) Income of the consumer [Y] Taste, Preference and Fashion [T] Size and composition of population (N) Price of the related commodity (Pr) Expected Price [E] Distribution of income. (Yd)

Price of the commodity itself : There is an inverse relationship between the price of the commodity and the quantity demanded. It means, generally with the rise in the price, quantity demanded falls and vice-versa also.

Income of the Consumer :

Income of the consumer affects

demand for normal goods and inferior goods in different ways. Both cases can be discussed as follows : (i) Normal goods : There is a positive relationship between the income of the consumer and the quantity demanded for normal goods. With increase in income, the purchasing power of

consumer increases, hence he demands more of normal goods.

Own Price 10 15 20 25

Qty. demanded when income = Rs. 5000 100 90 70 40

Qty. demanded when income = Rs. 8000 140 120 90 50

(ii)

Inferior Goods :

Those goods are referred as inferior whose

demand varies inversely with income beyond definite income level. It means beyond a definite income, when income increases, quantity demanded for inferior goods decreases and vice versa also.

Own Price 10 15 20 25

Qty. demanded when income = Rs. 5000 100 90 70 40

Qty. demanded when income = Rs. 8000 80 70 60 30

Change in Price of related goods : There are two types of related goods.

(i)

Substitute goods : Those goods which can be used in place of Ex. Tea and Coffee,

one another are known as substitute goods. Reynolds and Rotomac, Pepsi and Coke.

When the price of substitute goods increases, the consumer demands less of substitute goods and more of the particular goods. This is due to the reason that the particular good becomes cheaper as

compared to its substitute good.

Similarly with fall in price of

substitute good the particular good becomes costlier as compared to its substitute goods and reduces the demand of particular good. Thus, there is a direct positive relationship between price of substitute goods and the quantity demanded of particular goods. If PEPSI and COKE are substitute goods. Pr ice 10 15 20 25 Qty. demanded of Pepsi when price of coke= Rs. 20 per unit 100 80 60 40 Qty. demanded of Pepsi when price of coke = Rs.30 per Unit 140 120 100 80

(iii)

Complementary goods : Those goods which cannot be used in

absence of one another are known as complementary goods or those goods which are used together to satisfy a particular demand are called complementary goods. camera and roll etc. When the price of complementary goods increases, for example with increase in price of petrol, the demand for complementary good Ex. Bike and petrol, ink and pen,

falls which in turn reduces the demand of particular good, here demand for bike decreases and vice versa . Hence there is an inverse relationship between the price of complementary goods and the demand of particular goods. Qty. demanded of BIKE when price of PETROL= Rs.50/200 160 120 80 Qty. demanded of BIKE when price of PETROL = Rs. 70 180 140 100 60

Price of X 30 40 50 60

Change in taste and Fashion Any favorable change in taste for a goods leads to increase in quantity demanded of the goods and unfavorable change leads to decreases in quantity demanded of the goods. Similarly, the commodities which are in fashion are demanded more and vice versa also.

Size and Composition of population If size of population increases, there will be more requirements of goods and services, hence quantity demanded will be higher. Composition of population determines the types of consumer

demanded .Baby related goods, young or old related goods. If old people are increasing demand for medicines will increase.

Expected Price : When the expected price of a commodity is higher than the market price, the consumer prefer to demand early, hence in this case quantity demanded increases. When the expected price is likely to be less than the market price, the consumer prefers to postpone the demand, hence quantity demanded decreases.

Distribution of income : Equal distribution leads to increase in demand and unequal distribution leads to decrease in demand.

Government Policies : Favourable govt. policies leads to increase in demand and vice-versa.

Season and Climate : Favourable season and climate leads to increase in demand and vice-versa.

DEMAND FUNCTION It expresses relationship between demand for a commodity and various factors affecting it. It is of two types.

Individual Demand Function It shows the demand of a commodity by an individual consumer in the markets & its various determinants D = f (P, Pr, Y, T, E) D f = = Demand of a Commodity Function

P Pr Y T E

= = = = =

Price of a commodity Price of related goods Income of Consumer Taste of Consumer Expectations

Market Demand Function : It shows the relationship between market demand of a commodity to various determinants : D = f (P ,Pr, Y, T, E, N, S, G, Yd) D f P Y Pr T E N S G Yd = = = = = = = = = = = Demand of a commodity Function Price of a commodity Income Price of related goods Taste & Preferences Expectations Population Season & Climate Govt. Policy Distribution of income

Law of Demand Other things being equal when with the increase in price demand decrease and with the fall in price demand increases i.e. there is a inverse relationship between price and demand i.e. law of demand. P increases D decreases P decreases D increases

Assumptions of the Law

(i) (ii) (iii) (iv) (v) (vi)

No change in income of consumer No change in population. No expectations regarding future change in price of commodity No change in price of related goods No change in government policy. No change in season and climate.

(vii) No change in distribution of income.

Explanation of the Law

Demand Schedule

Demand Curve

Individual Demand Schedule

Market Demand Schedule

Individual Demand Curve

Market Demand Curve

Demand Schedule : It is schedule in which other things remaining the same express the relationship between different amounts of commodity demand at different prices.

1.

Individual Demand Schedule :

It shows demand of an individual consumers in the market at different Prices & Other things being equal Price 1 2 3 4 Demand 50 40 30 20

10

Its clear from the table that when price increases from Rs. 1 to 2, 3, 4, 5 demand decreases from 50 to 40, 30, 20 & 10. 2. Market Demand Schedules : It shows demand of all the consumers in the market at different prices for this its assumed that there are 2 consumers in market i.e. A & B and by joining their demand market demand is obtained Market demand = A'SD + B'S D. Price of A's Demand B's Demand Market Commodity Demand 1 50 60 50+60= 110 2 40 50 40+50 = 90 3 30 40 30+40 = 70 4 20 30 20+30 = 50 5 10 20 10+20 = 30 It clear from the table that as price increases from Rs. 1 to 2, 3, 4 & 5 market demand decreases from 110 to 90, 70, 50 & 30. B. Demand Curve : It is graphic presentation of demand schedule expressing the relation between different quantities at different prices. 1. Individual Demand Curve : The graphic presentation of Individual demand schedule is called individual demand curve

Its clear from the diagram that demand curve is sloping downward that is inverse relationship between price and demand 2. Market Demand Curve : The graphic presentation of market demand schedule is called market demand curve.

In the diag (i) A's Demand, AA is sloping downward. In the diag (ii) B's Demand Curve BB & in the diag (iii) Market demand curve MM is sloping downward. Causes of Operation of Law of Demand or why more qty is demanded at lesser price or causes of downward sloping demand curve The following are the causes of downward sloping demand curve 1. Law of diminishing Marginal utility : According to this law as

the consumer in a given time increases the consumption of a same commodity, the utility from each successive unit goes on diminishing. Therefore, the consumer will buy more and more units of commodity only when he has to pay less and less price for each success unit. That's why he will demand more at less price.

2.

Change in No of Consumers : When price of a commodity falls some new consumer enter into

the market therefore demand increase. On the other hand when price of commodity increases some old consumers will exit the market and therefore demand will decrease.

3.

Substitution Effect : An increase in price of the commodity say Pepsi also means that

price of its substitutes say coke has fallen in relation to that of Pepsi even though the price of coke remains unchanged. So people will buy more of Coke & Less of Pepsi. This is called substitution effect.

4.

Psychological Effect : When price of commodity falls people favor to buy more which is

natural & psychological therefore demand increases with the fall in price. For e.g. when price of silk falls it is purchased for all the members of family.

5.

Income Effect : A fall in price leads to increase in real income of consumer with

the result that he buys more when price falls. Similarly increase in price leads to fall in real income and as a result demand falls.

6.

Different Uses of a Commodity : A commodity having different uses in generally used at large scale

for e.g. milk is used for tea, coffee, curd, cheese etc. If price of milk goes up its consumption is restricted to very important uses say tea consequently demand for milk falls which proves that with the Increase in price demand falls. CONTRADICTIONS/POSITIVELY SLOPING DEMAND CURVE OR

EXCEPTIONS TO LAW OF DEMAND 1. Ignorance of Consumer If consumer is not aware of competitive price of commodity he may purchase more of commodity at higher price, it may also be due to the thinking of consumer that high price commodities are always superior. 2. Costly Items or Luxury Items : These are those items which are purchased by rich people to distinguish them from poor people such as diamond sets, costly carpets, cars etc. demand of these commodities increase with increase in price. 3. Extra Ordinary Situation : Wars, famines etc. are extra-ordinary situations when consumers become abnormal and he may purchase more qty. of commodity with increase in price so law of demand does not apply. 4. Change in fashion taste and preference : Such changes in behaviors of consumer are also responsible for making law of demand ineffective. 5. Inferior goods : These are low quality goods such as coarse grain, coarse wheat etc. in case of such goods when price falls demand falls because people start purchasing superior brands of commodity with extra purchasing power. 6. Expected Change in Price : We may purchase large qty of goods even with the slight increase in price in present when it is expected that price of commodity will increase on near future. 7. Basic Necessities of Life : There are certain basic necessities of life such as Salt, Sugar etc. In case of such goods demand of commodity remains the same irrespective of change in price.

CHANGE

IN

DEMAND

Due to change in Price Due to factors other than or price Movement along the same demand curve or or Shift in demand curve or Change in Qty. demanded Extension of Demand Contraction of Demand Change in demand Increase in demand Decrease in Demand

CHANGE IN QUANTITY DEMANDED Change in quantity demanded : when demand changes due to changes in price that is called change in qty. demanded Its of 2 types : 1. Extension Demand : Other thing being equal when with fall in price demand extends its called extension in demand

Price

Demand

5 1

1 5

Its clear from the table that when price falls from Rs. 5 to Rs. 1 demand extends from 1 unit to 5 units. In the diag downward movement along the same demand curve is showing extension of demand. 2. Contraction of Demand Other things being equal, when with the increase in price demand falls that is called contraction of demand. Price 1 5 Demand 5 1

It is clear from the tables that when price increases from Rs. 1 to Rs.5, then demand falls from 5 to 1 unit. In the diagram upward movement along the same demand curve from point B to A is showing contraction of demand .

Difference between Extension & Contraction of Demand Extension of demand Cause It is caused by fall in price Price Demand 5 1 1 5 Contraction of demand It is caused by Increase in price Price Demand 1 5 5 1

Movement : there is a downward movement along the same curve

Movement: there is an upward movement along the same curve

Increase in Demand When demand increases due to factors other than price i.e. increase in demand. It is explained in two parts :

1.

Same price more demand : When at the same price, more quantity is demanded i.e. called increase in demand.

Price 3

Demand 3

2.

More Price - Same Demand When at the more price same qty. is demanded i.e. also called Increases in demand Price 3 4 Demand 3 3

It is clear from the table that when price increases from 3 to 4 Rs. demand remains the same i.e. 3 units. In the diagram right side shifting of demand curve from DD to D1D1 is showing increase in demand.

Causes of Increase in Demand or Causes of Right Side Shifting of Demand Curve : 1. 2. 3. 4. Increase in Income of Consumer. Increase in wealth of consumer. When taste and Preference shift in the favor of commodity. When price of commodity is expected to increase in near future. 5. 6. 7. Increase in no. of consumer. When price of substitute good increase. When price of complementary good falls. Decrease in Demand 1. Decrease on Demand : When demand decreases due to factors other than price is that is called decrease in demand. Explanation : It is explained in 2 parts.

2.

Same Price Less Demand : When at the same price less qty. demanded that is called

decrease in demand. Price 3 3 Demand 3 2

It is clear from the table that remaining the price same demand decrease from 3 units to 2 units. In the diag. left side shifting of demand curve from DD to D1 D1 is showing decrease in demand

2.

Less Price Same Demand : When at the less price same qty. is demanded i.e. called

decrease in demand

Price 3 2

Demand 3 3

It is clear the diagram that left side shifting of demand curve from DD to D1D1 is showing decrease in demand

CAUSES OF DECREASE IN DEMAND OR LEFT SIDE SHIFTING OF DEMAND CURVE

(i) (ii) (iii) (iv)

Decrease in Income of Consumer Decrease in wealth of consumer When taste & Preferences shift against the commodity. When price of commodity is expected to decrease in near future.

(v) (vi)

Decrease in no. of consumer in the market. When price of substitute goods decreases

(vii) When price of complementary goods increases. Increase in demand and extension in demand.
Basis Meaning Increase in Demand When Demand increases as a result of changes in other factors (like increase in income), it is termed as increase in demand. In this case demand curve shifts upwards or rightwards Extension in Demand When demand increases as a result of decrease in price while other factors remaining constant it is known as extension in demand. In case of extension of demand downward movement along the

Effect on Demand

curve Graphical Presentation

same demand curve takes place.

SP Exp. 3 3 Law of Demand

MD 3 4

MP 3 4

SD 3 3

P 5 1 Applicable

D 1 5

Not Applicable

Shifting in demand curve and movement along same demand curve ?

Basis Meaning Shifting in demand curve It takes place due to change in other factors while price of the commodity remaining constant In it demand curve shift rightward or leftward Increase and Decrease in Demand It is termed as change in Demand. Not Applicable Movement along same demand curve It takes place due to change in prices of the commodity while other factors remaining constant. In it either downward or upward movement along the same demand curve takes place. Expansion and Contraction in Demand It is termed as Change in quantity Demanded Applicable

Effect on Demand curve Components Alternate Name Law of Demand

Graphical

CLASSIFICATION OF GOODS WITH REFERENCE TO DEMAND OR NORMAL, INFERIOR & GIFFEN GOODS NORMAL GOODS

(i)

These are those goods in which income effect positive i.e. with an increase in income, demand increases with the decrease in income, demand decreases

(ii)

In case of such goods price effect is negative i.e. with the increase in price demands falls and fall in prices demand increase

PE = - ve

(iii) (iv)

In case of such goods law of demand applies for eg. clothes, shoes

Inferior goods:(i) These are low quality goods such as Bajra, coarse wheat, inferior meat (ii) In these goods income effect is negative i.e. with the increase in income demand falls & with the fall in income demand increases

Giffen goods 1. The concept of Giffen goods was given by Sir Robert Giffen.

2.

In these goods income effect is negative i.e. with the creases in income demand decrease & with the decrease in income demand increase

3.

In case of such goods price effect is positive i.e. with the increase in price demand increases and vice versa.

4. 5.

In case of such goods law of demand does not apply. All inferior goods are Giffen goods but all Giffen goods are not inferior goods.

Difference between normal goods and inferior goods Normal Goods Inferior Goods

Normal goods are those goods Inferior goods are those goods

whose

demand

increase

with whose

demand

decrease

with

increase in income and decrease increase in income and increase with decrease in income. Income effect is positive. Fine Rice and Wheat with decrease in income. Income effect is negative. Coarse Rice and Bajara.

Shift to right with increase in Shift to right with decrease in income and shift to left with income and shift to left with decrease in income. increase in income.

Difference between substitute goods and complementary goods Substitute goods Complementary goods

Substitute goods are those goods Complementary goods are those which are used in place each other goods which are used together to to satisfy the same want. Tea and coffee. satisfy the same want. Tea and sugar

Shift to right with increase in price Shift to left with increase in price of coffee and vice-versa. of tea and vice-versa.

Types of Demand 1. Price Demand :- Other things being equal demand of a commodity at the prevailing market price is called the price demand. 2. Income Demand:- Other things being equal demand of a commodity at particular level of income is called income demand 3. Direct Demand:- It refers to demand of those goods which are used for the direct satisfaction of final consumers for eg clothes, shoes etc.

Bricks Cement Sand Timber Iron

Building (Direct Demand)

(DERIVED DEMAND)
Tea Coffee Sweets Butter Cheese

Milk

4.

Derived Demand:- Indirect demand is known as derived demand for eg. demand for factors of production is derived demand

because here demand depends on the demand of commodity. 5. Joint demand:- It means to demand of those goods which are demanded together such as pen & ink, car & petrol. 6. Composite Demand:- It refers to demand of a commodity in it various alternatives uses such as demand of milk ,demand of electricity, demand of sugar. 7. Competitive Demand:- Demand for substitute goods is known as competitive demand such as Pepsi & Coffee, Tea and Coffee.