Demand Theory and

Types
 Learning Objectives

By the end of this session, you will be able to:

• Understand the basic concept of demand

• Definitions of demand

• Different types of Demand

 Meaning….
 Demand means the ability and willingness to buy a specific quantity of a commodity at the
prevailing price in a given period of time. Therefore, demand for a commodity implies the desire to
acquire it, willingness and the ability to pay for it. Thus

Desire for specific commodity.

+
Sufficient resources to purchase the
desired
commodity.
+
Willingness to spend the resources.
+
a. Availability of the commodity at
(i) Certain price (ii) Certain place (iii)
Certain time.
 Types Of Demand

There are following four types of Demand:

1) Direct and Indirect Demand

2) Derived demand and autonomous demand

3) Durable and non durable goods demand

4) Total market and market segment demand

 1.Direct and indirect demand

• Demand for goods that are directly used for consumption by the ultimate

consumer is known as direct demand (example: Demand for T shirts). On the other

hand demand for goods that are used by producers for producing goods and

services. (example: Demand for cotton by a textile mill).

• Also Known as Producers’ goods and consumers’ goods

 2.Derived demand and autonomous demand:

When a produce derives its usage from the use of some primary product it is known as derived

demand. (example: demand for tyres derived from demand for car) Autonomous demand is

the demand for a product that can be independently used. (example: demand for a washing

machine)
 3.Durable and non durable goods demand:

 Durable goods are those that can be used more than once, over a period of time

(example: Microwave oven)

Non durable goods can be used only once (example: Band-aid)

 4.Total market and market segment demand

A particular segment of the markets demand is called as segment demand

(example: demand for 21 laptops by engineering students) the sum total of the

demand for laptops by various segments in India is the total market demand.

(example: demand for laptops in India)

Determinants of Demand
 Price

• Price is the most important determinant of demand.

• A “demand curve” plots combinations of prices and quantity demanded.

• A shift in price causes a shift along the demand curve.

• A change in price causes a shift along the demand curve.

• A shift along the demand curve is referred to as a “shift in the quantity demanded.”

• A shift in any other variable except price causes a shift in the entire demand curve.

• A shift in the entire demand curve is referred to as a “shift in demand.”

 Income

• Changes in income can increase or decrease demand.

• A good whose demand decreases with an increase in income is called an “inferior
good.”
• A good whose demand increases with an increase in income is called a “normal
good.”

• An increase in income will reduce the demand for ramen noodles or generic

products.

• An increase in income will increase the demand for cars or clothing.

• An increase in income will significantly increase the demand for air travel or
jewelry.
 Price of other goods

• Changes in the prices of other goods can increase or decrease demand.

• A good that causes an increase in the demand for another good when its price
increases is called a “substitute good.”

• A good that causes a decrease in the demand for another good when its price
increases is called a “complementary good.
• An increase in the price of peanut butter will reduce the demand for jelly. Peanut
butter and jelly are complements.

• An increase in the price of Pepsi will increase the demand for Coke. Pepsi and Coke
are substitutes.
 Number of Buyers

• An increase in the number of potential buyers will increase the demand for the

good.

• For example, the demand for land increases as the population increases.

• Similarly baseball tickets are generally more expensive in larger cities.

 Future Prices

• An increase in the expected future price of a good increases current demand.

• A decrease in the expected future price of a good decreases current demand.

• For example, when a good is temporarily put on sale, people stock up on the good.
 Taste

• Demand curves can shift due to changes in tastes over time.

• For example, demand for cereal may be high in the morning but low at night.
Law of Demand
 Law of Demand

 States that a quantity of a good demanded during a given period relates inversely to

its price, other things constant.

• Price increases Quantity Demanded decreases

• Price decreases Quantity demanded increases

Creates a downward sloping demand curve

Law of Demand
 Demand schedule:
A table showing the quantities of a good that a consumer is willing and able to buy at the prevailing price in a given
time period. (Table –1)
 Demand Curve:

A curve indicating the total quantity of a product that all consumers are willing and able to

purchase at the prevailing price level, holding the prices of related goods, income and other

variables as constant.
Demand Curve
Exceptions to the Law of
Demand
 Exceptions to the Law of Demand

 The law of demand does not apply in every case and

situation. The circumstances when the law of demand
becomes ineffective are known as exceptions of the
law. Some of these important exceptions are as under.
 Giffen Goods.
 Conspicuous consumption.
 Conspicuous necessities.
 Expected changes in price.
 Ignorance.
 Extraordinary situations.
 Change in fashion.
 1. Giffen Goods

 Sir Robert Giffen of Ireland first observed

that people used to spend more their income
on inferior goods like potato and less of their
income on meat.
 If the price of this good rises they will
become so poor that they will be found to
spend less on other items and buy more
potatoes in order to get a minimum diet and Sir Robert Giffen
keep themselves alive.
For such goods, the demand curve will be
upward sloping.
 2. Veblen Goods
 This is known as ‘snob appeal’, which
induces people to purchase items of
conspicuous consumption.
 A few goods like diamonds etc are
purchased by the rich and wealthy sections
of the society. The higher the price of the
diamond the higher the prestige value of it.
 So when price of these goods falls, the
consumers think that the prestige value of
these goods comes down. So quantity
demanded of these goods falls with fall in their
price.
 3. Conspicuous Necessities

• In case of certain highly essential items such as life- saving drugs, people buy a fixed quantity at
all possible price.
• Their response to price change is almost nil.
• Besides these, certain things become the necessities of modern life, for example the demand
for T.V. sets, automobiles and refrigerators etc. has not gone down in spite of the increase in their
price.
 Some more reasons for exception….

4. Expected change in price: When the prices are rising

households tend to purchase large quantities of the
commodity out of the apprehension that prices may still
go up. When prices are expected to fall further, they wait
to buy goods in future at still lower prices.

5. Ignorance: A consumer’s ignorance is another factor

that at times induces him to purchase more of the
commodity at a higher price. This is especially so when the
consumer is haunted by the phobia that a high- priced
commodity is better in quality than a low-priced one.
 Some more reasons for exception….

6. Extraordinary Situations: Emergencies like war, famine

etc. negate the operation of the law of demand. At such
times, households behave in an abnormal way.
Households accentuate scarcities and induce further
price rises by making increased purchases even at higher
prices during such periods.

7. Change in Fashion: A change in fashion and tastes

affects the market for a commodity.
Elasticity of demand
 Meaning of Demand Elasticity

Elasticity of Demand is a technical term used by economists to describe the

degree of responsiveness of the demand for a commodity due to a change in

any of the determinants of demand.

Elasticity of Demand =

percentage change in quantity demanded

percentage change in determinant of demand

Degrees of Demand Elasticity

Perfectly
Elastic

Relatively
Elastic

Demand
Elasticity
Unitary
Perfectly
Elastic
Inelastic

Relatively
Inelastic
 A) Perfectly Elastic Demand (Ed = ∞)

Consumers have indefinite demand at a particular price and none at all at an

even slightly higher than this given price, demand is PERFECTLY ELASTIC
 B) Relatively Elastic Demand (Ed >1)

When the proportion of change in the quantity demanded is greater than that of

price, the demand is said to be RELATIVELY ELASTIC For e.g. Luxury Goods like Cars,

Mobile Phones, Bikes etc.

 C) Unitary Elastic Demand (Ed =1)

When the proportion of change in demand is exactly the same as the change

in price, the demand is said to be UNITARY ELASTIC.

 D) Perfectly Inelastic Demand (Ed = 0)

When the demand for a commodity shows no response to a change in price/

whatever change in price, the demand remains same, it is called PERFECTLY

INELASTIC.
 E) Relatively Inelastic Demand (Ed < 1)

When the proportion of change in the quantity demanded is less than that of price

the demand is considered to be RELATIVELY INELASTIC. For e.g. Medicines, Petrol,

Diesel.
 Price and Income
Elasticity of Demand
 Types of Elasticity of Demand

Demand
Elasticity

Cross Income
Elasticity Elasticity
 1 ) Price Elasticity of Demand

 The responsiveness of changes in quantity

demanded due to changes in price is referred to
as price elasticity of demand. The price elasticity
of demand is measured by dividing the
percentage change in quantity demanded by
the percentage change in price. It is denoted as
(Ed ).
Price Elasticity = Percentage change in quantity
demanded
Percentage change in price
Ed = ΔQ / Q/ ΔP / P
 1 ) Price Elasticity of Demand

For example:
Quantity demanded is 20 units at a price of Rs.500. When there is a fall
in price to Rs. 400 it results in a rise in demand to 32 units. Therefore the
change in quantity demanded is12 units resulting from the change in
price of Rs.100.

Solution:

The Price Elasticity of Demand is = 500 / 20 x 12/100 = 3

 2) Income Elasticity

Income elasticity of demand measures the responsiveness of quantity demanded to a

change in income. It is measured by dividing the percentage change in quantity
demanded by the percentage change in income. If the demand for a commodity
increases by 20% when income increases by 10% then the income elasticity of that
commodity is said to be positive and relatively high. It is denoted as Ei

Income Elasticity = percentage change in quantity demanded

percentage change in income
 Various types of income elasticity:

Zero Income Elasticity: The increase in income of the individual does not make
any difference in the demand for that commodity. ( Ei = 0)
Negative Income Elasticity: The increase in the income of consumers leads to less
purchase of those goods. ( Ei < 0).
Unitary Income Elasticity: The change in income leads to the same percentage of
change in the demand for the good. (Ei = 1).
Income Elasticity is Greater than 1: The change in income increases the demand
for that commodity more than the change in the income. ( Ei > 1).
Income Elasticity is Less than 1: The change in income increases the demand for
the commodity but at a lesser percentage than the change in the Income. ( Ei <
1).
Cross and Advertising
Elasticity of Demand
 Types of Elasticity of Demand

Demand
Elasticity

Cross Income
Elasticity Elasticity
 3) Cross Elasticity

Cross elasticity measures the responsiveness of the quantity demanded of a

commodity due to changes in the price of another commodity.

Cross Elasticity Of Demand

= Proportionate/percentage change in demand for X

Proportionate/percentage change in price of Y

If two goods are substitutes then they will have a positive cross elasticity of
demand. In other words if two goods are complementary to each other then
negative cross elasticity may arise.
 4 ) Advertising Elasticity of Demand

Advertising elasticity of demand (AED) is a measure of a market's sensitivity to

increases or decreases in advertising saturation. Advertising elasticity is a

measure of an advertising campaign's effectiveness in generating new sales. It is

calculated by dividing the percentage change in the quantity demanded by

the percentage change in advertising expenditures.

Measurement method
of Elasticity of Demand:
Percentage Method
Methods of Calculating Elasticity of Demand

Percentage
Method

Elasticity of
Demand
Arc
Method

Point
Method
 Percentage Method

The most popular method used to measure elasticity.

Elasticity of demand is expressed as the ratio of proportionate change in

quantity demanded and proportionate change in the price of the commodity.

Ep= percentage change in quantity demanded

percentage change in determinant of demand

 1 ) Percentage Method

For example:
Quantity demanded is 20 units at a price of Rs.500. When there is a fall
in price to Rs. 400 it results in a rise in demand to 32 units. Therefore the
change in quantity demanded is12 units resulting from the change in
price of Rs.100.

Solution:

The Price Elasticity of Demand is = 500 / 20 x 12/100 = 3

 Point Method

This method attempts to measure the price elasticity of demand at a particular

point on demand curve.

Point Elasticity = Lower segment of demand curve below the point

Upper segment of demand curve below the point

 Measurement method
of Elasticity of Demand:
Arc Method and Uses of
demand Elasticity
Methods of Calculating Elasticity of Demand

Percentage
Method

Elasticity of
Demand
Arc
Method

Point
Method
 Arc Method

Arc Elasticity of Demand measures the elasticity at the mid point between two

points on a curve indicating that these points are in the same demand curve.
 Uses of Demand elasticity

Decision of Monopolist

The Government

Business Sector

Input Price

Rate of Exchange and Balance Payment

Concept of
Supply
 Concept of Supply

Meaning of Supply
Supply refers to the amount of a good or service that the producers/providers
are willing and able to offer to the market at various prices during a period
of time. There are two important aspects of supply:

Supply refers to what is offered for sale and not what is finally sold.
Supply is a flow. Hence, it is a certain quantity per day or week or month, etc
 Concept of Supply
•The buyers' demand for goods is not the only factor determining market prices
and quantities. The sellers' supply of goods also plays a role in determining
market prices and quantities.

•Like the buyers' demand, the sellers' supply can be represented in three
different ways: by a supply schedule, by a supply curve, and algebraically.

•Note that as the price of good X increases, the quantity supplied of good X
increases. This kind of behavior on the part of sellers is in accordance with
the law of supply.
 Reasons for a change in supply

Changes in the prices of other goods: Suppliers are frequently able to

switch their production processes from one type of good to another. Farmers,
for example, might decide to grow less wheat and more corn on the same land
if the price of corn rises relative to the price of wheat. In this case, the supply
curve for wheat would shift to the left.

Changes in the prices of inputs: The prices of the raw materials or inputs
used to produce a good also cause the supply curve to shift.
An increase in the prices of a good's inputs will raise costs to suppliers
and cause suppliers to supply less of that good at all prices. Therefore,
an increase in the prices of a good's inputs leads to a leftward shift of
the supply curve for that good.
 Reasons for a change in supply

3. Changes in technology: Advances in technology often have the effect of

lowering the costs of production, allowing suppliers to supply more
goods at all prices. For example, the development of pesticides has
reduced the amount of damage done to certain crops and therefore has
reduced the cost of farming. The result has been an increase in the
supply of these crops at all prices, which can be represented by a shift
to the right in the supply curves for these crops.
Determinants
of Supply
 Determinants of Supply

Price of the Good/ Service: The most obvious one of the determinants of
supply is the price of the product/service. With all other parameters being
equal, the supply of a product increases if its relative price is higher. The
reason is simple. A firm provides goods or services to earn profits and if the
prices rise, the profit rises too.

Price of Related Goods: Let’s say that the price of wheat rises. Hence, it
becomes more profitable for firms to supply wheat as compared to corn or soya
bean. Hence, the supply of wheat will rise, whereas the supply of corn and
soya bean will experience a fall.
 Determinants of Supply

Price of the Factors of Production: Production of a good involves many

costs. If there is a rise in the price of a particular factor of production, then the
cost of making goods that use a great deal of that factors experiences a huge
increase. The cost of production of goods that use relatively smaller amounts of
the said factor increases marginally.

Government Policy: Commodity taxes like excise duty, import duties, GST,
etc. have a huge impact on the cost of production. These taxes can raise
overall costs. Hence, the supply of goods that are impacted by these taxes
increases only when the price increases. On the other hand, subsidies reduce
the cost of production and usually lead to an increase in supply.
 Determinants of Supply

Other Factors: There are many other factors affecting the supply of goods or
services like the government’s industrial and foreign policies, the goals of the
firm, infrastructural facilities, market structure, natural factors etc.
Elasticity of Supply
 Supply Elasticity

Price elasticity of supply (Pes) measures the relationship between change in

quantity supplied and a change in price.

(1) When supply is elastic, producers can increase production without a rise in

cost or a time delay

(2) When supply is inelastic, firms find it hard to change their production levels in

a given time period

 Formula for Price Elasticity of Supply

• The formula for price elasticity of supply is:

• Percentage change in quantity supplied divided by the

Percentage change in price

• The co-efficient of elasticity of supply is positive, because an

increase in price is likely to increase the quantity supplied to the

market
 Degrees of Supply Elasticity

ES > 1 price-elastic supply

ES = 1 unit-elastic supply
ES < 1 price-inelastic supply
Es = 0 perfectly inelastic supply
Es= infinity perfectly elastic supply
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