Demand

DEMAND DEWETT Page nos 85/95

DEMAND • The word demand refers to the quantity of a commodity or service that the consumers are – • Willing to Purchase • Able to purchase • At various prices during a period • “Demand i s an ef fe ctive de si re ” -

Demamd • • •

The word effective desire includes the following 5 elements Desire Means to purchase ( if a poor man desires for a car, his desire cannot be called demand) Willingness to use those “ Means to fulfill the desire”- if a rich miser desires for a car, then his desire will not be called demand, also there is desire and means to purchase.

• 4. Price. Demand in economics is always at a price. For example, you will be willing to purchase a pen for Rs 10/= but you may not buy that pen, if the price is Rs 100/• 5 Time Period – Demand is always expressed with reference to a particular time period. For example, cars per day, 1000 cars per week etc

Demand and Price • The demand for a commodity is closely related to the price. • At lower prices he will buy more of the commodity and only less at higher prices”

Demand schedule •

Demand schedule means a table showing different quantities demanded by the consumer at various prices • Demand schedules are of two types 3. Individual demand schedule 4. Market demand schedule

Individual Demand Schedule Sl no

Price per Kg

Quantity demanded in Kgs

1

50

5

2

40

10

3

30

15

4

20

20

5

10

25

• Individual demand schedule • The table gives the demand schedule of an individual for sugar. The quantity demanded increases when the price falls and decreases when price rises. At a price of Rs 50/ Kg, the individual demands 5 Kgs. But when the price falls to Rs 10, his demand increases to Rs 25 kg.

Market demand schedule • Market demand schedule is also known as Industry demand schedule. • This is the total quantity of a commodity demanded at different prices by all the buyers of the commodity in the market

• It is assumed here that there are only three buyers in the market A,B and C.

Sl no

price Deman d by A

D ema nd by B

D ema nd by C

MKT DEMAN D

1 50

30

20 0

50

2 40

40

40 20 100

3 30

60

60 30 150

4 20

80

70 50 200

5 10

100

90 60 250

DEMAND CURVE 50 price 40 30 20 10

Units demanded 0

5

10

15

20

25

THE LAW OF DEMAND • From the demand schedule, we know that Demand varies with price • We can now formulate the law of demand. • This law states that Demand varies inversely (in the opposite direction) with price. ie the price rises demand contracts and if the price falls, demand extends. • In other words, demand increases with a falling price and decreases with a rising price

Exceptions to the Law of Demand 1. CONSPICIOUS CONSUMPTION Where a consumer regards the consumption of a commodity as a mark of distinction, he will go in for higher price commodity. Eg-Diamonds. Such consumers measure utility of a commodity entirely by its price. Hence more will be purchased when its price goes up where according to the law od demand, less is purchased at a higher price than at a lower price.

2. GIFFIN PARADOX • Sir Robert Giffin observed in mid 19th century that when the price of bread increased, the low paid workers in Britain spent more on it- since it was their main food and they cut on meat. • This means that demand of bread increased when its price went up, which is an exception to the law of demand

3. Changes

in expectation

• When prices are expected to continue rising, buy more even though prices has risen

4. Trade cycle. • In times of general economic prosperity, people buy more, even when prices have gone up.

5.

Brands v/s Status

• Some persons conscious of their higher status buy more of the higher priced brands as status symbol.

6. Other Misc situation • When commodity goes out of fashion, its demand may fall despite its falling price

Factors which bring changes in Demand (other than price) 1. Change in fashion (less demand even though price is less) 2. Change in weather ( a fall in price of woolen clothes does not increase their demand in summer) 3. Changes in quantity of money in circulation. (if money circulation increases, purchasing power increases)

• 4. Changes in population (if birth rate increases, more toys will be sold. More old age population means more demand for walking stick, falls teeth and medicine) • 5. Habits/Taste and Customs (if people develop taste for tea in place of lassie, the demand for Tea will be more ) • 6. Technical progress ( due to this, old things are not wanted. Gramophone was replaced by Radio, Radio sets replaced by TV sets • 7. Advertisement (an advertisement may create a new type of Demand- medicine, toilet, accessories etc)

INTER RELATED DEMANDS • JOINT DEMAND When different things are demanded for a joint purpose, it is a joint demand Milk, Sugar and Tea are wanted for making Tea Bricks, mortar, wood etc are needed for a building when commodities are jointly demanded their prices are influenced by the demand for ultimate object. For eg, prices of bricks, wages of masons etc are greatly affected by the demand for houses.

DIRECT AND DERIVED DEMAND • In the previous example, the demand for the ultimate object is called DIRECT DEMAND • The demand for labor and accessories which go to make final product is called Derived Demand • It is really the house we want, other things are wanted only because we want a house

COMPOSITE DEMAND • The demand for a commodity that can be put to several uses is a composite demand. • For eg, coal can be used for heating, cooking and for running steam engines

• • • •

ELASTICITY OF DEMAND TYPES FACTORS MEASUREMENT SIGNIFICANCE

ELASTICITY OF DEMAND • We have seen that demand extends or contracts respectively with a fall or rise in price, • This quality of demand by virtue of which it changes (increases or decreases) when price changes (decreases or increases) is called Elasticity of Demand • Elasticity means sensitiveness or responsiveness of demand to the change in price.

• Take the case of salt. • A big fall in price may not induce an extension of its demand. On the other hand, a slight fall in orange may cause a considerable extension in their demand. • We say the demand in former case is “inelastic” and in the latter case “elastic”

• The demand is elastic when with a small change in price there is a great change in demand. It is inelastic or less elastic when a big change in price induces only a small change in demand.

TYPES OE ELASTICITY Types of elasticity

Price elasticity

Income elasticity

Cross elasticity

ELASTICITY • Price elasticity is the responsiveness of demand to change in price. • Income elasticity is a responsiveness of demand to a change in consumer’s income. • Cross elasticity means a change in demand for a commodity owing to change in the price of another commodity

PRICE- DEGREES OF ELASTICITY OF DEMAND • The demand of an article may be 2. Perfect Elasticity of Demand 3. Perfectly Inelastic Demand 4. Very Elastic Demand 5. Less Elastic Demand

PERFECT (INFINITE) ELASTICITY OF DEMAND Y P R I C E D

D’

O

QTY

X

• In this case, demand varies considerably even without any variation in price whatsoever. The price may remain the same, but the demand may still increase or fall considerably • The demand curve would be perfectly parallel to the base

PERFECT INELASTIC DEMAND Y

D

P R I C E D

O

QTY

D'

X

• This is the other extreme limit • It means, whatsoever, the rise or fall in the price of the commodity in question, its demand remain remains absolutely unchanged. No amount of change in price induces a change in demand

VERY ELASTIC DEMAND • Demand is said to be very elastic when even a small change in price of a commodity leads to a considerable extension/contraction of the amount demanded of it. As a result of change of ‘f’ in price the qty demanded extends/ contracts MM’CLEARLY A LARGE CHANGE IN DEMAND

Y D

N N’

D’

P r I c e O

M

M’

CHANGE IN DEMAND

X

LESS ELASTIC DEMAND • When a substantial change in price brings only a small extension/ contraction in demand , it is said to be less elastic. A fall of NN’ in price extends demand only by MM (in the figure) which is very small

y

D

C N N H N G I N N P R N’ I C E

0

D’ M M’ CHANGE IN DEMAND

x

ELASTICITY OF DEMAND

• FACTORS DETERMING THE SAME

NECESSARIES • We must buy them whatever be the price. The price may rise or fall but demand will remain the same • The demand is less elastic or comparatively inelastic

FOR LUXURIES • The demand is more elastic. A little fall in their price stimulates the demand and a little rise discourages it • It must be remembered that necessaries and luxuries are relative terms. For the same commodity, the demand may be elastic for some and inelastic for others. Hence it is necessary to refer to the class of people with respect to whom the demand is elastic or inelastic.

Existence of substitutes. • Eg – Tea and coffee For commodities having substitutes, the demand is elastic. If the price of any one falls, it will be purchased in large quantities. If the price rises, the demand for it will contract and the substitutes will be purchased.

SEVERAL USES • When a commodity has several uses demand for it is elastic • If a commodity has only one use, a change in price of the commodity will influence its one use only. Even if its price falls considerably, it cannot be put to any other use. Hence the demand is inelastic. But if it is possible to use for a number of purposes, the demand will be obviousely elastic.

• It may be borne in mind that demand for a commodity may be elastic for one and inelastic for another. Foe eg, the demand for coal in railway engines is inelastic because there is no alternative. But its use for domestic purpose is not so essential. More of it will be used only if the price falls. Hence for domestic use the demand for coal is elastic.

POSSIBILITY OF POSTPONEMENT • When we can postpone buying a commodity, the demand is elastic. More is purchased when price falls, less when it raises. For instance, if the price of warm suiting goes up, its demand will considerably contract because its purchase can be conveniently postponed. If it becomes cheap, demand will extend.

RANGE OF PRICES • Elasticity of demand depends also on the level of prices. If price is too high or too low, the demand will be comparatively inelastic. For moderate prices it is elastic. • when the prices are already too high or too low, a small change in them will not affect demand much

• example:- take the case of FM Radio which is becoming popular. But whether the demand for it is elastic or inelastic will depend upon the price range. If the price of radio is about Rs 1000/-, a fall in price by about Rs 100/= or so will not affect its demand much. In other words, the demand will be inelastic. Now take the other extreme. If the price is Rs 50/everybody who is interested would have purchased it and a fall in price will not lead to any extension of demand, hence the demand may again be inelastic. But if the price is Rs 250-300, the demand will be elastic

PROPORTION OF INCOME SPENT • Another factor on which elasticity of demand for a commodity depends is the proportion on one’s income spent on the commodity. For instance, a person spends a small amount out of his income on newspaper. Any change, in its rate will not marginally affect its demand. In other words, the demand is inelastic. But, quite a large amount is spent on Milk. If the price of milk rises, less of it will be purchased and if its price falls, more will be purchased- demand is elastic

MEASURMENT OF PRICE ELASTICITY •

There are 3 methods

Geometrical method Proportional method

Total Expenditure method

PROPORTIONAL METHOD • Price elasticity of demand measures how much the quantity demanded of a good changes when price changes. • The precise definition of price elasticity Ep is the % change in Qty demanded devided by % change in price. (for convenience we drop minus sign, so elasticities are all +ve)

• ED (price elasticity of demand)= %change in Qty demanded % change in Price The exact formula ED = < Q

Q

P

Q1+Q2 2

P1+P2 2

< Q (QI +Q2) /2

Q

P

0 10 10 20 10

6 4 2

2

5

5

10/5 by 2/5 =5(elastic)

2

15

3

10/15 by 2/3 =1(unity elastic)

30 10

0

2

25

1

10/25 by 2/1= (inelastic)

GEOMETRIC METHOD •

•

• •

• •

This method is used to measure the elasticity of demand at any given point on the demand curve Elasticity is represented by the fraction. Distance from D1 to the point on the curve decided by the distance from the other end to that point D1P1/DP1,DIP2/DP2,DIP3/DP3 If P2 is the middle point of DDI, then elasticity at P2 will be D1P2/DP2 =1 (D1P2 being equal to DP2) At anypoint lower than P2, elasticity will be less than unity At any point above P2, it will be greater than unity.

D P3 P

P2

P1 D1 Q Ep =

l ow er se gme nt Up pe r seg me nt

If demand is not a straight line? • DRAW A TANGENT • DDI is the demand curve. PM is the tangent. • At point T, elasticity will be TM/PT • ELASTICITY= LOWER SEGMANT UPPER SEGMANT

Y P

D

P1 P R I C E

T TI

D1

O

MI QUANTITY

M

X

TOTAL EXPENDITURE METHOD •

Refer the demand schedule relating to kerchief • UNITY ELASTICITY When the amount spent remains same (2-3) the elasticity is said to be unity • GREATER THAN UNITY When amount spent increases with fall in price(or decreases with a rise in price), the elasticity is said to be greater than unity (between prices 3 and 4) • LESS THAN UNITY When the total amount spent decreases with a fall in price (or increases with a rise in price), the elasticity is said to be less than unity ( between 1 and 2)

Price per kerchief

No Total demand amount spent ed

7

2

14

1

4

3

12

2

3

4

12

3

2

8

16

4

Graphical method – total expenditure method •

Take total expenditure along the X- axis and price along Y- axis. We get a backward bending curve. The portion 0L represents less than unity elasticity, because an increase or decrease in price increases or decreases the total expenditure. The portion LU represents unity elasticity because a change in price has got no effect on total expenditure. The portion UM represents more than unity elasticity because an increase in price decreases the total expenditure and a decrease in price increases the total expenditure.

y

P R I C E

o

M

U L

TOTAL EXPENDITURE

x

INCOME ELASTICITY OF DEMAND • Income elasticity of Demand means the change in demand which occurs as a result of change in income • Proportionate change in Qty purchased Proportionate change in income. While price remains constant

Income elasticity • When our income increases, we desire to purchase more of the things than we were previously purchasing, unless the commodity happens to be an inferior one. It is Zero when change in income makes no change to our purchase and it is negative when with an increase in income, the consumer purchases less. Eg in the case of inferior goods.

CROSS ELASTICITY OF DEMAND • Cross elasticity of demand refers to the change in demand for a good as a result of change in price of another good. • Proportionate change in Qty demanded of X Proportionate change in the price of Y Cross elasticity of demand arises in cases of inter-related goods, such as substitutes and complementary goods.

Significance-Elasticity of Demand • FOR BUSINESS MEN AND MONOPOLISTICS • It guides the businessmen in fixing the prices of his goods. If the demand for a good is inelastic, he knows that people must buy it whatsoever be the price. He can raise the price • When demand is elastic , a small fall in price will increase the sales and bring more profit.

FOR FINANCE MINISTER • FM also takes note of elasticity of demand when selecting commodities for taxation. In case he wants to be certain of the revenue he takes these commodities for which the demand is inelastic(liquor/cigarettes). People must continue buying them even though the prices rise with tax. If the demand is elastic, people will buy less of them and govt would get less revenue.

For industries • The volume of industrial output depends on the nature of demand. If demand is elastic, by slightly reducing the price, sales can be increased and output also can be increased.

Internatinal trade • The country will benefit the most from international trade, the demand for whose imports is very elastic and that for exports is inelastic. • The present position in respect of India’s exports and imports is reverse of it. Because her demand for imports of crude oil, machineries etc are inelastic while foreign countries demand for exports from India are elastic • Therefore , India. Is unable to benefit fro IT