Lecture 07

Unit No.2- Demand Analysis Lesson No.-7 Law of Demand Learning Outcomes

After reading this lesson you shouldUnderstand the relationship between the price of a commodity and its demand. Understand the chief characteristics of the Law of Demand. Classify various commodities into normal good, inferior goods and giffens goods. Analyze the demand structure of various types of goods.

IntroductionStudents! You already know the meaning of the term “Demand” and its determinants. Can you recollect the factors which determine the demand? Amongst the entire factors that determine the demand, price is the most important one; because of a commodity is a point at which the demand and supply forces equate each others at a particular level of quantity. For e.g. – You have to buy a two wheeler, then a part from other factors like taste, habits, availability of substitutes; ultimately the price of a particular bike will determine the demand. Activity: 1 Take any commodity of your day to day use and conduct a survey of 10 consumers Within your class who consumer that commodity. Highlight the importance of price as factors determine the demand. Law of demand Suppose you want to buy mangoes. at Rs.100 per dozen you buy 6 dozens. If the price of mangoes increase to 200/- then how much will you buy? Definitely less quantity of goods. What kind of relationship is there between the price and quantity demanded? There is inverse relation. The law of demand states that “Ceteris paribus (other things remaining the same), higher the price, lower the demand and vice versa. “The law is stated primarily in terms of the price and quantity relationship. The quantity demanded is inversely related to its price. Here we consider only two factors i.e. price and quantity demanded.

All the other factors which determine are assumed to be constant. Which are those factors? AssumptionsIncome of the consumer is constant. There is no change in the availability and the price of the related commodities (i.e. complimentary and substitutes) There are no expectations of the consumers about changes in the future price and income. Consumers’ taste and preferences remain the same. There is no change in the population and its structure. IllustrationPrice (in Rs.) 5 4 3 2

Quantity demanded (in units) 80 100 150 200

Activity-2 Take quantity on X axis and price on Y axis. Draw the demand curve and describe it.

Price

Qty.

Chief characteristicsSo by observing a demand curve the chief characteristics areInverse relationship between the price and the quantity demanded. This is shown by the downward sloping demand curve. Price is an independent variable and the demand is dependent. It is the effect of price on demand and not vice versa. Reasons underling the law of demand- this inverse relationship can be explained in terms of two reasons, viz, 1) Income effect- the decline in the price of a commodity leads to an equivalent increase in the income of a consumer because he has to spend less to buy the same quantity of goods. The part of the money left can be used for buying some more units of commodity. For e.g.- suppose the price of mangoes falls from Rs.100/- per dozen to 50/per dozen. Then with the same amount of 100/- you can buy one more dozen, i.e.,2 dozens at Rs. 50/2) Substitution effect- When the price of a commodity falls, the consumer tends to substitute that commodity for other commodity which is relatively dearer. For e.g. – Suppose the price of the Urad falls, it will be used by some people in place of other pulses. Thus the demand will increase. Activity – 3 Take any commodity (Like mobile services, automobile etc.). Analyze the income and substitution effect on the quantity demanded because of the changes in price. Exceptions1) Conspicuous consumption – The goods which are purchased for ‘Snob appeal’ are called as the conspicuous consumption. They are also called as ‘Veblen goods because Veblen coined this term. For e.g.- diamonds, curios. They are the prestige goods. The would like to hold it only when they are costly and rare. So, what can be the policy implication for the manager of a company who produces it? A producer can take advantage by charging high premium prices. 2) Speculative market: in this case the higher the price the higher will be the demand. It happens because of the expectation to increase the price in the future. For e.g. shares, lotteries, gamble and ply-win type of markets.

3) giffens goods: It is a special type of inferior goods where the increase in the price results into the increase In the quantity demanded. This happens because these goods are consumed by the poor people who would like to buy more if the price increases. For e.g. a poor person who buys inferior quality vegetables. If the price of such vegetable increase then they prefer to buy because they think that it would be of a better quality 4) Ignorance: Many a times consumer judges the quality of a good from its price. Such consumers may purchase high price goods because of the feeling of possessing a better quality. The exceptional demand curve shows a positive relation between the price and the quantity demanded. What can be the shape of the curve? Such demand curve is upward sloping. Diagrammatic representation of the upward sloping demand curve:

Price

Qty. Activity: 4 Give some more examples of exceptional demand curve and classify these commodities into the above categories: Exercises-

Points to ponderSlide 1

___________________________________ ___________________________________ Law of demand

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According to the law of demand “there’s an inverse relationship between the price and the quantity demanded.

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Slide 2

Assumptions On the following assumptions law of demand is based: Income Population Tastes and preferences Availability of related commodities Price of related commodities

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Slide 3

Relationship between price and quantity demanded In the case of demand there exist an inverse relationship between price and the quantity demanded. With increase in price demand decreases, and with decrease in price quantity demanded increases.

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Slide 4

Characteristics of law of demand Inverse relationship between price and quantity demanded Price is taken as independent and demand is taken as dependent variable

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Slide 5

Reasons of inverse relationship Income effect Substitution effect

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Slide 6

Exception to the law of demand Conspicuous consumptions Speculative market Giffens goods ignorance

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