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  1. 1. Demand And Supply: Theory And Analysis
  2. 2. Elements of Demand 1. Desire to have the goods or services: the first necessary condition to have a demand is that the consumer should have desire to purchase goods and services from the market 2. Willingness to pay: it means readiness to pay and purchase the various amounts of the products at various prices 3. Ability to pay: purchasing capacity of the individual (financial ability)
  3. 3. Cont…….. 1. Per period of time: Demand must be time related such as hours, days, weeks, months etc 2. Other things being equal/ ceteris paribus: There might various factors that can influence demand other than price of the product such as income, taste and preferences, price of related goods, weather, customs and traditions etc which are assumed to be unchanged during the period of analysis
  4. 4. Meaning of Demand • The quantity of a good or services that a consumer is willing and able to purchase at various prices for a period of time is called demand.
  5. 5. Determinants of demand 1.Price of the commodity: • Other things remaining the same, the demand for a commodity is inversely related to its price. • Quantity demanded is higher at lower price and it is lower at higher price • Higher the price, lower the demand and vice versa
  6. 6. CONT………. 2.Income of the consumers: a. Inferior goods: there is an inverse relationship income of the consumers and the demand for inferior goods, other things remaining the same. b. superior goods:there is positive and direct relationship income of consumers and the demand for superior goods, other things remaining the same
  7. 7. Cont……………… 3.Taste and Preference : If the consumer has more taste and preference on a particular goods, demand for a commodity increases and vice versa.
  8. 8. CONT…………. 4.Price of related goods: a. Complementary goods: they are those goods which are consumed together to satisfy a particular want. They are jointly demanded. For example, ink and pen. A fall in price of one commodity will cause the demand for the other to rise, other things remaining the same. For example, a rise in price of pen will cause a fall in the demand for ink and vice versa. b. Substitute goods: they are those goods which can be used in place of the other. For example, tea and coffee. A rise in price of one commodity will cause the demand for the other to rise, other things remaining the same. For example, a rise in price of tea will cause a rise in the demand for coffee and vice versa.
  9. 9. Cont………….. 5. Advertisement: When a producer spends more and more on advertisement demand for a commodity will increase because consumers are able to get more information about product. 6. Fear of shortage: If the people have fear of shortage of good in the future, the demand for the good will be higher in the present. 7. Price expectation: If people expect price of a product is increasing in the future, then the demand for the product will be higher in present.
  10. 10. Cont……………….. 8.Size of the population: Demand for a good will be higher in case of larger population and favorable composition of population. 9.Government policy (tax): If the government imposes heavy indirect taxes on commodities, it leads to increase in price of commodities and demand will fall. 10.Climate and weather: in colder area, woolen clothes have a high demand but the same clothes have a low demand in warmer areas.
  11. 11. Cont…………….. 11.Customs and traditions: Goods related with customs have positive relationship with the demand for a specific festival. Unrelated goods have a lesser demand. 12.Money supply: If money supply is increased in a country, demand is high and vice versa. 13. Seasonal factors: demand for ice-creams is higher in the summer than in the winter.
  12. 12. Demand Function A functional relationship between demand and its determinants is called demand function. It can be written as Dx= f(Px,Y, PR, Pop, Adv,………………) Where, Dx = demand for good X Px= price of good X f = function Y= income of the consumer Pop= population Adv= advertisement
  13. 13. Types of demand function 1. Linear demand function: • if the slope of demand curve remains constant throughout its length, it is known as linear demand function. • If both independent variable (price of the commodity) and dependent variable (demand for same product) change at a constant rate, the demand function will be linear.
  14. 14. Cont…………….. Mathematically, Qx =a- bPx Where, Qx= demand for x good Px= price of x good a =intercept/autonomous demand/ demand at zero price b =slope of demand curve(rate of change in demand with respect to change in price)
  15. 15. Linear demand schedule Px Q=100-5Px 0 100 5 75 10 50 15 25 20 0
  16. 16. Linear demand curve
  17. 17. 2. Non-linear Demand Function • If the slope of demand curve changes all along the demand curve, it is said to be non-linear demand function. • mathematically, • Qx=apx b
  18. 18. Non-linear demand schedule PX Qx 20 10 10 20 5 40
  19. 19. Non-linear demand curve
  20. 20. Law of Demand a. Statement • Other things remaining the same, quantity demanded increases with fall in price and vice versa. In other words, when price of a commodity falls, quantity demanded for the commodity will increase and vice versa, other things remaining the same. • “Higher the price, lower the demand , ceteris paribus” • “Lower the price, higher the demand”
  21. 21. Cont…….. Mathematically, Dx=f(Px), other things remaining the same QX=a-bPx Where Dx=quantity demanded f=function Px=price
  22. 22. b. Assumptions • No change in income of the consumers • No change in price of related goods • No change in taste and preference • No change in advertisements • No change in population size • No change in whether and climate
  23. 23. i. Demand schedule: The tabular presentation of various combination of price of a commodity and its quantity demanded at a given period of time, other things remaining the same. combinations Price(Rs/kg) Quantity demanded(kg) A 5 100 B 4 200 C 3 300 D 2 400
  24. 24. cont…………… • The table shows the demand of all the consumers in a market. When the price decreases there is increase in demand for goods and vice versa. When price is Rs.5 demand is 100 kilograms. When the price is Rs.4 demand is 200 kilograms. Thus the table shows the total amount demanded by all consumers various price levels
  25. 25. ii.Demandcurve:. The graphical representation of demand schedule is called demand curve
  26. 26. • If we plot all combinations of price and quantity demanded exhibited in table we get a downward sloping demand curve as shown in the figure • There is inverse relationship between price and quantity of demand • The demand curve slopes downward from left to right indicating inverse relationship between price and demand.
  27. 27. Exceptions of law of demand • Law of demand does not hold true for all the goods, persons, times, places and environments. • There are certain factors that cause to violate the law, which are known as the exceptions or limitations of the law of demand. They are as follows:
  28. 28. Cont……. 1. Basic or necessary goods: those goods which are necessary for the continuation of the life of the people. The demand for necessary goods such as salt, medicine remains unchanged for all level of increase or decrease in price of such goods which violates the law of demand.
  29. 29. Cont……. 2. Prestigious goods: those goods which are related with the prestige of buyers such as jewellery. 3. Change in taste and preferences: if consumer’s taste and preferences change in favor of a particular commodity, then demand for that goods increases even if price increases and vice-versa
  30. 30. Cont…. 4. Price or shortage expectations: when consumer feels that any commodity is going to be shortage in near future or price is going to be high, they demand more goods and services at present paying higher prices due to the fear of further rise in price
  31. 31. Cont………… 5. Demonstration effect: • the behavior of general individuals is to imitate the consumption pattern of other individuals, basically of their rich neighbors. • It a neighbors buys a television set, it influences other members of the society to buy the same
  32. 32. Cont……. 6. Change in population size: 7. Change in income 8. Ignorance 9.Emergencies
  33. 33. 10. Giffen Goods: • Those giffen goods in which there is positive relationship between price and demand are called Giffen goods. • Sir Robert Giffen found through research on the consumption habit of British workers, as price of bread increased, they purchased more of bread. • The reason given for this was that, when the price of bread went up, it caused such a large decline in the purchasing power of the poor people that they were forced to cut down the consumption of meat and other expensive foods.
  34. 34. Reasons for Downward Slopping Demand Curve 1. Law of diminishing marginal utility: due to the operation of the diminishing marginal utility on consumption process, consumers will only buy additional units if price is reduced. 2. Income effect: it refers to the effect on demand for goods due to change in real income of consumers as a result of change in the price of commodity. A decline in price of a production will increase the purchasing power of one’s money income. Hence, consumer is able to buy more of the commodity than before
  35. 35. Cont……… 3. Substitution effect: it is the effect related in the purchase of cheaper commodity in place of a dearer one due to change in price. Consumers tend to substitute cheaper products for dearer products. For example, a decline in price of wai wai will increase the pruchasing power of consumers, making them able to buy more wai wai. At a low price, wai wai is relatively more attractive and it is a substitute for mayos.
  36. 36. Cont………… 4. Multiple uses: There are some commodities which can be put into several uses. For example, electricity could be used for lighting, cooking, heating and so on. When the price of electricity rises, its consumption may be restricted only for lighting and hence total demand for electricity will decrease. 5. Entry and exit of new consumers: when price of a commodity fall, then the existing consumers consume more than before on the one hand and on the other hand, a new consumers who did not consume before starts to consume such commodity. As a result, the demand for that commodity increases. The opposite case will be true if price rises.
  37. 37. Individual demand • The demand of one person is called individual demand • The quantity demanded for a particular commodity by an individual consumer from the market at various prices per period of time is called individual demand. • The individual demand curve can be explained with the help of demand schedule and demand curve.
  38. 38. Individual Demand Schedule:
  39. 39. Individual Demand Curve
  40. 40. Market demand Market demand for a product is the sum of demand of all individuals for that product. The market demand curve is the horizontal summation of all the individual demand curves in a given market. • It shows the quantity demanded of the good by all individuals at varying price points
  41. 41. Market demand schedule Px A’S Demand (DA) B’S Demand (DB) Market demand (DM)=(DA+DB) 5 1 2 3 4 2 3 5 3 3 4 7 2 4 5 9 1 5 6 11
  42. 42. Cont…………….. • Suppose there are two buyers of a product in the market i.e A & B • First Coolum shows the various possible market prices of the product. • Columns 2nd and 3rd show the quantity demanded of A and B respectively. • On the 5th column market demand (total quantity demanded of individuals A and B) has shown. • Market demand is the horizontal summation of individuals demand for a product at each possible price.
  43. 43. Market Demand Curve
  44. 44. Cont………… • The curve DA shows the individual demand curve of consumer A. • The curve DB shows the individual demand curve of consumer B. • The curve denoted by DM is the market demand curve- which is the horizontal summation of individual demand curves for a product at each possible price.
  45. 45. CONT………….. • All individual and market demand curves are downward sloping from left to the right indicating an inverse relationship between price and demand • Market demand curve is flatter than the individual demand curves. It happens because as price changes, proportionate change in market demand is more than proportionate change in individual demand.
  46. 46. Movement along demand curve/change in quantity demanded • Movement alone the demand curve can be defined as the state of increase or decrease in quantity demanded due to fall or rise in price where all other factors remaining the same. • In other words, change in quantity demanded due to change in only price is called movement alone the demand curve. • Movement of price-quantity combination from one point to another point on the same demand curve.
  47. 47. Cont…………
  48. 48. Cont………… Rightward movement: • It is the graphical representation of expansion in demand brought by fall in price, other things remaining constant. If price falls, consumes demand more. It is called expansion in demand. It is shown by movement from a point in left side to another point in right side of same demand curv
  49. 49. cont,……………… Leftward movement: • It is the graphical representation of contraction in demand brought by rise in price, other things remaining constant. If price rises, consumes demand less. It is called contraction in demand. It is shown by movement from a point in right side to another point in left side of same demand curve.
  50. 50. Change in Demand/Shift in Demand Curve • Change in demand due to change in various non-price factors, where price remaining the constant is defined as shift in demand curve. • If a demand curve shifts towards right and towards left from its original position due to the determinants of demand other than change in price (due to non- price factors) is called shift in demand curve.
  51. 51. CONT……..
  52. 52. Cont………… i. Increase in Demand: It is shown by rightward shift in demand curve from D1 to D2. Demand rises from OQ1 to OQ2 due to favorable change in other factors at the same price OP1 ii. Decrease in Demand: it is shown by leftward shift in demand curve from D1 to D3. Demand falls from OQ1 to OQ3 due to unfavorable change in other factors at the same price OP
  53. 53. Cont…….. • In Fig., demand for the commodity is OQ1 at a price of OP1. Change in other factors leads to a rightward or leftward shift in the demand curve i. Rightward Shift: When demand rises from OQ1 to OQ2(known as increase in demand) at the same price of OP1, it leads to a rightward shift in demand curve from D1 to D2. ii. Leftward Shift: On the other hand, fall in demand from OQ1 to OQ3 (known as decrease in demand) at the same price of OP1, leads to a leftward shift in demand curve from D1 to D3.
  54. 54. Factors Causing Shift in Demand Curve • Change in Income of the consumers • Change in taste &Preference of the consumers • Change in Price of related goods(increase in price of substitute goods and decrease in price of com. goods) • Change in Size of the population • Change in Government policy • Change in Climate and whether • Change in Wealth distribution • Change in Advertisement • Change in Fear of shortage • Change in Price expectation
  55. 55. Supply The quantity of goods and services that the suppliers are willing and able to produce & sale in the market at various prices, per period of time is called supply.
  56. 56. Determinants of Supply • Price of product: other things remaining the same, there is positive relationship between price and supply. • Prices of related goods: Change in the prices of related goods can also change the volume of supply for a product. A decline in price of wheat may cause a farmer to produce and offer more rice at each possible price. • Number of firms: if a number of firms is more in the industry, it increases supply.
  57. 57. Cont…………… • Technology: if the producers are using modern and latest technology, it increases output. Old technology reduces the supply. • Tax and subsidy policy of the government: if the government imposes high rate of tax on the goods and services, it reduces supply. The economic assistance provided by government to business firms which increases supply. • Cost of production: it includes prices of raw materials, wages, cost of energy and so on. If the overall costs of production increases then it reduces the production and thereby supply.
  58. 58. Cont…………… • Objective of firms: If the objective of a firm is sale maximization, it increases supply • Development of infrastructures: well developed infrastructures like road, transport and so on helps to increase in supply. • Natural factors: Favorable natural factors help to boost up the production while unfavorable ones hinder it and supply is adversely affected.
  59. 59. Supply Function Supply function shows the functional relationship between supply and its determinants. Qx =f(Px, PR, Nf T………………….) Where, Qx= supply of a commodity X F=function Px= price of X good
  60. 60. Types of supply function 1. Linear supply function 2. Non-linear supply function NOTE: every things are same as in types of demand function but in supply function the relationship between price and supply should be positive
  61. 61. Law of supply a. Statement Other things remaining the same, quantity supplied increases with rise in price and vice versa.(HIGHER THE PRICE HIGHER THE SUPPLY AND VICE- VERSA) b. Assumptions • No change in number of firms • No change in technology • No change in tax and subsidy • No change in priced of inputs • No change in price expectation • No change in objectives of firms
  62. 62. i. Supply Schedule: A tabular representation of various combinations of price and quantity supplied of a commodity at various prices is called supply schedule. Price (Rs/kg) Quantity supplied(kg) 20 100 40 200 60 300 80 400 100 500
  63. 63. Cont…………… • When price of a product is Rs. 20 per unit, then quantity supplied is 100 units. • As the price rises to Rs.40 per unit, then supply also increases from 100 units to 200 units. • Similarly, as there is further rise in price from Rs. 40 to 60,80 and 11, the supply further increasing from 200 units to 300,400 and 500 units respectively.
  64. 64. Cont…………….
  65. 65. Individual Supply • The quantity supplied by an individual producer in the market at different prices per period of time is called individual supply.
  66. 66. Individual Supply Schedule
  67. 67. Individual supply curve
  68. 68. Market supply • The quantity supplied by all the individual suppliers in the market at various prices is called market supply.
  69. 69. Market Supply Schedule
  70. 70. CONT……………. • The aggregate or market supply schedule equals the sum of all individual supply schedules. Likewise, the sum of the supply curve of each supplier is equal to the market supply. Below is an example of the supply schedule of cantaloupes at each price between $1 and $5 by the only 2 farmers at a farmer's market.
  71. 71. market Supply Curve
  72. 72. Movement Along Supply Curve/Change in quantity supplied
  73. 73. Shift in Supply Curve/ Change in Supply
  74. 74. Cont…………. • The shift in supply curve can also be of two types – rightward shift and leftward shift. • The rightward shift occurs in supply curve when the quantity of supplied commodity increases at same price due to favorable changes in non-price factors of production of the commodity. Similarly, a leftward shift occurs when the quantity of supplied commodity decreases at the same price.
  75. 75. Cont……………. • In the above fig. III, let us suppose that SS is the original supply curve where Q amount of commodity has been supplied at price P. Due to favorable changes in non-price factors, the production of the commodity has increased and its supply has been increased by Q2 – Q amount, at the same price. This has caused the supply curve rightwards and new supply curve S2S2 has formed. This is called increase in supply. • In the same, due to unfavorable changes in non-price factors of the commodity, the production and supply have fallen to Q1 amount. Accordingly, the supply curve has shifted leftwards and new supply curve S1S1 has formed. This is called decrease in supply
  76. 76. • Causes of changes in supply • cost of production • No of firms in the industry • Fiscal policy of the government(tax and subsidy) • Changes in technology • Objective of the firm • Infrastructures • Size of population
  77. 77. Determination of equilibrium price • The price at which the quantity demanded equals the quantity supplied is called equilibrium price because at this price the two market forces of demand and supply exactly balance each other. • Equilibrium is a situation where demand and supply are equal.
  78. 78. Interaction between demand and supply price Quantity demanded Quantity supplied result 10 10 50 Excess supply(S>D) 8 20 40 Excess supply(S>D) 6 30 30 Equilibrium(D=S) 4 40 20 Excess demand(S<D) 2 50 10 Excess demandS<D)
  79. 79. Cont…………… • Table shows the relationship between price of a commodity, its quantity demanded and quantity supplied. • Quantity demanded is inversely related to price whereas price and supply are directly related. • When price is Rs. 6 per unit, quantity demanded is equal to quantity supplied. • So equilibrium price is Rs. 6 and equilibrium quantity is 30 units.
  80. 80. Graphically
  81. 81. Cont……….. • In Fig 11.1, DD is the demand curve sloping downward and SS is the supply curve sloping upward. Market is in equilibrium at point ‘E’, where two curves intersect each other. At the equilibrium point, OQ quantity is demanded and supplied at price OP.
  82. 82. Cont………….. • If the equilibrium is now disturbed and the price rises to OP1, the quantity of the good supplied is OQ2 will exceed the quantity demanded OQ1. Sellers will be willing and able to supply more of the good at this price than buyers are prepared to buy. • There is an excess supply equal to Q1Q2. In order to dispose of this excess supply, the sellers will compete with each other and in doing so the price will fall down facilitating way to clear unwanted in inventories. • Thus, there is a tendency of sellers to cut prices in the event of excess supply, implying a downward pressure on prices. Further, consumers noticing excess supply offer a lower price for the good. As price falls in this way, the quantity demanded will rise and the quantity supplied will fall. Ultimately, the demand and supply will coincide at the equilibrium price OP.
  83. 83. Cont…………… • Conversely, if the price falls to OP2, the quantity demanded OQ2 will exceed the quantity supplied OQ1. The reason is that new consumers who could not afford this commodity at the higher price will also purchase it. Further, suppliers would restrict supply due to lower price. The excess demand in this situation is equal to Q1Q2. • More demand and less supply and competition between buyers as a result will force the price up, until excess demand is completely wiped out. The tendency of the buyers to bid up prices when there is excess demand implies an upward pressure on prices. Once again the equilibrium price of OP is reached. The corresponding quantity demanded and supplied will, thus, be OQ.
  84. 84. When demand and supply both increase in the same proportion
  85. 85. Cont………….. • There will be no change in equilibrium price when demand and supply both increase in the same proportion. In the above diagram DD and SS are demand and supply curves intersecting at E. The equilibrium price is OP and OQ is the equilibrium quantity. After increase in both demand and supply in same proportion, the two curves shift to D1D1and S1S1 respectively. The equilibrium price OP obviously remains unchanged.
  86. 86. When increase in demand is more than increase in supply:
  87. 87. Cont……….. In the above diagram, DD and SS are demand and supply curve and the equilibrium price is OP. D1D1 and S1S1 are the new demand and supply curves when increase in demand is more than increase in supply. OP1 is the new equilibrium price.
  88. 88. When increase in demand is less than increase in supply:
  89. 89. Effect of increase in market demand on equilibrium price at constant supply
  90. 90. Effect of increase in market supply on equilibrium price at constant demand
  91. 91. Cont………… • When increase in demand is less than the increase in supply, the equilibrium price will fall as shown in the figure-3. This will result in the fall of equilibrium price from OP to OP1& increase in equilibrium quantity from OQ to OQ1. This will benefit the consumer as not only the equilibrium price has decreased but equilibrium quantity has increased.
  92. 92. Meaning of Elasticity of Demand • The law of demand shows the direction of change in the demand with the change in price. But this law does not explain what percentage change in price leads to what percentage change in demand. • Thus to measure the degree of relationship between price and demand, we use the concept of elasticity of demand.
  93. 93. • The elasticity of demand is the ratio of the percentage change in the demand to the percentage change in any quantitative determinant of demand. Ed= percentage ∆ in demand /percentage ∆ in any its determinants • Types of elasticity of demand 1. Price elasticity of demand (Ep) 2. Income elasticity of demand(Ey) 3. Cross elasticity of demand(Exy)
  94. 94. 1. Price Elasticity of Demand • Other things remaining the same, price elasticity of demand is the ratio of the percentage change in the demand for a commodity with the percentage change in price of the same commodity.
  95. 95. CONT………………
  96. 96. Types of Price Elasticity of Demand
  97. 97. 1. Perfectly Elastic Demand(EP =∞. ): • If a very small (insignificant) change in price of a good leads an infinitive change in quantity demanded for that good, then the demand is known as perfectly elastic demand. • This is an imaginary situation and not found in real life.
  98. 98. Graphically
  99. 99. • The demand curve is a horizontal straight line and lies parallel to x-axis. • The demand curve shows the change in price is insignificant, however, the change in quantity demand is infinitive. • OP is the new price which is derived from a very small fall. At price op, the demand is indeterminate, i.e. OQ1 or OQ or OQ2.
  100. 100. 2. Perfectly inelastic demand(Ep=0) • If the quantity demanded is totally irresponsive to the change in the price of a good , then the demand is known as perfectly inelastic demand. • This demand is found in case of basic necessary goods such as salt, medicines etc. • Therefore, numerical value of elasticity becomes zero.
  101. 101. • As shown in figure, the movement in price from OP1 to OP2 and OP2 to OP3 does not show any change in the demand of a product (OQ). • The demand remains constant for any value of price.
  102. 102. 3. Relatively Elastic Demand (EP>1): • If percentage change in quantity demanded is greater than the percentage change in price of a good, then the demand is known as relatively elastic demand. • Mathematically, relatively elastic demand is known as more than unit elastic demand (Ep>1). • For example, if the price of a product increases by 20% and the demand of the product decreases by 25%, then the demand would be relatively elastic.
  103. 103. Graphically
  104. 104. • This type of demand is found in case of luxurious goods such as automobiles, gold and diamond etc. • The demand curve will be relatively flatter. • The percentage decrease in quantity demanded is greater than the percentage increased in price. • i.e. ∆Q(Q2-Q1)/Q>∆P(P2-P1)/P.
  105. 105. 4. Relatively Inelastic Demand(EP<1): • If percentage change in quantity demanded is less than the percentage change in price of a good, then the demand is known as relatively inelastic demand. • Mathematically, relatively elastic demand is known as less than unit elastic demand (Ep<1). • For example, if the price of a product increases by 20% and the demand of the product decreases by 15%, then the demand would be relatively inelastic
  106. 106. graphically
  107. 107. • This type of demand is found in case of daily consumption goods such as food cloth and shelter. • The demand curve will be relatively steeper. • The percentage decrease in quantity demanded is less than the percentage increased in price i.e. ∆Q/Q<∆P/P.
  108. 108. 5. Unitary elastic demand(EP=1) • If percentage change in quantity demanded is exactly equal to the percentage change in price of a good, then the demand is known as unitary elastic demand. • Mathematically, relatively elastic demand is known as unitary elastic demand (ep=1). • For example, if the price of a product increases by 20% and the demand of the product decreases by 20%, then the demand would be unitary elastic.
  109. 109. graphically
  110. 110. • The percentage decrease in quantity demanded is less than the percentage increased in price i.e. ∆Q/Q=∆P/P.
  111. 111. Determinants of price elasticity of demand 1. Availability of close substitutes: goods with close substitutes tend to have more elastic demand than less or no close substitutes because it is easier for consumer to switch from that good to others. Coca- cola and Pepsi are easily substitutable but rice is food without close substitute. The demand for rice is less elastic than the demand for coke. 2. Luxurious vs. necessities: the demand for necessities such as electricity and rice tends to be inelastic and the demand for luxuries automobiles and diamond tends to be elastic.
  112. 112. CONT……….. 3. Time period: good tends to have less elasticity in the short run rather than in the long run because the consumer will have choice in the long run but in the short run he is compelled to purchase it. 4. Level of income: the rice people do not respond to small change in price of goods and services. For rich people, demand remains relatively inelastic while for poor people, demand becomes relatively elastic
  113. 113. Cont…. 5. Goods of several uses: if there is increase in price of electricity, demand for it becomes less elastic but demand for electricity becomes more elastic if there is fall in price of electricity. 6. Seasonal change: the demand for warm cloth becomes highly elastic in summer season but less in winter season. 7.Price expectation: if the consumer feels that price is going to be high in near future, then demand becomes more elastic at present and vice versa
  114. 114. CONT………… 9.Habitual goods: the demand for habitual goods such as wine, alcohol, cigarettes remain relatively inelastic to any change in price. 10.Demand for complementary goods: if demand for bike is elastic, demand for petrol will also elastic and vice versa.
  115. 115. Use of price elasticity of demand • Product pricing: if demand for goods is elastic, the reduction in price leads to an increase in quantity demanded and profit. • Pricing of input: If the demand for inputs is elastic, the producers are prepared to offer low price for the inputs and they are ready to pay high price for inelastic inputs.
  116. 116. CONT……………. • Pricing of joint products(Production of more than one products from production process. For example, production of fur and meat from the sheep farming. In these products price can not be determined on the basis of cost. So price should be determined on the help of price elasticity of demand)
  117. 117. Cont………….. • Demand forecasting: given the elasticity of demand and the state of independent variable, it is possible to forecast the demand for a good. • To formulate tax policy: .
  118. 118. CONT………………. • To formulate trade policy: if the country is suffering from deficit balance of trade, then it should try to increase in price of those exports which have inelastic demand and reduces the price of those goods which have elastic demand
  119. 119. Cont……….. • To formulate investment policy: the government should leave to the private sector to produce those goods which have elastic demand and should produce those whose demand are inelastic such as health, education, electricity etc • Categorizing the goods: necessities/luxurious
  120. 120. Measurement of price elasticity of demand. 1. Total outlay method: • In this method, price elasticity of demand is measured by observing the direction of change in total expenditure in response to change in the price of the good. • Total outlay/expenditure= PXQ • Based on the direction of the change in the total expenditure, the elasticity of demand may be
  121. 121. a. Elasticity of demand greater than unity: • If there is inverse relationship between the change in price of a good and the corresponding change in total expenditure of a buyer on that good, then demand is known as relatively elastic demand. • Decrease in price leads to an increase in total expenditure and vice-versa. • Such type of elasticity is found in case of luxurious goods such as automobilies.
  122. 122. b. Elasticity of demand equal to unitary • If total expenditure on a good of a buyer is totally irresponsive to the change in price of that good, then the demand is known as unitary elastic demand. • This type of demand is found in case of normal goods.
  123. 123. c. Elasticity of demand less than unitary • If there is positive relationship between the change in price of a good and the corresponding change in total expenditure of a buyer on that good, then demand is known as relatively inelastic demand. • Decrease in price leads to an decrease in total expenditure and vice-versa. • Such type of elasticity is found in case of inferior goods.
  124. 124. Table P Q TE=PXQ EP 6 1 6 EP>1 5 2 10 EP>1 4 3 12 EP=1 3 4 12 EP=1 2 5 10 EP<1 1 6 6 EP<1
  125. 125. Graphically •In the graph, total outlay or expenditure is measured on the X-axis while price is measured on the Y-axis. In the figure, the movement from point A to point B shows elastic demand as we can see that total expenditure has increased with fall in price. •The movement from point B to point C shows unitary elastic demand as total expenditure has remained unchanged with the change in price. •Similarly, the movement from point C to point D shows inelastic demand as total expenditure as well as price has decreased.
  126. 126. 2. Point method a. Linear demand curve: it is the ratio lower segment of demand curve to the upper segment
  127. 127. b. non-linear demand curve •DD is a non-linear demand curve. To measure elasticity at P on it, the tangent MN is drawn. Here EP = PN/MP. • Ep=lower segment of tangent line/upper segment of tangent line
  128. 128. c. Arc method: it takes average quantity and average price to calculate Ep.
  129. 129. Cont…………… Where, ΔQ = change in quantity demanded = Q2 – Q1 Q1 = initial quantity demanded Q2 = new quantity demanded ΔP = change in price = P2 – P1 P1 = new price
  130. 130. 2. INCOME ELASTICITY OF DEMAND • Other things remaining the same, income elasticity of demand is the ratio of the percentage change in the demand for a commodity with the percentage change in income of the consumer. Ey= % ∆ in demand /% ∆ in income = ∆Q/∆Y * Y/Q Where, ∆Q=Q2-Q1 & ∆Y=Y2-Y1
  131. 131. TYPES OF INCOME ELASTICITY OF DEMAMD 1. Negative income elasticity of demand ( EY<0) • If there is an inverse relationship between income of the consumer and demand for the commodity, then income elasticity will be negative. • That is, if the quantity demanded for a commodity decreases with the rise in income of the consumer and vice versa, it is said to be negative income elasticity of demand. • As the income of consumer increases, they either stop or consume less of inferior goods.
  132. 132. Graphically
  133. 133. Cont……………… • In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. • When the consumer’s income rises from OY to OY1 the quantity demanded of inferior goods falls from OQ to OQ1 and vice versa. • Thus, the demand curve DD shows negative income elasticity of demand. • This demand is found in case of inferior goods.
  134. 134. Cont……….. 2. Zero income elasticity of demand ( EY=0) • If the quantity demanded for a commodity remains constant with any percentage rise or fall in income of the consumer and, it is said to be zero income elasticity of demand. • For example: In case of basic necessary goods such as salt, kerosene, electricity, etc. there is zero income elasticity of demand.
  135. 135. Cont…………….. • In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. • The consumer’s income may fall to OY1 or rise to OY2 from OY, the quantity demanded remains the same at OQ. • Thus, the demand curve DD, which is vertical straight line parallel to Y-axis shows zero income elasticity of demand.
  136. 136. Cont…………… 3. Positive income elasticity of demand (EY>0) If there is direct relationship between income of the consumer and demand for the commodity, then income elasticity will be positive. That is, if the quantity demanded for a commodity increases with the rise in income of the consumer and vice versa, it is said to be positive income elasticity of demand. For example: as the income of consumer increases, they consume more of superior (luxurious) goods. On the contrary, as the income of consumer decreases, they consume less of luxurious goods.
  137. 137. Cont……………. Positive income elasticity can be further classified into three types: a. Income elasticity greater then unity (EY > 1) If the percentage change in quantity demanded for a commodity is greater than percentage change in income of the consumer, it is said to be income greater than unity. For example: When the consumer’s income rises by 3% and the demand rises by 7%, it is the case of income elasticity greater than unity.
  138. 138. graphically
  139. 139. Cont………….. In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. The small rise in income from OY to OY1 has caused greater rise in the quantity demanded from OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity greater than unity.
  140. 140. Cont……………….. b. income elasticity equal to unity (EY = 1) If the percentage change in quantity demanded for a commodity is equal to percentage change in income of the consumer, it is said to be income elasticity equal to unity. For example: When the consumer’s income rises by 5% and the demand rises by 5%, it is the case of income elasticity equal to unity.
  141. 141. graphically
  142. 142. Cont……………….. • In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. The small rise in income from OY to OY1 has caused equal rise in the quantity demanded from OQ to OQ1 and vice versa. Thus, the demand curve DDshows income elasticity equal to unity.
  143. 143. Cont…………….. c. income elasticity less then unity (EY < 1) If the percentage change in quantity demanded for a commodity is less than percentage change in income of the consumer, it is said to be income greater than unity. For example: When the consumer’s income rises by 5% and the demand rises by 3%, it is the case of income elasticity less than unity.
  144. 144. graphically
  145. 145. Cont…………….. In the given figure, quantity demanded and consumer’s income is measured along X-axis and Y-axis respectively. The greater rise in income from OY to OY1 has caused small rise in the quantity demanded from OQ to OQ1 and vice versa. Thus, the demand curve DD shows income elasticity less than unity.
  146. 146. 3. Cross elasticity of demand • It is the ratio of proportionate change in the quantity demanded of Y to a given proportionate change in the price of the related commodity X. • It is a measure of relative change in the quantity demanded of a commodity due to a change in the price of its substitute/complement. It can be expressed as:
  147. 147. Types of cross elasticity of demand 1. Positive cross elasticity of demand(case of substitute goods) • When goods are substitute of each other then cross elasticity of demand is positive. • In other words, when an increase in the price of Y leads to an increase in the demand of X. For instance, with the increase in price of tea, demand of coffee will increase. • as price of Y commodity increases to OP1 demand of X-commodity increases to OM1 Thus, cross elasticity of demand is positive.
  148. 148. graphically
  149. 149. Cont…………….. 2. Negative cross elasticity of demand(case of complementary goods): • In case of complementary goods, cross elasticity of demand is negative. • A proportionate increase in price of one commodity leads to a proportionate fall in the demand of another commodity because both are demanded jointly. • When the price of commodity increases from OP to OP1 quantity demanded falls from OM to OM1. Thus, cross elasticity of demand is negative.
  150. 150. graphically
  151. 151. Cont………………… 3. Zero cross elasticity of demand: Cross elasticity of demand is zero when two goods are not related to each other. For instance, increase in price of car does not effect the demand of cloth. Thus, cross elasticity of demand is zero. It has been shown in fig
  152. 152. Price elasticity of supply • Other things remaining the same, price elasticity of supply is the ratio of the percentage change in the supply of a commodity with the percentage change in price of the same commodity. Ep = % ∆ in supply /% ∆ in price Ep = ∆Q/∆P * P/Q Where, ∆Q=Q2-Q1 & ∆P=P2-P1
  153. 153. Types of price elasticity of supply 1. perfectly elastic supply (Es=∞) 2. Perfectly inelastic supply (Es=0) 3. Relatively elastic supply (Es>1) 4. Relatively inelastic supply (Es<1) 5. Unitary elastic supply (Es=1)
  154. 154. Perfectly elastic supply
  155. 155. Perfectly inelastic supply
  156. 156. Unitary elastic supply
  157. 157. Relatively elastic supply
  158. 158. Relatively inelastic supply

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