CA FOUNDATION - ECONOMICS

2
THEORY OF DEMAND
AND SUPPLY

UNIT 1: LAW OF DEMAND AND ELASTICITY OF DEMAND

1. Law of Demand and Elasticity of Demand

Meaning of Demand
• In ordinary speech, the term demand is many times confused with ‘desire’ or
‘want’.
• Desire is only a wish to have anything.
• In economics demand means more than mere desire.
• Demand in economics means an effective desire for a commodity i.e. desire backed
by the ‘ability to pay’ and ‘willingness to pay’ for it.
• Thus, demand refers to the quantity of a goods or service that consumers are
willing and able to purchase at different prices during a period of time.
(1) Demand is always with reference to a PRICE.
(2) Demand is to be referred to IN A GIVEN PERIOD OF TIME.
(3) Consumer must have necessary purchasing power to back his desire for the
commodity.
(4) Consumer must also be ready to exchange his money for the commodity he
desires
• E.g. Mr. A’s demand for sugar at Rs. 15 per kgs. Per week.

2. What Determines Demand? / Factors Affecting Demand:

D = f (P, Pr, Y, T, E, O)
(1) Price of the Commodity (P): (ceteris paribus) Other things being equal, demand of
a commodity is inversely related to its price because when price increases then
demand decreases and when price decreases then demand increases.
(2) Price of Related Commodities (Pr): Related commodities are of two types.
(a) Complementary goods: Complementary goods are those goods, which are
consumed together or simultaneously, example, tea and sugar, automobiles
and petrol, pen and ink. There is an inverse relation between change in

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price of one complement and demand of other complementary good. Other

things being equal, a fall in the price of one will cause the demand of other
to rise and vice versa.
(b) Substitutes or Competing goods: Substitutes are those goods which can be
used in place of one another, example, tea and coffee, ink pen and ball
pen. There is positive relation between change in price of one substitute and
demand of other substitute good, i.e., a fall in price of one leads to a fall in
the quantity demanded of its substitute and vice versa.

(3) Income of the Household (Y):

(a) Other things being, in case of Normal/Luxury goods, demand for goods
increases with increases in household’s income and vice versa. So, there is
positive relation.
(b) In case of Inferior goods, increase in income decrease the quantity demanded.
So, there is inverse relation.
(c) In case of Necessaries as the income of household increases, the demand for
necessaries also increases in the beginning and becomes income inelastic
(constant) thereafter.

(4) Taste and Preference of Consumers (T):

A positive change in the taste and preference shall lead to an increase in demand
and vice versa. Fashion can also demand, and goods which are more in fashion
command higher demand than goods which are out of fashion. ‘Demonstration
effect’ plays also an important role in affecting demand for a product.

(5) Future Expectations about Price (E) :

If there is future expectation about rise in price than at present, demand rises,
and if there is future expectation about fall in price then at present, demand
falls. For example, in share market, it happen.

(6) Other Factor (O):

(a) Size of population: Generally, larger the size of population of a country,
more will be the demand for commodities and vice versa.
(b) Composition of population: If the number of children is large, demand for
toys and biscuits will be high; similarly, if there are more old people, goods
such as sticks and artificial teeth, etc., will be in more demand.

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(c) Distribution of income: While equitable distribution of the income in the

community leads to increase in consumption, so APC (Average Propensity
to Consume) will rise; an unequal distribution of income brings a fall in the
quantity demanded, so consumption decreases and so APC will fall.
Note: ‘Quantity supplied’ and ‘factor price’ do not determine demand.

3. THE LAW OF DEMAND

• The Law of demand expresses the nature of functional relationship between the
price of a commodity and its quantity demanded.
• It simply states that demand varies inversely to the changes in price i.e. demand
for a commodity expands when price falls and contracts when price rises.
• “Law od Demand states that people will buy more at lower prices and buy less
at higher prices, other things remaining the same.” (Prof. Samuelson)
• It is assumed that other determinants of demand are constant and ONLY PRICE
IS THE VARIABLE AND INFLUENCING FACTOR.
• Thus, the law of demand is based on the following main assumptions: -
1. Consumers income remain unchanged.
2. Taste and preference of consumers remain unchanged.
3. Price of substitute goods and complement goods remain unchanged.
4. There are no expectations of future changes in the price of the commodity.
5. There is no change in the fashion of the commodity etc.
• The law can be explained with the help of a demand schedule and a corresponding
demand curve.
• Demand schedule is a table or a chart which shows the different quantities of
commodity demanded at different prices in a given period of time.
• Demand schedule can be Individual Demand Schedule or Market Demand
Schedule.

4. INDIVIDUAL DEMAND SCHEDULE

Individual Demand Schedule is a table showing different quantities of commodity that
ONE PARTICULAR CONSUMER is willing to buy at different level of price, during a given
period of time.
Table 1: Demand Scheduled of an Individual Buyer
Price of Sugar Rs. Per Kg. Quantity Demanded Kgs. Per month
1 5
2 4

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3 3
4 2
5 1

MARKET DEMAND SCHEDULE

• Market Demand Schedule is a table showing different quantities of a commodity
that ALL THE CONSUMERS are willing to buy at different prices, during a given
period of time.
Table 2: Market Demand Schedule
Price of sugar Rs. Quantity Demanded p.m. kgs. Market Demand
Per kg. Consumer A Consumer B A+B
1 5 6 5 + 6 = 11
2 4 5 4+5=9
3 3 4 3+4=7
4 2 3 2+3=5
5 1 2 1+2=3
(Assumption: There are only 2 buyer in the market)
• Both individual and market schedules denotes an INVERSE functional relationship
between price and quantity demanded. In other words, when price rises demand
tends to fall and vice versa.

5. RATIONAL FOR THE LAW OF DEMAND:

WHY DOES DEMAND CURVE SLOPE DOWNWARDS? PE = SE + IE
1. Substitution Effect: When the price of a commodity falls, it becomes relatively
cheaper than other substitute commodities. This induces the consumer to
substitute the commodity whose price has fallen for substitute commodities,
which have now become relatively expensive. As a result of this substitution
effect, the quantity demanded of the commodity, whose price has fallen, rises.
2. Income Effect: When the price of a commodity falls, the consumer can buy more
quantity of the commodity with his given income. As a result of a fall in price of the
commodity, consumer’s real income or purchasing power increases. This increase
the consumer to buy more of same commodity. This is called income effect. Thus,
Price Effect (PE) = Substitution Effect (SE) + Income Effect (IE)
3. Number of Consumers: When price of a commodity is relatively high, only few
consumers can afford to buy it, and when its price falls, more numbers of

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consumers would start buying it because some of those who previously could not
afford to buy may now afford to buy it. Thus, when the price of a commodity falls,
the number of its consumer’s increases and this also tends to raise the market
demand for the commodity.
4. Law of Diminishing Marginal Utility (Law of DMU): A consumer is in equilibrium
(i.e. maximizes his satisfaction) when the marginal utility of the commodity and
its price equalize. According to Marshall, the consumer has diminishing utility for
each additional unit of a commodity and therefore, he will be willing to pay only
less for each additional unit.

6. EXCEPTIONS TO THE LAW OF DEMAND

Exception means law of demand does not apply, and if law of demand does not apply,
then at higher price demand will be higher and at lower price demand will be lower.
In this case, direct relation between price and demand is found and slope of demand
curve will be positive.

In the above figure, there is positive relation between demand and price.
1. Conspicuous Goods: Some consumers measure the utility of a commodity by its
price, i.e., if the commodity is expensive, they think that it has got more utility.
As such, they buy less of this commodity at low price and more of it at high
price. This concept of ‘Conspicuous Consumption’ is given by the Veblen and it
is called Veblen effect or prestigious goods effect. Diamonds are often given as
an example of this case. The higher the price of diamonds, higher is the prestige
value attached to them, and hence, higher is the demand for them.
2. Giffen Goods: ‘Giffen goods’ are those goods, which are considered inferior by
consumers, and examples of such are low quality of rice and wheat. Sir Robert
Giffen found that when price of bread increased, the British workers purchased
more bread not less of it. This was something against the law of demand. Why
did this happen? The reason given for this that when the price of bread wen up, it

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caused such as large decline in the purchasing power of the poor people that they
were forced to cut down the consumption of meat and other more expensive foods.
Since bread, even when its price was higher than before was still the cheapest
food article, people consumed more of it and not less when its price went up. Such
goods which exhibit direct price- demand relationship are called Giffen goods. In
case of a Giffen good, demand curve will upward sloping to the right.
3. Conspicuous Necessities: The demand for certain goods is effected by the
demonstration effect of the consumption pattern of a social group. These goods,
due to their constant usage, have become necessities of life. For example, the price
of television sets, refrigerators, coolers, cooking gas, etc., have been continuously
rising, but their demand does not fall.
4. Future Expectations about Prices: It has been observed that when price are rising
household expecting that the price in the future will be still higher, tend to buy
larger quantities of commodities. For example, when there is an expectation that
price of share would rise in future, then demand for the same rises at present.
5. Irrational and Impulsive Purchases: Impulsive purchases means ‘purchases by
impression’. At times, consumers tends to make impulsive (without any calculations
about price and usefulness of the product) purchases, the law of demand fails.
6. Demand for Necessaries: In case of necessaries, people have to consume the
minimum quantity, whatever is the price.
7. Speculative Goods: The law of demand also not apply in share market because
when price are rising, more will be demanded.
8. Ignorance Effect: Generally, it is assumed that a household has perfect knowledge
about price and quality of goods. However, in practice, a household may demand
larger quantity of a commodity even at a higher price because it may be ignorant
of the ruling price of the commodity.
The law of demand also fails if there is a change in income or prices of the related
goods or in taste and fashion (Pr, Y, T, E, O), etc.

7. EXPANSION AND CONTRACTION IN DEMAND / MOVEMENT (CHANGE IN QUANTITY

DEMANDED) D = f (P, Pr, Y, T, E, O)
Due to changes in price alone demand for a commodity changes, it is called movement.
Movements are two types.
1. Expansion in Demand/Increase in Quantity Demand/ Downward Movement on
the Same Demand Curve: Rise in demand due to fall in price is called expansion
of demand.

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2. Contraction of Demand/ Decrease in Quantity Demand/ Upward Movement along

the same Demand Curve: Fall in demand due to rise in its price is called contraction
of demand. In other words, contraction of demand is the result of increase in the
price of good concerned.

8. INCREASE AND DECREASE IN DEMAND /SHIFTING (CHANGE IN DEMAND)

D= f(P, Pr, Y T E O): When due to change in factors other than price, i.e., Pr, Y, T, E,
O demand for a commodity changes, it is called shifting. Shifting is of two types.
1. Increase in Demand/Rightward shift in the Demand Curve:
When there is increase in demand due to change in factors other than price, it is
called increase in demand.

Causes of increase in demand:

• Rise in price of substitutes,
• Fall in price of a complement good,
• Rise in income,
• Taste and preference favour of commodity,

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• Increase in population,
• Same price and increase in demand or

2. Decrease in Demand/ Leftward Shift in Demand Curve: When decrease in demand

is due to changes in factor other than price, it is called decrease in demand.

Causes of Decrease in demand:

• Fall in price of substitutes,
• Rise in price of a complement,
• Fall in income,
• Taste and preference against the commodity,
• Future expectation about fall in price,
• Decrease in population,
• Same price and decrease in quantity demanded or

9. ELASTICITY OF DEMAND
• Elasticity of demand is defined as the responsiveness or sensitiveness of the
quantity demanded of a commodity to the changes in any one of the variable on
which demand depends.
• These variables are price of the commodity, prices of the related commodities,
income of the consumers and many other factors on which demand depends.
• Accordingly, we have price elasticity, cross elasticity, elasticity of substitution,
income elasticity and advertisement elasticity.
• Unless mentioned otherwise, it is price elasticity of demand which is generally referred.

10. PRICE ELASTICITY OF DEMAND:

• Price elasticity measures the degree of responsiveness of quantity demanded of a
commodity to a change in its price, given the consumer’s income, his tastes and
prices of all other goods.

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• It reflects how sensitive buyers are to change in price.

• Price elasticity of demand can be defined “as a ratio of the percentage change in
the quantity demanded of a commodity to the percentage change in its own price”.

11. PRICE ELASTICITY OF DEMAND (EP)

It is measured as percentage change in quantity demanded divided by the percentage
change in price, other things remaining equal.
percentage Change in Quantity Demanded
Ed =
Percentage Change in Price

12. INCOME ELASTICITY OF DEMAND (EY)

Income elasticity of demand means the ratio of percentage change in quantity
demanded due to percentage change in income of consumers.

% Change in Quantity Demanded

Ey =
% Change in Income

13. CROSS ELASTICITY OF DEMAND (Ec)

The cross elasticity of demand is proportional change in quantity of X demanded
resulting from given relative change in the price of the related commodity Y.

% Change in Quantity Demand of ‘X’

Ec =
% Change in Price of ‘Y’

14. ADVERTISEMENT ELASTICITY

Advertisement elasticity of sales or promotional elasticity of demand is the

responsiveness of a good’s demand to changes in firm’s spending on advertising. It
measures the percentage change in demand that occurs given a one percent change in
advertising expenditure.
Higher the value of advertising elasticity, greater will be the responsiveness of demand
to change in advertisement. Advertisement elasticity varies between zero and infinity.
It is measured by using the formula;

% Change in Quantity Demand

Ea =
% Change in Spending on Advertising

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15. THE DEGREE (TYPES) OF PRICE ELASTICITY OF DEMAND

• Price elasticity measures the degree of responsiveness of quantity demanded of a
commodity to a change in its price. Depending upon the degree of responsiveness
of the quantity demanded to the price changes, we can have the following kinds
of price elasticity of demand.
1. Perfectly Inelasticity demand: (Ep = O) :

When change in price has no effect on quantity demanded, then demand is

perfectly in elastic. E.g. – If price falls by 20% and the quantity demanded
remains unchanged then,
EP = 0/20 = 0. In this case, the demand curve is a vertical straight line curve
parallel to y- axis as shown in the figure.

2. Perfectly Elastic Demand: (EP = ∞ ):

When with no change in price or with very little change in price, demand for
a commodity expands or contracts to any extent, the demand is said to be
perfectly elastic. In this case, the demand curve is a horizontal and parallel
to X –axis.
The figure shows that demand curve DD is parallel to X- axis which means
that at given price, demand is ever increasing.

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3. Unit Elastic Demand: (EP = 1):

When the percentage or proportionate change in price is equal to the
percentage or proportionate change in quantity demanded, then the demand
is said to be unit elastic. E.g. If price falls by 10% and the demand rises by
10% then, Demand Curve DD is a rectangular hyperbola curve suggesting
unitary elastic demand.
EP = 10/10 = 1

4. Relatively Elastic Demand: (EP > 1):

When a small change in price leads to more proportionate change in quantity

demanded then the demand is said to be relatively elastic E.g. If price falls
by 10% and demand rises by 30% then, EP = 30/10 = 3 >1. The coefficient
of price elasticity would be somewhere between ONE and INFINITY. The
elastic demand curve is flatter as shown in figure Demand curve DD is flat
suggesting that the demand is relatively elastic or highly elastic.

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5. Relatively Inelastic Demand: (Ep < 1):

When a big change in price leads to less than proportionate change in

quantity demanded, then the demand is said to be relatively inelastic. E.g.
If price falls by 20% and demand rises by 5% then,
EP = 5/20 = 1/4 < 1. The coefficient of price elasticity is somewhere between
ZERO and ONE. The demand curve DD is steeper suggesting that demand is
less elastic or relatively inelastic. Relatively inelastic demand occurs in case
compulsory goods i.e. necessities of life.

16. INCOME ELASTICITY OF DEMAND:

(i) Zero income elasticity, (EY=0)
Ex. Salt, match box, lifesaving drugs
(ii) Negative income elasticity (EY ,< 0)
Eg: -inferior good, second hand products (Inverse relation)
(iii) Unitary income elasticity (EY = 1)
e.g. Normal goods
(iv) Income elasticity greater than one ( EY > 1 )
Eg. Luxury goods, superior good (direct relation)
(v) Income elasticity less than one (EY < 1)
Eg. Necessaries good, perishable goods.

17. MEASUREMENT OF PRICE ELASTICITY OF DEMAND.

• The different methods of measuring price elasticity of demand are:
1. The Percentage or Ratio or Proportional Method,
2. The Total Outlay Method,
3. The Point or Geometrical Method, and
4. The Arc Method.

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1. The Percentage Method:

This method is based on the definition of elasticity of demand. The coefficient of price
elasticity of demand is measured by taking ratio of percentage change in demand
to the percentage change in price. Thus, we measure the price elasticity by using the
following formula-
Ep = Δq/q x p/∆p = Δq/p p/q
Where –
∆q = change in quantity demanded
q = original quantity demanded
∆p = change in price
p = original price
If the coefficient of above ratio is equal to ONE or UNITY, the demand will be unitary.
If the coefficient of above ratio is MORE THAN ONE, the demand is relatively elastic.
If the coefficient of above ratio is LESS THAN ONE, the demand is relatively inelastic.

2. The total Outlay or Expenditure Method or Seller’s Total Revenue Method:

The total outlay refers to the total expenditure done by a consumer on the purchase
of a commodity. It is obtained by multiplying the price with the quantity demanded.
Thus,
Total Outlay (TO) = Price (P) X Quantity (Q)
TO = P X Q
In this method, we measure price elasticity by examining the change in total outlay
due to change in price.
Dr. Alfred Marshall laid the following proposition:
a) When with the change in price, the TO remains unchanged, Ep = 1.
b) When with a rise in price, the TO falls or with a fall in price, the TO rises, Ep > 1.
c) When with a rise in price, the TO also rises and with a fall in price, the TO also
falls, Ep<1.
Price per unit (Rs.) Quantity Total Outlay (PXQ) Elasticity of
Decrease/Increse Demanded Demand
5 4 20 units 25 100 100 Ep = 1
4 5 25 units 20 100 100 Unitary
5 4 20 units 30 100 120 Ep > 1
4 5 30 units 20 120 100 Elastic
5 4 20 units 22 100 88 Ep < 1
4 5 22 units 20 80 100 Inelastic

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• However, total outlay method of measuring price elasticity is less exact. This
method only classifies elasticity into elastic, inelastic and unit elastic.
• The exact and precise coefficient of elasticity cannot be found out with this method.

3. The Point Method or Geometric Method:

• The point elasticity method, we measure elasticity at a given point on a demand
curve.
• This method is useful when changes in price and quantity demanded are very
small so that they can be considered one and the same point only.
• E.g. If price of X commodity was Rs. 5,000 per unit and now it changes to Rs. 5,002
per unit which is very small changes. In such a situation we measure elasticity at
a point on demand curve by using formula Δq/q x p/q
• Diagrammatically also we can find elasticity at a point by using the formula –
Lower Segment of the Demand Curve
Ep =
Upper Segment of the Demand Curve

(Downward sloping straight line Linear demand curve.)

Figure:
• The figure shows that even though the shape of the demand curve is constant, the
elasticity is different points on the curve.
• If the demand curve is not a straight line curve, then in order to measure elasticity at
a point on demand curve we have to draw tangent at the given
• point and then measure elasticity using the above formula.
• We can also find out numerical elasticities on different points.

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18. THE ARC ELASTICITY METHOD :

• When there is large change in the price or we have to measure elasticity over an arc
o the demand curve, we use the “arc method” to measure price elasticity of demand.
• The arc elasticity is a measure of the “average elasticity” i.e. elasticity at MID-
POINT that connects the two points on the demand curve.
• Thus, an arc is a portion of a curved line, hence a portion of a demand curve.
Here instead of using original or new data as the basis of measurement, we use
average of
The formula used is –

q1-q2 P1+P2
Ep = x
q1+q2 P1-P2

19. FACTOR AFFECTING/ DETERMINANTS OF ELASTICITY OF DEMAND
1. Availability of Substitutes: If commodities have more close substitutes, have
more elastic demand. And, if a commodity have less substitutes, have inelastic
demand. For example, Coca Cola, Pepsi have close substitutes, so demand tends
to be elastic. Other commodities such as salt have inelastic demand.
It should be noted that while as a group of a good may have inelastic demand,
but when we consider its various brands, we say that a particular brand has
elastic demand. Thus while demand for petrol is inelastic, the demand for Indian
oil’s petrol is elastic demand.
2. Position of a commodity in the Consumer’s Budget: Generally, greater the
proportion of income spent on a commodity, the greater will be its elasticity of
demand and vice versa. The demand for goods like salt, matches, buttons, etc.,
tends to be highly inelastic because consumer spends small part of his income. On
the other hand, demand for goods like clothing tends to be elastic sine consumer
spends high part of hi income.
3. Nature of the Commodity: In general, luxury goods are price elastic while
necessities are price inelastic. Thus while the demand for television is relatively
elastic, the demand for necessities, e.g. food and housing, is inelastic.

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4. Number of Uses: The more the possible uses of a commodity the greater will be
its price elasticity and vice versa. To illustrate, milk has several uses. If its price
falls, it can be used for a variety of purpose like preparation of curd, cream, ghee
and sweets. But if its price increases, its use will be restricted only to essential
purposes.
5. The Period: A person can be better adjust himself in the long period. So demand
will be elastic in long period. But in the short period, demand will be inelastic
because he has no time to adjust his demand.
6. Consumer Habits: If a consumer is habitual consumer of a commodity no matter
how much its price change, the demand for the commodity will remain inelastic.
7. Tied Demand/Joint Demand: The demand for those goods, which are tied/joint to
others, is normally inelastic as against those whose demand is independent. For
e.g., demand of stationary with computer.
8. Price Range: Goods, which are in very high price range or in very low price range
have inelastic demand, but those, which are in middle price range have elastic
demand. Generally, low price good keeps the price elasticity of demand for a
good low.

Price Elasticity

Income Elasticity

Cross Elasticity

Advertisement
Elasticity

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MODULE MULTIPLE CHOICE QUESTIONS

1. Demand for the commodity refers to. (Para 1)

a. Desire backed by the ability to pay for the commodity.
b. Need for the commodity and willingness to pay for it.
c. The quantity demanded of that commodity at a certain price.
d. The quantity of the commodity demanded at a certain price during any particular
period of time.

2. Contraction of the demand is the result of: (Para 7)

a. Decrease in the number of consumers.
b. Increase in the price of the good concerned.
c. Increase in the prices of other goods.
d. Decrease in the income of purchasers.

3. All but one of the following are assumed to remain the same while drawing an
individual’s demand curve for a commodity. Which one is it? (Para 3)
a. The preference of the individual.~ b. His monetary income
c. Price of the commodity d. Price of the related goods

4. Which of the following pairs of goods is an example of substitutes? (Para 2, Point 2(b))
a. Tea and sugar. b. Tea and coffee
c. Pen and ink. d. Shirt and trousers.

5. In the case of straight line demand curve meeting the two axes, the price-elasticity of
demand at mid-point of the line would be: (Para 17, Point 3)
a. 0 b. 1 c. 1.5 d. 2

6. The law of demand, assuming other things to remain constant, establishes the
relationship between. (Para 3)
a. Income of the consumer and the quantity of a good demanded by him.
b. Price of a good and the quantity demanded.
c. Price of a good and the demand for its substitute.
d. Quantity demanded of a good and the relative prices of its complementary
goods..

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7. Identify the factor which generally keeps the price-elasticity of demand for a good
low: (Para 19)
a. Variety of uses for that good..
b. Very low price of a commodity.
c. Close substitutes for that good.
d. High proportion of the consumer’s income spent on it.

8. Identify the co-efficient of price-elasticity of demand when the percentage increase in

the quantity of a good demanded is smaller than the percentage fall in its price.
a. Equal to one b. Greater than one. (Para 15, Point 5)

c. Smaller than one. d. Zero.

9. In the case of an inferior good, the income elasticity of demand is: (Para 16, Point 2)
a. Positive. b. Zero.
c. Negative. d. Infinite.

10. If the demand for a good is inelastic, an increase in its price will cause the total
expenditure of the consumers of the good to: (Para 17, Point 2)
a. Remain the same.
b. Increase.
c. Decrease.
d. Any of these.

11. If regardless of changes in its price, the quantity demanded of goods remains
unchanged, then the demand curve for the goods will be: (Para 15, Point 1)
a. Horizontal. b. Vertical.
c. Positively sloped. d. Negatively sloped.

12. Suppose the price of the Pepsi increase, we will expect the demand curve of Coca Cola
to: (Para 8)
a. Shift towards left since these are substitutes.
b. Shift towards right since these are substitutes.
c. Remain at the same level.
d. None of the above.

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13. All of the following are determinants of demand except: (Para 2)

a. Tastes and preferences. b. Quantity supplied.
c. Income of the consumer. d. Price of related goods.

14. A movement along the demand curve for soft drinks is best described as: (Para 7)
a. An increase in demand. b. A decrease in demand.
c. A change in quantity demanded. d. A change in demand.

15. If the price of the Pepsi decreases relative to the price of Coke and 7-UP the demand
for: (Para 2, Point 2(b))
a. Cock will decrease. b. 7-Up will decrease.
c. Coke and 7-Up will increase. d. Coke and 7-Up will decrease.

16. If a good is a luxury, its income elasticity of demand is: (Para 16, Point 4)
a. Positive and less than 1. b. Negative but greater than 1.
c. Positive and greater than 1. d. Zero.

17. The price of hot dogs increase by 22% and the quantity of hot dogs demanded falls by
25%. This indicates that the demand for the hot dogs is: (Para 11)
a. Elastic. b. Inelastic.
c. Unitarily elastic. d. Perfectly elastic.

18. If the quantity demanded of mutton increases by 5 % when the price of chicken increases
by 20%, the cross-price elasticity of demand between mutton and chicken is. (Para 13)
a. - 0.25 b. 0.25 c. - 4 d. 4

19. Given the following four possibilities, which one results in an increase in total consumer
expenditure. (Para 17, Point 2)
a. Demand is unitary elastic and price falls.
b. Demand is elastic and prices rises.
c. Demand is inelastic and price falls.
d. Demand is inelastic and prices rises.

20. Which of the following is an incorrect statement? (Para 16)

a. When goods are substitutes, a fall in the price of one (ceteris paribus) leads to a
fall in the quantity demanded of its substitutes.

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b. When commodities are complements, a fall in the price of one (other things being
equal) will cause the demand of the other to rise.
c. As the income of the consumer increases, the demand for the commodity increases
always and vice versa.
d. When a commodity becomes fashionable people prefer to buy it and therefore its
demand increases.

21. Suppose the price of movies seen at a theatre rises from Rs. 120 per person to Rs. 200
per person. The theatre manger observes that the rise in price causes attendance at
a given movie to fall from 300 persons to 200 persons. What is the price elasticity of
demand for movies? (Use Arc Elasticity Method) (Para 17, Point 4)
a. 5 b. 8 c. 1.0 d. 1.2

22. Suppose a department store has a sale on its silverware. If the price of a plate –
setting is reduced from Rs. 300 to Rs. 200 and the quantity demanded increases from
3,000 plate- setting to 5,000 plate –settings, what is the price elasticity of demand
for silverware? (Use Arc Elasticity Method) (Para 17, Point 4)
a. 8 b. 1.0 c 1.25 d. 1.50

(Refer Chart)
23. When the numerical value of cross elasticity between two goods is very high, it means
a. The goods are perfect complements and therefore have to be used together.
b. The goods are perfect substitutes and can be used with ease in place of one
another.
c. There is high degree of substitutability between the goods.
d. The goods are neutral and therefore cannot be considered as substitutes.

24. If the local pizzeria raises the price of a medium pizza from Rs.60 to Rs. 100 and
quantity demanded falls from 700 pizzas a night to 100 pizzas a night, the price
elasticity of demand for pizzas is:
(Use Arc elasticity method) (Para 17, Point 4)
a. 67 b. 1.5 c. 2.0 d. 3.0

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25. If electricity demand is inelastic, and electricity charges increase, which of the following
is likely to occur? (Para 15, Point 5)
a. Quantity demanded will fall by a relatively large amount.
b. Quantity demanded will fall by a relatively small amount.
c. Quantity demanded will rise in the short run, but fall in the long run.
d. Quantity demanded will fall in the short run, but rise in the long run.

26. Suppose the demand for meals at a medium-priced restaurant is elastic. If the
management of the restaurant is considering raising prices, it can expect a relatively:
a. Large fall in quantity demanded. (Para 15, Point 4)
b. Large fall in demand
c. Small fall in quantity demanded
d. Small fall in demand.

27. Points elasticity is useful for which of the following situations? (Para 17, Point 3)
a. The bookstore is considering doubling the price of notebooks.
b. A restaurant is considering lowering the price of its most expensive dishes by 50 percent.
c. An auto producer is interested in determining the response of consumers to the
price of cars being lowered by Rs.100
d. None of the above

28. A decrease in price will result in an increase in total revenue if: (Para 17, Point 2)
a. The percentage change in quantity demanded is less than the percentage change
in price.
b. The percentage change in quantity demanded is greater than the percentage
change in price.
c. Demand is inelastic.
d. The consumer is operating along a linear demand curve at a point at which the
price is very low and the quantity demanded is very high.

29. Demand for a good will tend to be more elastic if it exhibits which of the following
characteristics? (Para 19)
a. It represents a small part of the consumer’s income.
b. The good has many substitutes available.
c. It is a necessity (as opposed to luxury)
d. There is little time for the consumer to adjust to the price change.

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(Para 17, Point 2)&(Para 15, Point 5)

30. An increase in price will result in an increase in total revenue if ? :
a. The percentage change in quatity demanded is less than the percentage change in price.
b. The percentage change in quatity demanded is greater than the percentage
change in price.
c. Demand is elastic.
d. The consumer is operating along a linear demand curve at a point at which the
price is very high and the quantity demanded is very low.

31. Demand for a good will tends to be more inelastic if it exhibits which of the following
characteristic. (Para 19)
a. The good has many substitutes.
b. The good is a luxury (as opposed to a necessity)
c. The good is a small part of the consumer’s income.
d. There is a great deal of time for the consumer to adjust to the change in prices.

32. Suppose a consumer’s income increases from Rs.30,000 to Rs.36,000. As a result, the
consumer increases her purchases of compact discs (CDs) from 25 CDs to 30n CDs.
What is the consumer’s income elastic of demand for CDs? (Use Arc Elasticity Method)
a. 0.5 b. 1.0 c. 1.5 d. 2.0 (Para 17, Point 4)

33. What will happen in the rice market if the buyers are expecting higher rice prices in the
near future? (Para 2, Point 5)
a. The demand for rice will increase.
b. The demand for rice will decrease.
c. The demand for rice will be unaffected.
d. None of the above

34. If case of Giffen goods, the demand curve will be: (Para 6, Point 2)
a. Horizontal
b. Downward-sloping to the right.
c. Vertical
d. Upward-sloping to the right.

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35. When the economist speak of the utility of a certain good, they are referring to
a. The demand for the goods. (Unit 2, Para 2)

b. The usefulness of the goods in consumption.

c. The expected satisfaction derived from consuming the goods.
d. The rate at which consumers are willing to exchange one good for another.

36. Conspicuous goods also known as. (Para 6, Point 1)

a. Prestige goods. b. Snob goods.
c. Veblen goods. d. All of the above.

37. The quantity purchased remains constant irrespective of the change in income. This is
known as (Para 15, Point 1)
a. Negative income elasticity of demand.
b. Income elasticity of demand is less than one.
c. Zero income elasticity of demand.
d. Income elasticity of demand is greater than one.

38. As income increases, the consumer will go in for superior goods and consequently the
demand for inferior goods will fall. This means: (Para 16, Point 2)
a. Income elasticity of demand is less than one.
b. Negative income elasticity of demand.
c. Zero income elasticity of demand.
d. Unitary income elasticity of demand.

39. When income increases the money spent on necessaries of life may not increase in the
same proportion. This means: (Para 16, Point 5)
a. Income elasticity of demand is zero.
b. Income elasticity of demand is one.
c. Income elasticity of demand is greater than one.
d. Income elasticity of demand is less than one.

40. The luxury goods like Jewellery and fancy articles will have (Para 16, Point 4)
a. Low income elasticity of demand.
b. High income elasticity of demand.
c. Zero income elasticity of demand.
d. None of the above.

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41. A good which cannot be consumed more than one is known as: (General)
a. Durable good b. Non-durable good.
c. Producer good. d. None of the above.

42. Demand is the (Para 3)

a. The desire for a commodity given its price and those of related commodities.
b. The entire relationship between the quantity demanded and the price of a good
other things remaining the same.
c. Willingness to pay for a good if income is larger enough.
d. Ability to pay for a good.

43. If, as people’s income increases, the quantity demanded of good decreases, the good
is called. (Para 16, Point 2)
a. A substitute. b. A normal good.
c. An inferior good. d. A complement.

44. The price of tomatoes increases and people buy tomato puree. You infer that tomatoes
puree and tomatoes are: (Para 2, Point 2(b))
a. Normal goods. b. Complements.
c. Substitute goods. d. A complement.

45. Chocolate and icecream are substitutes. If the price of the Chocolate increases, the
demand for Chocolate will: (Para 8)
a. Increase or decrease but the demand curve for Chocolate will not change.
b. Increase and the demand curve for Icecream will shift right words.
c. Not change but there will be a movement along the demand curve for Icecream.
d. Decrease and demand curve for Icecream will shift leftwards.

46. Potatoes chips and popcorn are substitutes. A rise in the price of potato chips will
______ the demand for the popcorn and the quantity of popcorn will _____________
(Para 2, Point 2(b))
a. Increase; increase b. Increase; decrease.
c. Decrease; decrease. d. Increase; decrease.

47. If the price of Orange juice increases, the demand for Apple Juice will__________
(Para 2, Point 2(b))
a. Increase. b. Decrease.
c. Remain the same. d. Become negative.

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48. When total demand for a commodity whose price has fallen increases, it is due to:
a. Income effect. b. Substitution effect. (Para 5, Point 2)
c. Complementary effect. d. Price effect.

49. With a fall in the price of a commodity. (Para 5, Point 2)

a. Consumer’s real income increases.
b. Consumer’s real income decreases.
c. There is no change in the real income of the consumer.
d. None of the above.

50. With the increase in the price of diamond, the quantity demanded also increases. This
is because it is (Para 6, Point 1)
a. Substitution good. b. Complementary good.
c. Conspicuous good. d. None of the above.

51. An example of a good that exhibit direct price-demand relationship is. (Para 6, Point 2)
a. Giffen goods. b. Complementary goods.
c. Substitution goods. d. None of the above.

52. In Economics, when demand for a commodity increases with a fall in its price it is
known as: (Para 7)
a. Contraction of demand. b. Expansion of demand.
c. No change in demand. d. None of the above.

53. The price of the commodity decreases from Rs. 6 to Rs.4 and the quantity demanded
of the goods increases from 10 units to 15 units, find the coefficient of price elasticity.
(Use Point elasticity Method) (Para 17, Point 1, Currently solve with % method)
a. 1.5 b. 2.5 c. -1.5 d. 0.5

54. Which of the following statements about price elasticity of demand is correct? (Para 10)
a. Price elasticity of demand is a measure of how much the quantity demanded of
a good responds to change in the price of that good.
b. Price elasticity of demand is computed as the percentage change in quantity
demanded divided by the percentage change in price.
c. Price elasticity of demand in the long run would be different from that of the short run.
d. All of the above.

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55. At higher prices demand more of certain goods not for their worth but for their prestige
value- This is called . (Para 2, Point 4)

a. Veblen effect. b. Giffens paradox.

c. Speculative effect. d. None of the above.

56. If the price of air-conditioner increases from Rs.30,000 to Rs.30,010 and resultant
change in demand is negligible, we use the measure of ____________ to measure
elasticity. (Para 17, Point 3)

a. Point elasticity. b. Perfect elasticity.

c. Perfect in elasticity. d. Price elasticity.

57. Which of the following statements is correct? (Unit 3, Para 2, Point 3)

a. When the price falls the quantity demanded falls.
b. Seasonal changes do not affect the supply of a commodity.
c. Taxes and subsidies do not influence the supply of the commodity.
d. With lower cost, it is profitable to supply more of the commodity.

58. The cross elasticity between Rye bread and Whole Wheat bread is expected to be:
a. Positive. b. Negative. (Refer Chart)

c. Zero. d. Can’t say.

59. The income elasticity of tomatoes is 0.25, it means tomatoes are: (Refer Chart)
a. Inferior goods. b. Luxury goods.
c. Normal goods. d. Can’t say.

60. The cross elasticity between personal computer and soft ware’s is: (Refer Chart)
a. Positive. b. Negative.
c. Zero. d. One.

61. The cross elasticity between Bread and DVDs is: (Refer Chart)
a. Positive. b. Negative.
c. Zero. d. One.

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62. Suppose the income elasticity of education in private school in India is 1.6. What does
this indicate? (Para 16, Point 4)
a. Private school education is a luxury.
b. Private school education is a necessity.
c. Private school education is an inferior commodity.
d. We should have more private schools.

63. Suppose potatoes have (-) 0.4 as income elasticity. We can say from the data given
that: (Para 16, Point 2)
a. Potatoes are inferior goods.
b. Potatoes are superior goods.
c. Potatoes are necessities.
d. There is a need to increase the income of consumers so that they can purchase
potatoes.

ANSWERS :

1 d 2 b 3 c 4 b 5 b 6 b
7 b 8 c 9 c 10 b 11 b 12 b
13 b 14 c 15 d 16 c 17 a 18 b
19 d 20 c 21 b 22 c 23 c 24 d
25 b 26 a 27 c 28 b 29 b 30 a
31 c 32 b 33 a 34 d 35 c 36 b
37 c 38 b 39 d 40 b 41 b 42 b
43 c 44 c 45 b 46 a 47 a 48 d
49 a 50 c 51 a 52 b 53 c 54 d
55 a 56 a 57 d 58 a 59 c 60 b
61 c 62 a 63 a

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SUMMARY

 Buyers constitute the demand side of the market; sellers make the supply side of that
market. The quantity that consumers buy at a given price determines the size of the
market.

 Demand means desire or wish to buy and consume a commodity or service backed by
adequate ability to pay and willingness to pay

 The important factors that determine demand are price of the commodity, price of
related commodities, income of the consumer, tastes and preferences of consumers,
consumer expectations regarding future prices, size of population, composition of
population, the level of national income and its distribution, consumer-credit facility
and interest rates.

 The law of demand states that people will buy more at lower prices and less at higher
prices, other things being equal.

 A demand schedule is a table that shows various prices and the corresponding
quantities demanded. The demand schedules are of two types; individual demand
schedule and market demand schedule.

 According to Marshall, the demand curve slopes downwards due to the operation of
the law of diminishing marginal utility. However, according to Hicks and Allen it is due
to income effect and substitution effect.

 The demand curve usually slopes downwards; but exceptionally slopes upwards under
certain circumstances as in the case of conspicuous goods, Giffen goods, conspicuous
necessities, future expectations about prices, demand for necessaries and speculative goods.

 When the quantity demanded decreases due to a rise in own price, it is contraction of
demand. On the contrary, when the price falls and the quantity demanded increases
it is extension of demand.

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 The demand curve will shift to the right when there is a rise in income (unless the good
is an inferior one), a rise in the price of a substitute, a fall in the price of a complement,
a rise in population and a change in tastes in favour of commodity. The opposite
changes will shift the demand curve to the left.

 Elasticity of demand refers to the degree of sensitiveness or responsiveness of demand

to a change in any one of its determinants. Elasticity of demand is classified mainly
into four kinds. They are price elasticity of demand, income elasticity of demand,
advertisement elasticity and cross elasticity of demand.

 Price elasticity of demand refers to the percentage change in quantity demanded of

a commodity as a result of a percentage change in price of that commodity. Because
demand curve slopes downwards and to the right, the sign of price elasticity is negative.
We normally ignore the sign of elasticity and concentrate on the coefficient. Greater
the absolute coefficient, greater is the price elasticity.

 In point elasticity, we measure elasticity at a given point on a demand curve. When the
price change is somewhat larger or when price elasticity is to be found between two
prices or two points on the demand curve, we use arc elasticity

 Income elasticity of demand is the percentage change in quantity demanded of a

commodity as a result of a percentage change in income of the consumer. Goods and
services are classified as luxuries, normal or inferior, depending on the responsiveness
of spending on a product relative to percentage change in income.

 The cross elasticity of demand is the percentage change in the quantity demanded of
commodity X as a result of a percentage change in the price of some relatedcommodity
Y. Products can be substitutes, and their cross elasticity is then positive; cross elasticity
is negative for products that are complements.

 Advertisement elasticity of sales or promotional elasticity of demand measures the

responsiveness of a good’s demand to changes in the firm’s spending on advertising.

 Forecasting of demand is the art and science of predicting the probable demand for
a product or a service at some future date on the basis of certain past behaviour
patterns of some related events and the prevailing trends in the present.

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 The commonly available techniques of demand forecasting are survey of buyers’

intentions, collective opinion method, expert opinion method, barometric method,
and statistical methods such as trend projection method, graphical method, least
square method, regression analysis, and market

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