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DEMAND AND PRICE ELASTICITY

Introduction

Demand refers to the particular quantities of commodities, which a consumer is able and willing
to buy at a given price and at a given period of time.

COMPONENTS OF DEMAND

1. Commodities must have the same price.

2. Commodities must be available at a given period of time.
3. Consumer is willing and able to buy.

FACTORS AFFECTING DEMAND

1. Price of a commodity (Px): There is an inverse relationship between the price of a commodity
and its quantity demanded. Higher the price, lower the quantity demanded and lower the price,
higher the quantity demanded, keeping other factors constant.

2. Price of related goods (Pr): There are two types of related goods in an economy:

⮚ Substitute Goods: These are the goods which can be used in place of another. There is a
direct relationship between the price of a commodity and demand for its substitutes.
For example, If the price of Stick Pen increases, the demand for Reynolds Pen increases,
and when the price of Stick Pen decreases, the demand for Reynolds Pen decreases.
Hence, there is a direct positive relationship.
⮚ Complementary Goods: These are the goods which are used together. There is an
inverse relationship between the price of a commodity and its demand. For example, if
the price of a Toy increases, the demand for Battery decreases, and if the price of a Toy
decreases, the demand for Battery increases. Hence, there is an inverse relationship.

3. Income of a consumer (Y):- Income of a consumer can be studied with two types of
commodities:
⮚ Normal Goods: There is a direct relationship between the income of a consumer and
the demand for normal goods. An example of a normal good is Full Cream Milk. For
example, If the income of a consumer increases, the demand for full cream milk
increases, and when the income of a consumer decreases, the demand for full cream
milk decreases. Hence, there is a direct relationship between the income of a
consumer and the demand for normal goods.
⮚ Inferior Goods: There is an inverse relationship between the level of income and
demand for inferior goods. An example of an inferior good is Double Toned Milk.
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For example, if the income of a consumer increases, the demand for inferior goods
decreases, and when the income of a consumer decreases, the demand for inferior
goods increases. Hence, there is an inverse relationship between the income of a
consumer and the demand for inferior goods.

4. Taste and preferences (T): In case of favourable tastes for a commodity, the demand for the
commodity increases and in case of unfavourable tastes of a commodity, the demand
decreases. For example, the demand for fountain pen decreases due to unfavourable change in
consumer's taste and preferences.

Demand Function

Dx = F (Px, Pr, Y, T), where;

Dx = Demand for commodity X,

Px = Price of a commodity X,
Pr = Price of related goods of X,
Y = Income of a consumer,
T = Taste and preferences

MARKET DEMAND

It is a quantity of a commodity that all consumers are able and willing to buy at a given price and
at a given period of time.

FACTORS AFFECTING MARKET DEMAND

1. Price of a commodity (Px): There is an inverse relationship between the price of a commodity
and its quantity demanded. Higher the price, lower the quantity demanded and lower the price,
higher the quantity demanded, keeping other factors constant.

2. Price of related goods (Pr): There are two types of related goods in an economy:

⮚ Substitute Goods: These are the goods which can be used in place of another. There is a
direct relationship between the price of a commodity and demand for its substitutes.
For example, If the price of Stick Pen increases, the demand for Reynolds Pen increases,
and when the price of Stick Pen decreases, the demand for Reynolds Pen decreases.
Hence, there is a direct positive relationship.
⮚ Complementary Goods: These are the goods which are used together. There is an
inverse relationship between the price of a commodity and its demand. For example, if
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the price of a Toy increases, the demand for Battery decreases, and if the price of a Toy
decreases, the demand for Battery increases. Hence, there is an inverse relationship.

4. Income of a consumer (Y):- Income of a consumer can be studied with two types of
commodities:
⮚ Normal Goods: There is a direct relationship between the income of a consumer and
the demand for normal goods. An example of a normal good is Full Cream Milk. For
example, If the income of a consumer increases, the demand for full cream milk
increases, and when the income of a consumer decreases, the demand for full cream
milk decreases. Hence, there is a direct relationship between the income of a
consumer and the demand for normal goods.
⮚ Inferior Goods: There is an inverse relationship between the level of income and
demand for inferior goods. An example of an inferior good is Double Toned Milk.
For example, if the income of a consumer increases, the demand for inferior goods
decreases, and when the income of a consumer decreases, the demand for inferior
goods increases. Hence, there is an inverse relationship between the income of a
consumer and the demand for inferior goods.

4. Taste and preferences (T): In case of favourable tastes for a commodity, the demand for the
commodity increases and in case of unfavourable tastes of a commodity, the demand
decreases. For example, the demand for fountain pen decreases due to unfavourable change in
consumer's taste and preferences.

5. Population size (Po): Market demand can vary with the size of the population of an area. If the
population is dense, then the demand for the commodity increases, whereas if the population is
less, then the demand for the commodity decreases.

6. Distribution of Income (D): Distribution of the level of income varies in a country between the
rich and poor. It can be understood by the following examples:

⮚ In case of tea, distribution of the level of income has no effect because the majority of
the people has the purchasing power to purchase a cup of tea.
⮚ In case of purchasing a car, distribution of the level of income matters because the
majority of the people does not have the purchasing power to purchase a car.

Market Demand Function

Dx = F (Px, Pr, Y, T, Po, D), where;

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Dx = Demand for commodity X,

Px = Price of a commodity X,
Pr = Price of related goods of X,
Y = Income of a consumer,
T = Taste and preferences
Po = Population size of an area,
D = Distribution of Income between citizens

LAW OF DEMAND -

According to the law of demand, when the price of a commodity increases, its quantity
demanded decreases, and when the price of a commodity decreases, its quantity
demanded increases, keeping other factors remains same.

Assumptions:
1. No change in price related to other goods
2. No change in the income level of a consumer
3. No change in taste and preferences of a consumer

Note:- Due to the inverse relationship between price and demand, the demand curve is
always downward sloping.

Schedule –

Price of X = (Px) Demand of X=(Dx)

10 100
20 80
30 60
40 40
50 20

Demand Curve -
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Slope = △P/ △Q= Negative

Note – Demand Curve is a downward-sloping straight line.

Change in demand and change in quantity demanded

BASIS CHANGE IN DEMAND CHANGE IN QUANTITY DEMANDED

Meaning It is due to the change in other It is due to the change in the price of a
factors, keeping the price of a commodity, keeping other factors constant.
commodity constant.
Other It is also called a shift of the It is also called a Movement along the
name demand curve. demand curve.
Shift and There is a rightward shift (increase There is an Expansion in demand
Movement in demand) or leftward shift (downward movement of the demand
(decrease in demand) curve) and Contraction of demand (upward
movement of the demand curve).
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New In this case, a new demand curve In this case, no new demand curve will be
demand will be formed. formed.
curve

Other type of Goods –

Vablen/Veblen Goods

Veblen goods are named after the American economist ‘Thorstein Veblen’. A veblen good is a
type of luxury good for which the quantity demanded increases as the price increases. These are
the goods that are perceived as a status symbol by the society. When the price of such commodity
increases, its demand also increases. These goods do not follow the law of demand.

Example: iPhone 11, Luxury cars, etc.

Giffen Goods

Giffen goods are highly inferior goods, showing a very high negative income effect. As a result,
when the price of such commodities falls, their demand also falls, and when the price of such
commodities increases, their demand also increases. Giffen goods reveal their Giffen nature
during extreme circumstances. They do not follow the law of demand. They are inferior quality
products with no readily available substitutes. When the price of such commodity increases, its
demand also increases. These goods do not follow the law of demand. Cheaper varieties
of goods like bajra, potatoes, salt, etc., come under Giffen goods.
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Public Goods

A public good (also known as a social good or collective good) is a good that is both non-
excludable and non-rivalrous, in that individuals cannot be excluded from its use or could
benefit from without paying for it, and where consumption by one individual does not reduce
availability to others or the good can be used simultaneously by more than one person.
Examples: footpath and street lighting.

Free Goods

A free good is available in as great a quantity as desired with zero opportunity cost to society.
A free good is a good that is not scarce, and therefore, is available without limit.
A good that is made available at zero price is not necessarily a free good. For example, a shop
might give away its stock in its promotion but producing these goods would still have required
the use of scarce resources. Example: Air, water and sunlight.
Necessity Goods
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Necessity goods are products and services that consumers will buy regardless of the changes in
their income levels, therefore, making these products less sensitive to income change.
As for any other normal good, an income rise will lead to a rise in demand, but the increase for
a necessity good is less than proportional to the rise in income, so the proportion of
expenditure on these goods falls as income rises. If income elasticity of demand is lower than
unity, it is a necessity good. Example: transportation, medicine, education, communication, etc.

Elasticity: It is a degree of responsiveness.

Related concepts –

⮚ Elasticity of Demand - It is a degree of the responsiveness of demand due to change in its

factors.
⮚ Price Elasticity of Demand - It is a degree of the responsiveness of demand due to change
in price.

Measures of Elasticity

⮚ PERCENTAGE METHOD:- % Change in quantity demanded / % Change in price

Degrees of Elasticity of Demand:-

There are 5 degrees of elasticity of demand; these are:

1. ELASTIC

Price Quantity

10 10

6 20

Elasticity = % Change in quantity demanded / % Change in price

Elasticity= 100 % / 40 %
Elasticity = 2.5
Hence, Elastic.

2. PERFECTLY ELASTIC
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Price Quantity

10 10

10 20

Elasticity = % Change in quantity demanded / % Change in price

Elasticity= 100% / 0
Elasticity = ∞
Hence, Perfectly Elastic.

3. UNIT ELASTIC

Price Quantity
10 10
6 14

Elasticity = % Change in quantity demanded / % Change in price

Elasticity = 40 % / 40 %
Elasticity = 1
Hence, Unit Elastic.

4. INELASTIC

Price Quantity

10 10

6 12

Elasticity = % Change in quantity demanded / % Change in price

Elasticity = 20 % / 40 %
Elasticity = 0.5
Hence, Inelastic.

5. PERFECTLY INELASTIC
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Price Quantity

10 10

6 10

Elasticity = % Change in quantity demanded / % Change in price

Elasticity = 0 / 40%
Elasticity = 0
Hence, Perfectly Inelastic.

FACTORS EFFECTING ELASTICITY OF DEMAND:

1. Level of Income: If a consumer has a high level of income, then demand for a
commodity is less elastic. On the other hand, if a consumer has less income, then
demand for the commodity will be more elastic.

2. Availability of Substitutes: If a commodity has more number of substitutes available,

its demand will be more elastic. On the other hand, if a commodity has less number
of substitutes, its demand will be less elastic.

3. Percentage Share in Total Expenditure: If the commodities percentage share in total

expenditure is very high, its demand will be more elastic. On the other hand, if the
percentage share in total expenditure is very low, its demand will be less elastic.

4. Price of a Commodity: If the price of the commodity is very high, its demand will be
more elastic. If the price the commodity is very low, its demand will be less elastic.