Demand And Supply:

Theory And Analysis

Unit 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)
 Cont……..
4. Per period of time: Demand must be time
related such as hours, days, weeks, months etc
5.Other things remaining the same/ ceteris
paribus: There might various factors that can
influence demand other than price of the product
(pulsar bike) such as income, taste and
preferences, price of related goods (other bikes),
weather, customs and traditions etc which are
assumed to be unchanged during the period of
analysis
Differences between demand and desire
Basis of differences Desire Demand

Nature It is a wise to have Demand is a desire backed

something. by willingness and ability
to pay.

Resources Resources are not required Resources are required to

to have desire. be demand.
Limit It is boundless and a man It is limited by price of the
can have unlimited number commodity and income of
of desires. the consumer.
Example If a beggar wants to buy a If a millionaire wants to
car, it is his desire. buy a car, it may be
demand
 Meaning of Demand
• The quantity of a good (pulsar bike)
or services (services of doctors
nurses, teachers, lawyers, ) that a
consumer is willing and able to
purchase at various prices for a
period of time is called demand.
Determinants of Demand/Factors Affecting
Demand
1.Price of the Commodity:
• Other things remaining the same, the demand
for a commodity (pulsar bike, vegetables) is
inversely related to its own price.
• Quantity demanded is higher at lower price and
it is lower at higher price
• Higher the price, lower the demand and vice
versa
 Cont..
2.Income of the Consumers: goods are classified into
superior and inferior goods on the basis of income.
a. Inferior Goods/low quality products: There is an inverse
relationship income of the consumers and the demand for inferior
goods, other things remaining the same. (If demand for a
commodity decreases as a result of increase in income of the
consumer, then such commodity is called inferior goods and vice
versa)/ the goods having negative income effect.
b. Superior Goods/high quality products: There is A positive and
direct relationship between income of consumers and the demand
for superior goods, other things remaining the same (If demand for
a commodity increases as a result of increase in income of the
consumer, then such commodity is called superior goods and vice
versa/ the goods having positive income effect.
 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.
 If a new goods comes in the market with new
taste than other products, the preference of people
for that product increases which ultimately
increases its demand.
 CONT..
4.Price of Related Goods: If demand for one commodity (Coke) changes due to
change in price (Pepsi) of another one then such goods are called related goods.
It is of two types-
a. Complementary goods:
 They (car and petrol)/ink and pen/tea and sugar are those goods which
are consumed/demanded together/jointly to satisfy a particular want
(travel).
 They are jointly demanded.
 For example, Bike and petrol. A fall in price of one commodity (bike)
will cause the demand for the other to rise (petrol), other things
remaining the same and vice versa.
 In case of complementary goods, price of one commodity and demand
for another one are inversely related/ as price of one commodity goes
up (bike) demand for another one (petrol) goes down and vice-versa.
 Cont..
b. Substitute Goods:
 They are those goods which can be used in place of the other.
 For example, pulsar and VR bikes/coke and Pepsi/tea and
coffee/nokia and samsung mobiles/sinex and decold. A rise
in price of one commodity (sinex) will cause the demand for
the other (decold) to rise, other things remaining the same
and vice versa.
 In case of substitute goods, price of one commodity (Pulsar)
and demand for another one (VR) are positively related/ as
price of one commodity (Pulsar) goes up demand for another
one (VR) also goes up and vice-versa.
 They are also called competitive goods.
 Cont…………..
5. Advertisement Expenditure:
 When a seller spends more and more on advertisement,
demand for a commodity will increase because
consumers are able to get more information (price,
location, quality and functions) about product and
 Sometimes causes to the change in the preferences of
the buyers to purchase more quantity of the product
 Advertisement is not an expenditure rather it is an
investment.
 A high volume of advertisement causes to increase in
demand than a low value of it.
 Cont..
6.Fear of Shortage:
 If the people have fear of shortage of a certain good in the
future, the demand for that good will be higher in the
present.
 Fear of shortage and the demand are positively/directly
related.
7. Price Expectation:
 If people expect that price of a product is increasing in the
future, then the demand for the product will be higher in
present.
 Cont………………..
8.Size and Composition of the
population:
 Demand for a good will be higher in case of larger
population (increase in the size of population
means increase in number of consumers, which
will create new demand) and vice-versa and
 favorable composition (sex, religion, caste, age)
of population (teen agers usually prefer pulsar
bikes, fashionable clothes, junk foods).
 Cont..
9.Government Policy (tax and subsidy):
i. Tax
 The compulsory monetary charge imposed by the government for its
citizens and institutions for the services provided in different sectors
according to rules is called tax. It is of two types:
a. Direct Tax:
 the tax which is paid by the person or institution upon which it is
imposed by the government and can not be shifted to others is called
direct tax.
 For example, Income tax (1% (450,000),10% (450,000-550,00)%, 20%
(550,00-750,00),30% (750,00-2,000,000)and 36% (>2,000,000), property
tax, profit tax, interest tax, vehicle tax.
 If the government imposes heavy direct taxes on income, it leads to
decrease in income of the consumers and demand will fall.
 Cont..
b. Indirect/invisible Tax:
 The tax which is imposed on one person or institution
but its burden can be shifted to another person or
institution is called indirect tax.
 VAT (value added tax-13%), Custom duty (tax
imposed on exported and imported goods), excise duty
(tax which is imposed on harmful and luxurious goods
(alcohol, cigarettes, tobacco and luxurious cars ) to
reduce the volume of production and consumption).
 If the government imposes heavy indirect taxes on
commodities, it leads to increase in price of
commodities and demand will fall.
 Cont..
ii. Subsidy:
 The economic assistance (money, cutting
machines, tax exemption on imported raw
materials ) provided by the government to
business organization is called subsidy.
 Subsidy reduces cost of production and price
thereby increasing demand for commodities.
 Cont..
10.Seasonl factors:
 Demand for some products is different in
different times of year.
 Demand for ice-cream is higher in the summer
than in the winter
 Demand for warm clothes is higher in the
winter than in the summer.
 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.
 For example, buying presents at Deepawali, Vijaya
Dhashami is higher
12.Money Supply:
If money supply is increased in a country, demand is
high and vice versa.
 Cont..
13. Ignorance:
 It the consumer is not aware of the competitive
price of the commodity, he purchases more of
the commodity even at high price.
 It is because high priced commodity are
generally considered as superior in quality.
 Demand Function
A functional relationship between demand and its determinants is called
demand function.
Symbolically,
Dx = f(Px, income (Y), PR, Pop, Adv,………………)
Where,
Dx = demand for X Good
Px= price of X good (-)
f = function
PR= price of related goods (- for complementary goods and + for substitute
goods)
Y= income of the consumer (- for inferior goods and + for superior goods)
Pop= size and composition of population (+)
Adv= advertisement (+)
 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.
 Cont……………..
Mathematically,
Qx =a- bPx (y=mx+c)
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)=
 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
 Types of Demand Function
1. Linear Demand Function:
a. Statement
 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.
 Cont……………..
b. 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)
 c. Linear Demand Schedule: It is the
tabular presentation of linear demand function.

Px (Rs/unit ) Qx=100-5Px (unit )

0 100
5 75
10 50
15 25
20 0

 In the above table price has increased by a constant rate i.e. Rs 5 and demand
also has decreased by constant rat i.e. 25 units.
 Slope from 0-5 == =-5
 Slope from 5-10 == =-5 and so on.
d. Linear Demand Curve: it is a graphical
representation of linear demand schedule.

PX  In the figure, DD is a
linear demand curve
which is a straight line
indicating that its slopes
remains constant
throughout its length
(both price and demand
changes at the same
QX rate).
2. Non-linear Demand Function
 If the slope of demand curve changes along the demand
curve, it is said to be non-linear demand function.
 If both independent variable (price of the commodity)
and dependent variable (demand for same product) do
not change at a constant rate, the demand function will
be linear.

Mathematically,
 Qx=apxb
Non-linear Demand Schedule: it is a
tabular presentation of non-linear demand function.
Combinations Px Qx
A 10 100
B 20 80
C 25 75
D 50 40
E 90 10

 In the above table price and demand changes at different rates.

 Slope from A-B == =-2
 Slope from B-C == = - 1and so on.
Non-Linear Demand Curve: it is the
graphical presentation of non-linear demand schedule.

D
In the figure, DD is a non-linear
demand curve which shows that
demand and price do not change at
the same rate.

D
 Law of Demand
a. Statement
 Other things remaining the same/ceteris paribus, the law
of demand states that quantity demanded for a
commodity (whole body check up) increases with fall
in its price (whole body check up) and vice versa
 the price of a commodity (price of pulsar bike) and its
quantity demanded are inversely/negatively related.
 “Higher the price, lower the demand , ceteris paribus”
 “Lower the price, higher the demand, ceteris paribus”
d. Assumptions /Ceteris Paribus (other things
remaining the same)
 No change in income of the consumers
 No change in price of related goods
 No change in taste and preference
 No change in advertisement expenditure
 No change in population size
 No change in whether and climate
 No change in government policy (tax and
subsidy)
 Cont..
c. Mathematically,
Dx=f(Px), Ceteris Paribus
Qx=a-bPx
Where, Qx= quantity demanded for x good
f= function
Pt= Price of x good
a= intercept (Qx when PX=0)= Autonomous demand
b= slope (rate of change in Qx due to per unit change
in Px)
d. Demand Schedule: The tabular presentation
of the law of demand. It can be explained with
the help of following hypothetical table.
Price(Rs/kg) Quantity demanded(kg)
5 10
4 20
3 30
2 40
1 50

 In the above table, demand is 10 kg when price is 5Rs/Kg. the

demand has increased form 10 kg to 20 kg as price decreases
from 5 to 4 Rs/kg and so on.
 It shows that price and demand are inversely / negatively
related (as price decreases demand increases and vice versa)
 E. Demand Curve: it is a graphical presentation of demand
schedule.

 In the figure, DD is a demand

curve which is obtained by
plotting the demand
schedule in a graph.
 It slopes downward from left
to the right indicating an
inverse relationship between
price of a commodity and its
quantity demanded. 10 20 30 40
 Exceptions/limitations to the 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 of demand, which are known as the
exceptions or limitations of the law of demand.
They are as follows:
 Cont…….
1. Basic or Necessary Goods (Daily consumption
goods):
 Those goods which are necessary for the continuation
of the life of the people.
 The demand for necessary goods such as salt,
medicine, matches, LP gas, electricity remains
unchanged for all level of price i.e. increase or
decrease in price of such goods does not bring any
change in their demand.
 This is against the law of demand.
 Cont…….
2. Prestigious goods:
 Those goods which are related with the prestige of buyers
such as jewellery.
 Demand for prestigious goods (gold, automobilies)
increases even the price of such goods increases as they
offer prestige to the consumers, which is against the law
of demand.
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 at
the same price or the consumer is ready to pay higher
price even to purchase the same quantity of the good.
 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.
 This is against the law of demand.
 Cont…………
5. Demonstration Effect:
 the behavior of general individuals is to imitate
the consumption pattern of other individuals,
basically of their rich neighbors.
 If a individual sees his neighbors consuming
some goods then he/she will demand the same
goods.
 It a neighbors buys a television set, it influences
other members of the society to buy the same.
 Cont…….
6. Change in Population Size:
 As there is increase in population , it increases
quantity demanded even at higher price.
 Likewise, as there is drastic fall in population ,
quantity demanded falls even though there
may be fall in price.
 Cont..
7. Change in Income: Demand does not decrease
even if price increases if income of people
increases and vice-versa.
8. Ignorance: irrational consumer (who does not
care about market prices) generally purchases
more at the higher price.
9.Emergenciegs: During the emergencies such as
war, famines, natural disasters the law of
demand may not hold true.
 10. Giffen Goods:

• Those inferior 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.
Reasons for Downward Slopping Demand Curve (why dose
price increase due to fall in price and vice-vice versa?)

1. Law of Diminishing Marginal Utility:

 Marginal utility is the utility derived from the
consumption of an additional unit of a commodity.
 According to the law of diminishing marginal utility, the
marginal utility of a commodity declines continuously.
 Therefore, the consumer will buy more units of a
commodity when its price falls.
 Thus, the demand will be more at a lower price and less
at a higher price.
 In this way, the demand curve is downward sloping.
 Cont..
2. Real Income Effect:
 When price of a commodity falls, the real income of
the consumer increases. In other words, the purchasing
power of the consumer increases because he has to
spend less in order to buy the same commodity.
Therefore, he will buy more quantity when price falls.
 When price of a commodity rises, the real income of
the consumer decreases. In other words, the purchasing
power of the consumer decreases because he has to
spend more in order to buy the same commodity.
Therefore, he will buy less quantity when price falls.
 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.
 Cont…………
4. Multiple/different 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, it will be used only for
important purposes and hence total demand for electricity
will decrease.
 Similarly, when price of electricity falls, it will be used for
different purposes which ultimately increases its demand.
 Hence, demand curve slopes downward (inverse
relationship between price and demand)
 Cont..
5. Entry (new consumer creating demand) and Exit of
Consumers:
 when price of a commodity falls, then the existing consumers
(who use to buy at previous price) consume more than before
on the one hand and on the other hand, some new consumers,
who did not consume before, start to consume such
commodity-entry of new consumers due to fall in price.
 As a result, the demand for that commodity increases.
 The opposite case will be true if price rises- when the rises,
some of the consumers will reduce their purchase of the
commodity and hence demand fall-exit of existing consumer
from the market.
 Individual Demand
• The quantity demanded for a particular
commodity (orange) by an individual
consumer/household/firm/industry 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.
Individual Demand Schedule: The tabular presentation
of individual demand.

 The given table shows the

A’s Demand individual demand of
(QA)
consumer A.
 Individual demand of
consumer A is 100 kg when
price a product is 5 Rs/kg.
 As price decreases from 5
to 4 Rs/Kg, then demand
increases from 100 kg to
200KG and so on.
 According table, individual
demand for a commodity
and its price are
inversely/negatively related.
 Individual Demand Curve: The graphical
presentation of individual demand schedule.
DADA is an individual
DA
demand curve of
consumer A which is
obtained by plotting
individual demand
schedule .
It slopes downward from
left to the right indicating
DA
an inverse relationship
O between price and
demand.
Quantity
 Market Demand
 The quantity demanded for a particular commodity
(orange) by all individual
consumers/households/firms/industries from the
market at various prices per period of time is called
individual demand.
 Market demand for a product (orange) is the sum of
demand of all individuals for that product (orange).
 The market demand curve is the horizontal summation
of all the individual demand curves in a given market.
 Market demand also can be defined with the help of a
schedule and Curve.
 Market Demand Schedule: Tabular presentation of
market demand .
 Suppose there are two
P(Rs/kg) A’S Demand B’S Market buyers/consumers of a
(DA) Demand demand product in the market i.e A
Consumer A (DB) (DM)=(DA+ &B
Consumer B DB)  First Coolum shows the
various possible market
prices of the product.
 Columns 2nd and 3rd show
50 1 2 1+2=3 the quantity demanded of A
and B respectively.
40 2 3 2+3=5  On the 4th column market
demand (total quantity
30 3 4 3+4=7 demanded of individuals A
and B) has shown.
20 4 5 4+5=9  Market demand is the
horizontal summation of
individuals demand for a
10 5 6 5+6=11 product at each possible price.
Market Demand Curve: The graphical
presentation of market demand schedule.

 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
=DA+DB product at each possible price.
 Market demand curve also slopes
downward from left to the right
indication an inverse relationship
between price of a commodity
and its market demand
 Differences Between Individual And
Market Demand
1. Individual demand curves are nearer to origin
but market demand curve is farther from
origin.
2. Individual demand curve shows the small
quantity demand for a commodity but market
demand curve shows the larger amount of
quantity demanded for a commodity.
3. Individual demand curves are more steeper
than market demand curve.
 Question
Q. A market consists of three consumers A, B & C whose
individual demand equations are as follows:
A: P= 35-0.5QA
B: P=50-0.25QB
C: P=40- 2QC
The market supply equation is given by QS =40+3.5P
1. Determine the market equilibrium price and quantity.
2. At equilibrium price, determine the price elasticity of
demand and interpret your result.
 Question
Q. Let , demand function (Q)=200-20P
1. Compute price elasticity of demand at P=Rs.
5
2. Compute price elasticity of demand at p1=Rs.
6 and P2=Rs. 8 by arc method.
 Question
Consider the following individual demand schedules.
a. Compute market demand schedule and also derive marked demand curve.
b. Compute price elasticity of demand by arc method when price falls from
Rs. 8 to Rs. 6.

price A’s demand B’s demand C’s demand Market

(QA) (QB) (QC) demand
(QM=QA+QB
+QC)
10 1 3 5 9
8 2 4 6 12
6 3 5 7 15
4 4 6 8 18
2 5 7 9 21
 Movement along a demand
curve/change in quantity demanded
Movement alone the demand curve/change in quantity
demanded can be defined as the state of increase or
decrease in quantity demanded for a commodity
due to fall or rise in its own price, other things
remaining the same.
In other words, change in quantity demanded due to
change in only its own price is called movement alone
the demand curve/change in quantity demanded.
It explains how the price-quantity combinations move
from one point to another point of the same demand
curve.
 Cont…………
 Rightward Movement (expansion in
demand):
P3 It is the graphical representation of expansion
in demand brought by fall in price, other
P1 things remaining constant. Other things
remaining the same, if price falls, consumes
demand more. It is called expansion in
P2 demand. It is shown by movement from A
to B.
 Leftward Movement (Contraction in
Demand):
It is the graphical representation of contraction
Q2 in demand brought by rise in price, other
Q3 Q1
things remaining constant. If price rises,
Q1to Q2 consumes demand less. It is called contraction
in demand. It is shown by movement from A
Q1 to Q3 to C.
Change in Demand/Shift in Demand Curve

 Change in demand due to change in various

determinants of demand (like income of the
consumers, population, price of complementary and
substitute goods, etc.) other than its price 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.
 Cont..
D2
D1
 In Fig., demand for the commodity is OQ1
D3
at a price of OP1. Change in other factors
leads to a rightward or leftward shift in the
demand curve
i. Increase in demand/Rightward Shift in
demand curve: When demand rises from
OQ1 to OQ2(known as increase in demand) at
C A B
the same price of OP1, it leads to a rightward
shift in demand curve from D1 to D2.
ii. Decrease in demand/Leftward Shift in
demand curve: 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.
 Causes of Increase (rightward shift in
demand) in Demand
 Increase in consumer’s income for superior good
 Decrease in consumer’s income for inferior good
 Increase in the size of the population
 Increase in tastes and preferences for a commodity
 Increase in the price of substitute goods
 Decrease in the price of a complementary goods
 Fear of shortage
 Increase in advertisement expenditure
 Decrease in tax rates (Direct and indirect taxes) and increase in subsidy
 Increase is money supply
 Expectation of rise in price level
 Favorable season
 Decrease in interest rate
 Causes of Decrease in Demand
 decrease in consumer’s income for superior good
 increase in consumer’s income for inferior good
 decrease in the size of the population
 decrease in tastes and preferences for a commodity
 decrease in the price of substitute goods
 increase in the price of a complementary goods
 No fear of shortage
 decrease in advertisement expenditure
 Increase in tax rates (Direct and indirect taxes) and decrease in
subsidy
 decrease is money supply
 Expectation of fall in price level
 unfavorable season
 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
 Change in Size of the population
 Change in Government policy (tax and subsidy)
 Change in Climate and whether
 Change in Wealth distribution
 Change in Advertisement
 Change in Fear of shortage
 Change in Price expectation
 Supply
Meaning
The quantity of goods and services (health care)
that the suppliers (hospital) are willing and
able (financial ability) to produce & sale in
the market at various prices per period of
time is called supply.
Elements of Supply
 Desire to produce and sale goods and services
 Willingness to produce
 Ability to produce
 Determinants of Supply (factors affecting
supply)
1. Price of Product:
 other things remaining the same, there is a positive
relationship between price and supply (as price increases
supply also increases and vice-versa).
Causes of increase in supply due to rise in price
 Due to the profit environment, new firms (producers)
enter in the market and increase in supply.
 Existing Producers expand their production capacity and
increase their production.
 Producers are ready to offer larger quantities from old
stocks.
 Cont..
2. Prices of Related Roods (change in supply of one
goods due to change in price of another one):
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.
3. Number of firms/producers: If a number of firms
is more in the industry, it increases supply and vice
versa. The number of firms and supply of products are
positively related.
 Cont……………
4. Technology:
 If the producers are using modern and latest technology, it
increases output and supply in the market by reducing the
cost of production (long-run).
 Old technology reduces the supply (old technology will rise
costs and cause a decrease in supply).
5. Prices of Resources/ cost of production:
 An increase in the prices of resources like prices of raw
materials, energy, labor, capital (machinery goods) will
rise costs and cause a decrease in supply.
 On the other hand, a decline in resources prices will reduce
costs and cause a increase in supply.
 Cont..
6. Government Policy (tax and subsidy):
 If the government imposes high rate of
indirect tax on the goods and services, it
reduces supply.
 Subsidy lower costs and increase supply
 Cont……………
7. Development of Infrastructures:
 Well developed infrastructures like road, transport and communication,
rail way, high way, airport, bridge and so on helps to increase in supply.
 Producers can supply more quantity of product with the proper
development of infrastructures and vice-versa.
8.Natural factors:
 Favorable natural factors (timely monsoon, good climate) help to boost
up (increase) the production and supply.
 while unfavorable (late or early monsoon and bad climate) ones hinder
it and supply is adversely affected (supply decreases).
9. Season: supply of raincoat will be higher in rainy season than in winter.
10. Tradition and customs:
 Supply Function
Supply function shows the functional relationship between
supply of a product (timber)and its determinants.
Qx =f(Px, PR, Nf, T,………………….)
Where,
Qx= supply of X good
f=function
Px= price of X good (+)
PR= Price of related goods (+, -)
Nf= number of firms (+)
T= Technology (+)
 Types of Supply Function
1. Linear supply function
2. Non-linear supply function
 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/other things remaining the same
 No change in number of firms
 No change in technology
 No change in government policy
 No change in price of resources
 No change in infrastructures development
 No change in natural factors
 No change in price of related goods
Mathematiclly,
QX=a+bPx
c. Supply Schedule: A tabular representation of
the law of supply.
Price (Rs/kg) Quantity supplied(kg)
20 100
40 200
60 300
80 400
100 500

 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.
It shows that price of a commodity and its quantity supplied are positively related.
d. Supply Curve: the graphical presentation
of supply schedule

 In the figure, SS is a supply

curve which is obtained by
plotting the supply schedule.
 Supply curve slopes upward
from left to the right
indicating a positive
relationship between price
and supply.
 As price increases supply
also increases.
 Individual Supply
 The quantity supplied of a particular product
(chicken) by an individual
producer/supplier/firm in the market at
different prices per period of time is called
individual supply.
 The individual demand curve can be explained
with the help of demand schedule and
demand curve.
Individual Supply Schedule: it is the
tabular presentation of individual supply.
of
Producer A

 The given table shows the individual supply of producer A.

 Individual supply of consumer A is 100 kg when price a product is 20 Rs/kg.
 As price increases from 20 to 40 Rs/Kg, then supply increases from 100 kg to
200KG and so on.
 According table, individual supply for a commodity and its price are positively
related.
Individual Supply Curve: The graphical
presentation of individual supply schedule

 SS is an individual SUPPLY curve

of producer A which is obtained
by plotting individual supply
schedule .
 It slopes upward from left to the
right indicating an a positive
relationship between price and
demand.
 Market Supply
 The quantity supplied of a particular product by all the
individual suppliers/producers/firms in the market at
various prices per period of time is called market
supply.
 Market supply for a product (orange) is the sum of
supply of all individuals for that product (orange).
 The market supply curve is the horizontal summation
of all the individual supply curves in a given market.
 Market supply also can be defined with the help of a
schedule and Curve.
Market Supply Schedule: the graphical
presentation of market supply.

 Suppose there are two farmer of a

product in the market i.e 1 and 2
 First Coolum shows the various
possible market prices of the
product.
 Columns 2nd and 3rd show the
quantity supplied of 1 and 2
respectively.
 On the 4th column market supply
(total quantity supplied of farmer
1 and farmer ) has shown.
 Market supply is the
horizontal summation of individuals
supply for a product at each possible
price
Market Supply Curve: the graphical
presentation of market supply schedule

 The curve S1 shows the individual

SUPPLY curve of farmer 1.
SM=S1+S  The curve S2 shows the individual
S1
S2 2 Curve curve of farmer 2.
 The curve denoted by SM is the market
supply curve- which is the horizontal
summation of individual curves curves
for a product at each possible price.
 Market supply curve also slopes upward
from left to the right indication a
positive relationship between price of a
commodity and its market supply.
Movement along a Supply Curve/Change
in quantity supplied
Movement alone the supply curve/change in
quantity supplied can be defined as the state of
increase or decrease in quantity supplied for a
commodity due to fall or rise in its own price, all
other factors remaining the same.
B  Rightward Movement (expansion in
SUPPLY):
It is the graphical representation of expansion in
A AUPPLY brought by rise in price, other things
remaining constant. Other things remaining the
C same, if price rises, producer supply more. It is
called expansion in supply. It is shown by movement
from A to B.
 Leftward Movement (Contraction in supply):
It is the graphical representation of contraction in
supply brought by fall in price, other things
remaining constant. If price falls, producers supply
less. It is called contraction in supply. It is shown by
movement from A to C.
Shift in Supply Curve/ Change in Supply
A-B= Increase in supply  Change in supply due to change in various
A-C= Decrease in supply determinants of supply (like number of firms,
technology, cost of production, etc.) other than
its price is defined as shift in supply curve.
 In Fig., SUPPLY of the commodity is OQ at a
price of OP. Change in other factors leads to a
rightward or leftward shift in the supply curve
i. Increase in supply/Rightward Shift in supply
curve: When supply rises from OQ to OQ2(known
as increase in supply) at the same price of OP, it
C A B leads to a rightward shift in supply curve from S to
S2.
ii. Decrease in SUPPLY/Leftward Shift in
supply curve: On the other hand, fall in supply
from OQ to OQ1(known as decrease in supply) at
the same price of OP, leads to a leftward shift in
supply curve from S to S1.


 Causes Of Increase In Supply
 decrease in price of related goods
 Increase in number of
firms/producers/suppliers
 Modern and latest technology
 Decrease in prices of resources
 Decrease in tax rate and increase in subsidy
 Well developed infrastructures
 Favorable natural factors
 Causes Of Decrease In Supply
 increase in price of related goods
 decrease in number of firms
 Traditional/old/outdated technology
 increase in prices of resources/wage, price of raw
materials, price of energy, machinery goods
 increase in tax rate and decrease in subsidy
 Lack of infrastructures
 unfavorable natural factors/ late or early monsoon,
bad weather
 Causes of change in supply
 Change in price of related goods
 Change in number of firms
 Change technology
 change in prices of resources
 change in tax rate and increase in subsidy
 Change in infrastructures
 change in natural factors
 Market equilibrium and Price
determination)
a. Statement (how is equilibrium price
determined?)
 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 market demand and
market supply are equal of each other.
 Price of goods and services is determined on basis of
interaction between demand and supply. This is
called the price determination.
 b. Tabular Explanation
Price (Rs/kg) Quantity Quantity Result
demanded supplied  When prices are Rs. 10 and
(kg) (kg)
Rs 8 per unit, quantity
10 10 50 Excess supplied is greater than
supply(S>D)
quantity demanded.
8 20 40 Excess  When price is Rs. 6 per unit,
supply(S>D)
quantity supplied is equal to
6(equilibriu 30 30 Equilibrium( quantity demanded.
m price) D=S)  When prices are Rs. 4and Rs
4 40 20 Excess 2 per unit, quantity demanded
demand(D> is greater than quantity
S) supplied.
 So the equilibrium price is Rs.
2 50 10 Excess 6 and equilibrium quantity
demand
(D>S) (i.e. demand and supply ) is
30 units.
 c. Graphically
P1b (S)>p1a (D)  In Fig , DD is the demand
curve sloping downward
and SS is the supply curve
sloping upward. Market is
a b in equilibrium at point E
where two curves (DD &SS)
intersect each other.
 There is excess supply at
PE (D)=PE(S)
c d price P1 and it pulls price
down until it reaches at P.
 There is excess demand at
price P2 which pushes price
P2d(D)>P2c(S) up until it reaches at P.
 Through this interaction,
market ultimately
corrected and reached at
equilibrium.
1. Effect of increase in both Demand and Supply
in the Same Proportion/Percentage/amount

 No change in equilibrium
price (price remains
constant at P) but
 increase in equilibrium
quantity from Q to Q1 .
2. Effect of Increase in Demand is more
than Increase in Supply:
 Increase in
equilibrium price
from P to P1
 increase in
equilibrium quantity
from Q to Q1.
3. Effect of Increase in Demand is less
than Increase In Supply:
 Decrease in equilibrium
price from P to P1
 increase in equilibrium
quantity from Q to Q1.
4. Effect of Increase in Market Demand on
Equilibrium Price at Constant Supply

E2
E1

 Increase in equilibrium price from P0 to P1

 Increase in equilibrium quantity from Q0 to Q1.
5.Effect of Increase in Market Supply on
Equilibrium Price at Constant Demand

E1

E2

 Decrease in price from p0 to P1

 increase in equilibrium quantity from Q0 to Q1.
Elasticity of Demand: it gives both direction and magnitude of
change in demand due to change in its determinants (price, income and price of related
goods)

 The law of demand shows the direction of change in the

demand with the change in price (As price increases
demand decreases and vice-versa). But this law does not
explain what percentage change in price leads to what
percentage change in demand (which can be explained
by the elasticity of demand).
 Thus to measure the degree (direction and magnitude) of
relationship between price and demand, we use the concept
of elasticity of demand.
 It gives the answer of by how much the demand changes as
price increases or decreases
• 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=
(price, income and price of related goods)
• Types of elasticity of demand
1. Price elasticity of demand (Ep)
2. Income elasticity of demand(Ey)
3. Cross elasticity of demand(Exy)
 1. Price Elasticity of Demand (Ep)
 Other things remaining the same, price elasticity of
demand is the ratio of the percentage change in the
demand for a commodity (Petrol) with the percentage
change in price of the same commodity (petrol).

 Ep=-

 Ep =-
 CONT………………
=-
Ep =-
Ep=-
Where,
Q1 = initial demand
Q2= final demand
P1= initial price
P2= final price
Ep= coefficient of price elasticity of demand
∆Q= Change in demand=Q2-Q1
∆P= Change in price=P2-P1
Types of Price Elasticity of Demand
1. Perfectly Elastic Demand(EP =∞. ):
 If a very small (insignificant) change in price of a good leads an
Graphically
infinitive change (huge 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 (Extreme
case).

Graphically  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.
P2  Every unit (OQ1,OQ2, and OQ3)
is sold at the same price (OP) i.e.
P3 price cannot be increased or
decreased..
Q1 Q2 Q3  Ep=-
 Ep=- =∞
2. Perfectly Inelastic Demand(Ep=0)
 If the quantity demanded is totally irresponsive (no change in demand) to the changed (increase
or decrease ) in the price of a good , then the demand is known as perfectly inelastic demand/
When the quantity demanded for a commodity doesn’t change` with the change its price
 This demand is found in case of basic necessary goods such as salt, medicines (insulin) etc.

 In the figure, DD represents

perfectly inelastic demand curve
which is parallel to vertical axis.
 Demand remains constant at OQ
as price increases from OP to OP2
or decreases from OP to OP1.
 Ep=-
Q  Ep=- =0
3. Relatively Elastic Demand (EP>1):
 If percentage change in quantity demanded is greater than the percentage change in

Graphically
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 5% and the demand of the product
decreases by 8%, then the demand would be relatively elastic

 DD represents relatively elastic demand

curve which is flatter
 This type of demand is found in case of
luxurious goods such as automobiles,
LED television, refrigerator, gold and
diamond etc./ without which we can
-5% sustain our life
 The percentage decrease in quantity
demanded is greater than the percentage
+8% increased in price.
i.e. (Q1-Q)/Q>(P1-P)/P.
 Ep=-
 When price falls from P to P1 by 5%, the
quantity demanded increases from Q to
Q1 by 8%
Q Q1
4. Relatively Inelastic Demand(EP<1):
 If percentage change in quantity demanded is less than the percentage change in price
graphically
of a good, then the demand is known as relatively inelastic demand.
 Mathematically, relatively elastic demand is known as less than unit elastic demand (E p<1).
 For example, if the price of a product increases by 8% and the demand of the product
decreases by 5%, then the demand would be relatively inelastic.

 DD represents relatively inelastic demand

curve which is steeper.
 This type of demand is found in case of
daily consumption goods/necessity/basic
goods/necessary such as rice, vegetable,
petroleum products (Petrol, diesel, kerosene,
LP Gas) clothes. (without which we cannot
sustain our life)
+8%  The percentage decrease in quantity
demanded is less than the percentage
increased in price
 Ep=-
-5%  Q1-Q/Q <P1-P/P
 When price rises from P1 to P by 8%, the
quantity demanded decreases from Q1 to Q
by 5%

Q Q1
5. Unitary Elastic Demand(EP=1)
 If percentage change in quantity demanded is exactly equal to the percentage change in

Graphically
price of a good, then the demand is known as unitary elastic demand.
 Mathematically, relatively elastic demand is known as unitary elastic demand (e p=1).
 For example, if the price of a product decreases by 5% and the demand of the product also
increases by 5%, then the demand would be unitary elastic.

 Ep=-
 DD represents unitary elastic demand
curve which is flatter
 In the figure, percentage change in
-5% quantity demand is = the percentage
change in price.
 Q1-Q/Q =P1-P/P
+5%  When price decreases from P to P1 by
5%, the quantity demanded decreases
from Q to Q1 by 5%
 Question
1. Calculate the price elasticity of demand at price Rs. 100
for the following demand curve and interpret your result:
P=300-.
2. Demand function of a product is Q=50-2P+5Y+ Ps,
where P= Price of product, Ps= price of substitute goods.
At P=Rs. 15, Ps= Rs 20 and Y=10. Calculate:
Price elasticity of demand
Income elasticity of demand
Cross elasticity of demand.
Interpret your result.
 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
(relatively inelastic) 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 such as automobiles and LED
television, refrigerator tends to be elastic.
 CONT………..
3. Time period: Good tends to have less elastic 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.
 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 (jacket)
becomes highly elastic in summer season but less in
winter season.
7.Price expectation: if the consumer feels that price of a
commodity is going to be high in near future, then
demand for such commodity becomes more elastic at
present and vice versa
 Cont..
9.Habitual/accustomed goods: The demand for
habitual goods such as wine, alcohol,
cigarettes, drugs remain relatively inelastic to
any change in price (percentage increase in
price is greater than percentage decrease in
demand).
10.Demand for complementary goods (bike
and petrol): if demand for bike is elastic,
demand for petrol will also elastic and vice
versa.
 Use/applications of price elasticity of demand in
business decision making process

1. Product Pricing:
 The concept of elasticity can be applied in determining the price
of goods and services.
 If demand for goods is elastic, the reduction in price (a price cut
will lead to an increase in sales more than proportionately,
revenue will rise. Hence, in such a case a price cut policy will be
more appropriate) leads to an increase in quantity demanded and
profit and vice-versa.
 But for inelastic demand, by putting a higher price for the
commodity, the business would be profitable (by rising a price,
no significant decrease in sales will be affected, so that total
revenue and the profit would rise. Therefore, a price rise policy
would be appropriate).
 Cont..
2.Pricing of Input (labor):
 If the demand for inputs is elastic, the
producers are prepared to offer low price
(Wage and salary) for the inputs and they are
ready to pay high price (wage and salary) for
inelastic inputs.
 CONT…………….
3. Pricing of Joint Products
 If two or more than two products are produced
simultaneously/jointly from the same investment or plant, they
are said be the joint products.(Production of more than one
products from production process).
 For example, a farmer produces both wool and meat jointly his
from his sheep farming. In such a case, it is impossible to
separate the cost of production of wool and meat and it becomes
difficult to determine the price on the basis of cost.
 At that time, the prices of wool and meat are determined on the
basis of the price elasticity of demand.
 In such a case, a producer charges high price which has low
elastic (inelastic) demand and low price which has high elastic
(elastic) demand.
 Cont…………..
4. Demand Forecasting:
 Prediction of future demand scientifically is
called demand forecasting.
 Given the elasticity of demand , it is possible
to forecast the demand for a good.
 If Ep= 10, if price decreases by 1% then
demand increases by 10% in the future and
vise-versa.
.
 CONT..
5. To Formulate Tax Policy:
 If the government aims to collect maximum revenue, then
elasticity of demand suggests imposing high tax on necessary
goods and low tax on luxurious goods. As necessary goods have
inelastic demand, increase in price following the increase in tax
does not reduce the quantity demanded which results increase in
amount of tax. As luxurious goods have elastic demand, decrease
in price following the decrease in tax increases the quantity
demanded which results increase in amount of tax.
 If the government aims to create harmonized society, then it should
charge higher tax on luxurious goods than necessary goods.
 As the richer income group of people consume luxurious goods the
high tax burdens only to richer people than poor ones
 CONT……………….
6. To formulate foreign trade policy:
 foreign trade refers to the exports and imports of goods and
services of a county with the rest of the world.
 The concept of the price elasticity of demand can be used to
formulate foreign trade policy of a country.
 For example, if the country is suffering from deficit balance
of trade (import>export), then it should try to increase the
price of those exports which have inelastic demand in foreign
countries and reduce the price of those goods which have
elastic demand.
 It helps to narrow down the deficit balance of trade.
 Cont………..
7. To formulate investment policy by the government:
 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, petroleum product etc.
8. Categorizing the goods:
 goods which have inelastic demand are related to
necessary goods and
 having elastic demand are related to luxurious goods.
 Measurement of Price Elasticity of
Demand.
1. Total Outlay (Expenditure) 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, Where P= Per
unit price and Q= quantity demanded
 Based on the direction of the change in the total
expenditure, the elasticity of demand may be
a. Elasticity of Demand Greater than Unity
(Ep>1):
 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 automobiles, gold,
diamond etc.
 b. Elasticity of Demand Equal to Unity
(Ep=1)
 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.
 It total outlay remains unchanged due to the
change in price of a commodity (rise and fall). It
is said to be a elasticity of demand equal to
unity.
 Such type of demand is not found in real life.
 c. Elasticity of Demand Less than Unity
(Ep<1)
 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
necessary goods.
 Table
P Q TE=PXQ EP
6 1 6 EP>1
5 2 10
4 3 12 EP=1
3 4 12
2 5 10 EP<1
1 6 6

 Total expenditure is Rs 6 at price Rs. 6/unit. When price decreased from Rs 6 to Rs 5,

then total expenditure increased from Rs 6 to 10. this is called Ep>1.
 Total expenditure is Rs 12 at price Rs. 4/unit. When price decreased from Rs 4 to Rs 3,
then total expenditure remains same at Rs 12. this is called Ep=1.
 Total expenditure is Rs 10 at price Rs. 2/unit. When price decreased from Rs 2 to Rs 1,
then total expenditure decreased from Rs 10 to 6. this is called Ep<1.
 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.
Total outlay
 Measurement of Price Elasticity Of
Demand
2. Point Method:
 This method is used to measure the price
elasticity of demand at any given point in the
curve.
 According to this method, elasticity of demand
will be different on each point of a demand curve.
 Thus, this method is applied when there is small
change in price and quantity demanded of the
commodity.
 I. Linear Demand Curve
 Ep =
 Let a straight line demand curve AD is given  Therefore, ∆CRB &
and it is required to measure elasticity of
∆CQ1A are similar
demand at point C on the demand curve
 In given figure, corresponding to point C on the triangles
demand curve AD, price is OP1 and demand is
OQ1.
 With a small fall in price from 0P1 to 0P2,
demand rises from OQ1 to OQ2.
 Ep at point C =
 Q1Q2=RB, P1P2=CR, 0P1=Q1C
 Ep = …………………..1 R
 In triangles CRB & CQ1A
∠CRB=∠CQ1A (Right angles)
∠RBC=∠Q1AC (Corresponding angles)
∠BCR=∠ACQ (Remaining angles)
 Cont..
 Putting the value of RB/CR in equation 1
 Ep =
 Ep = ………………..2
 Again in the triangles DP1C & CQ1A
∠DP1C=∠CQ1A (Right triangles)
∠P1CD=∠Q1AC (Corresponding angles)
∠CDP1=∠ACQ1 (Remaining angles)
∆DP1C & ∆CQ1A are similar triangles
 Cont..

 Again OQ1=P1C

 From equation 2,
 Ep =
 Ep =
 2. Point Method
a. Linear Demand Curve: The slope of
demand curve remains constant
throughout its length for linear demand
curve Perfectly elastic

 It is the ratio lower segment of demand

Relatively elastic
curve to the upper segment
 Ep=
Unitary elastic
 At point M, Ep==∞ (Perfectly elastic)
 At point A, Ep= (relatively elastic) Relatively
 At point P, Ep==1 (unitary elastic)
 At point B, Ep= (relatively inelastic) inelastic
 At point N, Ep= (Perfectly inelastic)
Perfectly
inelastic
ii. Non-linear
demand curve
•The slope of demand Ep=
does not remain
constant throughout its
length.
•DD is a non-linear
demand curve. To
measure elasticity at P
on it, the tangent MN
is drawn. Here EP =
PN/MP.
 3. Arc method: it takes average quantity and average
price to calculate Ep.Q1

-
P1

-
P2

EP= -

EP= - Q1 Q2
  If there is substantial
Cont…………… (huge ) change in price and
Where, demand, we prefer arc
ΔQ = change in quantity method instead of point
demanded = Q2 – Q1
Q1 = initial quantity method/percentage.
demanded
Q2 = new quantity
demanded
ΔP = change in price = P2 –
P1
P1 = new price
 4. Percentage Method
 Ep=-

 Ep =-
 Ep=-
 Ep =-
 Ep=-
 Suppose a demand schedule is givens as
follows:
Price (Rs) 100 80 60 40 20 0
Demand 100 200 300 400 500 600

1.Work out the price elasticity of demand for the fall in

price from Rs. 80 to Rs. 60 by using percentage and arc
method and interpret your results
2. Calculate price elasticity of demand for the increase in
price from Rs. 60 to Rs. 80 by using percentage and arc
method and interpret your results.
3. Why is elasticity coefficient in the part (1) different
from Part (2).
2. Income Elasticity of Demand (Ey):

• 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=
=
 Cont..
=
Ey =
Where,
Q1 = initial demand
Q2= final demand
Y1= initial income
Y2= final income
Ey= coefficient of income elasticity of deamnd
 Types of Income Elasticity Of Demand

1. Negative Income Elasticity of Demand

(Ey<0)
2. Zero Income Elasticity of Demand (Ey=0)
3. Positive Income elasticity of demand (Ey>0)
 income elasticity of demand greater than unity
 income elasticity of demand equal to unity
 income elasticity of demand less than unity
 Types of income elasticity of demand

Graphically
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.
 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.

• In the figure, DD represents negative

income elastic demand curve which
slopes downward from left to the
Y2 right indicating that as income
increases from OY1 to OY2 then
demand for inferior goods decreases
Y1 from OQ1 to 0Q2.
• This type of demand is found in case
of inferior goods like mansuli rice.
Q2 Q1
2. Zero Income Elasticity of Demand ( EY= 0)
 If there is no change in demand despite the change in income, it is called zero income
elasticity of demand.
 For example: In case of basic necessary goods such as salt, medicine, kerosene, LP gas,
electricity, etc. there is zero income elasticity of demand.

 In the figure, DD represents

income demand curve which
is parallel to vertical axis
indicating demand remains
Y2
constant at OQ1 whether
income increases from OY1 to
Y1 OY2 or decreases from OY1
to OY3.
 Ey = =0 (percentage change
Y3 demand is zero)
Q1
 Cont……………
 3. Positive Income Elasticity of Demand (EY>0):
 If there is a direct/positive 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.
Positive income elasticity can be further classified into three types:
Graphically
a. Income Elasticity  Greater than 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.

 In the figure, DD is a income elasticity

greater than unity curve which slopes
upward from left to the right indicating
that as income increases from Y1 to Y2 by
3% , then demand increases from Q1 to
y2 +3 Q2 by 7%.
%  Percentage increase in demand is greater
y1
than the percentage increase in income
 >
7%+  Such type of demand is found in case of
luxurious goods like automobiles, gold,
diamond.
Q1 Q2
b. Income Elasticity  Equal to Unity (EY = 1)
 If the percentage change in quantity demanded for a commodity is equal to percentage change
Graphically
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.

Y2 • In the figure, DD is a income elasticity

equal to unity curve which slopes
+5%
upward from left to the right
Y1 indicating that as income increases
from Y1 to Y2 by 5% , then demand
+5% also increases from Q1 to Q2 by 5%.
• Percentage increase in demand is
equal to the percentage increase in
Q1 Q2 income
• =
c. Income Elasticity  Less then Unity (EY < 1)
If the percentage change in quantity demanded for a commodity is less than percentage change in
Graphically
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.

• In the figure, DD is a income elasticity less

Y2 than unity curve which slopes upward from
left to the right indicating that as income
increases from Y1 to Y2 by 5% , then
+5%
demand also increases from Q1 to Q2 by
Y1 3%.
• Percentage increase in demand is less the
+3% percentage increase in income
• <
• Such type of demand is found in case of
Q1 basic goods like rice, cloth etc.
Q2
 Use of income elasticity of demand
1. Long-term business planning: in the long-run,
demand for comforts and luxury goods may tend to
highly income elastic.
2. Marketing strategy: developing marketing
strategies- whether to produce necessary or luxury
goods.
3. Housing development Strategies: on the basis of
income elasticity of demand, housing development
requirements can be predicted and construction
work can be effectively lunched upon.
 Cont..
4. Classification of goods: Inferior goods
(increase in demand due to fall in income-negative
income elasticity of demand), superior goods
(increase in demand due to rise in income- positive
income elasticity of demand), neutral goods (no
change in demand due change in income- zero
income elasticity of demand), necessary goods
(income elasticity less than unity), luxurious goods
(income elasticity greater than unity)
 Measurement Of Income Elasticity Of
Demand By Point Method
1. Linear demand curve: DD1 is the income demand curve
sloping upwards to the right and it is required to measure income
elasticity of demand at point B on it.
Cont..
Cont..
 Q. Suppose the following demand schedule
for a certain product:
1. Calculate price elasticity of demand as the price
increases from Rs.8 to Rs 14 if the income is Rs.10,
000.
2. Calculate income elasticity of demand as income
increases from Rs 10,000 to Rs.15, 000 if price is Rs.
12.
price 8 10 12 14 16

Demand when 80 64 48 32 16
income=10,000

Demand when 100 90 60 40 30

income=15,000
 Question

 Compute income elasticity of demand at

movement from B to D and D to B.
 Interpret the results.

Point A B C D E
Income (Rs/ years) 4000 6000 8000 10000 12000
Demand(units per 50 100 120 140 150
month)
3. Cross Elasticity of Demand (Exy)
• It is the ratio of percentage change in the
quantity demanded of good X to a given
percentage change in the price of the related
commodity Y.
Mathematically,
Exy =
=
= x
= x
Types of price elasticity of demand
1. Positive Cross Elasticity of Demand (Exy>0): (Case of Substitute Goods)
Graphically
 If the demand for one commodity (say, coke) and the price of another commodity (say Pepsi)
are positively related, cross elasticity will be positive.
 In other words, if demand for one commodity(say coke) increases due to increase in the price
of another commodity (say Pepsi) and vice-versa, cross elasticity will be positive.
 It is connected with substitutes goods like coke and Pepsi.

• In the figure, the demand for coke has

Price P2 increased from Q1 to Q2 as a result of
of increasing the price of Pepsi from P1 to P2.
Pepsi P1 • DD represents positive cross demand curve
which slopes upwards from left to the right
indicating a positive relationship between
Q1 Q2 price of one commodity and demand for
another one
Quantity of Coke
2. Negative Cross Elasticity of Demand: Exy<0 (Case of Complementary Goods):
 If the demand for one commodity (say, petrol) and the price of another commodity (say, car)
Graphically
are negatively related, cross elasticity will be negative.
 In other words, if demand for one commodity(say, petrol) increases due to fall in the price of
another commodity (say, car) and vice-versa, cross elasticity will be negative.
 It is connected with complementary goods like car and Petrol.

• In the figure, the demand for petrol has

Price P2
of decreased from Q1 to Q2 as a result of
car P1 increasing the price of car from P1 to P2.
• DD is a negative cross demand curve
which slopes downwards from left to the
Q1 Q2 right indicating a negative relationship
between price of one commodity and
Quantity of Petrol demand for another one
 3. Zero Cross Elasticity of Demand (Exy=0):
When the change in price of one commodity has no effect on the demand for another
commodity, the cross elasticity of demand is said to be zero.
 For instance, the price of car and demand for rice have zero cross elasticity of
demand.
Such goods are known as unrelated goods.

In the figure, there is no

change in demand for
P2 rice (OQ1) due to
Price
increase in price of car
P1
of car from OP1 to OP2 or
P3
decrease in price from
Q1
OP1 to OP3.
Demand curve becomes
Quantity of rice
parallel to vertical axis.
 Use of Cross Elasticity of Demand
1. To formulate Business Policies: Demand for raincoats increases
as price of umbrella increases and raincoat producer should
formulate business policies accordingly. Similarly, if price of
shoes decreases, the leather producer should formulate business
policies to increase the production and supply of it.
2. To classify goods and markets: The goods having positive
cross demand can be classified as substitute goods and negative
one as complementary goods.
3. Pricing strategies: if cross elasticity is response to the price of
substitutes is greater than one, it would be inadvisable to increase
the price, rather, reducing price may prove beneficial.
 Numeric question.
commodity before After
Price quantity price quantity
Samosa (X) 20 1 20 2
Pakauda (Y) 10 2 15 1

1. Calculate the cross-elasticity between samosa and pakauda.

 initial demand for samosa (Q1X)=1
 New demand for samosa (Q2x)=2
 Initial price of pakauda (P1Y)=10
 New price of pakauda (P2Y)=15
 Exy= x = x =2>0

 Interpretation: since the coefficient of cross elasticity of demand between samosa and
pakuda is positive, these two goods are substitutes. Moreover, EXY=2, one percentage
increase in price of paksuda results two percent increase in demand for samosa.
 Cont..
Find the cross elasticity of demand between
1. tea (X) and coffee (Y), and 1. P1Y=30
2. Tea (X) and sugar (Z)  P2Y=20
 Q1X=150
 Q2X=100
 Exy= x = x =1>0 (tea and coffee are
commo before after
dity substitute goods)
Price quantity price quantity 2.
 P1z=15
 P2z=20
Coffee 30 300 20 400  Q1X=150
(Y)  Q2X=120
Tea (X) 10 150 10 100  Exy= x = x = -0.6<0 (tea and sugar are
complementary goods)
Sugar 15 100 20 90
(Z)
Tea (X) 10 150 10 120
 Differences Between Price, Income And
Cross Elasticity Of Demand
Ep Ey Exy

1. It is the ratio of 1. It is the ratio of 1. It is the ratio of

percentage change in percentage change in percentage change in
demand to percentage demand to percentage demand for X good to
change in price, other change in income, other percentage change in price
things remaining the same. things remaining the same of Ygood, other things
remaining the same

2. It is generally related 2. It is generally related 2. It is generally related

with daily consumption with normal, inferior and with substitute and
goods and luxurious goods. superior goods complementary goods

3. It is of five types- 3. It is of three types- 3. It is of three types

 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 =
Ep =
 Cont..
=
Ep =
Ep=
Where,
Q1 = initial supply
Q2= final supply
P1= initial price
P2= final price
Ep= coefficient of price elasticity of supply
∆Q= Change in supply
∆P= Change in price
 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)
 1. Perfectly Elastic Supply (Es=∞)
 If a very small (insignificant) change
in price of a good leads an infinitive
change (huge change) in quantity
supplied for that good, then the
demand is known as perfectly elastic
supply.
 This is an imaginary situation and not
S found in real life (Extreme case).
 The supply curve is a horizontal
straight line and lies parallel to x-axis.
 Price remains constant at OP1 whether
supply increases from OQ1 to
OQ2 or decreases from OQ1 to OQ3.

Q3 Q1 Q2
Quantity
supplied
 2. Perfectly Inelastic Supply (Es=0)

 If the quantity supplied is totally

irresponsive (no change in supply) to the
changed (increase or decrease ) in the price
of a good , then the supply is known as
perfectly inelastic supply.
 This supply is found in case of basic
necessary goods such as salt, medicines (low
priced items) etc.
 Therefore, numerical value of elasticity
becomes zero.
 In the figure, SS is perfectly inelastic supply
P3 curve which is parallel to vertical axis.
 Supply remains constant at OQ1 as price
increases from OP to OP2 or decreases from
S OP to OP1.
Q1 Quantity
supplied
3. Unitary Elastic Supply(Es=1)

S  If percentage change in
quantity supplied is
exactly equal to the
percentage change in
price of a good, then the
+5% demand is known as unitary
elastic supply.
 The percentage increase in
+5%
quantity supplied is exactly
S equal to the percentage
increased in price .
 =
 5%=5%
4. Relatively Elastic Supply (Es>1)
 If percentage change in
quantity demanded (+5%) is
greater than the percentage
change in price (+3%)of a
good, then the supply is known
as relatively elastic demand.
 >
 This type of supply is found in
+3%
case of luxurious goods such
as automobiles, gold and
+5% diamond etc.
5. Relatively Inelastic Supply (Es<1)
S
 If percentage change in quantity
supplied (+3%) is less than the
percentage change in price
(+5%)of a good, then the supply is
known as relatively inelastic supply.
 In the figure, price has increased
+5% from O1 to P2 by 5% and supply
increases from Q1 to Q2 only by
3%.
 <
+3%  This type of supply is found in case
of necessary goods such as rice,
S vegetables etc.

Quantity supplied
 Determinates Of Price Elasticity Of
Demand
 Change in the cost of production
 Time factor
 Nature of commodity
 Availability of facilities for expanding output
 Cont..

Thank you.
Any Questions???