Chapter 3

Concept of Demand and

Demand Determinents

Course: Principles of Economics

Course Code: BSEC 1103
Department of Business Studies
Contents
1. Concept of Demand
2. Determinants of Demand
3. Demand Schedule
4. Demand Curve
5. Law of Demand
6. Exceptions to the Law of Demand
7. Reasons behind Law of Demand
8. Elasticity of Demand
9. Price Elasticity of Demand
10. Cross Elasticity of Demand
11. Income Elasticity of Demand
1. Concept of Demand
Meaning of Demand
 In Economics:

 Demand means :
 desire to have a commodity
 backed by enough money to pay for the good demanded.

 In Economics : we are concerned only with demand,

 which is effectively backed up by an adequate supply of purchasing power, i.e., with effective
demand.
 if a person desires to buy a car, he should have enough money to buy that; then only
demand becomes effective.

 a person has the desire and enough money but at a particular point of time, he may not
have willingness to buy the good due to sudden change in his taste or preference.
1. Concept of Demand
Market Demand
Market Demand:
 The total sum of : the demands of all individual consumers, who purchase
the commodity in the market.

Market Demand Schedule

 Let us assume that there are

three consumers—A, B and C.

 Market demand is the sum of

A’s, B’s and C’s demand of, say,
apples.

 That is, at lower price,

demand is more and vice
versa.
2. Determinants of Demand
Demand Determinants
 Demand for a product depends upon on number of factors.

 The most important of these are:

 The price of the product
 Income of the consumer
 Tastes and fashion
 The prices of related goods

 We can put it in the functional form as:

Dx = f (Px, I, Py, T, F…)
Where Dx = demand of good x;
Px, = price of good x;
I = income of the
consumer;
Py = prices of related
goods;
T = tastes and
2. Determinants of Demand
Demand Determinants
1. Price of the commodity:
• Price of a commodity is an important factor that determines demand for
a commodity.
• When
• price of a commodity : rises, consumers buy less
and
fall, consumers buy more.

2. Income of the consumer:

• The greater the income, the greater will be the demand for a good.
• More income means greater purchasing power.
• People can afford to buy more when their incomes rise.
• If income falls, demand for a commodity also decreases.
2. Determinants of Demand
Demand Determinants
3. Prices of Related goods:
• Related goods are of two types—substitute and complements.
1.Substitute goods 2. Complementary goods
 Can be interchangeably used.  Are demanded together.
 E.g. tea and coffee are substitute  E.g. bread and butter or car and
goods. petrol.
 If tea is dearer, one can use
coffee and vice versa.  In case of complementary goods,

 When price of a substitute for a  the change in the price of any of

good the two goods also affects the
 falls, demand of the other.
 the demand for that good
declines  For instance,
and  if demand for two-wheelers
 rises, fall,
 the demand for that good  the demand for petrol also
2. Determinants of Demand
Demand Determinants
4. Taste and preferences of the consumer:

• If tastes and preferences are :

• favorable, :
• the demand for a good will increase.
• not favorable : (goes out of fashion or people’s tastes & preferences no
longer remain favorable)
• the demand decreases.
3. Demand Schedule
Demand Schedule
 A demand schedule is :
 a tabular statement that shows the different quantities of a
commodity that would be demanded at different prices.

 It expresses : what quantities of a good will be purchased at different

possible prices.

 A demand schedule is shown as below:

Price of Quantity
apple in per demand in
unit in OMR units It is clear from the table, that when price of an apple is
OMR. 8/- the consumer demands 5 apples and when price
8 5 falls to OMR. 2/- each, demand of apples goes up to 10
6 7 units. Thus, price and quantity demanded shows inverse
4 8 relationship.

2 10
4. Demand Curve
Demand Curve
 A Demand curve is the graphical representation of the demand
schedule.
 As
 prices of apples are measured along Y-axis
and
 quantities demanded along X-axis.

 A, B, C and D are : the different combinations

of price and quantity
demanded.

 Joining these points,: we get the demand

curve “dd”
 sloping downwards to the right,
 Indicating
 inverse relationship between price
and quantity demanded.
5. Law of Demand
Law of Demand

 Expresses : the functional relationship between price and quantity

demanded of a good.

 According to this law, :

 other things remaining constant (ceteris paribus),
 if the price of a commodity
 falls
 the quantity demanded of it will rise
and
 rises
 quantity demanded will fall.

 Thus, there is inverse relationship between price and quantity demanded.

 We buy more units of apple when its price comes down from OMR 4
per unit to OMR 2 per unit.
5. Law of Demand
Assumptions : Law of Demand
 The law of demand assumes the following:

1. Incomes of consumers do not change.

 If consumer’s income increases or decreases, the law will not hold
good.

2. People’s tastes and preferences remain unchanged;

3. Prices of substitutes and complements do not change.

5. Law of Demand
Law of Demand: Explained through Demand Schedule &
Demand Curve
Demand Schedule
Price of apple per Quantity demand
 It is seen in the table that : unit in Unit
 when the price of the commodity is 8 5
 Rial. 8/- per unit, consumers buy 5
6 7
units only and
 Rial. 2/- per unit, they buy 10 units of 4 8
the commodity. 2 10
 Thus, as price
 goes down,

 consumers buy more of a commodity and

vice versa.
5. Law of Demand
Law of Demand: Explained through Demand Schedule &
Demand Curve
Demand  Along x-axis, quantity is measured and along y-axis
Curve price of the commodity is measured.

 By joining various points or combinations of price and

quantity demanded,
 we get a curve ‘dd’ : falling downwards from left
to the right.

 This is known as the demand curve.

 The demand curve :
 clearly indicates : that price is inversely related
to quantity demanded.

 As price falls, demand rises and it shrinks when

price rises.
 It is to be noted here that we have assumed
‘other factors’ to be constant.
6. Exceptions to Law of Demand
 The conditions the law of Demand does not hold. (Inverse relationship)
1. Giffen goods
 Giffen good is : a special type of inferior good whose demand increases as the price of
the good increases.

 Example :
 Rice being a staple food of China,
 it was observed that when the price of rice was lowered the poor people of China
behaved in the Giffen manner; reducing their demand for rice and in the
remaining amount purchased more meat.
 When the price of rice was increased, then the demand for rice also increased as
they reduced their purchase of meat.
2. Conspicuous Consumption
 As observed by Thorstein Veblen : the demand curve does not slope downwards.

 Sometimes people buy some products to show their status in the society.
 E.g. Diamonds and other precious stones etc.
 Rich class buys such goods at very high price to show that they belong to a
prestigious class.
6. Exceptions to Law of Demand

3. Quality is judged by its high price.

 At high prices, some people buy more of such commodity than at lower price
 thinking that high priced are better than those priced lower.

 This is out of sheer ignorance that people act in such a way.

4. Speculation
 Guesswork or prediction of a future event and act accordingly.

 If the price of commodity is increasing

and
 people expect a further rise in the price,

 they will tend to buy more of the commodity at higher price than they did at the
lower price.

 It is observed that when there is a hike in edible oil prices recently, some people
purchased more of it in the expectation that future prices will be even more
7. Reasons behind Law of Demand
1. Law of Diminishing Marginal Utility
 The law states :
 that as more of a commodity is purchased, its marginal utility to the
consumer will be less and less.
 the consumer while purchasing the commodity values less and less the
additional units of the commodity.
 he will purchase more only if price falls.

 E.g.
 Consumer derives satisfaction :
 Worth - $5 from 1st apple &
$3 from 2nd apple.
 If the price per unit of apple :
 $5 - purchase only 01unit to equalize price with utility.
 $3 each - then he will purchase 02 units.

 This shows : when price falls, the consumer purchase more.

7. Reasons behind Law of Demand
2. Income effect
 When price of a good falls, real income of the consumer rises.
 If the consumer has $15 and price per unit of apple is $5.
 Then he can purchase 3 units of apple.
 If price falls to $3 then to purchase same 3 units, the consumer
will spend $3×3 = $9.
 This leaves a surplus of $6 with the consumer.

 Thus a fall in price has the same effect of increase in money income
and hence is known as the income effect of a price reduction.
 The consumer can purchase some more units of the good with the
surplus income released through the fall in price.
 Therefore when :
 price falls - amount purchased increases.
 price rises- amount purchased decreases.
7. Reasons behind Law of Demand

3. Substitution effect
 When price of a good falls, other things remaining constant,:
 the good becomes cheaper in comparison to other goods.
 the consumer will substitute the cheaper goods for the costlier
goods so that he will gain.

E.g.
 If the price of fish
 falls :
 the consumer to some extent will substitute it for meat leading to the
rise in demand for fish.
 rises:
 the consumer to some extent will substitute it for eggs leading to the
fall in demand for fish.
8. Elasticity of Demand
Elasticity of Demand
 “Elasticity of demand is :
 the responsiveness of the quantity demanded of a commodity
 to changes in one of the variables on which demand depends.

 In other words, :
 it is the percentage change in quantity demanded
divided by
 the percentage in one of the variables on which demand depends.”

 The variables on which demand can depend on are:

1. Price of the commodity

2. Prices of related commodities
3. Consumer’s income, etc.
8. Elasticity of Demand
Types of Elasticity of Demand
 Based on the variable that affects the demand, the elasticity of demand is
of the following types.
1. Price Elasticity
2. Cross Elasticity
3. Income Elasticity

 One point to note is :

 that unless otherwise mentioned, whenever the elasticity of
demand is mentioned, it implies price elasticity.
9. Price Elasticity of Demand
Price Elasticity of Demand
 Measures : the degree of responsiveness of demand to a change in price of the
commodity.

 Prof. Alfred Marshall: had introduced the concept of elasticity of demand in the
economic theory.

 “The elasticity (or responsiveness) of demand in a market :

 is great or small according as the amount demanded increases much or little
 for a given fall in price and diminishes much or little for a given rise in price.”

 We may thus define elasticity of demand :

 as the ratio of
 the percentage change in quantity demanded
 to the percentage
percentage change in demand
change in price.
Ep 
percentage change in price
9. Price Elasticity of Demand
Cases/kinds of Price Elasticity of Demand
There are five cases/kinds of price elasticity of demand.
1. Perfectly Inelastic Demand: No response
2. Inelastic Demand: Small response
3. Unitary Elastic Demand: Response is the same (equal)
4. Elastic Demand: Greater response
5. Perfectly Elastic Demand: Unlimited response
9. Price Elasticity of Demand
Case/kinds -Price Elasticity of Demand
1.Perfectly Inelastic Demand: (No
response)
Demand for a commodity will be said to be perfectly
inelastic, if :
 the quantity demanded does not change at all
 in response to a given change in price.
E.g. If 10 % change in price results in zero % change
in demand, it is exactly inelastic demand. Sce Price Change in Q. Change in
nari (OMR Price Deman Quantity
o ) [(V2-V1)/ ded Demanded
The demand curve : V1] *100
 vertical straight line perpendicular to Y- A 5 ----- 4 ----

axis as shown in Fig. 5.1 B 4 20% 4 0% increase

decrease
C 3.75 6.25% 4 0% increase
decrease
D 2.5 33% 4 0% increase
decrease
E 2 20% 4 0% increase
decrease
F 1 50% 4 0% increase
decrease
9. Price Elasticity of Demand
Case/kinds -Price Elasticity of Demand
2. Inelastic Demand: (Small response)
 Demand for commodity will be said to be
inelastic:
 if the % change in quantity demanded is
Sce Pric Change in Q. Change in
less than the % change in price. nari e Price Dema Quantity
E.g. If 10 % change in price results in 6 % o (OM [(V2-V1)/V1] nded Demanded
change in demand, it is inelastic demand. R) *100 [(V2-V1)/V1]
*100

A 5 ----- 4 ----
B 4 20% decrease 4.2 5% increase
C 3.75 6.25% 4.7 12% increase
decrease
D 2.5 33% decrease 5 6% increase

E 2 20% decrease 5.2 4% increase

F 1 50% decrease 6 15% increase
9. Price Elasticity of Demand
Case/kinds -Price Elasticity of Demand
3. Unitary Elastic Demand: (Equal
response)
 Demand for a commodity will be said to be unit
elastic :
 if the % change in quantity demanded
equals the % change in price.
E.g. If 10 percent change in price results in 10
percent change in demand, it is unit elastic
demand.
 The demand curve in such case is called
rectangular hyperbola.

Scena Price Change in Price Q. Change in

rio (OMR) Demande Quantity
[(V2-V1)/V1] d Demanded
*100
A 5 ----- 4 ----
B 4 20% decrease 4.8 20% increase
C 3.75 6.25% decrease 5.1 6.25% increase
D 2.5 33% decrease 6.8 33% increase
E 2 20% decrease 8.2 20% increase
F 1 50% decrease 12.3 50% increase
9. Price Elasticity of Demand
Case/kinds -Price Elasticity of Demand
4. Elastic Demand: (Greater response)
 Demand for a commodity will be said to be
elastic:
 if a change in price results in a significant
change in demand for this commodity.

E.g, If 10 % change in price results in 14 %

change in demand, it is elastic demand.

Scen Price Change in Q. Change in

ario (OMR) Price Deman Quantity
[(V2-V1)/V1] ded Demanded
*100
A 5 ----- 4 ----
B 4 20% decrease 7 75% increase
C 3.75 6.25% 9 29% increase
decrease
D 2.5 33% decrease 14 56% increase
E 2 20% decrease 20 43% increase
F 1 50% decrease 35 75% increase
9. Price Elasticity of Demand
Case/kinds -Price Elasticity of Demand
5. Perfectly Elastic Demand: (Unlimited
response)
 Demand for a commodity is said to be perfectly
elastic, when :
 a small change in its price results in an
infinite change in its quantity demanded.
E.g. If 10 % change in price results in (α) percent
change in demand, it is exactly elastic demand.
 Demand curve is horizontal straight line parallel to
X-axis .
9. Price Elasticity of Demand
Case/kinds -Price Elasticity of Demand
9. Price Elasticity of Demand
Case/kinds -Price Elasticity of Demand

Percent Percenta Type of elasticity?

age ge
Change change in
in price demand
13% 5% Inelastic (less than unit elastic)
25% 0% Perfectly inelastic demand
10% 28% More than unit elastic (elastic)
44% 44% Unitary elastic demand
30% ∞% Perfectly elastic demand
4% 6% More than unit elastic (elastic)
2% 1% Inelastic (less than unit elastic)
9. Price Elasticity of Demand
Measurement of Price Elasticity of Demand

 The important methods to measure elasticity are the following:

1. Percentage method.
2. Arc method.
3. Total outlay method.
4. Point/Geometrical method.
5. Revenue method.
price ( P2)−initial price ( P1)initial price ( P1)×100

9. Price Elasticity of Demand

Measurement of Price Elasticity of Demand
1. Percentage method
 According to this method:
 percentage change in price
is compared with
 the percentage change in demand.
 Elasticity is :
 the ratio of
 the percentage change in
quantity demanded
 to the percentage change in
price
PED = % Change in Quantity Demanded
% Change in Price

% Change in Quantity Demanded = New quantity(Q2) - Initial quantity(Q1) x 100

Initial quantity(Q1)

% Change in Price = New price(P2) - Initial price(P1) x 100

Initial price(P1)
9. Price Elasticity of Demand
Measurement of Price Elasticity of Demand
1. Percentage method P ercen tag e ch an g e in q u an tity d em an d ed
P rice elasticity o f d em an d =
P ercen tag e ch an g e in p rice
Example:
If the price of an ice cream cone increases from $2.00 to $2.20 and the amount
you buy falls from 10 to 8 cones, then your elasticity of demand would be
calculated as:
PED = % Change in Quantity Demanded
% Change in Price

% Change in Quantity Demanded = New quantity(Q2) - Initial quantity(Q1) x 100

Initial quantity(Q1)

% Change in Price = New price(P2) - Initial price(P1) x 100

Initial price(P1)
9. Price Elasticity of Demand
Measurement of Price Elasticity of Demand
1. Percentage method P ercen tag e ch an g e in q u an tity d em an d ed
P rice elasticity o f d em an d =
P ercen tag e ch an g e in p rice
Exercise 1: Exercise 2:
When the price of the good is Rs. 5, the Price of the commodity X falls from Rs.5
consumer buys 20 units of that good. When per kg to Rs.4 per kg and the quantity
the price changes to Rs. 7, the quantity demanded rises from 4 kg to 6 kg.
purchased changes to 12 units. Calculate Calculate price elasticity of demand
the price elasticity of demand?
and its nature?
9. Price Elasticity of Demand
Measurement of Price Elasticity of Demand
1. Percentage method P ercen tag e ch an g e in q u an tity d em an d ed
P rice elasticity o f d em an d =
P ercen tag e ch an g e in p rice
Exercise 3:
As a result of 10 % fall in price of a good, its demand rises from 100 units to 120 units.
Find out the price elasticity of demand?
Exercise 4:
If the initial demand was 100 units. With the rise in price by Rs.5, the quantity
demanded decreases by 5 units. Elasticity of demand is 1.2.
Find out the price before the change in demand?
Exercise 5:
The consumer buys 160 units of a good at a price of Rs.8 per unit. Price falls to Rs.6
per unit. How much quantity will the consumer buys at the new price if price
elasticity of demand is (-)2 ?
9. Price Elasticity of Demand
Determinants of Price Elasticity of Demand
 The various factors upon which elasticity depends are the following:
1. Substitute goods
2. Nature of commodity
3. Number of uses of commodity
4. Possibility of postponement of consumption
5. Percentage of income spent
6. Fashion
7. Change in taste
8. Price of the commodity
9. Price Elasticity of Demand
Determinants of Price Elasticity of Demand
1. Substitute goods
 A commodity will have elastic demand if there are good substitutes for it.
 This is because when price of a good rises, a consumer will not buy the good but purchase
its substitute.

2. Nature of commodity
 Necessity goods:
 All necessities like salt, rice etc. that have no substitutes/or less substitutes will have an
inelastic demand.
 People have to purchase such commodities for their food.
 Therefore, there will be some demand despite the changes in price.

 Luxury goods:
 Demand for luxury goods, on the other hand, will be elastic.
 If prices of such commodities rise even a little, consumers refrain to buy.
 At the same time a little lowering of price of such commodities attract a large number
of consumers.
9. Price Elasticity of Demand
Determinants of Price Elasticity of Demand
3. Number of uses of commodity:
 The larger the number of uses to which a commodity can be put, the higher will be its
elasticity.
 Therefore, the demand of such goods will have elastic demand.
 E.g. milk can be used for various purposes such as for making curd, cake, sweets etc.
 When its price goes down, demand increases but a little rise in its price makes
demand fall greatly.

4. Possibility of postponement of consumption:

 If there is a possibility of postponement of consumption of a commodity, then demand will
be elastic otherwise inelastic.
 Demand for certain goods can be postponed for some time such as computers, printers,
scanners etc.
 People may wait till they become cheaper. Therefore, their demand is elastic.
 But the demand for food or electricity cannot be postponed.
 As such their demand is inelastic.
9. Price Elasticity of Demand
Determinants of Price Elasticity of Demand
5. Percentage of income spent:
• If the percentage of income spent is very less then the demand will be inelastic.
• E.g. we spend a very less amount of our total money income on things like matches, pens, pencils etc.
• If prices of such commodities rise also, our demand is not reduced. Thus, demand of such goods is
inelastic.
6. Fashion:
• Commodities, which are in fashion, will have inelastic demand.
• Fashion minded people do not compromise with price.
• Even if price is high, some people will demand more just because goods are in fashion.

7. Change in taste:
• A habitual commodity (commodity for which consumers have developed a taste )will have inelastic
demand.
• A chain smoker always requires a cigarette, whatever the price may be.

8. Price of the commodity:

• Very high priced or very low priced goods have low elasticity
• Whereas moderately priced commodities are quite high-elastic.
• If a good is very expensive, demand will not increase much even if there is little fall in its price.
• And demand will not increase even at very low prices, because people have already purchased their
requirement at low prices.
9. Price Elasticity of Demand
Determinants of Price Elasticity of Demand
DETERMINANT CONDITION TYPE OF ELASTICITY

1- Substitute goods Price rises, buy the substitute Elastic

2- Nature of commodity Basic Inelastic

Luxuries Elastic
3- Number of uses of Larger number of uses Elastic
commodity Few number of uses Inelastic
4- Possibility of Buying can be postponed Elastic
postponement Buying cannot be postponed Inelastic
5- Percentage of income Less percentage of income Inelastic
spent spent Elastic
Large percentage of income
6- Fashion In fashion Inelastic
Not in fashion Elastic
7- Change in taste Habitually used Inelastic
Not habitually used Elastic
8- Price of commodity Very high priced; very low- Low elasticity
priced High elasticity
Moderately priced
10. Cross Elasticity of Demand
Cross Elasticity of Demand
 The cross elasticity of demand :
 measures the responsiveness in the quantity demanded of one good when
the price for another good changes.

 This measurement is calculated by :

 taking the percentage change in the quantity demanded of one good
and
 dividing it by the percentage change in the price of the other good.

 If the cross elasticity of demand is positive, the products are substitute goods.
 Coke and Pepsi, iPhone and Galaxy S series, Nike and Adidas are a few
examples of substitute goods

 If cross elasticity of demand is negative, the products are complements

 Cars and gasoline, tennis balls and tennis rackets
10. Cross Elasticity of Demand
Measurement of Cross Elasticity of Demand

Exercise:
1. Product X price is increased by 10% resulting
20% increase in quantity demand of goods Y.
Calculate the elasticity of demand and
identify what kind of product is this?

2. If price of product A increased by 10 Rial

resulting decrease in quantity demand for product
B by 50 quantity. Calculate the elasticity of
demand, its nature and type of goods?

3. If product X price is 10 Rial and quantity

demand for product Y is 50 units. If price of
product X is increased to 20 Rial the demand of
product Y increased to 85 units. Calculate the
elasticity of demand, type of product and
nature?
11. Income Elasticity of Demand
Income Elasticity of Demand
 Income elasticity of demand refers to :
 the sensitivity of the quantity demanded for a certain good to a change in the
real income of consumers who buy this good.

 The formula for calculating income elasticity of demand is :

 the percent change in quantity demanded divided by the percent change in
income.

 With income elasticity of demand, you can tell :

 if a particular good represents a necessity or a luxury.
11. Income Elasticity of Demand
Income Elasticity of Demand

Exercise:
Suppose Mr. Ahmed income is 5000 Rial and demand for a product is 2000 units
when his income is increased to 7000 Rial demand for the product increased to
7500.
Calculate income elasticity of demand?
11. Income Elasticity of Demand
Normal Goods Vs. Inferior goods
Normal Goods Inferior Goods
 Normal goods are those types of goods whose  In economics, inferior goods do not mean
demand increases when a consumer’s sub-standard goods but is relates to the
income rises. affordability of the goods.
 These goods have a positive relationship with
income and demand.  These goods are the one whose demand
 A positive increase in income leads to a positive
drops with the increase in consumer’s
increase in demand. income and vice versa.
 Examples- clothes, taxis, organic food,
high-end restaurants, organic pasta,  Such goods have better quality
noodles, whole wheat, alternatives.
electronics, home appliances, and food
staples.
11. Income Elasticity of Demand
Comparison : Normal Goods Vs. Inferior goods
Normal Goods Inferior Goods

Definition Goods have a higher demand Goods have a lower demand

when their consumer’s when their consumer’s
income rises. income decreases.

Correlation Between Demand As the consumer’s income As the consumer’s income

and Income increases the demand increases the demand
increases hence positive decrease hence negative
correlation. correlation

Income Elasticity Income elasticity is positive Income elasticity is negative

in this case. herein.

Examples Cars, branded items, Bicycles, clothes, milk, bus

computer, flat-screen TV, travel etc.
etc.
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Office:: BS043
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VERSION HISTORY

Version No Date Approved Changes incorporated

04 Sem. (I)
2022/2023

47