Theory of Demand

Prof. Hanumant Yadav

HNLU Raipur

Prof. H. Yadav 1
 Demand denotes the quantity demanded
of a product at a given price per unit of
time.
The law of demand states that quantity
of a product per unit of time increases
when it price falls, and decreases when
its price increases.
Law of demand states nature of
relationship between price and demand
of a product.
Prof. H. Yadav 2
The demand curve has a negative slope,
consistent with the law of demand.

Prof. H. Yadav 3
 Demand Function states quantitative
relationship between price and
demand of a product.
ELASTICITY OF DEMAND is the
responsiveness of demand for a
product to the change in its
determinant is called the

Prof. H. Yadav 4
1. Price Elasticity : Elasticity of demand for a
commodity with respect to change in its
price.
2. Income Elasticity : Elasticity of demand with
respect to change in consumers income.
3. Cross Elasticity : Elasticity of Demand for a
commodity with respect to change in the
price of its substitutes.

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 The price elasticity of demand is defined as
the degree of responsiveness of a demand for
a commodity to the change in its price.
Price Elasticity of demand is percentage
change in the quantity demanded of a
commodity as a result a certain change in
price.
Percentage change in quantity demanded
Ep =-----------------------------------
Percentage change in price

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 Elasticity declines along
demand curve as we
9 move toward the quantity
8 Ed > 1 axis
7
6 Ed = 1
5
4
3 Ed < 1
2
1 Ed = 0
0 1 2 3 4 5 6 7 8 9 10 Quantity

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1. Perfectly inelastic demand : Ep = 0
No change in demand due to change in price of a product.
2. inelastic demand : Ep less than (-)1 Quantity
demanded changes less than the proportionate change.
3. Unitary Elastic Demand : Ep = (-) 1
Quantity demanded changes with the proportionate change
in price.
4. Elastic Demand : Ep : more than (-) 1
Quantity demanded changes more than the proportionate
change in price
5. Infinitely elastic demand : Ep = infinite

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 The demand curve is horizontal, any change in
price can and will cause consumers to change
their consumption.

Perfectly
inelastic
demand curve

0 Prof. H. Yadav

Quantity 9
2. Quantity demanded changes with the
proportionate change in price.

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The quantity changes enormously in
response to a proportional change in price
(E = ).

Infinitely
elastic demand
curve

0
Quantity

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 The measure of price elasticity (Ep) is called
coefficient of price elasticity.
Consumer can buy any quantity and seller
can sell any commodity with the change in
the price of product.

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1. Availability of substitutes
2. Nature of commodity
3. Proportion of income spent on a
commodity
4. Time Factor
5. Range of alternative uses of a commodity

Prof. H. Yadav 13
 The supply of a product refers to the
various quantities of the product, which a
seller is willing and able to sell at different
prices in a given period of time.
Supply is also affected by several other
factors other than the price. Cost of
production is most important among them.

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 The factors other than price which influence
the supply are known as determinants of
supply such as :
1. Cost of production :
An increase in cost of production leads to
decrease in supply and vice versa.
2. Availability of other products
The producer supplier can switch over their
production to any of their complementary and
substitute product if their cost of production is
less.

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3. Climatic changes
When climatic conditions are favourable
production is usually more which may lead
to fall in costs leading to increase in supply.
4. Changes in Government policies
A rise in taxes has immediate affect on the prices of
commodity leading to rise in cost of production
resulting fall is supply
All the determinants are directly and indirectly
related with the cost of production.

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 The law of supply holds that other things
equal, as the price of a good rises, its
quantity supplied will rise, and vice versa.

Why do producers produce more output when

prices rise?
They seek higher profits
They can cover higher marginal costs of production

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The supply curve has a positive slope,
consistent with the law of supply.
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 Supply Function states quantitative
relationship between price and supply
demand of a product.
It can be stated in the following form :
Qx = f (P)
The supply function in the long run :
Q x = f ( P, C, Z, G)
Where Q is Supply (Quantity Supplied)
P is price, C is cost of production, Z is price of
complimentary and substitute goods, Govt. policy)

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1. Perfectly inelastic supply : Ep = 0
No change in supply due to change in price of a product.
2. inelastic supply : Ep less than 1
Quantity supplied changes less than the proportionate
change.
3. Unitary Elastic Supply : Ep = 1
Quantity supplied changes with the proportionate change in
price.
4. Elastic Supply : Ep : more than 1
Quantity supplied changes more than the proportionate
change in price
5. Infinitely elastic supply : Ep = infinite

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 A change in any variable other than price that
influences quantity supplied produces a shift
in the supply or a change in supply which is
depicted by Supply Curve.
Factors that shift the supply curve include:
Change in input costs
Increase in technology
Change in size of the industry

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For an given rental price, quantity supplied is
now lower than before.

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 In economics, an equilibrium is a
situation in which:
there is no inherent tendency to change,
quantity demanded equals quantity
supplied, and
the market just clears.
Market equilibrium is a situation
where demand and supply are equal.

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Equilibrium occurs at a price of $3 and a
quantity of 30 units.

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The shift in the supply curve moves the market equilibrium from
point A to point B, resulting in a higher price and lower quantity.

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 Legal Economics is composition of two words
: LEGAL and ECONOMICS.
LEGAL : Two concepts :
1- Matters related to principles and practices
of Law : e.g. Legal action, Legal advisor,
Legal matter, 2-
Activities and instruments accepted or
sanctioned by law : Legal activity, Legal
document,

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 Law is rule of conduct or procedure
established by custom, agreement
or authority.
Law is a rule of conduct or
procedure established and enforced
by the Authority, Legislation or a
custom of a given community, State
or nation.

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 Natural Law : A law whose content is set by nature and
hence has validity everywhere.
Physical Law : A scientific generalisation based on
empirical observations of physical behaviour.
Rule of Law : The principles that restricts Government
authority
Laws of Science : Absolute and inarguable facts of the
physical world.
Religious Law : Ordering principles of reality as revealed
by God defining and governing all human affairs.

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 Law (Principles) : Principles that describes
the fundamentals of something.
Scientific generalisation of theories of social
sciences with empirical observations,
evidences, facts and figures are known as
Laws.
Economic Laws : Universally accepted
theories of Economics. e.g. Law of demand,
law of diminishing return, etc.

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 Economics is the study of economic
activities of human beings.
Economics Activities are broadly divided in
to four categories : Consumption,
Production, Exchange, and Distribution.
Economic activities are governed or
regulated by the State hence Economic
activities of the State is also subject matter
of Economics, particularly Public Finance.

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 Economics is the study of how
individuals and societies choose to
use the scarce resources that nature
and previous generations have
provided.
Economics studies how people
make choices.

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 Economic laws are Government laws related
to economic activities of individuals,
organizations and corporate body; such as
Business laws, Land laws, labour laws,
banking laws, etc.
Government Laws:
Command, enforced by a sanction, universal
application, changeable by legislation.

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 Laws of Economics are accepted theories of
Economics pertaining to economic behaviour
of mankind with certain exceptions, such as
Law of Demand, Greshams law, .
Based on actual behaviour of mankind,
General appliaction, No binding on all the
citizens.

Prof. H. Yadav 36
1. Knowledge of fundamentals of Economics is
necessary for framing the Government laws
for regulating the economic activities,
Foreign Exchange, Commodity Market,
Monopolistic practices in the market, etc.
2. Knowledge of Economics is necessary for
specialisation .in various fields: Company
law, Contract law, Labour laws, Consumer
laws, taxation laws, International laws, etc.
3. To understand economic behaviour of
mankind :e.g. Consumer behaviour, Market
behaviour,

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4. The study of economics teaches a way of
thinking for making decisions:
Consumer, producer, trader all make
rational decisions. Three most fundamental
concept of economics : Opportunity Cost,
Marginalism and efficient markets help to
learn a way of thinking.
5. Learning of economics is necessary for
understanding society. Most of the theories
are based on the observation of happenings
in the society .

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6. An understanding of economics is essential
to an understanding of global affairs,
namely WTO, IPR, Dumping, Foreign
collaborations, Foreign Direct Investment,
Exchange rate, etc.
7. The study of economics helps to become an
informed citizen.

Prof. H. Yadav 39
 Classical Economists : Adam Smith : Wealth
of Nations (1776)
Neo-Classical Economist : Alfred Marshall :
Principles of Economics (1899)
Marxist : Karl Marx : Das Kapital 1880
J. M. Keynes : General Theory of
Employment, Interest and Money.

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 1. Micro Economics : It examines the
functioning of individual decision making units
i.e. business firms, and house holds. It
studies price theory and market.
2. MACRO ECONOMICS examines the economic
behaviour in aggregates i.e. Economy is a
whole. It studies Income, employment, output
on a national scale.
Micro economics studies individual trees while
Macro Economics studies forests.

Prof. H. Yadav 41
 Economy denotes activities related to the
production and distribution of goods and
services in a particular geographic region."
Three major economies:
1. Market Economy ( capitalist economic
system)
2. Controlled / Directed economy / Planned
Economy (Communism)
3. Mixed Economy

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 Primitive Economy : Self reliant economy. Households used
to produce for their own consumption.
Modern Economy : Knowledge based economy .
Planned Economy : Socialist economic system
Traditional economy (a generic term for the oldest and
traditional economic systems)
Participatory economics (a recent proposal for a new
economic system)
An economic system can be considered a part of the social
system and hierarchically equal to the law system, political
system, cultural system, etc.

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 An economic system is a particular set of
social institutions which deals with the
production, distribution and consumption of
goods and services in a particular society.
The economic system is composed of people,
institutions and their relationships to
resources, such as the convention of
property.

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 Capitalism : Free economy.
Communism : Factors of production are
controlled by the State. Monopoly of public
undertakings.
Socialism : Social ownership/Cooperative
ownership. As a matter of fact
communist State claims themselves as
socialist State.

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THEORIES :
1. Making Behavioural assumptions on the
basis of thoughts, observations, experience,
2. Deriving logical deductions with the help
of mathematical and statistical tools.
3. Testing the validity of theories with the
help of statistical tools and techniques.

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 Tabular and Graphical Analysis
Percentages
Averages : Measure of Central tendency
Variation : Deviation from Average
Correlation : Relationship between variables
Functional Analysis : Regression
Trend : Time series analysis
Input-output Analysis

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Year Steel Cement Aluminium

1990-91

1995-96

2000-01

2005-06

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90
80
70
60
50 East
40 West
North
30
20
10
0
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr

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 Trend of cement production in Chhattisgarh

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 MAYERS -
Consumption is the direct and final use of
goods and services in satisfying the wants of
human being.
Meaning of Wants : Wants are effective desire
of human beings.
Meaning of Utility : Utility is capability of
satisfying the wants.

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 Consumer behaviour theory explains the
relationship between changes in the price and
consumer demand in the one hand and
demand and income of the consumer on the
other hand.
Consumer behaviour theory assumes that every
individual tries to maximize his satisfaction by
consuming products and services with the
limited income available to him at a particular
time.

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 The income constraint or budget constraint
limits the consumer from satisfying all his
preferences and forces him to make choices.
A rational consumer allocates his spending in
such a way that the preferred combination
gives him the highest utility.

Prof. H. Yadav 53
 Demand denotes the quantity demanded of a
product at a given price per unit of time.
The law of demand states that quantity of a
product per unit of time increases when it
price falls, and decreases when its price
increases.
Law of demand states nature of relationship
between price and demand of a product.
Demand Function states quantitative
relationship between price and demand of a
product.

Prof. H. Yadav 54
 The responsiveness of demand for a product to
the change in its determinant is called the
ELASTICITY OF DEMAND.
Three kinds of Price Elasticities :
1. Price Elasticity : Elasticity of demand for a
commodity with respect to change in its price.
2. Income Elasticity : Elasticity of demand with
respect to change in consumers income.
3. Cross Elasticity : Elasticity of Demand for a
commodity with respect to change in the price
of its substitutes.

Prof. H. Yadav 55
 The price elasticity of demand is defined as
the degree of responsiveness of a demand for
a commodity to the change in its price.
Elasticity of demand is percentage change in
the quantity demanded of a commodity as a
result a certain change in price.
Percentage change in quantity demanded
Ep =-----------------------------------
Percentage change in price

Prof. H. Yadav 56
 There are two approaches to measure
utility:
Cardinal approach : According to Marshall,
utility can be measures and quantified. The
unit is termed as utils.
This approach expresses how much money
a consumer is willing to pay for a given unit
of product.
Various theories of economics are based on
this approach, namely, law of diminishing
utility, law of equi-marginal utility.

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 Ordinal approach : Economist J.R. Hicks and
P.G.D. Allen opined that utility cannot be
measured, but can be compared by ranking in
order of preferences.
Consumer makes qualitative preferences.
JR Hicks has explained this approach with the
help of indifference curve.
Assumptions : 1- Customer is consistent in
ranking, 2. The preference of customer is
based on the choice of product available.

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 According to Prof. K.E. Boulding :
The Marginal Utility of any quantity of a
commodity is the increase in total utility
which results from a unit increase in
consumption.
Average Utility : Average utility is obtained
by dividing the total utility of commodity
consumed by number pf units consumed.

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 The measure of price elasticity (Ep) is called coefficient of price
elasticity.
Type of Price Elasticity
----------------------------------
1. Perfectly inelastic demand : Ep = 0
No change in demand due to change in price of a product.
2. Inelastic demand : Ep less than 1 or ( 0.1 to 0.9) :
Quantity demanded changes less than the proportionate change.
3. Unitary Elastic Demand : Ep = 1
Quantity demanded changes with the proportionate change in price.
4. Elastic Demand : Ep : more than 1 Quantity demanded
changes more than the proportionate change inprice
5. Infinitely elastic demand : Ep = infinite
Consumer can buy any quantity and seller can sell any commodity
with the change in the price of product.

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1. Availability of substitutes
2. Nature of commodity
3. Proportion of income spent on a
commodity
4. Time Factor
5. Range of alternative uses of a
commodity

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1. Availability of substitutes
2. Nature of commodity
3. Proportion of income spent on a
commodity
4. Time Factor
5. Range of alternative uses of a commodity

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 Consumption of X commodity

No. of Marginal Total Utility Average

units Utility of X of X Utility of X
1 25 25 25.0

2 20 45 22.5

3 15 60 20.0

4 10 70 17.5

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 As a consumer increases the consumption
of any commodity keeping intact the
consumption of all other commodities, the
marginal utility of the variable community
eventually declines. K. E. Boulding
The marginal utility of a stock of similar
goods decreases with the increase in the
number of units in the stock. Briggs

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 As the consumer on consuming more and
more units of the same product, his utility
level goes down and he pays less for the
same commodity.
The total utility increases but a diminishing
rate.

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 The law of equimarginal utility states that the
consumer will spend his money income on
different products in such a way that the
marginal utility of each product is proportional
to its price.
MUx = Px, MUy = py, MUz = Pz
Consumer will go on consuming the product
till he reaches a point where MUx=Px.
Maximum satisfaction level : MUx=MUy=MUz

Prof. H. Yadav 66