UNIT 2

2.2 DEMAND ANALYSIS

 DEMAND – CONCEPT
 Demand is one of the forces determining price.
 Demand is an effective desire which can be fulfilled.
 Demand must satisfy following requisites:
i. Desire for a specific commodity/product;
ii. Availability of money;
iii. Willingness to spend money;
iv. Availability of the product at – a certain price; - a certain place; - a certain time.
DEFINITIONS
1. “Demand means various quantities of goods that would be purchased per time period at different prices in a
given market”. - Prof. Hibdon
2. “Demand refers to the quantities of a commodity that the consumers are able and willing to buy at each
possible price during a given period of time, other things being equal.” – Ferguson
3. “The Demand for anything, at a given price, is the amount of it, which will be bought per unit of time, at that
price”. – Benham
4. “By demand we mean the various quantities of a given commodity or service which consumers would buy in
one market in a given period of time at various prices.” – Bobber
 Thus, demand for a commodity / product is defined as the amount of that commodity/product that will be bought
per unit of time at a given price.
 Demand consists of a desire to have a product/service but a desire alone does not constitute demand unless it is
backed by ability to pay.
 However, Demand is different from desire in that:
Desire is a want/need whether we have resources or not. For e.g. I wish to have a private jet but it is just a desire if

I don’t have money.

Demand is a need for which a consumer has the ability and willingness to pay whereas Demand is always at a
price. E.g. Demand of onions @ Rs.75/kg is 1 kg but demand for onions @ Rs. 20/kg is 10 kgs.
Demand is always at a time. E.g. 5 litres of oil per month, 100 mgs of butter for a week.
 Types of Demand
• Demand is generally classified on the basis of various factors, such as nature of a product, usage of a product, number of
consumers of a product, and suppliers of a product.
• The demand for a particular product would be different in different situations.
1. Individual and Market Demand:
 It refers to the classification of demand of a product based on the number of consumers in the market.
 Individual demand can be defined as a quantity demanded by an individual for a product at a particular price and
within the specific period of time. For example, Mr. X demands 200 units of a product at Rs. 50 per unit in a week.
 The individual demand of a product is influenced by the price of a product, income of customers, and their tastes
and preferences.
 On the other hand, the total quantity demanded for a product by all individuals at a given price and time is
regarded as market demand.
 In simple terms, market demand is the aggregate of individual demands of all the consumers of a product over a
period of time at a specific price, while other factors are constant.
 For example, there are four consumers of oil (having a certain price). These four consumers consume 30 liters, 40
liters, 50 liters, and 60 liters of oil respectively in a month. Thus, the market demand for oil is 180 liters in a
month.
2. Organization and Industry Demand:
 It refers to the classification of demand on the basis of market. The demand for the products of an organization at given price
over a point of time is known as organization demand. For example, the demand for Toyota cars is organization demand.
 The sum total of demand for products of all organizations in a particular industry is known as industry demand.
 For example, the demand for cars of various brands, such as Toyota, Maruti Suzuki, Tata, and Hyundai, in India constitutes the
industry’ demand. The distinction between organization demand and industry demand is not so useful in a highly competitive
market.

3. Autonomous and Derived Demand:

 It refers to the classification of demand on the basis of dependency on other products.
 The demand for a product that is not associated with the demand of other products is known as autonomous or direct demand.
The autonomous demand arises due to the natural desire of an individual to consume the product.
 For example, the demand for food, shelter, clothes, and vehicles is autonomous as it arises due to biological, physical, and other
personal needs of consumers.
 On the other hand, derived demand refers to the demand for a product that arises due to the demand for other products.
 For example, the demand for petrol, diesel, and other lubricants depends on the demand of vehicles. Apart from this, the
demand for raw materials is also derived demand as it is dependent on the production of other products. Moreover, the demand
for substitutes and complementary goods is also derived demand.
4. Demand for Durable Goods and Non-Durable goods:
 It refers to the classification of demand on the basis of usage of goods. The goods are divided into two categories, perishable
goods and durable goods.
 Perishable or non-durable goods refer to the goods that have a single use. For example, cement, coal, fuel, and eatables.
 On the other hand, durable goods refer to goods that can be used repeatedly. For example, clothes, shoes, machines, and
buildings.
 Perishable goods satisfy the present demand of individuals. However, durable goods satisfy both present as well as future
demand of individuals. Therefore, consumers purchase durable items by considering its durability.
 In addition, durable goods need replacement because of their continuous use. The demand for perishable goods depends on the
current price of goods and customers’ income, tastes, and preferences and changes frequently, while the demand for durable
goods changes over a longer period of time.

5. Short-term and Long-term Demand:

 It refers to the classification of demand on the basis of time period.
 Short-term demand refers to the demand for products that are used for a shorter duration of time or for current period. This
demand depends on the current tastes and preferences of consumers.
 For example, demand for umbrellas, raincoats, sweaters, long boots is short term and seasonal in nature.
 On the other hand, long-term demand refers to the demand for products over a longer period of time.
 Generally, durable goods have long-term demand. The long-term demand of a product depends on a number of factors, such
as change in technology, type of competition, promotional activities, and availability of substitutes.
 The short-term and long-term concepts of demand are essential for an organization to design a new product.
 Determinants of Demand
 Determinants of demand are the factors that affect the demand for a commodity. There are factors that affect the demand at the
industry level and other factors that influence the demand for a commodity at the firm level.
 Determinants of Demand at Industry level
1. Price (Px) of the commodity: There is an inverse relationship between the Price of the commodity and its demand. When the
price of the commodity/product increases, its demand decreases and vice-versa.
2. Prices of Related Goods (Pr):
a. Substitutes- there is a direct relationship between the price of a substitute good and the demand for the commodity/good in
question. For e.g. : Tea and Coffee – if the price of coffee decreases, the demand for tea will decrease as tea will be substituted
by coffee (price of tea and income of people remaining same).
b. Compliments- there is an inverse relationship between the price of a compliment good and the demand for the commodity/ good
in question. For e.g. : Pen and Ink – if the price of pen decreases, the demand for ink/refills will increase.
3. Income (Y or I) = Income of the people/consumers (Disposable per capita income): Greater income means greater purchasing
power which means more demand and vice versa.
4. Distribution of Income: How the income is distributed in the society among various sections will determine what type of goods
will be demanded more, e.g. if there is more of middle class, there will be more demand for basic, durable and comfort goods.
5. Tastes and Preferences of Consumers: Habits, Fashion, Likes & dislikes, Trends
6. Size of Population (Number of customers): more the number of customers, greater will be the demand. For example, in an
overpopulated country, there would be more demand for necessity goods such as food grains.
7. Composition of Population (Demography): distribution of the population on the basis of Income, development/sectors (urban &
rural sector), regions, young & old, male & female.
8. Geographical Location of the buyers: Hilly areas, plains, coastal areas etc.
9. Weather conditions/seasons: winters – woollens; monsoon – umbrellas/rain coats; summers – fans, coolers, A/C etc.
10. Consumer’s expectation with regard to future price: if the consumers expect that in the near future the prices of the goods are
going to increase, then in the present the demand will increase.
11. Availability of credit: if credit is easily available, demand for vehicles, houses increases and vice versa.
12. Sociological factors: Festivals, customs, traditions, habits, literacy, social consciousness/awareness. E.g. use of computers will
depend upon the rate of literacy.
13. Business Cycle: Recession or Recovery- there will be decrease of demand in recession and demand will start to increase when
the economy starts to recover.
14. Government policies: increase in taxes reduces disposable income of the people, therefore, the demand decreases and vice-
versa.
 Determinants of Demand at Firm level
 From a manager’s point of view, it is the demand for a commodity faced by a firm which is more relevant.
 The demand for a commodity faced by a firm depends on –
a. The size of the market or the industry demand for the commodity.
b. The form in which the industry is organized [monopoly or oligopoly].
c. Number of firms in the industry.
d. Prices charged by the rival firms in the industry [substitutes].
e. Advertising expenditure by the rival firms.
 Monopoly and perfect market competition are rarely seen in the real market scenario. In the real world what we find is market
structure of Monopolistic competition and oligopoly.
 In “Oligopoly”, there are only few firms, producing a standardised (cement, steel, chemical) or differentiated (cars, soft drinks)
product. There is interdependence among the firms and therefore, Pricing, Advertising, Promotional Behaviour affect the
other firms and evoke imitation and retaliation. (commonly found structure in production sector).
 In “Monopolistic Competition”, there are many firms selling differentiated product. The firm has some degree of limited control
over the pricing. Any increase in the price would lead to a very large decline in the sales. (common in service sector).
 Thus, in these forms of market structure, the demand for the product of a firm will be affected by –
a. Changes in the number of consumers in the market
b. Consumer’s income
c. Consumer’s taste
d. Price of related goods
e. Price expectations
f. Level of advertising
g. Promotional efforts of the firm
h. Pricing and promotional policies of the other firms
i. Availability of credit
j. Type of goods that the firm sells (Durable goods have more volatile demand while non-durables/perishables have a stable
demand)
Thus, the determinants differ at industry & firm level, however, some factors are common as the firm is also a part of the industry.
 DEMAND FUNCTION
 Demand function expresses functional relationship between demand for a commodity and factors affecting it.

Dх = f (Pх, Pг, Y, T)

 Where,
f = function
Pх = Price of the commodity x
Pг = Price of the related goods (substitutes/compliments)
Y (or I) = Income of the consumers
T = Time
 We can also write demand function as QԀ = f (Pх, Pг, Y, T)
 Relationship between demand and its various determinants can be studied individually.
 In economics, for various purposes, it is useful to focus on the relationship between demand of a good and its own price while
keeping the other factors constant.
 In this case, we can write demand function as QԀ = f (Pх)
 LAW OF DEMAND
 Law of demand studies Price – Demand relationship.
 All other determinants are considered as constant.
 The Law states:
“Other things being equal, a rise in price of a commodity leads to a fall in the demand of that commodity and a fall in the price
of the commodity leads to a rise in the demand for it”.
Demand Schedule:
A table that shows the quantity demanded at each price, is called a demand schedule. 
Demand curve:
A demand curve shows the relationship between price and quantity demanded on a graph with quantity on the horizontal axis and
the price on the vertical axis. 
Demand Schedule
Price of milk Quantity demanded
(Rs.) (litres)
6 3
4 5
3 8
2 12
Demand Curve
 Why Does The Law Of Demand Operate? (Or Why Does Demand Curve Slope Downwards?)
 Demand curve slopes downward from left to right, showing the Inverse Relationship between price and demand. It is also called
the “Negative Slope of the Demand Curve”.
 Reasons for the downward sloping demand curve:
1. Law of Diminishing Marginal Utility:
 Utility is the capacity of a good to satisfy a want.
 Marginal Utility is the additional utility derived from the consumption of one more unit of that good.
 Law of diminishing utility states that, “with every increase in consumption of the commodity, its marginal utility will decrease”.
 The successive units consumed of a commodity will provide us lesser utility so we pay lesser price for that.
 A consumer will try to maximise his satisfaction by consuming more.
 He can do so by reaching a point where, “marginal utility = the price of the commodity”.
 This shows as the price decreases and the demand increases, the consumer is
Price Demand Total price Marginal
paying lesser for the additional unit consumed by him as his satisfaction has price
also decreased. 10 2 20 -
 Thus, the consumer tries to maximise his satisfaction by demanding more when 9 3 27 7
prices fall. 8 4 32 5
6 6 36 4
4 8 32 -4
2 10 20 -12
2. Income Effect
 Increase in the consumer’s income leads to an increase in the purchases.
 Decrease in the Price of the product implies that the consumer has to spend less for same quantity of the commodity.
 This implies that there is an increase in his Real Income and also an increase in his Purchasing power.
 Example: if the price of a commodity is Rs. 100, Demand at this price is 5 units, so I am spending Rs. 500. If price decreases to
Rs. 50, I will spend Rs. 250 for 5 units, therefore I save Rs.250 i.e. my Real Income or Increase in the purchasing power
(saving) increases by Rs.250. I can spend a part of this saving to buy the same commodity and rest on some other product.
3. Substitution Effect
 People substitute cheaper goods for costlier goods therefore, the demand for cheaper goods will increase.
 Example: LG washing machine and Samsung washing machine both costed Rs.50,000. Samsung reduces its price by Rs.5,000
so people will demand more of Samsung machine rather than LG.
 If the price of coffee falls, people will substitute coffee for tea thus, increasing the demand for coffee.
4. New consumers / change in number of consumers
 If the prices of a good decrease, new customers will be attracted and old customers will consume more thus, increasing its
demand.
 If the prices increase, consumers who find it difficult to cope with increased prices will not consume the product. Also some
consumers will consume less, thus, decreasing the demand.
5. Different uses of the commodity
 A product may have more than one use, but when price increases it will be used for important uses only thus, reducing the
demand. If the prices decline, the product will be used for various purposes, thus, increasing the demand. For e.g., when the
prices of sugar are high, it will be used only for preparing tea but when the prices decrease it can be used for other purposes
also, such as preparing sweets etc.
Exceptions to the Law of Demand (Contradictions to the Law of Demand)
1. INFERIOR GOODS
 An inferior good is a good whose demand decreases when consumer income rises (or demand increases when consumer income
decreases).
 If the income of the consumers increases, the demand of the inferior good does not increase because the consumers divert the
extra purchasing power (created due to increase in the income) towards purchasing more quantity of superior goods.
 An example can be of cheaper cars. Consumers generally prefer cheaper cars when their income is less. As consumer’s income
increases, the demand for cheap cars will decrease, while the demand for costly cars will increase so cheap cars are inferior
goods.
 Thus, the law of demand does not apply to inferior goods.
 A special type of inferior good, known as Giffen Good, which also disobeys the law of demand, was first noted by Sir Robert
Giffen.
 When the price of a Giffen good increases, the demand for that good increases and vice-versa.
 In 19th century in Ireland there was a rise in the price of potatoes. People were forced to reduce their consumption of expensive
items such as meat and eggs. Potatoes still being the cheapest food, in order to compensate they consumed more even though its
price was rising. This phenomenon was described as “Giffen’s Paradox”.
 Alfred Marshall also explained this concept giving the example of bread as a Giffen good.
 In early 19th century, English industrial workers consumed bread and meat. Bread was an inferior good and meat was a superior
good. increase in the price of bread made a large drain on the resources of the poorer labouring families and raised the marginal
utility of money to them so much that they were forced to curtail their consumption of meat and more expensive foods; and
bread being still the cheapest food which they could buy, they consume more and not less of it.
 Suppose, minimum monthly consumption of food grains by a poor household is 20 kg Bajra (inferior good) and 10 kg Rice
(superior good). The selling price of Bajra is Rs.5 per kg and the rice is Rs.10 per kg and the household spends its total income
of Rs.200 on the purchase of a total requirement of 30 kgs of food grains. Suppose, the price of Bajra rose to Rs.6 then the
household would be forced to reduce the consumption of rice by 5 kgs and increase the consumption of Bajra to 25 kg in order
to meet their requirement of 30 kgs
2. VEBLEN GOODS OR ARTICLES OF DISTINCTION
 This concept was given by Thorstein Veblen in 1899 and is also known as Veblen Effect.
 Veblen goods are types of luxury goods for which the quantity demanded increases as the price increases.
 This is clearly a contradiction to the law of demand.
 A higher price makes these goods more desirable. As the price increases, so does the demand for such goods, thus, resulting in
an upward - sloping demand curve.
 Veblen goods are articles of conspicuous consumption or conspicuous leisure which attract notice.
 Example: expensive watches, diamonds, jewellery, antiques etc.
 Other example of Veblen goods are goods that have Snob Appeal. They are desired by snobs because they seek to be different
by demanding excusive goods.
3. Expectation of Price change in Future
 If prices are expected to rise in future, the consumers would purchase more of that commodity even though the price is high in
order to escape himself from the pinch of much higher price in the future.
 On the other hand, if the consumer expects the price to fall in the future, then he will postpone his purchase despite less price of
the commodity in order to avail the benefits of much lower prices in the future.
 However, this contrary behaviour is only temporary.
4. Conspicuous Necessities
 There are certain commodities which have become essentials of modern life.
 These are the goods which consumer buys irrespective of an increase in the price.
 Example: TV, Refrigerator, automobiles, washing machines, air conditioners.
5. Ignorance (of consumers about quality)
 Often people feel that high-priced commodities are better in quality than low-priced commodities.
 They buy commodities that are relatively higher than the substitutes.
6. Emergencies
 During emergencies such as war, natural calamity- flood, drought, earth-quake, etc., the law of demand becomes ineffective.
 In such situations, people often fear the shortage of the essentials and hence demand more goods and services even at higher
prices.
7. Bandwagon Effect
 Here the consumer tries to purchase those commodities which are bought by his friends, relatives or neighbours.
 The consumer tries to emulate the buying behaviour of the group to which he belongs irrespective of the price.
 Example: smart phones or branded clothes or watches.
 CHANGES IN DEMAND
 In economics the terms change in quantity demanded and change in demand are two different concepts.
 Change in quantity demanded refers to change in the quantity purchased due to increase or decrease in the price of a product.
 In such a case, it is incorrect to say increase or decrease in demand rather it is increase or decrease in the quantity demanded.
 On the other hand, change in demand refers to increase or decrease in demand of a product due to various determinants of
demand, while keeping price at constant.
 Changes in quantity demanded can be measured by the movement of demand curve, while changes in demand are measured by
shifts in demand curve.
 The terms, change in quantity demanded refers to expansion or contraction of demand, while change in demand means increase
or decrease in demand.
1. Expansion and Contraction of Demand:
 The variations in the quantities demanded of a product with change in its price, while other factors are at constant, are termed as
expansion or contraction of demand.
 Expansion of demand refers to the period when quantity demanded is more because of the fall in prices of a product.
 However, contraction of demand takes place when the quantity demanded is less due to rise in the price o a product.
 For example, consumers would reduce the consumption of milk in case the prices of milk increases and vice versa.
 Expansion and contraction are represented by the movement along the same demand curve.
 Movement from one point to another in a downward direction shows the expansion of demand, while an upward
movement demonstrates the contraction of demand.
 When the price changes from OP to OP1 and demand moves from OQ to OQ1,
it shows the expansion of demand.
 However, the movement of price from OP to OP2 and movement of demand
from OQ to OQ2 show the contraction of demand.

2. Increase and Decrease in Demand:

 Increase and decrease in demand are referred to change in demand due to changes in various other factors such as change in
income, distribution of income, change in consumer’s tastes and preferences, change in the price of related goods, while Price
factor is kept constant.
 Increase in demand refers to the rise in demand of a product at a given price due to factors other than price so there can be -
a. More quantity demanded at same price or
b. Same quantity demanded at higher price.
 On the other hand, decrease in demand refers to the fall in demand of a product at a given price due to factors other than price
so there can be -
a. Smaller quantity demanded at same price or
b. Same quantity demanded at lower price

 Increase and decrease in demand is represented as the shift in demand curve.

 In the graphical representation of demand curve, the shifting of demand is demonstrated as the movement from one demand
curve to another demand curve.
 In case of increase in demand, the demand curve shifts to right, while in case of decrease in demand, it shifts to left of the
original demand curve.

 In the Figure, the movement from DD to D1D1 shows the increase in demand with price at constant (OP).
 However, the quantity has also increased from OQ to OQ1.
 Thus, Demand curve is shifting from left to right (outwards).

 In the Figure, the movement from DD to D2D2 shows the decrease in demand with price at constant (OP).
 However, the quantity has also decreased from OQ to OQ2.
 Thus, Demand curve is shifting from right to left (inwards).
ELASTICITY OF DEMAND
 Demand extends or contracts respectively with a fall or rise in price.
 This quality of demand by virtue of which it changes (increases or decreases) when price changes (decreases or increases) is
called Elasticity of Demand.
 Definitions
 “Elasticity of demand measures the responsiveness of demand to changes in price”. – Kennith Boulding

 “Elasticity of Demand is a measure of the relative change in the amount purchased in response to any change in price or a
given demand curve”. - Meyers

 “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”. – Dr. Marshall.

 Elasticity means sensitiveness or responsiveness of demand to the change in price.

 Thus, Elasticity answers how much the demand is flexible.
 This change, sensitiveness or responsiveness, may be small or great.
 For example in case of salt, even a big fall in its price may not induce an appreciable extension in its demand.
 On the other hand, a slight fall in the price of mangoes may cause a considerable extension in their demand.
 That is why we say that the demand in the former case is ‘inelastic’ and in the latter case it is ‘elastic’.
 The demand is elastic when with a small change in price there is a great change in demand; it is inelastic or less elastic when even
a big change in price induces only a slight change in demand.
 Types of Elasticity:
 Elasticity can be categorized into following types:
1. Price Elasticity,
2. Income Elasticity and
3. Cross Elasticity. 
I. PRICE ELASTICITY
 Price Elasticity is the responsiveness of demand to change in price;
 Income elasticity means a change in demand in response to a change in the consumer’s income; and
 Cross elasticity means a change in the demand for a commodity owing to change in the price of another commodity.
 Price Elasticity is simply referred to as Elasticity of demand (as price is the most influential and changeable factor).
 According to Kenneth Boulding:
“Elasticity of Demand measures the responsiveness of
demand to changes in price”. E.O.D. = Proportionate change in demand
Proportionate change in price

OR

E.O.D = q/q = ( q / q) X (p / q)
p/p
= (q / p) X p/q
Example:
Price of sugar is Rs. 5/kg and the quantity demanded at this price is 15 quintals.
If price falls to Rs.4 /kg, then the quantity demanded is 30 quintals.

Ep = Proportionate change in demand

Proportionate change in price

Proportionate change in Demand = change in demand / original demand = (30 – 15) / 15 = 15/15 = 1
Proportionate change in Price = change in price / original price = (5-4)/5 = 1/5
EOD (Ep) = = 5
This implies that demand of sugar is highly elastic. With a slight change in price there is a great change in demand.
 Degrees (or types) of Price Elasticity
1. Perfectly Elastic (Infinitely Elastic) Demand
 A small change in price leads to an infinite change in quantity demanded.
 Slightest increase in price contracts the demand to zero and slightest fall in price expands the demand to infinity.
 Demand, in this case, is hyper sensitive and Elasticity is Infinity.
 This is an extreme case of elasticity and is rarely found in practice.
 The demand curve is a horizontal straight line parallel to the X axis.
 Ep = α
 We can see in the figure, the horizontal straight line DD ՛ shows infinite elasticity of
demand. Even when the price remains the same, the demand goes on changing.
2. Perfectly Inelastic (Zero Elastic) Demand
 The other extreme limit is when demand is perfectly inelastic.
 Whatever the change in the price, Demand remains same, it does not change.
 In this case, the demand is not sensitive at all and Elasticity is zero. Ep = 0
 Demand curve is vertical straight line parallel to Y axis.
 We can see in the figure, the Vertical straight line DD ՛ shows perfectly inelastic demand.
 Even if the price changes, the demand remains the same.
 This is an extreme case of Inelasticity and is rarely found in practice.
3. Unit Elasticity of Demand (Unitary Elastic)
 Proportionate change in price will lead to an equally proportionate change in demand.
 p/p q/q
 Here, Elasticity is said to be unitary.
 Ep = 1
 Here the demand curve takes the shape of a Rectangular Hyperbola and the rectangles
formed under the hyperbola are equal.
 For example; 20% decrease in price leads to a 20% increase in demand. So Ep = 20/20 = 1
4. Relatively Elastic (Highly Elastic Demand)
 Demand is said to be very elastic when even a small change in the price of a commodity leads to a considerable extension/con­
traction of the amount demanded of it.
 Elasticity lies between 1 to infinity.
 Ep > 1
 E.g. Petrol, Durable goods; slight fall in price leads to a large proportionate
increase in quantity demanded of these articles.
 In Fig., DD’ curve illustrates such a demand.
 As a result of change of T in the price, the quantity demanded extends/contracts
by MM’, which clearly is comparatively a large change in demand.
5. Relatively Inelastic (Less than Unit Elastic)
 When even a substantial change in price brings only a small extension/contraction in demand, it is said to be less elastic.
 Elasticity lies between 0 and 1.
 Ep < 1
 E.g. Perishable Goods, Salt. With a considerable fall in the price there is only
a small increase in quantity demanded.
 In Fig., DD’ shows less elastic demand.
 A fall of NN’ in price extends demand by MM’ only, which is very small.

Question: A consumer buys 50 units of a good at Rs. 4 per unit. When its price falls by 25%, its demand rises to 100 units. Find
out the price elasticity of demand.
Solution: Ep = (% in q) / (% in p)
% in q = (100 -50) / 50 * 100 = 50/50 * 100 =100%
% in p = 25% (given)
Ep = 100/25 = 4
Ep = 4 > 1 therefore, the demand is highly elastic.
II. INCOME ELASTICITY
 Income Demand :
“Other things being equal, income demand indicates the relationship between income of the consumer and quantity of commodity demanded.”
 There is a direct relationship between Income and Demand.
 As income increases, the quantity demanded of a commodity increases and vice versa.
Income Elasticity of demand
“Income elasticity of demand means the ratio of the percentage change in the quantity demanded to the percentage in income”-Watson.
Ey = Percentage change in quantity demanded/Percentage change in income
Percentage change in quantity demanded = New quantity demanded (∆Q)/Original quantity demanded (Q)
Percentage change in income = New income (∆Y)/original income (Y)
Therefore, the income elasticity of demand can be symbolically represented as:
 ey = (∆Q/Q) / (∆Y/Y)
 ey = ∆Q/Q * Y/∆Y
 ey = ∆Q/∆Y * Y/Q
Change in demand (∆Q) is the difference between the new demand (Q1) and original demand (Q).
It can be calculated by the following formula:
∆Q = Q1 – Q
Similarly, change in income is the difference between the new income (Y1) and original income (Y).
It can be calculated by the following formula:
 The formula for measuring the income elasticity of demand is same as price elasticity of demand.
 The only difference in the formula is that in the income elasticity of demand, income (Y) is substituted as a determinant of
demand in place of price (P).
 Let us understand the concept of income elasticity of demand with the help of an example.
Suppose the monthly income of an individual increases from Rs. 6,000 (Y) to Rs. 12,000 (Y1). Now, his demand for clothes
increases from 30 units (Q) to 60 units (Q1).
The income elasticity of demand can be calculated as follows:
ey = ∆Q/∆Y * Y/Q
∆Q = Q1 – Q = 60 – 30 = 30 units
∆Y = Y1 – Y = 12000 – 6000 = Rs. 6000
ey = 30/6000 * 6000/30 = 1 (equal to unity)
 Types (or degrees) of Income Elasticity of Demand:
1. Positive Income Elasticity of Demand:
 Refers to a situation when the demand for a product increases with increase
in consumer’s income and decreases with decrease in consumer’s income.
 The income elasticity of demand is positive for normal goods.
 In this case, the income demand curve will have a Positive Slope from
left to right moving upwards.
The positive income elasticity of demand can be of three types, which are discussed as follows:
a. Unitary Income Elasticity of Demand
 Implies that positive income elasticity of demand would be unitary when the proportionate change in the quantity demanded is
equal to proportionate change in income.
 For example, if the income increases by 50% and demand also rises by 50%, then the demand would be called unitary income
elastic of demand.
 In such a case, the numerical value of income elasticity of demand would be more than one (e y = 1).

b. More than Unitary Income Elasticity of Demand

 Implies that positive income elasticity of demand would be more than unitary when the proportionate change in the quantity
demanded is more than proportionate change in income.
 For example, if the income increases by 50% and demand rises by 100%.
 In such a case, the numerical value of income elasticity of demand would be more than one (e y>1).

c. Less than Unitary Income Elasticity of Demand

 Implies that positive income elasticity of demand would be less than unitary when the proportionate change in, the quantity
demanded is less than proportionate change in income.
 For example, if the income increases by 50% and demand increases only by 25%.
 In such a case, the numerical value of income elasticity of demand would be less than one (e y<1).
2. Negative Income Elasticity of Demand
 Refers to a kind of income elasticity of demand in which the demand for a product decreases with increase in consumer’s
income.
 The income elasticity of demand is negative for inferior goods, or Giffin’s goods.
 For example, if the income of a consumer increases, he would prefer to purchase wheat instead of millet.
 In such a case, the millet would be inferior to wheat for the customer.
 Figure shows that when income is Rs. 10, then the demand for goods is 4 units. On the other hand, when the income increases
to Rs. 20, then the demand is 2 units.
 In the Figure, the slope of the curve is downward from left to right, which indicates that the increase in income causes decrease
in demand and vice versa.
 Therefore, in such a case, the elasticity of demand is negative.
3. Zero Income Elasticity of Demand:
 Refers to the income elasticity of demand whose numerical value is zero.
 This is because there is no effect of increase in consumer’s income on the demand of product.
 The income elasticity of demand is zero (ey = 0) in case of essential goods.
 For example, salt is demanded in same quantity by a high income and a low income individual.
 Figure shows that when income increases from Rs. 10 to Rs. 20, then the demand for goods is remain same, 4 units.
 In the Figure, the slope of the curve is parallel to Y-axis (income side), which indicates that the increase in income causes no
effect in demand.
 Therefore, in such a case, the elasticity of demand is zero.
III. CROSS ELASTICITY OF DEMAND
 It is the ratio of proportionate change in the quantity demanded of Y to a given proportionate change in the price of the related
commodity X.
 It is a measure of relative change in the quantity demanded of a commodity due to a change in the price of its substitute /
complement.
“The cross elasticity of demand is the proportional change in the quantity of X good demanded resulting from a given relative
change in the price of a related good Y” . – Ferguson
“The cross elasticity of demand is a measure of the responsiveness of purchases of Y to change in the price of X”. – Leibafsky
 It can be expressed as:
 Cross elasticity may be infinite or zero if the slightest change in the price of X causes a substantial change in the quantity
demanded of Y.
 It is always the case with goods which have perfect substitutes for
one another.
 Cross elasticity is zero, if a change in the price of one commodity will
not affect the quantity demanded of the other.
 In the case of goods which are not related to each other, cross elasticity
of demand is zero.
 Cross Elasticity of goods can be calculated as shown -
 Types of Cross Elasticity of Demand

1. Positive
 When goods are substitute of each other then cross elasticity of demand is positive.
 In other words, when an increase in the price of Y leads to an increase in the demand of X.
 For instance, with the increase in price of tea, demand of coffee will increase.
 In the fig. quantity has been measured on OX-axis and price on OY-axis.
At price OP of Y-commodity, demand of X-commodity is OM. Now as price of Y commodity
increases to OP1 demand of X-commodity increases to OM1. Thus, cross elasticity of demand is positive.

2. Negative
 In case of complementary goods, cross elasticity of demand is negative.
 A proportionate increase in price of one commodity leads to a proportionate fall in the demand
of another commodity because both are demanded jointly.
 In the fig. quantity has been measured on OX-axis while price has been measured on OY-axis.
When the price of commodity increases from OP to OP1 quantity demanded falls from OM to OM1.
Thus, cross elasticity of demand is negative.
3. Zero
 Cross elasticity of demand is zero when two goods are not related to each other (Independent Goods).
 For instance, increase in price of car does not effect the demand of cloth.
 Thus, cross elasticity of demand is zero.
 It has been shown in the fig.

 Therefore, Cross Elasticity depends upon substitutability of goods.

 If substitutability is perfect, cross elasticity is infinite;
 if on the other hand, substitutability does not exist, cross elasticity is zero.
 In the case of complementary goods like jointly demanded goods cross elasticity is negative.
 A rise in the price of one commodity X will mean not only decrease in the quantity of X but also decrease in the quantity
demanded of Y because both are demanded together.
 Uses of the Concept of Elasticity
1. It is useful in determination of the price of the commodities.
2. It is used for price discrimination in the Monopoly form of firm.
3. It is useful for Determination of the sales policies of super markets. e.g. they may charge lower price for goods whose demand
is highly elastic. This will increase the volume of sales which helps them to recover the marketing cost.
4. It is useful in factor pricing. E.g. workers producing products having inelastic demand can easily get their wages raised than
those producing products with elastic demand.
5. It is useful for the government for formulating taxation policies.
6. It is useful in Pricing public utilities like water, electricity etc.