# Demand

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```							        Chapter 3

Demand and Its Application
What is demand
 Demand   refers to the quantities of a
good that purchasers are willing and
able to buy at various prices per period
of time, other things remaining
constant
Elements of demand
 Willingness

 Ability

 Price

 Quantity

 Time

 Other   things being equal
Demand Schedule for Broccoli
Law of demand - A Downward Sloping Demand
Curve. higher the price, lower the demand
Determinants of demand
   Price
   Price of related good (Substitute &
Complementary)
   Income
   Tastes and preferences
   Other factors (fashion, future expectation,
population, weather, distribution of income,
Demand function
   Dx = f (Px ;Py; Y; T………)

 Dx = Demand for X commodity
 f = function of ( or depends upon)
 Px = Price of X commodity
 Pr = Price of related commodity
 Y = Consumer’s income
 T = Taste of consumer
Why demand curve slopes downwards
Market Demand Curve
 Market or aggregate         Px Qd1 Qd2 Qd3 Mar
demand for a                               ket
commodity gives
alternative amounts of      6   9    18   30   57
commodity demanded
by all individuals in the
market                      5   10   20   32   62
 Exceptions:
Bandwagon effect
4   12   24   36   72
Snob effect
Increase/decrease in demand vz
extension/contraction
Exceptions to law of demand
 Inferior goods
 Veblen goods – rare goods
 Necessities of life
 Future expectation regarding price rise
 Abnormal conditions as floods, famine etc
 Hobbies
Supply
 Supply refers to the quantities of a
product that suppliers are willing and
able to sell at various prices per unit of
time, other things remaining the same
Supply of Broccoli
Law of Supply - Upward sloping Supply Curve of
Broccoli
Factors affecting supply
   Quantity
   Product – perishable vz non perishable
   Suppliers
   Technology
   Time period
   Storage facilities
   Cost of production
Equilibrium in the Broccoli Market
How equilibrium price is set
Price Q          Q         Surplus/   Pressure on
Demand     Supply    shortage   price
1.2    100,000   400,000   +300,000   downward
1.1    125,000   350,000   +175,000   downward
1.0    150,000   300,000   +150,000   downward
.9     175,000   250,000   +75,000    downward
.8     200,000   200,000   0          equilibrium
.7     225,000   150,000   -75,000    upward
.6     250,000   100,000   -150,000   upward
.5     275,000   50,000    -225,000   upward
Demand, supply and shifts in
equilibrium
 Demand Shift
 Supply Shift

 Effect on equilibrium

E.g. Changes in demand and supply and price of
PCs
Elasticity
“The price elasticity of demand is a measure of how
much the quantity demanded of a good responds
to a change in the price of that good”

Determinants:
Availability of close substitutes
Necessities vs luxuries
Definition of the market
Time horizon
Proportion of Income spent
What is income and cross elasticity
   “The income elasticity of demand (e i) = is a measure of
how much the quantity demanded of a good responds to a
change in consumers’ income, computed as the percentage
change in quantity demanded divided by the percentage
change in income.”

   “The cross-price elasticity of demand ( e xy) = is a measure
of how much the quantity demanded of one good responds
to a change in the price of another good, computed as the
percentage change in quantity demanded of the first good
divided by the percentage change in the price of the second
good.”
Measures of Elasticity
   A. Point Elasticity = (Q2-Q1) / Q1* 100
(P2-P1) / P1 * 100

B. Arc Elasticity =
(Q2-Q1)/[(Q2+Q1)/2] * 100
(P2-P1)/[(P2+P1)/2] * 100
PRICE   QUANTITY DEMANDED

\$40           250
\$30           450
\$20           675
\$10           825
Price

P1
Inelastic Demand
Elasticity less than 1

P2

D

Q1 Q2              Quantity
D
Price

P1
Perfectly Inelastic Demand
Elasticity equals 0

P2

Q1 = Q2    Quantity
Price

Elastic Demand
Elasticity greater than 1

P1
P2
D

Q1      Q2      Quantity
Price

Perfectly Elastic Demand
Elasticity equals infinity

P1 = P2
D

Q1      Q2     Quantity
Impact of a Price Increase on
Expenditure
Inelastic        Rises

Elastic         Falls

Unit elastic     Constant
PRICE QUANTITY ELASTICITY EXPENDITURE CHANGE IN
OF DEMAND             EXPENDITURE

40     250                 10,000
2.0                   -3,500
30     450                 13,500
1.0                     0
20     675                 13,500
.3                   5,250
10     825                 8,250
Summary of Relationship Between Price Elasticity of Demand and
Total Revenue
Relation of price elasticity and MR
   MR = P ( 1 + 1/Ep)
(Figure continues on next slide)

Relationships Among Total Revenue; Marginal Revenue; Average
Revenue; and Price Elasticity of Demand
+/- +/-   +/-
QdX = f(PX, I, PY, T )

QdX/PX < 0+
QdX/I > 0 if a good is normal
QdX/I < 0 if a good is inferior
QdX/PY > 0 if X and Y are substitutes
QdX/PY < 0 if X and Y are complements
Applications of Elasticity
   Air fares pricing
   Agricultural products
   Demand for gasoline in long run
   Taxes on Cigarettes
   Engel’s law
   Maximising revenue
   Price discrimination in different markets

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