Business Economics - Law of Demand and Elasticity of Demand

THEORY OF DEMAND AND SUPPLY

UNIT -1: LAW OF DEMAND AND ELASTICITY OF DEMAND

At the end of this Unit, you will be able to:

1. Explain the meaning of Demand.

2. Describe what Determines Demand.

3. Explain the Law of Demand.

4. Explain the difference between Movement along the Demand Curve and Shift of the Demand Curve.

5. Define and Measure Elasticity.

6. Apply the Concepts of Price, Cross and Income Elasticities.

7. Explain the Determinants of Elasticity.

8. Explain the Importance of Demand Forecasting in Business.

9. Describe the various Forecasting Techniques.

SUMMARY

• Buyers constitute the demand side of the market; sellers make the supply side of that market. The quantity that consumers buy at a given price determines the size of the market.

• Demand means desire or wish to buy and consume a commodity or service backed by adequate ability to pay and willingness to pay

• The important factors that determine demand are price of the commodity, price of related commodities, income of the consumer, tastes and preferences of consumers, consumer expectations regarding future prices, size of population, composition of population, the level of national income and its distribution, consumer-credit facility and interest rates.

• The law of demand states that people will buy more at lower prices and less at higher prices, other things being equal.

• A demand schedule is a table that shows various prices and the corresponding quantities demanded. The demand schedules are of two types; individual demand schedule and market demand schedule.

• According to Marshall, the demand curve slopes downwards due to the operation of the law of diminishing marginal utility. However, according to Hicks and Allen it is due to income effect and substitution effect.

• The demand curve usually slopes downwards; but exceptionally slopes upwards under certain circumstances as in the case of conspicuous goods, Giffen goods, conspicuous necessities, future expectations about prices, demand for necessaries and speculative goods.

• When the quantity demanded decreases due to a rise in own price, it is contraction of demand. On the contrary, when the price falls and the quantity demanded increases it is extension of demand.

• The demand curve will shift to the right when there is a rise in income (unless the good is an inferior one), a rise in the price of a substitute, a fall in the price of a complement, a rise in population and a change in tastes in favour of commodity. The opposite changes will shift the demand curve to the left.

• Elasticity of demand refers to the degree of sensitiveness or responsiveness of demand to a change in any one of its determinants. Elasticity of demand is classified mainly into four kinds. They are price elasticity of demand, income elasticity of demand, advertisement elasticity and cross elasticity of demand.

• Price elasticity of demand refers to the percentage change in quantity demanded of a commodity as a result of a percentage change in price of that commodity. Because demand curve slopes downwards and to the right, the sign of price elasticity is negative. We normally ignore the sign of elasticity and concentrate on the coefficient. Greater the absolute coefficient, greater is the price elasticity.

• In point elasticity, we measure elasticity at a given point on a demand curve. When the price change is somewhat larger or when price elasticity is to be found between two prices or two points on the demand curve, we use arc elasticity

• Income elasticity of demand is the percentage change in quantity demanded of a commodity as a result of a percentage change in income of the consumer. Goods and services are classified as luxuries, normal or inferior, depending on the responsiveness of spending on a product relative to percentage change in income.