Demand: Law of Demand, Determinants, Elasticity of Demand and Measurement

Meaning of demand

Demand means the willingness and ability of a consumer to buy a commodity at a given price and at a given time. Mere desire is not demand; purchasing power and readiness to buy are essential.

Demand schedule and demand curve

Demand schedule

Demand schedule is a table showing quantities demanded at different prices.

Demand curve

Demand curve is the graphical representation of demand schedule. It generally slopes downward from left to right.

Law of demand

Law of demand: Other things remaining constant (ceteris paribus), quantity demanded of a commodity increases when price falls and decreases when price rises.

Reasons for law of demand (why demand curve slopes downward)

1. Law of diminishing marginal utility: as more units are consumed, additional utility falls, so consumer buys more only at lower price.
2. Income effect: fall in price increases real income, enabling purchase of more.
3. Substitution effect: when price falls, the commodity becomes relatively cheaper, so consumers substitute it for costlier alternatives.
4. New consumers effect: lower price attracts new buyers into the market.
5. Multiple uses: a commodity may be used for more purposes when its price falls.

Exceptions to law of demand

1. Giffen goods: inferior goods where demand rises with price due to strong income effect (rare).
2. Veblen goods (conspicuous consumption): higher price increases prestige, so demand may rise (luxury/status goods).
3. Speculation: if people expect future prices to rise, they may buy more even at higher current price.
4. Necessaries: demand may not change much with price (highly inelastic), though not a true exception, it weakens the law.
5. Ignorance/quality illusion: consumers may think higher price means better quality and buy more.

Determinants of demand

Demand depends on many factors:

1. Price of the commodity (main factor).
2. Income of consumer: higher income generally increases demand for normal goods.
3. Prices of related goods:
   • substitutes (tea/coffee)
   • complements (car/petrol)
4. Tastes, preferences, fashion.
5. Expectations about future price and income.
6. Population and number of buyers.
7. Advertisement and sales promotion.
8. Season and climate.
9. Government policy (tax/subsidy) and availability of credit.

Movement along demand curve vs shift of demand curve

• Movement along demand curve occurs due to change in price of the commodity:
  • expansion of demand (price falls → quantity rises)
  • contraction of demand (price rises → quantity falls)
• Shift of demand curve occurs due to change in other factors (income, tastes, prices of related goods etc.):
  • increase in demand (rightward shift)
  • decrease in demand (leftward shift)

Elasticity of demand: meaning and types

Meaning

Elasticity of demand measures the degree of responsiveness of quantity demanded to changes in its determinants like price, income and prices of related goods.

Price elasticity of demand (PED)

Price elasticity of demand is responsiveness of demand to change in price.

Formula (percentage method): E_d = \frac{\\%\\,\\Delta Q_d}{\\%\\,\\Delta P} Types of price elasticity:

• Perfectly elastic ($E_d = \\infty$)
• Perfectly inelastic ($E_d = 0$)
• Unitary elastic ($E_d = 1$)
• Relatively elastic ($E_d > 1$)
• Relatively inelastic ($E_d < 1$)

Income elasticity of demand (YED)

Income elasticity measures responsiveness of demand to change in income. E_y = \frac{\\%\\,\\Delta Q_d}{\\%\\,\\Delta Y} Normal goods: $E_y > 0$; Inferior goods: $E_y < 0$.

Cross elasticity of demand (XED)

Cross elasticity measures responsiveness of demand for one good to change in price of related good. E_{xy} = \frac{\\%\\,\\Delta Q_x}{\\%\\,\\Delta P_y} Substitutes: $E_{xy} > 0$; Complements: $E_{xy} < 0$.

Methods of measuring price elasticity (important)

1. Percentage (proportionate) method: E_d = \frac{\\%\\,\\Delta Q}{\\%\\,\\Delta P}
2. Total expenditure (outlay) method:
   • If price falls and total expenditure rises ⇒ demand is elastic ($E_d > 1$)
   • If price falls and total expenditure falls ⇒ demand is inelastic ($E_d < 1$)
   • If price changes and total expenditure remains same ⇒ unitary elastic ($E_d = 1$)
3. Point method (geometric method):
   • Elasticity at a point on straight-line demand curve is measured using lower and upper segments.
4. Arc method:
   • Used to measure elasticity between two points on a demand curve (average method).

Factors affecting price elasticity of demand

1. Nature of commodity: necessities are inelastic; luxuries are elastic.
2. Availability of substitutes: more substitutes → more elastic demand.
3. Proportion of income spent: higher expenditure share → more elastic.
4. Time period: demand is more elastic in the long run.
5. Number of uses: more uses → more elastic.
6. Habit: addictive goods tend to be inelastic.

Importance of elasticity of demand

• Helps business in pricing decisions and output planning.
• Useful for government in taxation and price control policies.
• Helps in determining monopoly price and understanding market behaviour.
• Important in international trade (terms of trade) and exchange rate impact.

Quick recap (1-minute revision)

• Demand = willingness + ability to buy.
• Law of demand: price and quantity demanded are inversely related (ceteris paribus).
• Determinants: income, related goods, tastes, expectations, population etc.
• Movement along curve = due to price; shift = due to other factors.
• Elasticity: responsiveness; types: price, income, cross.
• Methods of PED: percentage, total outlay, point, arc.