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

Question 1

What is elasticity of demand?

Accepted Answer

Elasticity of demand is the degree of responsiveness of quantity demanded to changes in price, income or prices of related goods.

Question 2

Define price elasticity of demand.

Accepted Answer

Price elasticity of demand measures the responsiveness of quantity demanded to a change in price of the commodity.

Question 3

What is cross elasticity of demand?

Accepted Answer

Cross elasticity of demand measures the responsiveness of demand for one good to a change in price of a related good.

Question 4

Define demand.

Accepted Answer

Demand is the willingness and ability of a consumer to purchase a commodity at a given price and time.

Question 5

State the law of demand.

Accepted Answer

Other things remaining constant, quantity demanded increases when price falls and decreases when price rises.

Question 6

State any one exception to the law of demand.

Accepted Answer

Veblen goods are an exception where demand may rise with price due to prestige and status effect.

Question 7

Explain determinants of demand.

Accepted Answer

Determinants of demand include **income of consumers**, **prices of related goods** (substitutes and complements), **tastes and preferences**, **population/number of buyers**, and **expectations** about future prices and income. Advertisement, season/climate and government policy (tax, subsidy) also influence demand. When these factors change, demand shifts.

Question 8

Explain reasons for the law of demand.

Accepted Answer

The demand curve slopes downward because of **diminishing marginal utility**—consumers buy more only at lower prices. A fall in price increases real purchasing power, creating **income effect**. The commodity becomes relatively cheaper than substitutes, creating **substitution effect**. Lower prices may also attract new consumers and increase use for multiple purposes, raising quantity demanded.

Question 9

Differentiate between movement along demand curve and shift of demand curve.

Accepted Answer

Movement along a demand curve occurs due to **change in price** of the commodity, causing **expansion** or **contraction** of demand. Shift of demand curve occurs due to **changes in other factors** like income, tastes, prices of related goods, expectations etc., causing **increase in demand (right shift)** or **decrease in demand (left shift)**.

Question 10

Explain price elasticity of demand and its types.

Accepted Answer

Price elasticity of demand measures how much quantity demanded responds to a change in price. If **Ed > 1**, demand is elastic; if **Ed < 1**, demand is inelastic; if **Ed = 1**, demand is unitary elastic. At extremes, **Ed = 0** indicates perfectly inelastic demand and **Ed = ∞** indicates perfectly elastic demand. Type depends on availability of substitutes, necessity and time period.

Question 11

Explain total outlay method of measuring price elasticity.

Accepted Answer

Under total outlay method, elasticity is judged by changes in total expenditure (Price × Quantity). If **price falls** and **total expenditure rises**, demand is **elastic (Ed > 1)**. If **price falls** and **total expenditure falls**, demand is **inelastic (Ed < 1)**. If total expenditure remains unchanged when price changes, demand is **unitary elastic (Ed = 1)**.

Question 12

Explain factors affecting price elasticity of demand.

Accepted Answer

Price elasticity depends on **availability of substitutes** (more substitutes → more elastic), **nature of commodity** (necessities inelastic, luxuries elastic), **proportion of income spent** (higher share → more elastic), and **time period** (more elastic in long run). Habit-forming goods tend to be inelastic and goods with many uses are more elastic.

Question 13

Explain law of demand. Discuss reasons and exceptions to the law of demand.

Accepted Answer

Law of demand states that, other things remaining constant, quantity demanded of a commodity increases when its price falls and decreases when its price rises. Thus, there is an inverse relationship between price and demand.

**Reasons for the law of demand:** The demand curve slopes downward mainly due to the **law of diminishing marginal utility**—as consumption increases, marginal utility falls, so consumers buy additional units only at lower prices. A fall in price increases purchasing power, creating **income effect**, which raises demand. The commodity becomes relatively cheaper than substitutes, so consumers substitute it for other goods, creating **substitution effect**. Lower prices may also bring in new consumers and encourage multiple uses, increasing quantity demanded.

**Exceptions to the law of demand:** In case of **Giffen goods** (rare inferior goods), demand may rise with price due to strong income effect. **Veblen goods** or prestige goods may have higher demand at higher prices due to status and conspicuous consumption. Under **speculative conditions**, if people expect further rise in price, they may buy more even at higher current price. Sometimes ignorance and quality illusion may also cause higher demand at higher prices.

Therefore, the law of demand generally holds, but exceptions occur under special situations.

Question 14

Explain elasticity of demand. Discuss price elasticity of demand and methods of measuring it.

Accepted Answer

Elasticity of demand refers to the degree of responsiveness of quantity demanded to changes in determinants such as price, income and prices of related goods. Among these, price elasticity of demand is most important.

**Price elasticity of demand (PED):** It measures the percentage change in quantity demanded due to a percentage change in price. Depending on responsiveness, demand may be elastic (Ed>1), inelastic (Ed<1), unitary (Ed=1), perfectly inelastic (Ed=0) or perfectly elastic (Ed=∞).

**Methods of measuring PED:**
1. **Percentage method:** Ed = (% change in quantity demanded) / (% change in price).
2. **Total outlay method:** Based on changes in total expenditure (P×Q). If price and total outlay move in opposite directions, demand is elastic; if they move in same direction, demand is inelastic; if total outlay remains constant, demand is unitary.
3. **Point (geometric) method:** Measures elasticity at a point on a straight-line demand curve using lower and upper segments.
4. **Arc method:** Measures average elasticity between two points on a demand curve.

Thus, elasticity of demand is an important tool for pricing, taxation and business decisions.

Question 15

Explain types of elasticity of demand (price, income and cross). State their significance in business and policy decisions.

Accepted Answer

Elasticity of demand indicates responsiveness of quantity demanded to changes in different factors. The main types are:

1. **Price elasticity of demand (PED):** Responsiveness of demand to price change. It helps firms in pricing decisions and helps government in taxation and price control. For example, taxing inelastic goods yields higher revenue with smaller quantity reduction.

2. **Income elasticity of demand (YED):** Responsiveness of demand to change in income. For normal goods YED is positive, while for inferior goods it is negative. It helps businesses forecast future demand when income levels change and helps planners understand consumption patterns.

3. **Cross elasticity of demand (XED):** Responsiveness of demand for one good to change in price of related good. It is positive for substitutes and negative for complements. It helps firms in competitive strategy, product pricing and understanding market interdependence.

**Significance:** Knowledge of elasticities supports decisions regarding pricing, output, advertising, product planning, taxation, subsidies and welfare policies. It helps both businesses and government predict market reactions and take better economic decisions.

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

8 more questions to unlock