TOPIC 2 : DEMAND

CLASSIFICATION OF GOODS AND SERVICES

Conventional:
a)

Free good
Free goods can be defined as goods with zero opportunity cost
(no production cost). The supply is unlimited and considered
gifts of nature. Examples are air, sunlight, rain and snow.

b)

Public goods and private goods

Public goods (social goods) can be defined as goods and
services provided by the government or the central authorities
for community use. Everyone in the community has right to
consume the goods without any exemption. Examples are street
lighting, roads, public phone, hospital and national defense.

Private goods can be defined as goods owned by

individual or private sector and only the owner is allowed
to consume the goods. Other people can be prevented
from using them. Examples are car and house.
Economic goods
Economic goods can be defined as goods where supply
is limited and require costs to purchase them. Opportunity
cost is involved in obtaining them. Can be seen and
touched. They can be divided into 2 groups:

c)

Commodities (tangible goods) i.e. books, clothes, cars

Services (intangible goods) i.e. insurance, loan

Islamic:

a)

Goods are bounties bestowed by God on mankind.

The Quran always refers to consumable goods by using
terms which attribute moral and ideological values to them.
2 terms used in the Quran in this respect are:
Al-tayyibat
Al-tayyibat means good things, good and pure things,
clean and pure things, good and wholesome things, and
sustenance of the best.
Thus consumer goods are intimately tied up with values in
Islam, denoting the values of goodness, purity and
wholesomeness. In contrast, bad, impure and worthless
objects cannot be used or nor considered as consumer
goods in Islam.

b)

Al-rizq
Al-rizq is used to denote the following meanings: Godly
sustenance, Divine bestowal, Godly provision, and
heavenly gifts.

Consequently, consumer goods are the useful, beneficial

consumable materials whose utilization brings about the
material, moral and spiritual betterment of the consumer.
Goods and services also can be divided based on the
consumption preference or hierarchy of needs.

a)
b)
c)
d)

Darurah (necessity/essential)
Haajiah (complementary/convenience goods)
Tahsiniyyah/kamaliyyat (luxury goods)
Tarafiat (harmful, dangerous, hazardous)

DEFINITION OF DEMAND
Demand can be defined as the ability and
willingness to buy specific quantities of goods in a
given period of time at particular price, ceteris
paribus.

LAW OF DEMAND
The law of demand states that, other things being
equal, the higher the price of a good, the lower is
the quantity demanded.

FOUNDATION BEHIND THE LAW OF DEMAND

Common sense

Diminishing marginal utilitysuccessive purchase will yield

less and less satisfaction

Income effect higher purchasing power when price of a

product declines lead to more purchase made.

Substitution effect rational consumer will shift to cheaper

product as a substitution of a similar product whose price
unchanged.

INDIVIDUAL AND MARKET DEMAND

a)

Individual demand
The individual demand refers to the quantity
demanded by an individual at varying prices for a
certain product.

The Demand Schedule of Individual A (Mawi) for

Good X (Ice-cream)

A demand schedule lists the quantities

demanded at each different price.

A demand curve graphs the relationship between

the quantities demanded of a good and its price,
ceteris paribus.

Ice-cream

Demand curve shows how many ice-cream he is willing to buy at diff prices.

Market demand shows total quantity demanded at

from each and everyone in the market (including
Mawi) at different level of prices.

Ice-cream

(in 000s)

Demand curve shows how many ice-cream people are willing to buy at
different prices.

The quantity demanded is always measured on

the horizontal axis and the price is measured on
the vertical axis.
The demand curve is downward sloping to show
the negative relationship between the price and
the quantity demanded.

THE DIFFERENCES BETWEEN CHANGES IN QUANTITY

DEMANDED AND CHANGES IN DEMAND
a)

Changes in quantity demanded

Refers to a movement along the demand curve. This is
caused by a change in the goods own price alone, ceteris
paribus.

b)

Expansion of demand - an increase in the amount

demanded
Contraction of demand - a fall in the quantity
demanded
An upward movement along the curve would
mean a fall in the quantity demanded.
A downward movement along the curve means a
rise in the quantity demanded.
Changes in demand
Refers to a shift of the demand curve. This is
caused by other factors and not by price of the
good.

The demand curve shifts when any of the factors

that affect quantity demanded (other than the price
of the good) change.

DETERMINANTS OF DEMAND
Income
There are 2 possible categories for the
relationship between changes in income and
changes in demand:

a)

Normal goods

Any good for which there is a direct relationship

(positive relationship) between changes in
income and its demand curve.

Inferior goods

Any goods for which there is an inverse

relationship (negative relationship) between
changes in income and its demand curve.

Normal good= increase in income, demand for

normal good will increase, DD shift to right

Inferior good= increase in income, demand for

inferior good will decrease, DD shift to left

Prices of related goods

b)

Complementary goods

A good that is jointly consumed with another

good. There is an inverse (negative) relationship
between a price change for one good and the
demand for the go together good.

PA

Qd A

Qd B

P car Qd car Qd petrol

Substitute goods

A good that competes with another good for

consumer purchases. There is a direct
(positive)
relationship between a price
change for one good and the demand for its
competitor good.

P A Qd A

Qd B

P tea Qd tea Qd coffee

c)

Tastes and preferences

Taste refers to the general preference of a
population or a particular individual. Fads,
fashions, advertising and new products can
influence consumer preferences to buy particular
good or service.

d)

Number of buyers
The number of buyers can be specified to include
both foreign and domestic buyers. If the number of
buyers increases, the demand curve shifts
rightward. Conversely, when the number of buyers
decreases, the demand curve shifts leftward.

e)

Expectations of buyers
This is regarding the effect on demand in the
present when consumers anticipate future
changes in prices of goods.

f)

Seasonal factor
Different products will be demanded at different
festive seasons.

g)

Innovation and technological progress

With the intensive an extensive research and
development done in the business world, new
products and innovative products keep entering
the market.

ELASTICITY OF DEMAND

Elasticity of demand is a quantitative

measurement of the relative size of
changes in the quantity demanded.

There are 3 types of elasticity of demand:

a) Price elasticity of demand
b) Income elasticity of demand
c) Cross elasticity of demand

PRICE ELASTICITY OF DEMAND

Price elasticity of demand can be defined as the ratio of the

percentage change in quantity demanded of a product to a
percentage change in its price.
In other words, it is the degree of responsiveness or sensitivity
of Qd of a good to a change in its market price, ceteris paribus.
The price elasticity of demand formula is:

DEGREES OF ELASTICITY

The degree of elasticity

measures the responsiveness
of quantity demanded to price
changes.

a)

Elastic demand (Ed > 1)

A condition in which the
percentage changes in
quantity demanded is greater
than the percentage changes
in price.
(% price < % Qd)

The bigger the Ed (above 1), the

more elastic it is. The small change in
price lead to bigger change in
quantity demanded. For example
luxuries goods and close substitutes
goods.

b) Inelastic demand (Ed < 1)

A condition in which the
percentage changes in quantity
demanded is less than the
percentage changes in price.
A change in price causes less
than proportionate change in
quantity demanded.

(% price > % Qd)

eg: Necessities goods

Curve is rectangular
hyperbola. Any point on
curve Ed = 1

c) Unit elasticity of demand (Ed =

1)
A condition in which the
percentage changes in
quantity demanded is equal
to the percentage changes
in price.
(% price = % Qd)

d) Perfectly elastic demand

(Ed = )
A condition in which a small
percentage changes in price
brings about an infinite
percentage changes in
quantity demanded.
An increase in price causes
infinite change in Qd.
price
price

Qd = zero
Qd = 0

e) Perfectly inelastic demand

(Ed = 0)
A condition in which the
quantity demanded does
not change as the price
changes.
Change in price will not
affect Qd

PRICE ELASTICITY OF DEMAND VARIATIONS

ALONG A DEMAND CURVE

FACTORS AFFECTING THE PRICE ELASTICITY OF

DEMAND
a)

Availability of substitutes
The more substitute there are, especially close substitute,
the more elastic the demand for a good will be. No
substitutes for that good, therefore demand inelastic.

b)

Proportion of income spent on the product

The larger the proportion of income spent on a good, the
more elastic the demand will be.
if the item represents small part of our budget, less attention
to price. Therefore, when price change, less respond in Qd
demand more inelastic. If bigger the percentage of total
budget demand more elastic.

c)

Necessities or luxuries
Luxuries tend to have elastic demand (buyer can postpone
purchase if P . Necessities, inelastic demand. (buyer must
buy no matter what price is.

d)

Time period
The longer the time, the more elastic the demand. We can
find substitutes or adjust consumption pattern. More product
developed. For a short period, demand tends to be inelastic.

e)

Price of the goods

Cheap goods - inelastic demand.
Expensive goods elastic demand.
a price change of cheap good wont affect budget much.

f)

Habits
Habitual smokers tend to have inelastic demand for
cigarettes.

CROSS PRICE ELASTICITY OF DEMAND

to measure the responsiveness of consumers
demand of a product to a given price change of
other product
how many % change in the quantity demanded of
product X given 1% change in the price of product
Y.
Formula:

= %QdX
%PY

= (QdX1QdX0) / QdX0
(PY1-PY0) / PY0

ELASTICITY COEFFICIENT

Exy = +ve : substitute goods

customers increase their demand for good X when price of
good Y rises
Exy = -ve : complement goods
customers decrease their demand for good X when price of
good Y rises
Exy = 0 :unrelated goods
customers demand of product X unchanged despite a rise of
price Y.

INCOME ELASTICITY OF DEMAND

to measure the responsiveness of consumers to a
given change in income
how many % change in the quantity demanded of a
product given 1% change in the income of
consumers.
Formula:

= %Qd
%I

(Qd1Qd0) / Qd0
(I1-I0) / I0

ELASTICITY COEFFICIENT

EI = +ve :
EI > 1 : luxury goods
increase in customers demand for luxury goods
higher than increase in payrise
0< EI< 1 : normal goods
increase in customers demand for normal goods
less than increase in payrise

EI =0 : necessity goods
demand for this goods is unchnaged despite a
payrise

EI = -ve : giffen/inferior goods

customers demand of product X decline despite a
payrise