MARKETS

• Supply and demand are the forces

that make market economies work.
• A market is a group of buyers and
sellers of a particular good or
service.
• Modern microeconomics is about
supply, demand, and market
equilibrium.
 MEANING OF DEMAND

• The demand for a commodity is the

amount of it that a consumer will
purchase or will be ready to take off
from the market at various given prices
at a given moment of time
 MEANING OF DEMAND

People demand goods because they have utility

or want satisfying power

To create demand the good should have –

utility, and the person should have the desire,
willingness and ability to buy the good
 DEMAND
• Quantity demanded is the amount of a
good that buyers are willing and able to
purchase.
• Law of Demand
– The law of demand states that, other things
equal, the quantity demanded of a good
falls when the price of the good rises &
vice-versa.
The Demand Schedule: The
Relationship between Price and
Quantity Demanded

• Demand Schedule
– The demand schedule is a table that
shows the relationship between the
price of the good and the quantity
demanded.
 The demand schedule:
The demand for potatoes (monthly)
The Demand Curve: The
Relationship between Price and
Quantity Demanded

• Demand Curve
– The demand curve is a graph of the relationship
between the price of a good and the quantity
demanded.

– A demand schedule or demand curve does not

tell what the price is, it only tells how much
quantity will be purchased a various prices.
 Point Price Market demand
(Rs per kg) (tonnes 000s)
E
100 A 20 700
B 40 500
D C 60 350
Price (Rs per kg)

80 D 80 200
E 100 100
C

60
B

40 A

Demand
20

Quantity (tonnes: 000s)

 LAW OF DEMAND

– As price of a good or service goes down the

quantity consumers wish to buy will increase
and when price goes up the quantity demanded
decreases, other factors remaining constant

– Inverse price demand relationship hence the

downward slope of the demand curve
 LAW OF DEMAND
– Why do buyers purchase a greater quantity at lower prices
and vice-versa?
• The substitution effect
• The income effect
The Substitution Effect
– The change in the quantity demanded of a good that results
because buyers switch to substitutes when the price of the
good changes
The Income effect
– The change in the quantity demanded of a good that results
because a change in the price of a good changes the buyer’s
purchasing power(their real income)
The Income Effect

•Income effect is negative for inferior goods

•In case price of an inferior good accounting for a
considerable proportion of total consumption falls
consumers’ real income increases: they become
relatively richer
•So they substitute superior good for the inferior
ones i.e. reduce the consumption of inferior goods
•So income effect on demand for inferior goods
becomes negative
 CHIEF CHARACTERISTICS OF
LAW OF DEMAND

• Inverse relationship
• Price ,independent variable, demand
dependent variable
• Other things constant
• Reasons underlying the law of
demand- income effect & substitution
effect
 DETERMINANTS OF DEMAND
• Price of the commodity- negative or inverse
relationship
• Taste & preferences of the consumers
• Money Income of the people
• Change in the prices of related goods
• Advertising & demand
• Number of consumers in the market
• Demonstration effect
• Consumer expectations with regard to future
prices
• Income distribution
 DETERMINANTS OF DEMAND
Price of related commodities:
• When change in price of the other commodity
leaves the amount demanded of the commodity
under consideration unchanged we say the two
commodities are unrelated, otherwise they are
related
• Substitutes-when price of one & quantity
demanded of the other move in same direction
e.g. apples & pears, rail & road transport, tea &
coffee
• Complements-when price of one & quantity
demanded of the other move in the opposite
direction e.g. bread & butter, pen & ink, tea &
sugar
 DETERMINANTS OF DEMAND
Income of the household
• The quantity demanded of a good &
income of household move in the same
direction
• In case of goods like foods, vegetables,
fruits etc after a certain level of income
any further increase in income may leave
amount demanded unchanged
• Inferior goods- amount demanded
decreases with increase in income
increases with decrease in income
 INCOME OF THE HOUSEHOLD
•For income demand analysis goods & services can be
grouped into four categories:
•Essential consumer goods: food grains, salt, oils, cooking
fuels, minimum clothing & housing
•Demand increases with increase in income only up to a
certain limit
•Inferior goods: e.g. bajra, bidis, kerosene stove, travelling by
bus etc
•Demand decreases with the increase in income of the
consumer
•Normal goods: demand increases with increase in income
•Prestige or luxury goods: consumed mostly by the rich e.g.
luxury cars, designer jewelry, costly cosmetics, antiques etc
•Demand arises only beyond a certain level of income
Market Demand versus Individual
Demand

• Market demand refers to the sum of

all individual demands for a
particular good or service.
• Graphically, individual demand
curves are summed horizontally to
obtain the market demand curve.
 Change in quantity
demanded & shift in demand

• Change in Quantity Demanded

– Movement along the demand curve.
– Caused by a change in the price of
the product.
 Changes in Quantity
Price of Ice- Demanded
Cream A tax that raises the
Cones
price of ice-cream
B cones results in a
Rs2.
0 movement along the
demand curve.

1.0 A

D
0 4 8Quantity of Ice-Cream Cones
Shifts in the Demand Curve

• Consumer income
• Prices of related goods
• Tastes
• Expectations
• Number of buyers
 Figure 3 Shifts in the Demand Curve

Price of
Ice-Cream
Cone

Increase
in demand

Decrease
in demand
Demand
curve, D2
Demand
curve, D1
Demand curve, D3
0 Quantity of
Ice-Cream Cones
Shifts in the Demand Curve

• Consumer Income
– As income increases the demand for a
normal good will increase.
– As income increases the demand for
an inferior good will decrease.
 Consumer Income
Price of Ice- Normal Good
Cream Cone
Rs3. An increase
0
2.5 in income...
0 Increase
2.0 in demand
0
1.5
0
1.0
0
0.5
0
D2
D1 Quantity
of Ice-
0 1 2 3 4 5 6 7 8 9 10 11 12 Cream
Cones
 Consumer Income
Price of low Inferior Good
quality rice
Rs3.
0
2.5 An increase
0
2.0
in income...
0 Decrease
1.5 in demand
0
1.0
0
0.5
0
D2 D1 Quantity of
low quality
0 1 2 3 4 5 6 7 8 9 10 11 12 rice
 Predicting and Explaining Changes in
Prices and Quantities

• Distinguishing Between
– A change in the quantity demanded
• A movement along the demand curve that
occurs in response to a change in price
– A change in demand
• A shift of the entire demand curve
Table: Variables That Influence
Buyers

Copyright©2004 South-Western
 Exceptions to the law of demand
• Expectations regarding future prices
• Status goods
• Giffen goods: named after Robert Giffen
• Giffen goods may be any inferior commodity
much cheaper than its superior substitutes
consumed by poor households as an essential
consumer good
• If price of such goods increases its demand
increases instead of decreasing e.g. bajra
 ELASTICITYOF DEMAND

• Generally, elasticity is a measure of the sensitivity

of one variable to another.

• It tells us the percentage change in one variable in

response to a one percent change in another
variable.
 ELASTICITYOF DEMAND
• Law of demand indicates only the direction of
change in quantity demanded to a change in
price ; it does not tell by how much the demand
will change due to price change
• This is provided by the concept of elasticity of
demand
• Elasticity of demand also called price elasticity
of demand relates to the responsiveness of
quantity demanded of a good to the change in its
price
 ELASTICITYOF DEMAND

• Price elasticity = percentage change in quantity

demanded/percentage change in price
• The percentage change in a variable is the
absolute change in the variable divided by the
original level of the variable.
• Price elasticity
= change in quantity demanded/quantity demanded
Change in price/price
 ELASTICITYOF DEMAND
• So the price elasticity of demand is also:

∆Q/Q P ∆Q
EP = =
∆P/P Q ∆P

Interpreting Price Elasticity of Demand Values

1) Because of the inverse relationship
between P and Q; EP is negative.
2) If EP > 1, the percent change in quantity is
greater than the percent change in price. We say
the demand is price elastic.
 ELASTICITYOF DEMAND
3) If EP < 1, the percent change in quantity is less than the percent
change in price. We say the demand is price inelastic.

4) If EP = 1, the percent change in quantity is equal to the percent

change in price. We say the demand is unit elastic.

5) If EP = 0, the demand is perfectly inelastic and does not respond

to change in price

6) If EP = infinity, the demand is perfectly or infinitely elastic

 ELASTICITYOF DEMAND
3) The primary determinant of price elasticity of demand is the
availability of substitutes.
– Many substitutes- demand is price elastic
– Few substitutes- demand is price inelastic

4) Other determinants of price elasticity of demand:

– The position of the commodity in a consumer’s budget
– Number of uses of a commodity
– Complementarities between goods
– Time & elasticity
 Price Elasticities of Demand

Price
Infinitely Elastic Demand

P* D

EP = - ∞
Quantity
 Price Elasticities of Demand
Completely Inelastic Demand
Price

EP = 0

Q* Quantity
 Unit elastic demand (PÎD = –1)
P

a
20

b
8
D

O 40 100
Q
 Elastic demand

P(Rs)
b
5
a
4
D

0 10 20
Q (millions of units per period of time)
 Inelastic demand

c
8

P(Rs)

a
4

0 15 20
Q (millions of units per period of time)
 Determinants of price
elasticity of demand
• The number & closeness of
substitutes
• The share of the commodity in the
buyers’ budget
• Nature of the commodity
• Number of uses a commodity can
be put to
• Habit forming characteristics
• Time period
 Types of income elasticity
• Zero income elasticity- change in income has no
effect on demand e.g. salt
• Negative income elasticity- increase in income may
lead to reduction in quantity demanded e.g. biris , low
quality cereals
• Positive income elasticity- increase in income leads
to increase in demand. Most of the goods are in this
category. Such goods are called positive goods e.g.
luxury goods have elasticity more than unity
 Income Elasticity of Demand

• Income elasticity of demand for a

product X is
• Ey =
• change in demand of X/original demand

Change in income/original income

• Income elasticity is positive for normal
goods but negative for inferior goods
 Cross Elasticity of Demand
• Cross elasticity is the measure of
responsiveness of demand for a commodity to
the changes in the price of its substitutes and
complementary goods
• Ec = proportionate change in demand for
product A / proportionate change in price of
product B
• To take the example of tea and coffee, the cross
elasticity of demand for coffee(Qc) with respect
to price of tea(Pt):
• Ec,t = change in Qc / original Qc

change in Pt/ original Pt

 Cross Elasticity of Demand….

• The same formula is used to measure the cross

elasticity of demand for complementary goods
• Demand for complementary goods has negative
cross elasticity while for substitutes it is positive
• Greater the cross elasticity, closer the
substitutes
• Higher the negative cross elasticity higher the
degree of complementarity