1. THE THEORY OF DEMAND & SUPPLY1

2. DEMAND
Demands for a commodity refers to the quantity of the commodity which an individual consumer is willing to and able to purchase per unit of time at a particular price. 2

3. DETERMINANTS OF DEMAND
Price of the commodity
Price of Related Goods and Services
Consumer’s Income
Consumer’s Taste & Preferences
Distribution of Income
Expectations
Sociological Variables
Demonstration Effect & Band –Wagon Effect 3

4. DEMAND SCHEDULE
Demand Schedule is the tabular presentation of a series of quantities which consumer would like to buy per unit of time at different prices. Demand schedule for fruits is given in Table below:
Demand Schedule for Fruit by an Individual
Price
(Rs per Kg)
Quantity
demanded (dozen)
100 1 90 3 80 7 70 11 60 13 4

5. DEMAND FUNCTION
Demand function is referred to as a mathematical expression of the relationship between quantity demanded of a commodity to the factors that determine the quantity demanded. 5

6. 6 Mathematically, Demand Function is expressed as – where:
Qdx refers to the quantity demanded of product X,
Px refers to the price of product X
Y refers to the level of household income
P1……P n-1 refers to price of related goods.
T refers to taste and references of consumer
Ey refers to the consumer’s expected further income.
Ep refers to consumer’s expectation about the future prices.
S refers to sociological factors.
refers to those determinants which are not covered in the list of determinants given above. 6

7. THE LAW OF DEMAND
The law of demand holds that other things equal, as the price of a good or service rises, its quantity demanded falls.
The reverse is also true: as the price of a good or service falls, its quantity demanded increases. 7

8. DEMAND CURVE
The demand curve has a negative slope, consistent with the law of demand. 8

9. WHY DEMAND CURVE SLOPES DOWNWARDS TO RIGHT?
Substitution Effect
Income effect
Diminishing Marginal utility (MU = P)
Number of Uses and Buyers 9

10. EXCEPTIONS TO LAW OF DEMAND
Giffen Goods
Status Goods
Expectation of future price
Emergencies
Ignorance 10

11. MOVEMENT ALONG THE DEMAND CURVE
The movement along the demand curve is due to change
in the own price of the commodity.
Extension of demand is when quantity demanded of a commodity increases as a result of fall in its price, other determinants remaining constant.
Contraction of demand is when quantity demanded of a commodity decreases as a result of increase in it price, other determinants remaining constant. 11

12. 12

13. SHIFT IN THE DEMAND CURVE
A change in any variable other than price that influences quantity demanded produces a shift in the demand curve or a change in demand.
Factors that shift the demand curve include:
Change in consumer incomes
Population change
Consumer preferences
Prices of related goods:
Substitutes: goods consumed in place of one another
Complements: goods consumed jointly 13

14. SHIFT IN THE DEMAND CURVE
This demand curve has shifted to the right. Quantity demanded is now higher at any given price. 14

15. TYPES OF DEMAND Direct/Autonomous Demand and Derived Demand
Non Durables Goods Demand and Durable Goods Demand
Industry Demand and Individual Firm Demand
Short Run Demand and Long-Run Demand 15

16. SUPPLY
Supply of a commodity refers to the various quantities of the commodity which a seller is willing and able to sell at different prices, in a given market, at a point of time, other things remaining the same. 16

17. DETERMINANTS OF SUPPLY
Price
Price of related goods
Cost of Production/Factors of Production
State of Technology
Goal of Producer
Natural factors
Other Factors 17

18. SUPPLY SCHEDULE
Supply Schedule is the tabular presentation of a series of quantities which producer would like to at different prices. Supply schedule for Garments is shown in Table below:
Price of Garment
(Rs.60 per garment)
Quantity Supplied 10 9 8 7 6 15 12 18

19. MARKET SUPPLY SCHEDULE
A market supply schedule for a commodity is the sum of individual supply schedules for all the producer producing a commodity in a given time. It reflects the sum total of various quantities offered for sale by all producers at different prices. Table shows the market supply schedule which illustrates a market comprising of producer A and B.
Price
(Rs.)
Individual Supply Schedule
QA QB
Market Supply Schedule
QA + QB 5 4 3 2 1 45 36 33 27 20 19

20. SUPPLY FUNCTION
Supply function refers to the mathematical expression of the quantity supplied and the factors that determine the supply.
Sx = f (P x P1….Pn C, T, G, O)
Where Sx refers to the quantity supplied of good X
Px refers to the price of good X
P1….Pn refers to the price of related goods
C refers to the cost of production
T refers to the state of technology.
G refers to the goal of the firm
O refers to other factors. 20

21. THE LAW OF SUPPLY
The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa. 21

22. WHY IS SUPPLY CURVE AN UPWARD SLOPING CURVE?
Profit Maximization
The Law of Diminishing Marginal Productivity 22

23. Supply Curve
The supply curve has a positive slope, consistent with the law of supply. 23

24. MOVEMENT OF SUPPLY CURVE
The change in the quantity supplied due to change in the price level is known as movement of supply curve.
Expansion of Supply: when the quantity supplied rises due to rise in the price of commodity
Contraction of Supply: When the quantity supplied falls due to the fall in the price of the commodity. 24

25. 25

26. Shift in the Supply Curve
A change in any variable other than price that influences quantity supplied produces a shift in the supply curve or a change in supply.
Factors that shift the supply curve include:
Price of related goods
Cost of Production/Factors of Production
State of Technology
Goal of Producer
Natural factors
Other Factors 26

27. Shift in the Supply Curve
For an given rental price, quantity supplied is now lower than before. 27

28. DETERMINATION OF EQUILIBRIUM
Equilibrium is established at the point where the quantity that suppliers are willing and able to offer for sale is the same as the quantity that buyers are willing and able to purchase. 28

29. EQUILIBRIUM
Equilibrium occurs at a price of $3 and a quantity of 30 units. 29

30. SHORTAGES AND SURPLUSES
A shortage occurs when quantity demanded exceeds quantity supplied.
A shortage implies the market price is too low.
A surplus occurs when quantity supplied exceeds quantity demanded.
A surplus implies the market price is too high. 30

31. 31

32. EQUILIBRIUM AFTER A DEMAND SHIFT
The shift in the demand curve moves the market equilibrium from point A to point B, resulting in a higher price and higher quantity. 32

33. EQUILIBRIUM AFTER A SUPPLY SHIFT
The shift in the supply curve moves the market equilibrium from point A to point B, resulting in a higher price and lower quantity. 33

34. ELASTICITY
Elasticity may be defined as “The percentage change in the dependent variable that is caused by a one percent change in one independent variables, others are held constant”. 34

35. Percentage change in determinant Y
ELASTICITY OF DEMAND
Elasticity of demand measures degree of responsiveness of the quantity demanded to change in any one of the factors that influence it.
Ed = Percentage change in quantity demanded of good X
Percentage change in determinant Y 35

36. KINDS OF DEMAND ELASTICITIES
Price elasticity of demand
Income elasticity of demand
Cross elasticity of demand
Advertising elasticity of demand
Price Expectation Elasticity 36

37. PRICE ELASTICITY OF DEMAND
Price elasticity of demand is referred to as degree of responsiveness of quantity demanded for a commodity to change in its price 37

38. (a) Perfectly Inelastic ep= 0
Price D P1 P0 D X
Quantity Demanded 38

39. b. Relatively Inelastic ep <1
Price D P0 P1 D X0 X1
Quantity Demanded 39

40. c) Unitary Elastic ep=1
Price D P0 P1 D X0 X1
Quantity Demanded 40

41. d) Relatively Elastic ep > 1
Price D P0 P1 D X0 X1
Quantity Demanded 41

42. e) Perfectly elastic ep =∞
Price P0 D X1 X0
Quantity Demanded 42

43. MEASUREMENT OF PRICE ELASTICITY
Elasticity of demand can be measured with the help of any one of the four techniques.
Percentage Method
Point Method
Arc Method
Total Outlay Method 43

44. PERCENTAGE METHOD
According to this method, elasticity of demand is the ratio of percentage (or proportionate) change in quantity demanded to a percentage (or proportionate) change in its price. 44

45. ILLUSTRATION
Find the elasticity of demand at price Rs 4, when price and quantity demanded behave in the following manner
Price (Rs per Litre) Quantity demanded (Litres) 45

46. Solution:
The elasticity of demand when price changes from Rs 4 to Rs 2. 46

47. Graphical Method / Point Method
This method is used to measure elasticity at a point on the demand curve. 47

48. Price e= D
e>1 B
e=1 A
e<1 C
E=0 D1
Quantity 48

49. Arc Elasticity
Arc elasticity is a measure of average elasticity i.e. it is the elasticity at the mid - point of the chord that connects the two point A and B on the demand curve, defined by the initial and new price level. 49

50. Price D A P1 B P2 D Q1 Q2
Quantity 50

51. Illustration
15 Units of commodity was demanded at the price of Rs 20 each. If the price of commodity falls to Rs 10, the demand for commodity increases to 25 units. Find the elasticity of demand using arc elasticity method. 51

52. Solution: 52

53. TOTAL OUTLAY METHOD/EXPRENDITURE METHOD
In this method, we study the elasticity of demand in relation to change in total outlay (expenditure) as a result of change in price and the consequent change in demand for a product.
Limitation: It does not give the precise value of the elasticity of demand, rather it only tells whether the elasticity is equal to one, greater than one or less than one. 53

54. 54 Price Quantity Demanded Total outlay Nature of Elasticity Case I
a ses
b ses
ses
Elasticity is more than one
Case II
Elasticity is less than one
Case III
No change
Unit elastic 54

55. FACTORS AFFECTING ELASTICITY OF DEMAND
Nature of Commodity
Number of close substitutes available
The Proportion of Buyer’s Budget
Number of uses of Commodity
Consumer’s Behaviour
Price Level of the Commodity
Time Period 55

56. INCOME ELASTICITY OF DEMAND
The income elasticity of demand measures the degree of responsiveness to income changes. The income elasticity of demand is defined as the percentage change in quantity demanded for a product divided by percentage change in income, everything else held constant.
Normal Good – Positive Income Elasticity
Inferior Good – Negative Income Elasticity 56

57. 57

58. ILLUSTRATION
A study conducted by researcher revealed that a rise in average household income from Rs. 30,000 to 40,000 led to increase in consumer’s demand for a commodity from 100 units per month to 200 units. 58

59. The income elasticity of demand is 3
Solution:
The income elasticity of demand is 3 59

60. TYPES OF INCOME ELASTICITY
Zero Income Elasticity
Unitary Income Elasticity
High Income Elasticity
Low Income Elasticity 60

61. DETERMINANTS OF INCOME ELASTICITY
Nature of the need of commodity
Initial level of income of country
Time period 61

62. CROSS ELASTICITY OF DEMAND
It is defined as percentage change in quantity demanded for one good divided by percentage change in the price of related good, everything is held constant. 62

63. The sign of cross elasticity is negative if x and y are complimentary goods and positive if x and y are substitute goods.
Determinant of cross elasticity – nature of the commodity relative to their use. 63

64. Illustration: Suppose that there is an increase in the price of tea from Rs100 per Kg to Rs 125 per Kg and consequently the quantity demanded of coffee would increase from Rs10 Kg to Rs 15 Kg. Find the cross elasticity of demand between coffee and tea. 64

65. Solution:
The higher the value the cross elasticity, the stronger will be the degree of substitutability or complementarily of two goods. 65

66. Advertising Elasticity of Demand
It measures degree of responsiveness of demand to changes in the advertising and other promotional expenses 66

67. Determinants of advertisement elasticity
Kind of product
Stage of product’s development
Target customers
Quantity and quality of advertisement
Reaction of rival firm 67

68. Illustration: Suppose the original level of advertising by Firm A is Rs 10 lakh and sales for the year end recorded was 500 units. With increase in advertisement expenditure to Rs12 lakhs, the sale volume increased by 200 units. Find the advertisement elasticity. 68

69. Original level of advertising = Rs. 10 Lakh
Solution
Original level of advertising = Rs. 10 Lakh
Original quantity = 500 units
New level of addressing = Rs. 12 lakh
New Quantity = 700 units
Therefore, the advertising elasticity of demand is 2, which is termed as relatively elastic. In other words, a 1% increase in the level of advertising will cause a 2 % increase in quantity demanded. 69

70. Elasticity of Price Expectation:
It is defined as the ratio of the relative change in expected future prices to the relative change in current price.
Symbolically: 70

71. Elasticity of Price Expectations Value of Coefficient
Purchasers Expectations
Relatively Elastic
Epe> 1
Purchases expect that future price will increase by a larger percentage than current price.
Relatively Inelastic
Epe<1
Purchaser expect that future price will increase by smaller percentage than current price
Unitary Elastic
Epe=1
Future price will increase by same percentage as current price
Perfectly Inelastic
Epe=0
An increase in current price will have no effect on future price
Perfectly Elastic
Epe=∞
Increase in current price will be followed by decrease in future price 71

72. Significance of elasticity of demand
Factor Pricing
Business Decisions
Government Policies
Taxation Policies
Foreign Trade
Demand Forecasting 72

73. Elasticity of Supply
Elasticity of supply of the commodity is defined as the responsiveness of quantity supplied to a unit change in price of that commodity. 73

74. Perfectly Elastic
Price P0 S X1 X0
Quantity Supplied 74

75. Perfectly Inelastic
Price S P1 P0 S X
Quantity Supplied 75

76. Relatively Inelastic
Price S P0 P1 D X1 X0
Quantity Supplied 76

77. Relatively Elastic
Price S P1 P0 Q0 Q1
Quantity Supplied 77

78. Unitary Elastic
Price S
Quantity Supplied 78

79. Determinants of Elasticity of Supply
Time
Nature of commodity
Future price expectation
Limited Supply of inputs
The cost of attracting factors of production 79