Anythibgvcn

Demand And Supply: Theory
And Analysis

Elements of Demand
1. Desire to have the goods or services: the
first necessary condition to have a demand is
that the consumer should have desire to
purchase goods and services from the market
2. Willingness to pay: it means readiness to pay
and purchase the various amounts of the
products at various prices
3. Ability to pay: purchasing capacity of the
individual (financial ability)

Cont……..
1. Per period of time: Demand must be time
related such as hours, days, weeks, months etc
2. Other things being equal/ ceteris paribus:
There might various factors that can influence
demand other than price of the product such as
income, taste and preferences, price of related
goods, weather, customs and traditions etc which
are assumed to be unchanged during the period
of analysis

Meaning of Demand
• The quantity of a good or services that a
consumer is willing and able to purchase at
various prices for a period of time is called
demand.

Determinants of demand
1.Price of the commodity:
• Other things remaining the same, the demand
for a commodity is inversely related to its price.
• Quantity demanded is higher at lower price and
it is lower at higher price
• Higher the price, lower the demand and vice
versa

CONT……….
2.Income of the consumers:
a. Inferior goods: there is an inverse
relationship income of the consumers and the
demand for inferior goods, other things
remaining the same.
b. superior goods:there is positive and direct
relationship income of consumers and the
demand for superior goods, other things
remaining the same

Cont………………
3.Taste and Preference :
If the consumer has more taste and preference on
a particular goods, demand for a commodity
increases and vice versa.

CONT………….
4.Price of related goods:
a. Complementary goods: they are those goods which are
consumed together to satisfy a particular want. They are
jointly demanded. For example, ink and pen. A fall in
price of one commodity will cause the demand for the
other to rise, other things remaining the same. For
example, a rise in price of pen will cause a fall in the
demand for ink and vice versa.
b. Substitute goods: they are those goods which can be
used in place of the other. For example, tea and coffee.
A rise in price of one commodity will cause the demand
for the other to rise, other things remaining the same.
For example, a rise in price of tea will cause a rise in the
demand for coffee and vice versa.

Cont…………..
5. Advertisement:
When a producer spends more and more on advertisement
demand for a commodity will increase because consumers
are able to get more information about product.
6. Fear of shortage:
If the people have fear of shortage of good in the future, the
demand for the good will be higher in the present.
7. Price expectation:
If people expect price of a product is increasing in the future,
then the demand for the product will be higher in present.

Cont………………..
8.Size of the population:
Demand for a good will be higher in case of larger
population and favorable composition of population.
9.Government policy (tax):
If the government imposes heavy indirect taxes on
commodities, it leads to increase in price of
commodities and demand will fall.
10.Climate and weather:
in colder area, woolen clothes have a high demand but the
same clothes have a low demand in warmer areas.

Cont……………..
11.Customs and traditions:
Goods related with customs have positive
relationship with the demand for a specific
festival. Unrelated goods have a lesser demand.
12.Money supply:
If money supply is increased in a country, demand is
high and vice versa.
13. Seasonal factors: demand for ice-creams is
higher in the summer than in the winter.

Demand Function
A functional relationship between demand and its
determinants is called demand function. It can be
written as
Dx= f(Px,Y, PR, Pop, Adv,………………)
Where,
Dx = demand for good X
Px= price of good X
f = function
Y= income of the consumer
Pop= population
Adv= advertisement

Types of demand function
1. Linear demand function:
• if the slope of demand curve remains
constant throughout its length, it is known
as linear demand function.
• If both independent variable (price of the
commodity) and dependent variable (demand
for same product) change at a constant rate,
the demand function will be linear.

Cont……………..
Mathematically,
Qx =a- bPx
Where,
Qx= demand for x good
Px= price of x good
a =intercept/autonomous demand/ demand at zero
price
b =slope of demand curve(rate of change in demand
with respect to change in price)

Linear demand schedule
Px Q=100-5Px
0 100
5 75
10 50
15 25
20 0

2. Non-linear Demand Function
• If the slope of demand curve changes all along
the demand curve, it is said to be non-linear
demand function.
• mathematically,
• Qx=apx
b

Non-linear demand schedule
PX Qx
20 10
10 20
5 40

Law of Demand
a. Statement
• Other things remaining the same, quantity
demanded increases with fall in price and
vice versa. In other words, when price of a
commodity falls, quantity demanded for the
commodity will increase and vice versa, other
things remaining the same.
• “Higher the price, lower the demand , ceteris
paribus”
• “Lower the price, higher the demand”

Cont……..
Mathematically,
Dx=f(Px), other things remaining the same
QX=a-bPx
Where Dx=quantity demanded
f=function
Px=price

b. Assumptions
• No change in income of the consumers
• No change in price of related goods
• No change in taste and preference
• No change in advertisements
• No change in population size
• No change in whether and climate

i. Demand schedule: The tabular presentation
of various combination of price of a
commodity and its quantity demanded at a
given period of time, other things remaining
the same.
combinations Price(Rs/kg) Quantity demanded(kg)
A 5 100
B 4 200
C 3 300
D 2 400

cont……………
• The table shows the demand of all the
consumers in a market. When the price
decreases there is increase in demand for
goods and vice versa. When price is Rs.5
demand is 100 kilograms. When the price is
Rs.4 demand is 200 kilograms. Thus the table
shows the total amount demanded by all
consumers various price levels

ii.Demandcurve:.
The graphical
representation
of demand
schedule is
called demand
curve

• If we plot all combinations of price and
quantity demanded exhibited in table we get a
downward sloping demand curve as shown in
the figure
• There is inverse relationship between price and
quantity of demand
• The demand curve slopes downward from left
to right indicating inverse relationship between
price and demand.

Exceptions of law of demand
• Law of demand does not hold true for all the
goods, persons, times, places and
environments.
• There are certain factors that cause to violate
the law, which are known as the exceptions or
limitations of the law of demand. They are as
follows:

Cont…….
1. Basic or necessary goods: those goods which
are necessary for the continuation of the life of
the people. The demand for necessary goods
such as salt, medicine remains unchanged for
all level of increase or decrease in price of
such goods which violates the law of demand.

Cont…….
2. Prestigious goods: those goods which are
related with the prestige of buyers such as
jewellery.
3. Change in taste and preferences: if
consumer’s taste and preferences change in
favor of a particular commodity, then demand
for that goods increases even if price increases
and vice-versa

Cont….
4. Price or shortage expectations: when
consumer feels that any commodity is going to
be shortage in near future or price is going to
be high, they demand more goods and services
at present paying higher prices due to the fear
of further rise in price

Cont…………
5. Demonstration effect:
• the behavior of general individuals is to imitate
the consumption pattern of other individuals,
basically of their rich neighbors.
• It a neighbors buys a television set, it
influences other members of the society to buy
the same

Cont…….
6. Change in population size:
7. Change in income
8. Ignorance
9.Emergencies

10. Giffen Goods:
• Those giffen goods in which there is positive
relationship between price and demand are
called Giffen goods.
• Sir Robert Giffen found through research on the
consumption habit of British workers, as price of
bread increased, they purchased more of bread.
• The reason given for this was that, when the price
of bread went up, it caused such a large decline in
the purchasing power of the poor people that they
were forced to cut down the consumption of meat
and other expensive foods.

Reasons for Downward Slopping
Demand Curve
1. Law of diminishing marginal utility: due to the
operation of the diminishing marginal utility on
consumption process, consumers will only buy
additional units if price is reduced.
2. Income effect: it refers to the effect on demand
for goods due to change in real income of
consumers as a result of change in the price of
commodity. A decline in price of a production
will increase the purchasing power of one’s
money income. Hence, consumer is able to buy
more of the commodity than before

Cont………
3. Substitution effect: it is the effect related in
the purchase of cheaper commodity in place of
a dearer one due to change in price.
Consumers tend to substitute cheaper products
for dearer products. For example, a decline in
price of wai wai will increase the pruchasing
power of consumers, making them able to buy
more wai wai. At a low price, wai wai is
relatively more attractive and it is a substitute
for mayos.

Cont…………
4. Multiple uses: There are some commodities which can
be put into several uses. For example, electricity could
be used for lighting, cooking, heating and so on. When
the price of electricity rises, its consumption may be
restricted only for lighting and hence total demand for
electricity will decrease.
5. Entry and exit of new consumers: when price of a
commodity fall, then the existing consumers consume
more than before on the one hand and on the other
hand, a new consumers who did not consume before
starts to consume such commodity. As a result, the
demand for that commodity increases. The opposite
case will be true if price rises.

Individual demand
• The demand of one person is called individual
demand
• The quantity demanded for a particular
commodity by an individual consumer from
the market at various prices per period of time is
called individual demand.
• The individual demand curve can be explained
with the help of demand schedule and demand
curve.

Market demand
Market demand for a product is the sum of
demand of all individuals for that product.
The market demand curve is the horizontal
summation of all the individual demand
curves in a given market.
• It shows the quantity demanded of the good by
all individuals at varying price points

Market demand schedule
Px A’S Demand (DA) B’S Demand (DB) Market demand
(DM)=(DA+DB)
5 1 2 3
4 2 3 5
3 3 4 7
2 4 5 9
1 5 6 11

Cont……………..
• Suppose there are two buyers of a product in the
market i.e A & B
• First Coolum shows the various possible market
prices of the product.
• Columns 2nd and 3rd show the quantity demanded
of A and B respectively.
• On the 5th column market demand (total quantity
demanded of individuals A and B) has shown.
• Market demand is the horizontal summation of
individuals demand for a product at each possible
price.

Cont…………
• The curve DA shows the individual demand
curve of consumer A.
• The curve DB shows the individual demand
curve of consumer B.
• The curve denoted by DM is the market
demand curve- which is the horizontal
summation of individual demand curves for a
product at each possible price.

CONT…………..
• All individual and market demand curves are
downward sloping from left to the right
indicating an inverse relationship between
price and demand
• Market demand curve is flatter than the
individual demand curves. It happens because
as price changes, proportionate change in
market demand is more than proportionate
change in individual demand.

Movement along demand
curve/change in quantity demanded
• Movement alone the demand curve can be
defined as the state of increase or decrease in
quantity demanded due to fall or rise in price
where all other factors remaining the same.
• In other words, change in quantity demanded due
to change in only price is called movement alone
the demand curve.
• Movement of price-quantity combination from
one point to another point on the same demand
curve.

Cont…………
Rightward movement:
• It is the graphical representation of expansion
in demand brought by fall in price, other things
remaining constant. If price falls, consumes
demand more. It is called expansion in
demand. It is shown by movement from a
point in left side to another point in right side
of same demand curv

cont,………………
Leftward movement:
• It is the graphical representation of contraction
in demand brought by rise in price, other
things remaining constant. If price rises,
consumes demand less. It is called contraction
in demand. It is shown by movement from a
point in right side to another point in left side
of same demand curve.

Change in Demand/Shift in Demand
Curve
• Change in demand due to change in various
non-price factors, where price remaining the
constant is defined as shift in demand curve.
• If a demand curve shifts towards right and
towards left from its original position due to
the determinants of demand other than change
in price (due to non- price factors) is called
shift in demand curve.

Cont…………
i. Increase in Demand: It is shown by rightward
shift in demand curve from D1 to D2. Demand
rises from OQ1 to OQ2 due to favorable
change in other factors at the same price OP1
ii. Decrease in Demand: it is shown by leftward
shift in demand curve from D1 to D3. Demand
falls from OQ1 to OQ3 due to unfavorable
change in other factors at the same price OP

Cont……..
• In Fig., demand for the commodity is OQ1 at a
price of OP1. Change in other factors leads to a
rightward or leftward shift in the demand curve
i. Rightward Shift: When demand rises from OQ1
to OQ2(known as increase in demand) at the same
price of OP1, it leads to a rightward shift in
demand curve from D1 to D2.
ii. Leftward Shift: On the other hand, fall in
demand from OQ1 to OQ3 (known as decrease in
demand) at the same price of OP1, leads to a
leftward shift in demand curve from D1 to D3.

Factors Causing Shift in Demand
Curve
• Change in Income of the consumers
• Change in taste &Preference of the consumers
• Change in Price of related goods(increase in price of
substitute goods and decrease in price of com. goods)
• Change in Size of the population
• Change in Government policy
• Change in Climate and whether
• Change in Wealth distribution
• Change in Advertisement
• Change in Fear of shortage
• Change in Price expectation

Supply
The quantity of goods and services that the
suppliers are willing and able to produce &
sale in the market at various prices, per period
of time is called supply.

Determinants of Supply
• Price of product: other things remaining the
same, there is positive relationship between price
and supply.
• Prices of related goods: Change in the prices of
related goods can also change the volume of
supply for a product. A decline in price of wheat
may cause a farmer to produce and offer more
rice at each possible price.
• Number of firms: if a number of firms is more in
the industry, it increases supply.

Cont……………
• Technology: if the producers are using modern and
latest technology, it increases output. Old technology
reduces the supply.
• Tax and subsidy policy of the government: if the
government imposes high rate of tax on the goods and
services, it reduces supply. The economic assistance
provided by government to business firms which
increases supply.
• Cost of production: it includes prices of raw materials,
wages, cost of energy and so on. If the overall costs of
production increases then it reduces the production
and thereby supply.

Cont……………
• Objective of firms: If the objective of a firm is
sale maximization, it increases supply
• Development of infrastructures: well
developed infrastructures like road, transport
and so on helps to increase in supply.
• Natural factors: Favorable natural factors help
to boost up the production while unfavorable
ones hinder it and supply is adversely
affected.

Supply Function
Supply function shows the functional
relationship between supply and its
determinants.
Qx =f(Px, PR, Nf T………………….)
Where,
Qx= supply of a commodity X
F=function
Px= price of X good

Types of supply function
1. Linear supply function
2. Non-linear supply function
NOTE: every things are same as in types of
demand function but in supply function the
relationship between price and supply should
be positive

Law of supply
a. Statement
Other things remaining the same, quantity supplied
increases with rise in price and vice versa.(HIGHER
THE PRICE HIGHER THE SUPPLY AND VICE- VERSA)
b. Assumptions
• No change in number of firms
• No change in technology
• No change in tax and subsidy
• No change in priced of inputs
• No change in price expectation
• No change in objectives of firms

i. Supply Schedule: A tabular representation of
various combinations of price and quantity
supplied of a commodity at various prices is
called supply schedule.
Price (Rs/kg) Quantity supplied(kg)
20 100
40 200
60 300
80 400
100 500

Cont……………
• When price of a product is Rs. 20 per unit,
then quantity supplied is 100 units.
• As the price rises to Rs.40 per unit, then
supply also increases from 100 units to 200
units.
• Similarly, as there is further rise in price from
Rs. 40 to 60,80 and 11, the supply further
increasing from 200 units to 300,400 and 500
units respectively.

Individual Supply
• The quantity supplied by an individual
producer in the market at different prices per
period of time is called individual supply.

Market supply
• The quantity supplied by all the individual
suppliers in the market at various prices is
called market supply.

CONT…………….
• The aggregate or market supply
schedule equals the sum of all individual
supply schedules. Likewise, the sum of the
supply curve of each supplier is equal to the
market supply. Below is an example of the
supply schedule of cantaloupes at each price
between $1 and $5 by the only 2 farmers at a
farmer's market.

Movement Along Supply
Curve/Change in quantity supplied

Shift in Supply Curve/ Change in
Supply

Cont………….
• The shift in supply curve can also be of two
types – rightward shift and leftward shift.
• The rightward shift occurs in supply curve
when the quantity of supplied commodity
increases at same price due to favorable
changes in non-price factors of production of
the commodity. Similarly, a leftward shift
occurs when the quantity of supplied
commodity decreases at the same price.

Cont…………….
• In the above fig. III, let us suppose that SS is the
original supply curve where Q amount of commodity
has been supplied at price P. Due to favorable changes
in non-price factors, the production of the commodity
has increased and its supply has been increased by
Q2 – Q amount, at the same price. This has caused the
supply curve rightwards and new supply curve S2S2 has
formed. This is called increase in supply.
• In the same, due to unfavorable changes in non-price
factors of the commodity, the production and supply
have fallen to Q1 amount. Accordingly, the supply curve
has shifted leftwards and new supply curve S1S1 has
formed. This is called decrease in supply

• Causes of changes in supply
• cost of production
• No of firms in the industry
• Fiscal policy of the government(tax and
subsidy)
• Changes in technology
• Objective of the firm
• Infrastructures
• Size of population

Determination of equilibrium price
• The price at which the quantity demanded
equals the quantity supplied is called
equilibrium price because at this price the two
market forces of demand and supply exactly
balance each other.
• Equilibrium is a situation where demand and
supply are equal.

Interaction between demand and
supply
price Quantity
demanded
Quantity supplied result
10 10 50 Excess supply(S>D)
8 20 40 Excess supply(S>D)
6 30 30 Equilibrium(D=S)
4 40 20 Excess
demand(S<D)
2 50 10 Excess demandS<D)

Cont……………
• Table shows the relationship between price of a
commodity, its quantity demanded and quantity
supplied.
• Quantity demanded is inversely related to price
whereas price and supply are directly related.
• When price is Rs. 6 per unit, quantity demanded
is equal to quantity supplied.
• So equilibrium price is Rs. 6 and equilibrium
quantity is 30 units.

Cont………..
• In Fig 11.1, DD is the demand curve sloping
downward and SS is the supply curve sloping
upward. Market is in equilibrium at point ‘E’,
where two curves intersect each other. At the
equilibrium point, OQ quantity is demanded
and supplied at price OP.

Cont…………..
• If the equilibrium is now disturbed and the price rises to OP1, the
quantity of the good supplied is OQ2 will exceed the quantity
demanded OQ1. Sellers will be willing and able to supply more of
the good at this price than buyers are prepared to buy.
• There is an excess supply equal to Q1Q2. In order to dispose of this
excess supply, the sellers will compete with each other and in doing
so the price will fall down facilitating way to clear unwanted in
inventories.
• Thus, there is a tendency of sellers to cut prices in the event of
excess supply, implying a downward pressure on prices. Further,
consumers noticing excess supply offer a lower price for the good.
As price falls in this way, the quantity demanded will rise and the
quantity supplied will fall. Ultimately, the demand and supply will
coincide at the equilibrium price OP.

Cont……………
• Conversely, if the price falls to OP2, the quantity demanded
OQ2 will exceed the quantity supplied OQ1. The reason is
that new consumers who could not afford this commodity
at the higher price will also purchase it. Further, suppliers
would restrict supply due to lower price. The excess
demand in this situation is equal to Q1Q2.
• More demand and less supply and competition between
buyers as a result will force the price up, until excess
demand is completely wiped out. The tendency of the
buyers to bid up prices when there is excess demand
implies an upward pressure on prices. Once again the
equilibrium price of OP is reached. The corresponding
quantity demanded and supplied will, thus, be OQ.

When demand and supply both
increase in the same proportion

Cont…………..
• There will be no change in equilibrium price
when demand and supply both increase in the
same proportion. In the above diagram DD
and SS are demand and supply curves
intersecting at E. The equilibrium price is OP
and OQ is the equilibrium quantity. After
increase in both demand and supply in same
proportion, the two curves shift to D1D1and
S1S1 respectively. The equilibrium price OP
obviously remains unchanged.

When increase in demand is more
than increase in supply:

Cont………..
In the above diagram, DD and SS are demand
and supply curve and the equilibrium price is
OP. D1D1 and S1S1 are the new demand and
supply curves when increase in demand is
more than increase in supply. OP1 is the new
equilibrium price.

When increase in demand is less than
increase in supply:

Effect of increase in market demand
on equilibrium price at constant
supply

Effect of increase in market supply on
equilibrium price at constant demand

Cont…………
• When increase in demand is less than the
increase in supply, the equilibrium price will
fall as shown in the figure-3. This will result in
the fall of equilibrium price from OP to OP1&
increase in equilibrium quantity from OQ to
OQ1. This will benefit the consumer as not
only the equilibrium price has decreased but
equilibrium quantity has increased.

Meaning of Elasticity of Demand
• The law of demand shows the direction of
change in the demand with the change in
price. But this law does not explain what
percentage change in price leads to what
percentage change in demand.
• Thus to measure the degree of relationship
between price and demand, we use the
concept of elasticity of demand.

• The elasticity of demand is the ratio of the
percentage change in the demand to the
percentage change in any quantitative
determinant of demand.
Ed= percentage ∆ in demand /percentage ∆ in any
its determinants
• Types of elasticity of demand
1. Price elasticity of demand (Ep)
2. Income elasticity of demand(Ey)
3. Cross elasticity of demand(Exy)

1. Price Elasticity of Demand
• Other things remaining the same, price
elasticity of demand is the ratio of the
percentage change in the demand for a
commodity with the percentage change in
price of the same commodity.

Types of Price Elasticity of Demand

1. Perfectly Elastic Demand(EP =∞. ):
• If a very small (insignificant) change in price
of a good leads an infinitive change in
quantity demanded for that good, then the
demand is known as perfectly elastic demand.
• This is an imaginary situation and not found
in real life.

• The demand curve is a horizontal straight
line and lies parallel to x-axis.
• The demand curve shows the change in price
is insignificant, however, the change in
quantity demand is infinitive.
• OP is the new price which is derived from a
very small fall. At price op, the demand is
indeterminate, i.e. OQ1 or OQ or OQ2.

2. Perfectly inelastic demand(Ep=0)
• If the quantity demanded is totally
irresponsive to the change in the price of a
good , then the demand is known as perfectly
inelastic demand.
• This demand is found in case of basic
necessary goods such as salt, medicines etc.
• Therefore, numerical value of elasticity
becomes zero.

• As shown in figure, the movement in price
from OP1 to OP2 and OP2 to OP3 does not
show any change in the demand of a product
(OQ).
• The demand remains constant for any value of
price.

3. Relatively Elastic Demand (EP>1):
• If percentage change in quantity demanded is
greater than the percentage change in price of a
good, then the demand is known as relatively
elastic demand.
• Mathematically, relatively elastic demand is
known as more than unit elastic demand (Ep>1).
• For example, if the price of a product increases by
20% and the demand of the product decreases by
25%, then the demand would be relatively
elastic.

• This type of demand is found in case of
luxurious goods such as automobiles, gold
and diamond etc.
• The demand curve will be relatively flatter.
• The percentage decrease in quantity
demanded is greater than the percentage
increased in price.
• i.e. ∆Q(Q2-Q1)/Q>∆P(P2-P1)/P.

4. Relatively Inelastic Demand(EP<1):
less than the percentage change in price of a
good, then the demand is known as relatively
inelastic demand.
known as less than unit elastic demand (Ep<1).
• For example, if the price of a product
increases by 20% and the demand of the
product decreases by 15%, then the demand
would be relatively inelastic

• This type of demand is found in case of daily
consumption goods such as food cloth and
shelter.
• The demand curve will be relatively steeper.
demanded is less than the percentage
increased in price i.e. ∆Q/Q<∆P/P.

5. Unitary elastic demand(EP=1)
exactly equal to the percentage change in
price of a good, then the demand is known as
unitary elastic demand.
known as unitary elastic demand (ep=1).
• For example, if the price of a product
increases by 20% and the demand of the
product decreases by 20%, then the demand
would be unitary elastic.

demanded is less than the percentage
increased in price i.e. ∆Q/Q=∆P/P.

Determinants of price elasticity of
demand
1. Availability of close substitutes: goods with close
substitutes tend to have more elastic demand than
less or no close substitutes because it is easier for
consumer to switch from that good to others. Coca-
cola and Pepsi are easily substitutable but rice is food
without close substitute. The demand for rice is less
elastic than the demand for coke.
2. Luxurious vs. necessities: the demand for necessities
such as electricity and rice tends to be inelastic and
the demand for luxuries automobiles and diamond
tends to be elastic.

CONT………..
3. Time period: good tends to have less elasticity in
the short run rather than in the long run
because the consumer will have choice in the
long run but in the short run he is compelled to
purchase it.
4. Level of income: the rice people do not respond
to small change in price of goods and services.
For rich people, demand remains relatively
inelastic while for poor people, demand
becomes relatively elastic

Cont….
5. Goods of several uses: if there is increase in price
of electricity, demand for it becomes less elastic
but demand for electricity becomes more elastic
if there is fall in price of electricity.
6. Seasonal change: the demand for warm cloth
becomes highly elastic in summer season but
less in winter season.
7.Price expectation: if the consumer feels that price
is going to be high in near future, then demand
becomes more elastic at present and vice versa

CONT…………
9.Habitual goods: the demand for habitual
goods such as wine, alcohol, cigarettes
remain relatively inelastic to any change in
price.
10.Demand for complementary goods: if
demand for bike is elastic, demand for petrol
will also elastic and vice versa.

Use of price elasticity of demand
• Product pricing: if demand for goods is elastic,
the reduction in price leads to an increase in
quantity demanded and profit.
• Pricing of input: If the demand for inputs is
elastic, the producers are prepared to offer
low price for the inputs and they are ready to
pay high price for inelastic inputs.

CONT…………….
• Pricing of joint products(Production of more
than one products from production process.
For example, production of fur and meat from
the sheep farming. In these products price can
not be determined on the basis of cost. So
price should be determined on the help of
price elasticity of demand)

Cont…………..
• Demand forecasting: given the elasticity of
demand and the state of independent
variable, it is possible to forecast the demand
for a good.
• To formulate tax policy:
.

CONT……………….
• To formulate trade policy: if the country is
suffering from deficit balance of trade, then it
should try to increase in price of those exports
which have inelastic demand and reduces the
price of those goods which have elastic
demand

Cont………..
• To formulate investment policy: the
government should leave to the private sector
to produce those goods which have elastic
demand and should produce those whose
demand are inelastic such as health,
education, electricity etc
• Categorizing the goods: necessities/luxurious

Measurement of price elasticity of
demand.
1. Total outlay method:
• In this method, price elasticity of demand is
measured by observing the direction of
change in total expenditure in response to
change in the price of the good.
• Total outlay/expenditure= PXQ
• Based on the direction of the change in the
total expenditure, the elasticity of demand
may be

a. Elasticity of demand greater than
unity:
• If there is inverse relationship between the
change in price of a good and the
corresponding change in total expenditure of
a buyer on that good, then demand is known
as relatively elastic demand.
• Decrease in price leads to an increase in total
expenditure and vice-versa.
• Such type of elasticity is found in case of
luxurious goods such as automobilies.

b. Elasticity of demand equal to
unitary
• If total expenditure on a good of a buyer is
totally irresponsive to the change in price of
that good, then the demand is known as
unitary elastic demand.
• This type of demand is found in case of
normal goods.

c. Elasticity of demand less than
unitary
• If there is positive relationship between the
change in price of a good and the
corresponding change in total expenditure of
a buyer on that good, then demand is known
as relatively inelastic demand.
• Decrease in price leads to an decrease in total
expenditure and vice-versa.
• Such type of elasticity is found in case of
inferior goods.

Table
P Q TE=PXQ EP
6 1 6 EP>1
5 2 10 EP>1
4 3 12 EP=1
3 4 12 EP=1
2 5 10 EP<1
1 6 6 EP<1

Graphically
•In the graph, total outlay or
expenditure is measured on the
X-axis while price is measured
on the Y-axis. In the figure, the
movement from point A to
point B shows elastic demand
as we can see that total
expenditure has increased with
fall in price.
•The movement from point B to
point C shows unitary elastic
demand as total expenditure
has remained unchanged with
the change in price.
•Similarly, the movement from
point C to point D shows
inelastic demand as total
expenditure as well as price has
decreased.

2. Point method
a. Linear demand curve: it
is the ratio lower segment
of demand curve to the
upper segment

b. non-linear demand
curve
•DD is a non-linear
demand curve. To measure
elasticity at P on it, the
tangent MN is drawn. Here
EP = PN/MP.
• Ep=lower segment of
tangent line/upper
segment of tangent line

c. Arc method: it takes
average quantity and average
price to calculate Ep.

Cont……………
Where,
ΔQ = change in quantity
demanded = Q2 – Q1
Q1 = initial quantity
demanded
Q2 = new quantity
demanded
ΔP = change in price = P2 –
P1
P1 = new price

2. INCOME ELASTICITY OF DEMAND
• Other things remaining the same, income
elasticity of demand is the ratio of the
percentage change in the demand for a
commodity with the percentage change in
income of the consumer.
Ey= % ∆ in demand /% ∆ in income
= ∆Q/∆Y * Y/Q
Where, ∆Q=Q2-Q1 &
∆Y=Y2-Y1

TYPES OF INCOME ELASTICITY OF
DEMAMD
1. Negative income elasticity of demand ( EY<0)
• If there is an inverse relationship between
income of the consumer and demand for the
commodity, then income elasticity will be
negative.
• That is, if the quantity demanded for a
commodity decreases with the rise in income of
the consumer and vice versa, it is said to be
negative income elasticity of demand.
• As the income of consumer increases, they either
stop or consume less of inferior goods.

Cont………………
• In the given figure, quantity demanded and
consumer’s income is measured along X-axis and
Y-axis respectively.
• When the consumer’s income rises
from OY to OY1 the quantity demanded of inferior
goods falls from OQ to OQ1 and vice versa.
• Thus, the demand curve DD shows negative
income elasticity of demand.
• This demand is found in case of inferior goods.

Cont………..
2. Zero income elasticity of demand ( EY=0)
• If the quantity demanded for a commodity
remains constant with any percentage rise or fall
in income of the consumer and, it is said to be
zero income elasticity of demand.
• For example: In case of basic necessary goods
such as salt, kerosene, electricity, etc. there is
zero income elasticity of demand.

Cont……………..
consumer’s income is measured along X-axis
and Y-axis respectively.
• The consumer’s income may fall to OY1 or rise
to OY2 from OY, the quantity demanded
remains the same at OQ.
• Thus, the demand curve DD, which is vertical
straight line parallel to Y-axis shows zero
income elasticity of demand.

Cont……………
3. Positive income elasticity of demand (EY>0)
If there is direct relationship between income of the
consumer and demand for the commodity, then
income elasticity will be positive. That is, if the quantity
demanded for a commodity increases with the rise in
income of the consumer and vice versa, it is said to be
positive income elasticity of demand. For example: as
the income of consumer increases, they consume more
of superior (luxurious) goods. On the contrary, as the
income of consumer decreases, they consume less of
luxurious goods.

Cont…………….
Positive income elasticity can be further classified
into three types:
a. Income elasticity greater then unity (EY > 1)
If the percentage change in quantity demanded for
a commodity is greater than percentage change
in income of the consumer, it is said to be income
greater than unity. For example: When the
consumer’s income rises by 3% and the demand
rises by 7%, it is the case of income elasticity
greater than unity.

Cont…………..
In the given figure, quantity demanded and
and Y-axis respectively. The small rise in
income from OY to OY1 has caused greater rise
in the quantity demanded
from OQ to OQ1 and vice versa. Thus, the
demand curve DD shows income elasticity
greater than unity.

Cont………………..
b. income elasticity equal to unity (EY = 1)
If the percentage change in quantity demanded
for a commodity is equal to percentage
change in income of the consumer, it is said to
be income elasticity equal to unity. For
example: When the consumer’s income rises
by 5% and the demand rises by 5%, it is the
case of income elasticity equal to unity.

Cont………………..
and Y-axis respectively. The small rise in
income from OY to OY1 has caused equal rise
demand curve DDshows income elasticity
equal to unity.

Cont……………..
c. income elasticity less then unity (EY < 1)
If the percentage change in quantity demanded
for a commodity is less than percentage
change in income of the consumer, it is said to
be income greater than unity. For example:
When the consumer’s income rises by 5% and
the demand rises by 3%, it is the case of
income elasticity less than unity.

Cont……………..
In the given figure, quantity demanded and
and Y-axis respectively. The greater rise in
income from OY to OY1 has caused small rise
demand curve DD shows income elasticity less
than unity.

3. Cross elasticity of demand
• It is the ratio of proportionate change in the
quantity demanded of Y to a given
proportionate change in the price of the
related commodity X.
• It is a measure of relative change in the
quantity demanded of a commodity due to a
change in the price of its
substitute/complement. It can be expressed
as:

Types of cross elasticity of demand
1. Positive cross elasticity of demand(case of
substitute goods)
• When goods are substitute of each other then
cross elasticity of demand is positive.
• In other words, when an increase in the price of Y
leads to an increase in the demand of X. For
instance, with the increase in price of tea, demand
of coffee will increase.
• as price of Y commodity increases to OP1 demand
of X-commodity increases to OM1 Thus, cross
elasticity of demand is positive.

Cont……………..
2. Negative cross elasticity of demand(case of
complementary goods):
• In case of complementary goods, cross elasticity
of demand is negative.
• A proportionate increase in price of one
commodity leads to a proportionate fall in the
demand of another commodity because both are
demanded jointly.
• When the price of commodity increases from OP
to OP1 quantity demanded falls from OM to OM1.
Thus, cross elasticity of demand is negative.

Cont…………………
3. Zero cross elasticity of demand:
Cross elasticity of demand is zero when two
goods are not related to each other. For
instance, increase in price of car does not
effect the demand of cloth. Thus, cross
elasticity of demand is zero. It has been shown
in fig

Price elasticity of supply
• Other things remaining the same, price elasticity
of supply is the ratio of the percentage change in
the supply of a commodity with the percentage
change in price of the same commodity.
Ep = % ∆ in supply /% ∆ in price
Ep = ∆Q/∆P * P/Q
Where, ∆Q=Q2-Q1 &
∆P=P2-P1

Types of price elasticity of supply
1. perfectly elastic supply (Es=∞)
2. Perfectly inelastic supply (Es=0)
3. Relatively elastic supply (Es>1)
4. Relatively inelastic supply (Es<1)
5. Unitary elastic supply (Es=1)

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