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Principles of Micro Economics (BBA 1st)

Chapter # 2 Demand
Meaning of Demand
Demand is the quantity of anything which will be purchased from the market at a specific price.
But two conditions are necessary for creating demand.
i. Willingness to purchase
Demand = Willingness + Purchasing Power
ii. Purchasing power

Individual Demand
The quantity of a commodity which a consumer is ready to purchase at different prices is called
individual demand.

Market Demand
The total quantity of a commodity which is purchased by all the consumers in the market at
different prices is called market demand. Market demand is the sum of individual demand.

Joint Demand
When two or more commodities are used to satisfy a single want then demand for all
commodities is called joint demand i.e. bike and petrol, ink and pen etc.

Composite Demand
Some commodities are used for different purposes. Demand for such commodities for all their
purposes is called composite demand i.e. electricity, wood etc.

Derived Demand
Whenever in order to meet the demand for a commodity, some other commodity is demanded,
then the demand for other commodity is called Derived Demand. For example the demands of
bricks, cement, iron for the construction of a house.

Q.No.1
Define and explain Law of Demand with its schedule and diagram.
Also describe its assumptions and limitations.
Ans:
Introduction:
Demand is the quantity of anything which will be purchased from the market at a specific price.
Law of demand shows the negative relationship between quantity demanded of a commodity
and its price i.e. P↓ Qd ↑ and P↑ Qd ↓. Thus demand is the function of price i.e. Qd = f (P). The
standard form of law of demand is Qd = a – bP.
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Law of Demand:
Law of demand has been defined as following.
According to Marshall:
“Other things being equal, the amount demanded increases with fall in price and diminishes
with rise in price”.
According to Baxter:
“The lower is the price, the greater is the quantity of the product demanded and vice versa”.
In simple words:
“Other things remaining the same, a rise in the price of a commodity is followed by a
contraction in demand and fall in price is followed by an extension in demand”.
Quantity
Schedule: Price
Demand
It is clear from the schedule that as the price of the commodity increases, 1 300
demand is decreasing. Price has risen from Rs.1 to Rs.3 per kg and 2 200
demand has fallen from 300 to 100. 3 100
Diagram:
Diagram shows that when price of a commodity is Rs.1 per kg, the
demand is 300kg as shown by the point A, when the price of
commodity is Rs.2 per kg, the demand is 200kg as shown by the
point B and when price of the commodity rises to Rs.3 per kg, the
demand is 100kg as shown by point C. Demand curve is drawn by
joining the points A, B, C. Diagram shows that demand curve is
negative sloped as it moves from left to right downwards.
Assumptions:
Law of demand holds under following assumption.

1. Homogeneous Units:
It is assumed that units of a commodity are homogeneous because if the quality of the lateral
units purchased is superior then with an increase in price, demand may not contract.

2. No Change in Income:
Income of the people should not be changed. In case of increase in income demand will also
increase. It violates the law of demand. We should keep in mind that law of demand express a
negative relationship between price and demand.

3. No Change in Taste and Fashion:

If the commodity is used as a fashion or the taste of the consumer changes, the law does not
hold good because if we like a particular commodity or its use is a fashion then instead of
increase in price, the demand will expand.
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4. No New Substitutes:
If new substitutes are discovered the demand for original commodity is subdivided, so the
demand for original commodity decreases without increase in price.

5. Price of the Substitute:

It is assumed that price of the substitutes do not change. If the prices of the substitutes
decrease, the demand for original commodity will decrease and vice versa.

6. No Change in Expectation:
Sometime the demand for a commodity either rises or falls merely due to expectations. If it is
expected that the price of a commodity will rise in next few days, the demand for that
commodity increase without decrease in price and vice versa.

7. The Use is not Distinctive:

The law of demand does not hold well if the use confers distinction. If the use of the commodity
is distinctive then even an increase in price cannot contract demand.

8. Climate and Weather Condition:

The law does not hold well when weather changes. In summer season demand for ice increase
at same price and in winter season even a lower price does not extend the demand.

9. No Change in Quantity of Money:

If the quantity of money increases, demand for goods and services will increase and with an
increase in price of goods and services may not decrease the demand and law do not hold true.

10.No Change in Population:

It is assumed that the population does not increase because with an increase in population
demand will increase at constant prices.

Exceptions or Limitations:
The limitation of law of demand is discussed below.

1. Inferior and Superior Goods:

The law of demand does not apply in case of inferior and superior goods. Fall in price of an
inferior good will bring further fall in demand and rise in price of a superior good will bring
further rise in demand.

2. Danger of being Scarce:

If there is danger that a commodity will become scarce or it will not be available in future, then
instead of increase in price, demand will increase.

3. Use Confers Distinction:

If the use of a commodity is distinctive, then the people will increase its purchase instead of
increase in price.
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4. Necessities of Life:
If the price of one of the necessity of life rises, the expenditures on other goods decrease
without increase in their prices.

5. Giffen Goods:
The law of demand does not come true in case of Giffen goods. People do not buy these goods
even at low prices.

6. Ignorance of Consumer:
The consumers usually judge the quality of a commodity form its price. A low price commodity
is considered as inferior and less quantity is purchased. A high priced commodity is treated as
superior good and more quantity is purchased. The law of demand does not apply in this case.

7. Depression:
The law of demand does not work during period of depression. The prices of the commodity are
low but there is no increase in demand. It is due to low purchasing power of people.

8. Speculation:
The law of demand does not apply in case of speculation. The speculators start buying shares
just to raise the prices. Then they start selling large quantity of shares to avoid loss.

9. Out of Fashion:
The law of demand does not apply in case of goods out of fashion. The decrease in price cannot
increase the demand of such goods

Slope of Demand Curve

The demand curve has tendency to move from left to right downwards. It means that
demand curve has negative slope.

Reasons of the Negative Slope of Demand Curve

There are three reasons of negative slope of demand curve.
1. Price Effect 2. Income Effect 3. Substitute Effect

Q.NO.2
Explain the Extension and Contraction in Demand, Rise and Fall in Demand
with schedule and diagrams. OR Explain the changes in Demand.
Ans:
Introduction:
The demand for a commodity may change due to many factors. For example
 Change in Price of the commodity  Change in Fashion
 Change in Income of the Consumer  Change in Weather
 Change in Price of Substitute  Change in Population
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A change in any factor can change the demand for commodity. This change in demand can be
classified as:

1. Extension and Contraction in Demand (Movement along the Demand

Curve)
If the change in demand is due to change in the price of that commodity, it is called extension
or contraction in demand.
When the price of a commodity decreases, its quantity demanded increase; it is called
extension in demand. When the price of a commodity increases, its quantity demanded
decreases; it is called contraction in demand.
Quantity
The movement of the demand is explained Price
Demand
with the help of schedule and diagram.
1 10
Schedule and diagram show that with the
2 8
increase in price, quantity demanded
3 6
contracts and with the decrease in price,
4 4
quantity demanded extends.
5 2
2. Shift in Demand Curve or Rise and Fall in Demand:
If the change in demand is not due to change in price, but due to change in some other factors
(like income, price of substitute and complementary goods, taste, fashion, habits, population
etc.), it is called shift in demand or rise and fall in demand.
When quantity demanded of a commodity decreases due to some other factors instead of
price; it is called Fall in demand.
When quantity demanded of a commodity increases due to some other factors instead of price;
it is called Rise in demand.

Rise in Demand:
There are also two types of rise in demand. Price Demand
First Type: 3 4
When the price remains constant and 3 6
quantity demanded increases due to other 3 8
factors, it is called rise in demand. As shown in by schedule and
diagram.

Second Type: Price Demand

When the price of the commodity increase 2 6
but quantity demanded remains constant, it 3 6
is called rise in demand. As shown by 4 6
schedule and diagram.
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Fall in Demand:
There are two types of fall in demand. Price Demand
3 8
First Type: 3 6
When the price remains constant and 3 4
quantity demanded decreases due to other
factors, it is called fall in demand. As shown by schedule and diagram.

Second Type:
When the price of the Commodity decreases Price Demand
but quantity demanded remains constant, it 4 6 is
also called fall in demand. As shown by 3 6
schedule and diagram. 2 6

Q.No.3
Define Elasticity of Demand. Also explain different methods to
measure it.
Ans:
Introduction:
There are many factors including price that disturb the demand. These factors change the
demand for anything. But we do not know that how much changes take place in quantity
demanded when price changes. For the sake of this purpose, we apply the concept of elasticity
of demand.

Elasticity of Demand:
According to Marshall:
“Degree of responsiveness of quantity demanded to change in price is known as elasticity of
demand”.
According to Lipsey:
“Elasticity of demand is the rate of the percentage change in demand due to percentage change
in price”.
In simple words:
Elasticity of demand is a relationship between the proportionate change in quantity demand and
proportionate change in price of a Proportionate Change in Quantity Demand
commodity. Symbolically it is written as: Ed = Proportionate Change in Price
Where
∆Q = Change in Quantity Demand ∆Q/Q ∆Q P ∆Q P
∆P = Change in Price
E d=
∆P/P
=
Q
×
∆P
=
∆P
×
Q
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Measurement of Elasticity of Demand:

Economists use following three different methods to measure elasticity of demand.
1. Total Expenditure or Unity Method
2. Percentage Method or Flux method
3. Mathematical Formulas Method

1. Total Expenditure or Unity Method:

In this method, we compare the changes in total expenditure before and after the change in
price. This method was presented by Prof. Marshall.

1. Elasticity equal to unity (E = 1):

If with a change in price total
Quantity Total
expenditure remains the Price
Demanded Expenditure
same, the elasticity of demand
2 4 8
is equal to unity. As shown by
4 2 8
schedule and diagram.

2. Elasticity greater than unity (E >1):

If with an increase in price total expenditure decreases and with a
decrease in price total
Quantity Total
expenditure increases, the Price
Demanded Expenditure
elasticity of demand is
2 4 8
called greater than unity
4 1 4
e.g. comforts, durable
goods, luxuries etc. As shown by schedule and diagram.

3. Elasticity less than unity (E <1):

If with an increase in price, total expenditure increases and with a
decrease in price, total
Quantity Total
expenditure decreases, the Price
Demanded Expenditure
elasticity of demand is
2 4 8
called less than unity e.g.
4 3 12
necessities of life etc. As
shown by schedule and diagram.

2. Percentage Method or Flux method:

In this method, we compare proportionate or percentages changes in quantity demanded and
proportionate or percentage change in price.
Percentage Change in Quantity Demand
Ed = Percentage Change in Price
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1. Elasticity equal to unity (E = 1):

If the percentage change in quantity demanded is equal to percentage 25%
Ed = 25%
=1
change in price, elasticity of demand is equal to unity. Such as
2. Elasticity greater than unity (E >1):
If the percentage change in quantity demanded is greater than percentage 30%
change in price, elasticity of demand is greater than unity. Such as Ed = 25%
>1

3. Elasticity less than unity (E <1):

If the percentage change in quantity demanded is less than percentage 20%
change in price, elasticity of demand is less than unity. Such as
Ed = 30%
<1

3. Mathematical Method:
This method is explained with the help of following two formulas.
1. Point Elasticity of Demand:
When there is very small change in demand due to a small change in price, it is called point
elasticity of demand. In such case the two points are so close that they seem a single point and
we have to measure elasticity on a single point. So we use the following formula of point
elasticity of demand. ∆Q P
Ed = ∆P × Q
Quantity
Price
Demanded Here ∆Q = 300 - 299 = 1
3 300 ∆P = 3 – 3.05 = -0.05
3.05 299 Q = 300 P=3
Thus elasticity of demand is
∆Q P 1 3
Ed = ∆P × Q = -0.05 × 300 = -0.2
Where "-" sigh shows inverse relationship between quantity demanded and price. So it is
ignorable then Ed = 0.2 which is less than unity.
2. Arc Elasticity of Demand:
When there is big change in demand due to big change in price, it is called arc elasticity of
demand. In such case the next point is far away from the initial point. So we have to measure
elasticity of demand on two different points. We use the arc elasticity of demand formula to
calculate elasticity.
Quantity
Price Q2 – Q1 P2 + P1
Demanded Ed = Q2 + Q1
×
P 2 – P1
4 200
2 400 Here Q1 = 200 P1 = 4
Q2 = 400 P2 = 2
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Q2 – Q1 P2 + P1
Thus elasticity of demand is Ed = Q2 + Q1
×
P2 – P1
400 - 200 2+4 200 6
Ed = 400 + 200
×
2-4
=
600
×
-2
= -1

Where "-" sigh shows inverse relationship between quantity demanded and price. So it is
ignorable then Ed = 1 which is equal to unity.

Q.No.4
Write short note on the followings.
(A) Income Elasticity of Demand
(B) Cross Elasticity of Demand
(C) Determinants of Elasticity of Demand
Ans:
A. Income Elasticity of Demand:
If the change in demand is not due to change in price but due to change in income of the
consumer, it is called income elasticity of demand.
According to Watson:
“Income elasticity of demand means the ratio of the percentage change in quantity demand to
the percentage change in income of the consumer”. Symbolically it is written as:

Percentage Change in Quantity Demand

Ey = Percentage Change in Income

∆Q/Q ∆Q Y ∆Q Y Where ∆Q = Change in Quantity Demand

Ey = ∆Y/Y
=
Q
×
∆Y
=
∆Y
×
Q and ∆Y = Change in Income
Quantity
Income Here
Demanded
∆Y = 2000 –1000 = 1000
1000 10 Y = 1000
∆Q = 20 - 10 = 10
2000 20 Q = 10
Thus elasticity of demand is
∆Q Y 10 1000
Ey = ∆Y
×
Q
=
1000
×
10
= +1

Where "+" sigh shows direct relationship between quantity demanded and income of
consumer. Ey = 1 shows income elasticity equal to unity.
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B. Cross Elasticity of Demand:

If the change in demand is not due to change in price of that good but the change in demand is
due to change in price of inter-related goods (substitutes & complementary), it is called cross
elasticity of demand.
According to Ferguson:
“Cross elasticity of demand is proportional change in quantity demand of a commodity X due to
proportional change in price of related commodity Y”. Symbolically it is written as:
Proportionate Change in Quantity Demand of X
Ec = Proportionate Change in Price of Y
∆Qx/Qx ∆Qx Py ∆Qx Py
Ec = ∆Py/Py
=
Qx
×
∆Py
=
∆Py
×
Qx
Where ∆Qx = Change in Quantity Demand of commodity X
∆Py = Change in price of commodity Y

1. Cross Elasticity of Substitutes Goods:

Those goods (X & Y) which have same qualities, features and limitations are called substitute
goods. The cross elasticity of demand is positive when two goods are substitute of each other
e.g. due to increase in price of rice, the demand of wheat is increased. It is explained as:
Here Quantity
∆Qx = 26 –24 = 2 Qx = 24 Commodity Price
Demanded
∆Py = 16 - 12 = 4 Py = 12 24 Kg
∆Qx Py 2 12 Wheat Rs.10/Kg
26 Kg
Ec = ∆Py × Qx = 4 × 24 = 0.25
Rs. 12/Kg
Rice 10 Kg
Rs. 16/Kg

2. Cross Elasticity of Complementary Goods:

Those goods (X & Y) which are purchased
Quantity
together to fulfill an economic desire are called Commodity Price
Demanded
complementary goods. The cross elasticity of
4
demand is negative when two goods are Ink Rs.5
2
complementary e.g. when the price of pen
Rs. 10
increase, the demand for ink decrease. It is Pen 2
Rs. 12
explained as:Here
∆Qx = 2 –4 = -2 Qx = 4
∆Py = 12 - 10 = 2 Py = 10
∆Qx Py -2 10
Ec = ∆Py × Qx = 2 × 4 = -2.5
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C. Determinants of Elasticity of Demand:

There are several factors which determine the elasticity of demand. These are as follows.
1. Nature of the Commodity:
The elasticity of demand for necessities of life is less elastic and for comforts and luxuries the
elasticity is more elastic.
2. The Possibility of Substitutes:
If there are close substitutes for a good, its demand is more elastic and if there are no close
substitutes of a good within same price range, the demand is less elastic.
3. Proportion of the Income Spent:
The demand for that commodity is less elastic on which less proportion of income is spent e.g.
salt. And the demand for that commodity is more elastic on which more proportion of income
spent e.g. car.
4. Number of Uses:
If the commodity has more number of uses, the demand is more elastic e.g. wood, coal, etc.
And if the commodity has only one use its demand is less elastic.
5. Durable Goods:
Durable goods have more elasticity of demand e.g. car, fan, house etc. Whereas perishable
goods have less elasticity of demand e.g. vegetables, fruits, etc.
6. Price Level:
Elasticity of demand for those goods which are either high priced or low priced is less elastic
e.g. diamonds or salt. On the other side, elasticity of demand for those goods having price in
the middle range is more elastic i.e. wheat, fan, heater etc.
7. Income Level:
For rich, elasticity of demand for different commodities is less elastic whereas for poor, the
elasticity for different commodities is more elastic.
8. Time Period:
In the long run demand is more elastic and in the short run demand is less elastic.
9. Postponement of Demand:
A commodity whose demand can be postponed elasticity of demand is more elastic e.g.
comforts and luxuries. And the commodity whose demand cannot be postponed the elasticity is
less elastic e.g. necessities of life.
10. Habits, Fashion or Consumer’s Taste:
A commodity which is liked by the people or it is in fashion, demand is less elastic because
people purchase them even at high price whereas a commodity which is out of fashion, its
demand is more elastic.
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Some More Types of Elasticity of Demand

More Elastic Demand:
When a small change in price causes a big change in demand, it is called more elastic demand.
The demand for comforts and luxury goods is more elastic.

Less Elastic Demand:

When a big change in price causes a very small change in demand, it is called less elastic
demand. The demand for necessities of life is less elastic.

Infinite Elastic Demand (Perfectly Elastic Demand):

When there is no change in price but quantity demand increases infinitely, it is called infinite or
perfectly elastic demand. Here the demand curve is horizontal.

Zero Elastic Demand (Perfectly Inelastic Demand):

When due to any change in price, demand remains unchanged; it is called zero or perfectly
inelastic demand. Here the demand curve is vertical.

Some Types of Goods

Substitute Goods:
Goods which can be used in place of other goods are called substitute goods i.e. Pepsi & Coke,
Beef & Mutton, Wheat and Rice etc.

Complementary Goods:
When the demand for one good depends upon other good and both goods are used together,
they are called complementary goods i.e. Pen & Ink, Car & Petrol, Mobile & Sim Card etc.

Normal Goods:
A good for which demand increase as consumer’s income rise is known as Normal good.

Inferior Goods:
A good for which demand falls as consumer’s income rise is known as Inferior good.

Giffen Goods:
Some of the inferior goods having expensive substitute are called Giffen goods or those inferior
goods in which law of demand does not apply is called Giffen goods i.e. rice and broken rice. In
case of Giffen goods demand curve is positive sloped.