UNIT-2

DEMAND AND
SUPPLY
BA LLB-113
 a. Theories of demand - demand function, law of demand
Concept of utility and utility theory-utility approach,
indifference curve approach  
b. Law of supply, supply function  

Unit-II: c. Price determination; shift of demand and supply 

Demand and
Supply   
d. Elasticity of demand and supply; consumer surplus   

e. Applications of demand and supply –tax floor and

ceilings; applications of indifference curves-tax, work
 The term demand refers to the quantity
demanded of a commodity per unit of time at a
given price.

THE Demand simply means a consumer’s desire to

buy goods and services without any hesitation
CONCEP and pay the price for it. 

T OF In simple words, demand is the number of goods

that the customers are ready and willing to buy at
DEMAND several prices during a given time frame.

Preferences and choices are the basics of

demand, and can be described in terms of the
cost, benefits, profit, and other variables.
 The law of demand is interpreted
as ‘the quantity demanded of a product
comes down if the price of the product goes
up, keeping other factors constant.’
In other words, if the cost of the product
The law of increases, then the aggregate quantity
demanded decreases.
demand-
The law of demand in economics explains
that when other factors remain constant, the
quantity demand and price of any product or
service show an inverse equation.
Demand curve
• The demand curve is based on the demand schedule.
The demand schedule shows exactly how many units of
a good or service will be purchased at various price
points.
Mathematical formulation-
• Demand equation
• Dx=100-5Px
• Here q=quantity demanded
• P= price of a commodity
 Downward sloping of demand curve to the
right

The demand of a product refers to the desire of acquiring it by the consumer but backed by his purchasing power and
willingness to pay the price. The law of demand states that there is an inverse proportional relationship between price
and demand of a commodity. When the price of commodity increases, its demand decreases.

Similarly, when the price of a commodity decreases its demand increases. The law of demand assumes that the other
factors affecting the demand of a commodity remain the same.

Thus, the demand curve is downward sloping from left to right.

 Exception of law of demand-
• Future price Expectation-
• The issue of price change in the market is another exception to the
law of Demand. There might be a situation when the Price of a
product or service increases and is subjected to future growth. So, the
customers may buy more of it to avoid further cost increment.
Eventually, there are times when the Price of a product is about to
decrease. Consumers may temporarily stop the purchase to avail of
the future benefits of price decrement. Recently, there has been a
massive rise in the price of onions. People were buying it more due to
the worry of the further cost increase.
 • A significant exception to the
law is the Demand for luxury
Status or goods. In such cases, even if
the price increases, the
luxury consumer won't stop
goods consumption. Cigarettes and
alcohol typically come in this
category.
 • A Giffen good, a concept
commonly used in economics,
refers to a good that people
consume more as the price rises.
Giffen Therefore, a Giffen good shows
an upward-sloping demand curve
goods- and violates the fundamental law
of demand.
• Bread, wheat, and rice are
examples of Giffen goods.
 PRODUCT PRICE

The income of the consumers

Determinant Price of related goods and services

s of demand-
Costs of related goods and services

Buyers in the market

Product price

• Demand of the product

changes as per the change
in the price of the
commodity. People
deciding to buy a product
remain constant only if all
the factors related to it
remain unchanged.
The income of
the consumers
• When the income
increases, the number of
goods demanded also
increases. Likewise, if the
income decreases, the
demand also decreases.
Consumer expectation

• High expectation of income

or expectation in the
increase in price of a good
also leads to an increase in
demand. Similarly, low
expectation of income or
low pricing of goods will
decrease the demand.
Price of related goods and
services:
• Costs of related goods and services: For a
complimentary product, an increase in
the cost of one commodity will decrease
the demand for a complimentary product.
Example: An increase in the rate of bread
will decrease the demand for butter.
Similarly, an increase in the rate of one
commodity will generate the demand for
a substitute product to increase. Example:
Increase in the cost of tea will raise the
demand for coffee and therefore,
decrease the demand for tea.
 Buyers in the
market
 If the number of buyers for a
commodity are more or less, then
there will be a shift in demand.
(a) MEANING OF
MOVEMENT
ALONG THE • Keeping all other factors the
DEMAND CURVE same, when there is a change
in demand of a commodity
due to change in price, it is
referred to as the change in
quantity demanded. It is
shown as a movement along
the demand curve when
expressed graphically.
• (a) UPWARD MOVEMENT OF DEMAND CURVE
• When the price of the commodity rises, the quantity demanded
falls. It leads to the upward movement of the demand curve.
• It is also known as contraction of demand.
• (b) DOWNWARD MOVEMENT OF DEMAND CURVE
• When the price of the commodity falls, the quantity demanded
rises. It leads to the downward movement of the demand curve.
• It is also known as expansion of demand.
Shift in Demand curve-

• Shift in the demand curve occurs when

a determinant of demand other than
price changes. It occurs when demand
for goods and services changes even
though the price didn't.
 Utility

It is a measure of In other words, it is a A utility is a measure of

satisfaction an individual measurement of how much one enjoys a
gets from the usefulness that a movie, favourite food, or
consumption of the consumer obtains from other goods. It varies with
commodities.  any good. the amount of desire.
Characteristic of Utility
• It is dependent upon human wants.
• It is immeasurable.
• A utility is subjective.
• It depends on knowledge.
• Utility depends upon use.
• It is subjective.
• It depends on ownership.
Measurement of utility

Cardinal- Marshall-  Utility can be

measured

Ordinal-Hicks- Utility can't be

measured
 Cardinal Approach
• In this approach, one believes that it is measurable.
One can express his or her satisfaction in cardinal
numbers i.e., the quantitative numbers such as 1, 2,
3, and so on. It tells the preference of a customer in
cardinal measurement. It is measured in utils.
• Limitation of Cardinal Approach
• In the real world, one cannot always measure utility.
• One cannot add different types of satisfaction from
different goods.
 Ordinal Approach

In this approach, one believes that it is comparable. One can express his or her satisfaction in
ranking. One can compare commodities and give them certain ranks like first, second, tenth, etc. It
shows the order of preference. An ordinal approach is a qualitative approach to measuring a
utility.

Limitation of Ordinal Approach

It assumes that there are only two goods or two baskets of goods. It is not always true.
The law of diminishing utility
• The law of diminishing marginal utility states
that the amount of satisfaction provided by the
consumption of every additional unit of good
decreases as we increase that good’s
consumption. Marginal utility is the change in
the utility derived from consuming another unit
of a good.
 • Law of Equi-Marginal Utility
explains the relation between
EMU the consumption of two or
(Equimargin more products and what
al principle) combination of consumption
these products will give
optimum satisfaction. 
 • Units of goods are homogenous.

Assumptions • No time gap between the consumption

of the different units.
of Law of
• Tastes, fashion, preferences, and
Equi- priorities remain unchanged.
Marginal • Consumer aims at maximum
Utility satisfaction.
• Consumer’s income is fixed and limited
 • A popular alternative to the marginal
utility analysis of demand is the
Indifference Curve Analysis. 
Indifferenc • This is based on consumer
preference and believes that we
e curve cannot quantitatively measure human
approach  satisfaction in monetary terms.
• This approach assigns an order to
consumer preferences rather
than them in terms of money.
INDIFFERENCE CURVE

An indifference curve is a curve that represents all the combinations of

goods that give the same satisfaction to the consumer.

Since all the combinations give the same amount of satisfaction, the
consumer prefers them equally. Hence the name indifference curve.
SUPPLY
• Supply in economics is defined as the total
amount of a given product or service a
supplier offers to consumers at a given period
and a given price level.
•  It is usually determined by market
movement. 
 SUPPLY
• Supply is the amount of an item that is available for use or purchase. 
• The definition of supply in economics is the amount of something that a
producer or seller is willing and capable to provide to buyers. Supply
simply constitutes of the amount of a product or item. 
• The concept of supply forms part of the foundation of all economic and
business activity. 
• Supply business defines the dynamics behind supply in business
operations. It involves the elements of input resources and costs, along
with productional factors that make up the final supply.
 • The law of supply in economics
states that supply will increase as
price increases, due to the fact
that producers want to maximize
Law of profits. 
• In this instance, the law assumes
Supply- that all other factors are equal and
price is the only independent
element, meaning supply is
completely dependent on the
price.
Supply curve-
• Supply Curve in Economics
• A supply schedule indicates the supply of a good at specific price
points. 
 ELASTICIT
Y
• Elasticity, ability of a
deformed material body to
return to its original shape
and size when the forces
causing the deformation are
removed. A body with this
ability is said to behave (or
respond) elastically.
 • A change in the price of a commodity affects
its demand . 
• We can find the elasticity of demand, or the
degree of responsiveness of demand by
comparing the percentage price  changes
Elasticity with the quantities demanded.
• “Elasticity of demand is the responsiveness
of demand of the quantity demanded of
a commodity to changes in one of the
variables on which demand depends. In
other words, it is the percentage change in
quantity demanded divided by
the percentage in one of the variables on
which demand depends.”
The Price of the commodity
variables
on which Prices of related
demand commodities
can
depend on Consumer’s income, etc
are:
 • Based on the variable that
affects the demand, the
Types of elasticity of demand is of
Elasticity the following types. One
point to note is that unless
of Demand otherwise mentioned,
whenever the elasticity of
demand is mentioned, it
implies price elasticity.
 The price elasticity of demand is the
response of the quantity demanded to
change in the price of a commodity.

It is assumed that the consumer’s

Price Elasticity income, tastes, and prices of all other
goods are steady.

It is measured as a percentage change

in the quantity demanded divided by
the percentage change in price.
 • perfectly elastic demand is when
the demand for the product is
entirely dependent on the price
of the product. This means that if
Perfectly elastic any producer increases his price
demand  by even a minimal amount, his
demand will disappear.
Customers will then switch to a
different producer or supplier.
 • Elastic demand
curves indicate that the
Elastic
quantity demanded or
demand
supplied responds to price
curve
changes in a greater than
proportional manner.
 •An inelastic demand or
supply curve is one where
Inelastic a given percentage
demand change in price will cause
curve a smaller percentage
change in quantity
demanded or supplied.
 • Perfectly inelastic demand
curve shows the elasticity of
Perfectly demand where the demand
does not change with any
inelastic change in price.
demand • Hence the demand curve is a
vertical curve straight line
parallel to OY Axis.
 Unit elastic demand is the economic
theory that assumes a change in
product price causes an equal and
proportional change in the quantity
Unit elastic demanded.
demand In other words, the percentage
curve change in demand for the product is
equal to the percentage change in
price.
 • Income Elasticity
• The income elasticity of demand is
INCOME the degree of responsiveness of
the quantity demanded to a
ELASTICI change in the consumer’s income. 
• Symbolically,
TY OF • EI=Percentage change in quantity
DEMAND demanded/Percentage change in
income
Cross
Elasticity
• Cross Elasticity

• The cross elasticity of
demand  of a commodity X
for another commodity Y, is
the change in demand of
commodity X due to a change
in the price of commodity Y. 
Equilibrium
price and
quantity
 Equilibrium is the state in which market
supply and demand balance each other,
and as a result prices become stable.

Equilibriu
m  Generally, an over-supply of goods or
services causes prices to go down, which
results in higher demand—while an
under-supply or shortage causes prices
to go up resulting in less demand.
A market is said to have reached equilibrium
price when the supply of goods matches demand.

A market in equilibrium demonstrates three

characteristics:

the behavior of agents is consistent,

there are no incentives for agents to change

behavior,

and a dynamic process governs equilibrium

outcomes.
CONSUMER SURPLUS

“Excess of the price that a

Hence, Consumer’s
consumer would be
Surplus = The price a
willing to pay rather than
consumer is ready to pay
go without a commodity
– The price he actually
over that which he
pays.
actually pays.”
 Application of Demand and
Supply-
• Price Ceilings-
• Price ceilings prevent a price from rising above a certain level.
• When a price ceiling is set below the equilibrium price,
quantity demanded will exceed quantity supplied, and excess
demand or shortages will result.
• Laws enacted by the government
to regulate prices are called price
controls. Price controls come in
two flavors. A price ceiling keeps a
price from rising above a certain
level—the “ceiling”.
• A price floor keeps a price from
falling below a certain level—the
“floor”.
 • Price floors prevent a price from falling
below a certain level.
• When a price floor is set above the
equilibrium price, quantity supplied will
exceed quantity demanded, and excess
supply or surpluses will result.
Price floors • When government laws regulate prices
instead of letting market forces
determine prices, it is known as price
control.
• A price floor is the lowest legal price that
can be paid in a market for goods and
services, labor, or financial capital.