ECONOMICS CHAPTER 2: LAW OF DEMAND Class: XII (ISC)

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q ECONOMICS CHAPTER 2: LAW OF DEMAND Class: XII (ISC) 2018-2019 Demand is the desire backed by the ability and willingness to buy that commodity. Ex. Household purchases 5 kgs of sugar per day @ Rs.

Household purchases 5 kgs of sugar per day @ Rs. 20 per kg. Main features of demand. Demand is also effective demand.

1 q ECONOMICS CHAPTER 2: LAW OF DEMAND Class: XII (ISC) Demand is the desire backed by the ability and willingness to buy that commodity. Ex. Household purchases 5 kgs of sugar per Rs. 20 per kg. Or. Demand for any commodity refers to the amount of that commodity that will be purchased at a particular price during a particular period of time. Ex. Household purchases 5 kgs of sugar per Rs. 20 per kg. Main features of demand. Demand is also effective demand. Desire becomes demand only when it is backed by purchasing power and willingness to spend. Demand is always at a certain price. Demand becomes meaningless unless stated in terms of price. Therefore, demand is always expressed in relation to a particular price. Demand is a flow concept. As it is expressed in terms of time, say per day, per week, per month etc. Types of demand. Joint Demand: A demand is said to be joint when the demand of two commodities is needed to satisfy one want. For example, Demand for fountain pen and ink. Therefore, both demands are said to be joint or complementary since one complements the other. Composite Demand: If a particular goods or service demanded can be put to several uses it is said to be composite demand. That is deriving different satisfaction from a particular commodity. Ex. Coal can be used for heating, cooking, operating railway engine, etc. Derived demand: When a commodity is demanded for the satisfaction of another commodity, that demand is said to be derived. Ex. Demand for steel,bricks, cement, stones, wood etc is a derived demand from the demand for houses and other buildings. Individual demand and market demand :It is the quantity of a commodity that an individual consumer is willing to purchase at a given price during a given period of time is known as the individual demand. Market demand: it refers to the total quantity that all total quantity of a commodity that all the households are willing to buy at a given price during a given period of time. Ex ante and Ex post: Ex ante demand refers to the amount of goods that consumers want to plans to purchase during a particular time period. Ex post refers to the amount of goods that the consumers actually purchases during a specific period. DETERMINANTS OF DEMAND/FACTORS AFFECTING DEMAND 1. Price is the most important factor affecting demand. Normally there is an inverse relationship between the price of the commodity and the quantity demanded ie.,when price increases quantity demanded for that commodity decreases and vice- versa. This type of demand is also known as price demand. Ex. A consumer demands just 1 kg when it is priced at Rs.40/kg and rises to 2 kgs when its price falls to Rs.30/kg. ( 1 )

2 2. Price of related goods. A change in price of one good affects the demand for another good. Related goods can be classified as substitute goods and complementary goods. Cross demand shows the functional relation between the price of a commodity and demand for some other related commodity. Ex. Substitute goods and complementary goods Substitute goods- Are goods which can satisfy the same type of demand and hence can be used in place of one another. Ex. When there is rise in price of tea demand for coffee will increase because Coffee has become relatively cheaper. Hence,demand for coffee will increase and that of tea will reduce. [there is a direct relationship between the demand for a product (tea)and the price of its substitute (coffee)] y Price of Tea x Demand of Coffee Complementary goods. Those goods which are complementary to one another in the sense that they are jointly or consumed together. Ex. If price of petrol will go up demand for car will decrease. [there is an inverse relationship between the price for a product (petrol)and the demand for car] y Price of Petrol Demand of Cars x 3. Income of the consumer. Income of the consumer also affects demand (Income demand) Normal goods They are those goods, the demand for which increases with the increase in income of the consumer. Ex. Furniture, Refrigerator. Inferior goods They are those goods, the demand for which falls as income of the consumer increases. Ex: Jowar, maize Inexpensive necessities of life Goods whose quantity purchased increases with the increase in income up to a certain level and thereafter remains constant irrespective of the level of income.ex. salt and matchboxes. 4. Consumers taste and preference. The level of demand also depends upon the consumers taste and preferences which in turn depends upon customs, fashion, general lifestyle etc. Ex. Consumers taste and preferences may change because of change in fashion. The physical fitness craze leading to an increase in demand for bicycles. 5. Consumers credit facilities. If consumers are able to get credit on easy terms and low interest rate from banks they would be tempted to purchase that commodity more, hence demand increases and if the consumers are not able to get credit on easy terms and low interest rate from banks they would be discouraged to take the loans and hence the demand will fall. Ex. Demand for cars will increase, if car loans from banks are easily and cheaply available. 6. Size and composition of Population Larger the population larger will be the demand and vice-versa. Along with the size of population the composition of the population also affects demand. Composition of population ( 2 )

3 refers to the various factors like the number of children, adults, males, females etc in the population. For example, increase in child population leads to increase in demand for toys etc. 7. Consumers expectations Consumers expectations with regards to future prices, income, availability of goods etc play an important role in determining the demand for goods and services. Ex. If consumers expect the price to rise in future, they would demand greater amount of commodity today. 8. Government policy If the government imposes taxes on various commodities in the form of sales tax, excise duties etc, the prices of the commodities will increase as a result its demand will fall. If the government incurs more expenditure on the construction of roads, bridges etc demand for goods needed for construction will increase. 9. Distribution of income. If the distribution of income in a country is unequal, there will be more demand for luxury goods like car etc whereas, if the income is evenly distributed there will be more demand for necessary goods. 10. Demonstration effect It refers to the tendency of a person to emulate the consumption style of other persons lie friend s neighbors etc. This effects the individual demand of a consumer. For instance- the demand for the luxury goods has increased in recent years because of the desire of people to follow the consumption style of others. 11. Climate Factors Demand for different goods depends upon climate factors because different goods are needed for different climates. for example demand for ice creams, cotton clothes increases in the summers. Likewise, the demand for heaters, woolen clothes increases in the winters. Demand Function Demand function states the relationship between the demand for a product and its determinants. D n=f (P n, P1 P n-1, Y, T, E, H, Y, G ) Where Pn = price of the commodity T= Taste and Preference G = Government Policy Law of Demand The law of demand holds that other things being 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. Following are the assumptions of the law of demand or other things being equal Habits, tastes and fashions remain constant Income of the consumer does not change. Prices of related goods remain constant Distribution of income should not change No change in population The commodity should be a normal commodity. ( 3 )

Demand schedule is a table that shows different quantities of a commodity that would be demanded at different prices Individual demand schedule It is the table which shows various quantities of a

4 Demand schedule is a table that shows different quantities of a commodity that would be demanded at different prices Individual demand schedule It is the table which shows various quantities of a commodity that would be purchased at different prices by a household. Price (Rs/kg) demanded(kg/day) Market demand schedule It is the table which shows various quantities of a commodity that all the buyers will purchase at different prices during a given period. Price (Rs/kg) Qt dd by A (kg/day) Qt dd by B (kg/day) Market Demand A+B Demand curve The graphical representation of the demand schedule is called demand curve. It is the curve showing different quantities demanded at various alternative prices during a given period. Individual curve It is the curve that shows different quantities of the good which a consumer is willing to buyat different prices during a given period of time. Market curve It is the curve that shows different quantities of the good which all consumers in the market are willing to buy at different prices during a given period of time. Reasons for downward slope of the demand curve to the right/reasons for the operation of law of demand.{lives} Law of Diminishing Marginal Utility. The law of diminishing marginal utility states that when an additional unit of a commodity is consumed the marginal utility derived from it is declining. This law to a large extent affects the law of demand. A rational consumer would naturally prefer to buy this additional unit only at a lower price. This, therefore, causes an inverse relationship between price and demand. A consumer will maximize his satisfaction when he equalizes the marginal utility of the commodity with its price Marginal utility of a commodity=price of a commodity ( 4 )

5 Income Effect It implies effect of change in consumer s real income resulting from change in the price of a commodity on his demand. As the price of a commodity decreases, the real income of the consumer increases. Hence, the consumer will now be able to demand more quantity of the commodity by spending the same amount of money. Substitution Effect. Substitution effect is the effect that a change in relative prices of substitute goods has on the quantity demanded. When price of any commodity increase while prices of other substitute goods remain unchanged, consumers would like to prefer the substitute goods. Ex. When there is rise in price of tea demand for coffee will increase because Coffee has become relatively cheaper. Hence, demand for coffee will increase and that of tea will reduce. Price Effect=Income Effect+ Substitution Effect Entry and Exit of Customers. When the price of a commodity falls, new consumers, who were unable to purchase this commodity earlier, will start buying it as they find it within their reach now. Conversely, in case of increase in its price, even some of the old consumers find it difficult to purchase the commodity. In this way, the change in number of customers in the market determines the law of demand. Various Uses. Some commodities have alternative uses. For example, milk can be used for preparing curd, cheese, sweets, tea, etc. If the price of such a commodity rises, it is used for more important uses. Consequently, demand will go down. On the other hand, when price falls, the commodity will be put to more uses where it was not being used earlier and its demand will go up. Exception to the law of demand Following are the exception to the law of demand/ Reasons for upward slope of the demand curve to the right D Price 1. Giffen s goods: There are certain goods which are inferior from the consumer s viewpoint. A fall in the price of such goods may not increase its demand because consumers start diverting their extra or saved purchasing power to buy superior commodities. Consequently, demand for inferior goods fall. Sir. Giffens, was the first who attracted our attention towards these goods. Therefore, these goods are also known as Giffen goods Ex. Bajra to wheat, maize to rice (As the price of maize falls real income of the consumer increases, now the consumer may afford to purchase superior goods like wheat and rice) 2. Abnormal conditions/emergencies: During emergencies like floods, hurricanes, earthquakes, etc. the consumer behaves in an abnormal way.even when the prices are high the demand is still high as people expect shortage of goods and hoard them. 3. Articles of distinction/article of snob effect: There are some commodities or services which are considered as a sign of elevated status or status symbol by those who possess them. For example, cars, ( 5 )

6 jewellery, etc. are some commodities which are used to showcase one's wealth. Veblen has termed these goods as conspicuous consumption. 4. Expectations regarding future prices: If a household expects the price of a commodity to increase, it may start purchasing greater amount of the commodity even at the presently increased price. Similarly, if the house hold expects the price of the commodity to decrease, it may postpone its purchases. Thus, law of demand is violated in such cases. 5. Quality-Price Relationship: When the consumer judges the quality of commodity from its price. They regard high-priced commodities are better in quality as compared to low priced commodities in such cases the law will not apply. This is known as Veblen effect. Change in quantity demanded/movement along the same demand curve ( change in its own price)- When the amount demanded of a commodity changes (rises or falls) as a result of changes in its own price, while other determinants of demand (Income, prices of related goods) remain constant, it is known as change in quantity demanded. Extension in demand. When the quantity demanded of a commodity rises due to fall in its price, other things remaining the same. It is called rise in quantity demanded or extension of demand. Contraction in demand. When the quantity demanded of a commodity decreases due to fall in its price, other things remaining the same. It is called fall in quantity demanded or contraction of demand Change in demand/shifts in demand (due to change in other factors) When the amount purchased of the commodity rises or falls because of change in factors other than the own price of the commodity, it is called change in demand. Increase in demand It refers to a situation when the consumers buy larger amount of a commodity at the same price. Decreases in demand. It refers to a situation when the consumers buy smaller amount of a commodity at the same price. ( 6 )

7 Extension of Demand Other things being equal, with the fall in price, quantity demanded for a commodity rises, it is called extension of demand. PRICE (Rs per unit) demanded (kgs) There is a downward movement along the same demand curve. It occurs due to fall in price of a commodity Increase in Demand An increase in demand implies that at a given price a larger amount is purchased due to change in other factors. PRICE (Rs per unit) demanded (kgs) Consumers demand curve shifts rightward. Increase in consumer s income. Increase in population. When price of the commodity is expected to increase in near future. Fall in the price of complementary goods Rise in price of substitute goods Favorable change in taste and preference ( 7 )

8 Contraction of Demand Other things being equal, with the rise in price, quantity demanded for a commodity falls, it is called contraction of demand. PRICE (Rs per unit) demanded (kgs) There is a upward movement along the same demand curve It occurs due to rise in price of a commodity Decrease in Demand An increase in demand implies that at a given price a smaller amount is purchased due to change in other factors. PRICE (Rs per unit) demanded (kgs) Consumers demand curve shifts leftward Fall in consumer s income. Decrease in population When price of the commodity is expected to fall in near future. Rise in the price of complementary goods Fall in price of substitute goods Unfavorable change in taste and preference INSTRUCTIONS TO STUDY THIS CHAPTER: Please read your book for detailed information of the above topics. The length of the answer depends on the marks in the question paper and may not only be substituted with what is mentioned in the notes. Examples can be used to elaborate your points for this chapter. ( 8 )

Theory of Demand and Supply 2

C H A P T E R Theory of Demand and Supply 2 Law of Demand and Elasticity of Demand Meaning of Demand u In ordinary speech, the term demand is many times confused with desire or want. u Desire is only a