CHAPTER 1 - BASICS OF DEMAND AND SUPPLY AND FORMS OF MARKET COMPETITION 1.1. DEFINITION OF DEMAND Demand refers to the quantity of a commodity that a consumer desires to have, backed up by sufficient resources and willingness to spend those resources on the commodity during a period at various possible prices. Demand Quantity Demand It is the quantity of a commodity that a It is the quantity of a commodity that a consumer is willing to buy at various consumer is willing to buy at a specific possible prices during a period. price at a particular time. It is a flow concept. It is a stock concept. Ex- 20,000 units of Car was demanded in Ex-10 kg of Wheat was demanded at a January price of Rs 40 DEMAND SCHEDULE It is a table related to price and quantity demanded. Types of Demand Schedule Price Individual Demand Market Demand A B MD [ A+B ] 10 5 4 9 20 3 2 5 30 2 1 3 The individual demand schedule refers to the demand schedule of an individual consumer. The market demand schedule refers to the demand schedule of all the consumers in the market. It shows different quantities of a commodity that all consumers in the market, intend to buy at different possible prices, during a period. Market demand is the sum total of Individual demand. DEMAND CURVE It is a graphical presentation of the demand schedule. It is a curve that shows various quantities demanded at various possible prices. The individual demand curve is a graphical presentation of the Individual demand schedule. The market demand curve is a graphical presentation of the market demand schedule. The market Demand curve is the horizontal summation of the individual demand curve. 1 CS EET ECONOMIC ENVIRONMENT 100 80 60 A B A+B 40 Price 20 0 10 20 30 40 50 Quantity Demanded 1.2. SLOPE OF DEMAND CURVE 1. The demand curve is a downward sloped curve also known as a negative slope. 2. The demand curve is downward sloped because of the inverse relationship between price and quantity demanded of the commodity. Slope of a Curve = ∆ Y axis Slope of Demand curve = ∆ P ∆ X axis ∆ QD 1.3. DEMAND EQUATION QD = Quantity Demand P = Price a = It indicates the Quantity Demand at zero price. QD = a – bP b = It indicates the rate at which Quantity Demand changes in response to change in price. b = ∆QD / ∆P, it being constant value makes the demand curve a straight line. The negative sign shows the inverse relation between P and QD 1.4. LAW OF DEMAND • “There is an inverse relation between price of a commodity and its quantity demand” LAW • The law states that keeping all other factors constant there is inverse OF DEMAND relation between price of a commodity and its quantity demanded. With the increase in price, quantity demanded decreases and vice- versa. ASSUMPTIONS / LIMITATIONS OF LAW 1. All the factors other than price are kept constant. 2. All the units of the goods are homogenous. 3. Commodity should be a normal good. 1.4.1. REASONS BEHIND LAW OF DEMAND / INVERSE RELATION BETWEEN PRICE AND DEMAND 1. Income effect (Real Income of the consumer)- Real income refers to the purchasing power or buying capacity of a consumer. With the decrease in the price of a 2 VISHAL RAMCHANDANI, CFA 9575933658 commodity, there is an increase in consumer's real income and he can buy more quantity of a commodity by spending the same amount. 2. Substitution effect- With the decrease in the price of the main commodity, it becomes relatively cheaper than its available substitutes. A rational consumer starts consuming more quantity of the main commodity whose price has fallen instead of available substitutes. This is known as the Substitution effect. 3. New consumer- When the price of a commodity decreases, many new consumers start consuming it as they can now afford it. 4. Many uses of a commodity- Several commodities have multiple uses. When the price of these commodities decreases, the consumer starts buying more quantity of it as it can be put to every possible use. This increases the quantity demanded of that commodity when its price falls. 5. Law of Diminishing Marginal Utility- The law states that as more and more units of a commodity are consumed, the marginal utility derived from each successive unit starts decreasing. The demand curve is downward sloping because of the law of diminishing marginal utility. Since additional units of a commodity give a consumer less satisfaction, additional units will be demanded at a lower price. 1.4.2. EXCEPTIONS TO LAW OF DEMAND 1. Necessity goods- These are those goods that are consumed by consumers regardless of their price in the market. These are consumed even at a higher price. Hence, the law of demand doesn't operate in case of necessity goods. 2. Articles of Distinction- These goods are very expensive and are used by the rich and elite class. They demand these goods to maintain their prestige and status in the society. With the increase in the price of these, their demand increases, and vice versa. Hence, the law of demand doesn't operate on these goods. 3. Expected future price- If there is an increase in the price of a good and the consumer expects the price to rise even further, he will increase the quantity demanded of that good is present. On the other hand, if there is a decrease in the price of a good and consumer expects the price to fall even further in the future, he will decrease the quantity demanded of that good in present. In both, the cases Law of demand doesn't hold good. 4. Giffen goods- Giffen goods were identified by British economists Robert Giffen. Giffen goods have 2 characteristics, firstly these goods are of very poor quality, and secondly, a major part of consumer's income is spent on these goods. In the case of Giffen goods, the income effect is negative and the substitution effect is positive. The income effect is so strong that it overrules the substitution effect. Hence with the fall in the price of a good, its quantity demanded also decreases. When the price of such a commodity decreases, the consumer’s purchasing power increases. Due to this he reduces his consumption of Giffen goods and diverts his income on other expensive goods. Hence the law of demand doesn't work on Giffen goods. Ex – Bajra and Jowar are Giffen goods. Wheat is a normal good. 3 CS EET ECONOMIC ENVIRONMENT 1.5. DEMAND FUNCTION It shows the functional relationship between the demand for a commodity and the factors affecting it. It shows the dependency of demand on these factors. These Factors are also known as factors affecting demand or Determinants of demand D (f) = [ Px , Pr , Y, T, Ex, N, DY, W ] 1.5.1. FACTORS AFFECTING DEMAND / DETERMINANTS OF DEMAND Price of Commodity [Px] •There is an inverse relationship between price of a commodity and its quantity demanded. With the increase in price, quantity demanded decreases and vice versa. Price of Related Goods [Pr] •Demand for a commodity is also influenced by change in price of related goods. Related goods are of 2 types- •1. Substitute goods •Substitute goods are competing goods and they have a tendency of replacing each other. •Due to increase in price of substitute goods there is increase in the demand of main commodity and vice versa. There is positive relation between price of substitute goods and demand of main commodity. •2. Complimentary goods •Complementary goods are used together. They complete the demand for each other. •Due to increase in price of complementary goods there is decrease in the demand of main commodity and vice versa. There is inverse relation between price of complimentary goods and demand of main commodity. Income level of Consumer [Y] •Change in the income of the consumer influence the demand for different goods. •Normal goods are the goods which are of better quality. Demand for these goods will increase with the increase in level of income of a consumer. •There is positive relation between consumer’s income and demand of normal goods. •Inferior goods are the goods which are of low quality. Demand for these goods will decrease with increase in level of income of a consumer. •There is inverse relation between consumer's income and demand of inferior goods. Taste and Preference [T] •Demand for those goods increases for which consumer develop strong taste and preference. If taste or preference for a product is fading (decreasing) its demand will decrease. Expected Future Price [Ex] •If consumer expect price of a commodity to rise in the future then he will increase the demand for that commodity in present and if consumer expects the price to fall in the future then he will decrease the present demand. Number of Buyers/ Population Size[N] •Increase in number of buyers will increase the demand for the good in the market. If size of population will be greater then there will be more demand for goods and services in that market. Distribution of Income [DY] •If distribution of income is equal, then there will be more demand for goods in the market. As more people would be able to buy the goods. On the other hand in case of unequal distribution of income, demand will be less as only few people will have purchasing power. Season and Weather [W] •Season and weather conditions also affect the market demand for a commodity. Example – During Winter, demand for woolen clothes will increase while in summers it will decrease.