Law Of Demand And Elasticity Of Demand, Studymaterial: Cpt Cpt GENERAL ECONOMICS, Micro Economics

Law of Demand and Elasticity of Demand

Concept of Demand and its Determinants

Objectives
After going through this lesson, you shall be able to understand the following concepts.

• Demand: Meaning

• Determinants of Demand

• Normal, Inferior and Giffen Goods: Meaning

Meaning of Demand

Demand for a commodity refers to the quantity of the commodity which a consumer is willing and is able to purchase at a particular price for a given period of time'.

In the definition given above, the two terms ‘willing’ and ‘able to purchase’ are worth noting. In economics, mere willingness to purchase a commodity does not constitute demand. Rather, this willingness must be backed by the ability to purchase the commodity (in terms of availability of money) for it to be regarded as demand.
In this regard, we can distinguish between two similar terms, desire and demand. While the desire for a commodity indicates mere willingness to purchase a commodity without sufficient purchasing power, demand for a commodity refers to the willingness to purchase which is further backed by the ability to purchase. To put in other words, it is only when a desire is backed by the sufficient purchasing power than such a desire becomes a demand. The following diagram and note further clarify this concept.

Demand- A Flow Concept

Demand for a good is a flow concept. This is because it is seen with reference to a continuous flow of purchases of commodity over a period of time. In this regard, it is expressed as per period of time, such as per day, per week, and so on. For instance, we say that quantity demanded of sugar is 2 kgs per week.

Determinants of Demand

Demand for a good is affected by numerous factors. The following are some of the major factors that determine the demand for a good.

• Price of the good

• Prices of related goods

• Income of the consumer

• Tastes and preferences of the consumer

Based on these factors, the household-demand function can be represented as:
D_x= f (P_x, P_y, Y, T)

where,

D_xrepresents demand for good X
P_xrepresents price of good X
P_yrepresents prices of related goods
Y represents income of the consumer
T represents tastes and preferences of the consumer

The following is a detailed explanation of each of these determinants.

1. Price of the good: The demand for a good shares an inverse relationship with its price. Other things remaining constant, as the price of a good rises, the quantity demanded of the good falls and vice-versa. For example, as the price of potatoes decreases, consumers tend to demand greater quantity of potatoes.

That is:
as P_x↓ ⇒ D_x↑ and
as P_x↑ ⇒ D_x↓
This inverse relationship between price of a commodity and its quantity demanded is known as the law of demand**
**discussed in detail in the next lesson

2. Prices of related goods: The demand for a good also depends on the prices of its related goods. Related goods can be classified into the following two categories.

(i) Substitute goods: These are the goods that can be consumed in place of each other. In case of such goods, if the price of one good increases, then a consumer consuming this good shifts his or her demand to the other (substitute) good and vice-versa.
Example: Tea and coffee are considered substitute goods. This is because as the price of tea increases, the consumers who take tea shifts their preference to coffee, since tea is expensive now. This reduces the demand for tea and instead raises the demand for coffee.

That is:
If P_tea ↑ ⇒ D_tea↓ ⇒ D_coffee ↑ and

If P_tea↓ ⇒ D_tea↑ ⇒ D_coffee ↓

(ii) Complementary goods: These goods are consumed jointly for the satisfaction of wants. In case of such goods, a rise in the price of one good results in a fall in demand for the other good and vice-versa.
Example: A CD player and a CD are complementary goods. If the price of CD player increases, then people will buy less CD players, consequently, the demand for CDs will also fall.

That is:
If P_CD_player↑ ⇒ D_CD_player↓ ⇒ D_CD↓ and
If P_CD_player↓ ⇒ D_CD_player↑ ⇒ D_CD↑

The following note explains the difference between the substitute goods and the complementary goods.

3. Income of the consumer: A consumer's income determines his/her purchasing power, thereby, affects his/her demand for goods. However, the effect of change in income on the demand for a good depends on the type of the good.

The following note describes the various kinds of goods and the relationship between the income of the consumer and their demand.

The following table summarises the different types of goods and the relationship of their demand with both income and price.

Types of Goods	Relationship with Income	Relationship with Price
Normal goods	Positive	Negative
Inferior goods	Negative	Negative
Giffen goods (Highly inferior goods)	Negative	Positive

Note 1: Among the different types of goods, only the demand for giffen goods shares a positive relationship with price. In other words, giffen goods violate the law of demand.

Note 2: All giffen goods are inferior goods but all inferior goods are not giffen goods. Only highly inferior goods are giffen goods.

Note 3: Assuming the income remains constant, a rise in the price of the commodity also reduces the purchasing power of the of the consumer for the commodity (in relative sense).

Can a good be regarded as ‘Inferior’ and ‘Normal’ Good at the same time?

Whether a good is inferior or normal good depends on the level of income of the consumer. This can be understood with the help of an example. Consider the case of coarse cereals. At low levels of income, coarse cereals can be regarded as a normal good. However, as the level of income of the consumer increases, he tends to substitute the coarse cereals with superior-quality cereals. In this regard, at high levels of income, coarse cereals become inferior good. This concept is explained below diagrammatically.

4. Consumer's tastes and preferences: A consumer's tastes and preferences highly influence his/her demand for goods. Tastes and preferences includes habits of the consumer, fashion, social customs, etc. Other things being equal, if a consumer prefers or develops a taste for a good over another, then his demand for that good increases and vice-versa.

5. Other factors: Besides the above-mentioned factors, there are a number of other factors as well that affect the demand for a good. Some of these factors are as follows:

a. Size of population: As the size of population increases, the demand for a good increases and vice-versa.

b. Composition of population: The kind of goods that will be demanded in the market depends on the composition of population in the country. For instance, if the country has a greater proportion of children, then the demand for goods such as baby food, baby clothing, etc. would be higher.

c. Income Distribution: The distribution of income in the country is also an important determinant of demand for goods. This is particularly true for consumer goods. For instance, if the income in the country is concentrated in only a few hands then it implies that the demand for consumer goods in general falls and vice-versa.

d. Future Expectation: A consumer’s expectations regarding the price of a good in the future also play a role in determining its demand. If the consumers expect the price of a good to rise in the future, they tend to demand greater quantities of it in the present. On the other hand, if they expect the prices to fall in the future, they may restrain consumption of the good at present. Such a consumer behaviour is especially seen in case of speculative goods.
The following note summarises the various determinants of demand.