Industrial Economics Unit 2

BASIC CONCEPT OF DEMAND
2.1 INTRODUCTION (THE CONCEPT OF DEMAND)
Demand is one of the crucial requirements for the existence of any business enterprise.
A firm is interested in its own profit and sales, both of which depend partially upon the
demand for its products.
Conceptually the term demand implies a desire for a commodity backed by ability and
willingness to pay for it. Unless a person has an adequate purchasing power or resources and
the perpardness to spend his resources, his desire for commodity would not be considered as
his demand. As for example, if a man wants to buy a car but he does not have sufficient
money to pay for, his want is not his demand for the car. And if a rich miserman wants to
buy a car but is not willing to pay, his desire too is not his demand for a car. But, if a man
has sufficient money and willing to pay, his desire to buy a car is an effective demand.
2.1.1 Definitions of Demand

(i) According to Hibdon, Demand means the various quantities of goods that would be
purchased per time period at, different prices in a given market.
(ii) According to Hanson, By demand is meant demand at a price, for it is impossible
to conceive of demand not related to price.
(iii) According to Benham, The demand for anything at a given price, is the amount
of it which will be bought per unit of time at that price.
2.2 LAW OF DEMAND

Copyright © 2008. New Age International. All rights reserved.
Y
The law of demand explains the relationship between
D
price and quantity demanded. It may be stated as follows:
Other things being equal, if the price of a commodity falls, the
quantity demanded of it will rise and if the price of a commodity
rises, its quantity demanded will decline. Thus, there is an
inverse relationship between price and quantity demanded,
Price
other things being same.

1
Means D ∝ D
P
O X
Where D = Demand and Demand
P = Price Fig. 2.1. Demand curve
7
Singh, Manoj Kumar. Industrial Economics and Principles of Management, New Age International, 2008. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/hec-ebooks/detail.action?docID=3017378.
Created from hec-ebooks on 2018-08-29 22:32:30.
8 INDUSTRIAL ECONOMICS AND PRINCIPLES OF MANAGEMENT
According to Marshall, The law of demand states that other things being equal the
quantity demanded increases with a fall in price and diminishes when price increases.
According to Prof. Thomas, At any given time, the demand for a commodity at the
prevailing price is greater than it would be at a higher price and less than it would be a lower
price.
2.2.1 Assumptions of Law of Demand

We have earlier stated in the definition that law of demand holds good when other
things remain the same.
So assumptions of law are:
1. There is no change in the income of consumer.
2. Price of the other goods should not vary.
3. Taste of people for particular commodity should not change.
4. Consumer should not have any expectations in variation of price of commodity.
2.3 CLASSIFICATION OF DEMAND
1. Price Demand,
Y
2. Income Demand, and
D
3. Cross Demand.
1. Price Demand
It refers to various quantites of a commodity that an
individual household is willing to buy at a given market price
Price
in a given period of time. Factors other than the price affecting

demand for commodity are presumed to remain unchanged.
The relationship between price and the demand for commodity D
is generally inverse, i.e., when price rises, demand falls and X
when price falls, demand rises. O
Fig. 2.2. Price demand
2. Income Demand Y
It refers to various quantities of a commodity demanded
by a consumer at various levels of his income, other things D
being equal. It indicates the functional relationship between

income of the consumer and quantity of commodity demanded.
Usually, the demand for a commodity increases as the
Income
income of a person increases.

For instance, when rise in income results in rise in
demand for a good is said to be a normal (Superior) goods. On
the contrary, when rise in income leads to fall in demand for
D
a good, the good is called a inferior goods means Income X
demand (In case of low quality and Inferior good substitute O Demand
goods). Fig. 2.3. Income demand (High
quality and high price goods)
Py = Price of the substitutes y

Pz = Price of complements z
C = Income of Consumer
E = Price expectation of the user
T = Taste or preference of user
U = All other factors.
2.5 ELASTICITY OF DEMAND
The concept of elasticity of demand is very useful in understanding many economic

problems and policies. The demand for any commodity is dependent upon the price of the
commodity, other things being equal. Whenever, there is a change in price, there is also a
change in the quantity demanded. The change in quantity demanded as a result of change
in price is known as Elasticity of Demand.
The different authors have defined elasticity of demand as:
1. Mrs. John Robinson: The elasticity of demand, at any price or at any output is the
proportional change of amount purchased in response to a small change in price, divided by
the proportional change of price.
2. R.G. Lipsey: The elasticity of demand may be defined as the ratio of the percentage
change in the quantity demanded to a percentage change in price.
3. Marshall: The elasticity (or responsiveness) of demand in a market is great or small
according as the amount demanded increases much or little for a given fall in price or
diminishes much or little for a given rise in price.
4. Meyers: The elasticity of demand is a measure of the responsiveness of quantity
demanded to a change in the price.
5. Behman: The concept relates to the effect of a small change in price upon the
amount demanded.
2.6 DEGREES OF ELASTICITY OF DEMAND
The elasticity of demand of a product may vary between zero and infinity as discussed
below:
(i) Elasticity is zero, if there is no change at all in quantity demanded when price
changes i.e., when quantity demanded does not respond to a price change. It is called perfectly
inelastic.
(ii) Elasticity is more than zero and less than one when the percentage change in
quantity demanded is less than the percentage change in price. In such a case demand is said
to be inelastic.
(iii) Elasticity is one, or unit elasticity if the percentage change in quantity demanded
is equal to the percentage change in price.
(iv) Elasticity is greater than one when the percentage change in quantity demanded
is greater than the percentage change in price. In such a case, demand is said to be elastic.
(v) Elasticity is infinite, when some small price reduction raises the demand from zero
to infinity. In such a case, demand is said to be perfectly elastic.
BASIC CONCEPT OF DEMAND 11
Demand Curve:
(i) Zero elasticity (ii) Unit elasticity
Y
Y
D
D
Price
Price
X X
Quantity Quantity
Fig. 2.7 Fig. 2.8

(iii) Infinite elasticity Y
P D
Price
X
Quantity
Fig. 2.9
Measure of Degree of Verbal description

elasticity elasticity
1. Zero Perfectly inelastice Quantity demanded does not change as price changes.
Quantity demanded changes by exactly the same
2. Unit Unit elasticity percentage as does price.

Purchaser are prepared to buy all they can obtain at some
3. Infinity Perfectly elastic price and none at all at an even slightly higher price.
2.7 MEASUREMENT OF ELASTICITY OF DEMAND
Prof. Marshall suggested a mathematical method for measuring elasticity of demand.

The formula for this method is given as follows :
Percentage change in demand for a product
Elasticity of Demand (E) =
Percentage change in the price of the product
Change in demand
× 100
Original demand
⇒ E =
Change in price
× 100
Original price
Change in demand Original price
⇒ E = ×
Original demand Change in price
∆Q P
⇒ E = ×
Q ∆P
∆Q P
⇒ E = ∆ ×
P Q
where ∆Q = Change in quantity demanded

∆P = Change in price
P = Original price
Q = Original quantity demanded.
This method is known as point method of calculating elasticity of demand.
Q. 1. The demanded for apples in a small town was 300 kgs. when the price has Rs. 30
per kg. The demand for it expanded to 350 kgs. When the price was reduced to Rs. 28 per kg.
what is the elasticity of demand for apples in that town?
Solution: The formula for elasticity of demand is
∆Q P
E = ×
Q ∆P
Now, in the problem given above

Change in demand (∆Q) = (350 300) kgs.
= 50 kgs.
Change in price (∆P) = Rs. 30 28
= Rs. 2
Original demand (Q) = 300
Original price (P) = Rs. 30
∆Q P
E = ×
Q ∆P
50 30 5
× = = 2.5. =
300 2 2
Elasticity of demand is thus 2.5. This means that the change in demand will be 2.5
times the change in price. Ans.
Q. 2. In the following demand schedule, Calculate the elasticity of demand with Rs. 50
as the initial price:
Quantity of XYZ demanded At a Price
24 units Rs. 4 per unit
BASIC CONCEPT OF DEMAND 13
Solution: Case 1: Data given in the above problem are when units demanded 24 units
at a price Rs. 4 per unit.
Change in demand = (∆Q) = 24 20
= 4 units
Change in price = ∆P = 5 4
= Re. 1 per unit
Original demand (Q) = 20 units
Original price (P) = 5 per unit
∆Q P
Elasticity of Demand (E) = ×
Q ∆P
4 5 20
= × =
20 1 20
E = 1.
Case 2: When units demanded = 16 units

Price = 6 per unit
Data given the above problem is
∆Q = 20 16
= 4 units
∆P = 6 5
= Rs. 1
Q = 20 units
P = 5 per unit
∆Q P
E = ×
Q ∆P
4 5 20
= × =
20 1 20
E = 1.
In both the cases, demand elasticity is 1 (E = 1) throughout the length of the demand
curve. The change in demand and change in price are so proportionate that elasticity is equal
to one. This type of elasticity of demand is called Unit, Elasticity.
Q. 3. A demand function is given as q = 50 5q. Compute the price elasticity of demand

at p = 5
Solution: We have q = 50 5p
dq d
⇒ = (50 5p)
dp dp
= 0 5
dq
⇒ = 5
dp
p = 5
q = 50 5p
= 50 5 × 5 = 25
Substituting these values in the elasticity formula which is given as

P dq ∆Q P P ∆Q
Ed = . = × = ×
q dp Q ∆P Q ∆P
F 5 I ( 5)
=
H 25 K
= 1
Ed = 1.
Q. 4. Given the demand function P = 20 2q, find the elasticity of demand at P = 4.

Solution: Given P = 20 2q
dp
⇒ = 0 2
dq
dq 1
Taking reciprocal, =
dp 2 Substituting the values in the elasticity
at P =
4, formula, we have;
P =
20 2q p dq
⇒ 4 =
20 2q Ed = ⋅
q dp
⇒ 2q =
20 4
F 4I × F − 1I
⇒ 2q =
16
16
= H 8 K H 2K
⇒ q = 1
2 = = 0.25
4
⇒ q = 8
Ed = 0.25. Ans.
EXERCISE
1. What are the determinates of Demand? Explain them in brief.

2. Define elasticity of demand and examine its significance in the theory of demand.
3. What is law of demand ? Explain it with the help of demand schedule and demand curve.
4. What is indifference curve and what are its basic properties?
GGG
!
BASIC CONCEPT OF SUPPLY
3.1 INTRODUCTION (CONCEPT OF SUPPLY)
Supply is one of the forces that determine the price in the market. Supply of a commodity
refers to the quantity of a product which a seller is willing and able to sell at a given price
per unit of time. In words of Anatol Mirad, The quantity supplied is defined as the quantity
of a commodity offered for sale at a given price in a given market at a given time. Supply
may also be defined as that part of stock that the seller offers for sale at a given price and
at a given time. Thus, supply means the quantity of a commodity offered for sales at a
particular price during a given period of time.
3.1.1 Definition of Supply

(1) According to Meyers: Supply may be defined as a schedule of the amount of a
product that would be offered for sale at all possible prices at any one instant of time, or
during any one period of time, for example, a day, a week, a month, a year and so on, in
which the conditions of supply remain the same.
(2) According to Anatol Mirad: The quantity supplied is defined as the quantity of a
commodity offered for sale at a given price in a given market at a given time.
Supply is always expressed with reference to a particular price and a particular time
period.
3.2 LAW OF SUPPLY
The law of supply states that Other things being

Y
S
equal, quantity supplied of a commodity is directly related
P
to the price of commodity.
Normally, at a higher price suppliers will be ready
to supply more units of a commodity and vice versa. P¢
The law of supply follows, The quantity supplied
Price
varies directly with price, when price falls supply will

P²
contract and when price rises, supply will extended. S
According to S.E. Thomas, A rise in price tends to
increase supply and a fall in price tends to reduce it. If
X
the price of a X increases, sellers will supply more X, on O M² M¢ M
the contrary, if the price of X falls, sellers will offer lower Quantity
quantity of X for sale. Fig. 3.1. Supply curve
15
3.3 CLASSIFICATION OF SUPPLY
(i) Individual supply and

(ii) Market supply.
(i) Individual supply: Individual supply can be defined as supply of a commodity
offered by individual firm in the market.
(ii) Market supply: Market supply can be defined as supply of a commodity offered
by all the firms dealing with or producing selling that commodity.
3.3.1 Supply Function

Supply function explains the relationship between the supply and the factors determining
supply of the commodity. In other words, supply function reflects the functional relationship
between supply and determinants of supply such as price of the commodity, price of other
goods, price of factors of production, goals or objectives of the firm. They explain variations
in the quantity of good supplied. The supply function can be stated as follows:
Qs = f (Pa, Pb, Pc, T, Tp)
where Qs = Supply
Pa = Price of that good of which supply is made
Pb = Price of other goods
Pc = Price of factor input
T = Technology
Tp = Time period.
The supply function states that the quantity supplied of any good (Qs) varies with price
of that good (Pa), the price of other goods (Pb), the price of factor Input (Pc), Technology T
and Time period Tp.
3.4 ELASTICITY OF SUPPLY
When a small fall in price leads to great contraction Y

in supply, the supply is comparatively elastic but a big fall
in price leads to a very small contraction in supply, the
supply is said to be comparatively inelastic. Conversely, a
small rise in price leading to a big extension in supply

shows elastic supply, and a big rise in price leading to a S S¢
Price
small extension in supply indicates inelastic supply. It has

two types: (i) Perfectly Elastic Supply and (ii) Perfectly
Inelastic Supply.
(i) Perfectly elastic supply: When a small rise in
price leads to infinitely large supply, supply is said to be O
X
Quantity of Supplied
elastic. Supply is said to be perfectly elastic when any
amount of units are supplied at the same price. The supply Fig. 3.2 (i). Perfectly elastic supply
curve will be straight line (ss′) parallel to OX-axis as shown curve
in Fig. 3.2 (i).
BASIC CONCEPT OF SUPPLY 17
(ii) Perfectly inelastic supply: When a change in price does not lead to any change
in quantity supplied, supply is said to be perfectly inelastic. The supply curve is a straight
line perpendicular to the x-axis shown in Fig. 3.2 (ii) ss′ is the perfectly inelastic supply
curve.
S¢
Y
Price
X
O S
Quantity of Supply
Fig. 3.2 (ii). Perfectly inelastic supply curve
3.5 MEASUREMENT OF ELASTICITY OF SUPPLY
Prof. Marshall suggested a mathematical method for measuring elasticity of supply. The
formula for this method is given as follows:
Percentage change in supply
Elasticity of supply (Es) =
Percentage change in price
Change in supply
× 100
Original supply
⇒ Es =
Change in price
× 100
Original price
Change in supply Original price
⇒ Es = ×
Original supply Change in price
∆Q P
⇒ Es = ×
Q ∆P
∆Q P
⇒ Es = ×
∆P Q
where: Es = Elasticity of supply

Q = Original supply
∆Q = Change in supply
P = Original price
∆P = Change in price.
Elasticity of supply will, therefore, be equal to the change in supply over change in price
multiplied by original price over original supply.
Q. 1. When price of a plastic toy is Rs. 2, its supply is 1000. But when price rises to
Rs. 3 per unit, supply of plastic toys also goes upto 2000 units. Calculate the Elasticity of
Supply.
Solution: ∆P = Rs. 3 Rs. 2
∆P = Rs. 1
∆Q = 2000 units 1000 units
= 1000 units
P = 2
Q = 1000
∆Q P
Elasticity of Supply (Es) = ×
∆P Q
1000 2
× =
=2
1 1000
E = 2
Elasticity of Supply = 2. Ans.
Q. 2. For the Supply Function q = 5 + 2P2 , find the elasticity of supply at p = 2.

Solution: Given q = 5 + 2p2
dq
⇒ = 4p
dp
At p = 2,
dq
= 4× 2
dp
dq
⇒ = 8
dp
At p = 2;
q = 5 + 2p2
= 5 + 2 × (2)2
= 5 + 8 = 13
∆Q P dq p
Es = × = ×
∆P Q dp q
dq p
⇒ Es = ×
dp q
2
= 8×
13
16
Es = .
13
16
Elasticity of supply is equal to . Ans.
13
BASIC CONCEPT OF SUPPLY 19
3.6 INDIFFERENCE CURVE ANALYSIS
An indifference curve is a curve which represents different combinations of goods which

give same satisfaction to the consumer.
The aim of indifference curve analysis is to analyse how a rational consumer choosen
between two goods. In other words, how the change in the wage rate will affect the choice
between leisure time and work time.
The term utility is something subjective. According to Hicks and Allen. Cardinal utility
measurement is not essential for constructing a theory of demand. In view of them, a consumer
makes comparisons of the satisfaction obtainable from different combinations of different
commodities.
1. According to Edgeworth: Indifference curve is that path on which a substitution of
a particular commodity by another in any manner or quantity gives the consumer the same
satisfaction in any position.
2. According to W. J. Boumol: An indifference curve as the locus of points each of
which represents a collection of commodities such that the consumer is indifferent any of
these combinations.
An indifference curve is a geometrical representation of the preference of a consumers
scale. For this any number of combinations of two products A and B which are located on an
indifference curve will show the same level of satisfaction to the consumer.
Example: A consumer has one apple and Y
10 bananas. Now he is prepared to give 4 bananas
to get 1 more apple. Thus, we can have four
10 A
combinations of apples and bananas which give the
same amount of satisfaction. Each combination 8
ABCD gives equal amount of satisfaction.
Bananas
6 B
Indifference Table
4 C
Combination Apples Bananas D
2
A 1 10
X
O 1 2 3 4
B 2 6 Apples
C 3 4 Fig. 3.3. An indifference curve

D 4 2
3.7 INDIFFERENCE MAP
An indifference map depicts a complete picture of consumers scale of preference for

Apples and Bananas. In Figure 3.4, an indifference map of a consumer is shown which
consists of five indifference map. Each indifference curve reflects a different level of total
utility. A higher indifference curve shown a greater amount of satisfaction. While the consumer
is indifferent among the combinations lying on the same indifference curve. Thus higher level
of satisfaction to a consumer is due to the higher curve in this way. In figure, we are showing
similar indifference curves having combinations of Apples and Bananas which refer greater
and lesser satisfaction than that shown on indifference Y

curve IC. Thus, in the figure IC, refers a lower level
of satisfaction than IC2, IC3, IC4 and IC5. It is conducted
that the aggregate utilities are remarkable but not
measurable as the increase in utility cannot be ranked
as we cannot say how much greater utility does IC2 IC 5
Apples
has than IC1. IC4
IC3
3.7.1 Income Effect: IC 2
IC
A change in quantity demanded as a result of 1
change in real income caused by change in price of a O

X
Bananas
commodity is called income effect. The change in
consumers income will change the consumers Fig. 3.4. An indifference map
equilibrium when the relative prices of goods remains the same. When price of a commodity
falls, less has to be spent on purchase of same quantity of the commodity. In short, a fall
in price increase the real income (Purchasing power) of a consumer with the result that he
buys more quantity with the same money income. Income effect is related to change in
income caused due to change in price and not due to change in money income.
3.7.2 Price Effect:

The consumer equilibrium shifts due to change in the price of one commodity when his
income and the price of the other commodity remains the same. It is known as Price effect.
Price effect denotes changes in demand of a commodity caused by change in its price. It is
the combined effect of income effect and substitution effect. Thus,
Price effect = Income effect + Substitution effect.
When the price of a commodity falls, real income of the consumer goes up leading to rise
in demand (Income effect). When price of a commodity falls, it becomes relatively cheaper
than its substitute goods leading to rise in demand (Substitution effect). Clearly, rise in
demand due to fall in price is the result of income effect and substitution effect. Thus change
in demand of a commodity caused by change in its price is known as price effect.
3.7.3 Substitution Effect:

Substitute goods are those goods which can be used in place of each other to satisfy a
given want e.g., coffee and tea or ghee and oil. They are also called competitive goods.
Between substitute goods, use of one in place of other when the former becomes relatively
cheaper is called a substitution effect. It refers to substitution of one commodity in place of

other commodity when it becomes relatively cheaper. A rise in the price of a commodity, say
coffee, also means that price of its substitute, say tea, has fallen in relation to that of coffee
even though price of tea remains unchanged. So people will buy more of tea and less of coffee
when price of coffee rises. In other words, consumers will substitute tea for coffee. This is
called substitution effect.
EXERCISE
1. Define elasticity of supply and examine its significance in the theory of supply.
2. What is law of supply ? Explain it with the help of supply schedule.
3. Briefly explain: Price effect, Income effect and Substitution effect.
GGG

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BASIC CONCEPT OF DEMAND

2.1 INTRODUCTION (THE CONCEPT OF DEMAND)

2.1.1 Definitions of Demand

2.2 LAW OF DEMAND

other things being same.

2.2.1 Assumptions of Law of Demand

2.3 CLASSIFICATION OF DEMAND

in a given period of time. Factors other than the price affecting

being equal. It indicates the functional relationship between

income of a person increases.

Py = Price of the substitutes y

2.5 ELASTICITY OF DEMAND

The concept of elasticity of demand is very useful in understanding many economic

2.6 DEGREES OF ELASTICITY OF DEMAND

Fig. 2.7 Fig. 2.8

Measure of Degree of Verbal description

2. Unit Unit elasticity percentage as does price.

2.7 MEASUREMENT OF ELASTICITY OF DEMAND

Prof. Marshall suggested a mathematical method for measuring elasticity of demand.

where ∆Q = Change in quantity demanded

Now, in the problem given above

Case 2: When units demanded = 16 units

Q. 3. A demand function is given as q = 50  5q. Compute the price elasticity of demand

Substituting these values in the elasticity formula which is given as

Q. 4. Given the demand function P = 20  2q, find the elasticity of demand at P = 4.

1. What are the determinates of Demand? Explain them in brief.

3.1.1 Definition of Supply

3.2 LAW OF SUPPLY

The law of supply states that Other things being

varies directly with price, when price falls supply will

3.3 CLASSIFICATION OF SUPPLY

(i) Individual supply and

3.3.1 Supply Function

3.4 ELASTICITY OF SUPPLY

When a small fall in price leads to great contraction Y

small rise in price leading to a big extension in supply

small extension in supply indicates inelastic supply. It has

Fig. 3.2 (ii). Perfectly inelastic supply curve

3.5 MEASUREMENT OF ELASTICITY OF SUPPLY

where: Es = Elasticity of supply

Q. 2. For the Supply Function q = 5 + 2P2 , find the elasticity of supply at p = 2.

3.6 INDIFFERENCE CURVE ANALYSIS

An indifference curve is a curve which represents different combinations of goods which

C 3 4 Fig. 3.3. An indifference curve

3.7 INDIFFERENCE MAP

An indifference map depicts a complete picture of consumers scale of preference for

and lesser satisfaction than that shown on indifference Y

change in real income caused by change in price of a O

3.7.2 Price Effect:

3.7.3 Substitution Effect:

cheaper is called a substitution effect. It refers to substitution of one commodity in place of

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Q. 3. A demand function is given as q = 50 5q. Compute the price elasticity of demand

Q. 4. Given the demand function P = 20 2q, find the elasticity of demand at P = 4.

The law of supply states that Other things being

An indifference map depicts a complete picture of consumers scale of preference for