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Business Economics Explanantion
Business Economics Explanantion
We demand goods and services because they have the capacity to satisfy
our wants. Goods are demanded because they possess utility.
LAW OF DEMAND
In our daily life, it is normally observed that decrease in price of a commodity
leads to increase in its demand. Such behaviour of consumers has been
formulated as 'Law of Demand'. Law of demand states the inverse relationship
between price and quantity demanded, keeping other factors constant (ceteris
paribus). This law is also known as the First Law of Purchase.
While stating the law of demand, we use the phrase 'keeping other factors
constant or ceteris paribus'. This phrase is used to cover the following
assumptions on which the law is based :
Table 3.3 clearly shows that more and more units of commodity are demanded,
when price of the commodity falls. As seen in Fig. 3.3, demand curve DD slopes
downwards from left to right, indicating an inverse relationship between price
and quantity demanded.
Let us now try to understand, why does the law of demand operate, i.e. why does
a consumer buy more at lower price than at a higher price. The various reasons
for operation of Law of Demand are:
3. Income Effect: Income effect refers to effect on demand when real income of
the consumer changes due to change in price of the given commodity. When
price of the given commodity falls, it increases the purchasing power (real
income) of the consumer. As a result, he can purchase more of the given
commodity with the same money income. For example, suppose Isha buys 4
chocolates @10 each with her pocket money of 40. If price of chocolate falls to 8
each, then with the same money income, Isha can buy 5 chocolates due to an
increase in her real income.
Price Effect is the combined effect of Income Effect and Substitution Effect.
Symbolically: Price Effect = Income Effect + Substitution Effect.
5. Different Uses: Some commodities like milk, electricity, etc. have several uses,
some of which are more important than the others. When price of such a good
(say, milk) increases, its uses get restricted to the most important purpose (say,
drinking) and demand for less important uses (like cheese, butter, etc.) gets
reduced. However, when the price of such a commodity decreases, the
commodity is put to all its uses, whether important or not.
1. Giffen Goods: These are special kind of inferior goods on which the consumer
spends a large part of Itis income and their demand rises with an increase in price
and demand falls with decrease in price. For example, in our country, it is often
seen that when price of coarse cereals like jowar and bajra falls, the consumers
have a tendency to spend less on them and shift over to superior cereals like
wheat and rice. This phenomenon, popularly known as 'Giffen's Paradox was first
observed by Sir Robert Giffen.
5. Fashion related goods: Goods related to fashion do not follow the law of
demand and their demand increases even with a rise in their prices. For example,
if any particular type of dress is in fashion, then demand for such dress will
increase even if its price is rising.
ELASTICITY OF DEMAND
INTRODUCTION
The law of demand gives us the direction of change in the quantity demanded as
a result of a change in price, but it does not specify the magnitude, amount or the
extent by which the quantity demanded changes with a change in its price. In
brief, it does not indicate, 'how much change in the quantity demanded due to
change in price. Therefore, the concept of 'Elasticity of Demand' was developed
to measure the magnitude of change in the quantity demanded.
The concept of elasticity was developed by Prof. Marshall in his book Principles of
Economics'.
Demand for a commodity is affected by a number of factors like change in its own
price, change in the income of consumer, change in the prices of related goods,
etc. Elasticity of demand refers to the percentage change in demand for a
commodity with respect to percentage change in any of the factors affecting
demand for that commodity.
Elasticity of demand =
Price of the given commodity; (2) Price of related goods; (3) Income of the
consumer. So, we have 3 dimensions of elasticity of demand: 1. Price elasticity of
demand: Price elasticity of demand refers to the percentage change in demand
for a commodity with respect to percentage change in the price of the given
commodity
As seen in the schedule, the quantity demanded can be 100 units, 200 units, 300
units and so on at the same price of 30. In Fig. 4.4, the quantity demanded can be
OQ or OQ, or OQ, at the same price of OP.
It must be noted that perfectly elastic demand is an imaginary situation.