Date – 25.1.

2021

Demand Analysis

1. Law of demand
2. Elasticity of demand
3. Kinds of elasticities of demand:
a. Price elasticity
b. Income elasticity
c. Cross elasticity
4. Law of Supply

Law of Demand

The law of demand or functional relationship between price and quantity demanded of a
commodity is one of the best known and most important laws of economic theory. According to
law of demand, 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, other things being same. The other
things which are assumed to be equal or constant are the prices of related commodities, income of
consumers, tastes and preferences of consumers, and such other factors which influence demand.
If these factors which determine demand also undergo a change, then the inverse price-demand
relationship may not hold good. For instance, if incomes of incomes of consumers increase, then
an increase in the price of a commodity, may not result in a decrease in the quantity demanded of
it. Thus the constancy of these other factors is an important assumption of the law of demand.

Prof. Alfred Marshall Defined the law thus: “The greater the amount to be sold, the smaller must
be the price at which it is offered in order that it may find purchasers or in other words the amount
demanded increases with a fall in price and diminishes with a rise in price”.

The law of demand may be illustrated with the help of a demand schedule and a demand curve.
i. Demand Schedule: To illustrate the relationship between the quantity of a commodity
demanded and its price, we may take hypothetical data for prices and quantities of a
commodity X. A demand schedule is drawn upon the assumption what all the other
influences remains unchanged. It thus attempts to isolate the influence exerted by the price
of the good upon the amount it sold.

Table : Demand Schedule of an individual consumers

Price Qty. demanded

(Rs.) (Units)

A 5 10

B 4 15

C 3 20

D 2 35

E 1 60

When price of commodity X is Rs. 5 per unit, a consumer purchases 10 units of the commodity.
When the price falls to Rs. 4, he purchases 15 units of the commodity. Similarly, when the price
further falls, quantity demanded by him goes on rising until at price Rs. 1, the quantity demanded
by him rises to 60 units. The above table depicts an inverse relationship between price and quantity
demanded as the price of the commodity X goes on rising, its demand goes on falling.

ii. Demand Curve: We can now plot the data from Table given on a graph with price on the
vertical axis and quantity on the horizontal axis. In Fig.1, we have shown such a graph and
plotted the five points corresponding to each price-quantity combination shown in Table
1.1. Point A, shows the same information as the first row of Table shown above that at Rs.
5 per unit, only 10 units of X will be demanded. Point E shows the same information as
 does the last row of the table, when the price is Rs. 1, the quantity demanded will be 60
units.

4
Price

10 20 30 40 50 60
Quantity

Fig. 1

We now draw a smooth curve through these points. The curve is called the demand curve for
commodity ‘X’. The curve shows the quantity of ‘X’ that a consumer would like to but at each
price; its downward slope indicates that the quantity of ‘X’ demanded increases as its price falls.
Thus the downward sloping demand curve is in accordance with the law of demand which as stated
above, describes an inverse price-demand relationship.
MARKET DEMAND FUNCTION

Market demand function is of great relevance for making of the business decision. Apart from the
determinants of individual’s demand such as price of a product, his income, prices of related
commodities, individuals preferences, advertising expenditure, market demand for a product
depends on an additional factor, namely the number of consumers which in turn depends on the
population of a region or city or country who consume the product. Market demand function can
be expressed in the general form as under:

QD = f(Px, I, Pr, T, A, N)

Where the additional factor is N which stands for the number of consumers or population.

For the purpose of estimation of demand for a product we need a specific form of the above market
demand function. Generally, it is the linear form which is chosen for estimating market demand
function. So in the linear form, the market demand function is given below:

QD = C + b1Px + b2I + b3Pr + b4T + b5A + b6N

C is a constant term which shows the intercept of the market demand curve on the X-axis. b1, b2,
b3 etc. are coefficients (these are generally called parameters) which show the quantitative
relationship of various independent variables with the market demand. In other words, these
coefficients, b1, b2, b3 show how much market demand changes as a result of a unit change in these
variables such as price, income, advertising expenditure, population (i.e., the number of
consumers).

As pointed out in case of individual demand, in economics it is considered important and useful to
focus on the relationship between quantity demanded of a product and its price, holding other
factors constant. Therefore, the I, Pr, T, and A are held constant, the market demand function can
be written as

QD = C – b1Px

Where, C = constant or intercept of the market demand curve

b1 = quantity demanded of product.

MARKET DEMAND CURVE

In order to do so we add or sum up the various quantities demanded by the number of consumers
in the market. In this way we can obtain the market demand curve for a commodity which like the
individual consumer’s demand curve will slope downward to the right. We can obtain the market
demand curve by the making horizontal addition of the demand curves of all individuals buying
the commodity.

In the fig A(a) and (b) are shows the individuals demand curve. Now, the market demand curve
can be obtained by adding together the amounts of the good which individuals wish to buy at each
price. Thus, at price P1 the individual A wishes to buy 2 units of the good; individual B wishes to
by 3 units of the good. The total quantity of the good that the two individuals plan to but at the
price P1 is therefore 2 + 3 = 5, when price OP2, individual A demands 4 units and individual B
demands 6 units of the commodity, so the market demand at price OP2 of the commodity is 4 + 6
= 10 units, which are equal to OQ1 and OQ2 in fig. 1.2 (c).

Y Y Y

Price Da Price Db Price DM

P1 P1 P1

P2 P2 P2
Db DM
Da
Q1 Q2
X X X
O 2 4 O 3 6 O 5 10
Quantity Quantity Quantity

(a) (b) (c)

 Figure A

The market demand curve slopes downward to the right, since the individual demand curves,
whose lateral summation gives us the market demand curve, normally slope downward to the right.
As the price of the commodity falls, it means that the new buyers will enter the market and will
increase the quantity demanded of the commodity. This is another reason why the market demand
curve slopes downward to the right.

DEMAND AND QUANTITY DEMANDED

Demand represents the whole demand schedule or curve and shows how price of a commodity is
related to the quantity demanded which the consumers are willing and able to but, other factors
which determine demand being held constant. On the other hand, quantity demanded refers to the
quantity which the consumers but at a particular price. The quantity demanded of a commodity
varies with changes in its price; it increases when price falls and decreases when price rises. The
changes in the demand for a commodity occur when there is a change in the factors other than
price, namely, tastes and preferences of the people, incomes of the consumers, and prices of related
goods.

RELATIONSHIP BETWEEN DEMAND FUNCTION AND DEMAND CURVE

Demand function specifies the relationship between quantity demanded of a product and many
variables such as the own price of the product, income of consumers, prices of related
commodities, tastes and preferences, expected future prices etc. [Qdx = f(Px, I, Px, T, A, N)] the
demand curve is a graphic representation of only a part of this demand function, namely, Qdx =
f(P), holding other independent variables in the demand function are kept constant at particular
levels. Demand function with many variables cannot be shown by the two dimensional curve, the
effect of changes in other variables or factors on the quantity demanded of a product is shown by
shifts in the whole demand curve. In the figure B shown below, we can see that DD is the market
demand curve, when the income of consumers increases then demand curve will shift to DD to
D1D1. It will seen that at a given price OP, with demand curve DD the consumers were buying OQ
quantity of the product and with rightward shift in the demand curve to D1D1 they demand greater
quantity OQ1 of the product.

Whereas, decrease in consumers’ income, fall in price of a substitute product, unfavorable change
in consumers’ preferences for the product, aggressive advertisement expenditure by competitive
firms will cause a decrease in demand for the product resulting in leftward shift in the demand
curve from DD to D2D2. With lower demand curve D2D2 at each price consumers will demand less
quantity of the product than before. Thus, at price OP on demand curve D2D2 the consumers would
bow demand OQ2 quantity of the product which is smaller than OQ.

Price D2 D D1
Y

Price
P D2 D D1

P
D2 D D1
X
0 Q2 Q Q1
D2 D
Quantity D1
X
0 Q2 Q Q1
Quantity Demanded

Fig. B

Demand curve of a product is a graphic representation of only a part of the demand function with
price of the product as the only independent variable. Whereas demand function specifies
relationship between quantity demanded of a product with many independent variables. To effects
of change in variables other than price as explained above, are shown through a shift in the demand
curve.
Determinants of Demand

The determinants of demand are:

1. Price of the Product

2. Income of the Consumer
3. Price of related goods
4. Tastes and Preferences of Consumer
5. Advertising

Price of the Product: Price is the single most important determinant of demand. It is the most
important aspect of the demand for any commodity. Normally, price and the demand for a
commodity is inversely related. In other words price of a commodity has a negative effect on
demand. With all other determinants of demand remaining unchanged, if the price of the product
falls, its quantity demanded will rise. Alternatively, if the price of the product increases, its quantity
demanded will fall. We can see this phenomenon during the sale or a discount season offered at
various retail shops like Pantaloon, Marks & Spencers, Shoppers Stop and so on.

Income of the Consumer

The other important determinant of demand for a commodity is the income of the consumer. The
demand for a commodity also depends upon the income of the consumers. The higher the income
of a consumer, higher is the demand for a commodity. The relationship between income of a
consumer and the demand of a commodity is positive. That is when income increases, demand
also increases. But, this may be true in case of normal goods. In case of inferior goods, with
increase in income, demand for such goods falls.

Price of Related Goods

Demand for a good also depends on the price of other related goods such as substitute and
complementary goods. Substitute goods are those goods that can be used in place of one another.
For example tea and coffee are substitutes of each other. Complementary goods are those goods
which are used jointly. For example, cars and petrol. If the price of one substitute good falls, the
demand for the other substitute good also falls. In case of complementary goods, if price of a good
decreases (say petrol), the demand for the other good (say car) increases. In other words in case of
substitute goods, there is a direct relationship between the price of one substitute (tea) and the
demand for the other substitute (coffee). Whereas in case of complimentary goods, there is an
inverse relationship between the price of one good and the demand for another good.

Tastes and Preferences

Tastes and preferences of the consumer also have an important effect on the demand of a
commodity. In spite of a fall in price, demand may not increase if the good has gone out of
fashion and in spite of increase in price, demand may not decrease because of the product being
in fashion.

Advertising

Advertising, over the years has become an important determinant of demand. Advertising create
demand for a product by generating awareness about various aspects of the product such as
features, price, and uniqueness of the products. A heavy expenditure is spent on advertising the
product. The aim of advertising is to stimulate demand for own brand. There are many instances
when advertisement has changed the lifestyle of people. For instance Cadbury India has
revolutionised the market for its leading product Dairy Milk through high profile advertising with
the famous actor Amitabh Bachchan endorsing the brand. Chocolate has been introduced as an
alternative to mithai, with the slogan ‘Kuch meetha ho jai’.

Population
Another important factors affecting the demand is the size of the population, age distribution, rural
urban distribution and gender distribution. If the population of a country is constantly increasing,
there will be more demand for food items and other goods and services to satisfy the needs of the
people. Similarly, age distribution of the population also determines what kinds of commodities
will be demanded. If the population consists of ageing people, there will be more demand for
medicines and health care services. On the other hand, if the population consists of young people
then there would be more demand for education, employment opportunities and designer apparels.

Growth of Economy

Economy’s growth rate affects the demand for a product and thereby determines the general
mood of business and general standard of living. If an economy is growing, there will be an
increased demand for goods of better quality.

Demand Function

When the relationship between demand and its determinants is expressed mathematically, it is
known as demand function. Thus, it can be said that demand for a product X (Di) is a function
of:

(i) Price of the commodity X (P)

(ii) Income of the consumer (Y)
(iii) Price of related (substitutes or complements) commodities (P0)
(iv) Tastes and preferences of the consumer (T)
(v) Advertising (A)
(vi) Future expectations (Ef)
(vii) Population and economic growth (N)
D = F(P, Y,P0, T,A,Ef, N)

Law of Demand

The law of demand states that other things remaining constant, when the price of a commodity
rises, the demand for that commodity falls and when the price of a commodity falls, the demand
for that commodity rises. In other word demand for a product is inversely proportional to its
price. Demand function can thus be stated as:
D=f(P)

Assumptions of the Law of Demand

1. Price of the substitute goods remains the same.

2. Price of complementary goods remains the same.
3. Income of the consumer remains the same.
4. There is no expectation of change in the future prices
5. Tastes and preferences of the consumer does not change.

Demand Schedule
Price (in Rs) Quantity demanded (in Rs)
5 1
4 2
3 3
2 4
1 5
Reasons for Law of Demand

The reasons behind law of demand are price effect, substitution effect, income effect and law of
diminishing marginal utility.

• Price effect: The concept of price effect explains the effect of prices on the demand. In
other words, it explains the reasons why a fall in price results in rise in demand and vice
versa. Furthermore, a fall in the price of a commodity would induce those consumers to
buy the product who could previously not afford for commodity.

• Substitution Effect: When the price of a commodity falls, it becomes easily affordable
and the demand for that product rises and making its substitute more expensive, assuming
that its price has not changed. It refers to the change in demand for a good as a result of a
change in the relative price of the good compared to that of other good. As a result demand
for the commodity rises. On the contrary, when price of this commodity rises, other
substitute become less expensive.

• Income Effect. The income effect is the change in the demand for goods and services due
to a change in consumer’s purchasing power resulting from a change in real income. When
price of a commodity falls, the consumer’s real income rises, though money income
remains the same. Thus, with fall in the price of the commodity, income remaining the
same, purchasing power of the individual rises, inducing the consumer to buy more of that
commodity.
Law of Diminishing Marginal Utility: According to this law, as the consumer consumes
successive units of a commodity, the utility derived from each additional unit (marginal unit) goes
on falling. Hence, the consumer would purchase only as many units of the commodity, where the
marginal utility of the commodity is equal to its price. If price falls, the consumer will be motivated
to demand more units of the commodity.

Demand Schedule and Demand Curve

Law of demand can be further explained with the help of demand schedule and demand curve. A
list or a tabular statement of the different combinations of price and quantity demanded of a
commodity is known as the demand schedule of the commodity. The demand the schedule and
demand curve can be drawn for an individual consumer, for a particular firm, as also for the entire
industry. The demand curve for a firm is achieved by the horizontal summation of individual
demand curves, and that of the industry by adding the demand curves of all the firms.

Exceptions to the law of demand

The exceptions to the law of demand are:

1. Giffen goods
2. Veblen goods
3. Expectation of price change
4. Necessary goods and services
5. Change in income

• Giffen goods
The concept of Giffen goods was introduced by Sir Robert Giffen. Giffen goods are inferior goods
in comparison to luxury goods. When the price of Giffen goods increases its demand also
increases and vice-versa. An example of Giffen goods is white bread. White bread is considered
to be a giffen good. Its demand falls when its price falls. Thus the law of demand does not hold
good in case of Giffen goods.

• Veblen goods or items of conspicuous consumption

Another exception to the law of demand is the Veblen goods. The concept of Veblen goods is
named after the economist Thorstein Veblen. He introduced a theory conspicuous consumption.
Acoording to this theory, Veblen goods become more valuable as their price increases. For
example Precious stones and metals such as gold and diamonds and luxury cars (say Rolls-
Royce). As the price of these goods increases, their demand also increases because these products
then become a status symbol.
 • Expectation of price change: According to the law of demand, a consumer buys less at a higher
price and more at a lesser price. The expectation of a fall in price in future may induce
consumer to buy less at the lower price so that he can take advantage of fall in price in future.
In such a situation, the law of demand does not hold good.
• Change in Income: If a household’s income increases, there may be an increase in demand of
products irrespective of their increased prices thereby, increasing the demand for the products.
Similarly, if their income has reduced then they may postpone their buying even if the prices
of such products have reduced. Thus, law of demand does not hold good.
• Necessary Goods and Services: Another exception to the law of demand is necessary or basic
goods. People will continue to buy necessities such as medicines or basic staples such as sugar
or salt even if the price increases. The prices of these products do not affect their associated
demand.

Shift of Demand Curve

A shift in the demand curve happens when the demand curve moves to the right or left. The demand
may rise or fall in case of change of demand. When it rises it is called ‘increase’, and when it falls, it is
called ‘decrease’ of demand.

.
 Graph A: Increase in Demand Graph B: Decrease in Demand

• The Graph A on the left side shows an increase in demand resulting in both a higher
price and a higher quantity.
• The Graph B on the right side shows a decrease in demand lowering both the price
and quantity.

Movement along the Demand Curve

When a quantity demanded rises due to fall in price only, it is called extension of demand. When quantity
demanded falls due to rise in price only, it is called contraction of demand. Lets see an example of extension
and contraction of demand.

Extension of demand: A rise in demand for the commodity due to decrease in the price of the commodity
results in extension of demand. When the price of a commodity is Rs. 15, the demand for the commodity
is 60 kgs. When the price comes down to Rs.10 there is extension in demand from 50 to 60 kgs. It can be
illustrated graphically as shown in the given diagram shows extension of demand. We can see that the
Quantity of demand is shown on OX axis. The price is shown on OY axis. The demand curve is represented
by DD. When price comes down the quantity demanded extends and demand curve moves downward.

Contraction of Demand: There is contraction of demand for a commodity when there is increase in the
price of commodity. When price is 10 dollars per kilogram the demand is 40 kilograms. When price
increases to 20 dollars there is contraction of demand from 40 to 30 kilograms.
Contraction of demand: When the demand for a commodity decreases due to an increase in price of
commodity, it is called contraction of demand. For example; when the price of a commodity X is Rs.10, the
demand for the commodity is 40 kgs. But when the price is . increased by Rs. 10 the quantity demanded
comes down by 10 kgs. We can see this graphically also. The graph shows the contraction of demand.
Quantity demanded is shown on OX axis. The price is shown on OY axis. When price increases the quantity
demanded comes down and the demand curve moves upward.

Elasticity of Demand

Elasticity of demand refers to the responsiveness of the quantity demanded of a commodity due to change in
one of the variable on which demand depends. In other words, elasticity of demand refers to the change in
demand when there is a change in another factor, such as price or income. If demand for a good or service
is static even when the price changes, demand is said to be inelastic. Examples of elastic goods are luxury
items and certain food and beverages.

Price elasticity of demand

The change in quantity demanded due to a change in price is known as Price elasticity of demand. It is
measured as percentage change in quantity demanded divided by the percentage change in price, other
things remaining equal. That is
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝑒𝑝 = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
∆𝑞 ∆𝑝
𝑒𝑝 = ×
𝑞 𝑝
Marshall who introduced the concept of elasticity into economic theory remarks that 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, and diminishes much or little for a given rise in price. This will be clear
from Fig. 1 and 2 which represent two demand curves. For a given fall in price, from OP to OP’, increase
in quantity demanded is much greater in Fig. 1 than in Fig. 2. Therefore, demand curve in Fig. 1 is more
elastic than the demand curve if Fig. 2 for a given fall in price for the portion of demand curves considered.
Demand for the good represented in Fig. 1 is generally said to be elastic and the demand for the good in
Fig. 2 to be inelastic.

D
Price

X
M
Quantity
Fig. 1 Elastic Demand

D
Price

X
N N’
Quantity
 Fig 2. Inelastic Demand

Kinds of price elasticity of demand

1. Unit Elasticity: ep=1
2. More than unit elastic: ep>1
3. Perfectly elastic=
4. Less than unit elastic ep<1
5. Elastic demand: ep=0

DETERMINANTS OF PRICE ELASTICITY OF DEMAND

The following are the main factors which determine price elasticity of demand for a commodity.

1. Availability of Substitutes: The availability of number and kinds of substitutes for a

commodity is the most important factor, If, for a commodity close substitutes are available,
its demand tend to be elastic. If the price of such a commodity goes up, the people will
shift to its close substitutes and as a result the demand for that commodity will greatly
decline. The greater the possibility of substituted, the greater the price elasticity of demand
for it. If for a commodity substitutes are not available, people will have to buy it even when
its price rises, and therefore its demand would tend to be inelastic.

2. Position of a commodity in a consumer’s budget: The greater the proportion of income

spent on a commodity, the greater will be generally its elasticity of demand and vice-versa.
The demand for goods like common salt, matches, buttons, etc. tend to the highly inelastic
because a households spend only a fraction of their income on each of them. On the other
hand, demand for goods like clothing, tends to be elastic since households generally spend
a good part of their income on clothing.
 3. Number of uses to which a commodity can be put: The more the possible uses of a
commodity the greater will be its price elasticity and vice-versa. For instance, milk has
several uses. If its price falls, it can be used for a variety of purposes like preparation of
curd, cream, ghee and sweets. But if its price increases, its use will be restricted only to
essential purposes like feeding the children and sick persons.

4. The period: The longer the time-period one has, the more completely on can adjust. A
homely example of the effect can be seen in motoring habits. In response to higher petrol
price, on can, in the short run, make fewer trips by car. In the longer run not only can one
make fewer trips but he can purchase a car with a smaller engine capacity when the time
comes for replacing the existing one. Hence, one’s demand for petrol falls by more when
one has made long term adjustment to higher prices.

5. Consumer habits: If a consumer is habitual consumer of a commodity no matter how

much its price change, the demand for the commodity will be inelastic.

6. Tied demand: The demand for those goods which are tied to others is normally inelastic
as against those whose demand is of autonomous nature.

7. Price Range: Goods which are in very high range or in very low price range have inelastic
demand but those in the middle range have elastic demand.

IMPORTANCE OF THE PRICE ELASTICITY OF DEMAND

The concept of price elasticity is also important in judging the effect of devaluation of a currency on its
export earnings. It has also a great use in fiscal policy because the Finance Minister has to keep in view
the elasticity of demand when it consider to impose taxes on various commodities.
Pricing Decision by Business Firms: The business firms take into account the price elasticity of demand
when they take decisions regarding pricing of the goods. This is because change in the price of a product
will bring about a change in the quantity demanded depending upon the coefficient of price elasticity. This
change in quantity demanded as a result of, say a rise in price by a firm, will affect the total consumer’s
expenditure and will therefore, affect the revenue of the firm. If the demand for a product of a firm happens
to be elastic, then any attempt on the part of the firm to raise the price of its product will bring about a fall
in its total revenue. Thus, instead of gaining from the increase in price, it will lose if the demand for its
product happens to be elastic. On the other hand, if the demand for the product of a firm happens to be
inelastic, then the increase in price by it will raise its total revenue. Therefore, for fixing a profit
maximizing price, the firm cannot ignore the price elasticity of demand for its product.

Cross elasticity of demand

The cross elasticity of demand is the percentage change in the quantity demanded of commodity X as a
result of a percentage change in the price of some related commodity Y.
Therefore, Coefficient of cross elasticity of demand of X for Y
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑋
= % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑌

∆𝑞𝑥 ∆𝑃𝑦 ∆𝑞 𝑃𝑦
𝐸𝑐 = + = ∆𝑃𝑥 × 𝑞
𝑞𝑥 𝑃𝑦 𝑦 𝑥

The cross elasticity of demand between the two substitute goods is positive in response to the rise in the
price of one good. The demand for the other good rises. Substitute goods are also known as competing
goods. While, when the two goods are complementary with each other just as bread and butter, tea and
milk etc., the rise in price of one good brings about the decrease in demand for the other. Therefore, the
cross elasticity of demand between the two complementary goods is negative.
Income elasticity of demand

Income elasticity of demand shows the degree of responsiveness of quantity demanded of a good to a
small change in the income of consumers. The degree of response of quantity demanded to a change in
income is measured by dividing the proportionate change in quantity demanded by the proportionate
change in income. Thus, more precisely, the income elasticity of demand may be defined as the ratio of
the percentage change in purchase of good to a percentage change in income which induces the former.
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑
Income elasticity = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒

Let Y stand for an initial income, ∆Y for a small change in income, q for the initial quantity purchased,
∆q for a change in quantity purchased as a result of a change in income ei for income elasticity of demand.
Then,
∆𝑞
×100 ∆𝑞 ∆𝑌 ∆𝑞 𝑌
𝑞
𝐸𝑖 = ∆𝑌 = ÷ = ∆𝑌 × 𝑞
×100 𝑞 𝑌
𝑌

When change in income and quantity demanded are large, mid-point method should be used to measure
percentage changes in income and quantity demanded. The mid-point method of measuring income
elasticity of demand can be stated as under:
𝑞2 −𝑞1 𝑌2 −𝑌1 ∆𝑞 𝑌1 +𝑌2
𝐸𝑖 = 𝑞1 +𝑞2 ÷ 𝑌1 +𝑌2 =𝑞 ÷
2 1 +𝑞2 ∆𝑌
2

∆𝑞 𝑌 +𝑌
= ∆𝑌 × 𝑞1 +𝑞2
1 2

Income elasticity of demand being zero is of great significance. Zero income elasticity of demand for a
good implies that a given increase in income does not at all lead to any increase in quantity demanded of
a good or expenditure on it. In other words, zero income elasticity signifies that quantity demanded of the
good is quite unresponsive to changes in income.

Income Elasticity, Normal good and Inferior Goods:

Besides, zero income elasticity is significant because it represents dividing line between positive income
elasticity on the side and negative income elasticity on the other. On the one side, when income elasticity
is more than zero (that is, positive), then an increase in income leads to the increase in quantity demanded
of the good. This happens in case of normal goods. On the other side of zero income elasticity are all those
goods whose income elasticity is less than zero (that is, negative) and in such cases increase in income
will lead to the fall in quantity demanded of the goods. Goods having negative income elasticity are known
as inferior goods. Goods with positive income elasticity are called normal goods. We thus see that zero
income elasticity is a significant value, for it helps us to distinguish normal goods from inferior goods.

Income Elasticity, Luxuries and Necessities: When income elasticity of demand for a good is equal to
one, then proportion of income spent on the good remains the same as consumer’s income increases.
Income elasticity of unity also represents a useful dividing line. If the income elasticity for a good is
greater than one, the proportion of consumer’s income on the good rises as consumer’s income increases,
that is, that good bulks larger in consumer’s expenditure as he becomes richer. On the other hand, if the
income elasticity for a good is less than one, the proportion of consumer’s income spent on it falls as his
income rises, that is, the good becomes relatively less important in consumer’s expenditure as his income
rises. A good having income elasticity more than one which therefore bulks larger in consumer’s budget
as he becomes richer is called a luxury. A good with an income elasticity less than one and which claims
declining proportion of consumer’s income as he becomes richer is called a necessity. It is important to
mention here that the definitions of luxuries and necessities on the basis of income elasticity may not
conform to their definitions in English dictionary because the dictionary’s luxuries may be necessities and
its necessities may be luxuries according to the above definition. But in economic theory it is useful to
call the goods with income elasticity greater than one as luxuries and goods with income elasticity less
than one as necessities.

Law of Supply
The law of supply states that other things remaining the same, the higher the price of a commodity the
greater is the quantity supplied. The law of supply can be understood with the help of supply schedule
and supply curve. Supply Schedule and Supply Curve
Supply schedule is a list or a tabular statement of the different combinations of price and quantity supplied
of a commodity. Supply curve is the graphical presentation of the supply schedule. It represents the
quantities supplied of a commodity at different price levels. Like demand, in order to derive the supply
curve for an individual firm, the quantity supplied is plotted on the horizontal axis and price on the vertical
axis.
For example, the supply curve shows us that an increase in the selling price of a good will increase the business'
willingness to produce the good. Thus, management can look at the schedule and plan what price they will market
the product in the market and how many units they will need to produce at that price point.

Supply schedule shows a tabular representation of law of supply. It presents the different quantities of a
product that a seller is willing to sell at different price levels of that product.
There are two types of supply schedules
I. Individual Supply Schedule represents the different quantities of a product supplied by an individual
seller at different prices.
Supply schedule for the different quantities of milk supplied in the market at different prices:
Individual Supply Schedule
Price of sugar (per
Quantity
kg supplied (in
in Rs) kgs)
10 10
12 13
14 20
16 25

II. Market Supply Schedule is a supply schedule which represents the different quantities of a product
that all the suppliers in the market are willing to supply at different prices. Market supply schedule can be
drawn by aggregating the individual supply schedules of all individual suppliers in the market. The table
shows the market supply schedule of a product supplied by three suppliers P, Q and R
 Market supply schedule
Price of product
Individual Supply Market Supply
X (per day) (per day)
P Q R
100 750 500 450 1700
200 800 650 500 1950
300 900 750 650 2300
400 1000 900 700 2600

Assumptions of Law of Supply

The law of supply expresses the relationship between change in supply with respect to change in price. In
other words, the main assumption underlying law of supply is that it studies the effect of price on supply
of a product, while keeping other determinants of supply at constant. Law of supply is based on certain
assumptions. They are as follows:
• Law of supply assumes that the price of a product changes, but the change in the cost of
production is constant.
• Law of supply assumes that there is no change in the technique of production.
• The law assumes that there is no change in the scale of production.
• The law assumes that the policies of the government remain constant.
• The law assumes that the transportation cost remain constant.
• The law assumes that there is no speculation about prices in future.

Exceptions to the law of supply

1. Speculation: Refers to the fact that the supply of a product decreases instead of increasing
in present when there is an expected increase in the price of the product. In such a case,
sellers would not supply the whole quantity of the product and would wait for the increase
in price in future to earn high profits. This case is an exception to law of demand.
2. Agricultural Products: It implies that law of supply is not valid in case of agricultural
products as the supply of these products depends on particular seasons or climatic
 conditions. Thus, the supply of these products cannot be increased after a certain limit in
spite of rise in their prices.
3. Changes in Other Situations: Refers to the fact that law of supply ignores other factors
(except price) that can influence the supply of a product. These factors can be natural
factors, transportation conditions, and government policies.

Change of Supply and Shift in Supply Curve

Change in quantity supplied refers to movements along the same supply curve due to change in
the price of the commodity. However, when change in supply is due to the change in factors such
as costs of production, technology and so on, it causes a shift in supply curve
upwards or downwards. It may mean that the productivity has increased because of
implementation of new machines.

This law can be explained with the help of a supply schedule as well as by a supply curve based on an
imaginary figures and data.

This can be shown by diagram as follows:

In the diagram, the supply curve (ss) is sloping upwards. It signifies that with supply schedule, the market
supply tends to expand with the rise and vice-versa. Similarly the upward sloping curve also reveals a
direct relationship between price and supply.
This law of supply can be explained as: OX axis shows quantity of demand and OY axis shows price.
SS1 line is the line of supply when the price of the commodity is OP then quantity of supply is OQ. When
the price rises from OP to OP2 and then supply also rises from OQ to OQ2. Similarly, if price is reduced
from OP to OP1, then supply will reduce from OQ to OQ1.

Thus, by looking at the diagram, it can be concluded that when price rises supply increases and when the
price goes down the supply also goes down.

MARKET EQUILIBRIUM
Equilibrium refers to a state of rest or a state of balance between two opposite forces.
For example, Demand and supply are two opposite forces. Consumers and producers respectively
are the true example of these opposite forces. Consumers would like to pay as low a price as
possible whereas producers are interested in charging a price as high as possible. But the two has
to agree on a price which is acceptable to both consumers and producers.

Market equi1ibrium implies that there is neither excess demand nor excess supply. Note here that
when we refer to market, it is always in context of one product. Equilibrium in the market occurs
when that price is reached where the demand for and supply of a commodity are equal to each
other.