Lesson 2.

1:
Basic Principles of
Demand
 Motivational

Let’s play
charades !!!
What is Demand?
Economists use the term demand to refer to the amount of some good
or service consumers are willing and able to purchase at each price.
Demand is based on need and wants- a consumer may be able to
differentiate between a need and a want, but from an economist’s
perspective they are the same thing. Demand is also base on ability to
pay. If you cannot pay for it, you have no effective demand.

Demand is also decision or the choice of the buyers or consumers as to

how of that product, item, commodity, or service they are willing and
able to purchase at a particular price.
 Law of Demand
Part 1: As PRICE increases, DEMAND decreases.

Demand goes
price goes up

down
THEN

Part 2: as PRICE decreases, the DEMAND increases.

Price goes down

Demand goes
up
THEN
 Demand Curve

“According to the Law of demand, as a price of a product or service rises, the

demand of buyers will decrease due to limited amount of cash they have to
make purchases. Demand is based on needs and wants- a consumer may be
able to differentiate between a need and a want, but from economist’s
perspective they are the same thing. Demand is also based on the ability to
pay. If you cannot pay for it, you no effective demand.”

A graph that illustrates the demand for a product. It shows how much consumer desire
for a product changes as the price changes.
 Market Demand Curve
This curve illustrates the quantities of apple juice demanded at each price ay all consumers in the
market.
 Demand Equilibrium

The quantity people are

willing to buy equals the 150
quantity people are willing
to sell at each price. 120
Excess Demand- the
quantity demanded is 90
greater than the quantity
supplied at the given price. 60
This is also called a
shortage. 30
 Lesson 2.2:
Elasticities of Demand
What is Elasticities of Demand?

The price elasticity of demand is the percentage change in the quantity demanded of a
good or service divided by the percentage change in the price. The elasticity of supply is the
percentage change in quantity supplied divided by the percentage change in price.
Elasticities can be usefully divided into five broad categories: perfectly elastic, elastic,
perfectly inelastic, inelastic, and unitary. An elastic demand is one in which the elasticity is
greater than one, indicating a high responsiveness to changes in charge. An elastic demand is
one in which elasticity is less than one, indicating low responsiveness or price changes. Unitary
elasticities indicate proportional responsiveness of either demand.

The degree to which changes in price cause changes in demand

or
If we change the price, will demand change a lot or a little?
 Exact formulations are as follows:

Percentage change in quantity demanded

n= Price Elasticity= Percentage change in price

Proportional change in quantity demanded

or = Proportional change in price

= Q/Q = Q x P ( = change )
P/P P Q
 Midpoint Method for Elasticity

● To calculate elasticity, instead of using simple percentage changes in

quantity and price, economists sometimes use the average percent
change in both quantity and price. \

Midpoint method for elasticity=

Using the Point Elasticity of Demand to Calculate Elasticity

● A drawback of the midpoint method is that as the two points get

farther apart, the elasticity value loses its meaning. For this reason,
some economists prefer to use the point elasticity method. In this
method, you need to know what values represent the initial values
and what values represent the new values.

new Q – initial Q
Point elasticity= initial Q .
initial P – new P
initial P
 Different Kinds of Price Elasticities

We have different ranges of price elasticities, depending on whether a 1%

change in price elicits more or less than a 1% change in quantity demand.

a. Price-Elastic Demand

If the price elasticity of demand is greater than one, we call this a price-
elastic demand. A 1% change in price causes a response greater than 1%
change in quantity demanded: ΔP<ΔQ
b. Unitary Price Elasticity of Demand
In this case, a 1% change in price causes a response of exactly
1% change in the quantity demanded.

When Area A = Area B, Rectangular Hyperbola! ΔP = AQ

c. Price-Inelastic Demand
Hence, a 1% change in price causes a response of less than 1% change in
quantity demanded: ΔP>ΔQ

ELASTICITY AND SLOPE

Elasticity and Slope are not the same. We will demonstrate that along a linear
demand curve (that is, a straight line with a constant slope) elasticity falls with price. As
a matter of fact, the elasticity along a downward-sloping Straight line demand curve
goes numerically from infinity to zero as we move down the curve.

The vertical demand curve has zero elasticity at every price as given below:
P P D

20p D
O O Q
Q Q1
(a) Perfectly Elastic Demand or α (b) Perfectly Inelastic Demand or Zero Elasticity
 EXTREME ELASTICITIES

In the figure (a) of the previous slide, we show

complete responsiveness. At a price of 20p, consumers
will demand an unlimited quantity of the commodity in
question. In figure (b), we show complete price
unresponsiveness. The demand curve is vertical at the
quantity Q1 unit. That means, the price is elasticity of
demand is zero here. Consumers demand Q1 units of this
particular commodity⎯no matter what the price is.
 ELASTICITY AND TOTAL REVENUE/
TOTAL EXPENDITURE
It is generally thought that the way to increase total receipts or total expenditure
is to increase price per unit. But the reality, this depends on the price elasticity of
demand.

Below, we show graphically what happens to total revenue in elastic, unit-elastic

and inelastic part of the demand curve.
 THREE TYPES OF PRICE ELASTICITY
AND TOTAL REVENUE
A. Price-Elastic Demand
A negative relationship exists between small changes in price and changes in the
total revenue. That is, if price is lowered, total revenue will rise when the firm faces price-
elastic demand. And, if it raises price, total revenue will fall.
B. Unit Price-Elastic Demand
Small changes in price do not change total revenue. In other words, when the firm is
facing demand that is unit-elastic, if it increases price, total revenue will not change; if it
decreases price, total revenue will not change either.
C. Price-Inelastic Demand
A positive relationship between small changes in price and total revenue. That is,
when the firm is facing demand that is price-inelastic, if it raises price, total revenue will go
up; if it reduces price, total revenue will fall. We can see in the previous figure the areas in
the demand curve that are elastic, unit-elastic and inelastic. For price rise from £5 per unit,
total revenue rises from £10 to £30, as demand is price-inelastic.
● The relationship between the price elasticity of demand and total revenue brings
together some important microeconomic concepts. Total revenue is the product of price
per unit times quantity of units sold (P x Q).

● The theory of demand states that, along a given demand curve, price and quantity
changes will move in opposite directions one increases and other decreases.
Consequently, what happens to the product of price times quantity depends on which of
the opposing changes exerts a greater force on total revenue. This is what price elasticity
of demand is designed to measure responsiveness of quantity to a change in price.
 DETERMINANTS OF PRICE ELASTICITY

A. Ease of Substitution
B. Number of Uses
C. Proportion of Income Spent on the Product
D. Time
E. Durability
F. Addiction
G. The Price of Other Products
VALUE OF ELASTICITY
An increase (+) in price will cause a fall (-) in quantity and, conversely a decree (-) in
the value of the answer must always be negative. The coefficient is expressed as S by putting
a minus sign in front of the equations, thus ED= −

ARC ELASTICITY
It is an estimate of elasticity along a range of a demand curve. It can be calculated
for both linear and non-linear demand curves using the following formula:

✓ Arc elasticity of demand

✓ Using income elasticity of demand

✓ Income elasticity

✓ Cross-elasticity
 THANK
You
For
Listening !