Federal Urdu University Islamabad

Faculty of Management Sciences

(Department of Business Administration)

Lecture # 4
Course Title: ‘Principles of Micro Economics’
Course Instructor: Ms. Maryam Bibi
Educational Level: Bachelor
Spring 2021
Market Demand for a Commodity

 Market demand for a commodity is simply the

horizontal summation of demand curves of all the
consumers in the market.
 It must be pointed out that market demand curve is
simply the horizontal summation of individual demand
curves only if consumption decisions of individual
consumers are independent.
 Consider the diagram, we assume two consumers in
the market.
Diagram
 Analysis

• At price $1, the market demand for 10

burgers is sum of 6 burgers demanded by
individual 1 and 4 burgers demanded by
individual 2.
 Bandwagon Effect

 People sometimes demand a commodity because

others are purchasing it, either to be fashionable or
because it makes the commodity more useful.
Example: In the case of e-mail, which becomes more
useful as more people use it.
 This result is a bandwagon effect or positive network
externality and it makes market demand curve for
commodity flatter or more elastic than otherwise.
 Snob Effect

• Snob effect occurs as many consumers seek to

be different and exclusive by demanding less of
commodity as more people consume it.
• If the price of a commodity falls and more
people purchase the commodity, some people
will stop buying it in order to stand out to be
different.
• This tends to make the market demand curve
steeper or less elastic than otherwise.
 Veblen Effect
 There are some individuals who want to impress
other people demand more of certain commodities
such as diamonds, rolls Royce's etc. This form of
consumption is called Veblen effect.
 This results in a steep or less elastic demand for
commodity than otherwise.
 Example: A rich person prefers to wear Rolex,
however Rolex does not keep time better than
Timex but its all about the wearer who want to
have a different and exclusive look.
 Types of Consumer Goods

 Normal Good : which you buy more when you have

more income. e.g; clothing.
 Inferior Good: which you buy less when you have
more income. e.g; Public transport when you can
afford a car.
 Giffen Good: which people buy less when price
decreases. e.g; when rice or potatoes become
cheaper people use to buy vegetables or meat i.e to
have some nutritious foods.
 Price Elasticity of Demand
 Elasticity measures how sensitive quantity demanded
is to change in price.
 Inelastic Demand:
 If price of petrol increases quantity demanded
decreases but by little amount.
 If the price decreases, quantity increases but by little
amount.
 This shows insensitivity to price, may
have very few substitutes.
Formula:
Price Elasticity of Demand=percent change in
quantity/percent change in price

= <1
 Elastic Demand:
 Here if price goes up, quantity demanded decreases.
 When prices go down quantity demanded go up.
 It mostly happens in case of substitutes and luxury
goods
 Mathematically,
 =>1
 Unit Elasticity of Demand:

Formula:
=
= =1
Unity means one
 Perfectly Inelastic Demand:
 Increase in price has no effect on quantity demanded.

 Formula:
 =
 = =0
 Perfectly Elastic Demand:
 If firm can not change the price ,

=
 = that is no change in price.
 Point Elasticity of Demand

 It is price elasticity of demand at a specific point on

demand curve instead over a range of it.
 At mid point elasticity of demand is equal to one.
 Below the midpoint, point elasticity of demand is less
than one.
 Above the mid point, point elasticity of demand is
greater than one.
 Diagram
P
t
2cm
U 8cm
2cm
R
2cm
S
2cm
T
0
Q
 In this diagram we see a linear demand curve which is
generally a straight line. It means there is
proportional change between demand and prices.
That’s why we can find point elasticity on this curve.
 Assume that we have mid point ‘R’ on demand curve
which divides the curve between lower and upper
segments.
 So formula for point elasticity of demand is=
 Assume that length of demand curve 8cm.
 Now length of demand curve is divided in to four equal
parts that is of ST =2 cm, RS = 2cm, UR = 2cm, tU =2cm
 We can find elasticity at point T, S,R,U, or at t.
 Suppose we want to find point elasticity at point S
 Point elasticity of demand ==
 Point elasticity at ‘t’ Point elasticity of demand = = = =
 Similarly we can find the other points.
 Cross Elasticity of Demand

We measure the responsiveness in quantity purchased

of commodity X as a result of change in price of
commodity Y by cross elasticity of demand.
Formula:
=
 Income Elasticity of Demand

 It measures the responsiveness of demand for a

particular good to the changes in consumer income.
 The formula for calculating income elasticity of
demand is the percentage change in quantity
demanded divided by percentage change in income.
 EdI =
 Engel Curve
 It is showing the amount of commodity that consumer would
purchase at various income levels holding prices and tastes
constant.
 Initially consumer’s equilibrium income is Rs. 300 at which he is
consuming Q1 units of X.
 When his income rises to Rs. 400, his consumption for normal good
also increases and move to new equilibrium E2.
 Again due to increase in income consumer will increase his
consumption and attain a new equilibrium point E3.
 By joining the three equilibrium points we will get Engle’s curve.
 It shows positive slope i.e ;
 Slope of EC = Change in Money
Change in Quantity purchased
Engel Curve for Luxury Goods
 Here if income increases, the consumer will start buying luxury
good instead of normal goods.
 Consider the diagram where initially the equilibrium exists at
E1.
 If the income level increases to 400, he will consume Q2 units
at E2 level of equilibrium.
 If income further increases, he will achieve the highest
equilibrium point at E3.
 By joining the equilibrium points we get engel curve which is
downward sloping i.e turned towards x-axis.
 Engel Curve for Inferior Goods
 Here consumer will reduce consumption of inferior
goods as if his income rises.
 Here also initially consumer is consuming Q1 of
commodity X at E1 equilibrium.
 So as income increases, consumer reduce the
consumption of inferior goods.
 According to Diagram, we get three equilibrium points
which are joined together to have Engel curve.
 We can see here that Engel curve is backward sloping
in case of inferior goods.
 Neutral Goods Case

 It shows whether consumer’s income increases or

decreases, the consumption pattern for particular
good does not change as we have taken the example
of salt.