DEMAND THEORY

COVERAGE

 An overview of Demand and Supply

 The market demand curve
 Industry and Firm Demand functions
 Price elasticity of Demand
EXPECTATION AT THE END OF THIS TOPIC

1. Explain the demand function and demand curve

2. Discuss price elasticity of demand

3. Describe income elasticity of demand

4. Explain cross elasticity and other elasticities

5. Account for the importance of elasticity in decision making

OVERVIEW OF DEMAND AND SUPPLY CONCEPTS

 Demand (D)
Is defined as the different quantities of a good or
service that consumers are willing and able (ready)
to buy at given prices within a given time period,
ceteris paribus.
 It can also be defined as the number of consumers willing
to purchase goods or services at a certain price
TYPES OF DEMAND

 Joint demand: This is a demand for complementary products and

services. Demand of goods and services that are interrelated. For
example, cereal and milk, car and fuel, phone and airtime or tea and
sugar.
 Composite demand: This happens when there are multiple uses for a
single product, for example, maize can be used as animal feed and
food in its whole form. The rise in demand for any of these products
leads to a shortage in supply for the others.
 Derived demand: This is the demand for a product that comes from
the usage of others. For example, demand for cotton is derived from
the demand for clothes. In this case the increase in demand for
clothes would lead to an increase in demand for cotton.
LAW OF DEMAND

 This law tries to explains the relationship between

quantity demanded and their prices, it is tested that
there is an inverse relationship between these two
variables. The law states that;
“as the price of a commodity/services in a given time period falls
the quantity demanded rises and as the price of a
commodity/services in a given time period increases the quantity
demanded falls ceteris paribus (other things remain constant)”
Exception to the law of demand
 Giffen goods (Inferior goods); these are goods which are regarded by
people as they are of low standard. its demand decrease as income of
consumers increases.
 Luxury goods; these are commodities which are expensive in nature.
People only demand for them just for prestige.
 Fear of serious shortage; when people fear that there will be a
shortage for a certain commodity in the near future they will buy
such commodity even if the price is increasing.
 Ignorance of consumer; sometime consumers might buy a product at
a higher price because they are ignorant/ they don’t have the
information that the same product can be obtained at the lower price
in the other market.
DETERMINANTS/FACTORS AFFECTING
DEMAND
 Price of a commodity: when a price of a commodity increases
consumers tends to purchase less of that commodity because their
ability to purchase declines, and when price of that commodity
decreases consumer will tend to purchase more that commodity
because their ability to purchase increases
 Consumers income: when consumer’s income increases then his/her
demand for normal goods will increase but his/her demand for
inferior goods will decrease, when consumer’s income decreases then
his/her demand for normal goods will decrease while his/her demand
for inferior goods will increase.
DETERMINANTS…………………….

 Price of related goods: The availability and price of

related goods affect the demand for goods and services.
The effect of related goods depends on whether they are
substitute goods or complementary good. For example,
availability of coffee and tea, if the price of coffee
increases one can choose tea.
 Tastes and preferences: if the tastes and preferences for
certain goods and services increases the purchase of said
goods and services increase and vice versa
DETERMINANTS…………………….

 Future expectation: these are factors that consumers may expect to change
in future and may cause either increase or decrease demand i.e. price,
income and supply. For example, if consumers think that price of a good will
increase in the future, they may decide to buy more of it now so that they
pay less and hence their current demand for that commodity will increase and
vice versa.
 Number of consumer in the market(population): population growth will
increase the demand for products because the pool of consumers has grown.
Population decline will the same effects
SUPPLY

 Supply (S)
Is defined to mean the willingness and ability of a
seller to offer a certain amount of goods or services
at a given market price during a specific period of
time.
 Supply is also an expression of seller’s plans or
intentions – an offer to sell – not a statement of
actual sales.
LAW OF SUPPLY

 The law of supply shows a positive (direct

relationship between price and quantity supplied.
The law states that;
 “at a specific period of time when the price of
good/services rises the quantity supplied also
rises and when the price of goods/services
declines the quantity supplied also falls other
factors remain constant”
DETERMINANTS/FACTORS AFFECTING
SUPPLY
 Price of the commodity: when a price of a commodity
increases the supply also increase and vice versa
 Production costs: If the price of resource used to produce
a good rise, the quantity supplied falls. For example, if
your producing a computer and the price of computer
chips increases then it will cost more to produce a
computer this may force you out of business because
consumers will demand fewer computer at higher price
DETERMINANTS……………
 Change in technology: New technologies means that either production
increases with the same level of resources or that fewer resources are
needed to produce the same level of output. If fewer resources are needed
to produce the same level of output when technology increases, then
production costs will fall causing supply to increase. Computer prices, for
example, have declined radically as technology has improved, lowering
their cost of production.
 Number of sellers: an increase or decrease in the number of sellers can
increase the production of goods and services in the economy
 Suppliers expectation: If the price of a good is expected to rise in the
future seller may hold back production in the present in the hopes of
making more profit by selling more in the future. If the farmer expect that
the future price of maize will decline they will increase the present supply
of maize in the hopes of making more money now.
THE MARKET DEMAND CURVE
 DEMAND CURVE AND DEMAND SCHEDULE
Demand can be presented using demand schedule and demand curve.
Demand schedule is a table showing relationship between prices and
quantity demanded for a given period of time.
Table 1: Demand Schedule

Price (tshs) Quantity demanded

(units)

5 600
10 500
15 400
20 300
25 200
30 100
DEMAND CURVE AND DEMAND SCHEDULE
……………..
 Demand curve is a graphical representation of the
relationship between prices and quantity
demanded for a given period. It is downward
sloping i.e., has a negative slope, from left to
right because of the inverse relationship between
price and quantity.
DEMAND CURVE
DEMAND CURVE

A demand curve can be used to illustrate either

the price-quantity relationship of an individual
consumer called an individual demand curve, or
for all consumers in a market called a market
demand curve. A market demand curve is
therefore a summation of individual demand
curves in a given market.
MARKET DEMAND SCHEDULE AND CURVE

Price Demand by consumers Market

A B C Demand

50 10 10 20 40
60 8 7 17 32
75 6 6 12 24
90 4 4 9 17
100 2 2 4 8
MARKET DEMAND CURVE
Categories of demand curves.

 Individual demand curve

 Market demand curve
 Firm demand curve
Movements of demand curve

 A demand curve can have movement along the same demand curve or
a shift of the demand curve. Movement along demand curve refers to
changes in quantity demanded due to changes in price. This occurs
only when price changes. It is shown by an individual demand curve.
 When a non-price determinant of demand changes, it causes the
curve to shift, that is, shift of demand curve. This happens when
there is a change in factors other than price of demand, resulting in a
new demand curve.
 This shift can either be to the left or right. A shift to the right means
an increase in the quantity demanded. For example, if disposable
income increases, one will demand more at a given price.
Movements of demand curve
Movements of demand curve

A shift to the left means a decrease in

quantity demanded. For example, if
disposable income falls, one will demand
less of a good at a given price.
Movements of demand curve
Movements of demand curve

 Demand curves are used to estimate behavior in

competitive markets and are often combined with supply
curves to find the equilibrium price and equilibrium
quantity. Equilibrium price (P*) is the price at which
sellers are willing to sell the same amount as buyers are
willing to buy.
 Equilibrium quantity (Q*) is the amount of good or service
that will be produced and bought in the market without
surplus/excess supply or shortage/excess demand. What is
produced is what is bought
Movements of demand curve
EQUILIBRIUM OF DEMAND AND SUPPLY

 Equilibrium is the intersection point of demand and

supply. At this point the market is sufficient such that, its
demand meets its goods supplied (demand = supply)
 When demand and supply in the market are not equal, the
market is either experiencing surplus or shortage of
commodities. Surplus occurs when quantity supplied by
suppliers is greater than quantity demanded (Qs > Qd).
 Shortage happens when quantities consumers want to buy
is greater than quantities suppliers want to sell. Quantity
demanded is greater quantity supplied (Qd > Qs)
DEMAND, SUPPLY AND EQUILIBRIUM
CURVE
INDUSTRY AND FIRM DEMAND FUNCTIONS

 The demand function for a product is a statement of the relation

between the aggregate quantity demanded and all factors affecting
this quantity. In functional form, a demand function may be
expressed as;
QD(x) = {Px, Y, Pr, Tp, E, Po}
Where,
 QD = Quantity demanded of a product X
 Px = Price
 Y = Income
 Tp = Taste and preference
 Po = Population
 Pr = Price of related products (substitute)
INDUSTRY AND FIRM DEMAND FUNCTIONS

A demand function showing the relationship

between price and quantity demanded can be
expressed as follows: -
QD = f(p)
Where;
 QD (x) = Quantity demanded for product X
F = Function of
P = price level.
Firm Demand Vs Industry Demand

 Firm Demand; is the demand indicated by consumers on

particular products or services offered by a specific firm.
The demand is independent from other firms.
 For Example: Companies like Coca Cola, Pepsi, AZAM,
JAMBO, METL and others in beverage industry have
different demand pattern on their carbonated soft drink
products. For instance, the demand for Coca-Cola, Pepsi,
mo-drinks or Azam drinks, is different, this leads to the
variation on market shares depicted from their sales
volume calculated in the industry analysis.
Firm Demand Vs Industry Demand

 Industry Demand; is the aggregate or total demand for

products that different firms make in an Industry. The industry
considers all products produced by firms are all similar. Firms
then offer products that are close substitutes, like the demand
for automobiles.
 For Example: in the Automotive Industry there are companies
like BMW, Mercedes-Benz, Volkswagen, Ford Motor, Toyota etc.
These firms offer automobiles in the industry, which acts as
substitutes as customers are offered with a wide range of
products they can choose from, depending on their needs and
wants.
Firm Demand Vs Industry Demand


For instance, an Individual can choose a vehicle
that satisfies their personal desires like a BMW,
MERCEDES for leisure, but a Company too in a
Business to Business scope can purchase trucks
from various firms in meeting their desires.
 Industry demand is used to estimate and forecast
the sales of a company i.e. relative to other
companies to determine the market share of each
one in the industry.
ELASTICITY OF DEMAND

 It measures the degree of responsiveness on the change

in the quantity demanded due to change in the factors
that influence/ affect that change (i.e. price of the
goods, price of related goods, consumer’s income, taste
and preference and other factors.)
 There are three types of Elasticity of Demand.
 Price Elasticity of demand
 Income elasticity of demand
 Cross elasticity of demand
 PRICE ELASTICITY OF DEMAND

 This is the degree of responsiveness of demand due to change in price

or any other factors which affect demand such as income.
 There are two approaches of calculating price elasticity of demand:
 Percentage method: According to this method price elasticity of
demand is given by:

Pe = Percentage change of quantity demanded

Percentage change in price of commodity

PRICE ELASTICITY OF DEMAND

 Formula approach: This is derived as follows:

PE = QN-QO x PO

QO PN-PO
Slope of a Demand Function

 The slope of a demand function is always

negative because of the inverse
relationship between quantity demanded
and price.
 PriceElasticity of Demand can be greater
than one, equal to one, less than one, zero
or undefined.
Types of Price Elasticity of Demand

 Elastic demand:
Price elasticity of demand is said to be elastic if a
change in price of a commodity brings a larger than
proportionate change in quantity demanded of a
commodity. Numerically the size of elasticity of
demand is greater than one and a demand curve of
elastic demand has a gentle slope.
Elastic demand curve
Types of Price Elasticity of Demand

 Inelastic demand:
Price elasticity of demand is said to be inelastic when a change
in price brings a smaller proportionate change in quantity
demanded. It means demand is less sensitive to the change in
price.
Goods which have inelastic demand include all necessities like,
food as a whole, salt, clothes etc.
Numerically the measure of inelastic demand is less than
one but greater than zero. 0 < Pe < 1
Inelastic demand curve
Types of Price Elasticity of Demand

 Unitary elastic:
Price elasticity of demand is said to be equal to
unit if a proportionate change in price brings an
equal proportionate change in quantity demanded.
Numerically the size of elasticity is equal to one.
Unitary elastic curve
Types of Price Elasticity of Demand

Perfectly elastic demand:

Price elasticity is said to be perfectly
elastic if demand changes while price
remains constant. Numerically the
measure is equal to infinity.
Perfectly elastic demand curve
Types of Price Elasticity of Demand

 Perfectly inelastic demand:

Price elasticity of demand is said to be
perfectly inelastic when quantity demanded
remains the same when price changes. It
means demand is totally irresponsive to the
changes in the price. Numerically the
measure is equal to zero.
Perfectly inelastic demand curve
INCOME ELASTICITY OF DEMAND

 This is the degree of responsiveness of change in demand

due to change in income. Income elasticity of demand can
be calculated either by percentage method or formula
method.
 Percentage method:
Ye = % change in quantity demanded

% change in income
INCOME ELASTICITY OF DEMAND

 Formula method:
CROSS ELASTICITY OF DEMAND

 This is the degree of responsiveness of

demand for a commodity due to a change
in price of its substitute. For example, if
the price of tea increases it will lead to a
decrease in demand for tea and an increase
in the demand for coffee.
CROSS ELASTICITY OF DEMAND CURVE
CROSS ELASTICITY OF DEMAND

 Cross elasticity of demand can be expressed by either the

percentage method or formula method.
 Percentage method:
Cross elasticity of demand = % change in quantity demanded of a commodity

% change in price of commodity

CROSS ELASTICITY OF DEMAND

 Formula method:
CROSS ELASTICITY OF DEMAND

 Cross elasticity of demand for substitutes is always

positive because an increase in the price of one
commodity, which has a close substitute, leads to an
increase in the demand for its substitute.
 Types of cross elasticity of demand
i. Positive cross elasticity
ii. Negative cross elasticity
iii. Zero cross elasticity
CROSS ELASTICITY OF DEMAND

 Positive cross elasticity

Positive cross elasticity occurs to goods which are substitutes in nature
and which a rise in price of one leads to an increase in demand of
another and a decrease in price of one leads to a decrease in demand for
the other.
CROSS ELASTICITY OF DEMAND

Negative cross elasticity

 This is a cross elasticity of complementary goods showing
that a rise in the price of one good, resulting in less being
demanded of that good, then causes less to be demanded
of the good in joint demand.
 Example a rise in the price of cars will cause a fall in the
quantity demanded of cars and petrol
Negative cross elasticity curve
CROSS ELASTICITY OF DEMAND

Zero cross elasticity

 This is a cross elasticity between two goods which have no
relationship at all for example clothes and cars. A change
in the price of one of the two commodities will have no
measurable effect upon the demand for the other
commodity. For example, when the price of cars increases
it will not have no effect on the demand for clothes.
Zero cross elasticity curve
Factors Influencing Elasticity of Demand for a
Commodity

i. Degree of the necessity of a commodity

ii. Extent of use
iii. Income level;
iv. Urgency of the demand;
v. Durability of the commodity,
vi. Proportion of income spent on commodity and
vii. Range of substitute.
IMPORTANCE OF ELASTICITY OF DEMAND

i. Price discrimination
ii.Shifting of Tax Burden
iii.Planning and forecasting
iv.International trade
v. Taxation policy
SUMMARY FOR PRICE ELASTICITY OF
DEMAND

Price elasticity of Demand curve Rise in the price will Fall in the price will
Demand is

>1 Elastic Decrease the Revenue Increase the revenue

=1 Unitary Elastic Not change the revenue Not change the revenue

<1 Inelastic Increase the revenue Decrease the revenue

THANK YOU.