THEORY OF DEMAND Lecture notes, Slides of Managerial Economics

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THEORY OF DEMAND

WHAT IS DEMAND?

A relation showing the quantities of

a good that consumers are willing

and able to buy at various prices

per period, other things remain

constant.

TYPES OF DEMAND

• Price Demand
• Indicates the “price effect”, which

explains the impact of changes in

price of a particular product on its

quantity demanded

• Income Demand
• Shows the “income effect”, which explains the impact of changes in the income of the consumer on the demand for a particular product

b. Inferior goods – the demand for such goods declines with increase in the income of the consumer and vice-versa

• The income effect is negative Income of the consumer Demand for x commodity (units) Particulars 1000 10 Inverse relationship between Income and demand depicting negative income effect 2000 05 3000 02

b. Normal goods – goods that experience an increase in its demand due to a rise in consumers' income

• The income effect is positive Income of the consumer Demand for x commodity (units) Particulars 1000 10 Positive relationship between Income and demand showing positive income effect 2000 20 3000 30

Two Types: a. Cross demand for Substitutes – used in place of another good to satisfy a particular want Examples:

• Tea and coffee
• Pepsi and Coca-Cola
• Wheat and rice
• The SUBSTITUTION EFFECT  always positive (direct)

b. Cross demand for Complementary Goods – goods used together for satisfying a particular want Examples:

• Smartphones and apps
• Pen and Ink
• Toothbrush and toothpaste
• The COMPLEMENTARY EFFECT  negative (inverse)

Quantity Demanded (Qd)

• Is the number that would be

bought by the public at a given

price

Demand Function:

Qd = a - bP

Qd = 20 – 2P

Price Quantity Demanded (Qd) 0 20 1 18 2 16 3 14 4 12 5 10 6 8 7 6 8 4 9 2 10 0

Demand Curve

• is a graph of the relationship

between the price of a good and the

quantity demanded

Downward Sloping P Qd

REASONS BEHIND DOWNWARD SLOPING DEMAND CURVES

1. Application of the Law of Diminishing Marginal Utility
2. Substitution effect
3. Income effect
4. Falling prices attract new consumers
5. When the price of a commodity decreases, the old buyers can afford to buy even more quantities of it.

FACTORS AFFECTING DEMAND

1. Taste & Preference

2. Income

3. Price of Related Goods

4. Expectations

5. Number of Buyers