Theory of Demand
Ekjyot Kaur Gujral
Assistant Prof of Economics
Army Institute of Law, Mohali
Concept of Demand
Desire, Want and Demand
Desire is a wishful thinking.
Want is when you have the ability to buy a thing but not the
willingness.
Demand is the quantity of a commodity that the consumer is
willing and able to buy at a given price at a given point of time.
Types of demand
Price demand: Expresses a relationship between price of a
commodity and its demand.
Da = f(Pa)
Income demand: Expresses a relationship between income of a
consumer and demand for a commodity.
Da = f(Y)
Cross Demand: Expresses a relationship between price of a
good ‘a’ and demand for its related good ‘b’.
Db = f(Pa)
Law of Demand
It states that when price of a good rises, the demand for that
good falls and when price of a good falls, its demand rises,
other things remaining the same.
There is an inverse relationship between price a commodity
and its demand.
Acc to Samuelson, “Law of Demand states that people will buy
more at lower prices and buy less at higher prices, ceteris
paribus, or other things remaining the same.”
Assumptions
‘Other things remaining the same’ means that the factors
influencing demand, other than the price, are assumed to remain
constant.
Dx = f ( Px , Pr , Y , T , E )
• Explanation:
Acc to the law, there is an inverse relationship
between price and demand for a commodity.
But the relationship is not proportional.
Law of demand simply indicates the direction of
change in demand as a result of change in price.
• Demand Schedule:
Price Quantity Demanded
1 4
2 3
3 2
4 1
• Demand Curve:
Graphical representation of the relationship between price
and demand.
• Why does demand curve slope downwards?
1. Law of Diminishing Marginal Utility
2. Income effect: It is the effect that a change in
person’s real income caused by the change in price
of the commodity, has on the quantity demanded of
that commodity.
𝑀𝑜𝑛𝑒𝑦 𝑖𝑛𝑐𝑜𝑚𝑒
𝑅𝑒𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 =
𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦
When Price of a commodity rises, Real income falls,
people will be able to buy less of a commodity than
before. So the Demand for the commodity falls.
Px RY Dx
Px RY Dx
3. Substitution effect: It is the effect that a change in the relative
prices of substitute goods has on the quantity demanded.
When the price of one good changes relative to another, the
relatively cheaper good is substituted for the expensive one. For
example, tea and coffee.
Price (tea) ↑ Demand (coffee) ↑ so Demand (tea) ↓
Price (tea) ↓ Demand (coffee) ↓ so Demand (tea) ↑
4. Different uses: Goods have alternative uses. Example, milk.
If the price of a commodity rises, it will be used only for the
most important use, hence demand will fall. If the price of the
commodity falls, then it will be put to several uses, hence
demand will rise.
5. Size of the consumer group: If price of a commodity rises,
less number of people will be able to purchase it than before,
so the demand falls. If price falls, then those people who were
earlier not able to buy it, will also start purchasing the
commodity, so demand rises.
• Exceptions to Law of Demand
In the case of some commodities, the law of demand fails.
Demand curve slopes upwards y
from left to right.
Price
O x
Quantity demanded
i. Veblen Goods: Named after the American economist T.
Veblen, these are articles of distinction or luxury goods.
They are demanded more due to their high price. If their
price falls then they no longer remain luxury items, their
demand will fall.
ii. Giffen goods: Named after Sir Robert Giffen. These are
those inferior goods in the case of which the law of demand
does not hold good. When their price falls, their demand also
falls.
Example, Bajra is an inferior good. When price of bajra
falls, real income of the consumer rises. With this, the
consumer will start demanding more of ‘wheat’ and thus his
demand for Bajra will fall.
Law of demand does not fail in case of all inferior goods.
All giffen goods are inferior goods but all inferior goods are
not giffen goods.
iii. Ignorance: Sometimes out of sheer ignorance, we
consider a good to be of low quality if it is priced low and of
high quality if it is priced high. So demand will be more for
a high priced good and low for a less priced good.
Determinants of demand
Demand for a commodity is determined by a number of factors:
1. Price of a commodity: Inverse relationship
2. Price of related goods (Pr):
a) Substitute goods: Goods that can be used in place of each other.
Coke and Pepsi. There is a positive relationship between price of one
good and the demand for its substitute good.
Price(pepsi) ↑ Demand(coke) ↑ (because Demand (pepsi) ↓ )
Price(pepsi) ↓ Demand(coke) ↓ (because Demand (pepsi) ↑ )
b) Complementary goods: Goods that complete the demand for each
other. Car and petrol. There is an inverse relationship between price of
one good and demand for its complementary good.
Price(car) ↑ Demand(petrol) ↓ (because Demand (car) ↓ )
Price(car) ↓ Demand(petrol) ↑ (because Demand (car) ↑ )
3. Income of the consumer (Y):
a) Normal goods: those goods in the case of which demand
increases with the increase in income of the consumer.
b) Inferior goods: those goods in the case of which demand
decreases with the increase in income of the consumer.
c) Necessities and inexpensive goods: demand for these goods
remain unchanged with the change in income.
4. Tastes and Preferences (T):
If the consumers develop a favourable taste and preference for a
commodity then the demand for that commodity rises and if they
develop an unfavourable taste for a commodity, then demand for
it falls.
5. Expectations (E) :
If the consumer expects price of a commodity to fall in the future,
then he will demand less of a commodity at present.
If the consumer expects price of a commodity to rise in the future
then he will demand more of the commodity at present.
6. Size and composition of population ( P) :
If population is more, demand for goods will be more and vice
versa
If the population consists of more females or children then
demand for the goods required by them will be more.
7. Distribution of income (Yd):
If there is equal distribution of income then the demand for
necessities will be more.
If the distribution of income is unequal then the demand for
luxuries will be more.
Change in demand and Change in quantity
demanded
1. Change in Quantity demanded is due to change in price only.
Represented as a movement along the demand curve
Extension or Contraction of Demand
2. Change in demand is due to change in any determinant of
demand other than the price.
Represented as a shift of the entire demand curve.
Increase or decrease in demand.
