Demand/Supply/Elasticities

GL for the 15th.

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• Created by: Salman
• Created on: 11-01-13 14:39

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1
2. THEORY OF DEMAND AND SUPPLY:
THEORY OF DEMAND:
Demand refers to the quantity of a product that consumers are willing and able to buy at a particular
price and over a given period of time. The law of demand states that more is bought at a lower price than at a
higher price. In other words, the law of demand postulates an inverse relationship between the price and
quantity demanded of a commodity, all other factors affecting demand remain constant (ceteris paribus).
A market demand curve for a certain product is derived from the horizontal summation of all individuals
demand curves at each and every price of the quantity demanded.
Price (\$) Consumer A + Consumer B + Consumer C = market demand
1 20 30 40 90
2 18 26 35 79
3 15 18 22 55
4 11 12 19 42
5 7 10 12 29
Thus, by plotting price against quantity demanded from the market schedule, a downward sloping
demand curve from left to right for the entire market is drawn.
Price D
P
P1
D
0 Quantity demanded
Q Q1
A fall in the price from OP to OP1 expands the quantity demanded from OQ to OQ1, whilst a rise will
do the contrary.

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FACTORS INFLUENCING DEMAND (DETERMINANTS):
There are indeed several factors which affect the quantity demanded for a certain product.
1. Change in the price of the commodity itself:
Changes in the price of the commodity will lead to changes in quantity demanded. For instance, a rise in
the price of good X will lead to a fall in quantity demanded for good X. This is because good X is now more

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Changes in population:
When the size of the total population changes, demand for goods and services would generally change.
An increase in total population would generally lead to an increase in demand. However, the pattern of demand
depends on the composition of the population in terms of age and sex. An increase in old age people would
mean a greater demand for walking sticks, spectacles. An increase in young people would mean greater

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MOVEMENTS ALONG AND SHIFTS OF A DEMAND CURVE:
A movement along the demand curve occurs when quantity demanded changes because of a change in
the price of the commodity alone, while other factors in conditions of demand (income, tastes, population, price
of complements and substitutes, etc) remain constant. Thus, a rise in the price will cause quantity demanded to

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Q2 Q Q1
ELASTICITY OF DEMAND:
The law of demand, which expresses an inverse relationship between quantity demanded and price,
shows only the direction of demand. No information is provided as to how much or to what extent will demand
change to a change in any of the variables affecting demand. This information is, however, provided by the
concept of elasticity of demand which shows the exact magnitude by which demand will change if there is a

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Price
D
P
25%
P1
D
50%
0 Quantity demanded
Q Q1
On the other hand, demand is said to be inelastic when a percentage change in price brings about a less
than proportionate change in quantity demanded. Hence, an inelastic demand occurs when the percentage
change in quantity demanded is less than the percentage change in price, and the coefficient of the elasticity is
less than 1 (PED < 1).…read more

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D
0 Quantity demanded
Q3 Q
Demand can also be perfectly elastic when a small percentage change in price brings about a change in
quantity demanded from zero to infinity. The coefficient of elasticity is equal to infinity.
Price
P D
0 Quantity demanded
Demand is perfectly inelastic when a percentage change in price brings about no change in quantity
demanded. The value of the PED is zero (PED = 0).…read more

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E = 0
0 Quantity
The above diagram shows a demand curve for which the price elasticity of demand is different at every price. It
varies according to the level of price. For instance, along the same demand curve, elasticity is unity at price 0P
(midpoint of demand curve), elastic at price 0P1 and inelastic at price 0P2.
FACTORS INFLUENCING PRICE ELASTICITY OF DEMAND:
There are various factors which influence the price elasticity of demand.

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Consumers will be in a position to afford its use even for less important purposes. On the other hand, a product,
which has a single use, has an inelastic demand, for example, toothpaste.
5. Habit:
There are certain goods which people consume because they have developed a habit, for example,
cigarettes for a chainsmoker. Once consumers develop a habit for a particular commodity, they will continue to
demand even if the price increases.…read more

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Price TR / TE
D
P1
10%
P
D
25%
0 Quantity 0 Price
Q1 Q
2. Price Inelastic:
Let initial price = £20, initial Quantity = 100
Thus, initial TR / TE = 20 * 100 = £2000
When price = £23 (15% increase), Quantity = 95 (5% decrease), then TR = 23 * 95= £2185.…read more