Managerial Economics
Chapter 2/B Com. & BBA
The Concept of Demand and Elasticity of Demand- Part I
I.Short Answer Type Questions
1. What is demand analysis?
Demand analysis attempt to determine the factors that affect the demand for a commodity or service
and to measure such factors and their influence on demand. Demand analyses include the study of law
of demand and demand forecasting.
2. What do we mean by demand in economics? Or Define demand.
Demand in economics means need or desire plus purchasing power plus willingness to pay or buy. This
implies that it is an effective desire. It is the various quantities of goods that consumers are able and
willing to buy at various prices during a given period of time.
3. State the law of demand.
The law of demand states that more quantity of a commodity will be purchased at a higher price than at
a lower price. This means that the quantity demanded increases when the price decreases and vice
versa.
4. What is demand schedule?
A demand schedule is a tabular representation of various quantities purchased by an individual or
individuals at different prices during a given period of time in a particular market.
5. What is individual demand schedule?
It is the tabular representation of various quantities purchased by an individual at different prices during
a given period of time in the market.
5. What is a market demand schedule?
It is the tabular representation of various quantities purchased by all the consumers in the market at
different prices during a given period of time.
6. What is a demand curve?
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Managerial Economics
A demand curve is a graphical representation of a demand schedule. It graphically represents various
quantities purchased by an individual or individuals at different prices during a given period of time. It
graphs the relationship between price and quantity demanded.
7. What do you mean by exceptions to the law of demand?
The law of demand states that there exists a negative relationship between quantity demanded and
price. In certain exceptional cases, the demand may increase with price or it may decrease with price.
This is called exceptions to the law of demand.
8. What is Giffen Paradox?
Sir Robert Giffen established that sometimes people buy less quantities of a commodity ( inferior goods)
at a lower price and more quantity of that commodity at higher price. So the law of demand does not
apply in this case. This exceptional behavior is called as Giffen Paradox in economics.
9. What are Giffen goods?
Giffen goods are certain special type of inferior goods whose demand increases with increase in price
and decreases with decrease in price. For example, bread consumed along with meat.
10. What is Veblen Effect?
Veblen effect is named after Sir Thorstein Veblen ( American Economist) . He opined that certain goods
are purchased by people due to status value to impress others. For such goods, when the price increases
the quantity demanded also increases and vice versa. This effect is called as Veblen Effect.
11. What is demonstration effect?
Sometimes people purchase a product not because of change in price or income but because their
neighbor or relatives purchased it. This is called as demonstration effect or contact effect. This effect
was developed by Prof. Duesenberry.
12. Explain the relationship between speculation and quantity demanded? (Speculation Effect)
If people speculate an increase in price, the demand for goods will increase and if they speculate a
decrease in price, the demand also decreases.
13. What are substitute goods?
When one product can be used in the place of another product without losing any level of satisfaction,
then we can call it as perfect substitutes. Eg. Pepsi and Coca Cola
14. What are complementary goods?
Two goods are said to be complementary of each other when they are used together. Eg. Petrol and car
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15. Define demand function.
The functional relationship between demand and its various determinants is called as a demand
function. In a demand function, this relationship is shown algebraically. The demand function can be
written as follows;
D = f ( P, Y, T, Ps, U ……………….)
Where D is the quantity demanded, P is the price of the product, Y is the income of the consumer, T is
the tastes of the consumer, Ps is the prices of substitutes and complements, U is miscellaneous factors
etc0
16. What do you mean by price demand?
Price demand refers to various quantities that a consumer would buy at a various prices during a given
period of time. The demand curve is negatively sloped.
17. What do you mean by Income demand?
Income demand refers to various quantities purchased by a consumer at different levels of income
during a given period of time. The demand curve is positively sloped
18. What do you mean by cross demand?
When demand for a commodity is related to the price of other commodity, it is called as cross demand.
The commodity may be substitute or complementary. If it is substitutes, then the demand curve is
positively sloped and if it is a complementary product, the demand is negatively sloped.
19. What is extension and contraction of demand?
When quantity demanded increases due to decrease in price , it is called as extension. Here the
consumer moves from left to right along the same demand curve. When less quantity is purchased due
to increase in price, it is called as contraction in demand. The consumer moves from right to left
upwards along the same demand curve.
20. What is shift in demand?
When more quantity is demanded at the same price, the demand curve shift to the right. This implies
that the quantity demanded increased due to other factors other than price in the demand function.
When less quantity is demanded at the same price, the demand curve shifts to the left.
21. What is Joint Demand?
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Managerial Economics
When two or more commodities are jointly demanded at the same time to satisfy a particular want, it is
called as joint demand or complimentary demand.
22. What is composite demand?
The demand for a commodity which can be put to several uses is called as composite demand. A single
product can be used for various purposes.
23. Distinguish between autonomous demand and derived demand?
When a product is demanded for direct consumption, it is called as direct demand or autonomous
demand. On the other hand, a commodity is demanded as a result of the demand for another
commodity or service, it is known as derived demand or induced demand.
24. Define elasticity of demand.
Elasticity of demand is the measuring yard to measure the degree of responsiveness of quantity
demanded to change in its determinants such as price, income, prices of related goods, advertising etc.
25. Define price elasticity of demand.
It measures the degree of responsiveness of quantity demanded to change in price. It can be measured
by the formula given below.
Ep = Percentage Change in Quantity Demanded / Percentage change in its price.
26. What is income elasticity?
Income elasticity measures the degree of responsiveness in quantity demanded to change in income of
the consumers. It is measured by the formula given below;
Ey = Percentage change in quantity demanded of a product/ Percentage change in income of the
consumer.
27. What is cross elasticity?
Cross elasticity measures the degree of responsiveness in quantity demanded of a product to change in
the prices of its related products. It can be measured by the formula given below:
Ec= Percentage change in quantity demanded of product A/ Percentage change in the price of product B
28. What is advertising elasticity?
Advertising elasticity measures the degree of responsiveness in quantity demanded of a product to
changes in the advertising budget for that product. It can be measured by the formula below:
Ea = Percentage change in quantity demanded / Percentage change in advertising budget.
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29. What is perfectly elastic demand?
When unlimited quantity is demanded at the same price ( or at a minute variation in price) , the
demand is said to be perfectly elastic or infinitely elastic. In this case, the demand curve is a line parallel
to the quantity axis ( x axis)
30. What is perfectly inelastic demand?
Demand is said to be perfectly inelastic when the same quantity is demanded at different prices. The
demand curve is a line parallel to the price axis ( y axis)
31. What is unit elasticity or unitary elastic ?
Demand is unitary elastic when a change in price leads to equi-proportionate inverse change in quantity
demanded. The elasticity coefficient (Ep) is equal to one. The demand curve is a rectangular hyperbola.
32. What is relatively elastic or elastic demand?
Demand is relatively elastic or highly elastic or elastic, when a small change in price leads to greater
proportionate inverse change in quantity demanded. The elasticity coefficient is greater than one
(EP>1). The demand curve is a negatively sloping flatter curve.
33. What is relatively inelastic demand or inelastic demand?
Demand is relatively inelastic or less elastic when a small change in price leads to less than
proportionate inverse change in quantity demanded. In this case, the elasticity coefficient is less than
one (EP<1). The demand curve is negatively sloping steeper curve.
34. What are the methods of measurement of price elasticity?
Price elasticity can be measure by using the following methods:
a.
b.
c.
d.
Proportionate or percentage method
Total expenditure or total outlay method
Geometric method or point elasticity method
Arc elasticity method
35. What is arc elasticity method.?
Arc elasticity is the elasticity at the mid-point of a demand curve. It is measured by finding out
comparing the change in quantity demanded and change in price in comparison with the averages of the
price and quantity variation. The following formula is used;
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Managerial Economics
Ep = dQ/dP x (P1+P2)/(Q1+Q2)
36. Define supply.
Supply in economics means the quantity of a commodity a firm or a producer is willing to supply at a
given price during a given period of time. It implies the total quantity of goods offered for sale at a given
period to time at a given price.
37. Define law of supply.
The law of supply is called as second law of market. The law states that, other things remaining the
same, a higher quantity will be offered for sale at higher prices and vice versa. Thus there exists a
positive relationship between quantity supplied and price.
II. SHORT ESSAY TYPE & ESSAY
1. State the law of demand. What are its assumptions?
Law of demand is one of the fundamental laws in economics. The law is popularly known as the ‘first law
of markets’ which was propounded by the famous economist, Alfred Marshall. The law explains the
consumer behavior in purchasing a product when the price of that product changes.
The law states that the quantity demanded of a product (Dx), depends upon its price (Px). This implies
that Dx = f (Px). When the price of the product (Px) increases, the quantity demanded of the product
(Dx) decreases and vice versa. Thus there exists and inverse relationship between quantity demanded
of a product and its price. This relationship is called as the Law of Demand in economics. The law states
that more of a commodity will be purchased at a lower price than at a higher price.
Assumptions of the Law
Law of demand is based on the following major assumptions:
a.
b.
c.
d.
e.
f.
g.
h.
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Income of the consumer remains the same
Tastes and preference of the consumers remain the same
Prices of related products such as substitutes and complements remain the same
Price expectations remain the same
Income expectations remain the same
The total population is constant
Advertisement of the product remains constant
The product should not be a prestigious product.
Managerial Economics
2. Why demand curve slopes downwards? (Answer for short and long essay)
A demand curve is the graphical representation of various quantities purchased by an individual or
individuals at different prices during a given period of time. It explains the relationship between the
price of a product and the quantity demanded of that product. This relationship is explained by the law
of demand in economics which states that more of a commodity will be purchased at a lower price than
at higher price. When we plot the relationship between the price and quantity demanded in a two
dimensional graph, we get a curve that slopes from left to right downwards. This curve is known as the
demand curve in economics.
Generally the demand curve is negatively sloping or sloping downwards from left to right due to the
following factors.
a.Law of Diminishing Marginal Utility
The law of diminishing marginal utility states that when a consumer consumes more of a commodity,
every additional unit of the commodity gives lesser and lesser satisfactions. In other words, this implies
that the marginal utility of the product decreases when more and more unit of a commodity is
consumed. Due to this law, a consumer will be prepared to buy more quantity of a product only at a
lower price. So more quantity will be purchased only at lower price and low quantity will be purchased
at higher price. Thus the demand curve slopes downwards from left to right.
b.Income Effect
When price of a commodity falls, the real purchasing power (real income) of the consumer increases
and vice versa. So when price falls, the real income of the consumer increases and this prompt the
consumer to buy more. This is called as income effect in economics.
c.Substitution effect
People have a tendency to substitute cheaper products in the place of dearer products. So when the
price of a product falls, this product will be used in the place of another products which is known as
substitution effect in economics. Due to this effect, the demand curve is negatively sloped.
d.Price effect
When the price of a product falls, those consumers who have not purchased the product will purchase.
At the same time, those who purchase the product will purchase more quantity. On the other hand, if
the price increases, the people who purchase the product may shift to substitutes or existing customers
may purchase less quantity. So the demand curve shows downward slope due to price effect.
e.Different uses of commodity
A commodity that has got various uses will be used only for the most important purpose when its price
increases. The same product will be put different uses when its price falls. So the demand for this
product varies inversely with its price.
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Managerial Economics
f.Tendency to satisfy unsatisfied wants
Human beings have a tendency to satisfy unsatisfied needs and wants. So they purchase products when
its price falls as it becomes affordable to them. Similarly, they stop purchase, when the price of the
product increases due to non-affordability.
Thus, we may conclude that the demand curve for a product is negatively sloped or downwards sloped
due to various forces mentioned above. This particular relationship is the basis of all sorts of
promotional activities such as discounts, buy one get one free etc.
3.What are the various exceptions to the law of demand? (Answer for short and long essay)
Law of demand explains the relationship between quantity demand and the price of a commodity. The
law states that there exists an inverse relationship between quantity demanded and its price. Based on
the law, we can derive a demand curve which is negatively sloped. But there are certain exceptional
situations in economics where the demand curve is positively sloped. Such types of demand curves are
called as exceptions to the law of demand.
The following are the major exceptions to the law of demand.
a.Giffen Goods or Inferior Goods
Sir Robert Giffen (English Economist), observed that the low paid Irish workers were so poor that they
spent a major portion of their income on bread (inferior good) and a small portion on meat (superior
goods). He found that when the price of bread decreased, they reduced the consumption of bread and
the saved income was spent on meat purchase. Thus when the price of bread decreased, the demand
for bread also decreased. On the other hand, when the price of bread increased, people purchased
more bread by reducing the consumption of meat and diverted that money for the purchase of bread.
This means that when the price of bread had gone up, its demand also increased. Thus there exists a
positive relationship between the price of bread and its quantity demanded. Such types of products are
called as inferior goods or Giffen goods and this exceptional behavior is called as Giffen Paradox. This
can be explained with the help of the following graph.
Y
D
Price of Bread
P1
P0
D
X
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O
Q1
Q2
Quantity demanded of bread
Managerial Economics
In the above diagram, the quantity demanded of bread is measured on X axis and the price of bread on Y
axis. When price is OP0, the quantity demanded is OQ1. When price increases from OP0 to OP1, the
quantity demanded of bread also increased from OQ1 to OQ2. Thus, this is an exception to the law of
demand in economics.
b.Prestige Goods
People purchase certain goods for demonstrating vanity in the society just to show that they are rich
enough to afford such goods. As the price of such goods increases, its demand also increases. For
example, costly diamonds, cars etc purchased by the rich people to show that they have got the
affordability to purchase such goods. This tendency was observed in economics by Thorstein Veblen (US
economist) in his doctrine of conspicuous consumption. This effect is termed as Veblen Effect in
economics after the name of Thorstein Veblen. He observed that these goods are purchased for snob
appeal or ostentation. The law of demand does not apply in this situation. In this case also, the demand
curve is a line which is positively sloped.
c.Demand for Necessities
The law of demand does not apply in the case of demand for necessities as the quantity demanded of
necessities more or less remain the same, irrespective of the fact that whether the price increases or
decreases.
d.Emergency
During emergencies like war, famine etc, people buy more when they expect that the price of the goods
may increase in future. So they purchase more even though the prices are increasing.
e.Speculation Effect
When people speculate and increase in price of shares in future, they buy more even thought he share
prices are going up. Similarly, they decrease the purchase when they speculate share prices are
decreasing. This is an exception to the law of demand
f.Fear of Shortage
Fear of shortage of products may induce people to buy more even though the prices are increasing.
g.Ignorance
Due to ignorance people buy more when the prices are increasing and buy less when the prices are
decreasing
i.Products that are out of fashion
People demand less even when the prices are decreasing if the product is out of fashion .
j.Special Occasions
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Managerial Economics
During special occasions such as marriage, festivals etc, people may buy more of a product even if its
prices are increasing.
k.Branded Products
The brand loyals will purchase more even if the price of the brand is increasing.
4.What are the various factors that affect the demand for a product ? (Determinants of demand)
The various factors that affect demand for a product are;
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
Price of the commodity in question
Nature of commodity such as necessity, comforts or luxury.
Income and wealth of the consumers
Tastes and preference of the consumers
Prices of related products such as substitutes and complementary
Consumer’s expectations about the future changes in price.
Advertisement of the product by the company
Usefulness of the product by people
Changes in the population of the country
Distribution of income and wealth in the country
Changes in the quantity of money in circulation
Changes in climatic conditions
Technological progress in the country
Government policy such as taxes, tax concessions etc
Business cycles and its phases such as prosperity, recession, depression etc
Demonstration effect by people
Availability of credit and loans in the country
Social customs and practices in a country.
5. Explain and illustrate extension and contraction of demand.
The change in demand due to change is price ( other factors remaining the same) is called as either
extension or contraction of demand. Extension and contraction takes place on the same demand curve.
When the price of a commodity falls, its quantity demanded increases. This is called as extension of
demand in economics. This can be explained with the help of the following diagram (1)
Y
D
Fig 1: Extension
Price
A
P1
B
Po
D
x
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O
Q1
Q2
Quantity demanded
In the figure, the quantity demanded is measured on X
axis and the price of the product is measured on Y axis.
When the price is OP1, the consumer is at point A on the
demand curve DD and purchases OQ1quantity. When
the price decreases from OP1 to OP0, the consumer
moves from point A to point B on the same demand
curve by increasing the purchase from OQ1 to OQ2. This
movement along the same demand curve is called as
extension.
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Contraction of Demand
When the price of a commodity increases, the consumer purchases less quantity. This is termed as contraction of
demand. This is shown with the help of the following diagram.
In the diagram, the quantity demanded is measured on X axis and the price of the commodity is measured on Y
axis. When the initial price is OP0, the consumer at point E on the demand curve and purchases OQ2 quantity.
When the price increases from OP0 to OP1, the consumer moves from point E to point F by reducing the purchase
from OQ2 to OQ1. This movement along the same demand curve is termed as contraction of demand.
Y
D
Price
F
OP1
E
OP0
D
X
O
Q1
Q2
Quantity demanded
6.Explain and illustrate shift in demand or increase and decrease in demand.
The demand for a product depends upon various factors such as price of the product, the income of the
consumer, tastes and preference of the consumer, expectation about future changes etc. The change in
demand due to change in other factors other than price is termed as shift in demand. Change in any one
of the factors other than price may shift the demand curve either upward or downward from its original
position. An upward shift in demand curve is called as increase in demand and a downward shift in
demand curve is called as decrease in demand.
Upward shift or increase in demand can be shown with the help of the following diagram.
Y
Price
D
D1
P
D1
D
X
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O
Q
Q1
Quantity demanded
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In the above diagram, the quantity demanded is measured along the X axis and the price along the Y
axis. DD is the demand curve for the product. At OP price the quantity demanded is OQ. When the
demand increases due to increase in income, favorable tastes and fashions, future expectation about
price increase, better advertising by the company etc, the demand curve shifts to the right as shown in
the diagram by the curve D1D1. This implies that more quantity is demanded at the same price OP as
quantity demanded increases from OQ to OQ1 on the new demand curve. This shift in demand curve
upwards is termed as increase in demand.
Decrease in demand
The decrease in demand is shown in the diagram below where the demand for the product decreases at
the same price as shown by the downward drift of the demand curve to left.
Price
D
D0
P
D
D0
O
Q0
Q
Quantity demanded
In the above diagram, the initial demand curve is DD where the quantity demanded is OQ at OP price.
Due decrease in population, tastes and fashions, decrease in income etc, the demand for the product
decreases at the same price. So the demand curve shifts from DD to D0D0 and the quantity demanded
decreases from OQ to OQ0 at the same price.
7. What are the different types of demand?
The various types of kinds of demand are:
1.Joint demand
When two or more commodities are jointly demanded to satisfy a want, it is called as joint or
complementary demand. For example, paper, pen and ink.
2.Composite demand
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If a commodity can be put to different uses, then it is called as composite demand. For example,
electricity can be used for various purposes so it has got composite demand.
3.Direct and Derived Demand
When a commodity is needed for direct consumption, it is called as direct demand or autonomous
demand. For example, food. When a commodity is demanded as a result of demand for another
commodity or service, it is known as derived demand or induced demand. For example, the demand for
tyres depends upon the demand for cars.
4.Industry Demand and Company Demand
The demand for the product of a particular company or firm is called as company demand. Industry
demand is the demand for the products of a particular industry.
4.Factors that affect price elasticity of demand for a product . (Essay Question)
The various factors that affect the price elasticity of demand are:
1.Nature of the commodity
Demand for luxury is more elastic than the demand for necessities. So demand for comforts and
luxuries are elastic in nature.
2.Availability of substitutes
If there are more substitutes available for a product, then the demand will be elastic in nature. On the
other hand, it there are no substitutes available for a product, then its demand will be inelastic.
3.Income of the consumers
The demands for the products by the richer classes are less elastic or inelastic in nature, whereas the
demands for products consumed by the poorer classes tend to be highly elastic.
4.Proportion of income spent on a product
I f the consumer spends a small portion of his income on a product, its demand will be inelastic in
nature. For example – common salt. On the other hand, if the consumer spends a very high proportion
of his income a product, then its demand will be highly elastic.
5.Habit of the consumers
For habitual buyers, the demand for the product will be inelastic whereas for brand switchers, it can be
elastic in nature.
6.Number of uses of a commodity
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If a commodity has got various uses, then its demand will be elastic in nature because of the fact that
when the prices increase, the product will be put to limited use and vice versa.
7.Postponement of Purchase
If we can postpone the purchase to a future date, then the demand will be elastic, whereas the
commodity is needed urgently, its demand tends to be inelastic.
8.Demand for complementary goods
The elasticity of demand for complementary goods depends upon the elasticity of demand of main
product. If the demand for the main product is elastic, then the demand for the related products also
will be elastic in nature.
9.Distribution of income and wealth in the society
If there is unequal distribution of income and wealth in a society, generally the demand will be inelastic
in nature. If the income is distributed equitably, then the demand tends to be elastic in nature.
10.Durability of the commodity
For durable commodities, the demand is elastic in nature because the purchase of such commodities
can be postponed.
11.Range of Prices
If the price happens to be too high or too low, its demand will be inelastic in nature.
……………………………..
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