Module1: Introduction,theory of demand

and supply

Economics is a social science concerned with the production,

distribution and consumption of goods and services.

Branches of Economics:

1. Macroeconomics-
● It is the branch of economics which studies the behavior of
aggregates of the economy as a whole.
● It aims to determine the aggregate output and employment level
of the economy.
● It assumes that all micro variables remain constant when we are
studying the level of output.
● It is also known as income and Employment theory.

2. microeconomics
● It is that branch of economics which studies the behavior of
individual units of an economy such as a firm, a household etc.
● It aims to determine the price of a commodity or a factor of
production.
● It assumes that all the Macro variables remain constant; it
assumes the national output, consumption, saving etc are
constant.
● It is also known as price theory.

Significance of Economics:

1. Economics provide information and forecasting to inform

decisions within the company and government.
 2. Economics issues influence our daily life. This includes issues
such as tax and inflation, interest rates and wealth. This all
impacts households.
3. Firms of all sizes and industries have to rely on economics
whether that's for product research and development, pricing
Strategies OR how to advertise.
4. Economic census theories and models to predict consumer
behavior and informed business strategies therefore it inspires
business success.
5. Economics affects the world. Our line in understanding domestic
and international perspectives provides a useful insight into how
different countries in societies interact.

Demand:

Concept of demand:-
● Desire means a mere wish to have a commodity.
● Wants is that Desire which is backed by means to buy and
willingness to spend. Every Desire is not a want. A desire
becomes so want only, if the person has means and willingness
to spend those means.
● A want becomes a demand only when it is stated with reference
to price.
● Thus, the demand for a good is defined as the quality of the
good a consumer or consumers taken together are willing to buy
at a particular price during a particular period of time.

Individual demand and market demand:-

● Individual demand is the quantity of a commodity that an
individual consumer is willing to buy at a given price during a
given period of time.
 ● Market demand is the total demand for a commodity that all the
consumers are willing to buy at a given price during a given time
period.

Determinants of Demand:-

1. Individual demand:
● Own price of the commodity- price is the most important
factor that influences a consumer decision to purchase a
particular commodity generally demand for a good Rises
with fall in price and fall with rise in price of that good.
● Price of Other goods:
(a) Substitute goods- two goods are substitutes, if
one can be used in place of other things are also
called competitive goods because they compete with
each other for demand in the market for example
coffee and tea.
(b) Complementary goods- complementary goods
are those goods which are used together to satisfy a
particular want like tea and sugar bread and butter
etc.There is an inverse relation between the price of
complementary good and demand for the given good
and increase in price of complementary goods leads
to a decrease in demand for a given good and vice
versa.
● Income of the consumers:
(a) Normal goods- generally an increase in the money
income of consumer increases the demand for a normal good and a
fall reduces the demand of it for example 2 liters of pure milk will be
bought by a person daily if his income increases and if the payment
reduces he will buy 2 liters of pure milk after every three days.
 (b)Inferior goods- a good is most likely to be inferior if it
has close substitute of higher quality if the given commodity is an
inferior good then an increase in income reduces the demand by a
decrease in income lead to rise in demand for example a consumer
may by toned milk when his income is less when his income increases
he will buy pure milk.
● Consumers taste and preferences:
Taste and preferences generally depend on Lifestyle, social
customs, religious value attached to a commodity, habitat of the
People. Change in this factor changes coming cialis taste and
preferences as a result consumers reduce or give up the
consumption of some goods and add new ones to their
consumption pattern a favorable change in consumer taste and
preference for a product means more of it will be demanded at
each price demand that will increase.

2. Market Demand:

● Population:
Higher the number of consumers or total population in a
market higher will be the market demand for a commodity
and vice versa. Demand is also influenced by place of
Residence particularly Urban and rural. There will be a
difference in demand made by Urban population and rural
population.
● Consumers Expectations:
If consumers expect a high rise in the price of a durable
commodities, they would buy more of at its higher current
price on other hand, if consumers expect a fall in the price
of certain goods, they postponed their prize purchase of
such good with a view to taking advantage of lower prices
in future, particularly in case of non essential goods.
 ● Distribution of Income:
If income is distributed more equally among the different
sections of people, all of them will be in position to make
demand for goods so command will be more. But if the
income is so and equally distributed that the majority of the
people get only a small proportion of national income, then
demand for goods will be Limited.
● Season and Weather:
The seasonal and weather conditions also have an effect
on consumer demand as in winter people prefer to buy
heaters and this increases with demand. In summer people
prefer to buy AC and increase its demand.

Types of demand:-
● Price demand- it refers to the various quantities of a commodity
or service that consumers would purchase at a given time in the
market and various hypothetical prices considering other factors
like income taste exactra remain unchanged.
● Income demand- the income demand refers to the various
quantities of goods and services which would be purchased by
the consumers at various levels of income, assuming other
factors such as taste, price of related goods etc.
● Cross demand- the cross demand means the quantity of goods
or services which will be purchased with reference to change in
price not of this goog but of Other interrelated goods. These
goods are either substitute or complementary goods.

Law of demand:-
The law of demand states that other things remaining constant,
quantity demanded of a commodity increases with a fall in price and
diminishes when price increases. It explains the inverse relationship
between the price and quantity demanded of a commodity. Law of
demand indicates only the direction of changes and not the magnitude
of change in demand. Further there is no proportional relationship
between Price and Demand.

Limitations of the law:-

There are certain exceptions to the law of demand by cases in which

demand does not contract when price rises and vice versa. These
cases are-
● Change in taste and fashion
● Change in income
● Change another prices
● Discovery of substitutes

Demand Curve:-
Demand curve is a graphical representation of the relationship
between the price and quantity demanded of a commodity.
Movement along the demand curve :-
● Change in quantity demanded refers to change in quantity
demanded of a commodity in response to change in its price,
other things remaining the same.
● Price changes lead to movement along the demand curve which
is known as change in quantity demanded.
● When price Rises demand decreases which is referred to as
contraction of demand and decrease in quantity demanded this
fall in demand results in upward movement along the curve.
● When price Falls demand increases which is called as expansion
of demand or increase in quantity demanded this is why is in
demand result in a downward movement along the same
demand curve under it:
1. Expansion in Demand- Expansion in demand refers to rise in
the quantity demanded due to a fall in price of a commodity or
other factors remaining constant; it is also known as increase in
quantity demanded. For example-
 2. Contraction in demand- contraction in demand refers to fall in
quantity demanded due to a rise in the price of commodity other
factors remaining constant it is also known as decrease in
quantity demanded. For example-

Shift of demand curve:-

Shifting of the demand curve from its initial position either to right or
the left is called shift of demand curve. Under it-
1. Increase in demand- Increase in demand refers to a rise in the
demand of a commodity at the same price. It is caused by any
other factors other than the own price of the commodity. It leads
to a rightward shift in the demand curve. For example-
2. Decrease in demand- decrease in demand refers to a fall in
demand of commodities at the same price. It is caused by any
factor other than the own price of the commodity. It leads to a
leftward shift in the demand. For example-
Elasticity of demand:-
It is the measure of responsiveness of demand to change in
prices. “The elasticity of demand is a measure of the relative
change in amount purchased in response to a relative change in
price on a given demand curve”. The elasticity of demand is
greater than unity and the inelastic demand less than Unity (but
not less than zero).

Type of Elasticity:-

1. Price elasticity:
Price elasticity of demand is a measure of the degree of
responsiveness of the demand for a good to change in its
price.
Formula-
Ep= % change in demand for the good/ % change
in the price of the good
Types of price elasticity of demand:
● Relatively inelastic demand- Demand is said to
be inelastic when the percentage change in
demand is less than the percentage change in
price. For example:

● Relatively elastic demand-Demand is said to be

elastic when the percentage change in demand
is more than percentage in price. For example:

● Unit elastic demand-When the percentage

change in demand is equal to the percentage
 change in the price of commodity, then the
demand for the commodity is called unit elastic.
For example:

● Perfectly inelastic demand- Demand is perfectly

inelastic when it does not change irrespective of
the changes in price. For example:

● Perfectly elastic demand- When the demand for

a commodity reduces 0 with an infinitely small
increase in price and increases to infinite with a
 very small reduction in price then demand is
said to be perfectly elastic. For example:

Factors determining price elasticity of demand of goods:

● Availability of close substitutes
● Nature of the commodity
● Proportion of total expenditure
● number of users
● period of time

2. Income elasticity:
● Income elasticity shows how the quantity demanded
will change when the income of the purchaser
changes the price of the commodity remaining the
same.
● It is the ratio of the percentage change in the amount
spent on the commodity to a percentage change in
the consumer's income, price of a commodity
remaining constant.
● Income Elasticity= proportionate change in quantity
purchased/proportionate change in income
 ● It is equal to Unity or one when the proportion of
income spent on a good remains the same even
though income has increased.
● It is greater than Unity when the proportion of income
spent on a good increases as income increases, for
example normal goods.
● It is less than Unity when the proportion of income
spent on a good decreases as income decreases, for
example inferior goods.

3. Cross elasticity of demand:

● It indicates that a change in the price of one good
causes a change in the demand for another good.
● It is a numerical measure of the degree to which
quantity demanded of one good responds to change
in the price of other commodities and other factors
kept constant.
● ec= % change in quantity demanded of good x/ %
change in price of good y
● This type of elasticity arises from interrelated goods
such as substitute and complementary goods.
● The cross elasticity of demand for complementary
goods is positive and that between substitutes is
negative.

Importance of price elasticity of demand:-

● Useful for business
● Helpful to finance minister
● Fixation of wages
● In the sphere of international trade
● Market forms
 Revenue concept:-
The relationship between marginal revenue average revenue
and price elasticity of demand is
Price elasticity of demand ep= average revenue/ average
revenue- marginal revenue

Supply:

Concept of supply:-
Supply is the amount of a commodity that the seller is willing to
sell in a market at a given price in a given period of time.

Law of supply:-
● It states that other things remaining constant for the same,
higher price larger is the quantity supplied and lower the
price that smaller is the quantity supplied.
● The function form , S= f(P)
S refers to supply of the commodity and p for price
● The supply function is based on the assumption that except
price all other factors remain unchanged. This is ceteris
pertibus’s supply function.

Factors determining the supply of a commodity:

● Commodities on price- price of a commodity is the most
important determinant of supply higher the price larger will
be the supply. The producer generally supplies more
quantity of a commodity at a higher price and vice versa. At
a higher price the producer will be able to earn more profits
and hence would be willing to sell more.
 ● Prices of other commodities- supply of a commodity also
depends upon the prices of other commodities. Producers
always have the possibility of shifting the resources from
the production of one commodity to the production of
another commodity.
● State of Technology- if there is an improvement in
production Technology then it may be possible for the firm
to produce more with the given resources. In such a case
the cost of production may fall and firms may be willing to
supply more at a given price.
● Taxes and subsidies- business firms treat taxes as cost
increase in taxes will increase production cost and reduce
supply. In contrast, subsidies are cash/ financial assistance
provided by the government to the producers if the
government subsidizes the production of a good with lower
the production cost and increased supply.
● Future expectation of rise in price- if the producer expects
an increase in the price in the near future, then they will
reduce the current supply so as to offer more goods in
future at Higher prices and if they expect the price to fall in
future they will supply more now to avoid loss in future.

Elasticity of supply:
● Price elasticity of supply is a measure of the degree of
response of supply for a good to change in its price.
● Price elasticity of supply measures the percentage change
in quantity supplied due to 1 percentage change in the
price of goods.
● Es= percentage change in quantity supplied/ percentage
change in price

Types of elasticity of supply:

1. Perfectly inelastic- the supply of a commodity is said to be
perfectly inelastic when quantity supplied does not change
at all in response to change in its price. For example-

2. Perfectly elastic- the supply of a commodity will be perfectly

elastic when it's supply changes to any extent irrespective
of any change in price. For example-

3. Unit elastic- the supply of a commodity is said to be unit

elastic when percentage change in supply is equal to
percentage change in price. For example-
4. Less elastic or inelastic- when the percentage in quantity
supplied is less than the percentage change in price. For
example-

5. Higher elastic- when percentage change in supply is

greater than percentage change in price supply is said to
be highly elastic. For example-
Market equilibrium:

● According to the law of demand the demand curve slopes

downward.In other words with the fall in price, quantity
demanded rises and vice versa.
● The supply curve slopes upward. In other words an industry
will offer to sell more quantities of goods at Higher price
than a lower one.
● The level of price at which demand and supply curve
intersect each Other will stay in the market and at the price
quantity demanded equal quantity supplied and it is called
equilibrium price.
● This point in the market is called the equilibrium point of the
market for market equilibrium.