Chapter 1

BASIC PRINCIPALS OF ECONOMICS

DEMAND AND SUPPLY ANALYSIS Demand: Ordinarily, it is merely desire Economical terminology A want backed up by purchasing power Demand for anything means quantity of that commodity which is bought, at a given price, per unit time Law of Demand: Functional relationship between price of commodity and quantity demanded for same Price and demand inversely related Statement Other things being equal, the demand for a commodity varies inversely as the price The demand for a commodity at a given price is more than what it would be at a higher price and less than what it would be at a lower price
1 Compiled by Prof. Prasad Parulekar

Assumptions of Law: Consumers income is given and constant No change in tastes, preferences and habits Prices for other goods are constant No change in size and composition of population i.e. All other things except price, remains constant Demand Schedule and Demand Curve: Demand Schedule: Explains various possible prices of commodity and different quantities demanded at those prices Individual and market demand schedule e.g. Demand Schedule for Milk Price per Individual Liter Rs. 24 22 20 18 16 A 1.00 1.25 1.50 1.75 2.00 B 0.75 1.00 1.25 1.50 1.75 C 0.50 0.75 1.00 1.25 1.50
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demand Market demand schedule D Nil 0.25 0.50 0.75 1.00 (Lt/day) 100 125 150 175 200

in schedule (Lt/day)

Compiled by Prof. Prasad Parulekar

Demand Curve: Geometrical device to express inverse price-demand relationship Exceptions of Law: In certain situations, law doesnt hold good. Continuous change in price: purchase more at higher price to protect from further rise OR purchase less at lower price awaiting for further decline Geffens Paradox: with reduced price for inferior commodity, superior commodity will be opted Conspicuous Consumption: high price commodities are bought as a matter of prestige, but diverts when price declines Ignorance Effect: buy more of commodity at higher price due to ignorance Determinants of Demand: In reality other things (other than price) also changes----demand changes without any change in price.
3 Compiled by Prof. Prasad Parulekar

 Income: direct relation with demand Population: direct relation with demand Tastes and Habits(likes, dislikes, prejudices, preferences): disliked itemsnot bought even at lower price and vice versa Other Prices: effect depends upon relationship between commodities in question; change in price of complementary commodity, changes demand for commodity in reference Advertisement: makes customer to buy the item at higher price, even not needed Fashions: lack of courage/desire to go against prevailing fashion or social customs and traditions Imitation: low income group imitate pattern of high income group Changes in Demand and Variations in demand: Variations: due to change in price Extension of demand: rise due to fall in price Contraction of demand: fall due to rise in price
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consumption

Changes:

due to changes in things other than price

(income, population etc.) Increase in demand: high demand at same price Decrease in demand: low demand at same price Elasticity of Demand: Law of demand: explains qualitative and not quantitative aspects of price-demand relationship The elasticity of demand explains the degree of responsiveness of demand to change in price The elasticity of demand in market is high or low accordingly as the demand changes (rise or fall) much or little for a given change (rise or fall) in price Elastic demand: demand changes considerably with small change in price Inelastic demand: change in price fails to bring significant change in demand Elasticity = ep = (%change in quantity demanded) / (% change in price)
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Types of Price Elasticity: Reveals that degree of responsiveness of demand to change in price differs from commodity to commodity Perfectly inelastic demand (ep = 0) Inelastic (less elastic) demand (ep < 1) Unitary elasticity (ep = 1) Elastic 9more elastic) demand (ep > 1) Perfectly elastic demand (ep = ) Determinants of Elasticity: Elasticity of demand depends upon various factors; classify commodities under broad categories and decide elasticity 1. Nature of Commodity: Necessities inelastic demand; comfort and luxuries elastic demand 2. Number of Substitutes available: larger the no. of substitutes, higher the elasticity 3. Number of Uses: alternate uses of same commodity; high price consumption restricted to more urgent uses; low price consumption may be extended to less urgent uses
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4. Possibility of Postponement of consumption: if so, demand is elastic 5. Range of Prices: inelastic demand for very low and very high priced commodities 6. Proportion of Income spent: inelastic demand for commodities on which less portion of income is spent 7. Unequal distribution of income and wealth: elastic demand 8. Durable goods: elastic demand 9. Complementarities of goods Measurement of Elasticity: 1. Percentage method: ep = (%change in demand) / (% change in price) 2. Total Outlay method: change in price is compared with change in total outlay i.e. total revenue or sell (price quantity bought or sold) 3. Point method: elasticity at a point on demand curve

Compiled by Prof. Prasad Parulekar

Compiled by Prof. Prasad Parulekar