The Market Forces of Demand and Supply

Introduction
Markets bring together buyers and sellers of a particular goods or services. The
terms demand and supply refer to the behavior of people as they interact with one
another in a competitive market economy. Demand and Supply are the two forces
which makes the economies work. These are the core of any exchange economy
and changes in demand and supply affects the events or policies in an economy.

1. Demand
Learning Objectives
1) Meaning of Demand.
2) Explain Law of Demand graphically with the distinction between individual and
market demand schedules and demand curve.
3) Shifts in demand curve.
4) Movements along the demand curve

Individuals often make genuine plans to purchase various items. In economics

demand does not merely means an empty desire for a good. For an economist
demand for a good is a plan to buy that good backed by ability to pay for it. In a
market sense also demand for a good is completed when a buyer purchases the
good by paying for it at the prevailing market price. For example- Mr.X wants to
buy a Mercedes car but unless he has the money to pay for it, his want is merely a
desire.
The law of demand is an important thought tool that economists use to
understand how prices are determined in different markets. The famous Law of

Demand tells us how the plans that people have to purchase specific quantities of
a certain commodity change with the price for those commodities. The relationship
between the quantities that people plan to buy and the price of that commodity is
generally referred to as the Law of Demand.

Law of Demand Other things being equal, when the price of a good rises, the
quantity demanded of the good falls, and when the price of the good falls, the
quantity demanded rises. Simply put demand for a good rises with a fall in its
price and vice-versa.
The law can be explained with the help of a demand schedule and a demand curve.
Demand Schedule A demand schedule is a tabular representation of the data
showing the relationship between the different quantities of the goods that people
plan to buy at various prices, other things remaining constant.
Both the demand schedule as well as the demand curve , are models in the sense
we have learned earlier.

Demand curve A Demand curve graphically represents the demand schedule

expressing the relationship between quantities demanded at different prices.

The assumption all things remaining equalis required since the objective in this
case is to focus on the relationship between prices and the quantities that are
planned to be bought at those prices. Economists do understand that various factors
apart from price also affect demand for a good. But if we were to include all these
factors nto our analysis, the model will become so complex that we will soon lose
track of the model. Hence, we use the assumption of ther things remaining
constant, not because that assumption is believed to be true, but simply because
without making that assumption, we will not be able to build a useful model to
explain how prices affect the purchase plans.
The law of demand can be explained with the help of the following example

The demand schedule showing the quantities demanded by an individual Anu for a
commodity i.e. mangoes at different price is shown in table 1.

Table 1- Anus demand schedule

Price of mangoes(per kg)
50
45
40
35
30
20
10

Quantity demanded
by Anu (kg)
2
6
8
10
16
20
24

The demand schedule shows the quantities of mangoes purchased at different

prices. As is evident from the table Anu purchases less of mangoes at higher price
and as price falls from Rs.50 to Rs.10 quantity demanded goes on increasing.
Demand Curve - A demand curve is a graphical representation of a demand
schedule. It shows the relationship between the price of a good and its quantity
demanded. The demand curve for table 1 is plotted below in fig.1 which shows the
price - demand relationship for mangoes for Anu.
Figure 1- Individual Demand curve

60
50
40
30
20
10
0
0

10

15

20

25

Explanation of the graph On the X-axis we measure price of mangoes and on the
Y-axis quantity of mangoes demanded at different prices. After plotting the demand
schedule for Anu we draw the demand curve DD. As seen in fig.1, demand curve
DD slopes downwards from left to right, indicating that as price rises demand will
fall and vice-versa, thus specifying an inverse price-demand relationship. This
inverse relationship is true for almost all goods in the economy.
Individual Demand vs. Market Demand
Individual Demand An Individual demand schedule represents the demand for a
good by a single individual. The table 1 shown above is an individual demand
schedule and similarly fig.1 represents individual demand curve.
Market Demand- Market demand is the sum of all the individuals demands in the
market for any particular goods or service at a particular price. Thus market
demand is the summation of all individual buyers demand at different prices.
Market demand schedule can be illustrated as follows
The market demand schedule for mangoes at different prices by 2 buyers ie Anu
and Tina is shown in table 2 given below
Table 2 Market demand schedule for mangoes

Price of mangoes(per kg)

50
45
40
35
30
20
10

Anu
2
6
8
10
16
20
24

Tina
4
5
9
14
18
22
28

Total market demand

6
11
17
24
34
42
52

The total market demand is arrived by summing up the individual demand for
mangoes horizontally at a given prices.
Market Demand curve Market demand curve is the sum of all individual buyers.
It is plotted by considering the total quantity demanded at individual prices. The
market demand curve can be shown in fig.2.
Figure 2 Market Demand Curve of two individuals Anu and Tina
60

60

50

50

40

40

30

30

20

20

10

10

0
0

10

15

20

25

30

Total Market Demand Curve

10

15

20

25

30

60
50
40
30
20
10
0
0

10

20

30

40

50

60

Explanation of the graph On the X-axis we measure price of mangoes and on the
Y-axis total market demand for mangoes at different prices. As seen in fig.2,
demand curve DD slopes downwards from left to right, indicating that as price
rises demand will fall and vice-versa, thus specifying an inverse price-demand
relationship.
Conclusion - Both individual and market demand curves reflect the same consumer
behavior and that is of an inverse price-demand relationship. The law of demand is
applicable in case of all market goods in the economy.
2. Shifts in demand curve and Movements along the demand curve
The law of demand is based on the condition that all other things or other
factors that can influence the demand behavior of an individual are assumed to
remain constant. As we have sen above, this is done only for clarity of thought
because we want to ficus on the relationship between prices and quantities
demanded. Some of the factors which determine demand are income, price of
substitutes and complements, taste and preferences and expectations. These factors
may alter the demand for a good even though prices remain constant at a particular
level. Thus we have variations in demand curve which is in form of either a shift in
demand curve or movement along the demand curve.

Shifts in demand curve

A shift in demand curve occurs when a demand curve will either shift rightwards
or towards left at a constant price. Shifts in demand curve are caused due to other
factors rather than prices. A shift can be in form of increase or decrease in demand.
The following fig. 3 will show the shifts in demand curve.
Figure 3- Shifts in demand curve

In the given fig.3 we measure quantity demanded on X-axis and price on Y-axis. D1
represents the original demand curve at price OP. Any change in other factors that
causes a rise/ increase in quantity demanded for a commodity at any given price
will shift the demand curve to the right i.e. from D 1 toD2. Similarly any change in
other factors that lowers/decreases the quantity demanded for a commodity at any
given price, will shift the demand curve to the left i.e. from D1 toD3.

A shift in demand curve explains how demand increases or decreases at constant

prices due to influence of other variables/ factors on consumer choices.
Movements along the demand curve
A movement along the demand curve occurs when a consumer moves from one
point to another on the same demand curve due to changes in price, other factors
remaining constant. Movement on the demand curve occurs in form of expansion
or contraction in demand. A rise in price will cause a contraction or fall in demand
whereas a fall in price will cause an expansion or rise in demand. Movement on
demand curve is caused only due to change in prices.
Example Suppose the policy makers decide to impose a high tax on the softdrink
tepsi to discourage its consumption. Imposition of tax will raise the price of tepsi
as a result demand may fall leading to contraction of demand. Similarly if the
policy makers remove the tax it will reduce the price leading to expansion in
demand. The following fig. 4 will show the movement along the demand curve.
Figure 4- Movement along the demand curve

Conclusion
A variation in demand can occur due to change in price or change in other factors
which influence the consumers choice. Variation of demand curve due to change
in price will cause movements along the same demand curve, while a change in
other factors at constant prices will cause a shift of demand curve.

Activity:

a) Make a market demand schedule and curve for burgers. Would a change in
price of burgers bring a change in its demand? What will be the effect on
demand for burgers if a tax of 10 percent is imposed on it? Give reasons for
your answers.
b) If the price of a movie ticket increases, will the sales decline? Discuss
c) What are the various ways that can be adopted to reduce smoking in society?
Discuss the impact that all these measures will have on the demand curve for
cigarettes.

2. Supply
Learning Objectives
1) Meaning of Supply.
2) Explain the law of Supply graphically with the distinction between individual
and market supply schedules and supply curve.
3) Shifts in supply curve.
4) Movements along the supply curve

The other side of the market is supply which examines the behavior of sellers.
Quantity supplied is the amount of a particular product that a seller plans to to offer
for sale at alternative prices during a given period of time.For example, say a seller
of mangoes would be willing to sell five dozen mangoes at 500 rs per dozen but
may be willing to sell seven dozen mangoes at 700 rs.dozen.
The supply behavior can be explained through the law of supply.
Law of Supply Other things being equal, when the price of a good rises, the
quantity supplied of the good rises, and when the price falls, the quantity supplied
falls as well. Simply put supply will increase with rise in price and vice versa;.
The law can be explained with the help of a supply schedule and a supply curve.

Supply Schedule A supply schedule, just like the demand schedule, is a tabular
representation of the data showing the relationship between the different quantities
of the goods supplied by the seller at each price.
Supply curve The Supply curve, analogous to the demand curve, graphically
represents the supply schedule showing how the quantity supplied of the good
changes as its price varies. The supply curve slopes upwards because a higher price
means a greater quantity supplied in most cases. In some cases, the supply may be
fixed. It may not be possible to increase the supply even if price increases.
The law of supply can be explained with the help of the following example
The supply schedule showing the quantities of mangoes supplied by a farmer at
different price is shown in table 3.
Table 3- Individual Supply schedule of mangoes
Price of mangoes (Rs/ kg)
500
600
700
800
900
1000

Quantity supplied (in kg)

0
100
200
300
400
500

Supply Curve - A supply curve is a graphical representation of the supply

schedule. It shows the relationship between the price of a good and its quantity
supplied. The supply curve for table 3 is plotted below in figure 5 which shows the
supply - price relationship for mangoes.

1200
1000
800

price

600
400
200
0
0

100

200

300

400

500

600

quantity supplied
Figure 5Individual Supply curve for mangoes

Explanation of the graph On the Y-axis we measure price of mangoes and on the
X-axis quantity of mangoes supplied at different prices. After plotting the supply
schedule we draw the supply curve SS. As seen in fig.5, supply curve SS slopes
upwards from left to right, indicating that as price rises quantity supplied also rises,
and vice-versa, thus specifying a direct supply - price relationship. This direct
relationship is true for almost all goods in the economy.
Individual Supply Vs Market Supply
Individual Supply An individual supply schedule represents the supply of goods
from a single sellers point of view. The table 3 shown above is an individual
supply schedule and similarly figure 5 represents individual supply curve.
Market Supply - Market supply is the sum of the supplies of all sellers. To find
the total quantities supplied at any price we add the individual quantities
horizontally. Thus market supply is the summation of all quantities supplied by
individual sellers at different prices. Market supply schedule can be illustrated as
follows

The market supply schedule for mangoes by 2 farmers Ben and Kelly is shown in
table 4 given below
Table 4 Market supply schedule of mangoes by two farmers
Price of mangoes (Rs/ kg)
500
600
700
800
900
1000

Ben
0
100
200
300
400
500

Kelly
0
150
300
450
600
700

Total market supply

0
250
500
750
1000
1200

Market supply curve Market supply curve shows how the total quantity
supplied varies as the price of the good varies. The market supply of the two
farmers curve can be shown in figure 6.
Fig. 6 Market Supply Curve of mangoes by Ben and Kelly
Bens SS curve

price

Kellys SS curve

1200

1200

1000

1000

800

800

600

price

400
200
0
0

600
400
200

100 200 300 400 500 600

quantity supplied

0
0 100 200 300 400 500 600 700 800

quantity supplied

The total market supply curve of mangoes by Ben and Kelly is shown in the
following figure 7.

Fig. 7 Total Market Supply curve

Total Market Supply

1200
1000
800

price

600
400
200
0
0

200

400

600

800

1000

1200

1400

quantity supplied

Explanation of the graph On the Y-axis we measure price of mangoes and on the
X-axis total market supply for mangoes at different prices. As seen in fig.7, supply
curve SS slopes upwards from left to right, indicating that as price rises quantity
supplied increases and vice-versa, thus specifying a direct supply-price
relationship.
Conclusion - Both individual and market supply curves reflect the same producer
behavior and that is of a direct price-supply relationship.
2. Shifts in supply curve and Movements along the supply curve

The law of supply is based on the condition that all other things or other factor
that can influence the supply of the commodities is assumed to remain constant.
However in reality supply can be influenced by several other factors besides price.
Some of the factors which determine supply are input prices, technology,
expectations and number of sellers. These factors may affect the supply of a good
even though prices remain constant at a particular level. Thus we have variations in
supply which is in form of either a shift in supply curve or movement along the
supply curve.
Shifts in supply curve
A shift in supply curve occurs when a supply curve will either shift rightwards or
towards left at a constant price. Shifts in supply curve are caused due to other
factors rather than prices. Any change that raises the quantity supplied at every
price, such as fall in input price, shifts the supply curve to the right and is called as
an increase in supply. Similarly any change that reduces the quantity supplied at
every price shifts the supply curve to the left is called as decrease in supply. A shift
can be in form of increase or decrease in supply. The following figure 6 will show
the shifts in supply curve

In the given fig.6 we measure quantity supplied on X-axis and price on Y-axis. S 1
represents the original supply curve at price OP. Any change in other factors that
causes a rise/ increase in quantity supplied for a commodity at any given price will
shift the supply curve to the right i.e. from S 1 to S2. Similarly any change in other
factors that lowers/decreases the quantity supplied for a commodity at any given
price, will shift the supply curve to the left i.e. from S1 to S3.
Movements along the supply curve
A movement along the supply curve occurs when a supplier moves from one point
to another on the same supply curve due to changes in price, other factors
remaining constant. Movement on the supply curve occurs in form of expansion or
contraction in demand. A rise in price will cause a contraction or fall in supply

whereas a fall in price will cause an expansion or rise in supply. Movement along
the supply curve is caused only due to changes in price.
Example A rise in price of sugar will result in a rise in quantity supplied by the
seller. The following figure 7 will show the movement along the supply curve.

Conclusion

Variation of supply curve due to change in price will cause movements along the
same supply curve, while a change in other factors at constant prices will cause a
shift of supply curve.
3. Market Equilibrium
As we saw, the demand curve tells us the quantities that individuals plan to demand
at various prices, while the supply curve represents the plans that individuals make
to supply various quantities at different prices. If planned demand is greater than
planned supply,there wil be a shortage in the market and the price will rise. As the
price rises, more will be supplied and less demanded. The price will continue to
rise till what people plan to demand becomes exactly equal to what people plan to
supply. On the other hand, if what people plan to supply at a given price exceeds
what people plan to buy at that price, stock will remain unsold and the price will
fall. As the price falls, the quantity that people plan to buy will rise and the
quantity that people plan to supply will fall. The price will stop falling when what
people plan to buy becomes equal to what people plan to sell. The point at which
the price is such that the plans to sellers as well as buyers are being fulfilled is
called an equilibrium point. The price at that point is called the equilibrium
price, while the quantity that is bought and sold at that price is called the
equilibrium quantity. The equilibrium price is sometimes called the market
clearing price because at this price everyone in the market has been satisfied. This
can be graphically depicted in the following figure 8..

Markets Not in Equilibrium

Markets are said not to be in equilibrium when there can either be a surplus or
shortages because of the mismatch between the plans of buyers and plans of
sellers. Surplus and Shortages in Market
Surplus occurs in market when quantity supplied is greater than quantity
demanded. Suppliers are unable to sell all they want to at the existing price. A
surplus is sometimes called as a situation of excess supply. Whenever there is

surplus in market, sellers respond by cutting their prices, falling prices in turn,
increase the quantity demanded and decreases the quantity supplied. Prices
continue to fall until the market reaches the equilibrium. This is shown in figure 9
panel (a). Suppose now the market price is below the equilibrium price as in panel
(b) of fig.9. In this case if goods demanded exceed the quantity supplied there
would be shortages of goods, which is called as a situation of excess demand.
Where a shortage occurs seller can respond to shortages by raising their prices
without losing sales. As the price rises the quantity demanded falls, the quantity
supplied rises and the market once again moves towards the equilibrium. Thus the
activities of buyers and sellers automatically push the market price towards the
equilibrium price. Once the market price reaches its equilibrium all buyers and
sellers are satisfied and there is no upward or downward pressure on price. The
working of the law of supply and demand leads to price adjustments of goods into
a state of balance.
Figure 9 Markets not in equilibrium
Panel (a)

Panel (b)

Conclusion Regardless of whether the price starts off too high or too low, the
activities of thebuyers and sellers automatically push the market price towards the
equilibrium price. Thus shortages or surpluses are only temporary, however how
quickly equilibrium is reached varies from market to market depending on how
quickly prices adjust to demand and supply conditions. This phenomenon is called
as the operation of law of supply and demand that prevails all over the economy.

4. Three Steps to Analyzing Changes in Equilibrium

The equilibrium price and quantity depend on the position of the supply and
demand curves. When some event shifts one of these curves, the market
equilibrium also changes, resulting in a new price and a new quantity exchanged

between buyers and sellers. How some event affects the equilibrium in a market
can be analyzed in three steps.
a) Decide whether the event shifts the supply curve, the demand curve or in some
cases both curves.
b) We decide whether the curve shifts to the right or left.
c) We use the supply- and- demand diagram to compare and see how the shift
changes the equilibrium price and quantity.
a) A change in market equilibrium due to a shift in demand
An event that raises the quantity demanded at any given price shifts the demand
curve to the right. The equilibrium price and quantity both rise. This incident can
be explained with the help of the following example
Suppose that during summer the weather is very hot. How does this event affect
the markets for air-conditioners (ACs)? This can be explained as follows:
The rise in heat will increase the demand for ACs at any given prices. The
supply curve is unchanged because it does not directly affect the firms.
Because of rise in demand, the demand curve will shift to the right. Figure
10 shows this increase in demand as the shift in demand curve from D1 to D2.
This shift indicates that the quantity of ACs demanded is higher at every
price.
At the old price OP there is now an excess demand and this shortage induces
firms to raise the price. As shown in figure 10 the increase in demand raises
the market price from OP to OP1 and the equilibrium quantity from OQ to
OQ1.

Figure 10 Increase in demand affects the equilibrium

Shifts in Curves versus Movements along the Curves

An important point to be noted in the above example is that when hot weather
increases the demand for ACs and drives up the prices, the quantity that the firms
supply rises, even though the supply curve remains the same. In this case there has
been an increase in quantity supplied but no change in supply. Supply refers to
the position of the supply curve, whereas the quantity supplied refers to the amount
the suppliers wish to sell. In this example the weather does not alter the firms
desire to sell at any given price. Instead it alters the consumers demand at any
given price and thereby shifts the demand curve to the right. The increase in
demand leads to a rise in equilibrium price. When the price rises, the quantity
supplied also rises. This increase in quantity supplied is represented by the
movement along the supply curve.
To summarize, a shift in the supply curve is called a change in supply, and a shift
in the demand curve is called a change in demand. A movement along a fixed
supply curve is called a change in the quantity supplied and movement along a
fixed demand curve is called a change in the quantity demanded.
b) A change in market equilibrium due to a shift in Supply
An event that reduces the quantity supplied at any given price shifts the supply
curve to the left. The equilibrium price rises and the equilibrium quantity falls.
This incident can be explained with the help of the following example
Suppose that due to unseasonal rains the sugarcane crop has been destroyed
driving up the prices of sugar. How does this event affect the market for sugar can
be explained as follows?
The change in price of sugar will raise the input cost of sweets affecting the
supply curve. By raising the cost of production, it reduces the amount of
sweets that shops would produce and sell at given prices. The demand curve
is unchanged because it does not directly affect the consumers.
The supply curve shifts to the left because at every price the total amount the
shops are willing to sell is reduced. Figure 11 shows this decrease in supply
as the shift in supply curve from S1 toS2.
At the old price OP there is now an excess demand and there is shortage of
sugar which induces firms to raise the price. As shown in fig.11 the shift in
the supply curve raises equilibrium price from OP to OP 1 and lowers the

equilibrium quantity from OQ to OQ1.As a result of increase in sugar price,

price of sweets also rises and the quantity of sweets sold falls.
Figure 11 A Decrease in Supply affects the equilibrium

c) Shift in both Supply and Demand

Here we will observe a simultaneous increase in demand and decrease in supply.
Two possible outcomes may result depending on the relative size of the demand
and supply shifts. In both cases, the equilibrium price rises. In figure 12, panel (a)
where demand increases substantially while supply falls just a little, the
equilibrium quantity also rises. By contrast, in panel (b) where supply falls
substantially while demand rises just a little, the equilibrium quantity falls. Thus
certain events certainly raise the price for example rise in sugar prices will raise the
cost of sweets but their impact on the quantity of sweets sold is ambiguous ( ie it
could go either way).
Figure 12 Shift in both Supply and Demand

Conclusion
Any event that causes a change in demand or supply or both will perhaps have an
impact on market equilibrium price and quantity.

Activity The market for pizza has the following supply and demand schedules.
Price ($)
$4
5
6
7
8
9

Demand
135
104
81
68
53
39

Supply
26
53
81
98
110
121

a. For the above schedule graph the demand and supply curves. What is the
equilibrium price and quantity in the market?
b. If the actual price is above the equilibrium price what will happen in the
market?
If the supply falls below the equilibrium price what will happen?
Activity: In what ways will a drought affect the price of food grains? Use the
demand-supply framework to explain.
Activity: Does a bumper crop of onions always benefit onion farmers? Discuss.
Activity: The graph below gives the prices of flash memory and computer storage (
memory) over time. Why do you think the prices have been falling over time?
Discuss.

________________________________________________________________

Revenue, Elasticity of Demand & its application.

Concept of Elasticity:
You have learnt in the previous section that given Ceteris paribus, with a change in price of a
commodity, its quantity demanded changes, i.e., rises or fails. In other words, price of a
commodity and its quantity demanded move in the opposite directions. However, for many
purposes it is not enough to know that there is a negative relationship between price and its
quantity demanded. This is a qualitative knowledge which tells us only the direction of response
to a change in price affecting demand. But many a times we are interested in knowing how

much of change in quantity demand. e.g. You might have read that 5% rise in the price of sugar
brought down its demand by 10% or the 10% increase in price of cigarettes reduced its demand
by 5%. There are many such instances where quantification of changes in demand is of a major
policy interest. In Economics this quantification or the size of the responsiveness of quantity
demanded is known as the concept of elasticity of demand.
Price elasticity of demand refers to the ratio of relative change in the quantity demanded of a
good to the relative change in the Price of that good. Alternatively it is the percentage change in
the quality demanded of a good divided by percentage change in the price or the determinants of
demand. You may recollect that price is one of the main determinants of demand. Besides price,
income of the consumers, prices of other commodities are also the demand determinants. Hence,
we can also study the concepts of income elasticity and cross elasticity of demand. It should,
however, be noted that when we talk of elasticity of demand, unless and otherwise specifically
mentioned, we consider it as price elasticity of demand.

Price elasticity measures the degree of responsiveness of quantity demanded of a product to a

change in its price, given the consumer's income, his tastes and prices of all other goods. In other
words, it equals the percentage change in the quantity demanded divided by the percentage
change in the price of the product. The price elasticity of demand for a product X is thus written
as:
Change in quantity demanded of X/ Original quantity demanded of X
Price Elasticity = ---------------------------------------------------------------------------------------------Change in price of X/ original price of X

The measures of elasticity are known as degrees of elasticity. They are shown below in the table.
Table
Numerical Value of
Elasticity
Greater than one ( but
less than infinity)
e >1
Less than one ( but
greater than zero)
e<1
One e = 1
Zero e = 0
Infinity e =

Degrees of Elasticity
Description

Percentage change in quantity

demanded is more than the
percentage change in price
Percentage change in quantity
demanded is less than the percentage
change in price
Percentage change in quantity
demanded is equal to the percentage
change in price
No change in quantity demanded in
response to changes in price
Buyers buy all they can at some
price

Terminology
Elastic
Inelastic
Unit Elasticity
Perfectly inelastic
Perfectly elastic

Activity:

Do you think that news paper sale will drastically reduce with change in its price
from 5Rs to 6 Rs.? Why?
Think about changes in demand for salt if its price changes. Why?
What can be the nature of elasticity for Healthcare?
Discuss in group the elasticity for following goods: Mobile phone, Refrigerator,
Television
Summarize your conclusions for all the above type of goods.

On the analysis of the real world situation, we find that demand is generally very inelastic in the
case of opposite extremes of absolute necessaries or pure luxuries. Similarly, when the price of
the commodity is either very high or very low, elasticity is very less. But elasticity is high when
the price is moderate or when other things are obtainable which serve the same purpose, i.e.,
when substitutes are available. Generally demand for goods like staple foods, common salt,
healthcare, vegetable, etc. is inelastic while demand for the goods like radios, televisions,
refrigerators, various brands of a goods or service have elastic demand.
Concept of Revenue :

Now you have understood that a purchase activity of a consumer or a selling activity by a seller
involves payment or receipt respectively. How will you find out the total amount spent by a
customer on purchases? Simple, the number of goods purchased multiplied by its price.
i.e. P x Q = total expenditure for the customer or his total spending. This is also known as
total outlay. Alternatively, it is also the total income for the seller which is known as total
revenue. By studying the changes in the total revenue / total expenditure against the change in
price, we can measure elasticity as shown in the following Table.
Table : Effect of Change in Price on Total Expenditure/Revenue/Outlay
Change in Price
(i) Falls/rises
(ii) Falls
(iii) Rises
(iv) Falls
(v) Rises
Diagram to be drawn here.

Change in Total
Expenditure
No Change
Rises
Falls
Falls
Rises

Price elasticity
1
More than 1
More than 1
Less than 1
Less than 1

Activity:
Given below is the Table showing quantity demanded , price , Total revenue and Measure
of price elasticity. Complete the Table by filling the gaps:
Sr. No.

Price (P)

1.

5
8
5

2.
3.

5
4

Quantity
Demanded (Q)
8
8
6
8
9

Total Revenue
(PxQ)
40
42
-

Price Elasticity
(e)
e=?
e=?
e =?

Practical Applications of the concept of the elasticity of demand:

The concept of elasticity is extremely useful not only for the producers and business firms but
also for policy makers and planners. Lets understand :
(i) Importance for Businessmen - Businessmen often have to consider the elasticity of demand
before making changes in the prices of their products or for making changes in the size of their
outputs. For example, a manufacturer who is thinking of expanding his output will need to make
some estimates of the level to which his price will have to be reduced in order to sell the extra
volume of goods he is thinking of producing. If the price elasticity is less than unity, then he will
be selling a larger quantity of goods in return for smaller total sales revenue. In other words, a
price reduction will not secure greater sales revenue in the case of inelastic demand. Conversely,
if the elasticity of demand for his product is greater than unity, it will mean that through a
relatively small reduction in price, he can secure a large increase in his sales.

(ii) Importance in indirect taxation: Knowledge of the elasticity of demand also plays an
important role in policy decisions with regard to indirect taxation. For example consider a
commodity on which the government is levying a tax. Now, the question is whether an increase
in the rate of tax will increase the government revenue? This will depend upon the elasticity of
demand at ruling price. If the elasticity is less than unity, the increase in the tax rate will not
affect the quantity demanded of the good in question and total tax revenue will increase. As
against this if the demand is highly elastic (i.e. elasticity is greater than one) the quantity
demanded of the good in question may considerably fall and as a result the tax revenues may
decline instead of increasing from a higher rate of tax.

The elasticity of demand also helps in ascertaining to what extent the tax burden can be shifted
on to the consumers. If the demand is perfectly inelastic, the sellers or manufacturers can wholly
shift the burden of increase in tax to the consumers. Conversely if the demand is perfectly elastic,
the whole burden of tax will have to be borne by the sellers or manufacturers. Where the demand
is neither perfectly inelastic nor perfectly elastic, both the producers and the consumers will
share the burden of the tax.

(iii) Importance in regulating prices especially of agricultural products: Demand for certain
products especially agricultural products is inelastic. In such cases, the government in order to
increase the income of the farmers, may regulate the supply and increase the price. The demand
being inelastic, the expenditure of the consumers on agricultural products increases and
consequently the revenues of the farmers increase.
(iv) Paradox of Plenty: Think about a drought in Maharashtra. What is the condition of
farmers? They suffer a lot, as there is no crop, no production, no income to them. Despite the
inelastic demand for food and likely rise in the prices of food, they cannot get any benefit; but in
fact suffer a lot.
Now, consider exactly opposite situation; very good monsoon and the farmers get a bumper
crop! What do you think to happen to the farmers? They would become rich? Guess!!
With bumper crop, the supply of agricultural production increases and supply being more than
demand, now their prices fall. This reduced price may dampen the spirit of the farmers and they
may feel demotivated in increasing the production of their crops. This is known as paradox of
plenty because bumper crops instead of raising the income of the farmers, may actually reduce

it. Thus, the concept of elasticity helps us to understand the paradox of plenty. It is because of the
inelastic demand of the agricultural products that the decrease in price ( because of surplus
output ) does not cause much increase in the quantity demanded and consequently the incomes of
farmers decline.
(v) International Trade: Do you know, what is export and import? What will happen if we
cannot manage without importing certain goods, of which prices rise? We have to continue
buying them despite rise in their prices. (Do you understand it means demand is inelastic for
imports?) What happens to the total Outlay or expenditure then? It will increase. Now think if
demand for imports is elastic and their prices rise. What will we do? Reduce the demand! If the
demand for a country's exports is inelastic, a fall in the prices of exported products will not
improve its foreign exchange earnings (earnings in foreign currency). This is because a fall in
prices of exported products will not much increase its quantity demanded and as a result the
country could suffer because of reduced prices. Conversely, if the demand for a country's exports
is elastic, a fall in their prices would cause an increase in its demand and this could improve the
foreign exchange earnings of the country.

Activity:
Complete the following sentences.
1.

If the demand for imported products is inelastic, an increase in their prices will not much
affect
its
---------and
as
a
result
the
country's
expenditure
__________________________. On the other hand, if the demand for imported products

is
elastic,
an
increase
in
their
prices
would
__________________________________________________________________.
2. If there is only one seller for the product in the market, the elasticity of demand for his
product would be ______________.
3. The
government
can
easily impose
taxes
_______________demand to collect tax revenue.

on

commodities

having

4. Though the demand for agricultural products is _________________ the farmers

economic conditions are never better off.
Summary:
1. Price elasticity measures the degree of responsiveness of quantity demanded of a product
to the change in its price.
2. The elasticity is high means demand is more elastic while the demand is less elastic
means elasticity is low.
3. P x Q = total expenditure / total outlay / total revenue.
4. When total revenue changes in the same direction, with change in price; e < 1.
5. When total revenue changes in the opposite direction, with change in price; e > 1.
6. When total revenue remains the same even with change in price, e = 1.
7. The concept of elasticity is extremely useful to businessmen and policy makers.
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