Test: Theory Of Demand- 1 - CA Foundation MCQ

An expansion or contraction of demand occurs as a result of the income effect or substitution effect. When the price of a commodity falls, an individual can get the same level of satisfaction for less expenditure, provided it's a normal good. In this case, the consumer can purchase more of the goods on a given budget.

The demand for a commodity is its quantity which consumers are able and willing to buy at various prices during a given period of time

1. Price of related goods:
a. Substitute Goods: 
When the price of substitute goods increases the demand of the given commodity increases and vice versa.
Example: Tea and coffee, when price of tea increases demand for coffee increases and vice versa.

b.Complementary Goods: 
When the price of complementary goods increases, the demand of the given commodity decreases and vice versa.
Example: Car and petrol, if the price of car increases demand for petrol decreases.

2. Income of the consumer: 
As the income of the consumer increases, his purchasing power increases and therefore the demand of the given commodity increases. Similarly, when the income of the consumer decreases, his purchasing power contradicts and hence the demand of the given commodity decreases.

According to relatively elastic demand, an increase in price will lead to greater than proportionate change in quantity demanded. In this case price increases by 22% and quantity demanded falls by 25% which is greater than 22% (increase in price) so the ans is elastic.

Infinity because price does not change but demand change due to change in other factors.

An increase or decrease in the price of such a good does not affect its quantity demanded. These goods have a perfectly inelastic relationship, in that any change in price does not change the quantity demanded.

Complementary goods are those goods which consume together.
For example - Car and petrol

When price of car increase then demand of petrol and car decreases because petrol is necessary to drive a car and when price of car increases then people do not buy car and due to this reason petrol is also not in demand so, demand curve shifts to left and remember complimentary goods are joint goods.

The Engel curve, named after the German statistician Ernst Engel (1821-96), is a relation between the demand for a good and the income of its buyers, the former depending on the latter.
The Engel curve of an individual consumer can be obtained from his ICC. 

E_d= (% change in demand) / (% change in price)

E_d = (40% / 20%)

E_d = 2 %

A Giffen good is typically an inferior product that does not have easily available substitutes. They are quite rare, to the extent that there is some debate about their actual existence. So fall in the price of such good like Bajra will also reduce its demand as income effect dominates the substitution effect.

Income elasticity = (% change in quantity demand ÷ % change in income)

Hence, income elasticity = 5 ÷ 1

= 5

In the case of an inferior good, the income elasticity of demand is Negative. A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes.

In the case of a straight-line demand curve meeting the two axes, the price-elasticity of demand at the mid-point of the line would be 1.

In economics and consumer theory, a Giffen good is a product that people consume more of as the price rises and vice versa—violating the basic law of demand in microeconomics. According to the Law of Demand, when the price of a commodity falls the demand for it rises. Giffen's Paradox is an exception to this law.

When the price of normal good falls, consumer's real income increases and this induces him to buy more of that commodity. this is known as the income effect.

In a very short period, supply is fixed as suppliers cannot increase the supply of a commodity. Since, in a very short period price is determined by demand only (supply being constant), thus the price that prevails in the very short period is called market price. Hence if the number of customers in the market increases suddenly, the supply will not be affected.

Quantity demand decrease because inferior goods are low quality goods and law of demand does not apply on inferior goods.

Complementary goods have a negative cross - price elasticity: As the price of one good increases, the demand for the second good decreases.

Substitute goods have a positive cross -price elasticity: As the price of one good increases, the demand for the other good increases.

If the price of any commodity decreases by 20% and the demand for that commodity increases by 40% then the elasticity of demand would be highly elastic as the proportionate change of quantity demand is greater than the proportionate change of price.

Movement along a demand curve occurs when the demand of a commodity changes due to change in its own price whereas shift in demand occurs when demand changes due to other factors keeping its own price constant. Price elasticity of demand measures relationship between price and demand of the product and hence it measures movement along demand curve.

The slope of a straight-line demand curve, one with a constant slope, has constantly changing elasticity. No two points on a straight-line demand curve have the same elasticity. The price elasticity of demand is different at each point on a demand curve with constant slope.

Those goods which are considered inferior by the consumers and which occupy a substantial place in consumers budget are called 'Giffen' goods.
These goods have got their name after Sir Robert Giffen.

More than one because change in demand is more than change in income

In the case of perfect substitutes, the cross elasticity of demand will be equal to positive infinity.

Substitutes: Two goods that are substitutes have a positive cross elasticity of demand: as the price of good Y rises, the demand for good X rises.

Two goods may also be independent of each other.

A normal good, also called a necessary good, is the opposite of an inferior good. A luxury good means a greater increase in income results in a larger percentage increase in demand. A normal good has an income elasticity of demand that is positive, but less than one.

Its answer is inferior good. Because there is negative relation between income and demand of inferior good. we know that when our income increase we would not like to purchase low quality products. so we can say that when income increase then demand of inferior good decrease.

When the price elasticity of demand for a good is perfectly inelastic (E_d =0), changes in the price do not affect the quantity demanded for the good;  and hence option B is the correct answer.

A movement along the demand curve will occur when the price of the good changes and the quantity demanded changes in accordance to the original demand relationship. In other words, a movement occurs when a change in the quantity demanded is caused only by a change in price.

Contraction of demand refers to the increase in own price of the commodity.

Expansion in demand refers to a rise in the quantity demanded due to a fall in the price of commodity, other factors remaining constant.

A Giffen good is typically an inferior product that does not have easily available substitutes. They are quite rare, to the extent that there is some debate about their actual existence. So fall in the price of such good like Bajra will also reduce its demand as income effect dominates the substitution effect.