Theory Of Demand (Theory of Consumer Behaviour) Class 12 Economics

Demand

• Demand for a commodity: Defined by the quantity a consumer is willing to purchase and can afford, considering the product's price, along with the consumer's tastes and preferences.
• Common usage: In everyday language, the terms desire, wants, and demand are often used interchangeably.
• Economic distinction: However, in economics, these terms each have unique meanings.

Let’s us understand the 3 different terms:

Desire: Essentially a mere wish for a commodity, without the means to acquire it.

• Example: A poor person's wish for a car, despite having only Rs. 200, illustrating desire as a simple yearning for ownership.
  

Wants: A desire that is bolstered by the capability and willingness to fulfill it. Not every desire becomes a want; a transformation occurs when the individual can afford to satisfy the desire.

• Example: The earlier mentioned poor person winning a lottery and acquiring sufficient funds to purchase a car turns the initial desire into a want.

Demand: An evolution of wants, distinguished by two additional specifics:

• Price Dependency: Demand is intrinsically linked to the commodity's price, asserting that the quantity demanded varies with price fluctuations—increasing demand at lower prices and decreasing at higher ones. Hence, demand is undefined without considering price.
• Time Relevance: Demand is always articulated in relation to a specific time frame, indicating that demand levels can shift even if the price remains constant, based on the time period in focus.
• Example: Umbrella demand spikes during the rainy season compared to other times, demonstrating how demand is not static but varies over different periods (hour, day, month, year) and can be applicable to an individual or the market at large.

Individual Demand:

• Defined as the specific quantity of a commodity that a single consumer is both willing and capable of purchasing at various price levels within a specified timeframe.

Market Demand:

• Represents the total quantity of a commodity that all consumers combined are willing and able to purchase at different price points over a designated period.

Demand Function

Illustrates the relationship between the quantity demanded of a specific commodity and the factors that influence it.

Individual Demand Function:

• Defines the functional relationship between individual demand and the factors affecting it.
• Expressed as: Dx=f(P_x,P_r,Y,T,F)
• Where   Dx  = Demand for commodity x
• P_x  = Price of the commodity x
• Pr  = Price of related goods
• Y = Income of the consumer
• T = Taste and preference
• F = Expectation of future price changes
• Indicates that the quantity demanded (D_x  ), on the left-hand side, depends on the variables on the right-hand side.

Market Demand Function:

• Describes the functional relationship between market demand and the factors affecting market demand.
• Affected by all factors influencing individual demand, plus additional factors such as the size and composition of the population, seasonal and weather variations, and income distribution.
• Expressed as:   =  (   ,   ,  ,  ,  ,   ,  ,  ) D_x  =f(P_x  ,P_r  ,Y,T,F,P_o,S,D)
  • Where   D x  = Demand for commodity x
  • P_x  = Price of the commodity x
  • P_r  = Price of related goods
  • Y = Income of the consumer
  • T = Taste and preference
  • F = Expectation of future price changes
  • P_o = Size and composition of the population
  • S = Season and weather
  • D = Distribution of income

Determinants of Individual Demand:

• Price of the commodity itself.
• Price of related goods.
• Consumer's income.
• Consumer's tastes and preferences.
• Expectations of future price changes.

Determinants of Market Demand:

• Size and composition of the population.
• Seasonal and weather conditions.
• Distribution of income among the population.

Demand Schedule

• A table detailing quantities of a commodity demanded at different price levels within a specified time period.
• Illustrates the relationship between commodity price and quantity demanded.
• Exists in two forms: Individual Demand Schedule and Market Demand Schedule.

Individual Demand Schedule:

• Shows various quantities of a commodity a single consumer is willing to purchase at different prices during a defined time period.
  
• As seen in the schedule, quantity demanded of ‘x’ increases with decreases in its price. The consumer is willing to buy 1 unit at Rs.5. When price falls to Rs.4, demand rises to 2 units.

Market Demand Schedule:

• Market demand schedule refers to a tabular statement showing various quantities of a commodity that all the consumers are willing to buy at various levels of price, during a given period of time. It is the sum all individual demand schedules at each and every price. Market demand schedule can be expressed as Dm = DA+DB+………..... Where Dm is the market demand and DA+DB+…… are the individual demands of Household A, Household B and so on.  
• Market demand is obtained by adding demand of household A and B at different prices. At Rs.5 per unit, market demand is 3 units. When price falls to Rs.4, market demand rises to 5 units. So, market demand schedule also shows the invers relationship between price and quantity demanded.

Demand Curve

• A graphical representation of the demand schedule.
• Connects points representing quantities of a commodity desired by a consumer at different prices, over a specific period, assuming other factors remain constant.
• Demonstrates the inverse relationship between the price of a commodity and the quantity demanded, with all other factors held constant.
• Can be constructed for any commodity by graphing each point from the demand schedule.
• Exists in two varieties: Individual Demand Curve and Market Demand Curve.

Individual Demand Curve:  

• Individual demand curve refers to a graphical representation of individual demand schedule.
  
• As seen in the diagram, price is taken on the vertical axis (Y-axis) and quantity demanded on the horizontal axis (X-axis). At each possible price, there is a quantity, which the consumer is willing to buy. By joining all the points (P to T), we get a demand curve ‘DD’. 

Market Demand Curve

• Market demand curve refers to a graphical representation of market demand schedule. It is obtained by horizontal summation of individual demand curves.

• DA and DB are the individual demand curves. Market demand curve (DM) is obtained by horizontal summation of the individual demand curves.

Law of Demand

• Describes an inverse relationship between price and quantity demanded, assuming all other factors remain constant.
• Also referred to as the 'First Law of Purchase'.

Assumption of Law of demand

The phrase "keeping other factors constant" is integral to the law of demand, encapsulating several critical assumptions:

• The price of substitute goods remains unchanged.
• Prices of complementary goods are constant.
• The consumer's income does not vary.
• There are no anticipated changes in prices in the future.
• Consumer tastes and preferences remain consistent.

The understanding of the law of demand is enhanced through the use of tables and graphs.

Demand Schedule

 Clearly shows that more and more units of commodity are demanded when price of the commodity falls. Demand curve DD slopes downwards from left to right, indicating an inverse relationship between price and quantity demanded.

Why Other factors are kept constant?

• The demand for a commodity is influenced by various factors, not just its price.
• To isolate the impact of a single factor on demand, it's essential to keep all other factors constant.
• Thus, when examining the 'Law of Demand', it is presumed that there are no changes in other influencing factors.

Individual Demand Vs Market Demand

Individual Demand:

• Represents the quantity of a commodity demanded by a single consumer at a specific price within a certain timeframe.
• May or may not adhere to the Law of Demand; an individual might demand more of a commodity even if its price increases.
• Not influenced by all factors that impact market demand.

Market Demand:

• The total quantity of a commodity demanded by all consumers at a specific price during a specified period.
• Always conforms to the Law of Demand; meaning, market demand decreases as price increases, and vice versa.
• Affected by all factors that influence individual demand.

Substitute Goods and Complementary Goods

Substitute Goods

• Substitute goods are those goods which can be used in place of one another for satisfaction a particular want, like tea and coffee. Demand for a given commodity varies directly with the price of substitute good. For Eg: if price of a substitute good (say, coffee) increases, then demand for given commodity (say, tea) will rise as tea will become relatively cheaper in comparison to coffee.
  
• As seen in the given diagram, price of coffee (substitute good) is shown on the Y-axis and demand for tea (given commodity) on the X-axis. When price of coffee rises from OP and OP1 demand for tea also rises from OQ to OQ1

Complementary Goods

• Complementary goods are those goods which are used together to satisfy a particular want. Demand for given commodity varies inversely with the price of a complementary good. For Eg: if price of a complementary good (say, sugar) increases, then demand for given commodity (say, tea) will fall as it will be relatively costlier to use both the goods together.
   As seen in the given diagram, price of sugar (complementary good) is shown on the Yaxis and demand for tea (given commodity) on the X-axis. When the price of sugar rises from OP to OP1 demand for tea falls from OQ to OQ1

Substitute Goods Vs Complementary Goods

Normal Goods and Inferior Goods

• Commodities frequently purchased are typically normal goods.
• A consumer tends to buy more normal goods as their income increases and less when their income decreases.
• Normal goods are defined by their demand increasing with an increase in consumer income.
• Example: A TV is considered a normal good if its demand increases with a rise in income.
• The income effect is positive for normal goods, indicating demand moves in the same direction as income changes.

Inferior Goods

• Inferior goods are characterized by a decrease in demand as consumer income increases.
• There is an inverse relationship between income levels and demand for inferior goods, indicating a negative income effect.
• Example: When a consumer's income rises and they opt to replace a black-and-white TV with a color TV, the demand for the black-and-white TV drops, classifying it as an inferior good.

Normal Goods Vs Inferior Goods

Change in Quantity Demanded Vs Change in Demand 

Shift in Demand Curve (Change in Demand) 

• The demand curve illustrates the relationship between a commodity's price and the quantity demanded, with all other factors held constant.
• Changes in factors other than the commodity's own price will inevitably occur, leading to a shift in the demand curve.
• A shift in the demand curve due to any factor aside from the commodity's own price is referred to as a change in demand.

Various Reasons for Shift in Demand Curve

• Change in the price of substitute goods.
• Change in the price of complementary goods.
• Change in consumer income levels.
• Alterations in consumer tastes and preferences.
• Expectations of future price changes.
• Variations in population size.
• Shifts in income distribution.
• Changes in season and weather conditions.

Illustration of the demand curve shift concept through diagrams

In demand for the commodity is OQ at a price of OP. Change in other factors leads to a rightward or leftward shift in the demand curve:

•  Rightward shift: When demand rises from OQ to OQ1 (known as increase in demand) at the same price of OP, it leads to a rightward shift in demand curve from DD to D1D1.
• Leftward shift: On the other hand, fall in demand from OQ to OQ2 (known as decrease in demand) at the same price of OP, leads to a leftward shift in demand curve from DD to D2D2

Increase in Demand

• Increase in Demand refers to a rise in the demand of a commodity caused due to any factor other than the own price of the commodity. In this case demand rises at the same price or demand remains same even at higher price. Increase in demand leads to a rightward shift in the demand curve.
• As seen in the given schedule and diagram, demand rises from 100 units to 150 units at the same price of Rs.20, resulting in a rightward shift in the demand curve from DD to D1D1. 
• Decrease in Demand Decrease in Demand refers to a fall in the demand of a commodity caused due to any factor other than the own price of the commodity. In this case, demand falls at the same price or demand remains same even at lower price. It leads to a leftward shift in demand curve.  
  
• As seen in given schedule and diagram, demand falls from 100 units to 70 units at same price of Rs.20 resulting in a leftward shift in the demand curve from DD to D1D1.
  

Movement Along the Demand Curve (Change in Quantity Demanded)

• When quantity demanded of a commodity change due to a change in its price, keeping other factors constant, it is known as change in quantity demanded. It is graphically expressed as a movement along the same demand curve. There can be either a downward movement or an upward movement along the same demand curve. Let us understand the movement along the demand curve. OQ quantity is demanded at a price of OP. Change is price leads to an upward or downward movement along the same demand curve.
• Upward movement: When price rises to OP2, quantity demanded falls to OQ2 leading to an upward movement from A to C along the same demand curve DD.
• Downward Movement: On the other hand, fall in price from OP to OP1 leads to an increase in quantity demanded from OQ to OQ1 resulting in a downward movement form A to B along the same demand curve DD. Expansion in Demand Expansion in demand refers to a rise in the quantity demanded due to a fall in the price of commodity other factors remaining constant.
• It leads to a downward movement along the same demand curve.
• It is also known as ‘Extension in Demand’ or ‘Increase in Quantity Demanded’. It can be better understood from table and graph. 
• As seen in the given schedule and diagram, the quantity demanded rises from 100 units to 150 units with a fall in the price from Rs.20 to Rs.15, resulting in a downward movement from A to B along the same demand curve DD.

Contraction in Demand

• Contraction in demand refers to a fall in the quantity demanded due to a rise in the price of commodity other factors remaining constant.
• It leads to an upward movement along the same demand curve.
• It is also known as ‘Decrease in Quantity Demanded’. It can be better understood from table and graph
• As seen in the given schedule and diagram, the quantity demanded falls from 100 units to 70 units with a rise in the price from Rs.20 to Rs.25, resulting in an upward movement from A to B along the same demand curve DD.
  

Elasticity of Demand 

• The price elasticity of demand measures how a change in price affects the demand for a product among its consumers.
• It is calculated by dividing the percentage change in a product's required quantity by the percentage change in the product's cost. This is also called percentage method of elasticity of demand,
  

Here,
e_d = Elasticity of demand
△Q = Change in quantity
△P = Change in price
P = Initial price
Q = Initial Quantity

Situations of Elasticity of Demand:

• Ed= 1: Also, called unitary elastic demand, or rectangular hyperbola. When change in demand and change in price is in the same proportion. A 10% increase in price leads to a 10% decrease in demand.
• Ed> 1: When change in demand is greater than the change in price. A 10% fall in price leads to a 30% increase in demand.
• Ed< 1: When change in demand is less than the change in price. A 30% decrease in price leads to a 10% increase in demand.
• Ed= ∞: It is also called perfectly elastic demand, as here the demand is infinity at the current price. Any change in price would cause demand to fall to zero.
• Ed= 0: It is called perfectly inelastic demand, as here, irrespective of price change, demand remains constant.

Rectangular Hyperbola (ed=1) : 
A rectangular hyperbola is a curve with equal rectangular areas on all sides. When the elasticity of demand equals one (ed = 1) at all points along the demand curve, the demand curve is indeed a rectangular hyperbola. As given in the figure beneath it is a  downward-sloping curve.

Geometric Method of Elasticity of Demand: 
Elasticity of demand is measured at any location by dividing the length of the lower segment of the demand curve by the length of the upper segment of the demand curve at that point. At the midpoint of any linear demand curve, the value of ed is unity.
A linear demand curve's elasticity may be simply assessed graphically. The elasticity of demand at each point on a straight line demand curve is determined by the ratio between the demand curve's lower and upper segments at that position.

Total Expenditure Method of Elasticity of demand: 

• It calculates the price elasticity of demand based on the change in total expenditure(Product of Price and quantity) incurred by a household on the commodity as a result of a price change.
• The price of a commodity and its demand are inversely linked.
• The responsiveness of the demand for the commodity to price changes determines whether expenditure on the good increases or decreases as a result of a rise in its price.

Relationship between Total Expenditure and Price of Elasticity of Demand:

• E_d=1 When total spending (price X quantity) remains constant despite a rise or reduction in the price of a good.
• E_d>1 When prices fall, total expenditure rises, and when prices rise, total expenditure falls.
• E_d<1 When total expenditure falls as a result of a price decrease and total expenditure rises as a result of a price increase.

Factors that influence price elasticity of demand:

• Availability of close substitutes: Demand for a commodity with many equivalents is typically more elastic than demand for goods with no replacements. Coca-Cola, Pepsi, Limca, and other similar beverages are suitable replacements. Even a minor increase in the price of coke will entice purchasers to seek alternatives. Electricity demand, on the other hand, will be less elastic because there are no close substitutes.
• Nature of the Commodity: Demand for essentials such as medicines and food grains is less elastic since we must consume them in the lowest quantity required, regardless of price. In any case, elasticity for comfort and extravagances like refrigerators, air conditioners and so on is more flexible on the grounds that their utilization might be delayed in the future if their cost rises.
• Price level: Demand for a higher-priced commodity such as air conditioners or automobiles is often more elastic than demand for a lower-priced commodity such as match box or pencils.
• Income level: Higher income groups have less elastic demand for commodities than lower income groups. For example, if the price of a commodity rises, a wealthy consumer is unlikely to cut his demand, whereas a poor buyer may.