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Q.1) Define the terms:
Demand, Elasticity of demand, Income elasticity, Cross elasticity, Point elasticity, Arc elasticity, Rise in Demand.
Answer:
Demand:
Demand is an economic principle referring to a consumer’s desire to purchase goods and services and willingness to pay a price for a specific good or service.
Elasticity of demand:
The concept of elasticity of demand is very important in economic theory and economic policy. It is used to measure the effect of change in price on quantity demanded. Elasticity tells us how much quantity demanded changes when there is a change in price. The more the quantity changes the more elastic demand of good or service is.
We can define it as follow:
“Elasticity of demand is the measure of responsiveness of quantity demanded to changes in price”
OR
“Percentage change in quantity demanded divided by percentage change in price”
Ed = % change in quantity demanded / % change in price
Ed = %Δ Q / %Δ P
Income elasticity of demand:
Income is one of the determinant of demand. So the concept of income elasticity is used to measure the effects of change in income of the consumer on demand for a commodity. It is defined as
“Income elasticity of demand of demand is the rate of responsiveness of demand to change in the income of the consumer”.
Cross elasticity of demand:
Is defined as
“the ate of responsiveness of quantity demanded of commodity A to change in price of commodity B”
Point elasticity of demand:
Point elasticity is defined as “The elasticity at a particular point on demand curve is called point elasticity”.
Arc elasticity of demand:
Arc elasticity means elasticity between two distinct points of a demand curve. Practically the concept of arc elasticity is used when there is a substantial change in price.
Rise in Demand:
There is rise in demand when consumption of commodity remain the same but there is increase in price of that commodity.
Read more: Class 11 KPK Economics Notes Chapter 2 (Consumer behavior)
Q.2) Explain Law of Demand with a schedule and diagram. Discuss assumptions and exception
Law of demand:
It is our common experience that the quantity of a commodity people buy is linked to its price. We may observe any number of markets we will always find that price of a commodity and its demand has inverse relation. Since the inverse relationship between price and quantity demanded is universally true, the economists call the relation as law of demand.
“If other things do not change people buy more of a good when its price falls and less of it when its price rise”.
This is the verbal statement of law of demand. The law can be shown in the form of a demand schedule or a demand curve.
Demand schedule:
A demand schedule shows the quantities of a good or service which buyers would be willing and able to purchase at various prices. When the price of P and Q are put in a table, we get a demand schedule as shown below. The demand schedule shows that when price Rs. 40 per kg, people buy 200 kg. of sugar. When price starts falling the demand for sugar expands. At price Rs.20 per kg, the quantity demanded reaches 600 kg.
Demand schedule is a table that shows relationship between price of a good and its quantity demanded.
Demand curve:
When the relation between and price is shown in a graph, it is called demand curve. Each point on the demand curve refers to a quantity that will be demanded at a given price. We have plotted the values of prices and quantity from the above table.
Quantity is measure along x axis and price along y axis. At price Rs. 40 the demand is 200. This gives us point a. similarly, we get the points b,c, d and e at other prices. When we join these points, we get demand curve DD. It is falling from left to right. Each point relates to particular quantity.
Assumptions
The inverse relation between price of a commodity and quantity demanded will be observed only if other factors influencing quantity are held constant i.e. “if other things do not change”
These are called the assumptions of law of demand. These include:
1. Income of the consumers does not change: If income changes it may neutralize the effect of change in price and people may buy the same quantity even when price rises.
2. Taste of the buyers do not change: Taste include customs, weather conditions, habits, fashion etc. when winter comes people buy more woolen clothing, Same in summer vice varsa.
3. Prices of related goods remain the same: Related goods may be either substitutes or compliments. Law of demand will only be true if their prices do not change. Thus even if the price of chicken is constant, people may buy more because the price of mutton has risen.
4. Population does not increase: Otherwise the number of buyers in the market will increase and demand will be more even without change in price.
5. People do not except early changes in price: Sometimes if the price increase and people expect that the price will further increase they start buying more and more even at high prices.
6. Quantity of money: Or availability of bank credit in the country does not change otherwise people purchasing power increase and they try to buy more.
Exceptions or exceptional demand curve
Normally demand curve slopes downward. But under some circumstances, it may rise upward. i.e people may buy more at higher prices. There are four man reasons why some goods become exceptions to law of demand
1. Giffen good: is some inferior goods having expensive substitutes e.g. wheat and potatoes. Poor families spend a large part of their income on wheat. When price of wheat falls some amount is saved which may be used to buy rice. Consuming more rice means less demand for wheat. So fall in price of wheat causes decreased in demand.
2. Hoarding: during war or some other reason may cause serious shortage. People may expect that the commodity will not be available in the market. They may buy more even through prices is increasing.
3. If a commodity becomes status symbol or distinction or: some snobbish persons may buy more at higher prices.
4. If people judge the quality by price of a commodity thinking higher price a sign of better quality. They may buy more even the price is higher.
Q.4 a) What is meant by rise and fall in demand?
b) Describe the causes of changes in demand
Answer:
Rise and fall in demand
When demand for a commodity goes up or down and not due to price but due to other factors, the change is called rise or increase in demand and fall or decrease in demand. In such a case the whole demand schedule changes and demand curve shifts.
In the table column 2 shows daily demand for eggs in summer at various prices. In winters people taste changes and preference for eggs increase. Column 3 shows this change. We see that at the same price people buy more eggs in winter than in summer.
| Demand in winters 160 dozensDemand in summer 100 dozens |
| Price RS. 24 per dozen in both seasons |
Rise in demand
When demand of a commodity goes up not due to the decrease in price but because of the other factors this is called rise in demand.
At price OP1 quantity demanded in summer is OQ1 while it is OQ2 in winter at the same price. In others words the demand of a commodity in increased or decreased at the same price due to the change in season.
Fall in demand
When the demand of a commodity goes down not due to the increase in price but because of the other factors this is called rise in demand.
For example when a cricket match becomes dull and uninteresting, the number of tickets sold may not increase even if the price is reduced.
Read more: Economics Chapter 3 (Some Mathematical and Statistical Concepts)- Class 11
The figure shows the fall in demand D1 D1 is the original demand and the D2 D2 is the new demand showing a fall.
Causes of changes in demand (demand shifters)
Many factors are responsible for rise and fall in demand of a commodity.
1. Change in income:
Demand for a commodity is directly affected by changes in income of the consumer. Normally when income of the consumer increases, they buy more of the commodity. Decrease in income has opposite effect.
2. Change in population:
If population increases the number of buyers also increase. Consequently, demand will rise at the same price and vice versa. For example the population in our country has increased so the the demand for housing is rising.
3. Change in consumer preference (taste or liking or disliking):
If people preferences change in favor of a particular commodity and they like to consume more of it, the demand will rise. And if change in taste is unfavorable the demand will fall. During winter people don’t often like cold drinks.
4. Prices and availability of related goods (substitutes and compliments):
A decrease in the price of a substitute of a commodity will cause fall in its demand. Meat and chicken are good substitutes for each other so if the price of chicken rise the demand for meat will rise.
5. Advertisement and publicity:
Through advertisement and publicity people choices can be changed and attracted. And people than change their buying behavior.
6. Change in income:
Distribution of income in favour of the poor increase the demand. For example if for some reason the income of poor is increased and the income of rich is decreased. Than the demand of ACs will fall and demand for fans will increase.
7. Expectation about future prices can effect current purchases:
If a rise in price of sugar is expected people buy larger quantity now. An expected fall in price has an opposite effect.
8. Change in quantity of money:
When quantity of money in a country increase, the demand for goods rise and vice versa.Because people get more money to buy more.
9. Expenditure tax:
Discourages people to buy goods. As a result demand for various items will fall.
Q.5) Differentiate between movement along the curve and shift of demand curve.
Answer:
The demand for a commodity depends upon many factors, these include price of a commodity and any other factors such as income level, taste of the buyer, prices of the substitute. A change in any factor can bring a change in quantity demanded. However the effect of change in price is studied separately.
we have classified the change in demand into two ways
a) Extension and contraction of demand showing influence of the price changes i.e. movement along demand curve.
b) Rise and fall in demand showing influence of changes in other factor. i.e. shift of demand curve.
Movement along the curve is experienced in extension and contraction where as
Shifting of demand curve is experienced in rise and fall of demand curve.
Shifting:
The demand curve shifts when consumers change their perceptions about the value of a product that they get. If consumers decide they are willing to pay higher prices for a product or want to purchase more of it, the demand curve shifts to the right. The less consumers are willing to pay for a product, the more the demand curve shifts to the left. In other words, perceived worth of a product shifts the demand curve right, while decreased perceived worth shifts the demand curve to the left. Factors that can shift the demand curve either way include changes in consumer expectations for a certain product, changes in income and changes in trends and what is fashionable factors other than price.
Moving:
Unlike shifts in demand curves that are dictated by consumer interest, movement in the demand curve occurs when the price of a product changes. For example, movement can occur if a candy manufacturer raises or lowers the price of a certain type of candy. Altering candy prices could cause consumers to buy more candy or less candy, depending on where the new price is set. The demand curve itself does not move; rather, there is movement along the curve.
So to further study the concept we will study extension, contraction and rise and fall in demand curve.
Movement along the curve:
Extension and contraction are the variations in the quantity demand of a commodity with the change in price. They are vice versa to each other. When price of a commodity decreases, people buy more quantity of it this is called extension of demand. And when the price of a commodity increases people buy less of it this is called contraction.
In the figure the shifting is shown by point A and point B.
Read more: Class 11 KPK Economics Notes Chapter 1 (Nature and scope)
Movement along the curve
Rise and fall in demand:
When demand for a commodity goes up or down and not due to price but due to other factors, the change is called rise or increase in demand and fall or decrease in demand. In such a case the whole demand schedule changes and demand curve shifts.
In the table column 2 shows daily demand for eggs in summer at various prices. In winters people taste changes and preference for eggs increase. Column 3 shows this change. We see that at the same price people buy more eggs in winter than in summer.
| Demand in winters 160 dozensDemand in summer 100 dozens |
| Price RS. 24 per dozen in both seasons |
Rise in Demand:
When demand of a commodity goes up not due to the decrease in price but because of the other factors this is called rise in demand.
At price OP1 quantity demanded in summer is OQ1 while it is OQ2 in winter at the same price. In others words the demand of a commodity in increased or decreased at the same price due to the change in season.
Fall in Demand
When the demand of a commodity goes down not due to the increase in price but because of the other factors this is called rise in demand.
For example when a cricket match becomes dull and uninteresting, the number of tickets sold may not increase even if the price is reduced.
The figure shows the fall in demand D1 D1 is the original demand and the D2 D2 is the new demand showing a fall.
Q.9) Explain the factors which determine elasticity of demand.
Answer:
Factors Determining Elasticity of Demand
There are several factors which determine the elasticity of demand.
i) For necessaries and conventional necessities:
We have to buy these commodities whatever be the price. A change in price, therefore, does not matter so far as the demand for such commodities is concerned. Salt is one such thing and wheat another. But in a poor country like India-even the demand for such things is somewhat elastic. The change in the price of wheat may be immaterial for upper and middle classes, but its consumption will certainly increase among the poor when its price falls.
ii) Demand for luxuries:
When the price of luxuries falls; people buy much more of them, and when the price raises the demand contracts. But luxury is a relative term. A high-priced luxury of the poor man is a low-priced necessary for the rich. For the same thing demand of the lower classes may be elastic and that of the rich classes less elastic.
iii) Demand for goods having many uses:
Coal is such a case When cheap, its use for less urgent needs will extend and when the price goes up, it will be put only to more urgent uses, and its demand will contract
iv) For substitutes the demand is also elastic:
For example, when price of tea rises, we may buy less of tea but more of coffee, and vice versa. We must, however, remember that very few things can serve as suitable substitutes.
v) Demand for durables:
When, for example, the building material is very costly, and building activity is very much reduced. The demand has contracted. When cheap material becomes available, the demand will extend.
vi) Price level:
If the price is either too high or too low, the demand will be less elastic. When the prices are moderate, elasticity will be greater.
vii) The same commodity may have inelastic demand for certain uses and elastic for certain other uses:
For example, wheat as human food has inelastic demand, but its demand as cattle feed is elastic.
viii) Proportion of total expenditure allocated for the commodity:
If the proportion of total expenditure devoted to a commodity is small, the demand for it tends to be inelastic. For example, the percentage of budget devoted by a typical household to soap, salt and ink is quite small and consequently the demand for these goods is relatively inelastic.
ix) Habit and fashion:
The demand for those goods which are habitually consumed or which are in fashion is inelastic. The reason is that such commodities become more or less a necessity for the consumer
x) Future expectations about price changes:
The future expectations about the price of any commodity also influence the elasticity of demand for it. For instance, if the price of any commodity is expected to rise in future, then a small decrease in its price will produce a considerable increase in its price.
xi) Jointly demanded goods:
In case of commodities having joint demand, the elasticity of demand for a good depends upon the elasticity of demand for other jointly-produced goods. For example, if the demand for cars increases, the demand for petrol will also increase with the same rapidity as the demand for cars does.
Conclusion:
These are only broad rules. But it is not possible to lay down any hard and fast rules as to which commodity has an elastic and which an inelastic demand. It all depends on the circumstances of the case.
Q.10) Write notes on the following:
a) Income elasticity.
b) Cross elasticity of demand.
Answer:
Income Elasticity:
Income is one of the determinant of demand. So the concept of income elasticity is used to measure the affects of change in income of the consumer on demand for a commodity. It is defined as
“Income elasticity of demand of demand is the rate of responsiveness of demand to change in the income of the consumer”.
e = % change in quantity demanded / % change in income
ey = (Δq/q) ÷ (Δy/y)
ey = (Δq/q) × (Y/Δy)
q is quantity demanded and Δq denotes change in quantity. Y represents income while Δy indicates change in income.
An example of a product with positive income elasticity could be Ferrari’s. Let’s say the economy is booming and everyone’s income rises by 400%. Because people have extra money. the quantity of Ferrari’s demanded increases by 15%.
We can use the formula to figure out the income elasticity for this Italian sports car:
Income Elasticity = 15% / 400% = 0.0375
An example of a good with negative income elasticity could be cheap shoes. Let’s again assume the economy is doing well and everyone’s income rises by 30%. Because people have extra money and can afford nicer shoes, the quantity of cheap shoes demanded decreases by 10%.
The income elasticity of cheap shoes is:
Income Elasticity = -10% / 30% = -0.33
Cross Elasticity:
The change in price of a commodity does not only affect its own demand but also the demand of many other related commodities. For instance meat and fish are substitutes. A change in price of meat will affect the demand of fish similarly bat and balls are compliments. A rise or fall in price of bat will affect he demand for balls. To measure this cross elasticity concept is used. If A and B are two related commodities than cross elasticity of demand in A for price changes in B
Is defined as
“The rate of responsiveness of quantity demanded of commodity A to change in price of commodity B”
Q.14) From given cross elasticities between goods, tell which ones are substitutes, complement or unrelated Point elasticity.
For good A and B, e = -1
For good X and y, e = 2
For good F and H, e = 0
Answer:
A & B are compliments
X & Y are substitutes
F & H are unrelated.
Substitutes have positive price elasticity.
Complements have negative price elasticity.
Q.15) Under what circumstances, demand curve will have cross elasticity
a) zero
b) negative
Answer:
a) Cross elasticity will be zero when there will be no relationship between two goods.e.g. shoes and pepsI.
b) In case two goods are compliments to each other cross elasticity will be negative. For example, meat and chicken are compliments to each other.
