Demand and supply(I)/ Micro economics

  The quantity of a commodity that a consumer is willing to buy and is able to afford, given prices of goods and consumer’s tastes and preferences is called demand for the commodity. The relation between the consumer’s optimal choice of the quantity of a good and its price is very important and this relation is called the demand function. Consider any two variables x and y. A function y = f (x) As the value of y depends on the value of x, y is called the dependent variable and x is called the independent variable. The graphical representation of the demand function is called the demand curve. The relation between the consumer’s demand for a good and the price of the good is likely to be negative in general. In other words, the amount of a good that a consumer would optimally choose is likely to increase when the price of the good falls and it is likely to decrease with a rise in the price of the good.

The negative slope of the demand curve can also be explained in terms of the two effects namely, substitution effect and income effect that come into play when price of a commodity changes. For example when bananas become cheaper, the consumer maximizes his utility by substituting bananas for mangoes in order to derive the same level of satisfaction of a price change, resulting in an increase in demand for bananas. Moreover, as price of bananas drops, consumer’s purchasing power increases, which further increases demand for bananas (and mangoes). This is the income effect of a price change, resulting in further increase in demand for bananas. For most goods, the quantity that a consumer chooses, increases as the consumer’s income increases and decreases as the consumer’s income decreases. Such goods are called normal goods. Thus, a consumer’s demand for a normal good moves in the same direction as the income of the consumer. there are some goods the demands for which move in the opposite direction of the income of the consumer. Such goods are called inferior goods. As the income of the consumer increases, the demand for an inferior good falls, and as the income decreases, the demand for an inferior good rises. Examples of inferior goods include low quality food items like coarse cereals. If the substitution effect is stronger than the income effect, the demand for the good and the price of the good would still be inversely related. However, if the income effect is stronger than the substitution effect, the demand for the good would be positively related to its price. Such a good is called a Geffen good. The quantity of a good that the consumer chooses can increase or decrease with the rise in the price of a related good depending on whether the two goods are substitutes or complementary to each other. Goods which are consumed together are called complementary goods. include tea and sugar, shoes and socks, pen and ink, etc. an increase in the price of sugar is likely to decrease the demand for tea and a decrease in the price of sugar is likely to increase the demand for tea. complements, goods like tea and coffee are not consumed together. In fact, they are substitutes for each other. Since tea is a substitute for coffee, if the price of coffee increases, the consumers can shift to tea, and hence, the consumption of tea is likely to go up. For normal goods, the demand curve shifts rightward and for inferior goods, the demand curve shifts leftward. If there is an increase in the price of a substitute good, the demand curve shifts rightward. On the other hand, if there is an increase in the price of a complementary good, the demand curve shifts leftward. If the consumer’s preferences change in favor of a good, the demand curve for such a good shifts rightward. On the other hand, the demand curve shifts leftward due to an unfavorable change in the preferences of the consumer. The demand curve for ice-creams, for example, is likely to shift rightward in the summer because of preference for ice-creams goes up in summer. At higher prices, the demand is less, and at lower prices, the demand is more. Thus, any change in the price leads to movements along the demand curve. The market demand for a good at a particular price is the total demand of all consumers taken together. The market demand for a good can be derived from the individual demand curves. 

Price elasticity of demand for a good is defined as the percentage change in demand for the good divided by the percentage change in its price. Price elasticity of demand for a good ED = percentage change in demand for the good/ percentage change in the price of the goo,.i.e = deltaQ/Q*P/delta P eD is estimated to be less than one and the demand for the good is said to be inelastic at that price. Demand for essential goods is often found to be inelastic. eD is more than one. The demand for the good is said to be elastic at that price. Demand for luxury goods is seen to be highly responsive to changes in their market prices and eD >1. eD is estimated to be equal to one and the demand for the good is said to be Unitary-elastic at that price.The elasticity of demand on different points on a linear demand curve is different varying from 0 to ∞. 

The price elasticity of demand for a good depends on the nature of the good and the availability of close substitutes of the good. Consider, for example, necessities like food. Such goods are essential for life and the demands for such goods do not change much in response to changes in their prices. Demand for food does not change much even if food prices go up. if close substitutes are not available easily, the demand for a good is likely to be inelastic. The expenditure on a good is equal to the demand for the good times its price. The elasticity of demand is a pure number.