Cross elasticity of demand-Explained with examples

Cross-Elasticity-of-Demand

Cross elasticity of demand is refers to the sensitivity of demand for one product to the price of another related product. It is the ratio of the percentage change in quantity demanded of good X and the percentage change in the price of good Y.

Cross elasticity = % change in quantity demanded of good X/ % change in the price of good YFormula of Cross elasticity of Demand 1 - Cross elasticity of demand-Explained with examples% Δ quantity demanded of goods x = percentage change in quantity demanded
% Δ Price of goods y  = percentage change in Income of Consumer

Types of cross elasticity of demand :

  1. Substitute Goods
  2. Complementary Goods
  3. Unrelated Goods

1. Substitute goods:

When the cross elasticity of demand for good X relative to the price of good Y is positive, it means the goods X and Y are substitutes to each other. It implies that in response to an increase in the price of good Y, the quantity demanded of good X has increased as people start consuming product X as the price of good Y goes up.

Substitute goods  - Cross elasticity of demand-Explained with examples
Substitute goods

For example, suppose a 10% increase in the price of tea results in an increase in demand for coffee by 15%. This shows that the goods are substitutes for each other.

2. Complementary goods:

When the cross elasticity of demand for good X relative to the price of good Y is negative, it means the goods are complementary to each other. It implies that in response to an increase in the price of good Y, the quantity demanded of good X has decreased due to the increase in the price of Y.

Complementary goods  - Cross elasticity of demand-Explained with examples
Complementary goods

For example, suppose the 10% increase in the prices of Android phones results in a decline in the quantity demanded of Apps by 15%. This relation shows that the goods are complementary to each other.

3. Unrelated goods:

When the cross elasticity of demand for good X relative to the price of good Y is zero, it means goods are unrelated to each other. It implies that there is no relationship between these both goods.

Unrelated goods  - Cross elasticity of demand-Explained with examples
Unrelated goods

 For example, suppose the 5% increase in the prices of coke results in no change in quantity demanded of butter. This shows that the goods are unrelated to each other.

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Income elasticity of demand and explained its types

Income-elastic-Demand

Income elasticity of demand (YED)refers to the ratio of the percentage of change in quantity demanded and percentage change in income level of consumer. It measures the degree of sensitivity of quantity demanded to change in income.

Hence,

It can be calculated as the percentage change in quantity demanded divided by the percentage change in income of the consumer.

Formula of Income elasticity of Demand - Income elasticity of demand and explained its types
% Δ quantity demanded = percentage change in quantity demanded
% Δ Income of Consumer = percentage change in Income of Consumer

Higher the income elasticity, more sensitive will be the demand with respect to income.

The income elasticity can be positive or negative depends upon the type of goods demanded whether normal or inferior.

For example, suppose a consumer’s income is increased by 10% which results in a rise in demand by 10 %, then income elasticity will be 10%/10% = 1. This implies that the commodity is a normal good.

Similarly, if a 15% hike in the income of consumers declines the demand for commodities by 4.5 %, then income elasticity will be -4.5%/15% = -0.3. It implies the commodity is inferior good.

Types of Income Elasticity of demand : 

  1. High elastic
  2. Unitary elastic
  3. Low elastic
  4. Zero elastic
  5. Negative elastic

1. High Elastic:

The income elasticity of demand can be said as high if the proportionate change in quantity demanded is proportionately more than the increase in income. It can be regarded as a positive income elasticity. For example, suppose the income of Mr A is increased by 20% and as a result, his quantity demanded is increased by 50%. In such a case, the income elasticity is high i.e. YED>1.

High elastic Demand  - Income elasticity of demand and explained its types
High-elastic-Demand

2. Unitary Elastic:

When the proportionate change in quantity demanded is equal to proportionate change in income, it can be said as unitary income elasticity of demand. For example, suppose the income of a consumer is increased by 50% which leads to rising in quantity demanded by 50%. In such a case, the income elasticity of demand would be called unitary i.e. YED=1.

Unitary elastic Demand - Income elasticity of demand and explained its types
Unitary-elastic-Demand

3. Low Elastic:

When the proportionate change in quantity demanded is less than the proportionate change in income, it can be regarded as low-income elasticity of demand. For example, let us assume the income of Sumit is increased by 50% but he extended his quantity demanded by 25% only. In such a case, the income elasticity is low i.e. YED<1.

Low elastic Demand  - Income elasticity of demand and explained its types
Low-elastic-Demand

4. Zero Elastic:

It can be said as zero when there is no change in quantity demanded with respect to change in income. For example, in the case of necessary goods, the income elasticity is zero as there is no effect of the increase in consumer’s income on his consumption. i.e. YED=0.

Zero elastic Demand  - Income elasticity of demand and explained its types
Zero-elastic-Demand-

5. Negative Elastic:

It refers to the situation where an increase in income leads to a fall in quantity demanded. The income elasticity is negative particularly for inferior goods also known as Giffen goods. For example, if the income of a consumer is increased, he would prefer to purchase wheat instead of millet. In such a case, millet is inferior to wheat and income elasticity is negative.i.e. YED <0.

Negative elastic Demand  - Income elasticity of demand and explained its types
Negative-elastic-Demand

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Price Elasticity of Demand and explained its Types

Price-elasticity-of-Demand

Price elasticity of demand (PED) refers to the degree of responsiveness of quantity demanded with respect to change in the price of that particular commodity, other things remain constant.

 it can be calculated as the percentage change in quantity demanded divided by the percentage change in price.

Formula of Price elasticity of Demand - Price Elasticity of Demand and explained its Types

% Δ quantity demanded = percentage change in quantity demanded

% Δ Price  = percentage change in price

For example, the price of a commodity falls from Rs 20 per unit to Rs 15 per unit and due to this, the quantity demanded of that commodity increases from 100 units to 150 units.

Then, The price elasticity can be calculated as:

Percentage change in demand = (change in demand/ original demand) *100

                      = (50/100) *100 =50%

Percentage change in price = (change in price/original price) *100

                        = (5/20) *100 =25%

Price elasticity of demand = 50/25 = 2

It means the quantity demanded increased by 2 time due to falling in price by Rs 5.

Degrees or Types of price elasticity of demand:

  1. Perfectly elastic
  2. Perfectly inelastic
  3. Unitary elastic
  4. Relatively elastic
  5. Relatively inelastic

1. Perfectly elastic ( PED = ∞):

The demand is said to be perfectly elastic when a small rise in price would result in a fall in demand to zero, while a small fall in price results in demand to become infinite. It is also known as infinite elasticity. It is a theoretical concept only as it has no importance in the practical world.

It is shown by a straight-line demand curve parallel to the horizontal axis.

For example, suppose the price of a commodity is rs 10 and its demand is 50 units. As the price falls to Rs 9, its demand increases to infinity.

Perfectly elastic Demand  - Price Elasticity of Demand and explained its Types
Perfectly-elastic-Demand

In fig, the x-axis shows the quantity demanded and the y-axis shows the price. Dd curve is the demand curve. The initial demand at price p is q units. When the price is slightly decreased, it leads to an increase in demand by a large amount i.e. Q1. It shows a perfectly elastic demand.

2. Perfectly inelastic (PED=0):

when demand doesn’t change with change in price( whether rising or fall), then demand is said to be perfectly inelastic. It implies that the demand remains constant for any value of the price. It is rarely found in real but the closest example we can take is water and other necessity goods.

 it is represented by a straight line parallel to the vertical axis.

For example, suppose the price of a bottle of water is rs 15 and its demand is 200 units. As the price increases to Rs 20, the demand remains constant at 200 units. It implies the demand is perfectly inelastic.

Perfectly inelastic Demand  - Price Elasticity of Demand and explained its Types
Perfectly-inelastic-Demand

In fig, the x-axis shows the quantity demanded and the y-axis shows the price. Dd is the demand curve. At the price p, the quantity demanded is q units. As the price increases to p1, there is no effect on the quantity demanded. It remains constant at initial quantity q. This implies that the demand is perfectly inelastic.

3. Unitary elastic ( PED = 1):

The demand can be said as unitary elastic when the percentage change in quantity demanded is equal to the percentage change in price. It is also known as unitary elasticity. It is an imaginary concept as rarely found in the practical world.

For example, suppose the price of a commodity is rs 50 and the quantity demanded in a specific market is 200 units. As the price increases to Rs 60, its demand declines to 160 units. It implies the unitary elastic demand.

Unitary elastic Demand  - Price Elasticity of Demand and explained its Types
Unitary-elastic-Demand

In fig, the x-axis shows the quantity demanded and the y-axis shows the price. Dd is the demand curve. At the price p, the quantity demanded is q units. As the price increases to p1, the quantity demanded decreases to q1 by an equal proportion. It implies that the demand is unitary elastic.

4. Relatively elastic ( PED > 1):

Relatively elastic demand occurs when a proportionate change in demand is greater than the proportionate change in price. It means that there will be a greater change in demand due to a small change in price. It is also known as highly elastic demand and more than unitary elastic demand.

For example, suppose the price of a commodity is rs 40 and the quantity demanded is 20 units. As the price declines to rs 30, its demand increases to 30 units. It implies a relatively elastic demand.

Relatively elastic Demand  - Price Elasticity of Demand and explained its Types
Relatively-elastic-Demand

In fig, the x-axis shows the quantity demanded and the y-axis shows the price. Dd is the demand curve. At the price p, the quantity demanded is q units. As the price is increased to p1, the quantity demanded is decreased to q1 units. Here, the change in price is less than the change in quantity demanded, therefore, it can be said as perfectly elastic demand.

Relatively inelastic demand ( PED <1):

The demand can be said as relatively inelastic when a proportionate change in quantity demanded is less than proportionate change in price. It means that the greater change in price leads to a smaller change in demand.

For example, suppose the price of a commodity is rs 10 and the quantity demanded is 20 units. As the price increases to rs 15, the quantity demanded declines to 15 units. It implies a relatively inelastic demand.

Relatively inelastic Demand - Price Elasticity of Demand and explained its Types
Relatively-inelastic-Demand

In fig, the x-axis shows the quantity demanded and the y-axis shows the price. Dd is the demand curve. At the price p, the quantity demanded is q units. As the price increases to p1, the quantity demanded fell to q1 units. Here, the change in price is more than the change in quantity demanded, therefore, it shows the relatively inelastic demand.

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Elasticity of demand – Meaning and its types

elasticity-of-Demand

The Elasticity of demand is an economic term that refers to the sensitivity of demand of a good to changes in other economic variables such as the price of goods, price of related goods and income of consumers, etc. In other words, it is the responsiveness of quantity demanded of a product to changes in one of the variables on which demand depends.

It can be calculated as the percentage change in quantity demanded divided by percentage change in another economic variable.

Formula of elasticity of Demand  - Elasticity of demand - Meaning and its types
% Δ quantity demanded = percentage change in quantity demanded
% Δ Economic Variable = percentage change in Economic Variable

A higher value for elasticity of demand with respect to any economic variable means that customers are more responsive to changes in that variable.

For example, prices of rice fall from rs.120/kg to Rs 100/kg. Due to this,  the quantity demanded in the market increases from 100kg to 120 kgs. It implies the response of demand to decline in the price of rice.

Types of elasticity of demand :

  1. Price elasticity of demand
  2. Income elasticity
  3. Cross elasticity

1. Price elasticity of demand:

It refers to the degree of responsiveness of quantity demanded with respect to change in the price of that particular commodity, other things remain constant.

 it can be calculated as the percentage change in quantity demanded divided by the percentage change in price.

Formula of Price elasticity of Demand - Elasticity of demand - Meaning and its types

% Δ quantity demanded = percentage change in quantity demanded

% Δ Price  = percentage change in price

2. Income elasticity of demand:

It refers to the ratio of the percentage of change in quantity demanded and percentage change in income level of consumer. It measures the degree of sensitivity of quantity demanded to change in income.

Hence,

It can be calculated as the percentage change in quantity demanded divided by the percentage change in income of the consumer.

Formula of Income elasticity of Demand - Elasticity of demand - Meaning and its types
% Δ quantity demanded = percentage change in quantity demanded
% Δ Income of Consumer = percentage change in Income of Consumer

Higher the income elasticity, more sensitive will be the demand with respect to income.

3. Cross elasticity of demand:

It refers to the sensitivity of demand for one product to the price of another related product. It is the ratio of the percentage change in quantity demanded of goods x and the percentage change in the price of goods y.

Formula of Cross elasticity of Demand 1 - Elasticity of demand - Meaning and its types
% Δ quantity demanded of goods x = percentage change in quantity demanded
% Δ Price of goods y  = percentage change in Income of Consumer

 

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Exceptions to the Law of Demand – Examples

Exceptions-to-the-Law-of-Demand

Before Explaining the Exceptions to the Law of Demand, you have to know the meaning of demand and law of demand. So, Demand is the amount of given commodity, at which consumer is willing and able to purchase in a given period of time. It is very important to understand that consumers willing to buy and able to buy are different. Consumers are willing to buy many things but they can’t afford them. So, it is the maximum amount a consumer is willing and able to consume a given commodity in a specified period of time.

The law of demand states that when the price of goods falls, its demand increases whereas the rise in price leads to a reduction in quantity demanded, other things being equal.

This law of demand generally applies to a number of goods. However, there are some circumstances when it does not hold true, which can be known as exceptions to the law of demand.

The Expectations of the Law of Demand: –

There five major expectations of the laws of demand. We will discuss the Situation where the law of demand is not applicable. These all are explained as follows: –

Price Expectations:

When the consumer expects that prices of certain goods are likely to increase in the future, he will buy more of the given goods even at higher prices in order to abscond himself from much higher prices in the future.

 Similarly, when a consumer expects that prices of specific goods are likely to fall in the future, he will postpone his purchases even at lower prices so that he can avail the benefits of much lower prices in the future. 

For example, sometimes, the prices of vegetables such as onions and tomatoes are increased to some extent. In that time, consumers used to start buying and storing more of these fearing a further increase in price, which results in an increase in demand.

Type of goods:

Different types of goods affect the demand in the market for them differently. Some of them are :

  1. Inferior goods: It refers to the goods whose demand declines when income increases. Generally, these are low-quality goods which are consumed by poorer sections in our society for their survival. So, consumers can move to better goods as their income increases. Similarly, if income declines, they can shift to inferior goods from good quality goods which leads to an increase in demand for such goods.
    • For example, as the income of consumers increases, the demand for public transportation declines as they would prefer to travel by own vehicles.
  2. Giffen goods: These can be regarded as cheaper varieties of inferior goods. There are very few commodities that are much cheaper than the superior substitutes and are consumed by households as an essential commodity e.g.bajra. As the price of these goods increases, the demand also goes up because, with the increase in price, the households cut the consumption of superior substitutes and demand more quantity of Giffen goods as income remains the same.
    • For example, suppose the minimum monthly consumption of a poor household is 40 kg bajra (Giffen good) and 10 kg rice(super substitute). The selling price of bajra and rice is Rs.5 and 20 respectively and they spend Rs.400 out of their income on these goods. Suppose the price of bajra increased to Rs.6, then the household is forced to reduce the consumption of rice by 3 kg and increase the quantity of bajra to 43 kgs in order to meet the monthly requirement of 50 kgs foodgrains in that budget only.
  3. Veblen goods: these are the types of luxury goods for which demand rises as its price rises. this term is given by the economist T. Veblen, who proposed the concept of “Conspicuous Consumption”. According to him, consumers are highly attracted by distinct and costly goods as these are treated as a sign of prestige. People buy these goods at a high price not due to intrinsic worth but to display themselves rich to the other members of the society to which they belong. This is known as snob appeal which induces consumers to purchase goods for conspicuous consumption. Thus consumer buys more of it when prices are high. 
    • For example, a man buys a Rolex watch for Rs.3,00,000, he usually intends others to know. He believes that the cost of the watch conveys a positive message about him to the public and creates a perception of ‘status’. Accordingly, more people will demand it in the market. Let us assume that the Rolex opens an outlet store and develops a line of the watches with similar features for the target consumers. Suddenly anybody can get the Rolex watches starting from Rs.30,000 which implies that the Rolex is no longer a sign of prestige or status. Thus, its demand goes down considerably.
  4. Complementary goods: it refers to the goods which are used together. E.g. shoe and polish, car and diesel, etc. As the price of one commodity increases, it raises the demand for another commodity even at high prices.
    • For example, the quantity demanded of the DVD player is increased due to a fall in price but consumers will demand more of DVD’s even at a higher price as these are a complement to each other.

Change in Taste and fashion:

Change in fashion, tastes and preferences of the consumers highly affect the demand for the commodities. When the goods become out of fashion or there is a change in preferences of the consumer, the law of demand becomes ineffective. People do not buy more even if the price falls.

For example, people do not purchase old fashioned clothes nowadays, even though they have become cheap. Similarly, they prefer to buy fashionable clothes even if the prices are high.

Emergency:

In case of emergencies like war, man-made or natural disasters, people often fear a shortage of essential goods. In such situations, they demand more even at high prices.

For example, in case of emergencies, the consumers prefer to buy necessity goods such as clothes, food, and medicines even at high prices in order to eliminate the future shortage.

Change in Income:

Sometimes, the demand for a commodity may change irrespective of the change in the price of that commodity. As the income changes, it will result in a change in demand. The increase in income makes consumers able to buy more products, thereby increasing the demand.similarly, he can skip the purchases when income is reduced. Hence, change in income can be regarded as an exception to the law of demand.

For example, if the income of Mr.X  is Rs.300 and the price of a restaurant meal is Rs.100, then he can buy only 3 meals a day at the maximum. But if his income rises to Rs.500, then he can afford 5 meals (assuming the price of meal constant) at the restaurant which would give him more satisfaction. It implies that a change in income affects the quantity demanded and violates the law of demand.

These are some exceptions where the inverse relationship between price and quantity demanded does not follow. It results in an upward sloping demand curve i.e. demand increases with an increase in price and vice versa.

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Exceptions to the Law of Demand

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Law of Demand – Explained with Example

Law-of-Demand-Feature-Image

 Law of demand expresses the relationship between price and quantity demanded of a given commodity. It states that “ the quantity demanded increases with a fall in price and diminishes with rising in price, other things being equal.” This happens because of the law of diminishing 

Thus, it shows the inverse relationship between quantity demanded of a given commodity and its price. This law defines the direction in which quantity demanded changes with a change in price. The ‘ other things’ includes all those factors which influence the demand such as the income of consumer, price of related goods, tastes of consumer and fashion etc.

Definition of the Law of Demand:

According to Prof. Marshall, “ The law of demand states that amount demanded increases with fall in price and diminishes when price increases.”

According to Benham, “ Usually a larger quantity of commodity will demand at a lower price than a higher price.”

According to Ferguson, “According to the law of demand, the quantity demanded varies inversely with price.”

Assumptions of the Law of Demand:

  1. There is no change in the tastes and preferences of consumers in a given time period.
  2. The income of consumer remains constant for that period of time.
  3. There is no change in the price of related goods.
  4. There is no change in the quality of that commodity.
  5. The habits of consumers remain unchanged during that period of that time.
  6. There are no expectations regarding the change in price by consumers.
  7. The given commodity is a normal good and has no substitute.

Characteristics of the law of demand :

  1. There is an inverse relationship between price and quantity demanded.
  2. Price is the independent variable.
  3. Demand is the dependent variable on the price of that commodity.

For example, when the price of 1 kg of mangoes goes down from Rs.80 to Rs. 50, the quantity demanded will go up. Many people who were not able to buy at Rs.80, are now able to purchase at Rs 50.

Similarly, if local Starbucks raises the price of coffee from Rs 700 to Rs. 1000, the quantity demanded will be decreased. Fewer people will buy their coffee, rather they prefer to make their own at home because of the increased price.

Illustration of the law of demand:

The law of demand can be illustrated with the help of the demand schedule and demand curve. These are shown as follows: –

Demand schedule:

The following schedule shows the series of prices and the quantity demanded ice cream respectively:

    PRICE OF ICE CREAM

    QUANTITY DEMANDED         

 50

2

 40

4

30

6

20

8

10

10

The above table shows that when the price of Rs 50, there were 2 units of ice cream demanded. As the price goes down to Rs 40, the quantity demanded increases to 4 units. Similarly, the decline in price to Rs.30, 20, 10 follows an increase in quantity demanded as 6, 8 and 10 units respectively.

Demand Curve:

The following graph shows the relationship between price and quantity demanded as Demand of Law expresses. In the graph, X-axis shows the quantity demanded of ice cream and Y-axis shows the price. DD is the demand curve whereas the points A, B, C, D and E show the relationship between price and quantity demanded. When the price is Rs.50, the quantity demanded ice cream is 2 units. As price decreases to Rs.40, the quantity demanded increases to 4 units. Similarly, as the price reduces to Rs 30, 20 and 10, the quantity demanded ice cream increases to 6, 8 and 10 units respectively.

Law of Demand Demand Curv - Law of Demand - Explained with Example
Law-of-Demand-Demand-Curve

 It clears that as the price of a commodity decreases, the quantity demanded the same increases and vice versa, provided other things being constant. In short, we can say that the law of demand describes the behaviour of buyers as they buy more of a commodity at a lower price than at a higher price. When this inverse relationship between price and quantity demanded is graphed, the result is a demand curve.

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Theory of demand – its graphical representation

Theory-of-Demand-Feature-Image

Theory of Demand is the economic relationship between the quantity demanded of goods and services that consumers are able to purchase at a given price level.

Consumers seek utility maximization which means satisfaction they derive from consuming goods and services for a given period and paying the price. Different income levels of consumers determine the different quantity of goods demanded to reflect their purchasing power and utilities.

For Example, Consumers from the low level of income may want Mercedes, but it does not add to quantity demanded as because they are not having enough purchasing power to buy it.

Terms related to Theory of Demand:

The Theory of Demand is related to the following two terms : –

  1. Demand Schedule
  2. Demand Curve 

Demand Schedule:

It is a tabular representation of the correlation between the price of the commodity and quantity demanded for a period of time.

  1. Individual demand schedule
  2. Market demand schedule
Individual demand schedule :

It is a tabular representation of different quantities of a commodity at which consumer is willing to buy at different price levels during a given period.

The following table shows the demand schedule of commodity ‘X’ :

Price (in Rs.)

Quantity Demanded (in units)

10

5

9

10

8

15

7

20

6

25

As shown in the above schedule, the quantity demanded of ‘X’ increases with a decrease in price. The consumer is willing to buy 5 units at a price of Rs 10. When the price falls to Rs 9, the quantity increases to 10 units. Similarly, as the price keeps on declining, the quantity keeps on increasing.

Market demand schedule:

It is a tabular statement showing different quantities of a commodity that all the consumers are willing to buy at various price levels during a period of time.

Following is the demand schedule of commodity ‘X’ by individual ‘P’, individual ‘Q’ and market demand :

Price

(in Rs.)

The demand by Individual ‘P’

( in units)

The demand by Individual ‘Q’

( in units)

Market Demand (‘P’ + ‘Q’)

(in units)

10

5

10

15

9

10

15

25

8

15

20

35

7

20

25

45

6

25

30

55

As shown in the schedule, at price Rs. 10, an individual ‘P’ demands 5  units of commodity ‘X’ whereas Q demands 10 units which result in 15 units as market demand. As price falls to Rs 9, the demand for ‘P’ and ‘Q’ increases to 10 and 15 respectively and the market demand reaches 25 units. Similarly, the price goes on declining and in result, the market demand keeps on increasing.

Demand Curve: –

It is a graphical representation of the correlation between the price of the commodity and quantity demanded for a period of time.

  1. Individual demand curve
  2. Market demand curve
Individual demand curve:

It is a graphical representation of corresponding quantities demanded by an individual of a specific item at different price levels. It is the locus all those points showing various quantities of an item that a consumer is willing to buy at various price levels during a period of time.

Theory of Demand individal  - Theory of demand - its graphical representation
Theory-of-Demand-individual

In the above graph, X-axis shows the quantity demanded by the X and Y-axis shows the price. The points A, B, C, D and E show the relationship between price and quantity demanded. DD is the demand curve. At price Rs.10, the quantity demanded is 5 units. As the price decreases to Rs.9, the quantity goes up to 10 units. Similarly, as the price reduces to Rs.8, 7 and 6, the quantity demanded increases to 15,20 and 25 units respective.

Because of the inverse relationship between price and quantity demanded, the DD curve is downward sloping.

Market demand curve:

It refers to the summation of individual demand curves in the market. In other words, It is the graphical presentation of the sum total of all individual demand for a specific commodity for a given period of time in the given market.

Theory of Demand Market - Theory of demand - its graphical representation
Theory-of-Demand–Market

The (a) and the (b) graph shows the individual demand curve for commodity X by ‘P’ and ‘Q’ whereas the (c) graph shows the market demand for the same i.e. sum of demand of ‘P’and ‘Q’.

In the graph, X-axis shows the quantity demanded and Y-axis shows Price. The points A, B, C, D and E show the relationship between price and quantity demanded. DD curve is the demand curve.

In graph (a), at price Rs.10, the quantity demanded by P is 5 units. As price reduces to Rs.9, the quantity demanded increases to 10 units. Similarly, as the price goes down to Rs8,7 and 6, the quantity demanded by P keeps on increasing to 15,20 and 25 units respectively.

In graph (b) for Q’s demand, at the price Rs 10, the quantity demanded by him is 10 units. As the price decreases to Rs 9, the quantity demanded rises to 15 units. Similarly, as the price continues to decrease to Rs.8,7 and 6, the respective quantity demanded increases to 20,25 and 30 units.

Similarly, in the graph (c) which shows the summation of P and Q, at price Rs.10, the quantity demanded is 15 units. As the price diminishes to Rs.9, the quantity demanded in the market increases to 25 units. Similarly, as the price is going down to Rs.8, 7 and 6, the quantity demanded in the market rises to 35,45 and 55 respectively. The DD curve shows the market demand curve.

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Utility – Meaning, Definition and its types

Utility-Feature-Image

The term Utility in economics refers to the satisfaction derived by a person from the consumption of any good or service at a given price and given time. It varies from person to person, place to place and time to time.

In other words, when a commodity is capable of satisfying a want, it can be said as it has a utility. It is measured in cardinal (numerical e.g 1,2,3,4,5 etc.) terms.

Definition: –

According to Prof. Hobson, “Utility is the ability of a good to satisfy a want.”

It is impossible to measure the satisfaction of a person as it varies from person to person. Still, this concept is very useful in understanding consumer behaviour.

Type of Utility:

It can be divided into two types. these are explained as follows: –

1. Total utility:

It refers to the total satisfaction obtained from the consumption of all possible units of a commodity. For example, if consumption of one apple gives a person satisfaction of 10 units and consumption of another apple gives the satisfaction of 8 units, the total satisfaction from two apples will be (10+8) = 18 units. If one more apple gives him the satisfaction of 6 units, then total satisfaction becomes (10+8+6)=24 units.

TUn = U1+U2+U3+………..+Un

Where,

TUn  = Total utility from n units of a given commodity

n = number of units consumed

 U1, U2, U3 ………….Un = utility from 1st, 2nd, 3rd to an nth unit of commodity.

2. Marginal utility:

It refers to the additional utility derived from the consumption of one more unit of a given commodity in a given time period.

As in the above example, the total utility increases from 18 to 24 units after the consumption of 3rd apple. Thus, an additional 6 units are the marginal utility-driven from the 3rd unit of apple.

MU can be calculated as

MUn = TUn – TUn-1

Where MUn = marginal utility from an nth unit

TUn = Total utility from n units

TUn-1 = Total utility from n-1 units

In simple words, MU is the change in total utility when more unit of a given commodity is consumed.

 Therefore,

 “MU= Change in TU/ Change in units consumed”

Illustration of Total and Marginal Utility:

Units of Apples T. U. M. U. Remarks
0 0 0  
1st 20 20 (20-0) Positive +
2nd 35 15 (35-20)
3rd 45 10 (45-35)
4th 50 5 (50-45)
5th 50 0 (50-50)  Zero 0
6th 45 -5 (45-50) Negative –

In the above table, the consumer consumes the 1st apple and it gives him the satisfaction of 20 units and consumption of 2nd apple gives the satisfaction of 15 units. So, the total satisfaction gets from the consumption of two apples will be (20+15) = 35 units. When he ate a 3rd apple it gives him the satisfaction of 10 units, then total satisfaction gets from all units of apple becomes (20+15+10) = 45 units. After that When he ate the 4th unit of apple it gives him the satisfaction of 5 units, then total satisfaction gets from all units of apple becomes (20+15+10+5) = 50 units. After that when he ate the 5th unit of apple it gives him the satisfaction of 0 units, then total satisfaction gets from all units of apple becomes (20+15+10+5+0) = 50 units. and after that when he ate the 6th unit of apple it gives him the satisfaction of -5 units, then total satisfaction gets from all units of apple becomes (20+15+10+5+0+(-5)) = 45 units. 

But the Margin Utility has there different type of situation: – 

  1. Positive 
  2. Zero
  3. Negative

These all explain further as following with the help of the above table: –

From the consumption of 1st unit to the 4th unit of the commodity, the M.U. driven from the consumption of these units is positive and the T.U. is increasing in the diminishing rate. when the consumer consumes the 5th unit of the commodity, the M.U. become zero and T.U. has no change. After that when consumer consumes the 6th unit of the commodity, the M.U. become Negative and T.U. is decreasing.

Total Utility Curve : –

Total Utility Curve graph - Utility - Meaning, Definition and its types
In the above graph, we take units of apple on X-axis and T.U. on the Y-axis. The graph shows that from the point “O” to the point “A” the T.U. is increasing in the diminishing rate and from the point, “A” to the point “B” the T.U. has no change. after that from the point, “B” to the point “C” the  T.U. is decreasing.

Marginal Utility Curve : –

Marginal Utility Curve grap - Utility - Meaning, Definition and its types
In the above graph, we take units of apple on X-axis and M.U. on the Y-axis. The graph shows that from the point “O” to the point “A” the M.U. driven the positive satisfaction and from the point, “A” to the point “B” the M.U. become zero. after that from the point, “B” to the point “C” the M.U. become Negative.

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Demand Meaning, Definition and Determinants

Meaning of Demand, Definition and Determinants

In economics, the demand for the commodity can be described as its quantity at which consumer is willing and able to purchase or consume a given commodity during a given period of time.

So, the commodity can be said as demanded when

  • A consumer possesses the willingness to buy it
  • Possesses the ability to purchase or consume it
  • And it is related to a given period of time.

For example:

Suppose Saurabh wants to purchase a motorbike for himself but he does not have sufficient money to buy it. It cannot be treated as demand. When he can afford the purchase of that motorbike in a given time, it can be called as demand for the motorbike by Saurabh.

Definition according to Prof. Bober:

“By demand, we mean the various quantities of a given commodity or service which consumers could buy in a given period of time at various prices or at various incomes or at various prices of related goods.”

Determinants of demand:

It refers to the factors which influence the demand for a particular commodity for a given period of time.

In other words, these factors directly or indirectly affect the demand for the commodity in the market. This can also be written as

This is the function of following main five determinants: 

          Qd = f ( P, Y, R, T, E)

Where:

Besides these, there are some other factors which determine the demand are :

These factors drive the demand for the commodities and also, growth of the economy, providing other things remain unchanged. An organization should understand the impact of these determinants of the demand. Some of these are explained as under :

1) The Price of the commodity:

It is the most important determinant. It affects the demand for goods at a large extent. As the law of demand, there is an inverse relationship between the price of commodity and Qd. the Qd increases with a reduction in price, assuming other things constant and vice versa.

For example,

A consumer prefers to make bulk quantity purchases when prices are less and makes fewer purchases when prices are high.

2) The income of consumers:

Income is another main determinant which represents the purchasing power of the consumer. When income increases, the consumer starts purchasing more which results in more demand and vice versa while other factors remain constant. Income and demand are directly related to each other in case of normal and superior goods.

For example:

Suppose if the salary of Mr A has increased, then he can purchase some luxury items such as television, air conditioners, and accessories.

The relationship between income and different types of goods can be discussed as under :

  1. Normal or Consumer goods: These refers to the goods which are consumed by all the people in society on a daily basis such as soaps, toothpaste, grains, clothes, etc. As the income increases, the Qd of consumer goods increases but up to a certain limit, other things remain the same.
  2. Inferior goods: inferior goods are those whose demand decreases when income increases and vice versa. For example, public transportation, generic grocery products, and kerosene, etc.

However, the goods are not always inferior or normal goods as inferior goods are normal goods for the people having a low level of income. Therefore, we can say that the level of income creates the perception of goods i.e normal or inferior.

3) The Price of related goods :

Demand for a given commodity can be influenced by the price of related goods. These related goods can be classified as :

  • Substitute goods: Substitute goods are those which can be used in place of each other for the satisfaction of some want e.g. tea and coffee, coke and limen Soda etc. There is a direct relationship between the price of substitute goods and given commodity, other things remain constant and vice versa. It implies as the price of substitute goods increases, the Qd for given commodity starts increasing.
    • For example, If the price of coke increases, it will result in more Qd for limca as the limca will become cheaper as compared to coke. Thus the price of substitute goods directly affects the Qd for the given commodity.
  • Complementary goods: complementary goods are those which are used together to satisfy a specific need such as cars and petrol, shoes and polish, pencils and erasers etc. there is a negative relationship between prices of complementary goods and Qd of the given commodity. It implies that as the price of complementary goods rises, the Qd for given commodity starts declining, other things being constant and vice versa.
    • For example, as the price of shoes starts increasing, the Qd for polish starts decreasing as it will become expensive when used together. So, the demand for a given commodity is inversely affected by the price of complementary goods.

4) Tastes and preferences:

Tastes and preferences have a great impact on the demand for the given commodity. These are highly influenced by the change in trends, fashion, lifestyle, sex, age, religious values, standard living, customs and common habits. Any change in these factors results in a change in tastes and preferences of consumers. Consumers switch over to new products in place of old ones for their consumption.

Also, the sex ratio, habits and age influences the demand for the product in a particular area. For example, if the number of females is more as compared to males in a specific area, the demand for feminine products will be more in that area such as makeup kits and cosmetics material.

5) Expectations of consumers:

If the price of the product is expected to rise in future, the consumers demand more to store it in the short run. For example, if it is expected that the prices of petrol and diesel will increase by next week, the demand for petrol and diesel would increase in present.

Similarly, if there is an expectation that the prices of products will fall in future, the consumers would delay the purchases of that product. Thus, price expectations also make a significant impact on the demand of buyers.

6) Growth of population: 

The size of the population determines aggregate demand in the country. More the growth of population more will be the demand and vice versa. Thus, the growth of population is directly related to demand of the commodities. For example, if the population in an economy is more, there will be more demand for food grains, pulses and other consumer goods.

7) Distribution of National Income:

 The market demand is highly influenced by the distribution of national income. The even distribution of national income creates a market demand for necessities goods and on the other hand, uneven distribution of national income creates a demand for luxury goods.

8) Credit availability:

The easy access to credit affects the demand for the given commodity at a large extent. It boosts up the demand in the economy as the consumers with a low level of income can afford expensive products such as consumer durables in instalments.

It increases the customer base for the business. Thus, most firms use this method to increase demand and sales of its products such as washing machines, refrigerators, LED Television and luxury cars etc.

9) Taxation and subsidies:

These refer to one of the major factors to affect the demand for commodities. Govt policy influences the demand through tax rates and subsidies in the market. For example, if the tax rate on a specific product is high, it will increase the price of the product. This would result in fall in the demand for that particular product and vice versa.

Similarly, the subsidies lower the price of the product and lead to more demand for the product in the market. Thus, low tax rates and more subsidies boost up the demand in the market and vice versa.

10) Climatic conditions:

The demand for some products varies with the climatic conditions of a specific area. For example, tea and coffee are more demanded in winter season whereas ice cream is more demanded in the summer season. Similarly, there are some specific products such as umbrella which are highly demanded in hilly areas as compared to plains. Thus, consumers demand different products under different climatic conditions.

Apart from the factors discussed above, there may be more determinants affecting the demand of a particular commodity. To be precise, some factors are important for one commodity and others could be for other commodities. Therefore, the importance of different factors varies with the buyers.

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Scope of Business Economics – Explain with Examples

Scope of Business Economics

Business economics is applied microeconomics employed for the purpose of decision making and planning for an organisation. The scope of business economics is wider since it uses the logic of different disciplines such as mathematics, statistics, marketing and finance to solve problems relating to decision making.

Analysis, estimation and forecasting of demand: 

Analysis of demand is all about studying consumer behaviour. It includes the understanding of changing the behaviour of consumers and their preferences with the effect of change in other determinants of demand such as the price of goods, tastes and preferences and income etc. Every business concern decides its level of production based on this demand analysis. They make research and conduct market surveys to know the preferences of consumers. Business economics estimates consumer behaviour in the market and forecasts the quantity demanded by consumers to the production department. It also includes the allocation of resources in an effective manner to meet consumer demands.

For example:

 Suppose sales of ‘X’ product in ABC Ltd. in April, May and June is 500,600 and 700 units respectively. So, we can easily estimate the demand for ‘X’ product for month July approximately 600 units, provided market conditions remain the same.

Cost and output analysis:

Business economics deals with various types of costs associated with the operations of an enterprise and the optimum level of output to achieve the organisational goals. The costs analysis enables the firm to identify the behaviour of all costs incurred in the organisation which leads to minimisation of costs whereas output analysis enables the firm to increase the output by securing economies of scale. Thus, business economics is concerned with the minimisation of costs and maximisation of output.

Some of the defined costs under business economics are :

  1. Opportunity costs
  2. Implicit and explicit costs
  3. Historical and replacement costs
  4. Short run and long run costs
  5. Fixed and variable costs
  6. Controllable and uncontrollable costs
  7. Incremental costs and sunk costs
  8. Total, Average and Marginal costs etc.

 

Capital budgeting and capital management:

Business economics assists long-run decisions of the firm such as capital budgeting and management of funds. Among the other decisions, managers have to take care of investment decisions that where to invest and how much to be invested. Various theories of business economics give an idea to evaluate these decisions and to allocate the capital. These theories also help the firm to assess the capital structure and its efficiency. Thus, when a firm has to take decisions regarding funds or finance, business economics serves the decision-making process.

Some of the methods used in capital budgeting are :

  1. Discounted payback period
  2. Net present value
  3. Profitability index
  4. Internal rate of return etc.

Market structure and pricing policies:

Business economics helps to know the extent of competition in the market through the analysis of the market structure. It also enables the firm to draft market strategies for market management under different competitive situations. On the other hand, this market analysis helps the firms to create pricing policies. It provides guidelines to determine price levels under different market conditions.

For example: –

Adoption of price skimming strategy includes the high price at the initial stage of the product to maximize profits before competition brings out and prices start to begin whereas penetration pricing includes low prices at the initial stage of the product to undercut the competition and gain market.

Inventory management:

Business economics helps firms while making inventory policies. The profitability of the firm depends on proper inventory management. The business theories provide rules to minimize the costs associated with the inventory such as raw material, work-in-progress and finished goods. Hence, business economics gives different methods such as ABC Analysis and economic order quantity models to maintain optimum stock of inventories.

For example: –

For the business dealing in perishable goods for which demand is time sensitive e.g. fashion items, calendar etc.-keeping inventory in stock can be costly.

Profit analysis:

Profit maximisation is the main aim of every business entity. But at the same time, it faces risks and uncertainty against it. It has to be innovative in its production and marketing of goods to attain the objectives. Business economics deals with all the matters relating to the profitability analysis such as break-even point. The profit theories enable the firm to measure and manage profits under different conditions. Also, it helps in planning profits in future.

Risk and uncertainty analysis:

As we know the business environment is uncertain and risky. Uncertainty exists when the outcomes of decisions can’t be predicted accurately and risk is the chance of loss when all possible outcomes and probability of happenings are not known. Business economics provide experience, insight and prudence to allow managers to make strategies to minimize the chances of failing to meet the organisational goals.

For example:

The investment in government bonds and securities are less risky as returns are certain whereas investment in new business or expansion are riskier as returns are uncertain.

Allocation of resources:

Allocation of resources in business economics means scientific management of resources in line of production, distribution, exchange and consumption. The different methods of resource allocation are explained in economic theories under different conditions.

 For example:-

In the capitalist economy, it is based on market mechanism whereas, in a free economy, it depends on the forces of demand and supply. Also, business economics uses advanced tools like linear programming and solver to create the best allocation for the optimum utilization of resources.

Conclusion:

Thus, there is very wast Scope of Business Economics, which covers all those problems which a manager has to face. As these problems can be internal or external, business economics gives different theories to tackle them.

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