Demand

Demand = desire + ability to pay + willingness to pay, at a given price and time.

Determinants of demand: own price, prices of related goods (substitutes and complements), income, tastes, expectations, population, and government policy.

FORMULADemand function: Dx = f(Px, Pr, Y, T, E, ...)

Law of demand

Other things being equal, price and quantity demanded move in opposite directions.

Why the demand curve slopes down:

Diminishing marginal utility
Income effect (a lower price leaves more money to spend)
Substitution effect (the good becomes cheaper than its substitutes)
New buyers enter the market
Goods with several uses get used more

Exceptions (demand rises with price):

Giffen goods: very inferior staples bought by poor households. A strong negative income effect beats the substitution effect.
Veblen goods: prestige items such as diamonds and luxury watches.
Expectation of further price rise: people buy more now.
Buyers who judge quality by price, and urgent necessities.

Movement versus shift

Cause	What happens	Name
Own price falls	Move down the same curve	Extension of demand
Own price rises	Move up the same curve	Contraction of demand
Any other factor improves demand	Whole curve shifts right	Increase in demand
Any other factor reduces demand	Whole curve shifts left	Decrease in demand

EXAM TIPOwn price moves you along the curve. Everything else shifts the curve.

Related goods

Substitutes (tea and coffee): price of one rises, demand for the other rises.
Complements (car and petrol, pen and refill): price of one rises, demand for the other falls.

Elasticity of demand

Elasticity measures how strongly quantity responds to a change in price, income or the price of another good.

FORMULAPrice elasticity (Ed) = % change in quantity demanded ÷ % change in price

Value of Ed	Name	Shape of demand curve
0	Perfectly inelastic	Vertical line
Between 0 and 1	Relatively inelastic	Steep
1	Unitary elastic	Rectangular hyperbola
More than 1	Relatively elastic	Flat
Infinity	Perfectly elastic	Horizontal line

Methods of measuring price elasticity

Percentage (proportionate) method: use the formula above.
Total outlay method (Marshall): look at what happens to total spending when price falls.
- Spending rises: Ed > 1
- Spending unchanged: Ed = 1
- Spending falls: Ed < 1
Point method: Ed = lower segment ÷ upper segment of a straight-line demand curve. At the midpoint Ed = 1.
Arc method: uses average (midpoint) values when changes are large.

FORMULAArc Ed = (ΔQ ÷ average Q) ÷ (ΔP ÷ average P)

Worked example: Price falls from ₹10 to ₹8 and quantity rises from 40 to 60.
ΔQ ÷ average Q = 20 ÷ 50 = 0.4. ΔP ÷ average P = 2 ÷ 9 = 0.222. Ed ≈ 1.8 (elastic).

What makes demand more elastic? Many substitutes, luxury goods, a large share of income, goods with many uses, and a longer time period. Necessities, habit-forming goods and cheap items have inelastic demand.

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

Ey	Type of good
Negative	Inferior good
Between 0 and 1	Normal necessity
More than 1	Luxury

Cross elasticity (Exy) = % change in quantity of X ÷ % change in price of Y

Exy	Relation
Positive	Substitutes
Negative	Complements
Zero	Unrelated goods

Theory of consumer behaviour

Cardinal approach (Marshall): utility can be measured in numbers (utils).

Law of diminishing marginal utility
Law of equi-marginal utility: the consumer is in equilibrium when MUx ÷ Px = MUy ÷ Py = MU of money.
Consumer surplus = what you are willing to pay − what you actually pay.

Ordinal approach (Hicks and Allen): utility can only be ranked, not measured.

An indifference curve (IC) joins combinations of two goods that give the same satisfaction.
ICs slope down, are convex to the origin (due to diminishing marginal rate of substitution), and never intersect. A higher IC means higher satisfaction.
The budget line shows combinations the consumer can afford. Maximum of X = income ÷ price of X.
Equilibrium: where the budget line just touches (is tangent to) the highest possible IC, so MRS = Px ÷ Py.

Demand forecasting

Demand forecasting estimates future sales so firms can plan production, stock, cash and expansion.

Survey methods	Statistical methods
Survey of buyers' intentions	Trend projection (fitting a line to past sales)
Expert opinion and the Delphi method (anonymous expert rounds)	Regression analysis
Sales force opinion	Barometric technique (leading indicators)
Market experiments (test markets)	Simultaneous equations

Supply

Supply is the quantity sellers are willing and able to offer at a given price and time.

Determinants: own price, prices of inputs, technology, prices of other goods, taxes and subsidies, goals of the firm, number of firms and expectations.

Law of supply: other things being equal, price and quantity supplied move in the same direction.

Exceptions: the backward-bending supply curve of labour (above a high wage, people prefer more leisure), perishable goods sold at any price, and rare goods like antiques.

Elasticity of supply (Es) = % change in quantity supplied ÷ % change in price

EXAM TIPFor straight-line supply curves: through the origin Es = 1; cutting the price axis Es > 1; cutting the quantity axis Es < 1.

Market equilibrium

Equilibrium is where quantity demanded = quantity supplied.

Price above equilibrium: surplus (excess supply), so price tends to fall.
Price below equilibrium: shortage (excess demand), so price tends to rise.

Worked example: Qd = 100 − 2P and Qs = 40 + 4P. Setting them equal: 60 = 6P, so P = ₹10 and Q = 80.

Change	Price	Quantity
Demand increases	Rises	Rises
Supply increases	Falls	Rises
Both increase equally	Unchanged	Rises

Quick elasticity and supply facts

Salt has inelastic demand: it is a necessity, has no close substitute and takes a tiny share of the budget.
Luxury goods have a high price elasticity: buyers can postpone or skip them.
Perishable goods have highly inelastic supply in the short run: they must be sold quickly whatever the price.
The point method of measuring price elasticity (lower segment ÷ upper segment on a straight-line demand curve) is credited to Marshall.
Supply function: if Sx = 5Px + 3, then at a price of ₹2, Sx = 5 × 2 + 3 = 13 units.