# AP Inter 1st Year Economics Notes Chapter 3 Theory of Demand

Students can go through AP Inter 1st Year Economics Notes 3rd Lesson Theory of Demand will help students in revising the entire concepts quickly.

## AP Inter 1st Year Economics Notes 3rd Lesson Theory of Demand

→ Demand means the desire backed up by ability to buy and willingness to pay.

→ Demand function shows the functional relationship between the demand of a commodity and its various determinants.
Dx = f(PX, P1, ………… Pn, y, T)

→ The price of the product, the income of the consumer, the tastes and habits, of consumer etc., are demand determinants.

→ Law of demand expresses the relationship between change in price and change in demand. It states that when price falls demand extends and when price rises demand contracts.

→ Demand schedule shows the different quantities of a commodity purchased at different prices.

→ Individual demand schedule shows that different quantities of a commodity purchased by a person at different prices.

→ Market demand schedule show that the total demand for a good at a particular time at different prices in the market.

→ Exceptions : Giffen’s Paradox prestige goods – speculation illusion.

→ Reasons for downward sloping demand curve – New buyers and old buyers – Income effect – Substitution – effect – Law of diminishing Marginal utility.

→ Income demand explains the functional relationship between changes in income and in quantity demanded.

→ Cross demand explains the functional relationship between the price of on commodity and the quantity demanded of another commodity.

→ Elasticity of demand means the degree of sensitiveness or responsiveness of demand to a change in its price.

→ Types of Elasticity of Demand :

1. Price Elasticity of Demand
2. Income Elasticity of Demand
3. Cross Elasticity of Demand.

→ Price elasticity of demand in five types :

1. Perfectly Elastic Demand
2. Perfectly Inelastic Demand
3. Unitary Elastic Demand
4. Relatively Elastic Demand
5. Relatively Inelastic Demand

→ Income elasticity of demand refers to the responsiveness of quantity demand to changes in the income of the consumer.

→ Cross elasticity of demand refers to the change in the quantity demanded of one good in response to the change in the price of related good.

→ The term demand, a broad concept, not only refers to the desire to have a good but also includes the ability and willingness to buy that good.

→ According to Prof. Benham demand means the different quantities which the consumers are prepared to buy at different prices in a given market, at a given time.

→ The term demand function states or expresses the functional relationship between the determinants of demand of a good and the demand of that good. It is expressed in the form of following equation.
De =f(Pa, Y, Prg, T,A)

→ Price of the good, income of the consumer, prices of related goods (substitutes, complementary goods), tastes, habits and preferences of the consumers, advertising expenditure are main determinants or the factors that influence the demand for a good.

→ Basing on the main determinants of demand, Demand is divided or classified into 3 types, namely a) Price Demand b) Income Demand c) Cross Demand.

→ The table which shows the different prices of a good and the quantities prepared to be purchased at such prices by an individual consumer in the market is called individual demand schedule.

→ The table which shows different prices of a good and the quantities prepared to be purchased by all the consumers in a market is known as market demand schedule.

→ The Law of Demand, an important law of Economics, states the basic fact that “other things remaining the same or constant, the quantity demand expands with a fall in price, and contracts with a rise in price”, implying that price and demand are inversely related.

→ The Law of Demand (exceptions to the Law of Demand) does not apply in the case of giffen goods, prestige goods, speculation, future expectations, phases of business cycles, etc.

→ New buyers, old buyers, income effect, substitution effect, law of diminishing marginal utility, multiple uses of a good are some of the reasons for downward slope of a demand
curve.

→ Income demand shows the various quantities of a good which are prepared to be purchased by a consumer at different levels of his income.

→ Income demand, states that income and quantity demanded are directly and positively related.

→ Basing on income demand, goods are divided into 2 types, namely normal goods and inferior goods.

→ Income demand curve for normal goods, slopes upwards from left to right and income demand curve for inferior goods slopes downwards from left to right.

→ Cross demand shows or explains the relationship between the changes in the price of one good (e.g. Coffee) and changes in the quantities demanded of its substitutes (Tea) and complementary goods.

→ The degree to which quantity demanded responds (changes) to a change in the price of the good, income of the consumer and prices of its related goods is known as elasticity of demand.

→ Basing on the main determinants of demand, elasticity of demand can be divided into 3 types, namely a) Price elasticity of demand b) Income elasticity of demand and c) Cross elasticity of demand.

→ The formula for calculating Elasticity of Demand is
Ed = $$\frac{\text { Proportionate or percentage change in quantity demanded }}{\text { Proportionate or percentage change in price / income / prices of related goods }}$$

→ Price elasticity of demand is of 5 types namely

• Perfectly Elastic or Infinite Elastic Demand (Ed = ∞)
• Perfectly Inelastic or Zero Elastic Demand (Ed = 0)
• Relatively Elastic Demand (Ed > 1)
• Relatively Inelastic Demand (Ed < 1)
• Unitary Elastic Demand (Ed = 1)

→ Formula method, expenditure or outlay method, point method and arc method are four important methods of measuring or calculating elasticity of demand.

→ Nature of the good, the number of substitutes available to the good, the number of uses of the good, possibility of postponement, time element, proportion of the income spent on the good, price level, the income group to which the consumer belongs are some of the factors that determine elasticity of demand.

→ The concept of elasticity of demand is useful to finance minister in determining the tax rates on goods to the monopolist in fixing the prices in different submarkets, in the pricing of joint products, in pricing of factors of production, nationalisation decisions, in international trade and in granting protection to domestic industries.