27-02-2013, 09:29 AM
Theory of Demand
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Theory of Demand
If necessity is the mother of invention, then demand is the mother of production.
A Bit of History…
Leon Walras (1834-1910) a French economist, gave demand theory as a fundamental principle of microeconomics which gives the analysis of the relationship between the demand for goods or services and prices or incomes.
The theory was subsequently developed by English economist Alfred Marshall (1842-1924), Italian Vilfredo Pareto (1848-1923), Soviet Eugen Slutsky (1880-1948), American Kenneth Arrow (1921- ) and the French-born Gerard Debreu (1921- ).
What is Demand ?
Demand is the basis of all productive activities. Demand theory is an economic theory that concerns the relationship between the demand for goods and their prices; it forms the core of microeconomics.
Demand theory examines purchasing decisions of consumers and the subsequent impact on prices.
The Law of Demand
Price changes lead to qty demanded changing...
Represented by movements along demand curve.
Inverse relationship between price and quantity demanded gives rise to a downward- sloping demand curve.
Determinants of Demand
Income of the consumer: Consumption is influenced by the income of a consumer. With every increase in the income of a consumer , his consumption pattern changes i.e, the purchasing power of the consumer increases. On the other hand any increase in the prices of product reduces the purchasing power of the consumer.
Price of the substitute product: A substitute product is one that provides the same level of satisfaction as the product already being consumed by the consumer. Assume that two products A and B are perfect substitutes for each other. If the price of a product goes up, while B remains constant, consumers will switch to product B. For ex, with the technological advancement in the telecommunication sector, wireless in local loop is being considered as a substitute for cellular phone in the long run. Similarly bio fertilizer proved to be good substitute for chemical fertilizers.
Nature of Demand curve:
A Demand Curve is a graphical representation of the relationship between price and quantity demanded (ceteris paribus). It is a curve or line, each point of which is a price-Quantity. That point shows the amount of the good buyers would choose to buy at that price.
The Law of Demand states that when the price of a good rises, and everything else remains the same, the quantity of the good demanded will fall.
“Everything else remains the same is an assumption. In this context, it means that income, wealth, prices of other goods, population, and preferences all remain fixed.
Kinds of Income Elasticity
Zero Income Elasticity of Demand: This refers the situation where a given increase in the income of the consumer does not result in any increase in demand. The quantity brought of the commodity remains constant.
Negative Income Elasticity of Demand for Inferior goods: This refers to that situation where a given increase in the money income of the consumer is followed by a actual fall in the quantity demanded of commodity. For inferior goods generally income elasticity will be negative.