Prices of other Commodities/ the Market Demand Schedule and Curve/ Changes in Demand / The Law of Demand / Causes of Downward Sloping Demand Curve/ Exceptions to the Law of Demand/ Exceptions to the Law of Demand:

Prices of other Commodities/ the Market Demand Schedule and Curve/ Changes in Demand / The Law of Demand / Causes of Downward Sloping Demand Curve/ Exceptions to the Law of Demand/ Exceptions to the Law of Demand:

1. Prices of other Commodities:

There are three types of commodities in this context.

Substitutes:

If a rise (or fall) in the price of one commodity leads to an increase (or decline) in the demand for another commodity, the two commodities are said to be substitutes. In other words, substitutes are those commodities that satisfy similar wants, such as tea and coffee.

If the price of coffee falls, the demand for coffee rises which brings a fall in the demand for tea because the consumers of tea shift their demand to coffee which has become cheaper. On the other hand, if the price of coffee rises, its demand will fall. But the demand for tea will rise because the consumers of coffee will shift their demand to tea.

Complementary Commodities:

Where the demand for two commodities is linked to each other, such as cars and petrol, bread and butter, tea and sugar, etc., they are said to be complementary goods. Complementary goods are those which cannot be used without each other. If, say, the price of cars rises and they become expensive, the demand for them will fall and so will the demand for petrol. On the contrary, if the price of cars falls and they become cheaper, the demand for them will increase and so will the demand for petrol.

Unrelated Goods:

If the two commodities are unrelated, say refrigerator and bicycle, a change in the price of one will have no effect on the quantity demanded of the other.

2. Income:

A rise in the consumer’s income raises the demand for a commodity, and a fall in his income reduces the demand for it.

3. Tastes:

When there is a change in the tastes of consumers in favor of a commodity, say due to fashion, its demand will rise, with no change in its price, in the prices of other commodities, and in the income of the consumer. On the other hand, a change in tastes against a commodity leads to a fall in its demand, other factors affecting demand remaining unchanged.

An Individuals Demand Schedule and Curve:

An individual consumer’s demand refers to the quantities of a commodity demanded by him at various prices, other things remaining equal (y, pr, and t). An individual’s demand for commodity “is shown on the demand schedule and on the demand curve. A demand schedule is a list of prices and quantities and its graphic representation is a demand curve.

Table 10.1: Demand Schedule:

Price (Rs.)	Quantity (units)
6	10
5	20
4	30
3	40
2	60
1	80

The demand schedule reveals that when the price is Rs. 6, the quantity demanded is 10 units. If the price happens to be Rs 5, the quantity demanded is 20 units, and so on. In Figure 10.1, DD₁ is the demand curve drawn based on the above demand schedule. The dotted points D, P, Q, R, S, T, and U show the various price-quantity combinations.

Marshall calls them “demand points”. The first combination is represented by the first dot and the remaining price- quantity combinations move to the right toward D₁.

The Market Demand Schedule and Curve:

In a market, there is not one consumer but many consumers of a commodity. The market demand of a commodity is depicted on a demanding schedule and a demand curve. They show the sum total of various quantities demanded by all the individuals at various prices.

Suppose there are three individuals A, В, and С in a market who purchase the commodity. The demand schedule for the commodity is depicted in Table 10.2.

The last column (5) of the Table represents the market demand of the commodity at various prices. It is arrived at by adding columns (2), (3), and (4) representing the demand of consumers A, В, and С respectively. The relation between columns (1) and (5) shows the market demand schedule. When the price is very high Rs. 6 per kg. the market demand for the commodity is 70 kgs. As the price falls, the demand increases. When the price is the lowest Re. 1 per kg., the market demand per week is 360 kgs.

TABLE 10.2: MARKET DEMAND SCHEDULE:

Price per kg. (Rs.) (1)	A (2)	Quantity Demanded in kgs. В + (3) +	С (4)	Total Demand (5)
6	10	20	40	70
5	20	40	60	120
4	30	60	80	170
3	40	80	100	220
2	60	100	120	280
1	80	120	160	360

From Table 10.2 we draw the market demand curve in Figure 10.2. D_M is the market demand curve which is the horizontal summation of all the individual demand curves D_A + D_B + D_C. The market demand for a commodity depends on all factors that determine an individual’s demand.

But a better way of drawing a market demand curve is to add together sideways (lateral summation) of all the individual demand curves. In this case, the different quantities demanded by consumers at one price are represented on each individual demand curve and then a lateral summation is done, as shown in Figure 10.3.

Suppose there are three individuals A, В and С in a market who buy OA, OB and ОС quantities of the commodity at the price OP, as shown in Panels (A), (В) and (C) respectively in Figurel0.3. In the market, OQ quantity will be bought which is made up by adding together the quantities OA, OB, and ОС. The market demand curve, D_M is obtained by the lateral summation of the individual demand curves D_A, D_B, and D_cin panel (D).

Changes in Demand:

An individual’s demand curve is drawn on the assumption that factors such as prices of other commodities, income, and tastes influencing his demand remain constant. What happens to an individual’s demand curve if there is a change in any one of the factors affecting his demand, the other factors remaining constant? When any one of the factors changes, the entire demand curve shifts. When an individual’s money income rises, other factors remaining constant, his demand curve for a commodity will shift upwards to the right. He will buy more of the commodity at a given price, as shown in Figure 10.4. Before the rise in his income, the consumer is buying OQ₁ quantity at OP price on the D₁D₁ demand curve.

With the increase in income, his demand curve D₁D₁ shifts to the right as D₂D₂. He now buys more quantity OQ₂ at the same price OP. When the consumer buys more of the commodity at a given price, this is called the increase in demand. On the contrary, if his income falls, his demand curve will shift to the left. He will buy less of the commodity at the same price, as shown in Figure 10.5. Before the fall in his income, the consumer is on the demand curve D₁D₁where he is buying OQ₁ of the commodity at OP Price. He now buys less quantity OP price at the given price OP. When the consumer buys less of the commodity at a given price, this is called the decrease in demand.

Demand curves are thus not stationary. Rather, they shift to the right or left due to several causes. There are changes in tastes, habits, and customs of the consumers; changes in income-expenditure; changes in the prices of substitutes and complements; expectations about future changes in prices and incomes and changes in the age and composition of the population, etc.

A movement along a demand curve takes place when there is a change in the quantity demanded due to a change in the commodity’s own price. This is illustrated in Figure 10.6 which shows that when the price is OP₁ the quantity demanded is OQ₁ with the fall in price, there has been a downward movement along with the same demand curve D₁D₁from point A to B. This is known as an extension in demand. On the contrary, if we take В as the original price-demand point, then a rise in the price from OP₂ to OP₁ leads to a fall in the quantity demanded from OQ₂ to OQ₁. The consumer moves upwards along the same demand curve D₁D₁ from point В to A. This is known as a contraction in demand.

The Law of Demand:

The law of demand expresses a relationship between the quantity demanded and its price. It may be defined in Marshall’s words as “the amount demanded increases with a fall in price, and diminishes with a price rise.” Thus it expresses an inverse relation between price and demand.

The law refers to the direction in which quantity demanded changes with a price change. The figure, it is represented by the slope of the demand curve which is normally negative throughout its length. The inverse price-demand relationship is based on other things remaining equal. This phrase points towards certain important assumptions on which this law is based.

It’s Assumptions. These assumptions are:

(i)             there is no change in the tastes and preferences of the consumer;

(ii)           the income of the consumer remains constant;

(iii)         there is no change in customs;

(iv)         the commodity to be used should not confer distinction on the consumer;

(v)           there should not be any substitutes of the commodity;

(vi)         there should not be any change in the prices of other products;

(vii)        there should not be any possibility of change in the price of the product being used;

(viii)     there should not be any change in the quality of the product; and

(ix)         the habits of the consumers should remain unchanged. Given these conditions, the law of demand operates. If there is change even in one of these conditions, it will stop operating.

Explain the law with the help of Table 10.1 and Figure 10.1.

Causes of Downward Sloping Demand Curve:

Why does a demand curve slope downward from left to right? The reasons for this also clarify the working of the law of demand. The following are the main reasons for the downward sloping demand curve.

(1) The law of demand is based on the law of Diminishing Marginal Utility. According to this law, when a consumer buys more units of a commodity, the marginal utility of that commodity continues to decline. Therefore, the consumer will buy more units of that commodity only when its price falls. When fewer units are available, the utility will be high and the consumer will be prepared to pay more for the commodity. This proves that the demand will be more at a lower price and it will be less at a higher price. That is why the demand curve is downward sloping.

(2) Every commodity has certain consumers but when its price falls, new consumers start consuming it, as a result, demand increases. On the contrary, with the increase in the price of the product, many consumers will either reduce or stop its consumption and the demand will be reduced. Thus, due to the price effect when consumers consume more or less of the commodity, the demand curve slopes downward.

(3) When the price of a commodity falls, the real income of the consumer increases because he has to spend less to buy the same quantity. On the contrary, with the rise in the price of the commodity, the real income of the consumer falls. This is called the income effect. Under the influence of this effect, with the fall in the price of the commodity, the consumer buys more of it and also spends a portion of the increased income in buying other commodities. For instance, with the fall in the price of milk, he will buy more of it but at the same time, he will increase the demand for other commodities. On the other hand, with the increase in the price of milk, he will reduce its demand. The income effect of a change in the price of an ordinary commodity being positive, the demand curve slopes downward.

(4) The other effect of change in the price of the commodity is the substitution effect. With the fall in the price of a commodity, the prices of its substitutes remain the same, consumers will buy more of this commodity rather than the substitutes. As a result, its demand will increase. On the contrary, with the rise in the price of the commodity (under consideration) its demand will fall, given the prices of the substitutes. For instance, with the fall in the price of tea, the price of coffee being unchanged, the demand for tea will rise, and contrariwise, with the increase in the price of tea, its demand will fall.

(5) There are persons in different income groups in every society but the majority is in the low-income group. The downward-sloping demand curve depends upon this group. Ordinary people buy more when the price falls and less when the price rises. The rich do not have any effect on the demand curve because they are capable of buying the same quantity even at a higher price.

(6) There are different uses of certain commodities and services that are responsible for the negative slope of the demand curve. With the increase in the price of such products, they will be used only for more important uses and their demand will fall. On the contrary, with the fall in price, they will be put to various uses and their demand will rise. For instance, with the increase in the electricity charges, power will be used primarily for domestic lighting, but if the charges are reduced, people will use power for cooking, fans, heaters, etc.

Exceptions to the Law of Demand:

In certain cases, the demand curve slopes up from left to right, i.e., it has a positive slope. Under certain circumstances, consumers buy more when the price of a commodity rises, and less when the price falls, as shown by the D curve in Figure 10.7. Many causes are attributed to an upward sloping demand curve.

(i) War:

If a shortage is feared in anticipation of war, people “may start buying for building stocks or for hoarding even when the” price rises.

(ii) Depression:

During a depression, the prices of commodities are very low and the demand for them is also less. This is because of the lack of purchasing power with consumers.

(iii) Giffen Paradox:

If a commodity happens to be a necessity of life like wheat and its price goes up, consumers are forced to curtail the consumption of more expensive foods like meat and fish, and wheat being still the cheapest, the food they will consume more of it. The Marshallian example applies to developed economies. In the case of an underdeveloped economy, with the fall in the price of an inferior commodity like maize, consumers will start consuming more of the superior commodity like wheat. As a result, the demand for maize will fall. This is what Marshall called the Giffen Paradox which makes the demand curve have a positive slope.

(iv) Demonstration Effect:

If consumers are affected by the principle of conspicuous consumption or demonstration effect, they will like to buy more of those commodities which confer distinction on the possessor, when their prices rise. On the other hand, with the fall in the prices of such articles, their demand falls, as is the case with diamonds.

(v) Ignorance Effect:

Consumers buy more at a higher price under the influence of the “ignorance effect”, where a commodity may be mistaken for some other commodity, due to deceptive packing, label, etc.

(vi) Speculation:

Marshall mentions speculation as one of the important exceptions to the downward sloping demand curve. According to him, the law of demand does not apply to the demand in a campaign between groups of speculators. When a group unloads a great quantity of a thing onto the market, the price falls and the other group begins buying it. When it has raised the price of the thing, it arranges to sell a great deal quietly. Thus when the price rises, demand also increases.

Income Demand:

We have so far studied price demand in its various aspects, keeping other things constant. Let us now study income demand which indicates the relationship between income and the quantity of a commodity demanded. It relates to the various quantities of a commodity or service that will be bought by the consumer at various levels of income in a given period, other things being equal. Things that are assumed to remain equal are the price of the commodity in question, the prices of related commodities, and the tastes, preferences, and habits of the consumer for it. The income-demand function for a commodity is written as Df (y). The income-demand relationship is usually direct.

The demand for the commodity increases with the rise in income and decreases with the fall in income, as shown in Figure 10.8 (A). When income is OI, the quantity demanded is OQ, and when income rises to OI₁ the quantity demanded also increases to OQ₁. The reverse case can also be shown likewise. Thus, the income demand curve ID has a positive slope. But this slope is in the case of normal goods.

Let us take the case of a consumer who is in the habit of consuming an inferior good. So long as his income remains below a particular level of his minimum subsistence, he will continue to buy more of this inferior good even when his income increases by small increments. But when his income starts rising above that level, he reduces his demand for the inferior good. In Figure 10.8 (B), 01 is the minimum subsistence level of income where he buys the IQ of the commodity. Up to this level, this commodity is a normal good for him so that he increases its consumption when his income rises gradually from Ol₁ to OI₂ and to OI. As “his income rises above 01, he starts buying less of the commodity. For instance, at the QI₃ income level, he buys I₃Q₃which is less than IQ. Thus, in the case of inferior goods, the income demand curve ID is backward sloping.

Cross Demand:

Let us now take the case of related goods and how the change in the price of one affects the demand of the other. This is known as cross demand and is written as D = f (pr).

Related goods are of two types, substitutes and complementary. In the case of substitute or competitive goods, a rise in the price of one good A raises the demand for the other good B, “the price of В remaining the same.

The opposite holds in the case of a fall in the price of A when the demand for В falls. Figure 10.9 (A) illustrates it. When the price of good A increases from OA to CM, the quantity of good В “also increases from OB to OB₁. The cross-demand curve CD for substitutes is positively sloping. For with the rise in the price of A, the consumers will shift their demand to В since the price of В remains unchanged. It is also assumed here that the incomes, tastes, preferences, etc. of the consumers do not change.

In case the two goods are complementary or jointly demanded, a rise in the price of one good A will bring a fall in the demand for good B. Conversely, a fall in the price of A will raise the demand for B. This is illustrated in Figure 10.9 (B) where when the price of A falls from OA, to OA, the demand for В increases from OB to OB₁. The demand curve in the case of complementary goods is negatively sloping like the ordinary demand curve.

If, however, the two goods are independent, a change in the price of A will have no effect on the demand for B. We seldom study the relation between two unrelated goods like wheat and chairs. Mostly as consumers, we are concerned with the price-demand relation of substitutes and complementary goods.

Short-Run and Long-Run Demand Curves:

The distinction may be made between short-run and long-run demand curves. In the case of perishable commodities such as vegetables, fruit, milk, etc., the change in quantity demanded to a change in price occurs quickly. For such commodities, there is a single demand curve with the usual negative slope.

But in the case of durable commodities such as gadgets, machines, clothes, and others, a price change will not have its ultimate effect on the quantity demanded until the existing stock of the commodity is adjusted which may take a long time. A short-run demand curve shows the change in quantity demanded to a change in price, given the existing stock of the durable commodity and the supplies of its substitutes. On the other hand, the long-run demand curve shows the change in quantity demanded to a change in price after all adjustments “have been made in the long run.

The relation between the short-run and long-run demand curves is shown in Figure 10.10. Suppose initially consumers are fully adjusted to OP₁ price and OQ₁ quantity demanded with equilibrium at point E₁, on the short-run demand curve D₁. Now assume that price falls to OP. In the short-run, consumers will react along the D₁ curve and increase the quantity demanded to OQ₁ with equilibrium at point E₁ After the lapse of some time when adjustments are made to the new price OP₂, a new equilibrium will be reached at point E₃ with quantity demanded at OQ₁. There will be now a new short-run demand curve passing through point E₁ A further fall in the price to ОР₁ would first lead to a short-run equilibrium at point E₄ with OQ_A quantity demanded and ultimately to a new equilibrium at point E₅with OQ₅ quantity demanded on the short-run demand curve, D₁ A line passing through the final equilibrium points E₁, E₃ and E₅ at each price traces out the long-run demand curve D_L. The long-run demand curve D_l is flatter than the short-run demand curves D₁, D₂, and D₃.

Defects of Utility Analysis or Demand Theory:

The Marshallian utility analysis has many defects and weaknesses which are discussed below.

(1) Utility cannot be measured cardinally:

The entire Marshallian utility analysis is based on the hypothesis that utility is cardinally measured in ‘utils’ or units and that utility can be added and subtracted. For instance, when a consumer takes the first chapati, he gets utility equivalent to 15 units; from the second and third chapati “10 and 5 units respectively and when he consumes the fourth chapati marginal utility becomes zero. If it is supposed that he has no desire after the fourth chapati, the utility from the fifth will be negative 5 units if he takes this chapati. In this way, the total utility in each case will be 15, 25, 30, and 30, when from the fifth chapati the total utility will be 25 (30-5).

Besides, the utility analysis is based on this assumption that the consumer is aware of his preferences and is capable of comparing them. For example, if the utility of one apple is 10 units, of a banana 20 units, and of an orange 40 units, it means that the consumer gives twice the preference to banana as against apple and four times to orange. It shows that utility is transitive. Hicks opines that the basis of the utility analysis, that it is measurable, is defective because the utility is a subjective and psychological concept that cannot be measured cardinally. In reality, it can be measured ordinally.

(2) Single Commodity Model is Unrealistic:

The utility analysis is a single commodity model in which the utility of one commodity is regarded as independent of the other. Marshall considered substitutes and complementaries as one commodity, but it makes the utility analysis unrealistic. For instance, tea and coffee are substitute products. When there is a change in the stock of any one product, there is a change in the marginal utility of both the products. Suppose there is the increase in the stock of tea. There will not only befall in the marginal utility of tea but also of coffee.

Similarly, a change in the stock of coffee will bring a change in the marginal utility of both coffee and tea. The effect of one commodity on the other, and vice versa is called the cross effect. The utility analysis neglects the cross effects of substitutes, complementaries, and unrelated goods. This makes the utility analysis unrealistic. To overcome it, Hicks constructed the two-commodity model in the indifference curve approach.

(3) Money is an Imperfect Measure of Utility:

Marshall measured utility in terms of money, but money is an incorrect and imperfect measure of utility because the value of money often changes. If there is a fall in the value of money, the consumer will not be getting the same utility from the homogeneous units of a commodity at different times. Fall in the value of money is a natural consequence of rising prices.

Again, if two consumers spend the same amount of money at a time, they will not be getting equal utilities because the amount of utility depends upon the intensity of desire of each consumer for the commodity. For instance, consumer A may be getting more utility than В by spending the same amount of money, if his “intensity of desire for the commodity is greater. Thus, money is an imperfect and unreliable measuring rod of utility.

(4) Marginal Utility of Money is not constant:

The utility analysis assumes the marginal utility of money to be constant. Marshall supported this argument on the plea that a consumer spends only a small portion of his income on a commodity at a time so that there is an insignificant reduction in the stock of the remaining amount of money. But the fact is that a consumer does not buy only one commodity but several commodities at a time. In this way, when a major part of his income is spent on buying commodities, the marginal utility of the remaining stock of money increases.

For instance, every consumer spends a major portion of his income in the first week of the month to meet his domestic requirements. After this, he spends the remaining amount of money wisely. It implies that the utility of the remaining sum of money has increased. Thus the assumption that the marginal utility of money remains constant is away from reality and makes this analysis hypothetical.

(5) Man is not Rational:

The utility analysis is based on the assumption that the consumer is rational who prudently buys the commodity and can calculate the dis-utilities and utilities of different commodities, and buys only those units which give him greater utility. This assumption is also unrealistic because no consumer compares the utility and disutility from each unit of a commodity while buying it. Rather, he buys them under the influence of his desires, tastes, or habits. Moreover, the consumer’s income and prices of commodities also influence his purchases. Thus the consumer does not buy commodities rationally. This makes the utility analysis unrealistic and impracticable.

(6) Utility Analysis does not study Income Effect, Substitution Effect and Price Effect:

The greatest defect in the utility analysis is that it ignores the study of income effect, substitution effect, and price effect. The utility analysis does not explain the effect of a rise or fall in the income of the consumer on the demand for the commodities. It thus neglects the income effect. Again, when with the change in the price of one commodity there is a relative change in the price of the other commodity, the consumer substitute’s one for the other.

This is the substitution effect which the utility analysis fails to discuss, being based on one- commodity model. Besides, when the price of one commodity changes, there is a change in its demand and in the demand for related goods. This is the price effect which is also ignored by the utility analysis. When say, the price of good X falls the utility analysis only tells us that its demand will increase. But it fails to analyze the income and substitution effects of a price fall via the increase in the real income of the consumer.

(7) Utility Analysis fails to clarify the Study of Inferior and Giffen Goods:

Marshall’s utility analysis of demand does not clarify the fact as to why a fall in the prices of inferior and Giffen goods leads to a decline in their demand. Marshall failed to explain this paradox because the utility analysis does not discuss the income and substitution effects of the price effect. This makes the Marshallian law of demand incomplete.

(8) The Assumption that the Consumer buys more Units of a Commodity when its Price falls is Unrealistic:

The utility analysis of demand is based on the assumption that the consumer buys more units of a commodity when its price falls. It may be true in the case of food products like oranges, bananas, apples, etc. but not in the case of durable goods. When, for example, the price of a bicycle or radio falls, a consumer will not buy two or three bicycles or radios. It is another thing that a rich man may buy two or three cars, pairs of shoes and a variety of clothes, etc. But he does so irrespectively of the fall in their prices because he is rich. The argument, therefore, does not hold good in the case of an ordinary person.

(9) This Analysis fails to explain the Demand for Indivisible Goods:

The utility analysis breaks down in the case of durable consumer goods like scooters, transistors, radio, etc. because they are indivisible. The consumer buys only one unit of such commodities at a time so that it is neither possible to calculate the marginal utility of one unit nor can the demand schedule and the demand curve for that good be drawn. Hence the utility analysis does not apply to indivisible goods.

These glaring defects in the utility analysis led economists like Hicks to explain the demand analysis of the consumer with the help of the indifference curve approach.