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Goods market
 SB 
DB   Shortage  PB 
until
DB > SB
 DB 
DB = SB
where ‘B’ stands for bicycles
Factor market
 SL 
DL   Shortage  PL 
until
DL > SL
 DL 
where ‘L’ stands for labor
DL = SL
Factor market
Si   Surplus  Pi 
Di < Si
 Di 
until
D i = Si
 Si 
where ‘i’ stands for iron
Goods market
Sc   Surplus  Pc
Dc< Sc
 Dc
until
 Sc 
where ‘c’ stands for cars
Dc = S c
LAW OF
DEMAND
As the price of a good increases, its quantity
demanded falls; as the price of a good falls, its
quantity demanded increases
In other words:
The “price effect” on quantity demanded is
negative
(i.e. Qd moves in the opposite direction of the price change)
Price effect =
Income effect
The effect of a
change in price on
quantity demanded
arising from the
consumer becoming
better or worse off
as a result of the
price change
+
Substitution effect
The effect of a change
in price on quantity
demanded arising
from the consumer
switching to or from
alternative products
(substitutes)
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Given Income
Rs. 100
Price of wheat is Rs. 15 / kg
Price of rice is Rs. 5 / kg
 6.6 kg of wheat
Rs. 100
OR
 20 kg of rice
One Scenario: He buys
4 kg of wheat

Rs 60
8 kg of rice

Rs. 40
Ratio of wheat consumption to rice consumption = 1:2
Price of wheat
rises to Rs. 20
per kg
Price of wheat is Rs. 20 / kg
Price of rice is Rs. 5 / kg
 5 kg of wheat
OR
Rs. 100
 20 kg of rice
If he wants to consume 4 kg of wheat, can he maintain the 1:2?
This is known as Income Effect.
 No.
Normal and inferior goods
Normal goods are those goods where the relationship
between income and consumption or Qd is positive.
Inferior goods are those goods where the relationship
between income and consumption Qd is negative.
Example
Inferior Good: Margarine
Normal Good: Butter
As the person becomes richer i.e. his Income goes up he might
reduce his expenditure on margarine and spend more on a
better quality substitute i.e. butter.
Given Income
Rs. 100
One Scenario: He buys
Price of wheat is Rs. 20 / kg
Price of rice is Rs. 5 / kg
3 kg of wheat

Rs 60
8 kg of rice

Rs. 40
Ratio of wheat consumption to rice consumption = 3:8
If expenditure is kept constant, loses 1 kg of wheat.
The ratio of wheat
consumption to rice
consumption has changed
from 1:2 to 3:8
This is known as Substitution Effect
Price effect = Income effect + Substitution effect
• Normal goods : I.E is negative, S.E is
negative. Hence P.E is also negative.
• Inferior goods : If I.E is sufficiently positive,
it can overturn the negative S.E to give a
positive P.E. In this case increase in Price will
also increase the Quantity Demanded (Giffen
Goods).
Individual and market demand
schedules
Price (P)
$ per Bushel
5
Quantity Demanded Quantity Demanded
by one individual (q) in the market* (Q)
Bushels per month (Bushels per month)
3.5
3,500
4
3
4.5
6.0
4,500
6,000
2
8.0
8,000
1
11.0
11,000
* There are 1000 identical individuals in the market.
Graphical illustration
P
P
d1
q
P
P
d2
q
P
d3
d1000
q
q
D = d1 + d2 + d3 + d4 … … … d1000
D
Q
P
D
Q
Graphical illustration
Movement
along demand
curve due to
rise in income
Income
DpG
Price
Shift due to
decrease in price
Qd
Shift due to increase
in income
Movement
along demand
curve due to
fall in price
DPG
Qd
Factors causing shift in
demand curve in PQ space
•
•
•
•
•
•
Income
Tastes
Price of Complimentary Goods
Price of Substitutes
Income Distribution
Future Prices
Demand function
Qd = f ( Pg , T , Psi … Psn , Pci … Pcm , Y , B , Pge t+1 )
Pg = Price of the good.
T = Tastes
Psi … Psn = Prices of substitute goods.
Pci … Pcm = Prices of complimentary goods.
Y = Income
B = Income Distribution
Pge t+1 = Future prices.
Equation 1 Qd= a – b P
In Q - P space
Equation 2B : Qd = 10,000 – 200 P
Equation 2A : Qd = 8,000 – 40 P
Equation 2C : Qd = 12,000 – 60 P
Qd
12000
10000
C`
8000
B`
A`
40
50
60
P
Task for students
Graph the income - Qd relationship in QY
space and YQ space.