Chapter 3

CHAPTER 3
DEMAND
 RESOURCES ARE SCARCE.
Demand is how much of a good an individual would be prepared to buy.
 House holds need to maximize there Utility to a budget constraint.
The rational consumer attempts to maximize utility or satisfaction subject to a budget constraint.
Marginal utility decreases as the consumption of a good increases. This is known as the Law of Diminishing Marginal
Utility.
The existence of diminishing marginal utility means that an individual can increase total utility by purchasing a
combination of goods and services rather than by allocating the budget to one good only. Total utility can be increased
by reallocating expenditure from goods with lower marginal utility to goods with higher marginal utility. Example fixed
budget & two goods. (drink and food).
Thus to be in equilibrium, i.e. maximizing

total utility, the following condition
must hold:
NOTE: CETERIS PARIBUS, Which means
ALL THINGS ARE HELD CONSTANT: whereby
other factors are assumed to be equal for example.
Sickness, whether, age distribution.
Demand can be illustrated using the graph represented by Price and quantity .
Shape of Demand curve is downward slopped

because of substitution effect and income effect.
- First, at a higher price the individual is unable to
purchase as many units of goods normally
purchased because of the budget or income
constraint.
- Second, at higher prices the individual substitutes
relatively cheaper goods for the good in question
The substitution effect is always negative, in other

words the increase in the price of a good will always
lead to the substitution of relatively cheaper goods for
that good. The income effect may be positive or
negative. For ‘normal’ goods
Types of Goods:
 Normal goods: Increase in income/Lower Prices = increase in Quantity demanded (Vice versa)
 Inferior Goods: Increased Income= Lower quantity Demanded. E.g Street food.
 Griffen Goods: Increased prices = increased quantity demanded. E.g staple food
 Veblen Good (Luxury good): Increased prices = increased quantity demanded. E.g jewelry
Parametes: Price is a depend variable and quantity is the independent variable. Factors affecting the Income(budget) could shift the
demand curve. E.g spectulation, expectation. etc. A movement along a demand curve is caused by a change in
price.
The market demand for a good is the sum of the demands
for that good of the individuals who comprise the market.
Diamond water Paradox: why is water not as

expensive as diamond even though it’s a necessity.
MUw,< MUd
price elasticity of demand,
This sensitivity of quantity demanded to price changes, which is known as price elasticity of demand,
The three possible classifications of price elasticity of demand
are: (a) price inelasticity;
(b) price elasticity; and
(c) unitary price elasticity.
Price Inelasticity: the proportional change in the quantity demanded is less than the
proportional change in price.
Price Elasticity: , the proportional change in the quantity demanded is greater than the
proportional change in price.
Unitary Price Elasticity: the proportional change in the quantity demanded exactly
equals the proportional change in price.
E=1
Price elasticity of demand is zero at every point on this curve, since no change in quantity
demanded takes place, and in the formula for calculating price elasticity: = 0
This demand curve is said to be perfectly inelastic.
In Figure 3.8, the demand curve D1D1 is a horizontal line. This type of demand curve
will be met when we analyse the theory of the competitive firm. It could describe the
demand for one farmer’s wheat output, i.e. he can sell as much as he can produce at the
price 0P, the going market price, but nothing at any price above 0P.
Other Elasticities of Demand : Other demand elasticities exist besides price elasticity of demand. A change in
the price of one good (B) can affect the quantity demanded of another good (A). The measure of this
responsiveness is known as cross elasticity of demand and is measured as:
NOTE THAT IN CALCULATIONS: REVENUE = PRICE X QUANTITY

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CHAPTER 3

 House holds need to maximize there Utility to a budget constraint.

Thus to be in equilibrium, i.e. maximizing

Shape of Demand curve is downward slopped

The substitution effect is always negative, in other

Diamond water Paradox: why is water not as

NOTE THAT IN CALCULATIONS: REVENUE = PRICE X QUANTITY

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