Understanding the Law of Demand and Elasticity: Concepts, Applications, and Analysis"
25/June/2025 00:57
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1. Law of Demand: Definition
The Law of Demand states that, other things being equal, when the price of a good falls, the quantity demanded increases, and when the price rises, the quantity demanded decreases. In simple terms, price and demand have an inverse relationship.
> Definition by Alfred Marshall:
"Other things being equal, the amount demanded increases with a fall in price and decreases with a rise in price."
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2. Assumptions of the Law of Demand
The law of demand operates only if the following conditions remain constant:
1. No change in consumer’s income
2. No change in the price of related goods
3. No change in consumer tastes and preferences
4. No expectation of future price changes
5. No change in population
6. No government intervention (e.g., taxes/subsidies)
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3. Why Does the Demand Curve Slope Downward?
The demand curve slopes downward from left to right due to the following reasons:
Reason Explanation
1. Law of Diminishing Marginal Utility Each additional unit provides less satisfaction, so buyers are willing to pay less.
2. Substitution Effect When price falls, the good becomes cheaper than alternatives, increasing demand.
3. Income Effect A fall in price increases consumers’ real income, enabling them to buy more.
4. New Buyers Lower prices attract new buyers who previously could not afford the product.
5. Multiple Uses When prices fall, goods are used for less important purposes too, increasing quantity demanded.
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4. Short Statement of Law of Demand
> "Other things remaining constant, the quantity demanded of a commodity increases when its price falls and decreases when its price rises."
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5. Cross Elasticity of Demand: Definition and Importance
Definition:
Cross elasticity of demand measures the responsiveness of demand for a good to a change in the price of another good.
E_{xy} = \frac{\% \text{ change in quantity demanded of Good X}}{\% \text{ change in price of Good Y}}
Importance:
Use Explanation
1. Classification of Goods Helps identify substitutes (positive cross elasticity) and complements (negative cross elasticity).
2. Business Pricing Strategy Helps in determining how price changes of one product affect others.
3. Mergers and Acquisitions Useful for competition analysis—firms in the same cross-elastic group are competitors.
4. Government Regulation Used in anti-monopoly cases to identify market boundaries.
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6. Elasticity of Demand: Definition
Elasticity of demand measures the degree of responsiveness of quantity demanded to a change in one of its determinants, like price, income, or the price of related goods.
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7. Difference Between Elastic and Inelastic Demand
Basis Elastic Demand Inelastic Demand
Responsiveness Large change in demand for a small price change Small change in demand for a large price change
E_p = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}
Methods of Measurement:
1. Percentage Method
2. Total Expenditure Method
3. Point Elasticity
4. Arc Elasticity
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9. Various Situations of Price Elasticity of Demand
Type Value Explanation
Perfectly Elastic ∞ Demand changes infinitely with no price change (horizontal curve)
Elastic >1 Demand changes more than price (luxury goods)
Unitary Elastic =1 Proportionate change in demand and price
Inelastic <1 Demand changes less than price (necessities)
Perfectly Inelastic 0 No change in demand with price change (vertical curve)
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Conclusion
Understanding the law of demand and elasticity concepts helps businesses, economists, and policymakers make informed decisions. Elasticity allows firms to predict consumer behavior, set optimal pricing, and maximize revenue, while demand theory is the cornerstone of microeconomic analysis.
