Demand of Goods and Services

Classification of Goods and Services

From conventional perspectiveFree goodsPublic goodsEconomic goods

From Islamic perspectivesAl-tayyibatAl-Rizq

Conventional PerspectivesFree Good

Goods that have no production cost (air, sunlight, rain

water).

Public Goods

Goods that have a common use and are benefit to

everyone (public clinics, schools, hospital and others.)

Economic goods

Goods which supply is limited and require costs to

purchase them (books, clothes, houses, movies)

Price is involved in obtaining them.

Islamic Perspective

Al-Tayyibat• Al-tayyibat means good things, clean and pure things, and

sustenance of the best.• Bad goods are not considered as goods in Islam.

Al- Rizq• Al-rizq is used to denote the following meanings;

- Godly sustenance, godly provision and heavenly gifts

• All these meanings denote that Allah s.w.t is the only sustainer and provider for all creatures.

Hierarchy of needs• Dharuriyah

• Goods that are classified as basic needs and necessary for a living. eg: food, cloth

• Hajiyat• Goods that will improve the quality of human life eg:

refrigerator, radio• Kamaliat

• Goods that contribute towards the perfection of human life (luxury goods). Eg: bungalow house, Mercedes cars

• Tarafiat• Not permissible (haram). Bring negative impact on society.

Not only extravagant and wasteful, but also cause harm to man. Eg: liquor

DEMAND OF GOODS AND SERVICES

Definition of demand

•The quantity of various goods that people are willing and able to buy at a particular time and at a given

range of prices.

DEMAND SCHEDULE AND DEMAND CURVE

• Demand Schedule • The demand schedule is a table that shows the relationship

between the price of the good and the quantity demanded

• Demand Curve • A demand curve is a graphical representation of a demand

schedule.• A graph of the relationship between the price of a good

and the quantity demanded. • slopes downward and to the right.

Figure 1 Siti’s Demand Schedule and Demand Curve

Copyright © 2004 South-Western

Price ofIce-Cream Cone

0

2.50

2.00

1.50

1.00

0.50

1 2 3 4 5 6 7 8 9 10 11 Quantity ofIce-Cream Cones

$3.00

12

1. A decrease in price ...

2. ... increases quantity of cones demanded.

A

B

The Individual Demand Curve andthe Law of Demand

Demand Schedule for Pizza

Price ($) Quantity of pizzas

per month2 13

4 10

6 7

8 4

10 1

The Individual Demand Curve andthe Law of Demand

• The individual demand curve shows the relationship between the price of a good and the quantity that a single consumer is willing to buy, or quantity demanded.

• The The law of demandlaw of demand states that states that the higher the price, the the higher the price, the smaller the quantity smaller the quantity demanded, ceteris paribus demanded, ceteris paribus (Other thing remain constant).(Other thing remain constant).

WHY?

The Substitution Effect• consumers react to an increase in a good’s price

by consuming less of that good and more of other goods.

The Income Effect• a person changes his or her consumption of

goods and services as a result of a change in real income.

Market Demand

• Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

• From Individual Demand to Market Demand

• market demand curveA curve showing the relationship between price and quantity demanded by all consumers, ceteris paribus.

Table 1.1 From Individual to Market Demand

Price Ind.1 Ind. 2 Market Demand

RM 2.00 600 300 (600 + 300) = 900

RM 3.00 400 200

RM 4.00 200 100

RM 5.00 100 50

How to calculate market demand?

0

D

Price of Ice-Cream Cones

Quantity of Ice-Cream Cones

A tax that raises the price of ice-cream cones results in a

movement along the demand curve.A

B

8

1.00

$2.00

4

Changes in Quantity Demanded Change in Quantity Demanded

Movement along the demand curve. Caused by a change in the price of the

product.

SHIFTS IN THE DEMAND CURVE

TastesTastes

IncomeIncomeNumber of buyers Number of buyers

ExpectationsExpectationsPrices of related goodsPrices of related goods

♥Shift factors of demand are factors that cause shifts in the demand curve

Shifts in the Demand Curve

Recall our assumption• hold other things constant – ceteris paribus allow only price to

change

• But what if other factors do change?• change in demand• shift to a new demand curve, either to the left or right.• alters the quantity demanded at every price.

Figure 3 Shifts in the Demand Curve

Copyright©2003 Southwestern/Thomson Learning

Price ofIce-Cream

Cone

Quantity ofIce-Cream Cones

Increasein demand

Decreasein demand

Demand curve, D3

Demandcurve, D1

Demandcurve, D2

0

DD11 DD22

PP

QDQD11 QDQD22

More incomeMore incomeresults inresults in

more demandmore demandfor new cars;for new cars;less demandless demandfor used cars.for used cars.

New CarsNew Cars Used CarsUsed Cars

Less incomeLess incomeresults inresults in

more demandmore demandfor used cars;for used cars;less demandless demandfor new cars.for new cars.

The Impact of a Change in Income

• Higher income decreases the demand for an inferior good

• Higher income increases the demand for a normal good

Change in Income

• An increase in income will lead to an increase in demand for most goods & services because the amount of purchasing power increases, vice versa

• As consumer’s income rises, the demand for higher quality goods will certainly increase (shown by the shift of dd curve to right) normal good

• Products for which demand declines as income rises inferior good

ComplementComplement[[InverseInverse]]

SubstituteSubstitute[[DirectDirect]]

MilkMilk CerealCereal Pop TartsPop Tarts

DD11 DD22

PPPP11

QDQD11

P2

DD11

DD22

DD

PP

QDQD22

Prices of Related Goods

• Changes in the price of substitutes• Rise in prices of one good lead to a contraction in the quantity of the

good demanded & increase in the demand for its substitutes

• Changes in the price of complements• Goods that are consumed together. When demand for one good rises, so

does demand for the other.

DD11 DD22

PP

QDQD11 QDQD22

An increase in tasteincrease in tastefor DVDs results in an

increase in demandincrease in demand.

A decrease in tastedecrease in tastefor videos results in a

decreasedecrease in in demanddemand.

DD33

QDQD33

DD11 DD22

PP

QDQD11 QDQD22

iPhoneiPhone

$399$399

Buy it now to save money.Buy it now to save money.

DD11 DD22

PP

QDQD11 QDQD22

If there is expected to be a major shortage of toilet tissuemajor shortage of toilet tissue,then consumers will stock up now or risk not getting any.

DD11 DD22

PP

QDQD11 QDQD22

Let’s say that we are coming out of recessioncoming out of recession & consumersfeel secure about their jobs. [Positive future incomePositive future income]

DD11

DD22

PP

QDQD11QDQD22

Let’s say that we are going into a recessiongoing into a recession and consumersdon’t feel secure about their jobs. [NegativeNegative future income future income]

DD11 DD22

PP

QDQD11 QDQD22

More demandMore demandfor both normalfor both normal& & inferior goodsinferior goods

New CarsNew Cars

Used CarsUsed Cars

When price changes, what happens?

•The curve does not shift.•There is a change in the quantity demanded

When something changes other than price, what happens?

The whole curve shifts,there is a change

in demand

Change in Quantity Demanded vs. Change in Demand

Change in quantity demanded Change in demand

Refer to a movement along a given demand curve

As a result of a change in the commodity price (price of the good itself whereas other factors influencing demand remains unchanged)

Refer to a shift in the demand curve (left / right)

As a result of a change in the economics variable and not the price of the good itself

A Change in Demand Versus a Change in Quantity Demanded

To summarize:

Change in price of a good or service leads to

Change in quantity demanded(Movement along the curve).

Change in income, preferences, orprices of other goods or services

leads to

Change in demand(Shift of curve).

The Exceptional Demand Curve

• Normal dd curve is always downward sloping showing inverse relationship between price of a good and quantity demanded

• However, there is a possibility that price increases, the quantity demanded also increases @ quantity demanded of a good decreases when its price falls

• Divided into 2• Regressive at high prices

• Happens to luxury goods like antique and jewellery items• Bought by the rich to show off their status• Higher price more goods would be demanded

• Regressive at low price• Happens to inferior goods like broken rice and salted fish• Lower the price offered, fewer would be demanded by the poor substitute the

existing goods to better quality goods

Luxuries goods• Those products that

have an income elasticity of demand greater than 1.

• The more expensive the goods, the greater will be the demand.

• Jewellery, antique furniture, picture of Mona Lisa etc

Q

Pd

Exceptional dd curve regressive at high price

Exceptional Demand

• Doesn't follow the law of demand

• Giffen goods• The demand curve for

giffen goods is normally upward sloping.

• Purchasing power has increase, which allowed people to replace with better quality goods

P

Q

d

Exceptional dd curve regressive at low price

ELASTICITY OF DEMAND

• Definition:Elasticity means responsiveness or sensitivity. Therefore elasticity of demand means the responsiveness of demand due to the changes of the factors that influence demand.

Types of Elasticity:

• Price elasticity of demand• Cross elasticity of demand• Income elasticity of demand• Price elasticity of supply

i. Price Elasticity of Demand (Ed)

• Ed measures the responsiveness of the quantity demanded due to the change in its price.

• Ed tries to measure how much does demand has decreased when price increased

• Calculating price elasticity of demand;Formula:

Ed = (% ∆ in Qd for product X) % ∆ in P of product X

= % ∆ in Q % ∆ in P

= (∆ Q) x P0

Q0 ∆P = (Q1 – Q0) x P0

Q0 (P1 – P0)

• Example: Price(RM) Quantity Demanded

2.00 103.00 5

• Calculate the price elasticity of demand when price increases from RM2.00 to RM3.00.

Ed = ∆ Q x P0

Q0 ∆ P = (Q1 – Q0) x P0

Q0 (P1 – P0) = (5 – 10) x 2

10 (3 – 2)= -1

# If price of good X increases by 1%, quantity of good X demanded will decrease by 1%

Degrees of Price Elasticity of Demand

• Elastic demand (Ed > 1)

Percentage change in quantity demanded is greater then the percentage change in price.

• %Δ Q > %Δ PP

Q

D

D

Smooth line dd curve

ii. Inelastic demand (0<Ed<1) or (Ed < 1)

• Percentage change in quantity is less than the percentage change in price.

• %Δ Q < %Δ P

P

Q

D

D

Steep line dd curve

iii. Unitary elastic (Ed = 1)

• Percentage change in quantity demanded is equal to the percentage change in price.

• %Δ Q = %Δ P

D

P

X

Hyperbola line dd curve

iv. Perfectly Elastic (Ed = ∞)

• Percentage change in quantity demanded is infinite in relation to the percentage change in price small % change in price of a good would lead to infinite changes in its quantity demanded

P

Q

DP0

Horizontal line demand curve

v. Perfectly Inelastic (Ed = 0 )

• Quantity demanded does not change as the price changes.

P

QQ0

D

P1

P2

Determinants of Price Elasticity of Demand

• Availability of substitutes

many substitutes more elastic ddless/no substitutes less elactic/ inelastic ddEg: petrol and detergents (liquid, soap)

• Relative importance of the goods in the budget

greater the income spent more elastic ddEg: dd for house is more elastic compared to demand for detergents because money spent on houses is greater than money spent on detergents.

• Time frame

In short run less elastic/ inelastic dd

In the long run demand more elastic because consumers can make adjustment and find other substitutes.

• The importance of goods – necessity or luxury

Necessity good inelastic dd eg: rice (great increase in price will not reduce the demand for rice very much).

Luxury goods/ less important goods elastic dd

• The number of usage

many number of usage more elastic compared to goods that have fewer usage. Eg: demand for rubber is more elastic because it can be processed into rubber hoses, tyres, gloves, & etc

• Income level

higher income people inelastic dd.

lower income group elastic dd (sensitive to price changes)

• Habits

habits inelastic dd. Eg: demand for cigarette by smokers.

Relationship between price elasticity of demand and total revenue (TR)

• Important for producers to decide whether they should increase, decrease or maintain the price of the good they sold in the market to enable them to maximize their profit

• TR = price x quantity• TR increases or decreases when there is price changes depend on

the price elasticity of demand.

i. If demand is elastic, to increase TR, price should be decreased.

ii. If demand is inelastic, to increase TR, price should be increased.

iii. If demand is unitary elastic, change in price would not affect and change in TR.

(i) Inelastic demand (Ed<1)Assume price increases from RM10 to RM15

Price (RM)

Quantity (units)

8 10

10

15Steep line demand curve

TR before = RM10 x 10 = RM100

TR after = RM15 x 8 = RM120

(TR increases)

# If demand is inelastic, an increase in price will lead to an increase total revenue & vice versa

ii) Elastic demand (Ed>1)Assume that price increases from Rm10 to RM11

Smooth line demand curve

P

Q7 10

10

11

TR before = RM10 x 10 = RM100

TR after = RM11 x 7 = RM77

(TR decreases)

# If demand is elastic, an increase in price will lead to a decrease in total revenue.

20

10

10 20

P

Q

iii) Unitary elastic demand (Ed=1)Assume that price increases from RM10 to RM20

TR before = RM10 x 20 = RM200

TR after = RM20 x 10 = RM200

(TR remains the same)

# If demand is unitary elastic, an increase in price will make total revenue remains the same

Hyperbola line dd curve

The R/ship between TR & Price Elasticity of Demand when Price Increases

Elasticity Coefficient

Price Elasticity of Demand

Price Quantity Demanded

Total Revenue

Ed>1 Elastic Increases Decreases more than

proportionate

Decreases

Ed=1 Unitary elastic Increases Decreases in exact

proportion

Remain the same

Ed<1 Inelastic Increases Decreases less than

proportionate

Increases

The R/ship between TR & Price Elasticity of Demand when Price Decreases

Elasticity Coefficient

Price Elasticity of Demand

Price Quantity Demanded

Total Revenue

Ed>1 Elastic Decreases Increases more than

proportionate

Increases

Ed=1 Unitary elastic Decreases Increases in exact

proportion

Remain the same

Ed<1 Inelastic Decreases Increases less than

proportionate

Decreases

Cross Elasticity of Demand (Exy)

• Exy measures the responsiveness of quantity demanded for one product to a change in the price of another product.

Formula:

Exy = % ∆ in Qx

% ∆ in Py

= ∆ Qx x Py0

∆ Py Qx0

= (Qx1 – Qx0) x Py0

(Py1 – Py0) Qx0

i) Exy < 0 product X is a complement of product Y

ii) Exy > 0 product X and Y are substitutes for one another

iii) Exy = 0 product X and Y are independent for one another

• Example:Price of Y Quantity x Quantity Y

RM10 60 15RM18 40 25RM25 20 30

• Calculate the cross elasticity of demand for good x when the price of y increases from RM18 to RM25

Answer:Formula :

= ∆ Qx x Py0

∆ Py Qx0

= (Qx1 – Qx0) x Py0

Qx0 Py1 – Py0

= 20 - 40 x 18 40 25 - 18

= -1.29

• Conclusion;Goods x and y are complement

Income Elasticity of Demand (Ey)

• Ey measures the responsiveness of quantity demanded to a change in income.

• Three possibilities:i. If Ey is positive = normal goods -

Ey >1 - luxury Ey ≤ 1 – necessity

ii. If Ey is negative = inferior goodsiii. If Ey is zero = essential goods

Eg. Ey = 5 if income increase 1%, quant. demanded for good X will increase by 5%

Ey = 0 if income changes, quant. demanded for good B remains unchanged

• Formula:Ey = % ∆ in Q

% ∆ in Y= ∆ Q x Y0

∆ Y Q0

= (Q1 – Q0) x Y0

(Y1 – Y0) Q0

= (Q1 – Q0) x Y0

Q0 (Y1 – Y0)

• Example:Income Qty A Qty B Qty C 100 10 20 20 120 15 20 18 150 17 20 14

Calculate the income elasticity of demand for goods A, B and C when income increases from RM120 to RM150.

• Good A:Ey = (QA1 – QA0) x Y0

QA0 (Y1 – Y0)

= (17 – 15) x 120 15 (150 – 120)

= 0.53

• Since Ey is positive and < 1, good A is a necessity good• When Y increase by 1%, quant. demanded for good A

increase by 0.53%

• Good B:Ey = (QB1 – QB0) x Y0

QB0 (Y1 – Y0)

= (20 – 20) x 120 20 (150 – 120)

= 0 (Good B is essential good)

# if Y change, q.demanded for good B remains unchanged

• Good C:Ey = (QC1 – QC0) x Y0

QC0 (Y1 – Y0)

= (14 – 18) x 120 18 (150 – 120)

= - 0.89

• Good C is an inferior good• When Y increase by 1%, quantity demanded for good C

decrease by 0.89%