Historical Background of Economics

Economic history is the study of economies or economic phenomena of the past.

Analysis in economic history is undertaken using a combination of historical
methods, statistical methods and the application of economic theory to historical
situations and institutions. The topic includes financial and business history and overlaps
with areas of social history such as demographic and labor history. The quantitative—in
this case, econometric—study of economic history is also known as cliometrics.[1]

Economy
is an area of
the production, distribution,or trade, and consumption of goods and services by
[1]

different agents. Understood in its broadest sense, 'The economy is defined as a social
domain that emphasize the practices, discourses, and material expressions associated
with the production, use, and management of resources'.

Economics
Is the social science that studies the production, distribution, and consumption of goods
and services. Economics focuses on the behavior and interactions of economic agents
and how economies work.

Development as a separate field

In Germany in the late 19th century, scholars in a number of universities, led by Gustav
von Schmoller, developed the historical school of economic history. It ignored
quantitative and mathematical approaches. Historical approach dominated German
and French scholarship for most of the 20th century.
The approach was spread to Great Britain by William Ashley, 1860–1927, and
dominated British economic history for much of the 20th century. Britain's first professor in
the subject was George Unwin at the University of Manchester.[2][3]
In France, economic history was heavily influenced by the Annales School from the
early 20th century to the present. It exerts a worldwide influence through its
Journal Annales. Histoire, Sciences Sociales

Gustav von Schmoller

Was the leader of the "younger" German historical school of economics. As an
outspoken leader of the "younger" historical school, Schmoller opposed what he saw as
the axiomatic-deductive approach of classical economics and, later, the Austrian
school—indeed, Schmoller coined the term to suggest provincialism in an unfavorable
review of the 1883 book Investigations into the Method of the Social Sciences with
Special Reference to Economics (Untersuchungen über die Methode der
Socialwissenschaften und der politischen Oekonomie insbesondere) by Carl Menger,
which attacked the methods of the historical school.

Economic history and economics

The study of dis-equilibrium may proceed in either of two ways. We may take as our unit
for study an actual historical case of great dis-equilibrium, such as, say, the panic of
1873; or we may take as our unit for study any constituent tendency, such as, say,
deflation, and discover its general laws, relations to, and combinations with, other
tendencies. The former study revolves around events, or facts; the latter, around
tendencies. The former is primarily economic history; the latter is primarily economic
science. Both sorts of studies are proper and important. Each helps the other. The panic
of 1873 can only be understood in light of the various tendencies involved—deflation
and other; and deflation can only be understood in the light of various historical
manifestations—1873 and other.

There is a school of thought among economic historians that splits economic history—
the study of how economic phenomena evolved in the past—from historical
economics—testing the generality of economic theory using historical episodes. US
economic historian Charles P. Kindleberger explained this position in his 1990 book
Historical Economics: Art or Science?.[5]

The new economic history, also known as cliometrics, refers to the systematic use of
economic theory and/or econometric techniques to the study of economic history. The
term cliometrics was originally coined by Jonathan R. T. Hughes and Stanley Reiter in
1960 and refers to Clio, who was the muse of history and heroic poetry in Greek
mythology. Cliometricians argue their approach is necessary because the application
of theory is crucial in writing solid economic history, while historians generally oppose
this view warning against the risk of generating anachronisms. Early cliometrics was a
type of counterfactual history. However, counterfactualism is no longer its distinctive
feature. Some have argued that cliometrics had its heyday in the 1960s and 1970s and
that it is now neglected by economists and historians.[6]
Cliometrics (klīəˈmetriks[needs IPA]), sometimes called new economic history,[1] or
econometric history,[2] is the systematic application of economic theory, econometric
techniques, and other formal or mathematical methods to the study of history
(especially social and economic history).[3] It is a quantitative (as opposed to
qualitative or ethnographic) approach to economic history.[4] The term cliometrics
comes from Clio, who was the muse of history, and was originally coined by the
mathematical economist Stanley Reiter in 1960.[5] There has been a revival in 'new
economic history' since the late 1990s.[6][7]
In recent decades economic historians, following Douglass North, have tended to
move away from narrowly quantitative studies toward institutional, social, and cultural
history affecting the evolution of economies.[7][a 1] However, this trend has been
criticized, most forcefully by Francesco Boldizzoni, as a form of economic imperialism
"extending the neoclassical explanatory model to the realm of social relations."[8]
Conversely, economists in other specializations have started to write on topics
concerning economic history.[a 2]

Economic history and the history of capitalism

A new field calling itself the "History of Capitalism" has emerged in US history
departments since about the year 2000. It includes many topics traditionally associated
with the field of economic history, such as insurance, banking and regulation, the
political dimension of business, and the impact of capitalism on the middle classes, the
poor and women and minorities. The field utilizes the existing research of business
history, but has sought to make it more relevant to the concerns of history departments
in the United States, including by having limited or no discussion of individual business
enterprises

Nobel Memorial Prize-winning economic historians

Simon Kuznets won the Nobel Memorial Prize in Economic Sciences ("the Nobel
Memorial Prize") in 1971 "for his empirically founded interpretation of economic growth
which has led to new and deepened insight into the economic and social structure
and process of development".
Milton Friedman won the Nobel Memorial Prize in 1976 for "his achievements in the fields
of consumption analysis, monetary history and theory and for his demonstration of the
complexity of stabilization policy".
Robert Fogel and Douglass North won the Nobel Memorial Prize in 1993 for "having
renewed research in economic history by applying economic theory and quantitative
methods in order to explain economic and institutional change".
Merton Miller, who started his academic career teaching economic history at the LSE,
won the Nobel Memorial Prize in 1990 with Harry Markowitz and William F. Sharpe.

Notable economic historians

Moses Abramovitz (January 1, 1912 – December 1, 2000) was a 20th-century American
economist and professor. During his career, he made many contributions to the study of
macroeconomic fluctuations and economic growth over time.
Robert (Bob) Carson Allen (born 10 January 1947 in Salem, Massachusetts) is Professor of
Economic History at New York University Abu Dhabi.[1] His research interests are
economic history, technological change and public policy[2] and he has written
extensively on English agricultural history.[3] He has also studied international
competition in the steel industry,[4] the extinction of Bowhead Whales in the Eastern
Arctic,[5] and contemporary policies on education.
Thomas Southcliffe Ashton (1889–1968) was an English economic historian. He was
professor of economic history at the London School of Economics at the University of
London from 1944 until 1954, and Emeritus Professor until his death in 1968. His best
known work is the 1948 textbook The Industrial Revolution (1760–1830), which put forth a
positive view on the benefits of the era.
Correlli Douglas Barnett CBE FRHistS FRSL FRSA (born 28 June 1927) is an English military
historian, who has also written works of economic history, particularly on the United
Kingdom's post-war "industrial decline".
Jörg Baten (born 24 June 1965 in Hamburg) is a German economic historian. He is the
former President of the European Historical Economics Society and is currently a
professor of economic history at the Eberhard Karls University of Tübingen.
Maxine Louise Berg, FRHistS, FBA (born 22 February 1950) is a British historian and
academic. Since 1998, she has been Professor of History at the University of Warwick.
She has taught at Warwick since 1978, joining the Department of Economics, before
transferring to History. She is a Fellow of the British Academy and of the Royal Historical
Society.
Jean-François Bergier (French: [bɛʁʒje]; 5 December 1931, Lausanne, Vaud – 29
October 2009, Blonay) was a Swiss historian. He was a professor at the University of
Geneva from 1963 to 1969 and at the Swiss Federal Institute of Technology in Zurich until
his retirement in 1999.
Ben Shalom Bernanke (/bərˈnæŋki/ bər-NANG-kee; born December 13, 1953) is an
American economist at the Brookings Institution[3] who served two terms as Chair of the
Federal Reserve, the central bank of the United States, from 2006 to 2014. During his
tenure as chair, Bernanke oversaw the Federal Reserve's response to the late-2000s
financial crisis. Before becoming Federal Reserve chair, Bernanke was a tenured
professor at Princeton University and chaired the department of economics there from
1996 to September 2002, when he went on public service leave.
Francesco Boldizzoni (born in 1979) is an Italian academic and historian. He is a
research professor of economic history at the University of Turin and a member of Clare
Hall, Cambridge.
Boldizzoni is primarily a historian of capitalism. He has developed an intellectual
framework that emphasizes the relevance of the history of ideas and concepts to the
understanding of the modern economy. He has advocated an anti-positivist approach
to social science history, which draws on historicism, post-structuralism, cultural
interpretation, and critical theory. He is currently best known for his critique of neoliberal
economic history, The Poverty of Clio.
Fernand Braudel (French: [bʁodɛl]; 24 August 1902 – 27 November 1985) was a French
historian and a leader of the Annales School. His scholarship focused on three main
projects: The Mediterranean (1923–49, then 1949–66), Civilization and Capitalism (1955–
79), and the unfinished Identity of France (1970–85). His reputation stems in part from his
writings, but even more from his success in making the Annales School the most
important engine of historical research in France and much of the world after 1950. As
the dominant leader of the Annales School of historiography in the 1950s and 1960s, he
exerted enormous influence on historical writing in France and other countries. He was
a student of Henri Hauser (1866-1946).
Braudel has been considered one of the greatest of the modern historians who have
emphasized the role of large-scale socioeconomic factors in the making and writing of
history.[1] He can also be considered as one of the precursors of world-systems theory.
Economics Goals
Microeconomic Goals
Efficiency and equity are the two microeconomic goals most relevant to markets,
industries, and parts of the economy, and are thus important to the study of
microeconomics.
Efficiency: Efficiency is achieved when society is able to get the greatest amount of
satisfaction from available resources. With efficiency, society cannot change the way
resources are used in any way that would increase the total amount of satisfaction
obtained by society. The pervasive scarcity problem is best addressed when limited
resources are used to satisfy as many wants and needs as possible.
While efficiency is indicated by equality between demand price and supply price for a
given market, there are no clear-cut comprehensive indicators for attaining this
efficiency goal. While it is possible, in theory, to pinpoint what is needed for efficiency,
the complexity of the economy makes the task difficult to accomplish in practice.
Equity: Equity is achieved when income and wealth are fairly distributed within a
society. Almost everyone wants a fair distribution. However, what constitutes a fair and
equitable distribution is debatable. Some might contend that equity is achieved when
everyone has the same income and wealth. Others contend that equity results when
people receive income and wealth based on the value of their production. Still others
argue that equity is achieved when each has only the income and wealth that they
need.
Equity means income and wealth are distributed according to a standard of fairness.
But what is the fairness standard? It could be equality. Or it could be the productive
value of resources. Or it could be need. Standards for equity moves into the realm of
normative economics.

Macroeconomic Goals
Full employment, stability, and economic growth are the three macroeconomic goals
most relevant to the aggregate economy and consequently are of prime importance
to the study of macroeconomics.

Full Employment: Full employment is achieved when all available resources (labor,
capital, land, and entrepreneurship) are used to produce goods and services. This goal
is commonly indicated by the employment of labor resources (measured by the
unemployment rate). However, all resources in the economy--labor, capital, land, and
entrepreneurship--are important to this goal. The economy benefits from full
employment because resources produce the goods that satisfy the wants and needs
that lessen the scarcity problem. If the resources are not employed, then they are not
producing and satisfaction is not achieved.

Stability: Stability is achieved by avoiding or limiting fluctuations in production,

employment, and prices. Stability seeks to avoid the recessionary declines and
inflationary expansions of business cycles. This goal is indicated by month-to-month and
year-to-year changes in various economic measures, such as the inflation rate, the
unemployment rate, and the growth rate of production. If these remain unchanged,
then stability is at hand. Maintaining stability is beneficial because it means uncertainty
and disruptions in the economy are avoided. It means consumers and businesses can
safely pursue long-term consumption and production plans. Policy makers are usually
most concerned with price stability and the inflation rate.

Economic Growth: Economic growth is achieved by increasing the economy's ability to

produce goods and services. This goal is best indicated by measuring the growth rate
of production. If the economy produces more goods this year than last, then it is
growing. Economic growth is also indicated by increases in the quantities of the
resources--labor, capital, land, and entrepreneurship--used to produce goods. With
economic growth, society gets more goods that can be used to satisfy more wants and
needs--people are better off; living standards rise; and scarcity is less of a problem.

Two Main Branch of Economics

Microeconomics

In our daily lives, we face innumerable economic decisions, such as choosing

what to buy with available money or what to do during our free time. These
topics, which are related to the decisions of individual agents (individuals,
families, businesses), are the object of study in an area of economics
called microeconomics.

Macroeconomics

Another area of economics is macroeconomics, which studies the relationship

between economic aggregates. Economic aggregates are elements that are
made up of the sum of other variables. For instance, the Gross Domestic
Product (GDP) is the sum of everything that is produced by each individual and
organization within a country. The consumer price index is made up of the
average price of numerous products. The aggregate investment is the sum of
the expenditures in investment of all businesses and families of a country, etc.
Source: https://economicpoint.com/branches-economics

Branches of Economics
From: EconomicPoint.com:
Behavioural Economics: It studies the effects of social, psychological, cognitive,
and emotional factors on the economic decisions. It uses
mainly microeconomics.
Ecological Economics: It studies the relation between the economy and the
environment and how to achieve sustainable development.
Environmental Economics: How natural resources are developed and
managed. It uses mainly microeconomics.
Health Economics: It studies the economy of the health and health care sector.
Focused on microeconomics
Information Economics: How information and information systems affect an
economy and economic decisions. It uses mainly microeconomics.
International Economics: How economic relations between countries, mainly
trade, investment and labor flows, affect the economies. It can use
microeconomics models, but is focused on macroeconomics aggregates.
Labour Economics: It studies the labour (job) markets. It also uses a lot of tools
from the microeconomics, but it can include macroeconomic analysis.
Monetary Economics: It studies means of payments (money, etc.) markets.
Population Economics: It studies demography using the tools of economics, and
the relation between economy and population.
Public Finance: It studies the role of the government in the economy: public
spending, taxes, deficit, etc.
Urban Economics: It applies the tools of economics to the study of cities: transit,
housing, crime, etc.
Source: https://economicpoint.com/branches-economics

An economic system, or economic order,[1] is a system of production, resource

allocation and distribution of goods and serviceswithin a society or a
given geographic area. It includes the combination of the various institutions,
agencies, entities, decision-making processes and patterns of consumption that
comprise the economic structure of a given community. As such, an economic
system is a type of social system. The mode of production is a related
concept.[2] All economic systems have three basic questions to ask: what to
produce, how to produce and in what quantities and who receives the output
of production.
The study of economic systems includes how these various agencies and
institutions are linked to one another, how information flows between them and
the social relations within the system (including property rights and the structure
of management). The analysis of economic systems traditionally focused on the
dichotomies and comparisons between market economies and planned
economies and on the distinctions
between capitalism and socialism. Subsequently,
[3] the categorization of
economic systems expanded to include other topics and models that do not
conform to the traditional dichotomy. Today the dominant form of economic
organization at the world level is based on market-oriented mixed economies.[4]
Economic systems is the category in the Journal of Economic
Literature classification codes that includes the study of such systems. One field
that cuts across them is comparative economic systems, which include the
following subcategories of different systems:

 Planning, coordination and reform.

 Productive enterprises; factor and product markets; prices; population.
 Public economics; financial economics.
 National income, product and expenditure; money; inflation.
 International trade, finance, investment and aid.
 Consumer economics; welfare and poverty.
 Performance and prospects.
 Natural resources; energy; environment; regional studies.
 Political economy; legal institutions; property rights.

COMPONENTS

There are multiple components to economic system. Decision-making structures

of an economy determine the use of economic inputs (the factors of
production), distribution of output, the level of centralization in decision-making
and who makes these decisions. Decisions might be carried out by industrial
councils, by a government agency, or by private owners. An economic system is
a system of production, resource allocation, exchange and distribution of goods
and services in a society or a given geographic area.
In one view, every economic system represents an attempt to solve three
fundamental and interdependent problems:

 What goods and services shall be produced and in what quantities?

 How shall goods and services be produced? That is, by whom and with what
resources and technologies?
 For whom shall goods and services be produced? That is, who is to enjoy the
benefits of the goods and services and how is the total product to be
distributed among individuals and groups in the society?

Every economy is thus a system that allocates resources for exchange,

production, distribution and consumption. The system is stabilized through a
combination of threat and trust, which are the outcome of institutional
arrangements.
An economic system possesses the following institutions:
 Methods of control over the factors or means of production: this may include
ownership of, or property rights to, the means of production and therefore
may give rise to claims to the proceeds from production. The means of
production may be owned privately, by the state, by those who use them, or
be held in common.

 A decision-making system: this determines who is eligible to make decisions

over economic activities. Economic agents with decision-making powers
can enter into binding contracts with one another.

 A coordination mechanism: this determines how information is obtained and

used in decision-making. The two dominant forms of coordination are
planning and markets; planning can be either decentralized or centralized,
and the two coordination mechanisms are not mutually exclusive and often
co-exist.

 An incentive system: this induces and motivates economic agents to

engage in productive activities. It can be based on either material reward
(compensation or self-interest) or moral suasion (for instance, social prestige
or through a democratic decision-making process that binds those involved).
The incentive system may encourage specialization and the division of labor.

 Organizational form: there are two basic forms of organization: actors and
regulators. Economic actors include households, work gangs and production
teams, firms, joint-ventures and cartels. Economically regulative organizations
are represented by the state and market authorities; the latter may be
private or public entities.

 A distribution system: this allocates the proceeds from productive activity,

which is distributed as income among the economic organizations,
individuals and groups within society, such as property owners, workers and
non-workers, or the state (from taxes).

 A public choice mechanism for law-making, establishing rules, norms and

standards and levying taxes. Usually, this is the responsibility of the state, but
 other means of collective decision-making are possible, such as chambers of
commerce or workers’ councils

The concept of demand and supply is all about balancing the requirements and
provision of products and service. There are various laws and determinants that
govern demand and supply quotients for both, individuals as well as the market.
Let us learn them all!

 Determinants of Demand
 Law of Demand
 Demand Schedule
 Individual and Market Demand Curve
 Change in Demand
 Exceptions to Law of Demand
 Concept and Determinants of Supply
 Law of Supply
 Supply Schedule
 Individual and Market Supply Curve
 Change in Supply
 Exceptions to Law of Supply
 Equilibrium Price
 Price Elasticity of Demand
 Cross Price Elasticity of Demand
 Income Elasticity of Demand
 Price Elasticity of Supply

Meaning and Determinants of Demand

We have often heard the phrase ‘there is a huge demand for product XYZ in the
market’. But what does this exactly mean? What constitutes the demand for a
product in the economy? Let us learn about the concept of demand and the
determinants of demand in a market.

What is Demand?
Demand in terms of economics may be explained as the consumers’ willingness
and ability to purchase or consume a given item/good. Furthermore, the
determinants of demand go a long way in explaining the demand for a particular
good.
For instance, an increase in the price of a good will lead to a decrease in the
quantity that may be demanded by consumers. Similarly, a decrease in the cost
or selling price of a good will most likely lead to an increase in the demanded
quantity of the goods.
This indicates the existence of an inverse relationship between the price of the
article and the quantity demanded by consumers. This is commonly known as the
law of demand and can be graphically represented by a line with a downward
slope.
The graphical representation is known as the demand curve. The determinants of
demand are factors that cause fluctuations in the economic demand for a
product or a service.
Some of the important determinants of demand are as follows,

1] Price of the Product

People use price as a parameter to make decisions if all other factors remain
constant or equal. According to the law of demand, this implies an increase in
demand follows a reduction in price and a decrease in demand follows an
increase in the price of similar goods.
The demand curve and the demand schedule help determine the demand
quantity at a price level. An elastic demand implies a robust change quantity
accompanied by a change in price. Similarly, an inelastic demand implies that
volume does not change much even when there is a change in price.

2] Income of the Consumers

Rising incomes lead to a rise in the number of goods demanded by consumers.
Similarly, a drop in income is accompanied by reduced consumption levels. This
relationship between income and demand is not linear in nature. Marginal utility
determines the proportion of change in the demand levels.

3] Prices of related goods or services

 Complementary products – An increase in the price of one product will

cause a decrease in the quantity demanded of a complementary product.
Example: Rise in the price of bread will reduce the demand for butter. This
arises because the products are complementary in nature.

 Substitute Product – An increase in the price of one product will cause an

increase in the demand for a substitute product. Example: Rise in price of tea
will increase the demand for coffee and decrease the demand for tea.
4] Consumer Expectations
Expectations of a higher income or expecting an increase in prices of goods will
lead to an increase the quantity demanded. Similarly, expectations of a reduced
income or a lowering in prices of goods will decrease the quantity demanded.

5] Number of Buyers in the Market

The number of buyers has a major effect on the total or net demand. As the
number increases, the demand rises. Furthermore, this is true irrespective of
changes in the price of commodities.

Solved Question on Determinants of Demand

Q: A rise in the price of petrol will ____ the demand for cars

a. Decrease
b. Increase
c. Not affect
d. None of the above

Ans: The correct answer is A. Petrol and car are complementary goods. The rise in
the price of petrol will decrease the demand for cars in the market.

Law of Demand and Elasticity of Demand

Now that we are familiar with the concept of demand and the determinants of
demand, let us study about another important concept – the elasticity of
demand. We will be studying the meaning and the types of demand elasticity.
Let’s get started.

Law of Demand
Economists use the term demand as a reference to the quantity of a good or
service that a consumer is willing and has the ability to purchase at a price.
Demand is based on needs and the ability to pay. Ability to pay is important as
in its absence the demand becomes ineffective.

The law of demand states that if all other factors remain constant, then the price
and the demanded quantity of any good and service are inversely related to
one another. This implies that if the price of an article increases then its
corresponding demand decreases. Similarly, if the price of an article decreases
then its demand should increase accordingly.
The price of the good and its price are plotted to form the demand curve. The
demand quantity at a particular price can be calculated from the demand
curve. This price and value relation is represented in a table known as the
demand schedule.

Solved Question for You

Q: What is Ceteris Paribus?

Ans: It is important to take into account the assumptions made while

constructing the law of demand. A primary assumption is ‘Ceteris paribus’. This
implies that everything aside from price remains constant and no change in any
other economic variable. Furthermore, the change in the demanded quantity is
only due to a change in prices.

Elasticity of Demand

The elasticity of demand is an economic term. It refers to demand sensitivity. In

other words, it helps to understand how the demand for good changes is when
there are changes in other economic variables. These economic variables
include factors such as prices and consumer income.

Demand elasticity is calculated as the percent change in the quantity

demanded divided by a percent change in another economic variable. A
higher value for the demand elasticity with respect to an economic variable
means that consumers are more sensitive to changes in this variable.

The elasticity of demand = (% Change in demanded quantity)/(% Change in

another economic variable)

Types of Demand Elasticity

Let us take a look at the types of demand elasticity. There are broadly three
types of demand elasticity.

1] Price Elasticity of Demand

This refers to the change or sensitivity in the customer’s demand for the quantity
of a good with respect to a change in its price. Companies often collect this
data on the consumer response to price changes. This helps them adjust the
price to maximize profits.

2] Income Elasticity of Demand

This is the responsiveness of demand for a product with respect to the change in
income. So it will help measure the increase or decrease in demand when the
income of the consumer increases or decreases.

3] Cross Elasticity of Demand

This value is calculated by using the percent change in demanded quantity for
a good and dividing it by the percent change in the price of some other good.
Moreover, this indicates the consumer reaction to demand a particular good in
accordance with price changes of other goods.

Demand elasticity is generally measured in absolute terms. This implies the sign
of the variable is ignored. If the value is greater than 1, it is elastic. Furthermore,
this implies demand is responsive to economic changes (like price). If the value
is less than 1 is inelastic.

This further implies demand does not show change according to economic
changes such as price. Demand is unit elastic when its value is equal to 1. This
implies the value of demand moves proportionately with economic changes.

Cross Elasticity of Demand

Have you noticed how a change in the price of petrol affects the demand for
automobiles that run on diesel? Have you ever wondered why the consumption
of tea increases when there is an increase in the price of coffee? Now, let us
familiarize ourselves with Cross Elasticity of Demand.

Economists define elasticity of demand as to how reactive the demand for a

product is to changes in factors such as price or income. However, the elasticity
of demand does not just stop there. There are times when the price change of
one product affects the demand for another product. And this concept is
called cross-elasticity of demand, which we will discuss in this article. However,
before we go further, let us briefly revisit the laws of supply and demand.

Now, in economic terms, cross elasticity of demand is the responsiveness of

demand for a product in relation to the change in the price of another related
product. The relevant word here is “related” product. Unrelated products have
zero elasticity of demand. An increase in the price of pulses will have no effect
on the demand for chocolates. You can measure the cross elasticity of demand
by dividing the percentage of change in the demand for one product by the
percentage of change in the price of another product.

Cross Elasticity of Demand = % of the change in the demand for Product A / %

of the change in the price of product B

The most important concept to understand in terms of cross elasticity is the type
of related product. The cross elasticity of demand depends on whether the
related product is a substitute product or a complementary product.

Substitute and Complementary Products

As mentioned earlier, cross elasticity measures the demand responsiveness in
relation to related products. And these related products can be either
substitutes or complementary products. Let us understand the difference
between the two.

Substitute Products
Substitute products are goods that are in direct competition. An increase in the
price of one product will lead to an increase in demand for the competing
product. For instance, an increase in the price of petrol will force consumers to
go for diesel and increase the demand for diesel. Now, the cross elasticity value
for two substitute goods is always positive. The more close the substitutes are in
terms of use and quality, the more positive the cross elasticity of demand would
be. That is, even a minor change in the price of one product highly affects the
demand for the substitute product.

However, if the related product is a weak substitute, then the demand will be
less cross elastic, but positive. That is, a change in the price of a product might
not greatly affect the demand for its substitute.

Complementary Products
Complementary goods, on the other hand, are products that are in demand
together. An ideal example would be coffee beans and coffee paper filters. If
the price of coffee increases, then the demand for filters would reduce because
the demand for coffee will reduce. The cross elasticity of demand for two
complementary products is always negative.

Again, the stronger the complementary relationship between two products, the
more negative the cross elasticity coefficient would be. For instance, if the price
of XBOX increases, the demand for XBOX compatible games would reduce.
Solved Question on Cross Elasticity of Demand

Q: What is the relevance of Cross Elasticity of Demand?

Ans: Cross elasticity of demand is an important and relevant concept for
industries and production units. Research analysts in a company closely analyze
the cross elasticity trends in the market between related products and then set
prices for their products.

A company can sell its premium product at a higher price if it has no substitutes.
However, if a product has a strong substitute available in the market, then the
company will strategically market and price that product to ensure a steady
demand.

Movement along the Demand Curve and Shift of the Demand Curve

While understanding the meaning and analysis of a demand curve in the study
of Economics, it is also important to be able to make a distinction between the
movement and shift of the demand curve. In this article, we will look at ways by
which you can understand the difference between a movement along a
demand curve and shift of the demand curve.

Every firm faces a certain demand curve for the goods it supplies. There are
many factors that affect the demand and these effects can be seen by
observing the changes in the demand curve. Broadly speaking, the factors can
be categorized into two types:
 Change in demand
  Change in the quantity demanded

Movement of the Demand Curve

When there is a change in the quantity demanded of a particular commodity,

because of a change in price, with other factors remaining constant, there is a
movement of the quantity demanded along the same curve.

The important aspect to remember is that other factors like the consumer’s
income and tastes along with the prices of other goods, etc. remain constant
and only the price of the commodity changes.
In such a scenario, the change in price affects the quantity demanded but the
demand follows the same curve as before the price changes. This is Movement
of the Demand Curve. The movement can occur either in an upward or
downward direction along the demand curve.

We know that if all other factors remain constant, then an increase in the price
of a commodity decreases its demand. Also, a decrease in the price increases
the demand. So, what happens to the demand curve?

In Fig. 1 above, we can see that when the price of a commodity is OP, its
demand is OM (provided other factors are constant). Now, let’s look at the
effect of an increase and decrease in price on the demand:
  When the price increases from OP to OP”, the quantity demanded falls to
OL. Also, the demand curve moves UPWARD.
 When the price decreases from OP to OP’, the quantity demanded rises
to ON. Also, the demand curve moves DOWNWARD.

Therefore, we can see that a change in price, with other factors remaining
constant moves the demand curve either up or down.

The shift of the Demand Curve

When there is a change in the quantity demanded of a particular commodity,
at each possible price, due to a change in one or more other factors, the
demand curve shifts. The important aspect to remember is that other factors like
the consumer’s income and tastes along with the prices of other goods, etc.,
which were expected to remain constant, changed.

In such a scenario, the change in price, along with a change in one/more other
factors, affects the quantity demanded. Therefore, the demand follows a
different curve for every price change.

This is the Shift of the Demand Curve. The demand curve can shift either to the
left or the right, depending on the factors affecting it.

Let’s look at an example which captures the effect of a change in consumer’s

income on the quantity demanded.

Quantity demanded when the average Quantity demanded when the average
Price (Rs.)
household income is Rs. 4000 household income is Rs. 5000

5 10 (A) 15 (A1)
 4 15 (B) 20 (B1)

3 20 (C) 25 (C1)

2 35 (D) 40 (D1)

1 60 (E) 65 (E1)

The demanded quantities are plotted as demand curves DD and D’D’ as shown
below:

From Fig. 2 above, we can clearly see that if the income changes, then a
change in price shifts the demand curve. In this case, the shift is to the right
which indicates that there is an increase in the desire to purchase the
commodity at all prices.
Hence, we can conclude that with an increase in income the demand curve
shifts to the right. On the other hand, if the income falls, then the demand curve
will shift to the left decreasing the desire to purchase the commodity.

Solved Question on a shift of the demand curve

Q1. In the case of movement of the demand curve, it:

o moves upward or downward

o moves left or right
o both of the above
o none of the above

Answer: Movement of the demand curve happens when all other factors
affecting the quantity demanded, remain constant and only the price changes.
Hence, the demand moves upward or downward along the same curve.
Therefore, the correct answer is option A