DEMAND ANALYSIS

UNIT II

MEANING OF DEMAND

Demand is one of the crucial requirements for the

existence of any business enterprise. A firm is
interested in its own profit and/or sales, both of
which depend partially upon the demand for its
product. The decisions which management takes
with respect to production, advertising, cost
allocation, pricing, etc., call for an analysis of
demand.

Demand for a commodity implies

Desire to acquire it

Willingness to pay for it, and

Ability to pay for it.

Individual Consumers Demand

QdX = f(PX, I, PY, T,A)
Qdx=quantity demanded of commodity X
by an individual per time period
Px =price per unit of commodity X
I= consumers income
PY=price of related (substitute or
complementary) commodity
T=tastes of the consumer
A= Advertisements

CAUSES OF INCREASE IN DEMAND

Increase

in consumer income
House hold income may rise for a
number of reasons
Rise in Gross Income
Rise in disposable income
Rise in discretionary income
Causes

consumers to buy more of the

product at each and every price.
Normal goods
Inferior goods

CHANGE IN CONSUMER INCOME

Normal
A

goods

good for which demand

increases as consumer
income rise

Inferior
A

goods

good which demand

decreases as consumer
income increases
Primary Goods:
Basic Goods-Wheat,Rice
Primary Raw material

CHANGES IN PRICE OF RELATED

GOODS
Substitutes
Goods

that are alternative

to each other
Goods

that are related in

such a way that an increase
in the price of one shifts the
demand curve for the other
rightward.
Increase in price of Coke
leads to increase in
demand for Pepsi

COMPLEMETS
They are the goods that tend to be bought
and used together, so that an increase in the
demand for one is likely to cause an increase
in the demand for the other .
Examples:
Motor cars and components and raw
materials that go into their manufacture
Bread and butter

TASTE AND PREFERENCE AND

ADVERTISEMENTS
Whenever fashion changes taste of the
consumer changes and so demand for the
product will change
Example : Styles of clothing, design ect
Footware :Styles and design

Advertisements :Sellers try to create

demand for their products by advertisements
Advertisements play a very important role
when there are many competitors in the
market

Market Demand Function

QDX = f(PX, N, I, PY, T,A,Po,Unexpected
things )
QDX = quantity demanded of commodity X
PX = price per unit of commodity X
N = number of consumers in the market
I = consumer income
PY = price of related (substitute or
complementary) commodity
T = consumer tastes
A= Advertisements
Po= Population

Individual Demand and Market Demand

To study a market, there are a number of buyers. The change from an individual
to a market demand schedule can be done easily by summing up the quantities
demanded by each consumer at various possible prices.
P

D1
35

D2

39

D3
26

100

D(Total)
Q

Market Demand Curve

Cont.

TYPES OF DEMAND

Consumer

goods and producer goods

Perishable and durable goods
Autonomous (Direct demand )Derived
demand(induced Demand),Replacement Demand
Individual's demand and market demand
Firm and industry demand
Demand by market segments and by total market

Derived Demand Ex: Demand for cement is derived from the

demand for building construction; demand for tires is derived from
the demand for cars or scooters, etc.

DIRECT DEMAND
Direct demand: The demand for a commodity which
is for direct consumption, i.e.. Demand for ultimate
object, is called direct demand, e.g food, cloth, etc.
Direct demand is called autonomous demand. Here
the demand is not linked with the purchase of some
main products demand for consumption

Example :Goods and services that satisfy consumer

desires directly
Determinants: product characteristics, tastes, ability
to pay

DERIVED DEMAND
When the commodity is demanded as a result of
the demand for another commodity or service, it
is known as the derived demand or induced
demand.
For example, demand for cement is derived from
the demand for building construction,
Demand for tires is derived from the demand for
cars or scooters, etc.

LAW OF DEMAND
The

law states that ceteris paribus there is an

inverse relationship between the price of a good
and the quantity of the good demanded per time
period.
Assumptions:
Income, Taste and preference, Prices of related
goods and other factors are assumed to be
constant.

DEMAND SCHEDULE

Price
x

(per Unit)
Px

1.5

1.0
2
.
0

0.5

Quantity of x demanded

(in Units)
Dx

1.0

2.0
3.0

4.5

DEMAND SCHEDULE IS TRANSLATED

INTO A DIAGRAM KNOWN AS THE
DEMAND CURVE

P
P1

A
B

P2

CHANGE IN PRICE=
change in quantity

demanded

Q1

Q2

Expansion and
contraction of demand

SHIFTS IN DEMAND CURVE

P

D1

D2

Q
Change in other factors =
change in demand

DETERMINANTS OF DEMAND :
EFFECT ON DEMAND CURVE

Things other than price that

cause the whole curve to shift
Increase: Shift to the right
Decrease: Shift to the left

Why the demand curve slopes downwards :

Price effect: Goods having multiple uses will be purchased more
when price decreases
Substitution Effect: When the price of commodity falls, Prices of
substitutes remains constant and it is costlier .
Income Effect: When the price of a good falls other things remaining
constant then the real income of the consumer increases .
Law of diminishing marginal utility
New Consumers: When the price of commodity falls, many other
consumers who were not consuming that commodity previously will
start consuming the commodity.

EXCEPTIONS OF THE LAW OF DEMAND

Status Symbol goods ,Veblen goods,Snob appeal
Veblen goods have snob value for which the consumer
measures satisfaction derived not by utility but by
social status

Giffen Goods :Direct price and demand relationship

Speculation :Expectations regarding future prices

Demonstration Effect :It is the influence on a persons

behaviour by observing the behaviour of others

ELASTICITY
The responsiveness of one variable to changes in
another
When price rises, what happens
to demand?
Demand falls
BUT!
How much does demand fall?

ELASTICITY
If price rises by 10% - what happens to demand?
We know demand will fall
By more than 10%?
By less than 10%?
Elasticity measures the extent to which
demand will change

ELASTICITY DEFINITION AND

MEASUREMENT
Elasticity Definition : It is defined as percentage
change in quantity demanded caused by one percent
change in demand determinants under
consideration.
Equation for measurement of elasticity :

Percentage change in quantity demanded of

good X
E=
-------------------------------------------------------------------Percentage change in demand determinants

DETERMINANTS OF ELASTICITY
Time

period the longer the time under

consideration the more elastic a good is likely

to be

Number

and closeness of substitutes

the greater the number of substitutes,

the more elastic

The

proportion of income taken up by

the product the smaller the proportion the
more inelastic

Luxury

or Necessity - for example,

addictive drugs

TYPES OF ELASTICITY
Price elasticity of demand
Income elasticity of demand
Cross elasticity
Promotional or Advertisemsent

Measurement of Elasticity :

POINT METHOD
ARC METHOD

POINT METHOD
Point elasticity: Elasticity measured at a given
point of a linear demand (or a supply) curve.

dQ P1
P =
x
dP Q1

ARC METHOD
Arc elasticity: Elasticity which is measured over a discrete

interval of a demand (or a supply) curve.

Average of the elasticity of the range on the demand curve
Q
Ed= --------P

P1 + P2
X

-----------Q1 +Q2

TYPES OF ELASTICITY
Ed > 1 Ed = 1 Ed< 1 Ed = 0 Ed

Elastic
Unitary Elasticity
Inelastic
Zero Elasticity,Perfectly Inelastic
Perfectly Elastic

ELASTICITY OF DEMAND ON
DIFFERENT POINTS OF CURVE
Ed=

Ed=
Price

1
Ed=1
Ed =

1
Ed =0

o
Quantity

PRICE ELASTICITY OF DEMAND

Price elasticity of demand is the percentage

change in quantity demanded given a percent
change in the price.
It is a measure of how much the quantity
demanded of a good responds to a change in the
price of that good.

COMPUTING THE PRICE

ELASTICITY OF DEMAND
The price elasticity of demand is computed as the
percentage change in the quantity demanded divided
by the percentage change in price.

Percentage change in quantity demanded

of good X

PED =
-------------------------------------------------------Percentage change in price

DETERMINANTS OF
PRICE ELASTICITY OF DEMAND

Necessities versus Luxuries

Availability of Close Substitutes

Time Horizon

Percentage of income spent on the good

Habitual Purchasing

Perfectly Elasticity of Demand

x axis = quantity demanded

= y axis = price

1
2
In this case, price reduction is not required to increase the
quantity demand.
=
The producers need not concentrate on price reduction
activities to improve the sales if his good comes under the
perfectly elasticity of demand.
Example: Imaginary

Perfectly Inelasticity of Demand

y
P

P
P1

E=0
X= units of goods demand.
Y= price of the commodity

x
In this case, even though the price of commodity
decreases, the demand remains the same. = 0
The producers need not increase or decrease the price of
the commodity to bring change in demand .
Example : Salt

Unitary Elasticity of Demand

E= 1

P
P1

X= units of goods demand.

Y= price of the commodity

1
0
This is a very rare phenomenon that occurs in a business
where the demand increases equally with the decrease in
price.
Example: Cloth

Relatively Elasticity of Demand

E>1
P

P1

P
D

X= units of goods demand.

Y= price of the commodity

x
1

There is a minimum reduction in price and the

demand increases rapidly. So a small change in
price increases the quantity demanded to large
extent to a producer .
Ex :Cell Phones ,Gold,holidays,cars etc (Luxury)

Relatively Inelasticity of Demand

y
E<1
P

P1

P
X= units of goods demand.
Y= price of the commodity

x 0x

1
Even though there is huge decrease in price, the quantity
demanded increase only a little.
Example:Inferior goods

INCOME ELASTICITY
Income

Elasticity of Demand

Income elasticity of demand measures how much

the quantity demanded of a good responds to a
change in consumers income.
It is computed as the percentage change in the
quantity demanded divided by the percentage
change in income.

COMPUTING INCOME ELASTICITY

Income
Elasticity
of Demand

Percentage Change
in Quantity Demanded

Percentage Change
in Income

POSITIVE INCOME ELASTIC DEMAND

DIAGRAM SUPERIOR GOODS

NEGATIVE INCOME ELASTICITY

DIAGRAM INFERIOR GOODS
Income (Y)

0
Quantity Demanded

TYPES OF ELASTICITY
I. High Income Elasticity

Ex: Ornaments,automobiles etc

II.Low Income Elasticity

Ex:Sugar,Soap etc

III.Unitary Income Elasticity

IV.Zero Income Elasticity
V.Negative Income Elasticity

Ex: Inferior Goods

CROSS- ELASTICITY OF DEMAND

Cross- elasticity of demand the percentage

change in demand divided by the percentage
change in the price of another good(related good).
Percentage Change in Quantity demanded

of X
E cross =
------------------------------------------------------------------Percentage Change in price of Y

SUBSTITUTES AND COMPLEMENTS

Substitutes are goods that can be used in place
of another.
Substitutes have positive cross-price elasticity.

Complements are goods that are used in

conjunction with other goods.
Complements have negative cross-price elasticity.

EXPRESSION OF C.E.D
Let us assume that two commodities X
n Y are related then the expression of cross
elasticity of demand would be
QX
Ecross

_________

PY

PY

x ____

QX

PRINCIPLES

Same formula is used for both substitutes and

complementary
goods

For substitutes cross elasticity is positive

For complementary goods cross elasticity is

negative

If the goods are non related i.e., neither

substitutes nor compliments C.E.D is zero

PROMOTIONAL ELASTICITY
Measures the responsiveness of demand to
changes in advertisements or promotional
expenses .
It is very useful for producers to calculate the
change in sales as a result of change in
advertisement expenditure .
It depends on stage of products development .

FACTORS INFLUENCING -PROMOTIONAL

ELASTICITY

Measures the responsiveness of demand to changes

in advertisements or promotional expenses .

It is very useful for producers to calculate the

change in sales as a result of change in
advertisement expenditure .
Influence of advertising by rivals.

It depends on stage of products development .

Different for new and old products and also for
products with an established and growing market.

FORMULA

Ea =

A
_____ x ___
A
S

S = Sales
A= Initial Advertisement cost
S = change in Sales
A = Change in Advertisement cost

IMPORTANCE OF ELASTICITY
Micro

level :
Relationship between changes
in price and total revenue
Deciding the price of output.
Importance in analysing time lags in
production.
Useful in deciding the prices of factors of
production.

Macro

Level :Importance in
determining
what goods to be taxed (tax revenue)

Heplful

in declaring public utilities.

Helpful

in international trade .

SUPPLY
Producers

side
A relation between the price of a
good and the quantity that the
producers are willing and able to
offer for sale during a given
period, other things constant.

LAW OF SUPPLY
The quantity of a good supplied during a given
period is usually directly related to the price of
the good
Increase in price leads to increase in quantity
supplied
Decrease in price leads to decrease in quantity
supplied.
Creates upward sloping supply curve

SUPPLY SCHEDULE
CURVE
Price of
Good

Quantity
Supplied

$3

50

$4

75

$5

100

$6

150

$7

200

SUPPLY
Price

Suppl
y

Quantity supplied

SUPPLY

Individual supply Firms Supply

The

supply of an individual producer

Market supply Industry Supply

The

sum of individual supplies of all producers in the

market

DETERMINANTS FOR THE SUPPLY

CURVE
Changes

in technology

Changes

in prices of relevant resources

Changes

in the prices of alternative

goods
Changes

in Producer Expectations

Changes

in the number of producers

EQUILIBRIUM

At specific price where:

Quantity demanded = Quantity supplied
Equilibrium price
Market

clearing price

Equilibrium Price =
Demand

= Supply

EQUILIBRIUM

At specific price
where:

Quantity Demanded
Equals
Quantity Supplied

Equilibrium

Rs
5

D
150

REACHING EQUILIBRIUM
P

If market price is
ABOVE equilibrium
Q > Q
s
D

Surplus
S

$6

Economy is at a
SURPLUS
Market price will fall

$5

100

15
0

200

REACHING EQUILIBRIUM
If

the market
price is BELOW
the equilibrium
price
Q > Q
D
s
Shortage

exists
Market price
rises to
equilibrium

P
S

$5
$4

Shortage
100

15
0

200

D
Q

GOVERNMENT INTERVENTION
Government involves in
pricing the good in the
economy
Price Setting
Subsidies

Government

payments to
reduce the cost of product or
to limit production.