Demand

and Supply
Analysis
 Demand ?????
▪ The process to satisfy human wants/ needs/desires.
▪ Want: having a strong desire for something
▪ Need: lack of means of subsistence
▪ Desire: an aspiration to acquire something
▪ Demand: effective desire
▪ Demand is that desire which is backed by willingness and
ability to buy a particular commodity.
▪ Demand is the quantity of a commodity/goods/service
which consumer/buyer are willing and able to buy at a
given price for a particular unit of time.
 Types of Demand
▪ Direct(Autonomous) and Derived Demand
▪ Direct demand is for the goods as they are such as Consumer
goods (Own sake by final consumer)
▪ Derived demand is for the goods which are demanded to
produce some other commodities; e.g. Capital goods (for
production of Other Products)

▪ Recurring and Replacement Demand

▪ Recurring demand is for goods which are consumed at frequent
intervals such as food items, clothes.
▪ Replacement Demand – Durable consumer goods are purchased
to be used for a long period of time
▪ Wear and tear over time needs replacement
 Types of Demand
▪ Complementary and Competing Demand
▪ Some goods are jointly demanded hence are complementary in
nature, e.g. software and hardware, car and petrol.
▪ Some goods compete with each other for demand because they
are substitutes to each other, e.g. soft drinks and juices.

▪ Individual & Market & Industry Demand

▪ Demand for an individual consumer is Individual demand. Eg.
Your demand for Indica car.
▪ Demand by all the consumers for the product know as Market
demand. Eg. Demand for Indica in 2013.
▪ Industry demand is the demand for the product by all firms in
the industry. Eg. Demand for car in year 2013 in India
 Determinants of Demand
▪ Price of the product
▪ Negative effect on demand - Higher the price-lower the
demand
▪ Income of the consumer
▪ Normal goods: Positive relation
▪ Inferior goods: Negative relation
▪ Price of related goods
▪ Substitutes
▪ If the price of a commodity increases, demand for its
substitute rises – Positive Impact
▪ Complements
▪ If the price of a commodity increases, quantity demanded of
its complement falls – Negative Impact
 Determinants of Demand
▪ Tastes and preferences
▪ Consumer’s Expectation of future Income & price
▪ Population
▪ Advertising
▪ Growth of Economy
▪ Consumer Credit
 Demand Function
▪ Interdependence between demand for a product and its
determinants can be shown in a mathematical functional
form
Dx = f(Px, Y, Py, T, A, N)
▪ Independent variables: Px, Y, Py, T, A, N
▪ Dependent variable: Dx
▪ Px: Price of x
▪ Y: Income of consumer
▪ Py: Price of other commodity
▪ T: Taste and preference of consumer
▪ A: Advertisement
▪ N: Macro variable like inflation, population growth, economic
growth
 Law of Demand
▪ A special case of demand function which shows relation between price and
demand of the commodity

Dx = f(Px)
Dx = a - bPx
▪ Other things remaining constant, (ceteris paribus) when the price of a commodity
rises, the demand for that commodity falls or when the price of a commodity falls,
the demand for that commodity rises.
▪ Price bears a negative relationship with demand
Reasons behind the Law
▪ Price effect
▪ Substitution Effect : When the price of a commodity falls (rises), its substitutes
become more (less) expensive assuming their price has not changed.
▪ Income Effect: When the price of a particular commodity falls, the consumer’s real
income rises, hence the purchasing power of the individual rises.
▪ Law of Diminishing Marginal Utility: as a person consumes successive units of a
commodity, the utility derived from every next unit (marginal unit) falls.
• Law of Diminishing Marginal Utility
– Marginal utility for successive units consumed goes on decreasing.
– When the good is consumed in standard quantity, continuously and in
multiple units and the good is not addictive in nature.
• The following diagrams show Total Utility (TU) and Marginal Utility (MU)
curves

TU of X MU of X

MU

TU

O O
Quantity of X Quantity of X
The Law of Demand
• The law of demand
states that there is a
negative, or inverse,
relationship between
price and the quantity
of a good demanded
and its price.
• This means that
demand curves slope
downward.
 Demand Schedule and Individual
Demand Curve

Point on e
Demand Price (Rs Demand 35
Curve per cup) (‘000 cups) d
a 15 50 30
c
b 20 40 25
c 25 30 b
20
d 30 20 a
15
e 35 10
O
10 20 30 40 50

Quantity of coffee
 Change in Demand
◼ Shift in demand curve from D0 to
D1
◼ More is demanded at same price.
Price D1
◼ Increase in demand caused by:
D0
◼ A rise in the price of a
D2
substitute
◼ A fall in the price of a
complement
◼ A rise in income
◼ A redistribution of income
towards those who favour the
commodity
◼ A change in tastes that favours
the commodity
0 ◼ Shift in demand curve from D0 to
Quantity
D2
◼ Less is demanded at each price.
 Movements Along and Shifts of The
Demand Curve
Price
Entire demand curve shifts
rightward when:
• income or wealth ↑
• price of substitute ↑
• price of complement ↓
• population ↑
• expected price ↑
• tastes shift toward ↑

D2
D1

Quantity
 Movements Along and Shifts of The
Demand Curve
Price
Entire demand curve shifts
leftward when:
• income or wealth ↓
• price of substitute ↓
• price of complement ↑
• population ↓
• expected price ↓
• tastes shift toward ↓

D1
D2

Quantity
 Exceptions to the Law of Demand
Law of demand may not operate due to the following
reasons:
▪ Giffen Goods – display direct price demand relationship –
Rice (inferior goods)
▪ Snob Appeal – veblen goods - Diamond
▪ Demonstration Effect - items of luxury, fashion
▪ Future Expectation of Prices (Panic buying)
▪ Goods with No Substitutes
▪ Life saving drugs, petrol and diesel
▪ Insignificant proportion of income spent
▪ Match box, Salt
 Supply?????
• Indicates the quantities of a good or service that the seller/producer
is willing and able to provide at a price, at a given point of time, other
things remaining the same.
• Supply of a product X (Sx) depends upon:
– Price of the product (Px)
– Cost of production (C)
– State of technology (T)
– Government policy regarding taxes and subsidies (G)
– Other factors like number of firms (N)
• Hence the supply function is given as:
Sx = (Px, C, T, G, N)
 Law of Supply
▪ Law of Supply states that other things remaining the same, the higher the
price of a commodity the greater is the quantity supplied.
▪ Price of the product is revenue to the supplier; therefore higher price
means greater revenue to the supplier and hence greater is the incentive
to supply.
▪ Supply bears a positive relation to the price of the commodity.

Supply Schedule Supply Curve

Point on Supply (‘000 35 e
Supply Price (Rs. cups per
30
Curve Per cup) month)
d
a 15 10 25
c
b 20 20 20
b
c 25 30 15
a
d 30 45
e 35 60 0 10 20 30 40 50 60
Quantity of Coffee
 Change in Supply

▪ Shift in the supply curve from

S0 to S1
S2 ▪ More is supplied at each
Price S0 price.
▪ Increase in supply caused by:
S1
▪ Improvements in the
technology
▪ Fall in the price of inputs
▪ Shift in the supply curve from
S0 to S2
▪ Less is supplied at each
price.
▪ Decrease in supply caused by:
O ▪ A rise in the price of inputs
Quantity ▪ Change in government
policy (VAT)
 Changes in Supply and in Quantity
Supplied
Price Entire supply curve shifts S1
rightward when: S2
• price of input ↓
• price of alternate good ↑
• number of firms ↑
• expected price ↑
• technological advance
• favorable weather

Quantity
 Changes in Supply and in Quantity
Supplied
Price
Entire supply curve shifts S2
leftward when: S1
• price of input ↑
• price of alternate good ↓
• number of firms ↓
• expected price ↑
• unfavorable weather

Quantity
Market Equilibrium
 Market Equilibrium
• Equilibrium occurs at the price where the quantity
demanded and the quantity supplied are equal to each
other.
• For prices below the equilibrium, quantity demanded
exceeds quantity supplied (D>S). Pulling price upward.
• For prices above the equilibrium, quantity demanded is
less than quantity supplied (D<S). Pushing price
downward.
Supply Demand
Price S Price (‘000 cups (‘000 cups /
(Rs) / month) month)
E
25
15 10 50
20 15 40
25 30 30
D 30 45 15
O
30
35 70 10
Quantity
 Market Equilibrium

Price per 2. causes the price 3. shrinking the

Pen to rise . . . excess demand . . .

E
4. until price reaches its
$3.00
equilibrium value of $3.00
.
H
1.00 J
Excess Demand
D
25,000 50,000 75,000 Number of pens per
1. At a price of $1.00 per
Month
Pen an excess demand of
50,000 pen . . .
23
 Excess Demand
• Excess demand
– At a given price, the excess of quantity demanded
over quantity supplied
• Price of the good will rise as buyers compete
with each other to get more of the good than
is available

24
 Excess Supply and Price Adjustment

1. At a price of $5.00 per

Price per pen an excess supply of
Pen 30,000 pen
...
Excess Supply at $5.00 S 3. shrinking the
excess supply . . .
$5.00 L
K
2. causes the
price to drop, E
3.00 4. until price reaches its
equilibrium value of
$3.00.

D
35,000 50,000 65,000 Number of pens per
Month
25
 Excess Supply
• Excess Supply
– At a given price, the excess of quantity supplied
over quantity demanded
• Price of the good will fall as sellers compete
with each other to sell more of the good than
buyers want

26
 Changes in Market Equilibrium
(Shifts in Supply Curve)
◼ The original point of equilibrium is
at E, the point of intersection of
curves D1 and S1, at price P and
quantity Q
Price S0
◼ An increase in supply shifts the
supply curve to S2. D1 S1
◼ Price falls to P2 and quantity rises S2
to Q2, taking the new equilibrium E0
P0
to E2 . E
P E2
◼ A decrease in supply shifts the P2 S0
supply curve to S0. Price rises to S1
P0 and quantity falls to Q0 taking S2 D1
the new equilibrium to E0
O
◼ Thus an increase in supply raises Q0 Q Q2 Quantity
quantity but lowers price, while a
decrease in supply lowers
quantity but raises price; demand
being unchanged.
 Changes in Market Equilibrium
(Shifts in Demand Curve)
• The original point of equilibrium
is at E, the point of intersection of
curves D1 and S1, at price P and
quantity Q
Price
D2 • An increase in demand shifts the
D1
S1 demand curve to D2 .
• Price rises to P1 and quantity rises to Q1
D0 taking the new equilibrium to E1
P1 E1
E • A decrease in demand shifts the
P demand curve to D0.
P* E2
D2 • Price falls to P* and quantity falls to Q* taking
the new equilibrium to E2.
S1 D0 D1 • Thus, an increase in demand
O Q* raises both price and quantity,
Q1
Quantity
while a decrease in demand
lowers both price and quantity;
when supply remains same.
 Increases in Demand and Supply

• Higher demand leads to higher • Higher supply leads to lower

equilibrium price and higher equilibrium price and higher
equilibrium quantity. equilibrium quantity.
Decreases in Demand and Supply

• Lower demand leads to • Lower supply leads to

lower price and lower higher price and lower
quantity exchanged. quantity exchanged.
 Change in Both Demand and Supply
▪ Whether price will rise, or remain
at the same level, or will fall, will
depend on:
D2 ▪ the magnitude of shift and
Price D1 ▪ the shapes of the demand
S1 and supply curves.
S2
P1 E1
▪ Therefore, an increase in both
P2
E2 supply and demand will cause
the sales to rise, but the effect on
price can be:
S1 D2 ▪ Positive (D increases more
S2
D1
than S)
O ▪ Negative (S increases more
Q1 Q2 Quantity
than D)
▪ No change (increase in
D=increase in S)