UNIT II

Demand Analysis

Introduction & Meaning: Demand in common parlance means the desire for an
object. But in economics demand is something more than this. According
to Stonier and Hague, “Demand in economics means demand backed up
by enough money to pay for the goods demanded”. This means that the
demand becomes effective only it if is backed by the purchasing power in
addition to this there must be willingness to buy a commodity. Thus
demand in economics means the desire backed by the willingness to buy
a commodity and the purchasing power to pay.

In the words of “Benham” “The demand for anything at a given price is

the amount of it which will be bought per unit of time at that Price”. (Thus
demand is always at a price for a definite quantity at a specified time.)
Thus demand has three essentials – price, quantity demanded and time.
Without these, demand has to significance in economics. It deals with four
aspects:

1. Consumption
2. Production
3. Exchange
4. Distribution

Factors Affecting Demand:

There are factors on which the demand for a commodity depends.

These factors are economic, social as well as political factors. The
effect of all the factors on the amount demanded for the commodity is
called Demand Function.
These factors are as follows:
1. Price of the Commodity: The most important factor-affecting amount
demanded is the price of the commodity. The amount of a commodity
demanded at a particular price is more properly called price demand.
The relation between price and demand is called the Law of Demand. It
is not only the existing price but also the expected changes in price,
which affect demand.
2. Income of the Consumer: The second most important factor
influencing demand is consumer income. In fact, we can establish a
relation between the consumer income and the demand at different
levels of income, price and other things remaining the same. The
demand for a normal commodity goes up when income rises and falls
down when income falls. But in case of Giffen goods the relationship is
the opposite.
3. Prices of related goods: The demand for a commodity is also
affected by the changes in prices of the related goods also. Related
goods can be of two types: (i). Substitutes which can replace each
other in use; for example, tea and coffee are substitutes. The change
in price of a substitute has effect on a commodity’s demand in the
same direction in which price changes. The rise in price of coffee shall
raise the demand for tea; (ii). Complementary foods are those which
are jointly demanded, such as pen and ink. In such cases
complementary goods have opposite relationship between price of one
commodity and the amount demanded for the other. If the price of
pens goes up, their demand is less as a result of which the demand for
ink is also less. The price and demand go in opposite direction. The
effect of changes in price of a commodity on amounts demanded of
related commodities is called Cross Demand.
4. Tastes of the Consumers: The amount demanded also depends on
consumer’s taste. Tastes include fashion, habit, customs, etc. A
consumer’s taste is also affected by advertisement. If the taste for a
commodity goes up, its amount demanded is more even at the same
price. This is called increase in demand. The opposite is called
decrease in demand.
5. Wealth: The amount demanded of commodity is also affected by the
amount of wealth as well as its distribution. The wealthier are the
people; higher is the demand for normal commodities. If wealth is
more equally distributed, the demand for necessaries and comforts is
more. On the other hand, if some people are rich, while the majorities
are poor, the demand for luxuries is generally higher.
6. Population: Increase in population increases demand for
necessaries of life. The composition of population also affects demand.
Composition of population means the proportion of young and old and
children as well as the ratio of men to women. A change in composition
of population has an effect on the nature of demand for different
commodities.
7. Government Policy: Government policy affects the demands for
commodities through taxation. Taxing a commodity increases its price
and the demand goes down. Similarly, financial help from the
government increases the demand for a commodity while lowering its
price. 8. Expectations regarding the future: If consumers expect
changes in price of commodity in future, they will change the demand
at present even when the present price remains the same.
9 Similarly, if consumers expect their incomes to rise in the near future
they may increase the demand for a commodity just now. 9. Climate
and weather: The climate of an area and the weather prevailing there
has a decisive effect on consumer’s demand. In cold areas woolen
cloth is demanded. During hot summer days, ice is very much in
demand. On a rainy day, ice cream is not so much demanded.
10. State of business: The level of demand for different commodities
also depends upon the business conditions in the country. If the
country is passing through boom conditions, there will be a marked
increase in demand. On the other hand, the level of demand goes
down during depression.

Law of Demand: Law of demand shows the relation between price

and quantity demanded of a commodity in the market. In the words of
Marshall, “the amount demand increases with a fall in price and
diminishes with a rise in price”. A rise in the price of a commodity is
followed by a reduction in demand and a fall in price is followed by an
increase in demand, if a condition of demand remains constant. The
law of demand may be explained with the help of the following
demand schedule.
DEMAND SCHEDULE
Price of Apple (In. Rs.) Quantity Demanded
10 1
8 2
6 3
4 4
2 5

Law is demand is based When the price falls from Rs. 10 to 8 quantity
demand increases from 1 to 2. In the same way as price falls, quantity
demand increases on the basis of the demand schedule we can draw
the demand curve
The demand curve DD shows the inverse relation between price and
quantity demand of apple. It is downward sloping.
Assumptions:
1. This is no change in consumers taste and preferences.
2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity .
5. The commodity should not confer at any distinction.
6. The demand for the commodity should be continuous.
7. People should not expect any change in the price of the commodity.

Exceptions to Law of Demand:

1. Giffen paradox: The Giffen good or inferior good is an exception to

the law of demand. When the price of an inferior good falls, the poor
will buy less and vice versa. For example, when the price of maize
falls, the poor are willing to spend more on superior goods than on
maize if the price of maize increases, he has to increase the quantity
of money spent on it. Otherwise he will have to face starvation. Thus a
fall in price is followed by reduction in quantity demanded and vice
versa. “Giffen” first explained this and therefore it is called as Giffen‟s
paradox.
2. Veblen or Demonstration effect: „Veblen‟ has explained the
exceptional demand curve through his doctrine of conspicuous
consumption. Rich people buy certain good because it gives social
distinction or prestige for example diamonds are bought by the richer
class for the prestige it possess. It the price of diamonds falls poor also
will buy is hence they will not give prestige. Therefore, rich people may
stop buying this commodity.
3. Ignorance: Sometimes, the quality of the commodity is Judge by its
price. Consumers think that the product is superior if the price is high.
As such they buy more at a higher price.
4. Speculative effect: If the price of the commodity is increasing the
consumers will buy more of it because of the fear that it increase still
further, Thus, an increase in price may not be accomplished by a
decrease in demand.
5. Fear of shortage: During the times of emergency of war People may
expect shortage of a commodity. At that time, they may buy more at a
higher price to keep stocks for the future.
6. Necessaries: In the case of necessaries like rice, vegetables etc.
people buy more even at a higher price.

Elasticity of Demand Elasticity of demand explains the relationship

between a change in price and consequent change in amount
demanded. “Marshall” introduced the concept of elasticity of demand.
Elasticity of demand shows the extent of change in quantity demanded
to a change in price. In the words of “Marshall”, “The elasticity of
demand in a market is great or small according as the amount
demanded increases much or little for a given fall in the price and
diminishes much or little for a given rise in Price” Elastic demand: A
small change in price may lead to a great change in quantity
demanded. In this case, demand is elastic. In-elastic demand: If a big
change in price is followed by a small change in demanded then the
demand in “inelastic”.

Measurement of Elasticity of Demand:

A. Perfectly elastic demand: When small change in price leads to
an infinitely large change is quantity demand, it is called perfectly
or infinitely elastic demand. In this case E=∞
 The demand curve DD1 is horizontal straight line. It shows the at
“OP” price any amount is demand and if price increases, the
consumer will not purchase the commodity.

B. Perfectly Inelastic Demand: In this case, even a large change in

price fails to bring about a change in quantity demanded.

When price increases from „OP‟ to „OP‟, the quantity demanded

remains the same. In other words the response of demand to a
change in Price is nil. In this case „E‟=0.
C. Relatively elastic demand: Demand changes more than
proportionately to a change in price. I.e. a small change in price
loads to a very big change in the quantity demanded. In this case E
> 1. This demand curve will be flatter.When price falls from „OP‟ to
„OP‟, amount demanded increase from “OQ‟ to “OQ1‟ which is
larger than the change in price.
D. Relatively in-elastic demand. Quantity demanded changes less
than proportional to a change in price. A large change in price leads
to small change in amount demanded. Here E < 1. Demanded carve
will be steeper. When price falls from “OP‟ to „OP1 amount
demanded increases from OQ to OQ1, which is smaller than the
change in price.
E. Unit elasticity of demand: The change in demand is exactly
equal to the change in price. When both are equal E=1 and
elasticity if said to be unitary. When price falls from „OP‟ to „OP1‟
quantity demanded increases from „OP‟ to „OP1‟, quantity
demanded increases from „OQ‟ to „OQ1‟. Thus a change in price
has resulted in an equal change in quantity demanded so price
elasticity of demand is equal to unity.

Types of Elasticity of Demand

1. Price Elasticity of Demand: Marshall was the first economist to

define price elasticity of demand. Price elasticity of demand
measures changes in quantity demand to a change in Price. It is the
ratio of percentage change in quantity demanded to a percentage
change in price. Proportionate change in the quantity demand of
commodity.
 Price elasticity = Proportionate change in the quantity demand of
commodity
_________________________________________________
Proportionate change in the price of commodity

2. Income Elasticity of Demand: Income elasticity of demand shows

the change in quantity demanded as a result of a change in income.
Income elasticity of demand may be slated in the form of a formula.
Income Elasticity = Proportionate change in the quantity demand of
commodity

____________________________________________________
Proportionate change in the income of the
people

Income elasticity of demand can be classified in to five types.

A. Zero income elasticity: Quantity demanded remains the same,
even though money income increases. Symbolically, it can be
expressed as Ey=0. It can be depicted in the following way: As
income increases from OY to OY1, quantity demanded never
changes.

B. Negative Income elasticity: When income increases, quantity

demanded falls. In this case, income elasticity of demand is
negative. i.e., Ey < 0. When income increases from OY to OY1,
demand falls from OQ to OQ1.

C. Unit income elasticity: When an increase in income brings

about a proportionate increase in quantity demanded, and then
income elasticity of demand is equal to one. Ey = 1. When
 income increases from OY to OY1, Quantity demanded also
increases from OQ to OQ1.

D. Income elasticity greater than unity: In this case, an

increase in come brings about a more than proportionate
increase in quantity demanded. Symbolically it can be written as
Ey > 1. It shows high-income elasticity of demand. When income
increases from OY to OY1, Quantity demanded increases from OQ
to OQ1

E. Income elasticity leas than unity: When income increases

quantity demanded also increases but less than proportionately.
In this case E < 1.

An increase in income from OY to OY, brings what an increase in

quantity demanded from OQ to OQ1, But the increase in quantity
demanded is smaller than the increase in income. Hence, income
elasticity of demand is less than one.

3. Cross Elasticity of Demand: A change in the price of one

commodity leads to a change in the quantity demanded of another
commodity. This is called a cross elasticity of demand. The formula
for cross elasticity of demand is:
Cross Elasticity = Proportionate change in the quantity demand of
commodity “X”

______________________________________________________
Proportionate change in the price of the
commodity “Y”

a. In case of substitutes, cross elasticity of demand is positive. E.g.:

Coffee and Tea When the price of coffee increases, Quantity
demanded of tea increases. Both are substitutes.

b. In case of compliments, cross elasticity is negative. If increase in

the price of one commodity leads to a decrease in the quantity
 demanded of another and vice versa. When price of car goes up
from OP to OP, the quantity demanded of petrol decreases from
OQ to OQ!. The cross-demanded curve has negative slope.
c. In case of unrelated commodities, cross elasticity of demanded
is zero. A change in the price of one commodity will not affect the
quantity demanded of another quantity demanded of commodity
“b” remains unchanged due to a change in the price of „A‟, as
both are unrelated goods.
4. Advertising Elasticity of Demand: Advertising elasticity of demand
shows the change in quantity demanded as a result of a change in
cost of Advertisement. Advertising elasticity of demand may be
slated in the form of a formula:
Advertising Elasticity =Proportionate change in the quantity demand
of commodity

_________________________________________________
Proportionate change in the advertisement
cost

Demand Forecasting:

Introduction: The information about the future is essential for both

new firms and those planning to expand the scale of their
production. Demand forecasting refers to an estimate of future
demand for the product. It is an objective assessment of the future
course of demand”. In recent times, forecasting plays an important
role in business decision-making. Demand forecasting has an
important influence on production planning. It is essential for a firm
to produce the required quantities at the right time. It is essential to
distinguish between forecasts of demand and forecasts of sales.
Sales forecast is important for estimating revenue cash
requirements and expenses. Demand forecasts relate to production,
inventory control, timing, reliability of forecast etc. However, there
is not much difference between these two terms.

Types of demand Forecasting: Based on the time span and

planning requirements of business firms, demand forecasting can be
classified in to
1. Short-term demand forecasting and 2. Long – term demand
forecasting.
1. Short-term demand forecasting: Short-term demand
forecasting is limited to short periods, usually for one year. It
relates to policies regarding sales, purchase, price and finances.
It refers to existing production capacity of the firm. Short-term
forecasting is essential for formulating is essential for
formulating a suitable price policy. If the business people expect
of rise in the prices of raw materials of shortages, they may buy
early. This price forecasting helps in sale policy formulation.
Production may be undertaken based on expected sales and not
on actual sales. Further, demand forecasting assists in financial
forecasting also. Prior information about production and sales is
essential to provide additional funds on reasonable terms.
2. Long – term forecasting: In long-term forecasting, the
businessmen should now about the long-term demand for the
product. Planning of a new plant or expansion of an existing unit
depends on long-term demand.

Methods of Forecasting: Several methods are employed for

forecasting demand. All these methods can be grouped under
survey method and statistical method. Survey methods and
statistical methods are further subdivided in to different
categories. 1. Survey Method: Under this method, information
about the desires of the consumer and opinion of exports are
collected by interviewing them. Survey method can be divided
into four type‟s viz., Option survey method; expert opinion;
Delphi method and consumers interview methods.
a. Opinion survey method: This method is also known as sales-
force composite method (or) collective opinion method. Under
this method, the company asks its salesman to submit estimate
of future sales in their respective territories. Since the forecasts
of the salesmen are biased due to their optimistic or pessimistic
attitude ignorance about economic developments etc. these
estimates are consolidated, reviewed and adjusted by the top
executives. In case of wide differences, an average is struck to
make the forecasts realistic. This method is more useful and
appropriate because the salesmen are more knowledge. They
can be important source of information. They are cooperative.
The implementation within unbiased or their basic can be
corrected.
B. Expert opinion method: 17 Apart from salesmen and
consumers, distributors or outside experts may also e used for
forecasting. In the United States of America, the automobile
companies get sales estimates directly from their dealers. Firms
in advanced countries make use of outside experts for
estimating future demand. Various public and private agencies
all periodic forecasts of short or long term business conditions.
C. Delphi Method: A variant of the survey method is Delphi
method. It is a sophisticated method to arrive at a consensus.
Under this method, a panel is selected to give suggestions to
solve the problems in hand. Both internal and external experts
can be the members of the panel. Panel members one kept apart
from each other and express their views in an anonymous
manner. There is also a coordinator who acts as an intermediary
among the panelists. He prepares the questionnaire and sends it
to the panelist. At the end of each round, he prepares a
summary report. On the basis of the summary report the panel
members have to give suggestions. This method has been used
in the area of technological forecasting. It has proved more
popular in forecasting. It has provided more popular in
forecasting non-economic rather than econo mic variables.
D. Consumers interview method: In this method the consumers
are contacted personally to know about their plans and
preference regarding the consumption of the product. A list of all
potential buyers would be drawn and each buyer will be
approached and asked how much he plans to buy the listed
product in future. He would be asked the proportion in which he
intends to buy. This method seems to be the most ideal method
for forecasting demand.

2. Statistical Methods: Statistical method is used for long run

forecasting. In this method, statistical and mathematical
techniques are used to forecast demand. This method relies on
post data.
a. Time series analysis or trend projection methods: A well-
established firm would have accumulated data. These data are
analyzed to determine the nature of existing trend. Then, this
trend is projected in to the future and the results are used as the
basis for forecast. This is called as time series analysis. This data
can be presented either in a tabular form or a graph. In the time
series post data of sales are used to forecast future. b.
Barometric Technique: Simple trend projections are not capable
of forecasting turning paints. Under Barometric method, present
events are used to predict the directions of change in future.
This is done with the help of economics and statistical indicators.
Those are (1) Construction Contracts awarded for building
materials (2) Personal income (3) Agricultural Income. (4)
Employment (5) Gross national income (6) Industrial Production
(7) Bank Deposits etc.
c. Regression and correlation method: Regression and
correlation are used for forecasting demand. Based on post data
the future data trend is forecasted. If the functional relationship
is analyzed with the independent variable it is simple correction.
When there are several independent variables it is multiple
correlation. In correlation we analyze the nature of relation
between the variables while in regression; the extent of relation
between the variables is analyzed. The results are expressed in
mathematical form. Therefore, it is called as econometric model
building. The main advantage of this method is that it provides
the values of the independent variables from within the model
itself.

Factors Influencing Demand Forecasting:

Demand forecasting is a proactive process that helps in
determining what products are needed where, when, and in what
quantities. There are a number of factors that affect demand
forecasting.

The various factors that influence demand forecasting are

explained as follows:
i. Types of Goods: Affect the demand forecasting process to a
larger extent. Goods can be producer‟s goods, consumer goods,
or services. Apart from this, goods can be established and new
goods. Established goods are those goods which already exist in
the market, whereas new goods are those which are yet to be
introduced in the market. Information regarding the demand,
substitutes and level of competition of goods is known only in
case of established goods. On the other hand, it is difficult to
forecast demand for the new goods. Therefore, forecasting is
different for different types of goods.
ii. Competition Level: Influence the process of demand
forecasting. In a highly competitive market, demand for products
also depend on the number of competitors existing in the
market. Moreover, in a highly competitive market, there is
always a risk of new entrants. In such a case, demand
forecasting becomes difficult and challenging. iii. Price of
Goods: Acts as a major factor that influences the demand
forecasting process. The demand forecasts of organizations are
highly affected by change in their pricing policies. In such a
scenario, it is difficult to estimate the exact demand of products.
 iv. Level of Technology: Constitutes an important factor in
obtaining reliable demand forecasts. If there is a rapid change in
technology, the existing technology or products may become
obsolete. For example, there is a high decline in the demand of
floppy disks with the introduction of compact disks (CDs) and
pen drives for saving data in computer. In such a case, it is
difficult to forecast demand for existing products in future.
v. Economic Viewpoint: Play a crucial role in obtaining demand
forecasts. For example, if there is a positive development in an
economy, such as globalization and high level of investment, the
demand forecasts of organizations would also be positive. Apart
from aforementioned factors, following are some of the other
important factors that influence demand forecasting: a. Time
Period of Forecasts: Act as a crucial factor that affect demand
forecasting. The accuracy of demand forecasting depends on its
time period.

The Charaterisitcs of Good Demand Forecasting:

 Accuracy: Accuracy is paramount in prediction, and it should closely

align with the actual demand observed in the market. The estimates
should minimize errors and discrepancies between predicted and
realized needs, enabling organizations to make precise production,
inventory, and resource allocation decisions.
 Granularity: Demand forecasting should provide insights at a
granular level, allowing businesses to understand buying patterns
for specific products, SKUs, regions, customer segments, or
channels. Granularity helps identify variations in requirements
across different dimensions, enabling targeted strategies and
informed decision-making.
 Scalability: Good demand forecasting software should be scalable to
accommodate varying data volume levels and complexity. Whether
dealing with large datasets, multiple products, or expanding
markets, the prediction process and techniques should be scalable
to handle increased requirements without sacrificing accuracy or
performance.
 Adaptability: Demand forecasting should be adaptable to changing
market conditions and business dynamics. It should be able to
capture and respond to shifts in customer behaviour, emerging
trends, competitive forces, and other external factors. The models
and methodologies should be flexible enough to incorporate new
data and adjust predictions accordingly.
 Timeliness: Timeliness is crucial in demand forecasting to support
effective decision-making. A good forecast should be available
within the required timeframe, allowing businesses to plan and act
proactively. Real-time insights provide a competitive advantage by
enabling swift responses to market changes.
  Transparency: Good demand forecasting should be transparent,
with clear documentation of assumptions, methodologies, and data
sources used in the process. This transparency lets stakeholders
understand and validate the forecast, facilitating trust and
confidence in the results.
 Continual Improvement: Demand forecasting should be a
continuous improvement process, and it should be refined and
updated based on feedback, performance evaluation, and the
availability of new data. Regularly analyzing forecast errors,
incorporating learning from past performance, and revising models
contribute to improving the accuracy and reliability of future output.
 Integration and Collaboration: Demand forecasting should integrate
with other business functions and foster collaboration across
departments. It should facilitate the exchange of data, insights, and
feedback among sales, marketing, operations, finance, and other
departments. Integration and collaboration enhance the accuracy
and relevance of forecasts.
 Sensitivity to External Factors: Good demand forecasting considers
the impact of external factors on the customer psyche. It accounts
for economic indicators, market trends, seasonality, promotions,
competitor activities, and other relevant factors influencing buying
behavior. Sensitivity to these external factors enhances the
accuracy and reliability of the forecasts.
 Communication and Visualization: Effective demand forecasting
involves clear communication and visualization of the forecasted
results. It should present the forecast in a concise, easily
understandable format using charts, graphs, and visual
representations. Clear communication facilitates decision-making
and aligns stakeholders with a common understanding of future
consumer needs.
By embodying these characteristics, businesses can develop demand
generating processes that provide accurate, actionable insights to support
planning, decision-making, and optimization of resources and operations.

These validated steps in the demand forecasting process help businesses

optimize inventory & resources, allow better coordination amongst
vertical stakeholders & improve customer experience leading to better
brand value. So, here are the key steps involved in the demand
forecasting process, which an organization must ensure to plan good
production & execute operations even better.
o Outlining the objectives
The first & foremost specification to start with is to have clear
objectives for which demand forecasting is to be done. The
parameters could range from planning long-term or short-term
demand, launching a product to a specific market segment,
planning a fully-fledged unveiling, and gauging the organization's
market share in the industry. These objectives help a company
know the precise modus operandi, eventually leading them to better
 evaluate customer demands based on territories & market response
to a new product.
o Timeline of Forecast
The following step is to decide on the duration of the forecasting
process. The tenure could be short (2-3 months) or a year-long
period. Management has to ensure that the timeline decided very
much regards the nature of the product. For instance, a demand
forecasting procedure involving perishable items (such as foods and
eateries) will have short-term forecasting, whereas solid
commodities carry a long-term prospect. Such astute planning
protects an enterprise from wasting its capital & subsequently
avoids heavy investment in warehouses & inventory.
o Determinants of demand
After setting the initial parameters of objectives & timeline, the next
step is to know the determinants which drive the demand. These
factors are influential and directly affect whether the product will
fare well in the market. These determinants range from the price of
the good, which will be finalized, to the median income of the
targeted group, the current customer behavior, the market trend,
and potential user consumption, which directly affect the pricing
points of the subjected good. An enterprise must have complete
knowledge of the working determinants directly influencing its
development to have near-accurate demand forecasting for a new
product, especially long-term.

o Choosing a method for Demand Forecasting

The initiation of the demand forecasting process starts based on the
nature of the product. Broadly these methods are divided into two
major categories: statistical & survey methods. A statistical form
collects & organizes working data relevant to the product type and
focuses on identifying trends that eventually help the forecasting
groundwork. In contrast, a survey method relies on an opinion poll
gauging the current pattern and tapping into the relevant human
psyche, which drives the user’s purchasing behavior. Each method
has its merit & it's up to the stakeholders to choose which way
works best for them.
o Collection & organization of data
Post the finalization of the method, the following requirement is to
gather pertinent data. This includes collecting both primary &
secondary data. Primary data is classified as first-hand information
not collected before, whereas secondary data is labelled as
information already available. Having such a repository gives a
company a starting point to plan out its product blueprint & prepare
for both planning & execution.
o Demand Estimation & Results Interpretation
With data helming the forecasting method, the eventual step is to
estimate the demand for upcoming years from the product
perspective. The managerial economics of an organization plus a
product's run in the market enable the stakeholders to be flexible in
 their production and drive result-oriented decision-making. Most of
the time, companies employing demand forecasting software have
their estimates appear in an equation form whose results can be
interpreted and presented in a comprehensible manner.
While the above steps in demand forecasting carry the entire approach to
analyzing the product's potential run in the market, a few other nuances
can be a deciding parameter too. From keeping a tab on competitors'
activities to planning promotional campaigns for a new product launch –
demand forecasting requires your organization to be a step ahead in
scrutinizing what will work best for them.

Law of supply: Law of supply states that when the price of a commodity
increases its supply also increases. Similarly, when the price of a commodity
decreases its supply also decreases. Hence, there is a direct relationship
between price and supply of a commodity. In other words, when the price
paid by buyers for a good rises, then suppliers increase the supply of that
good in the market.
Law of supply depicts the producer behaviour at the time of changes in
the prices of goods and services. When the price of a good rises, the
supplier increases the supply in order to earn a profit because of higher

prices.

The above diagram shows the supply curve that is upward sloping
(positive relation between the price and the quantity supplied). When the
price of the good was at P3, suppliers were supplying Q3 quantity. As the
price starts rising, the quantity supplied also starts rising.
Supply Function
It explains the relationship between the supply of a commodity and the
factors determining its supply. We can better represent the supply function
in the form of the following equation:

The supply function is expressed as, Sx = f (Px , P0 , Pf, St , T, O)

Where:

Sx = Supply of the given commodity x.

Px= Price of the given commodity x.

P0 = Price of other goods.

Pf = Prices of factors of production.

St= State of technology.

T = Taxation policy.

O = Objective of the firm.

A supply equation can be planned by inspecting the connection between

the independent variable and the supply. It can likewise be formed by
characterising whether the relationship is negatively related or positively
related. For instance, as a general rule, the market cost or price and
supply are contrarily associated. Then again, supply and innovative
improvement are positively related; for instance, better innovation and
technology demonstrate added supply.

Determinants of supply
The factors on which the supply of a commodity depends are known as the
determinants of demand. These are:

 Price of the Commodity

 Firm Goals
 Price of Inputs or Factors

 Technology
 Government Policy
  Expectations

 Prices of other Commodities

 Number of Firms

 Natural Factors

1. Price of the Commodity

It is the main and the most important determinant of demand. When the
price of the commodity is high, the producers or suppliers are willing to sell
more commodities.

Thus, the supply of the commodity increases. Similarly, when the price is
low the supply of the commodity decreases owing to the direct relationship
between the price of a commodity and its supply.

2. Firm Goals
The supply of goods also depends on the goals of an organization. An
organization may have various goals such as profit maximization, sales
maximization, employment maximization, etc. Where the firm’s objective is
the maximization of profit, it will sell more goods when profits are high and
less quantity of goods when the profits are low.

3. Price of Inputs or Factors

The price of inputs or the factors of production such as land, labor, capital,
and entrepreneurship also determine the supply of the goods. When the
price of inputs is low the cost of production is also low.

Thus, at this point, the firms tend to supply more goods in the market and
vice-versa.

4. Technology
When a firm uses new technology it saves the inputs and also reduces the
cost of production. Thus, firms produce more and supply more goods.

5. Government Policy
The taxation policies and the subsidies given by the government also
impact the supply of goods.

When the taxes are high the producers are unwilling to produce more goods
and thus, the supply will decrease.
On the other hand, when the government grants various subsidies and gives
financial aids to the producers, they increase the production of goods. Thus,
the supply also increases.

6. Expectations
When the producers or suppliers expect that the price shall increase in
future they hoard the goods so that they can sell them at higher prices
later. This will result in a decrease in the supply of goods.

Similarly, in case they expect a fall in price, they will increase the supply of
goods.

7. Prices of other Commodities

When the price of complementary goods increases their supply also
increases. Thus, this results in the increase in the supply of commodity also
and vice-versa.

Also, when the price of the substitutes increases their supply also increases.
This results in a decrease in the supply of goods.

8. Number of Firms
When the number of firms in the market increases the supply of goods also
increases and vice-versa.

9. Natural Factors
The factors like weather conditions, flood, drought, pests, etc. also affect
the supply of goods. When these factors are favourable the supply will
increase.

Thus, the supply of the product increments. Likewise, when the cost is
low, the inventory or supply of the product diminishes inferable from the
immediate connection between the cost of an item and its supply.