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.

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 Appel (In. Rs.) Quantity Demanded

10 1
8 2
6 3
4 4
2 5

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.
 Price

The demand curve DD shows the inverse relation between price and quantity demand of apple. It is downward
sloping.

Assumptions:

Law is demand is based on certain 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

Exceptional demand curve:

Some times the demand curve slopes upwards from left to right. In this case the demand curve has a positive
slope.

Price
When price increases from OP to Op1 quantity demanded also increases from to OQ1 and vice versa. The
reasons for exceptional demand curve are as follows.

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:

‘Veblan’ 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.

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 and Preference 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. 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.

6. 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.

7. Expectations regarding the future price and Income:

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. Similarly, if consumers expect their incomes to rise in the near future
they may increase the demand for a commodity just now.

8. 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.
 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”.

Types of Elasticity of Demand:

There are three types of elasticity of demand:

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross 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 price of commodity
There are five cases of price 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 ‘OP1’, 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 ‘OP1’, 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 ‘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.

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 stated in the form of a formula.

Proportionate change in the quantity demand of commodity

Income Elasticity = ------------------------------------------------------------------
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 income 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:

Proportionate change in the quantity demand of commodity “X”

Cross elasticity = -----------------------------------------------------------------------
Proportionate change in the price of commodity “Y”

a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea When the price of coffee
increases, Quantity demanded of tea increases. Both are substitutes.
 Price of Coffee

b. Incase 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.
 Factors influencing the elasticity of demand

Elasticity of demand depends on many factors.

1. Nature of commodity:
Elasticity or in-elasticity of demand depends on the nature of the commodity i.e. whether a commodity is a necessity,
comfort or luxury, normally; the demand for Necessaries like salt, rice etc is inelastic. On the other hand, the demand
for comforts and luxuries is elastic.

2. Availability of substitutes:
Elasticity of demand depends on availability or non-availability of substitutes. In case of commodities, which have
substitutes, demand is elastic, but in case of commodities, which have no substitutes, demand is in elastic.

3. Variety of uses:
If a commodity can be used for several purposes, than it will have elastic demand. i.e. electricity. On the other hand,
demanded is inelastic for commodities, which can be put to only one use.

4. Postponement of demand:
If the consumption of a commodity can be postponed, than it will have elastic demand. On the contrary, if the
demand for a commodity cannot be postpones, than demand is in elastic. The demand for rice or medicine cannot
be postponed, while the demand for Cycle or umbrella can be postponed.

5. Amount of money spent:

Elasticity of demand depends on the amount of money spent on the commodity. If the consumer spends a smaller
for example a consumer spends a little amount on salt and matchboxes. Even when price of salt or matchbox goes
up, demanded will not fall. Therefore, demand is in case of clothing a consumer spends a large proportion of his
income and an increase in price will reduce his demand for clothing. So the demand is elastic.

6. Time:
Elasticity of demand varies with time. Generally, demand is inelastic during short period and elastic during the long
period. Demand is inelastic during short period because the consumers do not have enough time to know
about the change is price. Even if they are aware of the price change, they may not immediately switch over to a
new commodity, as they are accustomed to the old commodity.

Importance of Elasticity of Demand:

The concept of elasticity of demand is of much practical importance.
1. Price fixation:
Each seller under monopoly and imperfect competition has to take into account elasticity of demand while fixing
the price for his product. If the demand for the product is inelastic, he can fix a higher price.

2. Production:
Producers generally decide their production level on the basis of demand for the product. Hence elasticity of demand
helps the producers to take correct decision regarding the level of cut put to be produced.

3. Distribution:
Elasticity of demand also helps in the determination of rewards for factors of production. For example, if the demand
for labour is inelastic, trade unions will be successful in raising wages. It is applicable to other factors of production.

4. International Trade:
Elasticity of demand helps in finding out the terms of trade between two countries. Terms of trade refers to the rate
at which domestic commodity is exchanged for foreign commodities. Terms of trade depends upon the elasticity of
demand of the two countries for each other goods.

5. Public Finance:
Elasticity of demand helps the government in formulating tax policies. For example, for imposing tax on a
commodity, the Finance Minister has to take into account the elasticity of demand.

6. Nationalization:
The concept of elasticity of demand enables the government to decide about nationalization of industries.

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. Similarly a multi product firm must take
into account the demand for different items. When forecast are mode covering long periods,
the probability of error is high. It is vary difficult to forecast the production, the trend of
prices and the nature of competition. Hence quality and competent forecasts are essential.

Prof. C. I. Savage and T.R. Small classify demand forecasting into time types. They are 1. Economic
forecasting,
2. Industry forecasting, 3. Firm level forecasting. Economics forecasting is concerned with
the economics, while industrial level forecasting is used for inter-industry comparisons and
is being supplied by trade association or chamber of commerce. Firm level forecasting
relates to individual firm.

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:

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
economic 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 past 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 i