Created By: Archana RBMI

Unit-2

DEMAND

ANALYSIS

Demand Analysis

NEED, WANT AND DEMAND

NEED- basic requirement
want- Desire Demand- desire + Purcahsing power

Demand

Desire

Willing ness

Ability

Deman d

What is Demand?
Demand means effective desire or want for a commodity which is backed up by the ability (purchasing power) and willingness to pay for it.
Demand = Desire + Ability to pay + Willingness to spend

Demand is a relative concept not absolute

It is related to price , time and place. The demand for a commodity refers to the amount of it which will be bought per unit of time at a particular price ( in a particular market).

DEMAND
Demand is the effective desire or want for a commodity, which is backed up by the ability (i.e. money or purchasing power) and willingness to pay for it. Demand = Desire + Ability to pay + will to spend The demand for a product refers to the amount of it which will be bought per unit of time at a particular price.

Essentials of Demand
Desire for a commodity,
Capacity to pay for it, Willingness to pay for it, Quantity bought and sold, A Specific Price, A Specific Time, A Specific Place.

Consumer Demand
Two levels: Individual Demand Market Demand
Market Demand is the sum total of all individual demands. Prices are determined based on Market Demand.

Demand Function.
There is a functional relationship between demand

and its various determinants. I.e., a change in any determinant will affect the demand. When this relationship expressed mathematically, it is called Demand Function. D = f (P, Y, T, Ps, U)
Where, D= Quantity demanded,

P= Price of the commodity Y= Income of the consumer, T= Taste and preference of consumers. Ps = Price of substitutes, U= Consumers expectations & others f = Function of (indicates how variables are related)

Demand Schedule
Demand schedule is a schedule which shows different

quantities of commodity, purchased at different prices. It is a list of price and quantities. Types: Individual demand Schedule , Market demand schedule

Individual demand Schedule ,

An individual demand schedule is a list of quantities of

a commodity purchased by an individual consumer at different prices

Price of Apple (In Rs.) 10 8 6 4 2 Q2uantity demanded 1 2 3 4 5

Individual demand curve

Market demand schedule

Market demand refers to the total demand for a

commodity by all the consumers. It is the aggregate quantity demanded for a commodity by all the consumers in a market. Market Demand Schedule for egg.
Price per dozen 10 8 6 4 2 A 1 2 3 4 5 B 2 3 4 5 6 C 0 1 2 3 4 D 0 0 1 2 3 Market demand 3 6 10 14 18

Market demand curve

Individual and Market demand

Individual Demand : Individual demand for a product is

the quantity of it a consumer would buy at a given price, during a given period of time. Market demand : Market demand for a product is the total demand of all the buyers in the market taken together at a given price during a given period of time. Demand Schedule: A tabular statement of price quantity (demanded) relationship at a given period of time Individual demand schedule Market demand schedule.

Demand Schedule: A demand schedule is a tabular presentation of the amount of goods consumers are willing and able to buy at different level of prices over a given period of time. Demand Curve: The graphical representation of demand schedule is the demand curve. The demand curve is a downward sloping curve from left to right. This characteristic of the demand curve is due to the inverse relationship between price and quantity demanded. 6.00 A Demand Table A Demand Curve
Price per DVDs (in rupees) Price per DVD rentals cassette Rs. demanded per week
5.00 4.00 3.50 3.00 2.00 1.00

E
D G C

A B C D E

0.50 1.00 2.00 3.00 4.00

9 8 6 4 2

Demand for DVDs

B A

.50

1 2 3 4 5 6 7 8 9 10 Quantity of DVDs demanded (per week)

17

Types of demand
Price Demand Income Demand

Cross Demand
Joint and complementary demand Composite demand Direct an derived demand Individual demand & Market demand Demand for producer goods and demand for consumer goods Direct & indirect demand

Price Demand
Price demand shows the relationship between price of

the goods and quantity demanded. If the price of goods is higher consumers will purchase less quantity of goods and if the price is lower, consumers will purchase more quantity of goods. It means there is inverse relationship between price and quantity demanded.

Income Demand
Income demand indicates the relationship

between income of the consumer and quantity of demanded commodity. In others words, it relates to the various quantities of a commodity that will be bought by the consumer at various levels of income.

Cross Demand
where change in the price of one-commodity results

in the change of the demand of other commodity (related goods).

Substitute- tea and coffee,

Complementary car and petrol,

Determinants of Demand
Price of the product Price of the related goods

Consumers income level

Distribution pattern of national income Consumers taste and preferences Advertisement of the product

Consumer credit facility

General std. of living and spending habits Climatic and weather conditions Savings

Factors influencing individual demands:

Price of the products. Income of the buyer. Tastes, Habits and Preferences. Relative prices of other goods. Relative prices of substitute and complementary products. Consumers expectations about future price of the commodity. Advertisement effect.

Factors influencing Market Demand

Price of the product. Distribution of Income and Wealth. Communitys common habits and scale of preferences. General standards of living and spending habits of the people. Number of buyers in the market and the growth of population. Age structure and sex ratio of the population. Future expecations. Level of taxation and Tax structure. Inventions and Innovations. Fashions Climate and weather conditions. Customs Advertisement and Sales propaganda.

Law of demand
there is an inverse relationship between price and quantity demanded. Statement of Law : Other things being equal, the higher the price of a commodity, the smaller is the quantity demanded and lower the price, larger the quantity demanded.

The Law of Demand

Other things equal: Quantity demanded rises as price falls Quantity demanded falls as price rises
P P D D

Assumptions to the Law of Demand:

No change in Consumers income. No change in consumers preferences. No change in the Fashion. No change in the Price of Related Goods. No change in size, age composition, sex ratio of the population. No change in the range of goods available to the consumers. No change in the distribution of income. No change in government policy. No change in weather conditions.

Why Demand Curve Slopes Downwards:

Factors behind Law of demand Substitution effect Income effect Law of diminishing Marginal Utility New buyers Different uses

Exceptions to Law of demand

Expectation regarding future prices Giffen goods

Articles of snob appeal / Veblen effect

Consumers psychological bias ( about quality and price relationship)

What are the exceptions to the Law of Demand?

Sometimes it may be observed, that with a fall in price, demand also falls and with a rise in price, demand also rises. This is apparently contrary to the law of demand. The demand curve in such cases will be typically unusual and will be upward sloping.

What are the exceptions to the Law of Demand?

1.Giffen Goods: In the case of certain Giffen goods, when price falls, quite often less quantity will be purchased because of the negative income effect and peoples increasing preference for a superior commodity with rise in their real income. E.g. staple foods such as cheap potatoes, cheap bread, pucca rice, vegetable ghee, etc. as against good potatoes, cake, basmati rice and pure ghee.

2. Giffen goods, Articles of Snob appeal (Veblen effect) : Sometimes, certain commodities are demanded just because they happen to be expensive or prestige goods and have a snob appeal. They satisfy the aristocratic desire to preserve the exclusiveness for unique goods. These goods are purchased by few rich people who use them as status symbol. When prices of articles like diamonds rise, their demand rises. Rolls Royce car is another example.

What are the exceptions to the Law of Demand?

What are the exceptions to the Law of Demand?

Speculation: When people are convinced that the price of a particular commodity will rise further, they will not contract their demand; on the contrary they may purchase more for profiteering. In the stock exchange, people tend to buy more and more when prices are rising and unload heavily when prices start falling.

What are the exceptions to the Law of Demand?

Consumers phychological bias or illusion: When the consumer is wrongly biased against the quality of a commodity with reduction in the price such as in the case of a stock clearance sale and does not buy at reduced prices, thinking that these goods on sale are of inferior quality.

Variation & Changes In Demand

(a) Variations i.e. extension and contraction in

demand due to price and (b) Changes i.e. increase and decrease in demand due to other factors (Income, taste etc.)

(a) Variations i.e. extension and contraction in demand due to price

Extension of Demand: This refers to rise in demand

due to a fall in price of the commodity. It is shown by a downwards movement on a given demand curve. Contraction of Demand: This means fall in demand due to increase in price and can be shown by an upwards movement on a given demand curve.

Changes i.e. increase and decrease in demand due to other factors

Increase in Demand: This refers to higher demand at

the same price and results from rise in income, population etc., this is shown on a new demand curve lying above the original one.
Same price; More demand,
Same demand; More price.
Same price; More demand Same demand; More price

price
3 3

demand
3 4

price
3 4

demand
3 3

 Decrease in demand: It means less quantity

demanded at the same price. This is the result of factors like fall in income, population etc. this is shown on a new demand lying below the original one.

Same price; Less demand price 3 3 demand 3 2 Same demand; Less price price 3 2 demand 3 3

Elasticity of Demand
Elasticity of demand is the degree of

responsiveness of demand to the changes in its determinants.

Elasticity of demand is defined as the percentage

change in quantity demanded caused one percent change in each of the determinants under consideration while the other determinants are held constant. Ed = % change in quantity demanded / % change in the determinant.

Types of Elasticity of Demand

There are mainly five types of Elasticity of Demand :
1. Price Elasticity of demand 2. Income Elasticity of demand 3. Cross Elasticity of demand

Price Elasticity of Demand :

Price Elasticity of Demand measures

the degree of responsiveness of the quantity demanded of a commodity due to a change in its own price. Ep = - (% change in quantity demanded) /
( % change in the Price). Here we ignore the ve sign as the relation between price and the quantity demanded is opposite.

Price Elasticity of Demand

Formula:
ep = Proportionate change in the Quantity demanded
Proportionate change in price
change in the quantity demanded Quantity demanded = ---------------------------------------------------------------change in price price

Price elasticity of demand

(Q2 Q1) Q1 ep = ------------------------------P2 P1 P1
Q1 = Original Quantity before price change. Q2 = Quantity demanded at the changed price. P1 = Original price. P2 = Changed price.

Illustration: If Q1 = 2000 P1 = 10

and

Q2 = 2500 P2 = 9

(2500 2000) 2000 ep = ----------------------------------------------------- =

-- 2.5

9 10 10 Price elasticity is negative showing inverse relationship.

Types/Degrees of Price Elasticity of demand

1.
2. 3. 4. 5.

Perfectly inelastic demand (ep = 0) Inelastic (less elastic) demand (e < 1) Unitary elasticity (e = 1) Elastic (more elastic) demand (e > 1) Perfectly elastic demand (e = )

Measurement of price elasticity of demand

Graphical Method (point and Arc method) Point Method Expenditure Method

Graphical Method
Perfectly Elastic Demand (ep= infinity)
Y p r i c e

Where no reduction in price is needed to cause an increase in demand. The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price. The shape of the demand curve is horizontal. The elasticity is = infinite.

Q1

Quantity Demanded

Perfectly inelastic demand (ep = 0)

Y p r P1 i c P e O

Q Quantity Demanded

Less Elastic Demand (ep<1)

Y p r P1 i c P e

D O Q1 Q Quantity Demanded X

Relative/Unitary Elastic Demand

Y p r i P1 c e P D

D O Q Q1 Quantity Demanded X

Highly Elastic Demand (ep>1)

Y p r i c e D P1 P D

Q1

Quantity Demanded


ep=infinity ep>1 ep=1

Point Elasticity of Demand

Formula :
ep=lower segment upper segment
ep<1

ep=0

Expenditure Method
Elastic Demand ( ep>1)

P (Rs.) 6 5

Q (Nos.) 10 13

TE (Rs.) 60 65

Inelastic Demand (ep<1)

P (Rs.) 6 5

Q (Nos.) 10 11

TE (Rs.) 60 55

 Unitary Elastic Demand (ep=1)

P (Rs.) 6
5

Q (Nos.) 10
12

TE (Rs.) 60
60

Percentage method
Pe= % change in Quantity demanded %change in Price

Average revenue method

E= A A-M

Arc method
Arc Definition
Q2 Q1 P2 P 1 EP P2 P 1 Q2 Q1

Factors determining Price Elasticity of Demand

Nature of the commodity
Variety of use Substitutes

Range of price
Income level Proportion of income spent on the commodity

Joint demand
Durability

Income Elasticity
Income Elasticity may be defined as the degree of responsiveness of

quantities demanded to a given change in income. Income Elasticity of Demand is defined as the ratio of the percentage or proportionate quantity demanded to the percentage or proportionate change in income. OR Q2 Q1 (effect) Q2 + Q1 ey = --------------------Y2 Y1 (cause) Y2 + Y1 Q1 Original Quantity demanded before Income change Q2 - Quantity demanded after Income changed Y1 - Original Income Y2 - Changed new income.

Measurement Of Income Elasticity Of Demand

Proportionate change in Demand Income Elasticity Of Demand = Proportionate change in Income

i.e.
Income Elasticity Of Demand =

q Q

y Y

Income Elasticity of Demand (Ey)

It is the degree of change or responsiveness of quantity

demanded of a good to a change in the income of the consumer. Ey = % change in Qd % change in Income

Kinds of Income Elasticity of demand

Positive Income Elasticity of demand Negative Income Elasticity of demand Zero Income Elasticity of demand

Income Elasticity of demand

Income Elasticity of demand equal to unity Income Elasticity of demand more than unity Income Elasticity of demand less than unity

Illustration

Suppose a consumer's income is Rs.1000 and he purchases 10 kgs. of sugar. If income goes up to Rs.1100 he is prepared to buy 12 kgs. Calculate income elasticity of sugar. Q2-Q1 12 - 10 Q2+Q1 12 + 10 ey = ---------- = -------------------Y2-Y1 1100 - 1000 Y2+Y1 1100 + 1000 = 2 -:- 100 = 1 x 21 22 2100 11 1 = 21 = 1.99 11 Demand for sugar is income elastic

Cross Elasticity
Cross elasticity of demand
Cross elasticity of Demand refers to the degree of responsiveness of demand for a commodity to a change in the price of some related commodity. Cross elasticity of demand is the ratio of proportionate or percentage change in demand of one commodity to proportionate or percentage change in the price of another related commodity.

Cross elasticity of Demand

Proportionate or %ge change ec = in the quantity demanded of X Proportionate or %ge change in the quantity demanded of Y
=

Qx2 - Qx1 Qx2 + Qx1 Px2 Px1 Py2 + Py1

If commodities are inter-related, a change in price of one may cause a change in the price of the other. This is known as Price elasticity of demand. Py2 Py1 Py2 + Py1 PxEpy = -------------------Px2 Px1 Px2 + Px1

Kinds of Cross Elasticity of demand

Positive cross Elasticity of demand - substitutes Negative cross Elasticity of demand -complementary Zero cross Elasticity of demand independent goods

Advertising
Important functions of advertising are (a) To shift the demand curve to the right (b) To reduce the elasticity of demand. (c) However, advertising has a cost payable to the media.

Promotional or Advertising Elasticity of Demand

Advertising elasticity of demand is the degree of responsiveness of demand to changes in advertising expenditure. Q2-Q1 Q Q2+Q1 Q Q A eA = ------------------------------- = -------------------------- = ------- x ----A2-A1 A2+A1 Q = Quantity of sales A A A Q

A = Advertisement expenditure.

Illustration:
At initial advertisement expenditure of Rs.50,000 the demand For the firms product is 80,000 units. When the advertisement Budget is increased to Rs.60,000 the sales volume increased to 90,000 units. What is the advertising elasticity? A1 = Rs. 50000 A2 = Rs.60000 A = Rs.10000 Q1 = 80000 units Q2 = 90000 units Q = 10000 units Q x A = 10000 x 50000 = 0.625 A Q 10000 80000 Note: When price-quantity changes are very small, point Elasticity is used. When there is substantial change, arc elasticity is used. eA = If Arc elasticity is found for the above example, eAarc = Q x A1 + A2 = 10000 x 50000 + 60000 = 0.647 A Q1 + Q2 10000 80000 + 90000

Point Elasticity of Demand

Point Elasticity of Demand at any point on the Linear Demand Curve is measured as under :

Lower segment of the Demand Curve ep = -------------------------------------------------Upper Segment of the Demand Curve

ep = Infinite elasticity

ep > 1 Elastic range

ep < 1 Inelastic range

Factors influencing elasticity of demand

1. Nature of the commodity. 2. Availability of Substitutes 3. Number of Uses 4. Consumers Income. 5. Height of Price and Range of Price Change. 6. Proportion of Expenditure. 7. Durability of the Commodity. 8. Habit. 9. Complementary Goods. 10. Time. 11. Recurrence of Demand. 12. Possibility of Postponement.