UNIT 2

Demand introduction
• Determinants of Demand
Basic Concepts & Tools for Analysis of Demand
• Individual and Market Demand
• Demand Schedule
• Demand Curve
• Shift in Demand Curve
• Exceptions to Demand Curve
• Demand Function.
• Law of Demand
• Types of Demand
Elasticity of Demand
• Types of Elasticity of Demand
• Price Elasticity Determinants
• Price Elasticity Types
• Income Elasticity Types
• Cross Elasticity
• Advertising Elasticity
• Significance of Elasticity of Demand
Demand Forecasting
• Forecasting Methods
Introduction to supply analysis
• Determinants of supply
• Elasticity of supply
• Factors influencing supply
 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)”.
 Determinants of Demand
• Price of the product
• Price of the related goods
• Consumer’s income level
• Distribution pattern of national income
• Consumer’s taste and preferences
• Advertisement of the product
• Consumer’s expectation about future price and supply position
• Demonstration effect and Band-Wagon effect (copying others)
• Consumer credit facility
• Demography and growth rate of population
• General std. of living and spending habits
• Climatic and weather conditions
• Custom
 Basic Concepts & Tools for Analysis of Demand
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’
 Demand curve
The demand curve is a graphical
representation of the relationship between the
price of a good or service and the quantity
demanded for a given period of time.
In a typical representation, the price will
appear on the left vertical axis, the quantity
demanded on the horizontal axis.
 Causes for Downward Sloping of Demand Curves
1) The law of diminishing the marginal utility
According to this principle, the marginal utility of a commodity reduces when
the quantity of goods is more. Consequently, when the quantity is more, the
prices will fall and demand will increase. Hence, consumers will demand more
goods when prices are less. This is why the demand curve slopes downwards.
2) Substitution effect
Consumers often classify various commodities as substitutes. For example, many
Indian consumers may substitute coffee and tea with each other for various
reasons. When the price of coffee rises, consumers may switch to buying tea
more as it will become relatively cheaper.
Economists refer to this as the substitution effect. Hence, if the price of tea reduces,
its demand will increase and the demand curve will be downward sloping.
3) Income effect
According to this principle, the real income of people increases when the prices of
commodities reduce. This happens because they spend less in case of falling
prices and end up with more money. With more money, they will, in turn,
purchase more and more. Therefore, the demand increases as prices fall.
 Demand Function
• It states the (functional/mathematical) relationship
between the demand for the product ( dependent
variable) and its determinants ( independent variables).
• QX = fX(PX, Prelated goods, income (M), preferences, . . )
QX = the quantity of good X
PX = the price of good X
Prelated goods = the prices of compliments or substitutes
Income (M) = the income of the buyers
Preferences = the preferences or tastes of the
buyers
 Law of demand
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”.
Factors behind Law of demand
1. Substitution effect
2. Income effect
3. Utility Maximising behaviour
Exceptions to Law of demand
-Expectation regarding future prices
-Giffen goods (inferior goods)
-Articles of snob appeal / Veblen effect(ostentatious good)
(Conspicuous goods /Esteem goods))
-Consumer’s psychological bias ( about quality and price
relationship)
 Types of demand
• Individual demand & Market demand
• Demand for capital goods (B2B) and demand for
consumer goods (B2C)
• Autonomous /Direct demand & Derived /Indirect
demand (pen & ink)
• Demand for durable & non-durable /replacement
goods
• Short term demand & Long term demand
 Elasticity of demand
Elasticity
Elasticity is a measure of how much buyers
and sellers respond to changes in market
conditions.
Elasticity allows us to analyze supply and
demand with greater precision.
Elasticity of Demand
It is the percentage change in quantity
demanded of a commodity to a percentage
change in any of the (independent) variables
that determine demand for the commodity.
 Factors influencing elasticity of demand

• Nature of commodity
• Availability of substitutes
• Income Level
• Level of price
• Postponement of Consumption
• Number of Uses
• Share in Total Expenditure
• Time Period
• Habits
 Price Elasticity Determinants

1. The Availability of Substitutes

2. The Proportion of Consumer’s Income Spent
3. The Number of Uses of a Commodity
4. Complementarity between Goods
5. Time and Elasticity.
1
2
 Significance of Elasticity of Demand
1. Elasticity of demand in production(elasticity is a concept which
enables all producers to take correct decision regarding the
quantum of output based on the demand.)
2. Elasticity of demand in Price Fixation(Every seller under
imperfect competition and monopoly has to consider the
elasticity of demand for his product when he fixes the price or
contemplates to change the price.)
3. Elasticity of demand in Distribution (if the demand for labour is
very elastic, the efforts of Trade Unions to increase the wages will
not meet with success. On the other hand if the demand for
labour is inelastic, as there may be little scope for automation)
4. Elasticity of demand in International Trade(while calculating
terms of trade, the intensities of demand of the two countries
requiring the product of the other country should be considered.)
5. Elasticity of demand in foreign Exchange(In deciding devaluation
or revaluation of the domestic currency, the authorities should
make a careful study of the elasticity of demand for the country’s
exports and imports and accordingly fix the exchange rate to
correct the disequilibrium in the balance of payments.)
6. Elasticity of demand in nationalizing an Industry(elasticity of
demand is used to enable the government to decide whether an
Industry can be declared as public utility to be nationalized.)
7. Elasticity of demand in Public Finance (In imposing a tax on a
commodity, the elasticity of demand of the commodity should be
carefully studied to find out the effect of taxation.The tax burden
should be equally borne by all and at the same time the
government should realize adequate revenue from that
commodity)
 DEMAND FORECASTING
2 MAIN CATEGORIES
MICROECONOMIC METHODS
( QUANTITATIVE) involves the prediction of activity of
particular firms, branded products, commodities, markets,
and industries.
- are much more reliable than macroeconomic methods
because the dimensionality of factors is lower and often can
easily be incorporated into a model.
MACROECONOMIC METHODS
(QUALITATIVE) involves the prediction of economic aggregates
such as inflation, unemployment, GDP growth, short-term
interest rates, and trade flows.
- is very difficult because of the complex
interdependencies in the overall economic factors
QUALITATIVE METHODS
1. SURVEY OF BUYERS INTENSIONS
2. EXPERTS OPINION METHOD
3. DELPHI METHOD
4. MARKET EXPERIMENTATION METHOD
5. COLLECTIVE OPINIONS METHOD
QUANTITATIVE METHODS
6. TIME SERIES MODELS
7. TREND ANALYSIS
8. MOVING AVERAGES METHODS
9. EXPONENTIAL SMOOTHING
10. CAUSAL MODELS
11. REGRESSION MODELS
 SUPPLY
• Supply is what the seller is able and willing to
offer for sale
• Supply Schedule: is a table showing how
much of a commodity, firms can sell at
different prices.
• Law of Supply: is the relationship between
price of the commodity and quantity of that
commodity supplied. i.e. an increase in price
will lead to an increase in quantity supplied
and vice versa.
• Supply Curve: A graphical representation of
how much of a commodity a firm sells at
different prices. The supply curve is upward
sloping from left to right. Therefore the price
elasticity of supply will be positive.
 Determinants Of Supply
1. The cost of factors of production: Cost depends on the price of
factors. Increase in factor cost increases the cost of production, and
reduces supply.
2. The state of technology: Use of advanced technology increases
productivity of the organization and increases its supply.
3. External factors: External factors like weather influence the
supply. If there is a flood, this reduces supply of various agricultural
products.
4. Tax and subsidy: Increase in government subsidies results in 43
more production and higher supply.
5. Transport: Better transport facilities will increase the supply.
6. Price: If the prices are high, the sellers are willing to supply more
goods to increase their profit.
7. Price of other goods: The price of other goods is more than ‘X’
then the supply of ‘X’ will be increased.
 Kinds Of Supply Elasticity
Price elasticity of supply:
Price elasticity of supply measures the responsiveness of
changes in quantity supplied to a change in price.
• Perfectly elastic: Suppliers are willing to supply any amount
at a given price (Es=∞)
• Perfectly inelastic: If there is no response in supply to a
change in price. (Es = 0)
• Unitary elastic: The percentage change in quantity supplied
equals the change in price (Es=1)
• Elastic: The change in quantity supplied is more than the
change in price (Ex= 1- ∞)
• Inelastic supply: The proportionate change in supply is less
than the change in price (Es =0-1)
Factors influencing supply