Lecture: 5

Market analysis – meaning, types, determinants of demand, demand function

Market
The organized exchange of commodities (goods, services, or resources) between buyers and
sellers within a specific geographic area and during a given period of time. Markets are the
exchange between buyers who want a good (the demand-side of the market) and the sellers who
have it (the supply-side of the market).
A market is the mechanism used to exchange commodities and to address the scarcity problem. It
is the primary method used to allocate resources in modern economies.
The word market comes from the Latin word “marcatus” which means merchandise or trade or a
place where business is conducted.
A market is the sphere within which price determining forces operate -Hibbard,B.H.
A market is the area within which the forces of demand and supply converge to establish a single
price -Encylopaedia.
Marketing
The Marketing is defined as the study of entire gamut of activities that direct the flow of goods
and services from the primary producer ultimate consumer.
Marketing is a social and managerial process by which individuals and groups obtain what they
need and want through creating, offering and exchanging products of value with others -Philip
Kotler.
Market Structures
The manner in which markets are organized, based largely on the number of participants in the
market and the extent of market control of each participant.
The degree of competition among buyers or sellers determines the basic structure of a market.
The four most common types of market structures are based on differing numbers of competitors
on the supply-side of the market.
Perfect Competition: The Benchmark
Perfect competition is the theoretical benchmark of efficiency achieved because the large number
of participants in the market gives neither buyers nor sellers market control. Other market
structures have different amounts of market control due to different numbers of competitors. In
general, more competition means less market control.
This market has many firms, each having a small share of the total industry output. The product
is relatively homogeneous, there is easy entry into the market, no collusion among firms is
possible, and no firm has control over the price of the product.
Assumptions of perfect competition
a. Large number of buyers and sellers
b. Product homogeneity
c. Free entry and exit of firms

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d. Goal of all firms is profit maximization
e. No Government regulation
f. Perfect mobility of factors of production-Like workers, raw materials also have free mobility
g. Perfect Knowledge-Buyers and sellers have complete knowledge of market conditions.
A firm operating in a perfectly competitive market has very little freedom with regard to price-
output decisions. The market sets the price of its product because there is no product
differentiation. Therefore, the firm’s main task is to produce at a unit cost consistent with the
market price. The firm’s demand curve is the same as its average revenue and marginal revenue,
as shows in Figure 1. There is no possibility for excess profits, and each firm will produce at the
level where average cost and marginal cost are equal to marginal revenue and market price.
Examples of perfect competition are few, such as small farmers, commodity and stock
exchanges.

Price MC

AC

AR

Output
Figure 1. Perfect competition firm: in the short run, the supply curve of the firm is the segment
of MC above min AVC.
Selling-Side Market Structures
Varying degrees of market control among sellers generate three alternative market structures.
Three market structures, along with perfect competition are illustrated by the market structure
continuum presented in the exhibit to the right. Moving from right to left, the number of
participants on the supply side of the market increases resulting in less market control.
Moving from left to right, the market control possessed by each seller increases, due to
fewer sellers.

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 Monopoly
In this type of market, one firm produces the entire output of a product or surface for which there
is no substitute. Monopoly may be established by a patent or granted to a firm by government to
produce a product or a firm by government to produce a product or provide a service.
When the general economic conditions cause a shift in the cost and demand curves, the
monopoly firm merely changes its price to a new optimum level of output. If the monopoly firm
decides not to maximize profits, it can set its price at a level that would bring in an acceptable
rate of profit. The decision depends on the elasticity of demand and on the degree of government
regulation. When the demand elasticity is high, a monopoly firm can increase its sales
significantly by relatively small price decreases; therefore, the price will be set slightly above the
marginal cost curve. In regulated monopolies, the price-output decision is also influenced by
public policy. Should the required output correspond to a price equal to marginal cost but below
average cost, a government subsidy would have to be provided to avoid a loss by the public
utility.
Price MC

AR

Q MR Output
Figure 2. Monopoly firm: In the short run, the price is set at output Q, where MC = MR.

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 Oligopoly

A market with a small number of firms whose products are either homogeneous or differentiated.
Barriers to entry are high and price decisions are interdependent. characterized by a small
number of relatively large competitors, each with substantial market control. Oligopoly sellers
exhibit interdependent decision making which can lead to intense competition and the motivation
to cooperate through mergers and collusion. Oligopoly tends to have serious inefficiency
problems, but also provides the benefits of innovation and large scale production.

Price Leadership
The largest firm in the market simply increases its price and all others follow suit. The
price leader, often identified as the dominant firm in the market, is usually successful in setting
price levels because it enjoys cost efficiency or marketing and distribution advantages. The
largest, or dominant, firm will set its price to maximize profit by producing where marginal cost
is equal to marginal revenue.
Non Price Competition
In many oligopoly markets there is substantial product differentiation. Under this
condition, the price is but one of several variables which determine demand. The firm to promote
competition uses product design, quality of service, terms of sale and adverting. The other firms,
usually, adjust their price accordingly and sales become non price competition, i.e. the firms try
to increase their share of the market by emphasizing the degree of differentiation in their
products.
Cartel
A cartel, usually, consists of a group of sellers that attempts to control the output and the price of
a commodity in a domestic or global market. Although a cartel tries to operate as profit
maximizing monopoly. To be successful, there must be perfect collusion among the members.
Monopolistic or imperfect competition
This market is characterized by product differentiation, easy entry, and a large number of
firms. The largest numbers of firms in the economy belong in the market, which is referred to as
monopolistic, or imperfect competition. Examples of monopolistic industries are retailing,
construction, light manufacturing, and the service industries.
Features of Market Firms
Perfect
Characteristics Monopoly Oligopoly Monopolistic
Competition
No. of sellers Many One Few Many
Homogeneous Homogeneous
Product Homogeneous Differentiated
(Unique) differentiated
Entry Free entry Blocked entry Restricted entry Relatively easier
Price making
Price policy Price taking Price making Rigid
Discretionary
Agricultural Fertilizers &
Example Public utilities Soap & Oil.
Commodities Pesticide

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 Buying-Side Market Structures
Varying degrees of market control on the demand side generate three additional market
structures.

These three market structures, along with perfect competition are illustrated by the market
structure continuum presented in the adjoining exhibit. Moving from right to left, the number of
participants on the demand side of the market increases resulting in less market control. Moving
from left to right, the market control possessed by each buyer increases, due to fewer buyers.
1. Monopsony: Monopsony contains a single buyer in the market. It is the worst-case scenario
of inefficiency on the buying side of the market.
2. Monopsonistic Competition: Characterized by a large number of relatively small
competitors, each with a modest degree of market control on the demand side. Key feature of
monopsonistic competition is product differentiation as each buyer seeks to purchase a
slightly different product.
3. Oligopsony: Characterized by a small number of relatively large competitors, each with
substantial market control. Oligopsony buyers, exhibit interdependent decision making which
can lead to intense competition and the motivation to cooperate.

Market Research
It is defined as gathering, recording and analyzing of all facts about problems relating to
the transfer and sale of goods and services from producer to consumer.
Market research refers to the systematic gathering and analysis of information relevant to
a problem in marketing. It describes research on markets, their size, geographical distribution,
and incomes and so on it is a sub-function of marketing research.
Objectives
1. to understand the existing traditional marketing system
2. to diagnose the problems confronting the farmers, marketing agencies and consumers in a
dynamic content
3. To analyse and predict the impact and effectiveness of alternate policy measures in solving
these problems.
4. To find out general market conditions and tendencies for a product
5. To define a probable market for a new product
6. To develop efficient distribution methods
7. To find out the customer feed back to a product.

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Market research in business and objective

Study of consumer demand by a firm so that it may expand its output and market its product.

Objectives

1. to discover people’s need or felt need of product which a firm contemplates to manufacture.

2. to examine the reactions of consumers when product put on market with a view to bring
improvements in quality, design and packaging of product on basis of their preferences.

3. to examine performance of present system of marketing with particular reference to costs and
efficiency

Steps in research

i. Problem Identification-Estimation of demand and supply, study of market function

and functionaries, estimation of marketing costs and margins for individual
commodities through various channels, assessment of marketing efficiency and
estimation of marketed surplus.

ii. Hypothesis formulation is to delineate research area

iii. Designing empirical procedures is to get appropriate data from farmers, consumers,
market middlemen and government department. Data collected through schedules and
questionnaires and protested in field. Apart from structured surveys, Participatory Rural
Appraisal (PRA) and Rapid Rural Appraisal (RRA) also employed.

iv. Collection and analysis of data- data collected is either by primary or secondary sources.
Primary data collected from farmer-produces, market middlemen and consumers. Secondary
Data collected from government and Semi-government departments. Collected data is tabulated
and analyzed using, suitable tools.

i. Interpretation of findings is to find solutions to problems of agricultural marketing. And

before finalizing the results, interaction with various stakeholders is essential.

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 Market Analysis
A Market analysis is a documented investigation of a market that is used to inform a firm's
planning activities particularly around decisions of inventory, purchase, work force
expansion/contraction, facility expansion, purchases of capital equipment, promotional activities,
and many other aspects of a company.

Dimensions of market analysis

David A. Aaker outlined the following dimensions of a market analysis

1. Market size (current and future)
2. Market growth rate
3. Market profitability
4. Industry cost structure
5. Distribution channels
6. Market trends
7. Key success factors
The goal of a market analysis is to determine the attractiveness of a market, both now and in the
future. Organizations evaluate the future attractiveness of a market by gaining an understanding
of evolving opportunities and threats as they relate to that organization's own strengths and
weaknesses.
Organizations use the findings to guide the investment decisions they make to advance their
success. The findings of a market analysis may motivate an organization to change various
aspects of its investment strategy. Affected areas may include inventory levels,a work force
expansion/contraction, facility expansion, purchases of capital equipment, and promotional
activities.
Market size
The most common measure of market size is the sum of the revenues of its participants. The
following are examples of information sources for determining market size:
▪ Government data
▪ Trade association data
▪ Financial data from major players
▪ Customer surveys
Market trends
Changes in the market are important because they often are the source of new opportunities and
threats. Moreover, they have the potential to dramatically affect the market size.
Examples include changes in economic, social, regulatory, legal, and political conditions and in
available technology, price sensitivity, demand for variety, and level of emphasis on service and
support.
Market growth rate
A simple means of forecasting the market growth rate is to extrapolate historical data into the
future. While this method may provide a first-order estimate, it does not predict important

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turning points. A better method is to study market trendsand sales growth in complementary
products. Such drivers serve as leading indicators that are more accurate than simply
extrapolating historical data.
Important inflection points in the market growth rate sometimes can be predicted by constructing
a product diffusion curve. The shape of the curve can be estimated by studying the characteristics
of the adoption rate of a similar product in the past.
Ultimately, many markets mature and decline. Some leading indicators of a market's decline
include market saturation, the emergence of substitute products, and/or the absence of growth
drivers.
Market segments
Markets are not uniform. Therefore it is also important for investors to identify and evaluate the
various segments that make up the total market. This analysis helps organizations determine
which areas account for the greatest share of the market's growth and are more susceptible to
change. This information, in turn, helps them pinpoint the most promising opportunities within
the overall market and guides the choice of specific investments.
Market profitability
While different organizations in a market will have different levels of profitability, they are all
similar to different market conditions. Michael Porter devised a useful framework for evaluating
the attractiveness of an industry or market. This framework, known as Porter's five forces,
identifies five factors that influence the market profitability:
▪ Buyer power
▪ Supplier power
▪ Barriers to entry
▪ Threat of substitute products
▪ Rivalry among firms in the industry
Industry cost structure
The cost structure is important for identifying key factors for success. To this end, Porter's value
chain model is useful for determining where value is added and for isolating the costs.
The cost structure also is helpful for formulating strategies to develop a competitive advantage.
For example, in some environments the experience curve effect can be used to develop a cost
advantage over competitors.
Distribution channels
Examining the following aspects of the distribution system may help with a market analysis:
▪ Existing distribution channels - can be described by how direct they are to the customer.
▪ Trends and emerging channels - new channels can offer the opportunity to develop a
competitive advantage.
▪ Channel power structure - for example, in the case of a product having little brand equity,
retailers have negotiating power over manufacturers and can capture more margin.

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Success factors
The key success factors are those elements that are necessary in order for the firm to achieve its
marketing objectives. A few examples of such factors include:
▪ Access to essential unique resources
▪ Ability to achieve economies of scale
▪ Access to distribution channels
▪ Technological progress
It is important to consider that key success factors may change over time, especially as the
product progresses through its life cycle.
Applications
The literature defines several areas in which market analysis is important. These include: sales
forecasting, market research, and marketing strategy. Not all managers will need to conduct a
market analysis. Nevertheless, it is important for managers that use market analysis data to how
analysts derive their conclusions and what techniques they use to do so.
Determinants of Demand

The demand is influenced by the following factors:

a) Tastes and Preferences of the Consumer: The changes in demand for various goods occur
due to changes in fashion, and massive advertisement by the sellers.

b) Income of the People: The greater the incomes of the people, the greater will be their
demand for goods and vice versa. Thus, there is a positive relationship between income and
demand when all other factors are kept constant.

c) Price of the Commodity: Greater the price of the commodity, the lesser will be its
demand and vice-versa. Thus, there is a negative relationship between the price and
quantity demanded of a commodity, if all other factors remain constant.

d) Changes in the Prices of the Related Goods: When the price of a substitute for a good
X falls, the demand for that good X will decline and when the price of the substitute rises,
the demand for that good will increase. Tea and coffee are very close substitutes. Therefore,
when the price of tea falls, the consumers substitute tea for coffee and as a result, the
demand for coffee declines. For goods that are complementary with each other, the change
in the price of any of them would affect the demand of the other. For instance, if the price of
milk falls, its demand would rise. Along with the demand for milk, the demand for sugar
would also rise, as milk and sugar are complementary goods. Likewise, when the price of
car falls, the demand for them would increase which in turn will increase the demand for
petrol.

e) Population: As population increases, the number of consumers would also increase and
as a result, more of goods will be purchased.

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f) Income Distribution: In a country with equitable distribution of income, there will be
lesser demand for certain luxury goods, while in a country where the income is unequally
divided among the very rich and very poor people, the demand for such luxury goods-will
be more.

g) Expectations about Future Prices: If consumers expect that the price of a good to rise
sharply in near future, they may buy more of that good now itself so as to avoid paying
higher prices later.
Demand Function
The demand equation is the mathematical expression of the relationship between the quantity of
a good demanded and those factors that affect the willingness and ability of a consumer to buy
the good.
For example, Qd = f(P; Prg, Y) is a demand equation
Where,Qd is the quantity of a good demanded,
P is the price of the good,
Prg is the price of a related good, and
Y is income;
The function on the right side of the equation is called the demand function. The semi-colon in
the list of arguments in the demand function means that the variables to the right are being held
constant as we plot the demand curve in (quantity, price) space.
A simple example of a demand equation is Qd = 325 - P - 30Prg + 1.4Y.
Here, 325 is all relevant non-specified factors that affect demand for the product.
P is the price of the good.
The coefficient is negative in accordance with the law of demand.
The related good may be either a complement or a substitute. If a complement, the coefficient of
its price would be negative as in this example. If a substitute, the coefficient of its price would be
positive.
Income, Y, has a positive coefficient indicating that the good is a normal good. If the coefficient
was negative the good in question would be an inferior good meaning that the demand for the
good would fall as the consumer's income increased.
Specifying values for the non price determinants, Prg = 4.00 and Y = 50,
results in the demand equation Q = 325 - P - 30(4) +1.4(50) or
Q = 275 – P
If income were to increase to 55 the new demand equation would be
Q = 282 - P.
Graphically this change in a non price determinant of demand would be reflected in an outward
shift of the demand function caused by a change in the x intercept.

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Inverse demand function
In its standard form a linear demand equation is
Q = a - bP.
That is, quantity demanded is a function of price. The inverse demand equation, or price
equation, treats price as a function g of quantity demanded:
P = f(Q)
To compute the inverse demand equation, simply solve for P from the demand equation.
For example, if the demand equation is
Q = 240 - 2P
then the inverse demand equation would be
P = 120 - .5Q
the right side of which is the inverse demand function.

Demand Function: The price-demand relationship can be expressed in the form of a demand
function as follows:
qd = 10 - 3P
On substitution of any scheduled value of P we get the relevant value of the quantity demanded.
Thus,
when P = 1 then qd =10 - 3 (1) = 7 or
when P = 3, then qd = 10 - 3 (3) = 1 etc.

Law of demand: The law of demand explains the inverse relation between quantity and price in
general. It can be stated as follows:
"Ceteris Paribus (other things remaining equal), the quantity of a good demanded will rise
(expand) with every fall in its price and the quantity of a good demanded will fall (contract) with
every rise in its price."

In a functional form this can be stated as,

qd = f (P) [ Y, Ps, N, Z ]const.
qd, the quantity of a good demanded functionally depends on its price P.
However, the quantity demanded is also causally related to other factors such as income of an
individual (Y), prices of substitutes (Ps), number of members in the family (N) and the tastes of
the consumer (Z). In order to satisfy price-demand relation, the effect of these other variables has
been restrained by assuming them to be constant.

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