Module III: Demand and Supply Analysis (10 Hours)

Law of Demand,
Elasticity of Demand - Price, Income & Cross elasticity.
Uses of elasticity of demand for Managerial decision making,
Measurement of elasticity of demand.
Law of supply, Elasticity of supply.
Note: Illustrative numerical examples to be used to explain the concepts.
Demand is the mother of
Production
basic business activity of all buss is buy and sell goods and
services.

Demand
Law of Demand
Demand Function
Elasticity of Demand
Demand Forecasting
 Demand

implies

Desire for a commodity

backed by
Ability to Pay
&
Willingness to Pay
 Demand

A want with three attributes – desire to buy,

ability to pay & willingness to pay –
becomes demand.

The term demand for a commodity always

has a reference to ‘a price’, ‘a period of
time’, and ‘a place’.
 Demand
Wrong Statement :

“Demand for a Motor Bike is 35000 units”.

Right Statement :

“The annual demand for a Motor Bike in India

at an average price of Rs. 50,000 is 35,000
units”.
 Demand - Definitions
“The demand for any commodity is the relationship
between the price and the quantity that will be
purchased at that price”.
Prof. Waugh

“The demand for a product is a schedule of the

amounts that buyers would be willing to
purchase at all possible prices at any one instant
of time”.
Prof. Meyers
 Factors Determining Demand
• Price of the commodity – Normally there is an inverse
relationship between the price of the commodity and the
quantity demanded. (Px)
• Price of related commodities (Pr)
• Income of the Consumer – Determines the purchasing
power of the consumer. Generally, there is a direct
relationship between the income of the consumer and
demand. (Y)
• Distribution of income (D)
• Consumer’s taste and preference (T)
• Consumer Expectation (expected change in price)
• Size and composition of population
• Other Factors e.g., natural calamities
 Demand Schedule
“The state of demand for any good in a given
market at a given time should state what the
volume of sales would be at a series of prices.
Such a statement taking the form of a tabular
statement is known as Demand Schedule”.
The demand schedule expresses the functional
relationship between the price of a commodity
and its quantity demanded.
Demand Schedules are of two types :
 Individual Demand Schedule
 Market Demand Schedule
 Individual Demand Schedule

An individual demand schedule deals with the

price of a commodity and its quantity demanded
by an individual consumer at a particular time.
The table showing such relationship is called
individual demand schedule.

Individual Demand
Schedule
 Market Demand Schedule
Shows the various commodities that would be
purchased at different prices by all the
buyers of that commodity. It is composed of
the demand schedules of all the individuals
purchasing that commodity.

Market
Demand
Schedule
 Demand Curve
When the demand for a commodity at different
prices is depicted in the graphical form, we will get
a line or curve which is called as Demand Curve.

The demand curve shows an inverse relationship

between the price of the commodity and its
quantity demanded. Higher the price, lower will be
the quantity demanded and vice-versa.

Demand Curve with

Demand Schedules
Types of Demand
These are some of the important types of demand that the firms must cater to before
deciding on the price and other factors related to their products.

1.Individual Demand and Market Demand: The individual demand refers to the
demand for goods and services by the single consumer, whereas the market demand
is the demand for a product by all the consumers who buy that product. Thus, the
market demand is the aggregate of the individual demand.
2.Total Market Demand and Market Segment Demand: The total market demand
refers to the aggregate demand for a product by all the consumers in the market who
purchase a specific kind of a product. Further, this aggregate demand can be sub-
divided into the segments on the basis of geographical areas, price sensitivity,
customer size, age, sex, etc. are called as the market segment demand.
3. Derived Demand and Direct Demand: When the demand for a product/outcome is
associated with the demand for another product/outcome is called as the derived
demand or induced demand. Such as the demand for cotton yarn is derived from the
demand for cotton cloth. Whereas, when the demand for the products/outcomes is
independent of the demand for another product/outcome is called as the direct
demand or autonomous demand. Such as, in the above example the demand for a
cotton cloth is autonomous.
.
4. Industry Demand and Company Demand: The industry demand refers to the
total aggregate demand for the products of a particular industry, such as
demand for cement in the construction industry. While the company demand is
a demand for the product which is particular to the company and is a part of that
industry. Such as demand for tyres manufactured by the Goodyear. Thus, the
company demand can be expressed as the percentage of the industry demand
5. Short-Run Demand and Long-Run Demand: The short term demand is more
elastic which means that the changes in price or income are reflected
immediately on the quantity demanded. Whereas, the long run demand is
inelastic, which shows that demand for commodity exists as a result of
adjustments following changes in pricing, promotional strategies, consumption
patterns, etc.
6. Price Demand: The demand is often studied in parlance to price, and is
therefore called as a price demand. The price demand means the amount of
commodity a person is willing to purchase at a given price. While studying the
demand, we often assume that the other factors such as income of the
consumer, their tastes, and preferences, the prices of other related goods
remain unchanged. There is a negative relationship between the price and
demand Viz. As the price increases the demand decreases and as the price
decreases the demand increases.
7. Income Demand: The income demand refers to the willingness of an individual
to buy a certain quantity at a given income level. Here the price of the product,
customer’s tastes and preferences and the price of the related goods are
expected to remain unchanged. There is a positive relationship between the
income and demand. As the income increases the demand for the commodity
also increases and vice-versa.
8. Cross Demand: It is one of the important types of demand wherein the demand
for a commodity depends not on its own price, but on the price of other related
products is called as the cross demand. Such as with the increase in the price of
coffee the consumption of tea increases, since tea and coffee are substitutes to
each other. Also, when the price of cars increases the demand for petrol
decreases, as the car and petrol are complimentary to each other.
Law of Demand

Assumptions

Exceptions

Shift & Movement in Demand Curve

Assumptions of Law of Demand
 Law of demand
• describes the relationship between the quantity demanded and the price of
a product.
• there is an inverse relationship between the price and quantity demanded of
a product.
– “Law of Demand states that higher the price lower the quantity
demanded and vice versa, other things remaining constant.”
 Law of Demand
• “The greater the amount to be sold, the smaller must be
the price at which it is offered in order that it may find
purchasers; or in other words, the amount demanded
increases with a fall in price and diminishes with a rise in
price”-Marshall.
• Therefore, demand is a function of price and can be
expressed as follows:
• D = f(P)
• D= Demand P= Price f = Functional Relationship
The Law of demand operates due to-
 Shift in Demand Due to Income Increase
• A shift in demand means that at any price (and at every price), the quantity
demanded will be different than it was before.
• graph of a demand curve for a normal good like pizza.
• Now income increases. As a result of the change, consumers going to buy
more or less pizza? (buys more )
• an increase in income causes an upward (or rightward) shift in the demand
curve, so that at any price, the quantities demanded will be higher,
•
Exceptions to the Law of Demand
 Exceptional Demand Curve
if the price of a product increases its demand also increases, which constitutes
an exception to law of demand.

• i. Giffen Paradox:
• Refer to one of the major criticism of law of demand. Giffin Paradox was
given by Sir Robert Giffen, who classified goods into two types, inferior
goods and superior goods, generally called Giffen goods.
• The inferior goods are those whose demand decreases with increase in
consumer’s income, eg.cheap potatoes and vegetable ghee.
• These goods are of low quality; therefore, the demand for these goods
decreases with increase in consumer’s income
• if the price of these goods increases, then the demand for these goods
increases assuming that the high price good would be of good quality.
example, coffee is considered as superior and tea as inferior. In case tile
price of both of these goods increases the consumers would increase the
demand of tea to satisfy their need by paying tile same amount.
ii .Necessity Goods:
Refer to goods that are considered as essential for consumer. The demand of
necessity goods does not increase or decrease with increase or decrease in their
prices. For example, salt is a necessity good whose consumption cannot be
increased in case its price decreases. In such a scenario, the law of demand is
not applicable.

iii. Prestige Goods:

Refers to goods that are perceived as a status symbol, such as diamond and
Johny Walker Scotch Whisky. The demand for these goods remains same in
case of increase or decrease in their price. In such a case, the law of demand is
not applicable.

iv. Speculation:
Refers to an assumption of consumers about the change in prices of a product in
future. If the price of a product is expected to rise in future, then the demand for
the product increases in the present situation.
v. Psychologically Bias Customers:
Refer to one of the important exceptions to the law of demand. Different
customers have different perceptions about the price of a product. Some
customers have perceptions that low price means bad quality of a particular
product, which is not true in all cases. Therefore, if there is a fall in the price of a
product, then the demand for that product decreases automatically.

vi. Brand Loyalty:

Refers to the preference of a consumer towards a particular brand. Consumers
do not prefer to change a brand with increase in the price of that brand.
example, if a consumer prefers, to wear Levi’s jeans, he would continue to
purchase it, irrespective of increase in its price. In such a situation, the law of
demand cannot be applied.

vii. Emergency Situations:

Refers to a condition for which the law of demand is not applicable. In
emergencies, such as war flood, earthquake, and famine, the availability of
goods become scarce and uncertain. Therefore, in such situations, consumer.’
prefer to store a large quantity of goods, regardless of their prices.
 Elasticity of Demand
Demand for goods varies with price. But the extent
of variation is not uniform in all the cases.
Sometimes demand is greatly responsive to
changes in price; at other times, it may not be so
responsive. The extent of variation in demand is
technically expressed as elasticity of demand.

According to Marshall, the elasticity of demand in a

market is great or small, depending on whether
the amount demanded increases much or little for
a given fall in price; and diminishes much or little
for a given rise in price.
 Types of Elasticity

Price Elasticity Degree of responsiveness

of demand for a commodity to a given change in
its price.
Income Elasticity Degree of responsiveness
of demand for a commodity to a given change in
the income of the consumer.
Cross Elasticity Degree of responsiveness
of demand for a commodity to a given change in
price of a related commodity – substitute or
complementary good.
 PRICE ELASTICITY

Degree of responsiveness of demand for a

commodity to a given change in its price.

OR
The extent of the change of demand for a
commodity to a given change in price, other
demand determinants remain constant, is termed
as the price elasticity of demand.
The Coefficient of price elasticity (ep)
% change in quantity demanded
(ep) = -------------------------------------------
% change in price
(ep) = ∆Q/Q ÷ ∆ P/ P
Or (ep) = ∆Q/Q × P/ ∆ P
Symbolically, ∆Q P
= ----------- × -----
∆P Q
Q= original Quantity demanded P =Original Price
∆Q = change in quantity demanded
∆ P = change in Price
 PRICE ELASTICITY OF DEMAND

Numerical Value Terminology Description

e=α Infinitely Elastic Consumers have infinite demand at a particular

price
and none at even slightly higher than this given
price.

e=0 Completely Inelastic Demand remains unchanged whatever may be

the change in price.

e>1 Relatively Elastic Quantity demanded changes by a larger percentage

than does price.

e<1 Relatively Inelastic Quantity demanded changes by a smaller

percentage
than does price.

e=1 Unitary Elastic Quantity demanded changes by exactly the same

percentage
as does price.
 Methods to Measure Elasticity
I) Percentage Method-
is used when change in price and consequent change in demand are very small.

% change in Quantity Demanded

ep = ---------------------------------------------
% change in price
II) Point Elasticity Method
refers to price elasticity of demand at any point on the demand curve.
Acc to Leftwitch- Elasticity computed at a single point on the curve for
the infinitely small change in price , is point elasticity.

∆Q P
ep = (-)-------- × ----
∆P Q
∆ Q/ ∆ P represents the slope of demand curve.
The price elasticity of demand at any point on linear demand curve is
equal to the Lower segment to the upper segment of the line.
ep = Lower segment / Upper segment
 Contd….
III) Total Outlay/Revenue Method

a) When with a change in price, the total outlay

remains unchanged, demand is unitary elastic
(e=1).
The total outlay remains constant in the case of
unitary elastic demand because the demand
changes in the same proportion as the price.

b) When with a rise in price, the total outlay falls,

or with a fall in price, the total outlay rises,
elasticity of demand is greater than unity.
Ep >1
Contd….

c) When with a rise in price, the total outlay

also rises,and with a fall in price, the total
outlay also falls, elasticity of demand is less
than unity.
ep < 1
Contd….

IV) Point Geometric Method

The simplest way of explaining the point method

is to consider a linear (straight-line) demand
curve. Let the linear demand curve be extended
to meet the two axes. Now, when a point is
taken on the linear demand curve, it divides the
straight line into two segments. The point
elasticity is, thus, measured by the ratio of the
lower segment of the curve below the given
point to the upper segment of the curve above
the point.
 Contd….

Lower segment (L)

e = ------------------------
Upper segment (U)

A
Price (Per Unit)

E = 4/2 = 2

0 B X
Quantity Demanded
 Factors Influencing
Elasticity of Demand

1. Nature of the Commodity

2. Availability of a Substitute
3. Number of Uses for a single Commodity
4. Consumer’s Income
5. Durability of the Commodity
6. Influence of Habits & Customs
7. Complementary Goods
 INCOME ELASTICITY

Degree of responsiveness of demand for a

commodity to a given change in the
income of the consumer.

OR

The ratio of proportionate change in the quantity

demanded of the commodity to a given
proportionate change in income of the
consumer.
Contd….

Proportionate change in quantity

demanded
Ey = ----------------------------------------------------
Proportionate change in consumer’s
income

Symbolically,
Q2-Q1 Y2-Y1
Ey = ---------- / ---------
Q2+Q1 Y2+Y1
 CROSS ELASTICITY

• Proportionate change in the quantity

demanded of X due to proportionate
change in the quantity demanded of Y.
 DEMAND FUNCTION

A demand function shows the relationship between

the demand for a good, and the variables which
may explain a change in such demand. Thus,
Dx = f (Px, Py, M, T, W)
Where,
Dx = Quantity Demanded per unit of time
Px = Price of X
Py = Mean Price of all other commodities
M = Consumer’s Income
T = Taste
W = Wealth of the consumer
 DEMAND FUNCTION

Of all the variables mentioned above T & W are

held constant as T is not quantifiable and W
does not exert a direct influence. Dx, therefore,
be assumed to be a function of Px, Py and M
only.
Demand functions are generally homogeneous of
degree zero. It means that changes in all the
independent variables namely Px, Py, and M are
uniform. If the degree of a homogeneous
function is zero, then it would imply that when all
prices and income change in the same
proportion, Dx would remain unchanged.
 DEMAND

FORECASTING
 DEMAND FORECASTING

Demand Forecasting is a tool of economic analysis

which estimates the potential demand for a
commodity in future which is based on some
factual information and post data. It is an
estimate regarding potential volume of sales or
quantity demanded and the price in future for a
given period of time.

It is an important tool for business decision making

and future planning. Its essential for all the firms
to avoid over production as well as under
production.
 OBJECTIVES

Short Run Objectives Long Run Objectives

Production Planning. Expansion of existing firms.

Availability of cheaper raw Long Run input planning.

material. Cost analysis
Availability of labour forces. Man power requirements
Optimum utilisation of (Trained and skilled labours
resources. and executives may be
required due to change in
Formulation of pricing techniques of production.)
policy.
Long Run financial planning
Financial planning.
 DETERMINANTS

 Time Element – Short Run / Long Run.

 Levels of Forecasting – Micro Level / Macro
Level / Industry Level / Firm Level.
 Classification of Commodities.
 Position of Goods in the Market – Established
and New.
 Specific factors concerned with the market and
the commodity.
 Process of or Steps in
Demand Forecasting
Determination of Objectives Determination of Time Period

Determination of the Factors

Scope of Demand Forecasting
Affecting Demand

Collection of Data Knowledge of Market Conditions

Types of Forecasting Nature of the Commodity

Method of Forecasting Conclusions & Inferences

Review of Performance
 METHODS / TECHNIQUES
Numerous Techniques are prevalent for
forecasting the demand for a product, but
manager has to ensure about the following while
selecting any technique:
1) Accuracy 2) Cost-effective
3)Timeliness 4) Simple to understand

The techniques of demand forecasting can broadly

be divided into :
• Qualitative Techniques
• Quantitative or Statistical Techniques
 QUALITATIVE TECHNIQUE

 SURVEY METHOD
Consumers’ Survey : Complete Enumeration
Sample Survey : Stratified and Cluster Sampling
End-Use Methods

OPINION POOL METHOD

Expert Opinion : Barometric, Simple & Delphi
Method
Market Studies and Experiments : Market
Studies and Consumer Clinics
 QUANTITATIVE TECHNIQUE

 GRAPHIC/TREND PROJECTION
 TREND FITTING
 Fitting trend equation through Least Square
Technique
 ECONOMIC METHODS
 Simultaneous Equation Method
 Salient Features of a Good
Forecasting Method

Simplicity
Accuracy
Reliable
Flexibility
Universal Applicability
Economical
 Limitations

Unrealistic Assumptions – Past and Present.

Expensive
Less Reliable
Requires Careful Use