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DEMAND

Chapter 2

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INTRODUCTION

Have you ever wondered why inessential thingslike diamonds are expensive and essentials likewater are at low cost

Why land in some parts of countries are moreexpensive than the other parts?

The answer to the above que can be found fromthe theory of Demand & Supply.

The theories will show how consumerpreferences determines the demand whilebusiness costs determines the supply

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DEM ND N LYSIS Demand means the Desire backed up by

abi l i ty pay and w i l lingness buy.

Demand = Desire + Ab i l i ty to pay +

Will ingness to buy

Prices are the too ls by which the market

coord inates ind iv idual desires.

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INDIVIDUAL AND MARKET DEMAND

Ind ividu al Demand : Individual demand for a product is thequantity 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 agiven 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 scheduleMarket demand schedule.

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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.

There is an inverse relationship between the Price of the product and its

quantity demanded, other things being equal.

The other thing that are assumed to be constant:

Prices of related products

Income of consumers

Tastes and preferences of consumers

If these factors undergoes a change the relationship of demand-supply

may not hold good.

Demand Schedule & Demand Curve:

Market Demand Schedule and Market Demand Curve:

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RATIONALE FOR LAW OF DEMAND

Substitution effectthe commodity withfallen price is preferred over the othercommodities.

Income Effectpurchasing power increases,consumer can buy the same quantity at alesser money or can buy more of the samecommodity with same money

Also, some consumers who could not affordpreviously are being able to purchase it now

Utility Maximizing behavior

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EXCEPTIONS

Conspicuous goods/ Articles of Distinction

Giffen Goods

HabitsComposite DemandComplimentary goods

Population

Conspicuous NecessityFridge, AC, TV Future Expectation

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FACTORS BEHIND LAW OF DEMAND

Price

Income & Income Distribution

Number & Prices of Substitutes

Consumers Preferences, Tastes and Needs

Number of ConsumersPopulation

Expectation of Consumers

Advertisement

Other FacilitiesAfter Sales Services,Warranty

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INCREASE AND DECREASE IN DEMAND

What happens if there is a change in,

consumers tastes & preferences, income &

price of related goods.

Two demand schedules for commodity X

Rightward Shift In Demand Curve:

When more is demanded at each price

Leftward Shift In Demand Curve:

When less is demanded at each price

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GENERAL DEMAND FUNCTION

Six variables that influence Qd

Price of good or service (P)

Incomes of consumers (M)

Prices of related goods & services (PR)

2-11

Expected future price of product (Pe) Number of consumers in market (N)

General demand function

( )Taste patterns of consumers ( )Taste patterns of consumers

( , , , , , )d R eQ f P M P P N ( , , , , , )d R eQ f P M P P N

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GENERAL DEMAND FUNCTION

Inverse for complements

2-12

Variable Relation to Qd

Sign of Slope Parameter

P

Pe

N

M

PR

Inverse

Direct

Direct

Direct

Direct for normal goods

Inverse for inferior goods

Direct for substitutes

b = Qd/P is negativec = Qd/M is positivec = Qd/M is negatived = Qd/PRispositived = Qd/PRisnegative

f = Qd/Peis positive

g = Qd/N is positive

e = Qd/ is positive

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ELASTICITY OF DEMAND Consider the following situation

1) Price of Radio falls from 500 to 400, Quantitydemanded Increases from 100 to 150

2) Price of wheat falls from 10/kg to 9/kg, Quantitydemanded Increases from 500 kgs to 520 kgs

3) Price of Salt falls from 3 to 2.5, Quantity demandedIncreases from 1000 kgs to 1005 kgs

We notice that as a result of fall in the price of allthree, the respective demand increases.

Then what is the differences? The difference lies in degree of response of demand

which can be found out by comparing the percentageschanges in prices & quantities demanded.

Here lies the concept of Elasticity

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ELASTICITY OF DEMAND

Elasticity of demand is the degree of responsiveness ofdemand to the changes in its determinants.

(A) PRICE ELASTICITY O DEMANDThe extent of response of demand for a

commodity to the changes in its price, otherdeterminants of demand remaining constantis called price elasticity of demand.

Except for few cases the price elasticity is

negative. But for sake of convenience, weignore the negative signE.g. if 1% change in price leads to 2% change in

quantity of A & 4% change in Quantity of B.

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TYPES OF PRICE ELASTICITY OF DEMAND1. Perfectly elastic demand refers to the situation where a

slightest rise in price causes an infinite increase in Qd.Demand is Hypersensitive and elasticity is Infinity

2. Perfectly inelastic demand refers to the situation wherethe demand is unaffected even after substantial change inprice. Qd remains unchanged and elasticity of demand is

zero3. Relatively/Highly elastic demand when a small

percentage change in price is accompanied by a largepercentage change in its Qd.

4. Relatively inelastic demand when a large percentagechange in price is followed by a small percentage change inits Qd.

5. Unitary elastic demand when percentage change in priceis accompanied by an equal percentage change in Qd.

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METHODS OF MEASURING PRICE ELASTICITY

Point methodDr. Marshall

Measure elasticity at a given point on a demandcurve

Makes use of derivativeArc method

Takes an arc of the demand curve rather thanpoint

Total Revenue or total Expenditure Method

If a slight fall in the price leads to sizeableincrease in demand, it will cause in increase in

total revenue

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PRACTICAL APPLICATION- Pricing decisions - Policy Formulation by Govt.

- Terms of trade - Foreign exchange rates

- Resource Prices - Public utilities

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B)INCOME ELASTICITY OF DEMANDThe degree of responsiveness of demand for a

commodity to the changes in the consumersincome is known as income elasticity ofdemand

Types of income elasticity1. Unitary income elasticity2. Income elasticity grater than one

3. Income elasticity less than one4. Zero income elasticity5. Negative income elasticity

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PRACTICAL APPLICATION

- Economic Development

- Growth rate of firm

- Demand forecasting- Economic/Production planning

- Foreign Trade

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(C) CROSS ELASTICITY OF DEMAND

The degree of responsiveness of demandfor a commodity to a given change in the

price of some other related commodity is

known as cross elasticity of demand.

The relation of complementary and

substitute product

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DEMAND FORECASTING

Demand forecasting is predicting or anticipating the

future demand for a product.Micro levelIndustry levelMacro level

USES OF DEMAND FORECASTING DATA Short term demand forecasting

1) Evolving production policy

2) Determining price policy

3) Evolving purchase policy

4) Fixation of sales targets

5) Short term financial policy ong term demand forecasting

1) Business planning

2) Man power planning

3) Long term financial planning

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METHODS OF DEMAND ESTIMATION

Consumers Interview

Market Experiment Method

Regression Method

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NECESSITY OF FORECASTING DEMAND

Achievement of planned objectives

Preparing a Budget

Stabilization of Production and Employment

Future Expansion

Long-term Investment Programs.

Sales BudgetingControl of Inventories

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NATURE AND SCOPE OF DEMAND FORECASTING

Time frame Short-term Forecast Long-term Forecast

Secular Forecast

Level of forecast Level of the Economy

Level of the Industries

Level of a Firm

General & Specific Forecast

Established & New Products

Classification of Products

Special factorsuncertainties, Fashion change

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CRITERIA FOR A GOOD METHOD OF DF

Plausibility Simplicity

Economy

Accuracy

Availability

Durability

Flexibility

Consistency

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METHODS OF DF OF AN ESTABLISHED PRODUCT

Interview and survey approach Buyers Interview Sales force polling

Consumer field survey

Panel or Experts

Delphi Method Forecast based on composite management opinion

Projecting Past Experience Correlation Analysis

Regression Analysis

Projection of Trends into Future

Some other methods Barometric Techniques

Controlled Experiments

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DF FOR NEW PRODUCT

Evolutionary Approach

Substitute Approach

Growth curve Approach

Opinion-Polling Approach

Sales Experience Approach

Vicarious Approach