Demand Module2

7/31/2019 Demand Module2

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Jain University Centre for Management Studies II Semester - Module 2

1 This for Private circulation only. This Module is complied by Anila Bajpai, Sunitha.B.K andYashoda

Jain University

Centre for Management Studies

II Semester

Business Economics

Module 2

Demand Analysis


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Objectives

To Know the Demand analysis

To Know the Elasticity of Demand and Supply

Meaning of Demand

Demand in Economics implies both the desire to purchase and ability to pay for theproduct or service.In other words Demand for a commodity is the amount of it that a consumer willpurchase from the market at various given prices during a specified time period

Demand refers to the total or a given quantity of a commodity that arepurchased by consumer in the market at a particular price at a particular time.

Hence, Demand = Desire for a commodity or services

+ Willingness to pay for its price

+ Ability to pay for it (sufficient amount to buy)

Determinants (Factors Affecting) of Demand

The law of demand, while explaining the price-demand relationship assumes other factors to be constant. In reality however, these factors such as income, population,tastes, habits, preferences etc., do not remain constant and keep on affecting thedemand. As a result the demand changes i.e. rises or falls, without any change inprice.

1. Income : The relationship between income and the demand is a direct one. Itmeans the demand changes in the same direction as the income. An increase inincome leads to rise in demand and vice versa.

2. Population : The size of population also affects the demand. The relationship is adirect one. The higher the size of population, the higher is the demand and vice

versa.3. Tastes and Habits : The tastes, habits, likes, dislikes, prejudices and preferenceetc. of the consumer have a profound effect on the demand for a commodity. If consumers dislike a commodity, he will not buy it despite a fall in price. On theother hand a very high price also may not stop him from buying a good if he likes itvery much.

4. Other Prices : This is another important determinant of demand for a commodity.The effect depends upon the relationship between the commodities in question. If the price of a complimentary commodity rises, the demand for the commodity inreference falls. E.g. the demand for petrol will decline due to rise in the price of cars and the consequent decline in their demand. Opposite effect will be

experienced in case of substitutes.


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5. Advertisement : This factor has gained tremendous importance in the moderndays. When a product is aggressively advertised through all the possible media,the consumers buy the advertised commodity even at a high price and many timeseven if they dont need it.

6. Fashions : Hardly anyone has the courage and the desire to go against the

prevailing fashions as well as social customs and the traditions. This factor has agreat impact on the demand.

7. Imitation : This tendency is commonly experienced everywhere. This is known asthe demonstration effects, due to which the low income groups imitate theconsumption patterns of the rich ones. This operates even at international levelswhen the poor countries try to copy the consumption patterns of rich countries.

Law of Demand

IntroductionDemand for a commodity is related to price per unit of time.It is the experience of every consumer that when the prices of the commodities fall,they are tempted to purchase more. Commodities and when the prices rise, thequantity demanded decreases.

There is, thus, inverse relationship between the price of the product and the quantitydemanded. The economists have named this inverse relationship between demandand price as the LAW OF DEMAND.

As Price Falls Quantity Demanded Rises As Price Rises

Quantity Demanded Falls

Statement of the Law

According to Prof. Samuelson:"The law of demand states that people will buy more at lower prices and buy less

at higher prices, other things remaining the same".

Assumptions of Law

The law of demand in order to establish the price-demand relationship makes anumber of assumptions as follows:

1. Income of the consumer is given and constant.2. There should not be any change in the tastes of the consumers for

goods.3. The purchasing power of the typical consumer must remain constant.4. The price of all other commodities should not vary


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5. The consumer should not anticipate a change in price6. No change in tastes, preference, habits etc.7. No change in the size and composition of population.

These Assumptions are expressed in the phrase other things remaining same

or Ceteris Paribus

Ceteris Paribus.

In economics, the term is used as shorthand for indicating the effect of oneeconomic variable on another, holding constant all other variables that may affect thesecond variable.

Demand Schedule or Demand Table

These are the two devices to present the law. The demand schedule is a schedule or a table which contains various possible prices of a commodity and differentquantities demanded at them. It can be an individual demand schedule representingthe demand of an individual consumer or can be the market demand scheduleshowing the total demand of all the consumers taken together, this is indicated in thefollowing table.

It can be observed that with a fall in price every individual consumer buys a larger

quantity than before as a result of which the total market demand also rises. In caseof an increase in price the situation will be reserved. Thus the demand schedulereveals the inverse price-demand relationship, i.e. the Law of Demand.

Demand Curve (DD)

It is a geometrical device to express the inverse price-demand relationship, i.e. thelaw of demand. A demand curve can be obtained by plotting a demand schedule ona graph and joining the points so obtained, like the demand schedule we can derivean individual demand curve as well as a market demand curve. The former showsthe demand curve of an individual buyer while the latter shows the sum total of all
http://4.bp.blogspot.com/_iFIztPmvqg8/SpLoQ8IU4QI/AAAAAAAABXo/ntXloXnZmDg/s1600-h/Demand-Schedule.jpg


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the individual curves i.e. a market or a total demand curve. The following diagramshows the two types of demand curves.
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In the above diagram, figure (A) shows an individual demand curve of any individualconsumer while figure (B) indicates the total market demand. It can be noticed thatboth the curves are negatively sloping or downwards sloping from left to right. Such

a curve shows the inverse relationship between the two variables. In this case thetwo variable are price on Y axis and the quantity demanded on X axis. It may benoted that at a higher price OP the quantity demanded is OM while at a lower pricesay OP1, the quantity demanded raises to OM1 thus a demand curvediagrammatically explains the law of demand

Why does the demand curve slope downwards?

The fundamental reasons for demand curve to slope downward are as follows:

(i) Law of diminishing marginal utility: The law of demand is based on the law of diminishing marginal utility. According to the cardinal utility approach, when aconsumer purchases more units of a commodity, its marginal utility declines. Theconsumer, therefore, will purchase more units of that commodity only if its price falls.Thus a decrease in price brings about an increase, in demand. The demand curve,therefore, is downward sloping.

(ii) Income effect: Other things being equal, when the price of a commoditydecreases, the real income or the purchasing power of the household increases. Theconsumer is now in a position to purchase more commodities with the same income.The demand for a commodity thus increases not only from the existing buyers butalso from the new buyers who were earlier unable to purchase at higher price. Whenat a lower price, there is a greater demand for a commodity by the households, thedemand curve is bound to slope downward from left to right.

(iii) Substitution effect: The demand curve slopes downward from left to right alsobecause of the substitution effect. For instance, the price of meat falls and the pricesof other substitutes say poultry and beef remain constant. Then the householdswould prefer to purchase meat because it is now relatively cheaper. The increase indemand with a fall in the price of meat will move the demand curve downward fromleft to right.

(iv) Entry of new buyers: When the price of a commodity falls, its demand not onlyincreases from the old buyers but the new buyers also enter the market. Thecombined result of the income and substitution effect is that demand extends, ceterisparibus, as the .price falls. The demand curve slopes downward from left to right.

Exceptions of the 'Law of Demand'

In the exceptional situations quoted above, the demand curve becomes an upwardsrising one as shown in the alongside diagram. In the alongside figure, the demandcurve is positively sloping one due to which more is demanded at a high price and

less at a low price.
http://economicsconcepts.com/law_diminishing_marginal_utility.htmhttp://economicsconcepts.com/law_diminishing_marginal_utility.htmhttp://economicsconcepts.com/law_diminishing_marginal_utility.htmhttp://economicsconcepts.com/law_diminishing_marginal_utility.htm


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The law of demand does not apply in every case and situation. The circumstanceswhen the law of demand becomes ineffective are known as exceptions of the law.Some of these important exceptions are as under.

1. Giffen goods:

Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties of this category like bajra, cheaper vegetable like potato come under thiscategory. Sir Robert Giffen or Ireland first observed that people used to spend moretheir income on inferior goods like potato and less of their income on meat. Butpotatoes constitute their staple food. When the price of potato increased, after purchasing potato they did not have so many surpluses to buy meat. So the rise inprice of potato compelled people to buy more potato and thus raised the demand for potato. This is against the law of demand. This is also known as Giffen paradox.

2. Conspicuous Consumption or Prestige Goods or Veblen Effect

This exception to the law of demand is associated with the doctrine propounded byThorsten Veblen. A few goods like diamonds etc are purchased by the rich andwealthy sections of the society. The prices of these goods are so high that they arebeyond the reach of the common man. The higher the price of the diamond thehigher the prestige value of it. So when price of these goods falls, the consumersthink that the prestige value of these goods comes down. So quantity demanded of these goods falls with fall in their price. So the law of demand does not hold good

here.


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3. Conspicuous necessities: Certain things become the necessities of modern life. So we have to purchase themdespite their high price. The demand for T.V. sets, automobiles and refrigerators etc.has not gone down in spite of the increase in their price. These things have becomethe symbol of status. So they are purchased despite their rising price. These can betermed as U sector goods.

4. Ignorance:

A consumers ignorance is another factor tha t at times induces him to purchase moreof the commodity at a higher price. This is especially so when the consumer ishaunted by the phobia that a high-priced commodity is better in quality than a low-priced one.

5. Emergencies:

Emergencies like war, famine etc. negate the operation of the law of demand. Atsuch times, households behave in an abnormal way. Households accentuatescarcities and induce further price rises by making increased purchases even athigher prices during such periods. During depression, on the other hand, no fall inprice is a sufficient inducement for consumers to demand more.

6. Future changes in prices: Households also act speculators. When the prices are rising households tend topurchase large quantities of the commodity out of the apprehension that prices maystill go up. When prices are expected to fall further, they wait to buy goods in futureat still lower prices. So quantity demanded falls when prices are falling.

7. Change in fashion:

A change in fashion and tastes affects the market for a commodity. When a broadtoe shoe replaces a narrow toe, no amount of reduction in the price of the latter issufficient to clear the stocks. Broad toe on the other hand, will have more customers

even though its price may be going up. The law of demand becomes ineffective.


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Rs.3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Ice-CreamCone

Quantity of Ice-CreamCones

0

Increasein demand

D 1

D 2

Rs.3.00

2.50

2.00

1.50

1.00

0.50

21 3 4 5 6 7 8 9 10 1211

Price of Ice-CreamCone

Quantity of Ice-CreamCones

0

Decreasein demand

D1

D2


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Thus, in order to explain increase or decrease in demand, we will have a newdemand curve altogether. Increase or decrease demand is called as shifts indemand, or changes in demand.

Summing Up: (i) Extension in demand is due to reduction in price.(ii) Increase in demand occurs due to changes in factors other than price.(iii) Contraction in demand is the result of a rise in the price commodity.(iv) A decrease in demand follows a change in factors other than price.(v) Changes in demand both increase and decrease are represent shifts in thedemand curve.(vi) Changes in the quantity demanded are represented by move along the samedemand curve.

Demand Distinctions / Types of Demand

The demand behaviour of the buyer of consumer goods differs with differenttypes of demand. From the business point of view, thus, we may distinguishbetween the following important types of demand.

1. Consumers goods: - Goods demanded by consumers for the direct satisfactionof their wants are refereed to as consumers goods or consumption goods, e.g.,food, clothes, house, etc.,

2. Goods which are demanded by producers in the process of production arerefereed to as producers goods or capital goods, e.g., tools and equipments,machinery, raw materials.

3. Perishable goods: - They do not have durability. That is, they cannot be storedfor a long time, e.g., milk, sweets etc.

4. Durable goods: - They can be stored for a long period e.g., furniture, TV set

Radio, Grinders etc.

5. Autonomous Demand: - Spontaneous demand for goods which is based on theurge to satisfy some wants directly is called autonomous demand. Demand for consum ers goods is autonomous. It is a final demand. It is a direct demand.

6. Derived Demand: - When demand for a product depends on the demand for some other commodities, it is called derived demand, e.g., demand for doors isderived from demand for houses, or demand for bulbs is derived from demandfor lamps. Similarly, demand for antennas is derived from the demand for TV

sets.


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7. Industry Demand: - It refers to the total demand for the commodity produced bya particular industry, e.g., total demand for cars in India is the demand for automobile industrys output in aggregate.

8. Company Demand: - The total demand for a product of a particular firm or company is called as Company Demand, e.g., Mandya sugar factory is a firmwhere as all sugar factories in India collectively make the sugar industry of India.

9. Short-run Demand: - It refers to the demand for goods within the short period. Itmeans the current demand with its nearest or immediate reaction to priceschanges, income fluctuations etc.

10. Long-run Demand: - It refers to the demand which exists over a long period of time. It means which will ultimately exist as a result of the changes in pricing,promotion, or product improvement, after enough time is allowed to let themarket adjust itself to the new situation.

11. Joint or Complementary Demand: - When two goods are demanded inconjunction with one another at the same time to satisfy a single want, they aresaid to be joint or complementary demand. Examples are pens and ink, carsand petrol, bread and butter, coffee, sugar and milk, pipe and pipe tobacco.

12. Composite Demand: - There is composite demand for a commodity when it isused for multiple purposes. For e.g. Electricity is used for lighting, AEH,

industrial, agricultural purposes etc., steel is needed for manufacturing cars,buildings, construction of railway etc.

ELASTICITY OF DEMAND

Meaning and Definition

Elasticity of Demand may be defined as the extent to which the quantitydemanded of a commodity changes in response to a given change in price,Income etc

Types of Elasticity of Demand

Price Elasticity of Demand

Income Elasticity of Demand

Cross Elasticity of Demand

Advertising or Promotional Elasticity of Demand


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3. Relative Elastic Demand :- A slight change in price leads to more thanproportionate change in demand. In other words A small change in the priceof the commodity leads to a more than proportionate change in the quantitydemanded. That means change in the quantity demanded is greater thanchange in price. More Elasticity(Ed>1)

4. Relatively Inelastic Demand :- A large change in price leads to less thanproportionate change in demand. In other words a change in price will bringabout a less than proportionate change in the quantity demanded. Thatmeans the change in the quantity demanded is lower than change in price.Ed


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5. Unitary Elastic Demand: - Proportionate change in price leads to equalproportionate change in demand.

Determinants of PED

1. Nature of the Commodity : - In case of comforts and luxuries, demand tendsto be elastic because people buy them more only when their prices are low.For e.g. TV sets, refrigerators, washing machines etc.In case of necessaries, demand is inelastic because whatever may be theprice people have to buy and use them for e.g. Rice, wheat, sugar, milk,vegetables etc.

2. Existence of Substitutes : - If a product has substitutes, demand tends tobecome elastic because people compare the prices of substitute goods andcheaper products are purchased for eg. Blades, soaps, tooth pastes etc.If a product has no substitutes, demand becomes inelastic.

3. Durability of the commodity :- If a product is perishable ;or nondurable,demand tends to be inelastic because people buy them again and again. For e.g. Milk, vegetables, fruits etc. what ever may be the price. If a product is durable, demand tends to be elastic because people buy themoccasionally. Change in price will affect their demand. For eg. Vehicles,machineries etc.

4. Level of income of the people: - Demand will be elastic in case of the poor people because even a small change in price will affect the demand for


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various products. On the other hand demand will be inelastic in case of richpeople because they are ready to spend any amount on buying a product.

5. Range of prices: - Demand tends to become elastic in case of goods havingmoderate prices. If certain articles become cheaper, they buy more and vice-versa. Demand tends to become inelastic in case where the prices of goodsare either too high or too low. For e.g. imported cars, diamonds and nails,needles etc.

6. Complementary goods: - Goods which are jointly demanded are inelastic innature. For e.g. Ink, petrol etc. Demand tends to be elastic in case of independent products. For e.g. Biscuits, chocolates, ice-creams etc.

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