Term Paper of Managerial Economics

Topic: Demand, Determinants of Demand and its Analysis

Submitted To:
Mr. P. S. Satsangi

Submitted By:
MILAN

Institute of Business Management, C. S. J. M. U., Kanpur.

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INDEX
S . N o .
1. 2. 3. 4.

Topic

P a g e N o.
3 45 56 6

Demand I. Meaning of Demand II. Business Significance of Demand Types of Demand Determinants of Demand Demand Function Law of Demand I. Assumption of the Law of Demand II. Demand Schedule III. Demand Curve IV. Rationale for Law of Demand V. Exception of the Law of Demand Demand Analysis I. Meaning of Demand Analysis II. Marginal Utility Approach III. Indifference Curve Analysis IV. Revealed Preference Approach V. Objectives of Demand Analysis
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5.

6 10

6.

10 13

7. 8.

Conclusion Bibliography

13 14 14

Demand
Meaning of Demand:Conceptually, the term Demand implies a desire for a

commodity backed by the ability and willingness to pay for it.

The concept of demands refers to the quantity of a good or service that consumers are willing and able to purchase at various prices dealing a period of time. The demand in economics is something more than desire to purchase though desire is one element of it. A beggar for instance, may desire food, but due to lack of means to purchase it, his demand is not effective. In economics, demands refer to effective demand, which implies three things (i) Desire (ii) means to purchase and, (iii) on willingness to use those means for that purchase. The demand for a commodity at a given price is the amount of it, which will be bought per unit of time at that price. A meaningful statement regarding the demand for a commodity should contain the following information: I. the quantity demanded of a commodity, II. the price at which a commodity is demanded, III. the time period over which a commodity is demanded and IV. the market area in which a commodity is demanded. For example, saying, the annual demand for TV sets in Delhi at an average price of Rs. 15,000 a piece is 50,000 is a meaningful statement.

Business Significance of Demand:The market for a firms product cannot be analyzed without reference to the demand condition. For a firm or an industry consisting of several firms, the extent of demand determines the size of market. Successful business firms, therefore, spend considerable time, energy and effort in analyzing the demand for their products. Without a clear
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understanding of consumers behavior and a clear knowledge of the market demand conditions, the firm is handicapped in its attempt towards profit planning or any other business strategy planning. For example, estimating present demand and forecasting future demand constitutes the first step towards measuring and determining the flow of sales revenues and profits which generate internal resources to finance business. The stability and growth of business is linked to size and structure of demand.

Types of Demand
1.

Individual and Market Demand: The quantity of a

commodity which an individual is willing to buy at a particular price of the commodity during a specific time period, given his money income, his taste, and prices of other commodities (particularly substitutes and complements), is known as individuals demand for a commodity. The total quantity which all the consumers of a commodity are willing to buy at a given price per time unit, given their money income, taste, and prices of other commodities (mainly substitutes) is known as market demand for the commodity. In other words, the market demand for a commodity is the sum of individual demands by all the consumers (or buyers) of the commodity, over a time period, and at a given price, other factors remaining the same.

Demand for Firms Product and Industrys Products: The quantity of a firms produce that can be
2.

disposed of at a given price over a time period, and at a given price, other factors remaining the same. Autonomous Demand for a commodity is one that arises independent of the demand for any other commodity whereas derived demand is one that is lied to the demand for some parent
3. 5

Autonomous

and

Derived

Demand:

product. Demand for food, clothes, shelter etc. is autonomous demand. Demand for land, fertilizers, and agricultural tools and implements are a derived demand, for these goods are demanded because food is demanded.
4.

Demand

for

Durable

and

non-durable

Goods:

Demand is often classified also under demand for durable and non-durable goods. Durable goods are those. Whose total utility (or use) is not exhausted by a single use. Such goods can be used repeatedly or continuously over a period. Durable goods may be consumer as well as producer goods. Durable consumer goods include clothes, shoes, owner occupied residential houses, furniture, utensils, refrigerators, scooters, cars, etc. The durable producer goods include mainly the items under fixed assets, such as building, paint, machinery, etc. Non-durable goods on the other hand, are those, which can be used or consumed only once (for example, food items) and their total utility is exhausted in a single use. Short-term demand refers to the demand for such goods as are demanded over a short period. In this category fall mostly the fashion consumer goods, goods of seasonal use, inferior substitutes during the scarcity period of superior goods, etc.
5.

Short-term

and

Long-term

Demand:

The long-term demand, on the other hand, refers to the demand, which exists over a long period. The change in long-term demand is perceptible only after a long period. Most generic goods have long-term demand. For example, demand for consumer and producer goods, durable and non-durable goods, is long-term demand, though their different varieties or brands may have only short-term demand.

Determinants of Demand
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1.

Price of the commodity: Ceteris paribus i.e., other

things being equal, the demand of a commodity is inversely related to its price. It implies that a rise in price of a commodity brings about a fall in its purchase and viceversa. This happens because of income and substitution effects.
2.

Income of the households: Other things being equal,

the demand for a commodity depends upon the income of the household. In most cases, the larger the average income of the household, the larger is the quantity demanded of a particular good.
3.

Price of the related goods: Related commodities are of

two types: (a) Complementary goods and (b) Completing goods or substitutes. Complementary goods are those goods, which are consumed together or simultaneously. For example, tea and sugar, automobiles and petrol, pen and ink are used together. When commodities are complements, a fall in the price of one (other things being equal) will cause the demand of the other to rise.
4.

Tastes and preferences of consumers: The demand

for a commodity also depends upon tastes and preferences of consumers and changes in them over a period of time. Goods, which are more in fashion command higher demand than goods, which are out of fashion.

I.

5.Other factors: Size of population: Generally, larger the size of

population of a country or region, greater is the demand for commodities in general.

II.

Composition of population: If there are more old

people in a region, the demand for spectacles, walking sticks, etc. will be high. Similarly, if the population consists of more of children, demand for toys, baby foods, toffees, will be more.

III.

Distribution of Income: The wealth of the country

may be so distributed that there are a few exceptionally rich people while the majority are exceedingly poor. Under such conditions, the propensity to consume of the country will be relatively less, for the propensity to consume of the rich people is less than that of the poor people. Consequently, the demand for consumer goods will be comparatively less. If the distribution of income is more equal, then the propensity to consume of the country as a whole will be relatively high indicating higher demand for goods. Apart from the above factors such as class, group, education, marital status and weather conditions, also play an important role in influencing household demand.

Demand Function
The above listed factors can easily be presented in the form of a demand function as follows: Qdc = f (Pc, Pr, Y, T, D,) Where Qdc is the quantity demanded of commodity c, Pc is the price of commodity c, Pr is the price of commodities, Y is the money income of the household, T is the taste of the household, D represent size of the population and other remaining factors.

Law of Demand
The demand for a commodity increases with fall in its price and decreases with the rise in its price, other thing remaining the same. The law of demand thus merely states that the price and the demand of a commodity are inversely related, provided all other things remain unchanged.

Assumptions of the Law of Demand:8

1.

Income level should remain constant: The law of

demand operates only when the income level of the buyer remains constant. If the income rises while the price of the commodity in question does not fall, it is quite likely that the demand may increase. Therefore, stability in income is an essential condition for the operation of the law of demand.

2.

Tastes of the buyer should not change: Any change

that takes place in the tastes of the consumers will in all probability prevent the working of the law of demand. It often happens that when tastes or fashions change people revise their preferences.

3.

Price of other goods should remain constant:

Changes in the prices of other goods often affect the demand for a particular commodity. If prices of commodities for which demand is inelastic rise, the demand for a commodity other than these in all probability will decline even though there may not be any change in its price. Therefore, for the law of demand to operate it is very necessary that prices of other goods do not change.

4.

No New substitutes for the commodity: If some new

substitutes for a commodity appear in the market, its demand generally decline. This is quite natural, because with the availability of new substitutes some buyers will be attracted towards new product and the demand for the older product will fall even though price remains unchanged. Hence, the law of demand operates only when the market for a commodity is not threatened by new substitutes.

5.

Price rise in future should not be expected: If the

buyers of a commodity expect that its price will rise in future they raise its demand in response to an initial price rise. This behaviour of buyers violates the law of demand. Therefore, for the operation of the law of demand it is necessary that there must not be any expectations of price rise in future.
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The law of demand may be illustrated with the help of a demand schedule and a demand curve.

Demand Schedule:The demand schedule thus shows the effect of price changes on the quantity sold in the market to the exclusion of all the factors.

Commodity
A B C D E

Price of Commodity (Rs.)

5 4 3 2 1

Quantity Demanded (Units)

10 15 20 35 60

Demand Curve:The graphical representation of the demand schedule is the demand curve. Individual demand curve indicates the quantity of the commodity that an individual will buy at different prices. It is customary in economics to measure a price along Y axis and quantity demanded on X axis.

Y
5 4

A B C D E

Price

3 2 1 0 10 20

30

40

50

60

Quantity
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Fig. 1: Demand Curve

The curve slopes downward. Any point on the graph indicates a single price quantity relation. The whole demand curve DD1 shows the quantity of commodity N that would be bought by an individual at different prices.

Rationale for Law of Demand: Why does demand

curve slope downwards? 1. Substitution Effects: When the price of a commodity
falls, it becomes relatively cheaper than other commodities. It includes consumers to substitute the commodity whose price has fallen for other commodities, which have now become relatively expensive. The result is that total demand for the commodity whose price has fallen increases. This is called substitution effect.
2.

Income Effects: When the price of commodity falls, the

consumer can buy the same quantity of the commodity with lesser money or he can buy more of the same commodity with the same money. In other words, as a result of fall in the price of the commodity, consumers real income or purchasing power increases. This increase in the real income includes him to buy more of that commodity. Thus demand for that commodity (whose price has fallen) increases. This is called income effect.

3.

New Consumer Creating Demand: When the price of a

commodity falls, more consumers start buying it because some of those who could not afford to buy it previously may afford to buy it. This raises the number of consumers of a commodity at a lower price and hence the demand for the commodity in question.

Exception of the Law of Demand:According to law of demand, more of a commodity will be demanded at lower prices, than at higher prices, other things being equal. The law of demand is valid in most of the cases; however there are certain cases where this law does not hold
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good. The following are the important exceptions to the law of demand.
1.

Conspicuous goods: Some consumers measure the

utility of a commodity by its price i.e., if the commodity is expensive they think that it has got more utility. As such, they buy less of this commodity at low price and more of it at high price. Diamonds are often given as example of this case. Higher the price of diamonds, higher is the prestige value attached to them and hence higher is the demand for them.
2.

Giffen goods: Sir Robert Giffen, and economist, was

surprised to find out that as the price of bread increased, the British workers purchased more bread and not less of it. This was something against the law of demand. Why did this happen? The reason given for this is that when the price of bread went up, it caused such a large decline in the purchasing power of the poor people that they were forced to cut down the consumption of meat and other more expensive foods. Since bread even when its price was higher than before was still the cheapest food article, people consumed more of it and not less when its price went up. Such goods which exhibit direct price-demand relationship are called Giffen goods. Generally, those goods which are considered inferior by the consumers and which occupy a substantial place in consumers budget are called Giffen goods. Examples: such goods are coarse grains like bajra, low quality of rice and wheat etc.
3.

Conspicuous necessities: The demand for certain

goods is affected by the demonstration effect of the consumption pattern of a social group to which an individual belongs. These goods, due to their constant usage, have become necessities of life. For example, in spite of the fact that the prices of television sets, refrigerators, coolers, cooking gas etc. have been continuously rising, their demand does not show any tendency to fail.
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It has been observed that when the price are rising, households expecting that the prices in the future will be still higher, tend to buy larger quantities of the commodities. For example, when there is wide-spread drought, people expect that prices of food-grains would rise in future. They demand greater quantities of food-grains as their price rise.
4. 5.

Future

expectations

about

prices:

Impulsive purchases: At times consumers tend to make

impulsive purchases without any cool calculations about price and usefulness of the product and in such contexts the law of demand fails. Generally, it is assumed that households have perfect knowledge about price and quality of goods. However, in practice, a household may demand larger quantity of a commodity even at a higher price because it may be ignorant of the ruling price of the commodity.
6.

Ignorance

effect:

Demand Analysis
Meaning of Demand Analysis:There are a large number of factors, which have a direct impact on the demand of a commodity or service. Demand analysis means the study of factors, which influence the demand of a commodity or service. It is only on the basis of these factors or determinants of demand one can forecast demand. Under demand analysis we study elasticity of demand and methods of its measurement, sales forecasts and different methods to forecast sales or demand, manipulating demand and appropriate change in allocation of resources. Analysis of demand enables the producer to adjust his production to the demand to maximize the objective function. Economists have developed several techniques of analyzing demand. Econometricians have tested some of the propositions underlying the economic theory of demand as developed by the economists. Of late, in the name of
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psychological economics, the behavioral scientists have attempted explanation as well as psychometric measure of consumers behavior. Following are the approaches for analyzing the demand:

Marginal Approach:1.

Utility

(Neo-Classical)

It is a traditional approach used by Marshall and Jevons to explain the consumer behavior. Consumers demand commodity because they derive or expect utility from the consumption of that commodity. The utils (utility-content of product) indicate value-in-use and they command price in the market; the price paid indicates the value-in-exchange. Sometimes we observe that products with tremendous valuein-use do not command any value-in-exchange i.e., those are free goods like air, water available in plenty at no price because there is no scarcity. Utility along with scarcity determines price. Diamond is not that useful, but being rare it is very valuable; therefore, such economic goods command a high price. Economists assume that the utils are cardinally measurable and comparable in terms of a measuring unit of money, provided the utility of that money is held constant. A consumer, while purchasing a commodity often compares his sacrifice (in terms of price paid0, i.e., value-in-exchange with his satisfaction. If price exceeds marginal utility, he

reduces his purchase. If marginal utility exceeds price, he enhances his purchase. Ultimately when price equals marginal utility, he is in an equilibrium state of his purchase
decision. Marginal utility of product Marginal Utility of money spent --------------------------------------Price of the product MUx [MUm = ----------] Px
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Indifference Approach:2.

Curve

(Ordinal

Utility)

This approach has been developed by the economists like Hicks and Allen to overcome some of the limitations of NeoClassical approach. Assuming ordinal measurement of utility and relatedness of goods and relaxing the assumption of constant marginal utility of money, the technique of indifference analysis has been developed. We start with a multi-commodity consumer rather than a single commodity consumer, typical of traditional utility approach. Thus, the utility function is stated as: U = U (X, Y) where x and y stand for two products. The consumer wants to purchase of combination of x (say, cereals) and y (say, vegetables). With given resources and given need, whenever he buys more of x he has to be satisfied with less of y. The rate at which this substitution takes place is termed as the Marginal Rate of Substitution, MRS which measures the slope of the Indifference curve MRSxy Y = ---------X dY OR ------dX

Even if the consumer moves from combination A to B there is no change in his satisfaction level, because the utility-content of the bundle as a whole is intact; more of x may reduce the utility of x, but less of y may have increased the utility of y. This follows from the Law of Diminishing Utility. Each indifference curve can, therefore, be treated as an iso-utility curve.

3. Revealed Preference Approach:Indifference curve analysis is a powerful tool, but beyond a point it cannot be stretched. Today, the businessmen have to understand the buyers behavior from the standpoint of more of psychology than of economics.

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A consumer buys a combination of x and y; his choice takes care of his preferences as well as his constraints. What is desirable may not always be available and feasible. Therefore while choosing, he balanced the two. Does this choice reveal his preference? Yes it does, provided the following axioms are satisfied:
1. Choice set is

complete. Before the buyer exercises his

choice, he takes into account all available choices.

2. Choice

is rational. Rationality on the part of the chooser implies that he is never satisfied (nonsatisfied) and that he wants to get the best satisfaction out of his least scarifies.

3. Choice is

optimal. Optimally means that either he

he minimizes his

maximizes his satisfaction or sacrifice, if there is no constraint.

4. Choice is strongly 5. Choice is 6.

ordered.

transitive.

Choice is consistent.

It the above axioms are satisfied, then only Choice reveals preference. It should now be clear that the demand analyst cannot use terms like demand, need preference, ordering, choice, etc., interchangeably.

Objectives of Demand Analysis:1. To study and analyze the determinants of demand. 2. To measure the elasticity of demand. 3. To prepare sales or demand forecasts. 4. Manipulating demand. 5. To make appropriate changes in allocation of resources.

Conclusion
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for a commodity backed by the ability and willingness to pay for it.

Demand

implies

desire

The Law of Demand holds that other things equal, as the price of a good or service rises, its quantity demanded will fall, and vice versa.

A Demand Curve is a graphical depiction of the law of demand. It has a negative slope.

A change in price results in a movement along a fixed demand curve. A change in any variable other than price that influences quantity demanded produces a shift in the demand curve. A shift in the demand curve to the right (left) results in a higher (lower) equilibrium price and quantity. The demand curve shifts to the right when incomes rise, population increases, preferences increase, the price of a substitute rises, or the price of a complement falls. Under Demand Analysis we study elasticity of demand and methods of its measurement, sales forecasts and different methods to forecast sales or demand, manipulating demand and appropriate change in allocation of resources. Analysis of demand enables the producer to adjust his production to the demand to maximize the objective function.

Bibliography
S. No .
1.

Book Name
Business Economics

Author

Publisher

Page No.
178 182, 199 - 208

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2.

Managerial Economics

D. N. Dwivedi

Vikas Publishing House Pvt. Ltd.

104, 115, 120 126, 131 133, 153, 160 163 -

3. 4. 5.

www.Wikipedia.org www.OnlineTexts.c om http://www.bized.co .uk

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