Business Economics

1. Suppose the demand equation for computers by Teetan Ltd for the year 2017 is given by Qd=
1200-P and the supply equation is given by Qs= 120+3P. Find equilibrium price and analyse
what would be the excess demand or supply if price changes to Rs 400 and Rs 120.
Ans:
Introduction:
In a market, the two forces demand and supply play a major role in influencing the decisions of
consumers and producers. The interaction between demand and supply helps in determining the
market equilibrium price of a product. Equilibrium price is a price where the quantity demanded
of a product by buyers is equal to the quantity supplied by sellers. In simple terms, equilibrium
price is a price when there is a balance between market demand and supply. The equilibrium
price of a product can change due to various reasons, such as reduction in cost of production, fall
in the price of substitutes, and unfavourable climatic conditions.
In equilibrium:
Quantity Demanded = Quantity Supplied
Qd = Qs

⇒ 1200-P = 120+3P

⇒ 1200 – 120 = 3P + P

⇒ 1080 = 4P

⇒ P = 1080 / 4
P = Rs. 270
Hence; the equilibrium price is Rs. 270.
Analysis:
Demand Equation is given by Qd= 1200 – P
Qd = 1200 – 270
Qd = 930
If price is Rs 400:
Demand:
Qd= 1200 – P
Qd = 1200 – 400
Qd = 800
If price is Rs 120:
Demand:
Qd= 1200 – 120
Qd = 1200 – 120
Qd = 1080
Similarly;
Supply equation is given by Qs= 120 + 3P
Qs= 120 + 3 (270)
Qs = 120 + 810
Qs = 930
If price is Rs 400:
Supply:
Qs= 120 + 3P
Qs= 120 + 3 (400)
Qs= 120 + 1200
Qs = 1320
If price is Rs 120:
Supply:
Qs= 120 + 3P
Qs= 120 + 3 (120)
Qs = 120 + 360
Qs = 480
Market Equilibrium: Demand and Supply Equilibrium
According to the economic theory, the price of a product in a market is determined at a point
where the forces of supply and demand meet. The point where the forces of demand and supply
meet is called equilibrium point. Conceptually, equilibrium means state of rest. It is a stage
where the balance between two opposite functions, demand and supply, is achieved.
Mathematically, market equilibrium is expressed as:
Qd(P) = Qs(P)
Where
Qd(P) is the quantity demanded at price P
Qs(P) is the quantity supplied at price P
Let us understand the concept of market equilibrium with the help of an example.
Table below shows the demand and supply of computers by Teetan Ltd for the year 2017 at
different price levels.

Price Supply Demand

270 930 930
400 1320 800
120 480 1080

Demand and Supply of computers by Teetan Ltd for the year 2017
In the table above, it can be observed that at the price of ₹ 270, the demand and supply of
computers is equal i.e. 930 computers. Therefore, market equilibrium exists at 930 where
demand and supply are the same. The below graph shows the market equilibrium of demand and
supply of computers mentioned in the above table.

Supply (S)
Price
E
930
Demand (D)

270 Quantity
Conclusion:
As mentioned earlier, the market equilibrium price of a product is determined at the point of
intersection of demand and supply. However, it is important to understand how the price is
determined. Let us understand and the determination market price with the help of an example.
Let us consider the example of computers (as given in Table above). In Table, it is mentioned
that when price is ₹ 120, the demand for computers is 1,080 units while supply is 480 units. This
indicates that there is a shortage of 600 computers in the market. As a result of this shortage, the
seller tries to increase their earnings by raising the price of computers. On the other hand,
consumers would be willing to purchase at the price quoted by the seller due to the shortage of
computers. This leads to an increase in the profit of the seller, which, in turn, would improve the
production of computers. As a result, the supply of computers increases. The process of increase
in prices goes on till the price of computers reaches to ₹ 270.
As shown in Table, at the price of 270, the demand is reduced to 930 computers, while the
supply is also increased to 930 computers. Thus, equilibrium is reached. This will lure
consumers to buy more due to reduction in the price of computers. As a result of increase in
buying, the equilibrium price would be ₹ 270.
It concludes that when the price changes to ₹ 400 and ₹ 120 the demand of computers decreases
to 800 units and increase to 1080 units respectively.
Similarly when the price changes to ₹ 400 and ₹ 120 the supply of computers increase to 1320
units and decreases to 480 units respectively.

Changes in When Changes in

At When Price supply and Price supply and
  Equilibrium changes to demand changes to demand
Price 270 400   120  
Supply 930 1320 Increase of 390 480 Decrease of 450
Demand 930 800 Decrease of 130 1080 Increase of 150
2. Assume that at the price of ₹75, the demand for the product is 250 units. If the price of the
product increases to ₹90, the demand decreases to 150 units. Calculate and analyse the
difference in the value of price elasticity using Arc Elasticity Method and Percentage Method.
Ans:
Introduction:
Price elasticity of demand is a measure of a change in the quantity demanded of a product due to
change in the price of the product in the market. In other words, it can be defined as the ratio of
the percentage change in quantity demanded to the percentage change in price. It can be
mathematically expressed as:

Proportionate Change in the Quantity Demanded

Price elasticity of demand =
Proportionate Change in Price

A percentage change in demand and price is denoted with a symbol Δ.

Thus, the formula for calculating the price elasticity of demand is as follows:

ep = ΔQ X P
ΔP Q

Where,
ep = Price elasticity of demand
P = Initial price
ΔP = Change in price
Q = Initial quantity demanded
ΔQ = Change in quantity demanded
Arc Elasticity Method:
This method is used to calculate the elasticity of demand at the midpoint of an arc on the demand
curve. In this method, the average of prices and quantities are calculated for finding elasticity. It
is assumed that the elasticity would be same over a range of values of variables considered. The
formula of the arc elasticity method is:
 ep = ΔQ X P + P1
ΔP Q + Q1

Where,
ΔQ is change in quantity (Q1 – Q)
ΔP is change in price (P1 – P)
Q in original quantity demanded
Q1 is new quantity demanded
P is original price
P1 is the new price
Given that;
P = ₹75
P1 = ₹90
Q = 250
Q1 = 150

Substituting the values in the formula, we get

ΔQ = Q1 – Q = 150 – 250 = –100
ΔP = P1 – P = 90 – 75 = 15
ep = (–100/15) x [(75 + 90)/(250 + 150)]
= (–100/15) x (165/400)
= – 2.75
As price and demand are inversely related and move in opposing directions. Therefore, the
negative sign is ignored. Thus, the elasticity is greater than one (ep > 1).
Hence the price elasticity (ep) is 2.75
Percentage Method:
It is also known as the ratio method. Using this method, a ratio of proportionate change in
quantity demanded to the price of the product is calculated to determine the price elasticity.
Thus,

ep = Q2 – Q1/ Q1
P2 – P1/ P1
Where,
Q1 = Original quantity demanded
Q2 = New quantity demanded
P1 = Original price
P2 = New price
Given that;
Q1 = 250
Q2 = 150
P1 = 75
P2 = 90

Substituting the values in the formula, we get

ep = [(150 – 250) / 250] / [(90 – 75) / 75]
= (– 100 / 250) / (15 / 75)
=–2
As price and demand are inversely related and move in opposing directions. Therefore, the
negative sign is ignored. Therefore, the negative sign is ignored. Thus, the elasticity is greater
than one (ep > 1).
Hence the price elasticity (ep) is 2
Conclusion:
If Ped > 1, then demand responds more than proportionately to a change in price i.e. demand is
elastic. For example if a 10% increase in the price of a good leads to a 30% drop in demand. The
price elasticity of demand for this price change is –3.
Elastic demand (Ped >1)

Price
Lost revenue from
Selling at a lower price
P1
Demand
P2 Increased revenue
from selling more at
a lower price

Q1 Q2 Quantity

Price elastic of demand

If the co-efficient of price elasticity of demand >1, then demand is said to be price elastic i.e.
highly responsive to a change in price.
 If demand for a product is price elastic, a supplier stands to gain extra revenue if they
reduce their prices.
 The change in quantity demanded will be proportionately higher than the reduction in
price.
It is concluded that the price elasticity of demand according to Arc Elasticity Method is 2.75 and
according to Percentage Method is 2. Hence the difference in the value of price elasticity is 0.75.
3. Alpha Ltd was planning to start production next year. Different departments of the company
were working together to forecast the demand of the product in the market.
a) If you are manager of the company mention the steps and the factors that would be relevant
for forecasting the demand of rice in the market.
Ans:
Introduction:
According to Evan J. Douglas, “Demand forecasting may be defined as a process of finding
values for demand in future time periods.”
Demand forecasting helps an organisation to take various business decisions, such as planning
the production process, purchasing raw materials, managing funds, and deciding the price of its
products. Demand can be forecasted by organisations either internally by making estimates
called guess estimate or externally through specialised consultants or market research agencies.
The steps for forecasting the demand of rice in the market:
1. Setting the Objective:
An organization needs to clearly state the purpose of demand forecasting before initiating it.

 Short-term or long-term demand for a product

 Industry demand or demand specific to an organisation
 Whole market demand or demand specific to a market segment

2. Determining Time Period:

Demand can be forecasted for a long period or short period. In the short run, determinants of
demand may not change significantly or may remain constant, whereas in the long run, there is a
significant change in the determinants of demand. Therefore, an organization determines the time
period on the basis of its set objectives.
3. Selecting a Method for Demand Forecasting:
The method of demand forecasting differs from organization to organization depending on the
purpose of forecasting, time frame, and data requirement and its availability. Selecting the
suitable method is necessary for saving time and cost and ensuring the reliability of the data.
4. Collecting Data:
After selecting the demand forecasting method, the data needs to be collected. Data can be
gathered either from primary sources or secondary sources or both. As data is collected in the
raw form, it needs to be analysed in order to derive meaningful information out of it.
5. Estimating Results:
The results should be easily interpreted and presented in a usable form. The results should be
easy to understand by the readers or management of the organization.
Factors Influencing Demand Forecasting:
Prevailing economic conditions: Demand forecasting can be affected by the changing price
levels, national and per capita income, consumption pattern of consumers, saving and investment
practices, employment level, etc. of an economy. Thus, it is important that existing economic
conditions should be assessed in order to align demand forecasting with current economic trends.
Existing conditions of the industry: The assessment of demand for an origination’s products and
services in also affected by the overall conditions of the industry in which the organisation opera
ate.. For example, concentration of an industry increases the level of competition, which directly
affects the demand for products and services of different organisations in the industry. In such a
case, demand forecasted by organisations may falter.
Prevailing market conditions: Changes in market conditions, such as change in the prices of
goods; change in consumers’ expectations, tastes and preferences; change in the prices of related
goods; and change in the income level of consumers also influence the demand for an
organisation's products and services.
Sociological conditions: Sociological factors, such as size and density of population, age group,
size of family, family life cycle, education level, family income, social awareness, etc. largely
impact demand forecasts of an organization. For example, markets having a large population of
youngsters would have a higher demand for lifestyle products, electronic gadgets, etc.
Psychological conditions: Psychological factors, such as changes in consumer attitude, habits,
fashion, lifestyle, perception, cultural and religious beliefs, etc. affect demand forecast of an
organisation to a large extent.
Competitive conditions: A market consists of several organisation offering similar products.
This gives rise to competition in the market, which affects demand forecasted by organisations.
For example, reduction in trade barriers increases the number of new entrants in a market, which
affects the demand for products and services of existing organisations.
Import-export policies: The demand for export-import goods gets directly affected by changes
in factors, such as import and export control, terms and conditions of import and export, import-
export policies, import/export conditions, etc.
b) The price of rice and its demand (in kg) produced by Alpha Ltd in 2018 is given in the table.
Fit a linear regression line and estimate and analyse the demand for rice when price is Rs 50 per
kg.

Price(Rs/kg) 17 20 24 28 32
Demand(Kg) 80 75 65 60 54

Ans:
Introduction:
The regression analysis method for demand forecasting measures the relationship between two
variables. Linear regression attempts to model the relationship between two variables by fitting a
linear equation to observed data. One variable is considered to be an explanatory variable, and
the other is considered to be a dependent variable. For example, regression analysis may be used
to establish a relationship between the income of consumers and their demand for a luxury
product. In other words, regression analysis is a statistical tool to estimate the unknown value of
a variable when the value of the other variable is known.
The formula for a simple linear regression is as follows:
Y = a + bX
Where Y is the dependent variable for which the demand needs to be forecasted; b is the slope of
the regression curve; X is the independent variable; and a is the Y-intercept. The intercept a will
be equal to Y if the value of X is zero.
Here Demand (Y) is dependent and Price (X) is independent variables.

SL No Price (x) Demand (Y) XY X² Y²

1 17 80 1360 289 6400
2 20 75 1500 400 5625
3 24 65 1560 576 4225
4 28 60 1680 784 3600
5 32 54 1728 1024 2916
Total 121 334 7828 3073 22766
Average 30.25 83.5      

Computing the value for the slope (b) of the regression curve using the following formula:

b = ∑XY - nXY
∑X² - nX²
Therefore, = 7828 – 5(30.25) (83.5)
3073 – 5 (30.25) (30.25)
= 7828 – 12629.38
3073 – 4575.31
= – 4801.38 / – 1502.31
= – 3.19

Compute the value for the Y-intercept using the following formula:

a = Y – bX

Therefore, a = 83.5 – (– 3.19) (30.25) = 179.99

Develop a linear regression equation for the trend line using the following formula:
Y = a + bX
Therefore, regression equation
Y = 179.99 + (– 3.19) (50)
Y = 179.99 – 159.5
Y = 20.49
Therefore, when price is Rs 50 per kg the demand will be estimated 20.49 Kg.

Conclusion:
Regression analysis is a family of statistical tools that can help business analysts build models to
predict trends, make tradeoff decisions, and model the real world for decision-making support.
These models can be used to predict the value of one or more variables from knowledge of the
value of other variables. Although a regression analysis is widely used in business for model
building and to support decision making, the models developed using regression analysis are not
perfect, and the analyst needs to demonstrate care in his or her interpretation.