Demand Curve

Demand curve is the graphical of relationship between quantity demanded and the
price of the product, while holding all other influences constant (in Latin: ceteris paribus).
The demand curve shows how many of a product will be purchased at different prices. Note
that demand is represented by the entire curve, not just one point on the curve, and represents
all the possible price-quantity choices given the ceteris paribus assumptions. When the price
of the product changes, quantity demanded changes, but demand does not change. Price
changes involve a movement along the existing demand curve.

Why demand curve slope download? The demand curve is downwardly or inversely sloped
because more people are willing to buy at a lower price or fewer people are willing to buy at
a higher price. The concept of diminishing marginal utility also contributes to the
downward slope of the demand curve. If a person goes to supermarket and buys five bananas
at Rs.10 each, his satisfaction from each banana will slowly decrease with every banana
eaten. The first banana always tastes the best, but with each additional banana consumed,
satisfaction decreases because of diminishing marginal utility.
Increased Real Income: A fall in the price of a good increases the real income of the
consumer. He is able to buy more of the good under question, or buy more of other goods.
Similarly, an increase in the price of a good reduces his real income. In this case, the income
effect leads to a reduction in the demand of the good. This factor also contributes to the
downward slope of demand curve.
Substitution Effect. When the price of a commodity falls, it becomes relatively cheaper in
comparison to its substitutes. Therefore, the consumer would prefer to substitute, this cheaper
commodity for other goods whose business analyst should keep this factor in mind while
forecasting demand of durable goods.
Propensity to Save. Demand for goods is affected by change in propensity to save Increase
in propensity save means less money is available to the purchase of goods. The demand,
therefore, will decrease with increase in propensity to save.
Advertisement Expenditure. Increase in advertisement expenditure up to a certain stage,
increase the demand rapidly by influencing consumer’s choice and preferences, and setting
new fashion trends. Generally, advertisement expenditure leads to increase in demand by
creating want for the commodity among people". Advertisement manipulates demand.

Shift in Demand
There are various factors besides price of a commodity that affect the demand for that
commodity. It should be noted that the ‘location’ of a demand curve (that is its distance from
origin) is determined by factors other than its own price, while its slope is determined by its
price. In other words, demand for a good change when, a consumer moves from one point to
another on the same demand curve (Movement along the demand curve) when the entire
demand curve shifts its position (Movement from one demand curve to the other).
Movement along the Demand Curve: A demand curve is drawn on the assumption that all
factors determining the demand behavior of a consumer, other than the price of the good
itself, remain the same. When price of the good changes, the consumer moves along the given
demand curve and changes the quantity demanded of the good.

Movement along the demand curve

A reduction in quantity of demand from Q2 to Q1 on account of an increase in price from P2

to P1 is termed as ‘contraction’ of demand. In this case, the consumer moves upward along
the demand curve. In contrast, suppose the price of the good falls from P1 to P2, the
consumer moves downward along the demand curve and increases the purchase of good from
OQ1 to OQ2. This is termed as ‘expansion’ of demand.
Movement from One Demand Curve to the Other: If the demand for good changes
without the change in price, the consumer shifts from one demand curve to the other. Such a
movement is termed as ‘increase’ in demand if the demand curve shifts to the right. And it is
termed as ‘reduction’ in demand when the movement is towards the left.
The shift in demand curve results from change in factors other than the price of the good.
Other factors which influence the demand curve are change in price of related goods, change
in income of the consumer, change in tastes and preferences of the consumer etc.

Movement from One Demand Curve to the Other

With a given price OP per unit of good X, the consumer buys OQ quantity when he is on the
demand curve D. Now the price of the commodity remains unchanged but the changes in
other factors caused demand curve to shift from D to D1. As a result of shift in demand,
keeping price constant, the demand of good X increases from OQ to OQ1.

Law of Demand
For most goods, the consumers are willing to purchase more units at a lower price
than at a higher price. The inverse relationship between price and quantity demanded is
referred as law of demand. Law of demand is the rule that people will buy more at a lower
price than at higher prices if all the other factors are constant. The idea of law of demand
seems to be pretty logical and accurate description of the behaviour we would all expect to
observe and for now, this will suffice.
Assumptions of the law of demand
The law of demand states that if other thing remains the constant demand Inversely
related with price. It suggests that the law of demand hold true, when certain conditions are
fulfilled. These conditions are known as the basic assumptions of the law of demand. They
are as under-
(i)Tastes and preferences of the consumer remain constant.
(ii)Consumer’s income is fixed and constant.
(iii)The price of related goods like substitutions and complementary remain constant.
(iv)The number of consumers (population) are remain constant.
(v)The distribution of national income is remain constant.
(vi) Climatic and weather conditions are unchanged.

Exception to Law of Demand

Giffen Goods: A Giffen good is one which people paradoxically consume more of as the
price rises, violating the law of demand. During the Irish Potato Famine of the 19th century,
potatoes were considered a Giffen good. Potatoes were the largest staple in the Irish diet, so
as the price rose it had a large impact on income. People responded by cutting out on luxury
goods such as meat and vegetables, and instead bought more potatoes. Therefore, as the price
of potatoes increased, so did the demand.
Veblen Effect: The more expensive these commodities become, the higher their value as a
status symbol and hence, the greater the demand for them. The amount demanded of these
commodities increase with an increase in their price and decrease with a decrease in their
price.
Ignorance: Sometimes, the quality of the commodity is Judge by its price. Consumers think
that the product is superior if the price is high. As such they buy more at a higher price.
Speculative effect: If the price of the commodity is increasing the consumers will buy more
of it because of the fear that it increases still further, Thus, an increase in price may not be
accomplished by a decrease in demand.
Fear of shortage: During the times of emergency of war People may expect shortage of a
commodity. At that time, they may buy more at a higher price to keep stocks for the future.
Necessaries: In the case of necessaries like rice, vegetables etc. people buy more even at a
higher price.
Elasticity of Demand
Elasticity is a central concept in the theory of demand. In this context, elasticity refers to how
demand responds to various factors, including price as well as other stochastic principles.
According to Marshall “the elasticity (or responsiveness) of demand in a market is great or
small according as the amount demanded increases much or little for a given fall in price or
diminishes much or little for a given rise in price”. One way to define elasticity is the
percentage change in one variable divided by the percentage change in another variable. It is
a measure of relative changes. Economists use elasticity to gauge the effectiveness of a price
change for a good or service. If the price of a good or service does not change as a result of
supply or demand, it is said to be inelastic.
Often, it is useful to know how the quantity demanded or supplied will change when
the price changes. This is known as the price elasticity of demand and the price elasticity of
supply. If a monopolist decides to increase the price of their product, how will this affect their
sales revenue? Will the increased unit price offset the likely decrease in sales volume? If a
government imposes a tax on a good, thereby increasing the effective price, how will this
affect the quantity demanded?
Elasticity is calculated as the percentage change in quantity over the associated
percentage change in price. For example, if the price moves from $1.00 to $1.05, and the
quantity supplied goes from 100 pens to 102 pens, the slope is 2/0.05 or 40 pens per dollar.
Since the elasticity depends on the percentages, the quantity of pens increased by 2%, and the
price increased by 5%, so the price elasticity of supply is 2/5 or 0.4.
Elasticity corresponds to the slope of the line and is often expressed as a percentage.
In other words, the units of measure do not matter, only the slope. Since supply and demand
can be curves as well as simple lines the slope, and hence the elasticity, can be different at
different points on the line.
Price, Income and Cross Elasticity
Price Elasticity: is defined as the measure of responsiveness in the quantity demanded for a
commodity as a result of change in price of the same commodity. It is a measure of how
consumers react to a change in price. In other words, it is percentage change in quantity
demanded by the percentage change in price of the same commodity. In economics and
business studies, the price elasticity of demand is a measure of the sensitivity of quantity
demanded to changes in price. It is measured as elasticity that is it measures the relationship
as the ratio of percentage changes between quantity demanded of a good and changes in its
price. In simpler words, demand for a product can be said to be very inelastic if consumers
will pay almost any price for the product, and very elastic if consumers will only pay a
certain price, or a narrow range of prices, for the product.
Inelastic demand means a producer can raise prices without much hurting demand for its
product, and elastic demand means that consumers are sensitive to the price at which a
product is sold and will not buy it if the price rises by what they consider too much. Drinking
water is a good example of a good that has inelastic characteristics in that people will pay
anything for it (high or low prices with relatively equivalent quantity demanded), so it is not
elastic. On the other hand, demand for sugar is very elastic because as the price of cool drinks
(a brand) increases, there are many substitutions which consumers may switch to.

There are five cases of price elasticity of demand

1. Perfectly elastic demand

When small change in price leads to an infinitely large change is quantity demand, it is
called perfectly or infinitely elastic demand. In this case E=∞

The demand curve DD1 is horizontal straight line. It shows the at “OP” price any amount is
demand and if price increases, the consumer will not purchase the commodity.
2. Perfectly Inelastic Demand
In this case, even a large change in price fails to bring about a change in quantity demanded.

When price increases from ‘OP’ to ‘OP’, the quantity demanded remains the same. In other
words, the response of demand to a change in Price is nil. In this case ‘E’=0.
3. Relatively elastic demand
Demand changes more than proportionately to a change in price. i.e. a small change in price
loads to a very big change in the quantity demanded. In this case E > 1. This demand curve
will be flatter.

When price falls from ‘OP’ to ‘OP’, amount demanded increase from “OQ’ to “OQ1’ which
is larger than the change in price.
4. Relatively in-elastic demand
Quantity demanded changes less than proportional to a change in price. A large change in
price leads to small change in amount demanded. Here E < 1. Demanded carve will be
steeper.

When price falls from “OP’ to ‘OP1 amount demanded increases from OQ to OQ1, which is
smaller than the change in price.

Unit elasticity of demand

The change in demand is exactly equal to the change in price. When both are equal E=1 and
elasticity if said to be unitary.
When price falls from ‘OP’ to ‘OP1’ quantity demanded increases from ‘OP’ to ‘OP1’,
quantity demanded increases from ‘OQ’ to ‘OQ1’. Thus, a change in price has resulted in an
equal change in quantity demanded so price elasticity of demand is equal to unity.

Income Elasticity: In economics, the income elasticity of demand measures the

responsiveness of the demand of a good to the change in the income of the people demanding
the good. It is calculated as the ratio of the percent change in demand to the percent change in
income. For example, if, in response to a 10% increase in income, the demand of a good
increased by 20%, the income elasticity of demand would be 20%/10% = 2.
There are three possibilities for a good's income elasticity:

1. A good is income elastic if the income elasticity of demand is greater than 1. This
implies that for a 1% change in income, demand for the good changes by more than
1%.
2. A good is income inelastic if the income elasticity of demand is greater than 0 but
less than 1. This implies that for a 1% change in income, demand for the good
changes by less than 1%.
3. A good is considered inferior if the associated income elasticity of demand is a
negative number. In this case, if income increases, consumers actually buy less of the
good.

Normal Goods: A positive income elasticity of demand is associated with normal goods; an
increase in income will lead to a rise in demand. If income elasticity of demand of a
commodity is less than 1, it is a necessity good. If the elasticity of demand is greater than 1, it
is a luxury good or a superior good.
Inferior Goods: Inferior goods have a negative income elasticity of demand. Demand falls as
income rises.

Cross Elasticity: The cross-price elasticity measures the responsiveness of our consumption
of one good when the price of another good changes. The cross-price elasticity of two goods,
say good A and good B, measures the percentage change in the quantity demanded of good
A, when the price of good B changes by 1%.
Cross-price elasticities are given two categories: complements and substitutes.
 1. Complements - Two goods that have a negative value for their cross-price
elasticity are considered complementary goods such as compact disk (CD) players
and compact disks. If the price of CD players increases then our consumption of CD's
decreases, leading to a negative relationship between the two. Conversely, if the price
of CD players falls (a negative coefficient), our consumption of CD's rises (a positive
coefficient).
2. Substitutes - Two goods that have a positive value for their cross-price elasticity
are considered substitutes such as ola cab prices and the demand for public
transportation. If the price of ola cabs rises, so does consumer demand for less
expensive transportation alternatives such as public transportation (buses, subways).

Price Line (Budget line)

Price line or Budget line is a line showing the various combinations of two goods that a
consumer can purchase by spending all income. The amount of goods that a consumer can
purchase over a given period of time is limited by the consumer’s income and by the prices of
the goods that he or she must pay. In what follows we assume (realistically) that the
consumer cannot affect the price of the goods he or she purchases. In economics, we say that
the consumer faces a budget constraint due to his or her limited income and the given prices
of goods.

Starting at endpoint J, the consumer could give up two units of Y and use the $2 not spent on
Y to purchase the first unit of X and reach point L. By giving up another 2Y, he or she could
purchase the second unit of X. The slope of −2 of budget line JK shows that for each 2Y the
consumer gives up, he or she can purchase 1X more.
The consumer can purchase any combination of X and Y on the budget line or in the
shaded area below the budget line (called budget space) with given income. For example,
income is 410, at point B the individual would spend $4 to purchase 2X and the remaining $6
to purchase 6Y. At point M, he or she would spend $8 to purchase 4X and the remaining $2
to purchase 2Y. On the other hand, at a point such as H in the shaded area below the budget
line (i.e., in the budget space), the individual would spend $4 to purchase 2X and $3 to
purchase 3Y and be left with $3 of unspent income. In what follows, we assume that the
consumer does spend all of his or her income and is on the budget line. Because of the
income and price constraints, the consumer cannot reach combinations of X and Y above the
budget line. For example, the individual cannot purchase combination G (4X, 6Y) because it
requires an expenditure of $14 ($8 to purchase 4X plus $6 to purchase 6Y).

Demand Forecasting
Demand forecasting refers to forecasting sales of a commodity or commodities for future
period. In simple words, Demand forecasting is an estimate of future sales. From a firm's
point of view, Demand forecasting means estimating in advance its share in the total market
demand. This estimate is made considering various factors—controllable and noncontrollable
and present and anticipated market conditions.

Forecasting helps a firm to assess the estimates. "It is an objective assessment of the future
course of demand. Demand forecasting is of great importance in business to forecast the
future demand, to plan, to assess the future business by estimating future situation. Hence, the
concept of demand forecasts is related to production, inventory control, timing reliability of
forecast etc.

Purpose of Demand Forecasting

(i) Evolving suitable production policy so as to avoid the problem of over-production and
under-production.
(ii) Helping the firm in reducing cost of purchasing raw materials and controlling
inventory by assuring regular supply of raw materials.
 (iii) Determining appropriate price policy so as to avoid an increase when the market
conditions are expected to be weak and a reduction when the market is going to be
quite strong.
(iv) Setting sales targets and establishing controls and incentives. If targets are set too
high, they will be discouraging salesmen who fail to achieve them; if set too low, the
targets will be achieved easily and hence incentives will prove meaningless. A
comparison between targeted sales and actual sales will help the management control
selling and salesmen activities.
(v) Forecasting short term financial requirements. Cash requirements depend on sales
level and production operations. Sales forecasts enable arrangement of sufficient
funds on reasonable term well in advance.
(vi) Regular availability of labour. Sales forecasting helps management in arranging the
labour force (trained and untrained) for maintaining a continuous flow of production
and to avoid any obstruction in the process of production due to shortage of labour
and to avoid the problem of surplus labour.
(vii) New unit planning or expansion of an existing unit. A long-term demand
forecasting helps to plan for new units or at the same time existing units to expand
their activities. A multi-product firm must determine total demand situation and the
demand for different items.
(viii) Planning for long term financial requirements. If the demand is more and it takes
long time then such long-term financial requirements could be planned and funds may
be arranged and made available at the right time.
(ix) Man power planning. The availability of trained and experienced manpower in
requisite number should be planned in advanced on the basis of long-term sales
forecasting. Training and personnel development are long term preposition and need
considerable time to complete. The development of these two potentials should be
planned well in advance.
METHODS OF DEMAND FORECASTING
1. Qualitative Methods
1.1 Survey Method
The most direct method of forecasting demand in the short-run is survey method. Surveys are
conducted to collect information about future purchase plans of the probable buyers of the
product. The surveys may be conducted by direct interview of buyers or by mailing
questionnaire asking the protentional buyers about their future purchase plans. Survey can be
a census survey or sample survey. Census survey is applied when the potential buyers are
living in a limited region or area. But generally, sample survey method is preferred because it
is less costly and less time consuming in comparison to census method. On the basis of
quantities of demand reported by probable buyers’ sales forecasts are prepared by sensible
analysis of the collected information.

The survey data can be used directly to prepare forecast. The utility of survey method is that
the factors having impact on demand can be identified. This method can be very useful for
making forecast of the demand for new products.

Limitations of Survey Method

1. Probable buyers themselves may not be aware of their demand: Thus, the information
so collected may be less authentic.
2. The purchasers may change their purchase plans. This is particularity possible in case
of consumers goods.
3. The household consumers are many which make this method costly and
impracticable.

1.2 Sales Force Opinion

This method is also known as Collective Opinion Method. The salesmen are the nearest
persons to the customers and are able to judge their mind and market conditions. They better
understand the reactions of the customers to the firm's products. Therefore, they are in a
position to provide estimates of probable demand in their regions or areas.

According to this method each salesman is asked to estimate the probable demand in his or
her area of operation. The estimates of different salesmen are collected and added together to
forecast the probable sales. To ensure greater accuracy the estimates given by salesmen are
checked in the light of opinion of marketing professionals and consultants. Thus, the final
estimates of demand are prepared. The method makes use of collective wisdom of sales force.

Advantages and Disadvantages of Sales Force Opinion

Advantages

(1) It is simple method-involving no mathematical calculations.

(2) It is based on the first-hand knowledge of salesman and the persons directly
connected with sales.
(3) This method is particularly useful for the sales forecast of new products.
Disadvantages

(1) It is a subjective approach. Thus, possibility of over estimates there.

(2) Suitable for short-term forecasts only.
(3) All salesmen may not be good estimators.
(4) Moreover, the sales-people consider only the regional factors. Factors of wider
implications, such as general business and economic conditions are not considered.

1.3 Executive Opinion Method

Under this method, opinions are sought from the executives of different disciplines, i.e.,
marketing, finance, production, etc., and estimate for future sales are prepared on their
opinions. Thus, this is a process of combining, averaging, or evaluating in some other way
the opinions and views of the top executives.

Opinions of outside experts may also be sought to examine the views of executives to arrive
at final estimates of demand.
Advantages- (1) The forecasts can be made speedily by analysing the opinions and views of
top executives. The technique is quite easy and simple. (2) There is no need of collecting
elaborate statistics for the forecasts, hence it is not much expensive. (3) In the absence of
adequate data, it is the only feasible method to be followed.
Disadvantages- (1) There is no factual basis of such forecasts, so, the method is inferior to
others. (2) Accuracy cannot be claimed under this method. (3) Responsibility for the accuracy
of data cannot be fixed on anyone.
 1.4 Market Experimentation
Market experimentation technique involves examining consumers behaviours under actual,
though controlled, market conditions.

Under this method, the firm selects some representative markets in different cities or areas
having similar characteristics such as population, income levels, occupational structure of
buyers, etc. After this market experiments are conducted by varying prices, advertising and
other controllable variable in the demand functions to know the reaction of consumers over a
period of time. The impact as change 'in demand-determinants on the demand of the product
are recorded weekly or fortnightly over a period of time on the basis of data so collected the
demand forecast for the product are prepared.

Limitations
(i) The method is expensive and time consuming.
(ii) (ii) It is risky because it may lead to unfavourable reactions on dealers, consumers
and competitors.
(iii) (iii) Difficulty of planning. It is not always easy to determine what conditions
should be taken to be constant and what factors should be regarded as variable so
as to separate and measure their influence on demand,

(iv) (iv) Difficult to satisfy the homogeneity of markets. It is hard to satisfy, the
homogeneity of market conditions.

2. Quantitative Methods for Forecasting Demand

2.1) Time series analysis or trend projection methods: A well-established firm would have
accumulated data. These data are analyzed to determine the nature of existing trend. Then,
this trend is projected in to the future and the results are used as the basis for forecast. This is
called as time series analysis. This data can be presented either in a tabular form or a graph.
In the time series post data of sales are used to forecast future.

2.2) Barometric Technique: Simple trend projections are not capable of forecasting turning
paints. Under Barometric method, present events are used to predict the directions of change
in future. This is done with the help of economics and statistical indicators. Those are (1)
Construction Contracts awarded for building materials (2) Personal income (3) Agricultural
Income. (4) Employment (5) Gross national income (6) Industrial Production (7) Bank
Deposits etc.

2.3) Regression and correlation method: Regression and correlation are used for
forecasting demand. Based on post data the future data trend is forecasted. If the functional
relationship is analyzed with the independent variable it is simple correction. When there are
several independent variables it is multiple correlation. In correlation we analyze the nature
of relation between the variables while in regression; the extent of relation between the
variables is analyzed. The results are expressed in mathematical form. Therefore, it is called
as econometric model building. The main advantage of this method is that it provides the
values of the independent variables from within the model itself.

CRITERIA OF A GOOD FORECASTING METHOD

1. Simplicity and Ease of Comprehension. Management must be able to understand

and have confidence in the techniques used. Complicated mathematical and statistical
techniques may be avoided.
2. Economy. Cost must be weighed against the importance of the forecast to the
operations of the business. The criticism should be the economic consideration of
balancing the benefits from increased accuracy against the extra cost of providing the
improved forecasting.
3. Availability. Techniques should give quick results and useful information.
4. Durability. Durability of the forecasting power of a demand and functions depends
on reasonableness and simplicity of functions fitted.
5. Accuracy. Sales forecasting is the basis of marketing planning and, therefore, sales
forecasts should be as much accurate as possible.