You are on page 1of 73

Unit - 2

Ch - 3
Demand Analysis
By Ram Ahir
The Concept of Demand. . .
Market refers to the interaction
between seller and buyers of a good or
services at a mutually agreed upon
price.
Demand is defined as that want, need
or desire which is backed by
willingness and ability to buy a
particular commodity, in a given period
of time.
Demand is the quantity of a commodity
which consumers are willing to buy at a
given price for a particular unit of time.
The Concept of Demand. . .
4Quantity
Demanded refers to
the amount
(quantity) of a good
that buyers are
willing to purchase
at alternative prices
for a given period.
P
Q
Unwilling to
buy
Willing
to buy
Definition of Demand
The demand for a product refers to the
amount of it which will be bought per
unit of time at a particular price
Demand = Desire + Ability to pay (i.e.,
Money or Purchasing Power) + Will to
spend
Demand is an effective desire, as it is
backed by willingness to pay and
ability to pay.
Types of Demand
1. Demand for consumers goods and
producers goods
2. Demand for perishable and durable goods
3. Autonomous (direct) and derived (indirect)
demand
4. Normal/superior and inferior goods
5. Necessary, comforts and luxury goods
6. Related goods: Substitutes and
complementary goods
7. Individual buyers demand and all buyers
(aggregate / market) demand.
8. Firm and Industry demand
9. Demand by market segments and by total
market

Consumers Goods and Producers Goods
Goods and Services used for final
consumption are called consumers
goods.
These include those consumed by
human-beings (e.g. food items,
clothes, kitchen tools, residential
houses, medicines, and services of
teachers, doctors, lawyers, washer
men and shoe-makers), animals (e.g.
dog food and fish food), birds (e.g.
grains), etc.
Producers goods refer to the goods
used for production of other goods.
Thus, producers goods consist of plant
and machines, factory buildings,
services of business employees, raw-
materials, etc.
The distinction is somewhat arbitrary.
This is because, whether a good is
consumers or producers depends on its
use.
For ex., if a sofa set is used in the
drawing room of a house - it is a
consumers good; while if is a used in
the reception room of a business house
it is a producers good.
But, the distinction is useful for a
proper demand analysis for while the
demand for consumers goods
depends on households income, that
for producers goods varies with the
production level, among other things.
Perishable and durable goods
Both consumers and producers
goods are further classified into
perishable (non-durable) and durable
goods.
In laymens language, perishable
goods are those which perish or
become unusable after sometime, the
rest are durable goods.
In economics, perishable goods refer
to those goods which can be
consumed only once while in case of
durable goods, their services only are
consumed.
Perishable goods include all services
(e.g. services of teachers and
doctors), food items, raw-materials,
coal, and electricity, while durable
goods include plant and machinery,
buildings, furniture, automobiles,
refrigerators, and fans.
Durable goods pose more complicated
problems for demand analysis than do
non-durables.
Sales of non-durables are made
largely to meet current demands
which depends on current conditions.
In contrast, sales of durable goods go
partly to satisfy new demand and
partly to replace old items.
Further, the letter set of goods are
generally more expensive than the
former set, and their demand alone is
subject to preponment and
postponement, depending on current
market conditions vis--vis expected
market conditions in future.
Autonomous (direct) and
Derived (Indirect) Demand
The goods whose demand is not tied
with the demand for some other goods
are said to have autonomous demand,
while the rest have derived demand.
Thus, the demands for all producers
goods are derived demands, for they
are needed in order to obtain
consumers or producers goods.



Thus, the demand for goods which
fulfill our basic Physiological
requirements, are generally included
in autonomous demand.
For example; Demand for soap,
clothing etc
While the demand for goods for the
production of other goods and
services are included in derived.
For example; Demand for raw material
like steel, cement, plant and
machinery etc,


Demand for money which is needed
not for its own sake but for its
purchasing power, which can buy
goods and services.
Similarly, demand for cars battery or
petrol is a derived demand, for it is
linked to the demand for a car.
There is hardly anything whose
demand is totally independent of any
other demand.
But the degree of this dependence
varies widely from product to product.

For ex: Demand for petrol is totally
linked to the demand for petrol driven
vehicles, while the demand for sugar
is only loosely linked with the demand
for milk.
Goods that are demanded for their
own sake have direct demand while
goods that are needed in order to
obtain some other goods possess
indirect demand.
In this sense, all consumers goods
have direct demands while all
producers goods, including money,
have indirect demand.
Normal/Superior and Inferior Goods
Normal goods, also called as superior
goods.
The former are those whose demand
increases as income increases, and
the latter are those whose demand
falls as income goes up, and vice
versa.
For example, milk, refrigerator,
television, education, and the good
quality of food grains and clothes are
superior goods while the poor quality
of food grains and clothes are inferior
goods.
In other words, the superior goods are
the ones which the rich people
consume while the inferior goods are
for the poor peoples consumption.
Further, these are relative concepts.
Thus, for example, scooter/bike is a
superior good in relation to a cycle,
while it is an inferior good relative to a
car.
Necessary, comforts and Luxury
Goods
In common sense, the necessary goods are
essential for existence, comforts goods make
the life comfortable and luxury goods are
luxuries of life.
However, in economics they have special
meanings.
These all are considered as superior goods
but of different degrees.
Thus, as the consumers income rise, more of
each of these three kinds of goods is
consumed but the proportion of the
consumption budgets differ.
In case of necessary goods, as income
increases, while the consumption
expenditure on them increases, the
percentage of total expenditure/income
spent on each of them goes down.
In case of comforts, the said percentage
remains the same, while in case of
luxuries, it goes up.
In general, ordinary foods, drinks,
clothing, some education and medical
aids are considered as necessary.
Some means of transport, good
quality of food, drinks and clothing,
tourism, etc. are taken as comforts.
Luxuries include foods in high end
hotels, designers clothing, specious
residences, foreign touruism, and so
on.

Substitute and Complementary Goods
Goods which crated joint demand are
complementary goods.
Therefore demand for one commodity is
dependent upon demand for the other one.
For ex: pen and ink, printer and ink cartridge,
computer and software, car and petrol(diesel)
etc.
Goods that complete with each other to satisfy
any particular want are called substitute.
Also, note that the degree of substitution might
vary form product to product.
Substitute and Complementary Goods
Example of Close substitutes: Coke
and Pepsi, WagonR and Santro, petrol
driven car or diesel driven car, saving a/c
with SBI or ICICI bank, investing in govt
bonds or company deposits, and so on.
On the other hand, there are products
which are not so good substitutes of each
other, for example, car and bike, airways
and railways.
This categorization of goods helps
producers in taking decisions related to
price, output, advertising, etc.
Individuals Demand and
Market Demand
The demand for a good by an
individual buyer is called individuals
demand while the demand for a good
by all buyers in a market is called
market demand.
For ex, if the milk market consisted of,
say, only three buyers, then
individuals and market demand
(monthly) could be as follows.
Individual firm Demand
Amuls Demand: Ice Cream Cones
Price/cones Daily
quantity
_________________________________
Rs10.00 12
Rs15.00 10
Rs20.00 8
Rs25.00 6
Rs30.00 4

Market Demand
4Market demand is the sum of all
individual demands at each possible
price.
4Assume the ice cream market has two
buyers as follows:
Price Per Cone Amul Vadilal Market
Demand
Rs10.00 12 + 7 = 19
Rs15.00 10 + 6 = 16
Rs20.00 8 + 5 = 13
Rs25.00 6 + 4 = 10
Rs30.00 4 + 3 = 7

Firm and Industry Demand
Most goods today are produced by
more than one firm and so there is a
difference between the demand facing
an individual firm and that facing an
industry (all firms producing a
particular good constitute an industry
engaged in the production of that
good).
For ex: Cars in India are manufactured
by Maruti Suzuki, TATA motors,
Hindustan Motors, Premier
Automobiles, and Standard Motor
Products of India.
Demand for Maruti car alone is a
firms (company) demand where as
demand for all kinds of cars is
industrys demand.

Similarly, demand for Godrej
refrigerators is a firms demand while
that for all brands of refrigerators is
the industrys demand.
Demand by Market Segments and
by Total Market
The market demand is the total
demand for the product in the market.
It is the sum (total) of the demand of a
product by all the consumers in the
market.
In managerial economic the total
market demand concept is having very
less importance.
On the other hand demand by
segment is the entire market is divided
into different groups on the basic of
location, demography, life style and
behavior of the consumers in the
classification is more meaningful in
managerial economics.
The demand condition in each
segment is different from other, which
provides better guidance for the
manager in understanding the
different class of consumers.

Recurring and Replacement
Demand
Consumer goods can be further
divided into consumable goods and
durable goods. Consumable goods
have recurring demand, i.e. they are
consumed at frequent intervals, like
eat food twice a day, take tea and
snacks three to four times a day, read
newspaper everyday, fill petrol in your
vehicle every week, etc.
Durable consumer goods are
purchased to be used for a long time
but they need replacement.
For ex : car, mobile, furniture, house
etc.
Why Demand Analysis is
needed?
Demand analysis is needed basically
for three purpose:
1. To provide the basis for analyzing
market influences on the demand
2. To provide the guidance for
manipulating the demand
3. To guide in production planning
through forecasting the demand
Demand Function
A function is that which describes the
relationship between a variable
(dependent variable) and its
determinants (independent variables).
Thus, the demand function for a good
relates the quantities of a goods which
consumers demand during some
specific period to the factors which
influence that demand.
Mathematically, the demand function
for a goods x can be expressed as
follows:
Demand function
Dx= f (Y, Px, Ps, Pc, T; Ep, Ey, N, D)

- Dx =Demand of goods x
- Y =Income of consumers
- Px =Price of x
- Ps =Price of substitute of x
- Pc =Price of complements of x
- T =Taste of consumers
- Ep =Consumers expectations about future price
- Ey = Consumers expectations about future income
- N =No. of consumers
- D =Distribution of consumers


The first five determinants affect the
demand for all goods, the next two are
influence mainly on the demand for
durable and expensive goods, and the
next tow are arguments only in the
demand functions for a group of
consumers.
The impact of these determinants on
Demand is
1) Price effect on demand: Demand
for x is inversely related to its own
price.
2) Substitution effect on demand: If y
is a substitute of x, then as price of y
increases, demand for x also
increases.
3) Complementary effect on demand:
If z is a complement of x, then as the
price of z falls, the demand for z goes
up and thus the demand for x also
tends to rise.
4)Price expectation effect on
demand: Here the relation may not be
definite as the psychology of the
consumer comes into play.
5) Income effect on demand: As
income rises, consumers buy more of
normal goods (positive effect) and less
of inferior goods (negative effect).
6) Promotional effect on demand:
Advertisement increases the sale of a
firm up to a point.

Socio-psychological determinants of
demand like tastes and preferences,
custom, habits, etc.
Demand Curve
Demand curve considers only the
price demand relation, other factors
remaining the same.
An individuals demand schedule for
commodity x
Price x (per unit) Quantity of x
demanded (in units)
2.0 1.0
1.5 2.0
1.0 3.0
0.5 4.5


The demand curve is negatively
sloped, indicating that the individual
purchases more of the commodity per
time period at lower prices.
The inverse relationship between the
price of the commodity and the
quantity demanded per time period is
referred to as the law of demand.
A fall in Px leads to an increase in Dx
because of the substitution effect and
income effect.
Determinants of Demand
CProducts Own Price
CConsumer Income
CPrices of Related Goods
CTastes & preferences
CExpectations about future price &
income
Number of Consumers & their
Distribution
Law of Demand
Law of demand states that, ceteris paribus,
demand for a product is inversely proportional
to its price.
Price of the product is the most important
variable of a products demand. i.e. Dx =
f(Px)
Law of Diminishing Marginal Utility:
According to this law, the consumer
consumes successive units of a commodity,
the utility derived from each additional unit
(marginal unit) goes on falling. Hence, the
consumer would purchase only as many units
of the commodity, where the marginal utility of
the commodity is equal to its price.
Demand Schedule and Demand
Curve
Demand Schedule is the list or tabular
statement of the different
combinations of price and quantity
demanded of a commodity.
Demand curve shows the relationship
between price of a good and the
quantity demanded by consumers.
Demand Schedule and Individual
Demand Curve
Point
on
Demand
Curve
Price (Rs
per cup)
Demand
(000
cups)
a 15 50
b 20 40
c 25 30
d 30 20
e 35 10
e
b
a
c
10 20 30
15
20
30
35
50 40
25
Quantity of coffee
O
d
43
Law of Supply
Any discussion on demand cannot be
complete without understanding supply.
Demand and Supply are like two sides of a
coin or two blades of scissors.
Demand indicates the willingness of a
purchaser to buy a particular commodity,
supply means the willingness of the firms to
sell a particular commodity.
Supply refers to the quantities of a good or
service that the seller is willing and able to
provide at a price, at a given point of time,
ceteris paribus.
The Law of supply states that other
things remaining the same, the higher
the price of a commodity, the grater is
the quantity supplied.
Supply Function:
Sx = f(Px, C, T, G, N)
Where C= Cost of Production(wages,
interest, rent and price of raw materials)
T = State of technology
G = Govt. policy regarding taxes and
subsidies
N = No. of firms
Determinants of Supply
Supply is positively related to price of the
commodity.
Supply is reduced if the cost of production
rises.
Technology bears a positive relationship with
supply. An improved techology reduces cost
of production per unit of output, enhances
productivity and thus increases the supply of
the product.
Government policies related to taxes and
subsidies on certain products also have an
effect on supply as they increase or decrease
the cost. Such effects may be either negative
(in case of taxes) or positive (in case of
subsidies).

No of firms: With increase in the number of
producers of a particular product, the supply
of the product in the market will increase.
If entry is unrestricted, new firms will continue
to enter the market, thus increasing supply
and degree of competition. (Perfectly
Competitive market, in the long run, as more
firms enter into the industry, the aggregate
supply curve of the product shifts to the right
(or left) due to an increase in the supply of
the product.)
Shift in Demand Curve
Shift of demand curve due to a change
in any of the factors other than price is a
change in demand.
When demand increases without any
change in price, the demand curve will
shift to the right, and with a reduction in
demand, the curve will shift to the left.
Demand curve shifts to the right if
income rises and shifts to the left if
income falls, ceteris paribus.
Change in Demand
D
1
D
2

D
0

Price
Quantity
0
Shift in demand curve from D
0

to D
1
More is demanded at same
price (Q
1
>Q)
Increase in demand caused
by:
A rise in the price of a
substitute
A fall in the price of a
complement
A rise in income
A redistribution of income
towards those who favour
the commodity
A change in tastes that
favours the commodity
Shift in demand curve from D
0

to D
2
Less is demanded at each
price (Q
2
<Q)


P
Q
1
Q
Q
2
49
Concept of Elasticity
Elasticity can be defined as the
proportionate change in demand of
product in response to the proportionate
change in any of the factors affecting
demand. The benefit of concept of
elasticity that it shows the amount of
change in the demand.
When the law of demand only shows
the direction of change in demand, the
elasticity of demand shows the direction
as well as the % change in demand. So,
Elasticity of demand is more useful
concept than price.

Concept of Elasticity
Elasticity is a measure of the
sensitiveness of one variable to
changes in some other variable.
It is expressed in terms of a
percentage and is devoid of any unit
of measurement.
Elasticity of a variable x with respect
to variable y is expressed as ex,y.
ex,y = % change in x
% change in y


Demand Elasticities
Demand elasticities refer to elasticities
of demand for a good with respect to
each of the determinants of its
demand.
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
4. Promotional elasticity of demand
Price elasticity of demand
Price elasticity can be defined as the
proportionate change in demand of
product in response to the
proportionate change in price of a
product.
Ep= % change in demand of X
% change in price of X
Price Elasticity of Demand is negative
since there is an inverse [negative]
relationship between price and the
demand of the product. If price
increase, demand decrease, if price
decrease, demand increases.

Types of price elasticity
1. Perfectly elastic demand ( e = )
When an insignificant or minor change
in the price will result in an extra
ordinary large change in demand, the
demand is said to be a perfectly elastic.
A slight change means a slight decrease
in the price will result in the increase in
demand to infinity and a slight increase
in the price will lead to the decrease in
demand to 0. But in actual situation the
demand cannot be perfectly elastic.


2. Perfectly inelastic demand: (e = 0)
When the demand for the commodity
remains constant irrespective of the
change in the price of commodity.
There is hardly any commodity in the
world for which this is true.
For ex: salt. Salt is an inexpensive and
yet an essential consumption item and
its consumption can vary only within a
small range.
For this reason alone, its consumption
hardly varies with variations in its
price.

3. Unitary elastic demand: (e = 1)
When the percentage change in the
price of a commodity brings about the
same percentage change in the
demand of the commodity, the
demand is said to be unitary elastic.
For, e.g., 5% increase or decrease in
the price will result in 5% decrease or
increase in demand for the
commodity.

4. Elastic demand [ e > l ]
In this case changes in price leads to
a more than proportionate change in
demand. For, e.g., if the price of
commodity X changes by 2 %, the
demand for X will change by more
than 2%.
Most luxury items have elastic
demands.

5. Inelastic demand [ e < l ]
In this case changes in price leads to
a less than proportionate change in
demand. For, e.g., if the price changes
2% the demand changes by less than
2%.
A large number of goods and services,
which include all the essential items,
have inelastic demand.


Income Elasticity of Demand
We know the income of the consumer is an
important determinant of demand.
Although income does not vary in the short
run, its impact on long term demand analysis in
very crucial.
Therefore it is useful to learn income elasticity
of demand (ey).
Income elasticity of demand measures the
degree of responsiveness of demand for a
commodity to a given change in consumers
income.
Assume that all other variables are ceteris
paribus.

Income elasticity of demand
The Income Elasticity expresses the
relationship between the % change in
income and corresponding % change in
demand for a particular commodity.
It measure the % change in demand
due to % change in the income of
consumers
ey = % change in demand of X
% change in income of consumer

ey = Q2 Q1/Q1
Y2 Y1/ Y1


Degrees of Income Elasticity
Income elasticity of demand also has
similar degrees of price elasticity of
demand, namely perfectly elastic,
perfectly inelastic, relatively elastic,
relatively inelastic and unitary elastic.
Hence, when the proportionate change
in demand is more than that in income,
demand is highly elastic; when the
proportionate change in demand is less
than that of income, demand is highly
inelastic.
Normally the demand for commodity
has a tendency to increase as income
increases, so income Elasticity is
generally positive, but this may not be
saw in case of inferior goods.
The demand for inferior goods reduces
as the income of the consumer
increases because higher income leads
to the use of superior quality of goods.
Hence the value of income elasticity
can be either negative or positive,
depending upon nature of product.

Degrees of Income Elasticity
1. Positive Income Elasticity
2. Zero Income Elasticity
3. Negative Income Elasticity
Positive Income Elasticity
A good that has positive income
elasticity is regarded as normal good.
A normal good is one which a consumer
buys in more quantities when his income
increases.
Ex : Clothes, fruits, jewellery, etc.
Zero Income Elasticity
Zero income elasticity implies that
there is no change in the demand for a
commodity when there is a change in
income. Such goods are called
neutral goods.
Ex: match box, salt, needles,
postcard etc.
Negative Income Elasticity
It implies that demand for a commodity
decreases as the income of the
consumer increases.
A good that has negative income
elasticity of demand is regarded as an
inferior good. i.e. The consumer buys
less of such a good when his income
increases and consumer would switch
over consumption to superior quality of
good with increase in income.
Ex : Poor quality of food, clothes etc.
Income Elasticity of demand is-
Positive for superior /normal goods
Negative for interior good
Positive and More than 1 for all
luxuries goods
Positive and around unity for all
comforts goods.
Positive and Less than 1 for all
superior and necesssary goods
May be 0 for the products like salt,
match box, needle, etc

Cross Elasticity of Demand
Demand for commodity is influents not only by price
commodity and income, but also by the price of other
commodity. It expresses the relationship between a
change in demand for a commodity due to change in
the price of some other commodity. It measures the
proportionate change in demand due to proportionate
change in price of some other commodity. Ec of
product is negative. For, e.g., tea & coffee in case of
substitute goods.
Ey = % change in demand of X
% change in Price of Y
It is positive if goods x and y are substitutes in the
consumption basket, negative if they are complements,
and zero if the two goods are unrelated.
The greater the magnitude of this elasticity, the
stornger is the relationship between two goods.

Positive Cross Elasticity:-
Substitute goods are those which compact with
each other. For, e.g., tea, coffee etc. For
substitutes goods the cross elasticity is
positive.
Generally if the price of tea falls, the demand of
tea rise and at the same, time tea become
cheaper than coffee. So, some of the customer
currently consuming coffee will start consuming
tea instead of coffee. So the demand of coffee
reduces.
For substitutes quantity demanded of one good
moves in the same direction as the price of the
other.
Ex : coke and pepsi, zen and santro, etc.

Negative Cross Elasticity:
Complementary goods are those goods which
have to be consumed simultaneously it means if
a consumer wants to consume one product he
has to consume other product.
For complements, quantity demanded of one
good moves in the opposite direction as the
price of the other.
For, e.g., car & petrol. Elasticity for
complementary goods is negative. If the price of
car reduces, the demand for it increases and at
the same time the requirement of petrol also
increases, which will increases the demand for
it.
Ex: bread and butter, tea and sugar, pen and
ink, etc.
Zero Cross elasticity:
Ec for unrelated goods is zero
because one commodity does not
affect the other commodity if the price
of one commodity changes it will not
affect the demand for other
commodity. If the price of tea changes
by 2% it will not create any affect on
the demand of clothes.


Promotional Elasticity of Demand
Advertising and promotion are vital tools
in the competitive market to generate
awareness about its products.
Promotional elasticity of demand
measures the degree of responsiveness
of demand to a given change in
advertising expenditure.
It must obviously be positive, for
advertisement expenditures are
supposed to boost up the market.
Some goods (like consumer goods) are
more responsive to advertising than
others (like heavy capital equipments)
When Ea > 1, a firm should go for
heavy expenditure on advertisement.
When Ea < 1, a firm should not spent
too much on advertisement because
the product is not sensitive to
promotion.
For Ex: we find the advertisement for
lubricants, generators, inverters, etc.
but would not find advertisements for
electricity, petrol or diesel.