DEMAND STRUCTURE &

ANALYSIS
 DEMAND CONCEPT
• Definition – Demand is defined as the desire to
buy a commodity backed by the willingness to
buy that in turn is backed by capacity to
purchase (purchasing power)

• Essential components of demand:

– Desire
– Willingness to buy
– Capacity to purchase
 LAW OF DEMAND
• Law of Demand states that when price of a commodity
increases its quantity demanded decreases and vice-
versa, other factors remaining constant

• According to the Law of Demand there is an inverse

relationship between price of a commodity and its
quantity demanded ↔ Price and demand move in
opposite direction

• According to the Law of Demand the demand curve is

downward sloping from left to right
 ASSUMPTIONS OF LAW OF DEMAND

• Tastes and preferences of consumers remain

constant
• Price of only the given commodity changes
over time
• Income of consumers remain constant
• Prices of other goods remain constant
• No substitute for the given commodity
• The demand for the commodity should be
continuous
 MARKET DEMAND
• Individual Demand Schedule – It represents a list of
quantities of a commodity purchased by an individual
consumer at different prices

• Market Demand Schedule – It refers to the total/aggregate

demand of a commodity by all the consumers in the market

• Market demand curve is the horizontal summation of

individual demand curves

• Market demand curve is flatter than individual demand

curves
FACTORS DETERMINING DEMAND
• Price of the given commodity

• Price of factors of production

• Income of consumers

• Price of complementary commodities

• Price of substitute commodities

• Tastes and preferences of consumers

 DEMAND FUNCTION
• It represents functional relationship between
demand for a commodity and its various
determinants
• Mathematical equation: D = f(P,Y,T,P*)
– D = Quantity demanded
– P = Price of the given commodity
– Y = Income of the consumer
– T = Tastes and preferences of consumers
– P* = Price of related products
 DEMAND CURVE ANALYSIS
• Law of Diminishing Marginal Utility
– As the consumer buys more and more of the
commodity, the marginal utility of the additional
units fall
↕
– The consumer is willing to pay only lower prices
for additional units ↔ If the price is higher, the
consumer will restrict its consumption ↔
Demand will fall
– Demand curve is having a negative slope
 DEMAND CURVE ANALYSIS (2)
• Principle of Equi-Marginal Utility
– Increase in quantity purchased ↔ Diminished marginal
utility from additional units consumed
– Consumer relates to marginal utility to price
– Higher quantity purchased at lower price

• Income Effect

• Substitution Effect (Substitute Commodities)

• Complementary Commodities
 EXCEPTIONS TO LAW OF
DEMAND
• Giffen’s Paradox
– When price of Giffen commodities decreases,
quantity demanded of such products also
decreases ↔ Demand for normal/luxury
commodities increases

• Demonstration Effect
– Prestige commodities
– When price of prestige commodities increases
quantity demanded also increases
 EXCEPTIONS TO LAW OF
DEMAND
• Lack of Knowledge/Ignorance

• Speculative Effect
– When the price of a commodity increases, consumer buys more
of such a commodity because of speculation of future rise in price

• Fear of Future Shortage

• Necessary Goods

• Brand Loyalty and Consumer Preference

 ELASTICITY OF DEMAND
Elasticity of Demand is defined as the
degree of responsiveness in quantity
demanded of a commodity to a change in
its price
↕
It represents the rate of change in
quantity demanded of a commodity to a
change in its price
 PRICE ELASTICITY OF DEMAND
• It is the ratio of percentage change in quantity
demanded of a commodity to a percentage
change in its price

• Classification
– Perfectly Elastic Demand (Infinitely Elastic)
– Perfectly Inelastic Demand (Zero Elasticity)
– Unitary Elastic Demand
– Relatively Elastic Demand (Positive Elasticity)
– Relatively Inelastic Demand (Negative Elasticity)
DETERMINANTS OF PRICE ELASTICITY
• Availability of Substitutes
– Higher the number of close substitutes available higher
the price elasticity of demand for a given commodity, and
vice-versa

• Proportion of income spent

– Demand tends to be inelastic for goods and services that
account for only small proportion of total income

• Time Period
– Demand is more elastic in the long run than in the short
run
PRICE ELASTICITY & DECISION MAKING
• Price elasticity is important for managerial
decision making

• If demand is inelastic at the current price, a

decrease in price will result in decrease in total
revenue ↔ Profit will decrease

• If demand is elastic at the current price, a

decrease in price will result in increase in total
revenue ↔ Profit will increase
 INCOME ELASTICITY OF DEMAND
• It is the ratio of percentage change in quantity
demanded of a commodity to a percentage
change in income of the consumer

• Classifications
– Zero Income Elasticity
– Negative Income Elasticity
– Positive Income Elasticity
 MANAGERIAL DECISION & INCOME
ELASTICITY
• If income elasticity > zero but less than unity , sales of the
commodity will increase at a slower rate than the rate of
income growth

• If income elasticity > unity then sales of the commodity

will increase at a faster rate than the rate of income
growth
↕
• Firms whose demand functions enjoy high income
elasticity have good growth opportunities in business cycle
boom↔ Helps in forecasting effects of change in income
on Dd
 CROSS ELASTICITY OF DEMAND
• The responsiveness of quantity demanded of a
commodity to changes in prices of other commodities
is measured by cross elasticity

• Cross elasticity of demand is defined as the percentage

change in quantity demanded of a commodity caused
by percentage change in the price of other commodity,
other factors remaining constant
•
• Cross elasticity is positive for substitutes and negative
for complements
CROSS ELASICITY & DECISION MAKING
• Industry configuration/boundary
– High or positive cross elasticity in one industry
– Low or negative cross elasticity in another industry

• The concept of cross elasticity assists

managerial decision making with regard to
price fixation of goods and services
– Substitutes
– Complements
ADVERTISEMENT ELASTICITY OF DEMAND

• Also known as promotional elasticity of demand it

measures the responsiveness of demand due to
change in advertisement and other promotional
expenses

• In managerial decision making advertisement

elasticity helps determining optimum level of
advertisement and promotional expenses

• If advertisement elasticity is high, it is profitable to

spend more on advertisement