Demand Analysis

Introduction

 The scope of economics broadly comprises a)consumption b)production c)exchange

and d)distribution
 Consumption deals with the behavior of consumers. A producer has to understand the
consumer behavior pattern before he commits his funds for production
 Exchange deals with how the goods, once produced, are sold for a price to the
customer
 Distribution deals with how the sale proceeds of the goods sold are distributed among
the various factors of production towards rent,wages,interest,and profits
 Basic laws of consumption deals with the salient aspects of consumer behavior
Basic laws of consumption

 Law of Diminishing Marginal Utility

 Law of Equi –marginal utility and consumer surplus
 Concept of indifference curves and
 consumer equilibrium
Law of Diminishing Marginal Utility
• Law of diminishing marginal utility state that the marginal utility derived on the
consumption of every additional unit goes on diminishing, other things remaining the
same
• Marginal utility refers to the additional utility derived from consumption of an
additional unit.
• Marginal utility is reducing from one level to the other level of consumption
• This law holds good only when other things remains the same.Here other things
include nature,size and quality ,zero time interval between any given levels of
consumption,the price of the related goods,taste and preference of the consumer and
so on.
• This is very important law which describes the consumption pattern of the
consumer
• It forms the basis for many decision relating to production, pricing and
investments
The law of Equi-Marginal Utility
• The Law of Equi-marginal utility explains the prerequisite for the consumer to
be in equilibrium.
• It states that the consumer is in equilibrium when the marginal utilities
obtained from the products bought are equal
• The consumer maximises his total utility by allocating his income among the
goods and services available to him in such a way that the marginal utility
from one good equals the marginal utility from the other good.

• Where X and Y refer to the product bought

Consumer Surplus
• Consumer Surplus is defined as the difference between the price that the consumer is
prepared to pay and the price that he is exactly paying.
• It is the value consumers get from a good without paying for it
• The concept of consumers surplus is very significant for the monopolist or the trader
to assess where the customer is prepared to pay a higher price and at what point
exactly he is paying a low price, in such a case. the trader can marginally increase the
price without losing the demand
Indifference Curve
• An indifference curve is a curve which reveal, certain combinations of goods
or services which yields him the same utility
• The consumer is indifferent to a particular combination as every combination
is yielding him the same utility.

• When the consumer is indifferent for a particular combination. It is called an

indifference curve.
Assumptions in indifferent curve
• The consumer behaves rationally
• The price and income of the consumer are defined for analysis
Properties of indifferent curve
• It slopes down from left to right
• It is convex to the origin
• It cannot intersect with other indifferent curve
Consumer equilibrium
• A consumer is said to be in equilibrium when he maximizes his utility,given
the budget constraint
• When the budget line is tangential to any of the indifferent curve,then he is
said to be in equilibrium
Limitations of Utility Theory
All the above theories are based on the utility concept. There is one limitation of
the utility concept. It can be ranked only. It cannot be measured absolutely. In
the earlier analysis, absolute values were given because we assumed that it
could the measured absolutely
Demand

 Every want supported by the willingness and ability to buy constitutes

demand for a particular product or service.
 A product or service is said to have demand when three conditions are
satisfied:
1) Desire on the part of the buyer to buy
2) Willingness to pay for it
3) Ability to pay the specified price for it
Types of demand

1. Consumer Goods vs Producer Goods

 Consumer goods refers to such products and services which are capable of
satisfying human need
 Consumer goods are those which are available for ultimate consumption. These
give direct and immediate satisfaction. Examples are bread, apple, rice, and
so on
 Producer goods are those which are used for further processing or production
of goods/services to earn income. Examples are machinery or a tractor, and
such others. These goods yield satisfaction indirectly. These are used to
produced consumer goods
 The demand for producer goods is indirect, where as demand for consumer
goods is director
2. Autonomous Demand vs Derived Demand
 Autonomous demand refers to the demand for products and services directly.
 The demand for the services of a super speciality hospital can be considered
as autonomous whereas the demand for the hotels around that hospital is
called a derived demand.
 Derived demand: the demand for a product arises out of the purchase of a
parent product.
 If there is no demand for houses, there may not he demand for steel, cement,
bricks, and so on. Demand for houses is autonomous whereas demand for
these inputs is derived demand.
3. Durable vs Perishable Goods :
 the demand for goods is classified based on their durability.
 Durable goods are those goods which give service relatively for a long period.
The life of perishable goods is very less, may be in hours or days.
 Examples of perishable goods are milk, vegetables, fish, and such. Rice,
wheat, sugar and such others can be examples of durable goods.
 Given certain freezing facilities the life of perishable goods can be extended
for some time.
 Products such as TV, refrigerator and washing machines and so on are useful
for a longer period and hence they are classified as consumer durables.
4.Firm Demand or Industry Demand
 The firm is a single business unit whereas industry refers to the group of firms
carrying on similar activity. The quantity of goods demanded by a single firm
is called firm demand and the quantity demanded by the industry as a whole
is called industry demand.
 One construction company may use 1oo tonnes of cement during a given
month. This is firm demand. The construction industry in a particular state
may have used ten million tonnes. This is industry demand.
5. Short-run Demand vs Long-run Demand
 short-run demand as ‘the demand with its immediate reaction to price changes, income
fluctuations and so on.
 Long-run demand is that demand which will ultimately exist as a result of the changes in
pricing, promotion or product improvement, after enough time is allowed to let the market
adjust itself to the given situation’.
 The demand for a particular product or service in a given region for a particular day can be
viewed as short-run demand.
 The demand for a longer period for the same region can be viewed as long-run demand.
 The existing demand based on the available tastes and technology at the current price is
short-run demand.
 The demand that can be created in the long-run by changes in the design as a result of
changes in technology is long run demand.
7. Total Market and Segment Market Demand
 The total demand for sugar in the region is the total market demand.
 The demand for sugar from the sweet-making industry from this region is the
segment market demand.
6. New Demand vs Replacement Demand
 New demand refers to the demand to the new products and it is the addition
to the existing stock.
 In replacement demand, the item is purchased to maintain the asset in good
condition.
 The demand for cars is new demand and the demand for spare parts is
replacement demand.
 Replacement demand may also refer to the demand resulting out of replacing
the existing assets with the new ones. Many companies announce exchange
schemes for TVs, washing machines and so on. They would like to tap the
replacement demand.
Factors Affecting Demand

There are factors on which the demand for a commodity depends. The effect of all the
factors on the amount demanded for the commodity is called Demand Function.
1. Price of the Commodity:
The most important factor-affecting amount demanded is the price of the commodity.
The amount of a commodity demanded at a particular price is more properly called price
demand. The relation between price and demand is called the Law of Demand. It is not
only the existing price but also the expected changes in price, which affect demand.
2. Income of the Consumer:
The second most important factor influencing demand is consumer income.The demand
for a normal commodity goes up when income rises and falls down when income falls.
3. Prices of related goods:
The demand for a commodity is also affected by the changes in prices of the related goods also.
Related goods can be of two types:

(i). Substitutes which can replace each other in use; for example, tea and coffee are substitutes.
The change in price of a substitute has effect on a commodity's demand in the same direction in
which price changes. The rise in price of coffee shall raise the demand for tea;

(ii). Complementary goods are those which are jointly demanded, such as pen and ink. In such
cases complementary goods have opposite relationship between price of one commodity and the
amount demanded for the other. If the price of pens goes up, their demand is less as a result of
which the demand for ink is also less. The price and demand go in opposite direction.
4. Tastes of the Consumers:
The amount demanded also depends on consumer‟s taste. Tastes include fashion,
habit, customs, etc. A consumer‟s taste is also affected by advertisement. If the
taste for a commodity goes up, its amount demanded is more even at the same
price. This is called increase in demand. The opposite is called decrease in
demand.
5. Wealth:
The amount demanded of commodity is also affected by the amount of wealth as
well as its distribution. The wealthier are the people; higher is the demand for
normal commodities. If wealth is more equally distributed, the demand for
necessaries and comforts is more
6. Population:
Increase in population increases demand for necessaries of life. The composition
of population also affects demand. Composition of population means the
proportion of young and old and children as well as the ratio of men to women. A
change in composition of population has an effect on the nature of demand for
different commodities.
7. Government Policy:
Government policy affects the demands for commodities through taxation. Taxing
a commodity increases its price and the demand goes down. Similarly, financial
help from the government increases the demand for a commodity while lowering
its price.
8.Expectations regarding the future:
If consumers expect changes in price of commodity in future, they will change the
demand at present even when the present price remains the same. Similarly, if
consumers expect their incomes to rise in the near future they may increase the
demand for a commodity just now.
9. Climate and weather:
The climate of an area and the weather prevailing there has a decisive effect on
consumer’s demand. In cold areas woolen cloth is demanded. During hot summer days,
ice is very much in demand. On a rainy day, ice cream is not so much demanded.
10. State of business:
The level of demand for different commodities also depends upon the business
conditions in the country. If the country is passing through boom conditions,
there will be a marked increase in demand. On the other hand, the level of
demand goes down during depression
Law of Demand

 Law of demand shows the relation between price and quantity demanded of a commodity in the
market.
 The amount demand increases with a fall in price and diminishes with a rise in price
Assumptions of Law of demand: This law is based on certain assumptions, which are as follows:
I. This law assumes the income of the consumer to be constant.
2. Preference of the consumer is constant and he is ready to spend for it even if it is
expensive.
3. A change in government policies will influence demand for the product hence this law assumes a
constant government policy.
4. No change in size, composition and sex ratio of population.
5. Change in weather conditions is also likely to affect the demand for a product. Therefore
this law assumes a stable weather condition.
EXCEPTIONS TO LAW OF DEMAND

Where there is shortage of necessities food

If the customers fear that there could be shortage of necessities, then this law does not hold good.
Where the product is such that it confers distinction
Products such as jewels, diamonds and so on, confer distinction on the part of the user.
Giffens’ paradox
People whose incomes are low purchase more of a commodity such as broken rice, bread etc
(which is their staple food) when its price rises. Conversely when its price falls, instead of buying
more, they buy less of this commodity and use the savings for the purchase of better goods such
as meat.
In case of ignorance of price changes
At times, the customer may not keep track of changes in price. In such a case, he tends w buy even
if there is increase in price.
 Change in Demand
The increase or decrease in demand due to change in the factors other than
price is called change in demand. Change in demand leads to a shift in the
demand curve to the right or to the left.
 Increase in Demand
If the consumers are willing and able to buy more of Rainbow shirts at the same
price, the result will be an increase in demand. The demand curve will shift to
the right
 Decrease in Demand
A decrease in demand occurs when buyers are ready to buy less of a product the
same price because of factors like fall in income, rise in price of complementary
goods and so on. A decrease in demand will shift the demand curve to the left
 Extension and Contraction in Demand
An extension is the downward movement along a demand curve, which indicates
that a higher quantity is demanded for a given fall in the price of the good.
A contraction Is the upward movement along a demand curve,which indicates
that a lower quantity is demanded for a given increase in the price of the good
 In the case of extension and contraction. the change is along the same demand curve, either down
wards or upwards respectively.
Significance of the Law of Demand

 It indicates the consumer behavior for a given change in the variables in the
study
 The results of law of demand are basis for further decisions relating to costs,
output, investment appraisals and so on.
 organizations spend huge amount of resources to understand the consumer
behavior and lo know where demand exists for what products and services.
 Demand analysis forms the first step to know about consumer behavior which
is very complex.
Elasticity of Demand

 The manager must know the quantitative relationship between the demand for his product
and its determinants for taking certain managerial decisions. This leads to the concept of
‘elasticity of demand’
 Elasticity of demand explains the relationship between a change in price and consequent
change in amount demanded.
 Elasticity of demand shows the extent of change in quantity demanded to a change in price
 Elastic demand: A small change in price may lead to a great change in quantity demanded.
In this case, demand is elastic
 In-elastic demand: If a big change in price is followed by a small change in demanded then
the demand in “inelastic”
Measurement of Elasticity of Demand

Perfectly elastic demand:

 When any quantity can be sold at given price and when there is no need to
reduce price
 When small change in price leads to an infinitely large change is quantity
demand, it is called perfectly or infinitely elastic demand
 price any amount is demand and if price increases, the consumer will not
purchase the commodity.
Perfectly Inelastic Demand
 Even a large change in price fails to bring about a change in quantity
demanded.
 The response of demand to a change in Price is nil.
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
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.
Unit elasticity of demand:
 The change in demand is exactly equal to the change in price
Types of Elasticity of Demand

Price Elasticity of Demand:

 Price elasticity of demand measures changes in quantity demand to a change in Price
 Price elasticity is always negative which indicates that the customer tends to buy more with every
fall in price

 Q1 is quantity of demand before price change,Q2 quantity of demand after price change,P1 price
before change and P2 price after change
 The price is said to be elastic when the proportionate change in quantity
demanded is more than the proportionate change in price.
 For instance, a 5 percent fall in the price results in an increase of 20 percent
in the quantity demanded, the price is said to be elastic, which implies that
the elasticity is more than one (e> 1).
 The price is said to be inelastic when the proportionate change in quantity
demanded is less than the proportionate change in price.
 For instance, a 10 percent increase in the price results in an 2 percent drop
in the quantity demanded, the price is said to be inelastic, which implies that
the elasticity is less than one (e < 1).
 Significance of price elasticity of demand
It is necessary that the trader should be aware of the impact of changes in the
quantity demand for a given change in price. He can take a decision as to how
much he can supply if he is aware of the likely change in quantity demanded as a
result of change in price.
Income Elasticity of Demand:
 Income elasticity of demand shows the change in quantity demanded as a
result of a change in income
 Income elasticity of demand is positive, which indicates that consumer tends
to buy more and more with every increase in income
Significance of Income elasticity
 In determining the effects of changes in business activity, it is necessary for the trader to be
aware of the income elasticity of demand for given commodities
 With the help of income elasticity of demand he can estimate the likely changes in the demand
for his product as a result of changes in the national income.
 Income elasticity will help us in knowing whether a commodity is a superior good normal good or
an inferior good.
 if the income elasticity is positive and greater than one it is a superior good. The superior goods
such as automobiles and refrigerators can be advertised in business magazines for better
attention from the consumers. Retail show rooms also can be located where high income group
customers find it convenient to shop.
 If the income elasticity is positive and less than or equal to one. it is a normal good.
 If the income elasticity is negative it is an inferior goods knowledge of the nature of goods helps
in allocating advertisement budget.
Cross Elasticity of Demand:
 A change in the price of one commodity leads to a change in the quantity
demanded of another commodity. This is called a cross elasticity of demand.
 Cross elasticity is always positive for substitutes (which means that the
demand for tea goes up if there is an increase in the price of coffee) and
negative for complements (which means that if there is an increase in the
price of sugar., the demand for coffee tends to fall).
Advertising Elasticity of Demand
 Advertising elasticity of demand shows the change in quantity demanded as a
result of a change in cost of Advertisement
 Advertisement elasticity is always positive
 Factors Governing Elasticity of Demand

 Nature of the product:

The products based on their market can be classified into necessities, comforts
and luxuries. The nature of product has a significant impact on the elasticity of
demand.
Necessities have inelastic demand where as comforts and luxuries have elastic demand
 Time frame
 Degree of postponement
 Number of alternative use
 Tastes and preferences of the consumer: The customer who is particular about
his taste and preferences tend to buy the product in spite of the changes in
price. Hence the product is said to be inelastic.
 Level of price: If the price is too high or too low then the product is
likely to have an inelastic demand because a further decrease will not
increase more demand.
 Government policy: A liberal government policy provides an elastic
demand and vice-versa.
 Expectation of price
 Durability of product
POINT ELASTICITY

 A demand curve does not have the same elasticity throughout its entire
length. In general elasticity differs at different points on a given demand
curve.
 This does not hold good in the following three cases:
a) perfectly elastic b) perfectly inelastic and c) unity elasticity.
 The demand curves in each of these cases possess a single elasticity
throughout Its entire length.
Figure shows the changing elasticity at different points of a demand curve.
 The elasticity computed at a single point on the demand curve for an
infinitesimal change in price is called point elasticity..
 The point elasticity is defined as the proportionate change in quantity
demanded resulting from a very small change in price of that commodity.
It is expressed as:
ARC ELASTICITY

 The elasticity between two separate points of demand curve is called arc
elasticity