UNIT 2 DEMAND ANALYSIS

INTRODUCTION:

UNIT 2 is basically on the demand analysis. This unit will give you detail
idea about the meaning of demand and its determinants, supply and its
determinants law of demand and supply, elasticity of demand and supply.
It will give you an idea about the relationship between price and quantity
demanded.
 Lesson 6 Demand and its determinants

Learning outcomes

After studying this unit, you should be able to:

appreciate the significance of demand analysis

specify a demand function, identifying the determinants
classify various types of demand
comprehend a long list demand concepts
locate the sources of demand
relate demand to the nature of market structure

INTRODUCTION
Students why have you selected M.B.A. in your career? It is
because M.B.A.’s have great demand in a job market. Thus demand is one of the
most critical economic decision variables. Demand reflects the size and the
pattern of market.
Business activity is always market-determined. The manufacturers’
inducement to invest in a given line of production is limited by the size of market
The demand for output and input; the demand for the firm and the industry; the
demand by the consumer and stockiest; and similar other demand concepts
become therefore, relevant for managerial decision analysis. Even if the firm
pursues objectives alternative to profit-maximization, demand concepts still
remain relevant.
For example, suppose the firm is aiming at ‘customer service’ not
profit. How can it ensure quantity and quality of service, without analyzing what
the customer really wants? Or suppose, the firm is destined to discharge ‘social
responsibility’ of business. Can this be done without evaluating social
preferences? Tastes, preferences and choices are all concepts directly built into
the economic concepts of ‘demand’.

SIGNIFICANCE OF DEMAND ANALYSIS

Demand is one of the crucial requirements for the functioning of any
business enterprise its survival and growth.

Demand analysis is of profound significance to management. Information

on the size and type of demand helps management in planning its
requirements of men, materials, machines, money and what have you.
o For example, if the demand for a product is subject to temporary
business recession, the firm may plan to pile up the stock of unsold
 products. If the demand for a product shows a trend towards a substantial
and sustained increase in the long run, the firm may plan to install
additional plant and equipment to meet the demand on a permanent basis.
If the demand for a firm’s product is falling, while its rival’s sale is
increasing, the firm needs to plan its sales tactics; the firm may need to
undertake some sales promotion activity like advertisement. If the firm’s
supply of the product is unable to meet its existing demand, the firm may
be required to revise its production plan and schedule; or the firm may
have to review its purchase plan for inputs and the suppliers’ response to
input requirements by the firm. In the same way, larger the demand for a
firm’s product, the higher is the price the firm can change.
o The common theme underlying these examples is that the whole
range of planning by the firm–production planning, inventory planning,
cost budgeting, purchase plan, market research, pricing decision,
advertisement budget, profit planning etc. – call for an analysis of demand.
In fact, demand analysis is one area of economics that has been used
most extensively by business. The decision which management makes
with respect to any functional area, always hinges on an analysis of
demand.

Demand analysis seeks to identify and measure the forces that determine
sales; it reflects the market conditions for the firm’s product. Once the
demand analysis is done, the alternative ways of creating, controlling or
managing demand can be inferred.

Activity 1

Briefly answer the following questions :

a) Why is a person interested in knowing the demand for the shares he has
purchased?
………………………………………………………………………………………………
………………………………………………………………………………………………
……………………………………

b) Why should the Food Corporation of India be concerned about the demand for
foodgrains to be released for public distribution system?

c) Why does the Maruti Udyog Ltd. Ask one of its officers to estimate the demand
fro Premier 118 NE in 1990?
d) Why does a bank analyse the seasonal demand for credit?

CONCEPT OF DEMAND

As we have indicated earlier, ‘demand’ is a technical concept from Economics.

Demand for product implies:

a) desires to acquire it,

b) willingness to pay for it, and
c) Ability to pay for it.

All three must be checked to identify and establish demand. For example : A
poor man’s desires to stay in a five-star hotel room and his willingness to pay
rent for that room is not ‘demand’, because he lacks the necessary purchasing
power; so it is merely his wishful thinking. Similarly, a miser’s desire for and his
ability to pay for a car is not ‘demand’, because he does not have the necessary
willingness to pay for a car. One may also come across a well-established
person who processes both the willingness and the ability to pay for higher
education. But he has really no desire to have it, he pays the fees for a regular
cause, and eventually does not attend his classes. Thus, in an economics sense,
he does not have a ‘demand’ for higher education degree/diploma.

It should also be noted that the demand for a product–-a commodity or a

service–has no meaning unless it is stated with specific reference to the time,
its price, price of is related goods, consumers’ income and tastes etc. This
is because demand, as is used in Economics, varies with fluctuations in these
factors. To say that demand for an Atlas cycle in India is 60,000 is not meaningful
unless it is stated in terms of the year, say 1983 when an Atlas cycle’s price was
around Rs. 800, competing cycle’s prices were around the same, a scooter’s
prices was around Rs. 5,000. In 1984, the demand for an Atlas cycle could be
different if any of the above factors happened to be different. For example,
instead of domestic (Indian), market, one may be interested in foreign (abroad)
market as well. Naturally the demand estimate will be different. Furthermore, it
should be noted that a commodity is defined with reference to its particular
quality/brand; if its quality/brand changes, it can be deemed as another
commodity.

To sum up, we can say that the demand for a product is the desire for that
product backed by willingness as well as ability to pay for it. It is always
defined with reference to a particular time, place, price and given values of
other variables on which it depends.
Activity 2

a) Construct some specific examples showing that despite having a ‘desire’, a

person may not have
i) ‘willingness to pay’ :

ii) ‘ability to pay’ :

b) What do you mean by :

i) A household’s demand for a T.V. set:

ii) A firm’s demand for labour :

iii) Our Government’s demand for defence equipment:

Demand Function and Demand Curve

Demand function is a comprehensive formulation which specifies the factors that

influence the demand for the product. What can be those factors which affect
the demand?

For example,

Dx = D (Px, Py, Pz, B, W, A, E, T, U)

Here Dx, stands for demand for item x (say, a car)

Px, its own price (of the car)
Py, the price of its substitutes (other brands/models)
Pz, the price of its complements (like petrol)
B, the income (budget) of the purchaser (user/consumer)
W, the wealth of the purchaser
 A, the advertisement for the product (car)
E, the price expectation of the user
T, taste or preferences of user
U, all other factors.

Briefly we can state the impact of these determinants, as we observe in normal

circumstances:
i) Demand for X is inversely related to its own price. As price rises, the demand
tends to fall and vice versa.

ii) The demand for X is also influenced by its related price—of goods related to X.
For example, if Y is a substitute of X, then as the price of Y goes up, the
demand for X also tends to increase, and vice versa. In the same way, if Z goes
up and, therefore, the demand for X tends to go up.

iii) The demand for X is also sensitive to price expectation of the consumer; but
here, much would depend on the psychology of the consumer; there may not
be any definite relation.

This is speculative demand. When the price of a share is expected to go up,

some people may buy more of it in their attempt to make future gains; others
may buy less of it, rather may dispose it off, to make some immediate gain.
Thus the price expectation effect on demand is not certain.

iv) The income (budget position) of the consumer is another important influence
on demand. As income (real purchasing capacity) goes up, people buy more of
‘normal goods’ and less of ‘inferior goods’. Thus income effect on demand may
be positive as well as negative. The demand of a person (or a household) may
be influenced not only by the level of his own absolute income, but also by
relative income—his income relative to his neighbour’s income and his
purchase pattern. Thus a household may demand a new set of furniture,
because his neighbour has recently renovated his old set of furniture. This is
called ‘demonstration effect’.

v) Past income or accumulated savings out of that income and expected future
income, its discounted value along with the present income—permanent and
transitory—all together determine the nominal stock of wealth of a person. To
this, you may also add his current stock of assets and other forms of physical
capital; finally adjust this to price level. The real wealth of the consumer, thus
computed, will have an influence on his demand. A person may pool all his
resources to construct the ground floor of his house. If he has access to some
additional resources, he may then construct the first floor rather than buying a
flat. Similarly one who has a colour TV (rather than a black-and-white one) may
demand a V.C.R./V.C.P. This is regarded as the real wealth effect on demand.
vi) Advertisement also affects demand. It is observed that the sales revenue of a
firm increases in response to advertisement up to a point. This is promotional
effect on demand (sales). Thus

vii) Tastes, preferences, and habits of individuals have a decisive influence on

their pattern of demand. Sometimes, even social pressure—customs, traditions
and conventions exercise a strong influence on demand. These socio-
psychological determinants of demand often defy any theoretical construction;
these are non-economic and non-market factors—highly indeterminate. In
some cases, the individual reveal his choice (demand) preferences; in some
cases, his choice may be strongly ordered. We will revisit these concepts in the
next unit.

You may now note that there are various determinants of demand, which may be
explicitly taken care of in the form of a demand function. By contrast, a demand
curve only considers the price-demand relation, other things (factors) remaining
the same. This relationship can be illustrated in the form of a table called demand
schedule and the data from the table may be given a diagrammatic
representation in the form of a curve. In other words, a generalized demand
function is a multivariate function whereas the demand curve is a single variable
demand function.

Dx = D(Px)

In the slope—intercept from, the demand curve which may be stated as

Dx = α + β Px, where α is the intercept term and β the slope which is negative
because of inverse relationship between Dx and Px.

Suppose, β = (-) 0.5, and α = 10

Then the demand function is : D=10-0.5P

TYPES OF DEMAND

Till now we have that may specify demand in the form of a function. Much of this
specification and its form depends on the nature of demand itself – its type and
determinants. From this standpoint, we can talk about a few other distinct
concepts of demand:

i) Direct and Derived Demands

Direct demand refers to demand for goods meant for final consumption; it is the
demand for consumers’ goods like food items, readymade garments and houses.
By contrast, derived demand refers to demand for goods which are needed for
further production; it is the demand for producers’ goods like industrial raw
materials, machine tools and equipments. Thus the demand for an input or what
is called a factor of production is a derived demand; its demand depends on the
demand for output where the input enters. In fact, the quantity of demand for the
final output as well as the degree of substituability/complementarty between
inputs would determine the derived demand for a given input.
For example, the demand for gas in a fertilizer plant depends on the amount of
fertilizer to be produced and substitutability between gas and coal as the basis
for fertilizer production. However, the direct demand for a product is not
contingent upon the demand for other products.

ii) Domestic and Industrial Demands

The example of the refrigerator can be restated to distinguish between the
demand for domestic consumption and the demand for industrial use. In case of
certain industrial raw materials which are also used for domestic purpose, this
distinction is very meaningful.
For example, coal has both domestic and industrial demand, and the distinction
is important from the standpoint of pricing and distribution of coal.

iii) Autonomous and Induced Demand

When the demand for a product is tied to the purchase of some parent product,
its demand is called induced or derived.
For example, the demand for cement is induced by (derived from) the demand
for housing. As stated above, the demand for all producers’ goods is derived or
induced. In addition, even in the realm of consumers’ goods, we may think of
induced demand. Consider the complementary items like tea and sugar, bread
and butter etc. The demand for butter (sugar) may be induced by the purchase of
bread (tea). Autonomous demand, on the other hand, is not derived or induced.
Unless a product is totally independent of the use of other products, it is difficult
to talk about autonomous demand. In the present world of dependence, there is
hardly any autonomous demand. Nobody today consumers just a single
commodity; everybody consumes a bundle of commodities. Even then, all direct
demand may be loosely called autonomous.

iv) Perishable and Durable Goods’ Demands

Both consumers’ goods and producers’ goods are further classified into
perishable/non-durable/single-use goods and durable/non-perishable/repeated-
use goods. The former refers to final output like bread or raw material like
cement which can be used only once. The latter refers to items like shirt, car or a
machine which can be used repeatedly. In other words, we can classify goods
into several categories: single-use consumer goods, single-use producer goods,
durable-use consumer goods and durable-use producer’s goods.

This distinction is useful because durable products present more complicated

problems of demand analysis than perishable products. Non-durable items are
meant for meeting immediate (current) demand, but durable items are designed
to meet current as well as future demand as they are used over a period of time.
So, when durable items are purchased, they are considered to be an addition to
stock of assets or wealth. Because of continuous use, such assets like furniture
or washing machine, suffer depreciation and thus call for replacement. Thus
durable goods demand has two varieties – replacement of old products and
expansion of total stock. Such demands fluctuate with business conditions,
speculation and price expectations. Real wealth effect influences demand for
consumer durables.

v) New and Replacement Demands

This distinction follows readily from the previous one. If the purchase or
acquisition of an item is meant as an addition to stock, it is a new demand. If the
purchase of an item is meant for maintaining the old stock of capital/asset, it is
replacement demand. Such replacement expenditure is to overcome
depreciation in the existing stock.
Producers’ goods like machines. The demand for spare parts of a machine is replacement
demand, but the demand for the latest model of a particular machine (say, the latest
generation computer) is anew demand. In course of preventive maintenance and
breakdown maintenance, the engineer and his crew often express their replacement
demand, but when a new process or a new technique or anew product is to be introduced,
there is always a new demand.
You may now argue that replacement demand is induced by the quantity and quality of
the existing stock, whereas the new demand is of an autonomous type. However, such a
distinction is more of degree than of kind. For example, when demonstration effect
operates, a new demand may also be an induced demand. You may buy a new VCR,
because your neighbor has recently bought one. Yours is a new purchase, yet it is induced
by your neighbor’s demonstration.

vi) Final and Intermediate Demands

This distinction is again based on the type of goods- final or intermediate. The demand
for semi-finished products, industrial raw materials and similar intermediate goods are all
derived demands, i.e., induced by the demand for final goods. In the context of input-
output models, such distinction is often employed.

vii) Individual and Market Demands

This distinction is often employed by the economist to study the size of the buyers’
demand, individual as well as collective. A market is visited by different consumers,
consumer differences depending on factors like income, age, sex etc. They all react
differently to the prevailing market price of a commodity. For example, when the price is
very high, a low-income buyer may not buy anything, though a high income buyer may
buy something. In such a case, we may distinguish between the demand of an individual
buyer and that of the market which is the market which is the aggregate of individuals.
You may note that both individual and market demand schedules (and hence curves,
when plotted) obey the law of demand. But the purchasing capacity varies between
individuals. For example, A is a high income consumer, B is a middle-income consumer
and C is in the low-income group. This information is useful for personalized service or
target-group-planning as a part of sales strategy formulation.
viii) Total Market and Segmented Market Demands
This distinction is made mostly on the same lines as above. Different individual buyers
together may represent a given market segment; and several market segments together
may represent the total market. For example, the Hindustan Machine Tools may
compute the demand for its watches in the home and foreign markets separately; and then
aggregate them together to estimate the total market demand for its HMT watches. This
distinction takes care of different patterns of buying behavior and consumers’ preferences
in different segments of the market. Such market segments may be defined in terms of
criteria like location, age, sex, income, nationality, and so on

x) Company and Industry Demands

An industry is the aggregate of firms (companies). Thus the Company’s demand
is similar to an individual demand, whereas the industry’s demand is similar to
aggregated total demand. You may examine this distinction from the standpoint
of both output and input.

For example, you may think of the demand for cement produced by the Cement
Corporation of India (i.e., a company’s demand), or the demand for cement
produced by all cement manufacturing units including the CCI (i.e., an industry’s
demand). Similarly, there may be demand for engineers by a single firm or
demand for engineers by the industry as a whole, which is an example of
demand for an input. You can appreciate that the determinants of a company’s
demand may not always be the same as those of an industry’s. The inter-firm
differences with regard to technology, product quality, financial position, market
(demand) share, market leadership and competitiveness---- all these are possible
explanatory factors. In fact, a clear understanding of the relation between
company and industry demands necessitates an understanding of different
market structures.
Exercises-

State whether True or False-

1. The demand for management trainees is derived demand.
2. The share market is always subject to speculative demand.
3. Demand for tea is autonomous demand.
4. Shift in a demand curve can be shown on the same demand curve.
5. Demand function is single variate.

Quote appropriate examples of-

1. Seasonal demand :
2. New demand :
3. Close substitutes :
4. Perfect compliments :
5. Segmented market demand :

For the following products what can be the factors (other than its price) which can affect
the demand.
1. Umbrella
2. Kids wears
3. Text books
4. Mobiles
5. Tractors

How is consumption different from demand?

Case Study

Read the following article and state the factors responsible for the demand of Indian skilled labour abroad.

Why the west wants desi pros

ECONOMICTIMES.COM [ MONDAY, APRIL 26, 2004 12:55:43 AM ]
If you are Indian and highly skilled in the specialised professions like IT and medicine then countries like the US,
the UK and the rest of Europe are desperately on the look out for you. And why not? You bring much needed talent
in sparsely supplied fields and high-end jobs also mean more money through taxes for the host countries.

Till recently, you had to be either a high-powered banker or an MNC executive if you were to make it to the rich
countries. Now not only are Indians, engaged in new economy sectors, moving abroad but jobs are also moving to
India

The US and the UK have created special immigration schemes to attract Indians, apart from improvising on
existing schemes that have existed for some years in Australia, Canada, and New Zealand. Germany, meanwhile,
has brought about a new "green card" scheme to recruit foreign IT specialists and to train 2,50,000 domestic
specialists by 2005.

As is well-known, the Silicon Valley is much dependent on Indians for supplying entrepreneurs as well as workers.

The new approach centres around the governments’ working in close quarters with employers to cut down on
labour shortages. The recruitments are highly tailored to meet specific requirements by industry and then to fast-
track admissions on a temporary basis.

While much ink has been spilled over the rising trend of Indian professionals snatching away the jobs from their
American and European counterparts in their country, nobody doubts that the skilled, English speaking,
hardworking, tech-savvy, and of course much economical Indian professionals deserve them.

Therefore, is it any surprise that more and more Indian professionals are now packing their bags and heading
towards newer foreign destinations than the traditional US-UK-West Asia to fulfil their career goals. However, this
should not ring alarm bells for countries like the US, UK and Canada, which already have huge Indian
populations.

Primarily, because this flight is one that is tremendously beneficial to the host country as it gets to benefit greatly
from the presence of skilled Indian workers. More and more Indian doctors, nurses, teachers and software
professionals wanting to migrate, mean big revenues in the form of taxes and services. Further, they also add to the
country’s knowledge bank and help boost the skill base.

Although most developed nations like the UK and Australia remain apprehensive about employing the services of
highly skilled overseas workers, analysts suggest that in the long-term, such migrations will benefit these countries
more than it harms them.

According to Harvard Professor Jorge Borjas the benefit from the highly-skilled immigrants to the US economy are
greater than the short term concern of losing jobs. An immigrant with below-average education will cost the US
about $13,000 per year whereas one with at least two years of college education generates $198,000 in taxes over
his lifetime.

The past decade has witnessed the entire world inching closer under the fold of globalisation. Countries have come
closer and mutual inter-dependence in terms of trade and commerce have taken a huge northward leap. Therefore it
comes as no surprise that the IT industry, especially in the Silicon Valley, is effectively manned by Indian software
engineers.
Slide 1 ___________________________________
Meaning of Demand
Demand means effective desire
___________________________________
Effective desire=desire+willingness to pay +
ability to pay ___________________________________
Without willingness and ability to pay desire
can’t be effective demand
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Slide 2 ___________________________________
Types of Demand
1. Direct and derived demand
___________________________________
2. Domestic and industrial demand
3. Autonomous and induced demand ___________________________________
4. Perishable and durable goods demand
5.
6.
New and replacement demand
Final and Intermediate demand
___________________________________
7. Individual and market demand
8. Short run and long run demand ___________________________________
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___________________________________

Slide 3 Factors determining demand ___________________________________

Price of the product

___________________________________
Price of related goods
Income of the consumers ___________________________________
Tastes preferences of the consumer
Availability of the goods ___________________________________
Advertisement for the product
Price expectation of the user ___________________________________
Other factors

___________________________________
___________________________________
Slide 4 ___________________________________
Demand schedule
It’s a tabular representation of the price and
___________________________________
the quantity demanded.
It tells us the relation between the price of the ___________________________________
product and the quantity demanded

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Slide 5 ___________________________________
Types of demand schedule
Two types of demand schedule
___________________________________
1. Individual demand schedule
2. Market demand schedule ___________________________________
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Slide 6 ___________________________________
why demand curve slopes downward
Inverse relationship between price and the
___________________________________
quantity demanded
Substitution effect ___________________________________
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Slide 7
Change in demand
Change in demand means increase or
decrease in the demand due to factors other
than price of the product
Slide 8
Reasons for changes in demand
Changes in number of consumers
Changes in the income and wealth of the
consumer
Changes in consumer tastes and preferences
Expectation of changes in price
Changes in the price of substitute
Changes in the price of complementary
goods
Slide 9
Changes in quantity demanded
It is based on the assumption of the law of
demand
Changes in quantity demanded due to
changes in the price of the products.
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