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UNIT –2:
DEMAND AND SUPPLY
ANALYSIS
• Contents (8 Hrs)
• 2.1 Theory of Demand. Types of Demand. Determinants of demand , Demand
Function ,Demand Schedule , Demand curve.
• 2.2 Law of Demand, Exceptions to the law of Demand , Shifts in demand curve.
• 2.3 Elasticity of Demand and its measurement. Price Elasticity. Income Elasticity. Arc
Elasticity. Cross Elasticity and Advertising Elasticity.
• 2.4 Uses of Elasticity of Demand for managerial decision making.
• 2.5 Demand forecasting meaning, significance and methods.( numerical Exercises).
• 2.6 Supply Analysis; Law of Supply, Supply Elasticity; Analysis and its uses for
managerial decision making.
• 2.7 Price of a Product under demand and supply forces.
• 1.5 Utility Analysis. Cardinal Utility and Ordinal Utility.
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2.1 THEORY OF DEMAND. TYPES OF DEMAND.

DETERMINANTS OF DEMAND , DEMAND FUNCTION
,DEMAND SCHEDULE , DEMAND CURVE.

• Theory of Demand
• What is demand ?
• “Demand for anything means the quantity of that commodity, which is
desired to be bought, at a given price, per unit of time.”
• It is interpreted as your want backed up by your purchasing power.

Desire to
acquire it,

Demand for a Willingness to

commodity pay for it, and
implies:

Ability to pay
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TYPES OF DEMAND.

Direct and derived demand

Recurring and replacement demand

Complementary and competing demand

Demand for capital goods and consumer goods

Demand for perishable goods and durable goods

Individual and market demand

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DETERMINANTS OF DEMAND

• The demand for a commodity arises from the consumer’s

willingness and ability to purchase the commodity. The
demand theory says that the quantity demanded of a
commodity is a function of or depends on not only the
price of a commodity, but also on income of the person,
price of related goods – both substitutes and
complements – tastes of consumer, price expectation
and all other factors. Demand function is a
comprehensive formulation which specifies the factors
that influence the demand for the product.

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DETERMINANTS OF DEMAND
Dx = Demand for item x

Px = Price of item x

Py = Price of substitutes

Pz = Price of complements

B = Income of consumer

E = Price expectation of the user

A = Advertisement Expenditure

T = Taste or preference of user Notes

U = All other factors

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THE DEMAND FUNCTION

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

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THE RELATIONSHIP…

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DEMAND SCHEDULE AND DEMAND

CURVE
• A demand curve considers only the price-demand
relation, other factors remaining the same. The inverse
relationship between the price and the quantity
demanded for the commodity per time period is the
demand schedule for the commodity and the plot of
the data (with price on the vertical axis and quantity
on the horizontal axis) gives the demand curve of the
individual.

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Demand Curve
2.5

2
Price of X

1.5

0.5

0
Demand for
X

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2.2 LAW OF DEMAND, EXCEPTIONS

TO THE LAW OF DEMAND , SHIFTS IN
DEMAND CURVE.
• Law of Demand
• The Law of demand explains the functional relationship
between price of a commodity and the quantity demanded of
the commodity.
• It is observed that the price and the demand are inversely
related which means that the two move in the opposite
direction.
• An increase in the price leads to a fall in quantity demanded
and vice versa.
• This relationship can be stated as “Other things being equal,
the demand for a commodity varies inversely as the price”.
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2.2 LAW OF DEMAND, EXCEPTIONS TO THE LAW

OF DEMAND , SHIFTS IN DEMAND CURVE.

According to Law of Demand, there is an inverse relationship between the price

of a commodity and the quantity demanded (other things remaining equal)

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EXCEPTIONS TO THE LAW OF DEMAND

Conspicuous goods : These are certain goods which are purchases to project the status and prestige of the
consumer. For e.g. expensive cars, diamond jewellery, etc. such goods will be purchased more at a higher price
and less at a lower price.

Giffen goods : These are special category of inferior goods whose demand increases even if with a rise in price.
For eg. coarse grain, clothes, etc.

Share’s speculative market : It is found that people buy shares of those company whose price is rising on the
anticipation that the price will rise further. On the other hand, they buy less shares in case the prices are falling as
they expect a further fall in price of such shares. Here the law of demand fails to apply.

Bandwagon effect : Here the consumer demand of a commodity is affected by the taste and preference of the
social class to which he belongs to. If playing golf is fashionable among corporate executive, then as the price of
golf accessories rises, the business man may increase the demand for such goods to project his position in the
society.

Veblen effect : Sometimes the consumer judge the quality of a product by its price. People may have the
expression that a higher price means better quality and lower price means poor quality. So the demand goes up
with the rise in price for eg. : Branded consumer goods.

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MOVEMENTS AND SHIFTS IN

DEMAND CURVE
• If the quantity demanded of a commodity increases or decreases due to a fall or
rise in the price of a commodity alone, ceteris paribus. It is called movement along
the demand curve which occurs only due to change in price of that commodity,
ceteris paribus, Extension of Demand or movement along the demand curve to the
right. When the quantity demanded rises due to fall in price of that commodity, and
other parameters remaining constant it is called extension of demand which is shown
in the following diagram.

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MOVEMENTS AND SHIFTS IN

DEMAND CURVE
• Contraction or Movement towards left of demand curve : When the
quantity demanded of a commodity falls due to rise in the price of
that commodity it is called contraction of demand and is shown in the
following diagram.

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THEREFORE…
• Both the situation of extension and contraction can be shown in a
single diagram as below:

Movement along Demand Curve

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MOVEMENTS AND SHIFTS IN

DEMAND CURVE
• Change in Demand or shift of demand or
Increase and Decrease in demand : When the
quantity demanded of a commodity rises or
falls due to change in factors like income of the
consumer, price of related goods, etc. and
keeping the price of the commodity to be
constant, it is called shift in Demand.

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MOVEMENTS AND SHIFTS IN

DEMAND CURVE
• Increase in Demand or Shift of Demand Curve towards the Right : When the
quantity demanded of a commodity rises due to change in factors like
income of the consumable etc. price of the commodity remaining unchanged
it is called increase in demand.

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MOVEMENTS AND SHIFTS IN

DEMAND CURVE
• Decrease in Demand or shift of Demand Curve towards the left : When the
demand for a commodity falls due to other factors, the price remaining
constant, it is termed as decrease in demand or shift of demand curve
towards the left.

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2.3 ELASTICITY OF DEMAND

• 2.3 Elasticity of Demand and its measurement.

• Price Elasticity.
• Income Elasticity.
• Arc Elasticity.
• Cross Elasticity and
• Advertising Elasticity.

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ELASTICITY OF DEMAND
Introduction Elasticity is the measure of responsiveness.

It is the ratio of the percent change in one variable to the percent

change in another variable.

The key thing to understand is that we use elasticity when we want to

see how one thing changes when we change something else.

How does demand for a good change when we change its price?

How does the demand for a good change when the price of a
substitute good changes?

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CONCEPT OF ELASTICITY
The law of demand tells us that
consumers will respond to a price
decline by buying more of a product. It
does not, however, tell us anything
about the degree of responsiveness of
consumers to a price change. The
contribution of the concept of elasticity
lies in the fact that it not only tells us
that consumer's demand responds to
price changes but also the degree of
responsiveness of consumers to a price
change. The figure shows two demand
curves. Let Da be the demand for
cheese in Switzerland and Db be the
demand for cheese in England.

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CLASSIFICATION OF DEMAND
CURVES ACCORDING TO THEIR
ELASTICITIES
Depending on how the total revenue changes, when price changes
we can classify all demand curves in the following five categories:
1. Perfectly inelastic demand curve

2. Inelastic demand curve

3. Unitary elastic demand curve

4. Elastic demand curve

5. Perfectly elastic demand curve

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Perfectly Inelastic Demand : These are certain goods like salt, match box
etc. whose demand neither increase nor decrease with a change in price.
A perfectly inelastic demand curve is a vertical straight line parallel to Y –axis which shows
that whatever may be the change in price the demand will remain constant at OQ.

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Perfectly Elastic Demand : That is [ed = ∞]. When the quantity demanded of a commodity
changes infinitely due to a slight or no decrease in price, such goods are said to have perfectly
elastic demand.

A perfectly Elastic Demand Curve is a straight line parallel to X –axis.

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Relatively Inelastic Demand (ed < 1)

In this type of goods and services the proportionate change in quantity demand is less than the
change in price. These are mostly essential goods of daily use like rice, wheat etc.

In the diagram change in quantity QQ1 is less than proportionate to the change in
price PP1.

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Relatively Elastic Demand : In such type of goods the percentage change in quantity demanded
of a commodity is more than proportionate to the percentage change in price, eg. luxury car.

In the diagram we see that change in quantity demanded QQ1 is more than
proportionate to the change in price PP1.

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Unit Elastic Demand (ed = 1)

Here the rate of change in demand is exactly equal to the rate of change in price. Therefore the
products or service with unit elasticity are neither elastic nor inelastic.

A Unit elastic Demand curve is a rectangular - hyperbola as shown above

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NUMERICAL MEASUREMENT OF ELASTICITY

• What does it mean when we say that the elasticity of demand is

0.5? 0.4? 2.3? To answer this question we have to examine the
following definition for elasticity coefficient, Ed.

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COMPUTATION OF
ELASTICITY COEFFICIENTS

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ARC PRICE ELASTICITY OF

DEMAND
• The question is, how is it that we
get different demand responses for
the same range of price change?
The answer is that our initial
quantity demanded and price have
been different.
• When we calculate for price fall,
they are 2000 for initial quantity
demanded and 4 for initial price.
• When we calculate it for price rise
they are 3250 for initial quantity
demanded and 3 for initial price.

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APPLICATIONS OF ELASTICITY

• The concept of elasticity has a wide range of

applications in economics. In particular, an
understanding of elasticity is fundamental in
understanding the response of supply and
demand in a market.
• Some common applications of elasticity
include:

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APPLICATIONS OF ELASTICITY

• Effect of changing price on firm's revenues: If the

demand for the product is price inelastic, the
firm would not want to lower its price since that
would reduce its total revenue, increase its total
costs and this will give it lower profits.

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• Analysis of incidence of the tax burden and other government

policies: In economics, tax incidence is the analysis of the effect
of a particular tax on the distribution of economic welfare. Tax
incidence is said to "fall" upon the group that, at the end of the
day, bears the burden of the tax. The key concept is that the
tax incidence or tax burden does not depend on where the
revenue is collected, but on the price elasticity of demand (and
price elasticity of supply). For example, a tax on orange
farmers might actually be paid by owners of agricultural land
or consumers of oranges.

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• Effect of international trade and terms of trade

effects: Marshall-Lerner Condition gives a
technical reason why a reduction in value of a
nation's currency need not immediately improve
its balance of payments. The condition states
that, for a currency devaluation to have a
positive impact on trade balance, the sum of
price elasticity of exports and imports (in
absolute value) must be greater than 1.
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• Analysis of consumption and saving behavior:

the way consumers respond to the change in
prices or other determinants of demand,
determines their consumption pattern and
savings pattern. For example, a consumer
purchases 2 bottles of cold drinks instead to 4,
when price rose from 10 to 15. Other things
remaining constant, he is saving more money
than before.
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• If the elasticity of the firm's sales with

reference to advertisement expenditure is
positive and higher than for its expenditure on
product quality and customer service, then the
firms would find it more beneficial to
concentrate its sales efforts on advertising
rather than on product quality and customer
service.

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