Demand Analysis - Concept of Demand

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Free BCom Notes Micro Economics Demand Analysis - Concept of Demand
Demand Analysis - Concept of Demand

Micro Economics

Introduction
Demand = Desire + Ability to Pay + Willingness to Pay

Ordinarily by demand we mean desire. But demand is different from desire. The willingness to
have something can be called as desire. Those desires become demand which are backed by
purchasing power, e:g., ability to pay and willingness to pay for it. It means the following three
conditions are necessary for demand:
1. Desire
2. Purchasing Power or ability to pay
3. Willingness to pay
Above conditions must be there to create demand.

Concept of Demand
Goods are demanded because they have utility demand is that quantity of a commodity which a
person is ready to buy at a particular price and during a specific period of time.
When price of sugar is Rs. 30 per kg the demand for it is 10 kgs per week. The reference of price
and time is essential for-demand, because demand differs with price and time. Thus following
features of demand are clear from the above:
1. Utility is the base of demand.
2. Demand is a relative concept.
3. Reference of price and time is necessary for demand

Types of Demand

1. Direct Demand: When a commodity is demanded to satisfy human wants directly, it is direct or
conventional demand. For example, the demand for food; clothes have direct demand. Consumer
goods have direct demand.

2. Indirect Demand: Indirect demand is also known as derived demand. When goods are
demanded indirectly, i.e., to produce consumer goods, it is indirect demand. For example, the
demand for factors of production is indirect demand.

3. Joint Demand: When two or more goods are demanded jointly to satisfy a single need, it is
known as joint demand for example, to make tea, water, sugar, tea powder, milk etc. is jointly
demanded. The demand for complementary goods is joint demand.

4. Composite Demand: The demand for commodities, which is used for satisfying several want at
a time, is composite demand. For example, the demand for electricity is composite demand.

5. Competitive Demand: Competitive demand is when demand for a commodity competes with its
substitutes. For example tea and coffee have competitive deinand.

Demand analysis formula – Demand Function

Demand function is a mathematical relationship between the quantity demanded of the

commodity and its determinants. It can be represented as
Where Q = quantity demanded of a commodity
Demand functions are generally of two kinds. They are:

Individual demand function – this is the mathematical relationship between the demand by an
individual consumer and the determinants of individual demand.
Market or aggregate demand function – this is the mathematical relationship between the market
demand for a commodity and the determinants of the market demand.

Meaning of Elasticity of Demand:

Demand extends or contracts respectively with a fall or rise in price. This quality of demand by
virtue of which it changes (increases or decreases) when price changes (decreases or increases)
is called Elasticity of Demand.

“The elasticity (or responsiveness) of demand in a market is great or small according as the
amount demanded increases much or little for a given fall in price, and diminishes much or little
for a given rise in price”. – Dr. Marshall.

What is the Income Elasticity of Demand?

Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain good
to a change in real income of consumers who buy this good, keeping all other things constant.
The formula for calculating income elasticity of demand is the percent change in quantity
demanded divided by the percent change in income. With income elasticity of demand, you can
tell if a particular good represents a necessity or a luxury.

Demand Forecasting

Demand forecasting is a combination of two words; the first one is Demand and another
forecasting. Demand means outside requirements of a product or service. In general, forecasting
means making an estimation in the present for a future occurring event. Here we are going to
discuss demand forecasting and its usefulness.

Demand Forecasting

It is a technique for estimation of probable demand for a product or services in the future. It is
based on the analysis of past demand for that product or service in the present market condition.
Demand forecasting should be done on a scientific basis and facts and events related to
forecasting should be considered.

Therefore, in simple words, we can say that after gathering information about various aspect of
the market and demand based on the past, an attempt may be made to estimate future demand.
This concept is called forecasting of demand.

For example, suppose we sold 200, 250, 300 units of product X in the month of January,
February, and March respectively. Now we can say that there will be a demand for 250 units
approx. of product X in the month of April, if the market condition remains the same.

Supply analysis

(Supplier /Producer point of view)

Unlike a demand curve, a supply curve has a positive slope, reflecting the law of supply. The law
of supply states that quantity supplied is positively related to price; i.e., firms offer larger amounts
at higher prices and smaller amounts at lower prices. In this case, price is the reward for
production so that higher market prices bring forth larger quantities. Higher prices provide firms
with extra funds to purchase more resources or inputs to increase production. Higher prices also
act as a signal to producers that consumers value their goods highly and desire more of them.

Producer or manufacturer of the goods always thinks to supply more goods at high price for the
consumer to get more income .Like demand, supply is not a given quantity—that is called
quantity supplied. It is a relationship between price and quantity. As the price of a good rises,
producers are generally wants to sell in larger quantity. The reverse is equally true: as price
decreases, so the supplier don’t like to sell or supply in large quantity. Like demand, supply can
also be described in a table or a graph.

Types of Supply:

There are five types of supply:

1. Market Supply:

Market supply is also called very short period supply. Another name of market supply is ‘day-to-
day supply or ‘daily supply’. Under these goods like—fish, vegetables, milk etc., are included. In
this supply is not made according to the demand of purchasers but as per availability of the
goods.

2. Short-term Supply:

In short period supply, the demand cannot be met as per requirements of the purchaser. The
demand is met as according to the goods available.

3. Long-term Supply:

In this, if demand has been changed the supply can also be changed because there is sufficient
time to meet the demand by making manufacturing goods and supplying them in the market.

4. Joint Supply:

Joint supply refers to the goods produced or supplied jointly e.g., cotton and seed; mutton and
wool. In joint supplied products one is the main product and the other is the by-product of its
subsidiary. By-product is mostly the automatic outcome when the main product is produced.

For example

When the sheep is slaughtered for mutton wool is obtained automatically.

5. Composite Supply:

In this, the supply of a commodity is made from various sources and is called the composite
supply. When there are different sources of supply of a commodity or services, we say that its
supply is composed of all these resources. We normally get light from electricity, gas, kerosene
and candles. All these resources go to make the supply of light. Thus, the way of supplying the
light is called composite supply.

Definition of 'Law Of Supply'

Definition: Law of supply states that other factors remaining constant, price and quantity supplied
of a good are directly related to each other. In other words, when the price paid by buyers for a
good rises, then suppliers increase the supply of that good in the market.
Description: Law of supply depicts the producer behavior at the time of changes in the prices of
goods and services. When the price of a good rises, the supplier increases the supply in order to
earn a profit because of higher prices.

Shifts in supply
The position of a supply curve will change following a change in one or more of the underlying
determinants of supply. For example, a change in costs, such as a change in labour or raw
material costs, will shift the position of the supply curve.

Rising costs
If costs rise, less can be produced at any given price, and the supply curve will shift to the left.

Falling costs
If costs fall, more can be produced, and the supply curve will shift to the right.

Any change in an underlying determinant of supply, such as a change in the availability of factors,
or changes in weather, taxes, and subsidies, will shift the supply curve to the left or right.

Difference Between Short Run and Long Run Production Function

A short-run production function refers to that period of time, in which the installation of new plant
and machinery to increase the production level is not possible. On the other hand, the Long-run
production function is one in which the firm has got sufficient time to instal new machinery or
capital equipment, instead of increasing the labour units.

Difference Between Short Run and Long Run Production Function

July 20, 2017 By Surbhi S Leave a Comment

short run vs long rn production functionA short-run production function refers to that period of
time, in which the installation of new plant and machinery to increase the production level is not
possible. On the other hand, the Long-run production function is one in which the firm has got
sufficient time to instal new machinery or capital equipment, instead of increasing the labour
units.

The production function can be described as the operational relationship between the inputs and
outputs, in the sense that the maximum amount of finished goods that can be produced with the
given factors of production, under a particular state of technical knowledge. There are two kinds
of the production function, short run production function and long run production function.

What is National Income: Basic Concepts

National Income is total amount of goods and services produced within the nation during the
given period say, 1 year. It is the total of factor income i.e. wages, interest, rent, profit, received by
factors of production i.e. labour, capital, land and entrepreneurship of a nation.

Concepts of National Income

There are various concepts of National Income, such as GDP, GNP, NNP, NI, PI, DI, and PCI
which explain the facts of economic activities.

GDP at market price: Is money value of all goods and services produced within the domestic
domain with the available resources during a year.
GDP = (P*Q)

Where,
GDP = gross domestic product

P = Price of goods and services

Q= Quantity of goods and services

GDP is made up of 4 Components

consumption
investment
government expenditure
net foreign exports of a country
GDP = C+I+G+(X-M)
Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import

Gross National Product (GNP): Is market value of final goods and services produced in a year by
the residents of the country within the domestic territory as well as abroad. GNP is the value of
goods and services that the country's citizens produce regardless of their location.
GNP=GDP+NFIA or,

GNP=C+I+G+(X-M) +NFIA

Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import

NFIA= Net factor income from abroad.

Net National Product (NNP) at MP: Is market value of net output of final goods and services
produced by an economy during a year and net factor income from abroad.
NNP=GNP-Depreciation
or, NNP=C+I+G+(X-M) +NFIA- IT-Depreciation
Where,
C=Consumption
I=Investment
G=Government expenditure
(X-M) =Export minus import

NFIA= Net factor income from abroad.

IT= Indirect Taxes

National Income (NI): Is also known as National Income at factor cost which means total income
earned by resources for their contribution of land, labour, capital and organisational ability. Hence,
the sum of the income received by factors of production in the form of rent, wages, interest and
profit is called National Income.
Symbolically,
NI=NNP +Subsidies-Interest Taxes
or, GNP-Depreciation +Subsidies-Indirect Taxes
or, NI=C+G+I+(X-M) +NFIA-Depreciation-Indirect Taxes +Subsidies

Personal Income (PI): Is the total money income received by individuals and households of a
country from all possible sources before direct taxes. Therefore, personal income can be
expressed as follows:
PI=NI-Corporate Income Taxes-Undistributed Corporate Profits- Social Security Contribution
+Transfer Payments.
Disposable Income (DI) : It is the income left with the individuals after the payment of direct taxes
from personal income. It is the actual income left for disposal or that can be spent for
consumption by individuals.
Thus, it can be expressed as:

DI=PI-Direct Taxes

Per Capita Income (PCI): Is calculated by dividing the national income of the country by the total
population of a country.
Thus, PCI=Total National Income/Total National Population

Measurement of National Income

There are three methods to calculate National Income:

Income Method
Product/ Value Added Method
Expenditure Method
INCOME METHOD
In this National Income is measured as flow of income.

We can calculate NI as:

NET NATIONAL INCOME = Compensation of Employees+ Operating surplus mixed (w +R +P +I)

+ Net income + Net factor income from abroad.

Where,

W = Wages and salaries

R = Rental Income

P = Profit

I = Mixed Income

Product/ Value Added Method

In this National Income is measured as flow of goods and services.

We can calculate NI as:

NATIONAL INCOME = G.N.P – COST OF CAPITAL – DEPRECIATION – INDIRECT TAXES

Expenditure Method
In this National Income is measured as flow of expenditure.

We can calculate NI through Expenditure method as:

National Income=National Product=National Expenditure.

What Is Inflation?

Inflation is a quantitative measure of the rate at which the average price level of a basket of
selected goods and services in an economy increases over a period of time. It is the constant rise
in the general level of prices where a unit of currency buys less than it did in prior periods. Often
expressed as a percentage, inflation indicates a decrease in the purchasing power of a nation’s
currency.

KEY TAKEAWAYS
Inflation is the rate at which the general level of prices for goods and services is rising and,
consequently, the purchasing power of currency is falling.

Inflation is classified into three types: Demand-Pull inflation, Cost-Push inflation and Built-In
inflation.

Most commonly used inflation indexes are the Consumer Price Index (CPI) and the Wholesale
Price Index (WPI).

Inflation can be viewed positively or negatively. Individuals with tangible assets, like property or
stocked commodities, may like to see some inflation as that raises the value of their assets.
People holding cash may not like inflation, as it erodes the value of their cash holdings.

Ideally, an optimum level of inflation is required to promote spending to a certain extent instead of
saving, thereby nurturing economic growth.

Types of Inflation

Demand Pull Inflation

Cost-Push Inflation
Open Inflation
Repressed Inflation
Hyper-Inflation
Creeping and Moderate Inflation
True Inflation
Semi-Inflation
Demand Pull Inflation

This is when the aggregate demand in an economy exceeds the aggregate supply. This increase
in the aggregate demand might occur due to an increase in the money supply or income or the
level of public expenditure.

This concept is associated with full employment when altering the supply is not possible. Take a
look at the graph below:

types of inflation - demand pull inflation

In the graph above, SS is the aggregate supply curve and DD is the aggregate demand curve.
Further,

Op is the equilibrium price

Oq is the equilibrium output
Exogenous causes shift the demand curve to the right to D1D1. Therefore, at the current price
(Op), the demand increases by qq2. However, the supply is Oq.

Hence, the excess demand for qq2 puts pressure on the price, increasing it to Op1. Therefore,
there is a new equilibrium at this price, where demand equals supply. As you can see, the excess
demand is eliminated as follows:

The price rises which leads to a fall in demand and a rise in supply.
Learn more about the Impact of Inflation here in detail.

Cost-Push Inflation

Supply can also cause inflationary pressure. If the aggregate demand remains unchanged but the
aggregate supply falls due to exogenous causes, then the price level increases. Take a look at
the graph below:

types of inflation - cost push inflation

In the graph above, the equilibrium price is Op and the equilibrium output is Oq. If the aggregate
supply falls, then the supply curve SS shifts left to reach S1S1.

Now, at the price Op, the demand is Oq but the supply is Oq2 which is lesser than Oq. Therefore,
the prices are pushed high till a new equilibrium is reached at Op1.

At this point, there is no excess demand. Hence, you can see that inflation is a self-limiting
phenomenon.

Open Inflation

This is the simplest form of inflation where the price level rises continuously and is visible to
people. You can see the annual rate of increase in the price level.

Repressed Inflation

Let’s say that there is excess demand in an economy. Typically, this leads to an increase in price.

However, the Government can take some repressive measures like price control, rationing, etc. to
prevent the excess demand from increasing the prices.

Hyper-Inflation

In hyperinflation, the price level increases at a rapid rate. In fact, you can expect prices to
increase every hour. Usually, this leads to the demonetization of an economy.

Creeping and Moderate Inflation

Creeping – In this case, the price level increases very slowly over an extended period of time.
Moderate – In this case, the rise in the price level is neither too fast nor too slow – it is moderate.
True Inflation

This takes place after the full employment of all the factor inputs of an economy. When there is
full employment, the national output becomes perfectly inelastic. Therefore, more money simply
implies higher prices and not more output.

Semi-Inflation

Even before full employment, an economy might face inflationary pressure due to bottlenecks
from certain sectors of the economy.
Let us discuss these two methods indetailed below.

Through PINs:

Inflation is measured by calculating the changes occurred in PINs over a passage of time. The
rate of inflation can be calculated by taking the percentage rate of change in the price index for a
given period of time.

The formula used for calculating inflation through PINs is as follows:

Rate of Inflation = PINt-PINt-1/PINt-1 * 100

Where, PINt = Price Index Number for year t

PINt-1 = Price Index Number for the preceding year (t-1)

The most commonly used price indices for calculating inflation through PINs are as follows:

(a) Consumer Price Index (CPI):

Refers to the price index that measures the change occurred in the prices of consumer goods
and services purchased by households over a period of time. The Bureau of Labor Statistics,
U.S., has defined CPI as “a measure of the average change over time in the prices paid by urban
consumers for a market basket of consumer goods and services.”

(b) Wholesale Price Index (WPI):

Refers to the price index that is used to estimate the average change in price of goods in
wholesale market. W PI is also known as Producers Price Index (PPI). It is different from CPI as
the amount paid by consumers does not come directly to producers. This is because of the
reason that the revenue generated from the sales of goods and services is subject to price
subsidization, profits, and taxes.

(c) Let us understand the computation of inflation rate with the help of PIN. Suppose CPI of a
country in February 2007 was 202.416, while in February 2008 was 211.080.

Therefore, the rate of inflation in the country over a period of one year is as follows:

Rate of Inflation = PINt-PINt-1/PINt-1 * 100

Where, PINt = 211.080

PINt = 202.416

Rate of Inflation = 211.080- 202.416 /202.416 * 100

Rate of Inflation = 4.28%

Through GNP Deflator:

Apart from PIN, GNP deflator is also used for the measuring the rate of inflation. GNP deflator is
the measure of price levels of all the final goods and services produced in an economy in a
specific period of time.

The formula used for the calculation of GNP deflator is as follows:

GNP Deflator = (Nominal GNP ÷ Real GNP) * 100

Where Nominal GNP = GNP at current prices

Real GNP = GNP at constant prices

The percentage change in GNP deflator of two consecutive years provides the rate of inflation.

Let us calculate the rate of inflation through GNP deflator with the help of an example. Suppose
nominal GNP of a country in 2006-2007 is Rs. 1840 thousand crores and real GNP is Rs. 1236
thousand crores. In addition, in 2005-2006, the nominal GNP is Rs. 1560 thousand crores and
real GNP is Rs. 1100 thousand crores.

Now, the rate of inflation is calculated as follows:

GNP Deflator (2006-2007) = (1840/1236)* 100 = 149

Now, GNP Deflator (2005-2006) = (1560/1100) * 100 =142

Therefore, the rate of inflation in the country between 2005-2006 and 2006-2007 would be as
follows:

Rate of Inflation = [(149-142)/142] *100

= (7/142)* 100

= 4.9%