DEMAND

Chapter 2
INTRODUCTION
Have you ever wondered why inessential things
like diamonds are expensive and essentials like
water are at low cost
Why land in some parts of countries are more
expensive than the other parts?
The answer to the above que can be found from
the theory of Demand & Supply.
The theories will show how consumer
preferences determines the demand while
business costs determines the supply
DEMAND ANALYSIS
Demand means the Desire backed up by
ability pay and willingness buy.

Demand = Desire + Ability to pay +
Willingness to buy

Prices are the tools by which the market
coordinates individual desires.
INDIVIDUAL AND MARKET DEMAND
Individual Demand : Individual demand for a product is the
quantity of it a consumer would buy at a given price, during
a given period of time.
Market demand : Market demand for a product is the total
demand of all the buyers in the market taken together at a
given price during a given period of time.
Demand Schedule: A tabular statement of price quantity
(demanded) relationship at a given period of time
Individual demand schedule
Market demand schedule.


LAW OF DEMAND
Statement of Law : Other things being equal, the higher the price of a
commodity, the smaller is the quantity demanded and lower the price,
larger the quantity demanded.
There is an inverse relationship between the Price of the product and its
quantity demanded, other things being equal.
The other thing that are assumed to be constant:
Prices of related products
Income of consumers
Tastes and preferences of consumers
If these factors undergoes a change the relationship of demand-supply
may not hold good.

Demand Schedule & Demand Curve:
Market Demand Schedule and Market Demand Curve:





RATIONALE FOR LAW OF DEMAND
Substitution effect the commodity with
fallen price is preferred over the other
commodities.
Income Effect purchasing power increases,
consumer can buy the same quantity at a
lesser money or can buy more of the same
commodity with same money
Also, some consumers who could not afford
previously are being able to purchase it now
Utility Maximizing behavior

EXCEPTIONS
Conspicuous goods/ Articles of Distinction
Giffen Goods
Habits
Composite Demand Complimentary goods
Population
Conspicuous Necessity Fridge, AC, TV
Future Expectation
FACTORS BEHIND LAW OF DEMAND

Price
Income & Income Distribution
Number & Prices of Substitutes
Consumers Preferences, Tastes and Needs
Number of Consumers Population
Expectation of Consumers
Advertisement
Other Facilities After Sales Services,
Warranty


INCREASE AND DECREASE IN DEMAND
What happens if there is a change in,
consumers tastes & preferences, income &
price of related goods.
Two demand schedules for commodity X
Rightward Shift In Demand Curve:
When more is demanded at each price
Leftward Shift In Demand Curve:
When less is demanded at each price

GENERAL DEMAND FUNCTION
Six variables that influence Q
d

Price of good or service (P)
Incomes of consumers (M)
Prices of related goods & services (P
R
)

2-11
Expected future price of product (P
e
)
Number of consumers in market (N)

General demand function

( ) Taste patterns of consumers

( ) Taste patterns of consumers

( , , , , , )
d R e
Q f P M P P N

( , , , , , )
d R e
Q f P M P P N
GENERAL DEMAND FUNCTION
Inverse for complements
2-12
Variable Relation to Q
d
Sign of Slope Parameter
P
P
e
N
M
P
R
Inverse
Direct
Direct
Direct
Direct for normal goods
Inverse for inferior goods
Direct for substitutes
b = Q
d
/P is negative
c = Q
d
/M is positive
c = Q
d
/M is negative
d = Q
d
/P
R
is
positive
d = Q
d
/P
R
is
negative
f = Q
d
/P
e
is positive
g = Q
d
/N is positive
e = Q
d
/ is positive

ELASTICITY OF DEMAND
Consider the following situation
1) Price of Radio falls from 500 to 400, Quantity
demanded Increases from 100 to 150
2) Price of wheat falls from 10/kg to 9/kg, Quantity
demanded Increases from 500 kgs to 520 kgs
3) Price of Salt falls from 3 to 2.5, Quantity demanded
Increases from 1000 kgs to 1005 kgs
We notice that as a result of fall in the price of all
three, the respective demand increases.
Then what is the differences?
The difference lies in degree of response of demand
which can be found out by comparing the percentages
changes in prices & quantities demanded.
Here lies the concept of Elasticity



ELASTICITY OF DEMAND
Elasticity of demand is the degree of responsiveness of
demand to the changes in its determinants.

(A) PRICE ELASTICITY O DEMAND
The extent of response of demand for a
commodity to the changes in its price, other
determinants of demand remaining constant
is called price elasticity of demand.
Except for few cases the price elasticity is
negative. But for sake of convenience, we
ignore the negative sign
E.g. if 1% change in price leads to 2% change in
quantity of A & 4% change in Quantity of B.
TYPES OF PRICE ELASTICITY OF DEMAND
1. Perfectly elastic demand refers to the situation where a
slightest rise in price causes an infinite increase in Qd.
Demand is Hypersensitive and elasticity is Infinity
2. Perfectly inelastic demand refers to the situation where
the demand is unaffected even after substantial change in
price. Qd remains unchanged and elasticity of demand is
zero
3. Relatively/Highly elastic demand when a small
percentage change in price is accompanied by a large
percentage change in its Qd.
4. Relatively inelastic demand when a large percentage
change in price is followed by a small percentage change in
its Qd.
5. Unitary elastic demand when percentage change in price
is accompanied by an equal percentage change in Qd.


METHODS OF MEASURING PRICE ELASTICITY
Point method Dr. Marshall
Measure elasticity at a given point on a demand
curve
Makes use of derivative
Arc method
Takes an arc of the demand curve rather than
point
Total Revenue or total Expenditure Method
If a slight fall in the price leads to sizeable
increase in demand, it will cause in increase in
total revenue


PRACTICAL APPLICATION

- Pricing decisions - Policy Formulation by Govt.
- Terms of trade - Foreign exchange rates
- Resource Prices - Public utilities




(B) INCOME ELASTICITY OF DEMAND

The degree of responsiveness of demand for a
commodity to the changes in the consumers
income is known as income elasticity of
demand
Types of income elasticity
1. Unitary income elasticity
2. Income elasticity grater than one
3. Income elasticity less than one
4. Zero income elasticity
5. Negative income elasticity

PRACTICAL APPLICATION


- Economic Development
- Growth rate of firm
- Demand forecasting
- Economic/Production planning
- Foreign Trade

(C) CROSS ELASTICITY OF DEMAND

The degree of responsiveness of demand
for a commodity to a given change in the
price of some other related commodity is
known as cross elasticity of demand.
The relation of complementary and
substitute product



DEMAND FORECASTING
Demand forecasting is predicting or anticipating the
future demand for a product.
Micro level Industry level Macro level
USES OF DEMAND FORECASTING DATA
Short term demand forecasting
1) Evolving production policy
2) Determining price policy
3) Evolving purchase policy
4) Fixation of sales targets
5) Short term financial policy
Long term demand forecasting
1) Business planning
2) Man power planning
3) Long term financial planning
METHODS OF DEMAND ESTIMATION
Consumers Interview
Market Experiment Method
Regression Method
NECESSITY OF FORECASTING DEMAND
Achievement of planned objectives
Preparing a Budget
Stabilization of Production and Employment
Future Expansion
Long-term Investment Programs.
Sales Budgeting
Control of Inventories
NATURE AND SCOPE OF DEMAND FORECASTING
Time frame
Short-term Forecast
Long-term Forecast
Secular Forecast
Level of forecast
Level of the Economy
Level of the Industries
Level of a Firm
General & Specific Forecast
Established & New Products
Classification of Products
Special factors uncertainties, Fashion change
CRITERIA FOR A GOOD METHOD OF DF
Plausibility
Simplicity
Economy
Accuracy
Availability
Durability
Flexibility
Consistency

METHODS OF DF OF AN ESTABLISHED PRODUCT
Interview and survey approach
Buyers Interview
Sales force polling
Consumer field survey
Panel or Experts
Delphi Method
Forecast based on composite management opinion
Projecting Past Experience
Correlation Analysis
Regression Analysis
Projection of Trends into Future
Some other methods
Barometric Techniques
Controlled Experiments



DF FOR NEW PRODUCT
Evolutionary Approach
Substitute Approach
Growth curve Approach
Opinion-Polling Approach
Sales Experience Approach
Vicarious Approach