DEMAND ANALYSIS

MEANING OF DEMAND
• Demand for a commodity refers to the
quantity of the commodity which an
individual consumer household is willing to
purchase per unit of time at a particular price.
– Individual Demand
– Market Demand
 MEANING OF DEMAND
Demand for a commodity implies
Desire of the consumer to buy the product
His willingness to buy the product
Sufficient purchasing power in his possession
to buy the product.
 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.
INDIVIDUAL AND MARKET DEMAND
SCHEDULES
A demand schedule at any particular time refers to
the series of quantities the consumer is prepared to
buy at its different prices.
The demand schedule for an individual consumer is
called an individual demand schedule. Likewise, if we
have similar demand schedules for all consumers in
the market, we can add up the quantities demanded
of the commodity by these consumers at each price
and get a summed-up schedule called the market
demand schedule.
 INDIVIDUAL DEMAND
SCHEDULE FOR ORANGES

Price of oranges Quantity demanded

(Rs. Per dozen) of oranges (dozens)
5 1
4 2
3 3
2 4
1 5
 MARKET DEMAND SCHEDULE FOR
ORANGES
Price of Quantity demanded of Market
oranges oranges by consumers demand of
(dozens) oranges
(dozens)
A B C D
10 1 0 3 0 4

9 3 1 6 4 14

8 7 2 9 7 25

7 11 4 12 10 37

6 13 6 14 12 45
INDIVIDUAL DEMAND CURVE

The demand schedule when

D represented diagrammatically
Individual is known as the demand curve.
Demand When this diagram is based on
Curve an individual demand schedule,
we get an individual demand curve.
D

O
Units of good X
 MARKET DEMAND CURVE
Y

10 D
9
8
DC
7
6 DA
DD
DB

O X
4
UNITS OF GOOD X
 Types of demand
Individual demand & Market demand
Demand for capital good (producers’ goods) and
demand for consumer goods
Autonomous demand & Derived demand
- Direct & indirect demand
Demand for durable & non-durable goods
- Replacement demand in case of durable goods
Short term demand & Long term demand
 TYPES OF DEMAND
• Industry demand and firm demand
• Total demand and market segment demand
 Types of Demand
• Capital goods – one of the triads in productive
inputs (land, labor, capital); consists of durable
produced goods that are in turn used in
production
• Derived demand – demand for factor of
production that results from demand of final
good to which it contributes (tires for car)
Derived and Autonomous Demand
• Those inputs or commodities which are demanded to
help in further production of commodities are said to
have Derived demand. Ex raw materials, machines
• Autonomous demand, is the one where a commodity
is demanded because it is needed for direct
consumption. Ex pieces of furniture at household
 Demand for producers’ goods and
consumers’ goods
• The difference in these two types of demand
are that consumers’ goods (soft drinks, milk,
bread) are needed for direct consumption,
while the producers’ goods (Various types of
machines, steel, tools) are needed for
producing other goods.
 Demand for durable and non-durable
goods
• Non-durable goods are the ones which cannot be
used more than once. Eatables, photographic film,
soaps. These meet the current need. (Perishable and
non-perishable)
• Durable goods, on the other hand, are the ones
which have repeated uses. Shoes, readymade
garments, residential house, electronic domestic
appliances. These are the ones which can be stored
and whose replacement can be postponed. These
meet both the current as well as future need.
 Types of Demand
• Durable goods- products that have expected
lives of 3 years or more
– Non durable goods – food, clothing & gasoline
 Why do Demand Curves Slope
Downwards?
• Reasons
– More uses when the price falls
– Raise in real income of consumer
– Substitution effect
 Determinants of Demand
 Price of the product
 Price of the related goods
 Consumer’s income level
 Distribution pattern of national income
 Consumer’s taste and preferences
 Advertisement of the product
 Consumer’s expectation about future price and supply position
 Demonstration effect and Band-Wagon effect
 Consumer credit facility
 Demography and growth rate of population
 General std. of living and spending habits
 Climatic and weather conditions
 Customs

 Demand Function: It states the (functional/mathematical)

relationship between the demand for the product ( dependent
variable) and its determinants ( independent variables).
 Law of Demand
• A decrease in the price of a good, all other things
held constant, will cause an increase in the quantity
demanded of the good.
• An increase in the price of a good, all other things
held constant, will cause a decrease in the quantity
demanded of the good.
– Other things equal assumption (ceteris paribus): factors
other than those considered do not change, example price
only changes and other variables remain constant
• QDx = f(Px)
• This the mathematical relationship between
the quantity demanded and the price of the
product X.
• There is a inverse relationship between the
quantity demanded and the price of the
product.
 DEMAND FUNCTION
The demand function can be written in a
simple mathematical language as:
Q = f(Px, Py , Pz ,…..Pn ; I; T; A)
 DEMAND FUNCTION
The amount demanded (per unit of time) of a
commodity X by a consumer (denoted by Qx ) depends
upon:
• Price of the commodity (Px)
• Price of substitutes (Ps) and complements (Pc)
• Income of the household (I)
• Effects of distribution of income
• Tastes and preferences of the household (T) and,
• The amount annually spent on advertisement of the
product (A)
 DEMAND FUNCTION
In case we are analyzing the demand for
goods which are durable, storable and are
expensive, we have to add these variables
also:
• Consumers’ expectations of future prices (Ep)
and,
• Consumers’ expectations future income (Ey)
 Prices of related commodities
• The demand for a commodity depends also on
the prices of its substitutes and
complementary goods.
Tea and coffee, pizza and burger, these are the
substitutes for which the change in the price
will affect the demand of the other in the
same direction.
• A Commodity is deemed to be a complement of
another when it complements the use of the other.
• When the use of any two goods goes together so
that their demand changes (increases or decreases)
simultaneously, they are treated s complements.
– Example: Milk and sugar, Petron and car, razor and blade
printer and cartridge, Camera and film
• When two products are substitutes, an
increase in the price of one will increase the
demand for the other
• Because complements are used together, they
are typically demanded jointly
– If price of complement (lettuce) goes up, demand
for related good (salad dressing) will decline
• Goods that are not related to one another are
independent goods (butter and golf balls)
• Change in price of one has little or no effect
on the demand of the other
 Income of the household
• Income is the basic determinant of the
quantity demanded of a product as it
determines the purchasing power of the
consumer. That is why the people with higher
current disposable income spend a larger
amount on normal goods and services than
those with lower incomes.
 Income of the household
• For the purpose of income-demand analysis,
goods and services may be grouped under
four broad categories, viz., (a) essential
consumer goods; (b) inferior goods; (c) normal
goods (superior goods) and (d) prestige or
luxury goods
 Income of the household
• Essential consumer goods (ECG) Example: food
grains, salt, vegetables oils, matches, cooking fuel, a
minimum clothing and housing, etc.
• Quantity demanded of such goods increases with
increase in consumer’s income only up to a certain
limit, other factors remaining the same.
• Inferior Goods: corn is inferior to wheat and
rice, kerosene stove is inferior to gas-stove,
traveling by bus is inferior to traveling by taxi.
• The demand for inferior goods increases up to
a certain level with the increase in the income
and then starts decreasing with further
increase in the income beyond a point of
income.
• Normal Goods: Technically, normal goods are
those which are demanded in increasing
quantities as consumers’ income rises.
Clothing is the most important example of
this.
• Demand for such goods increases with the
increase in income of the consumer, but at
different rates at different levels of income.
• Demand for normal goods initially increases
rapidly, and later, at a lower rate.
• Prestige or Luxury Goods: These are
consumed mostly by the rich section of the
society, e.g., luxury cars, stone studded
jewellery, costly cosmetics, antiques.
• Demand for such goods arises only beyond a
certain level of consumer’s income.
 Tastes and preferences
• These depend on the social customs, religious
values attached to a commodity, habits of the
people, the general life-style of the society.
Industry demand and firm demand
• Firm demand denotes demand for a particular
product of a particular firm subject to competition
and economic condition
• Industry demand refers to the total demand for the
product of a particular industry – subject to
economic condition
 Total demand and market segment
demand
• Demand for market segments is to be studied by
breaking the total demand into different segments
like geographical areas, sub-products, product use,
distribution channels, size of customer group etc.
Demand for T-Shirts is market demand, which can be
based on the segment market like, for kids, youth
and old people.
• In some industries, there are no
substitutes and there is no
competition.
• In a market that has only one or few
suppliers of a good or service, the
producer(s) can control price, meaning
that a consumer does not have choice,
cannot maximize his or her total utility
and has very little influence over the
price of goods.
Change in Quantity Demanded

Price
An increase in price
causes a decrease in
quantity demanded.
P1

P0

Quantity
Q1 Q0
Change in Quantity Demanded

Price
A decrease in price
causes an increase in
quantity demanded.

P0

P1

Quantity
Q0 Q1
Sample data by Villegas to show the shift of curves
 THE LAW OF DEMAND
The law of demand states that the amount
demanded of a commodity and its price are
inversely related, other things remaining constant.
Exceptions to the Law of Demand:
(i) Giffen goods – staple food
(ii) Veblen goods which are used as status
symbols (snob effect)
(iii) Expectations of change in the price of the
commodity – stocks, oil, gold, etc.
The relationship between demand and supply
underlie the forces behind the allocation of
resources. In market economy theories, demand
and supply theory will allocate resources in the
most efficient way possible.
 Law of Supply
• A decrease in the price of a good, all other
things held constant, will cause a decrease in
the quantity supplied of the good.
• An increase in the price of a good, all other
things held constant, will cause an increase in
the quantity supplied of the good.
Change in Quantity Supplied

A decrease in price
Price causes a decrease in
quantity supplied.

P0

P1

Quantity
Q1 Q0
Change in Quantity Supplied

An increase in price
Price causes an increase in
quantity supplied.

P1

P0

Quantity
Q0 Q1
 Law of Supply
• Example: as corn prices increases, farmer finds it
profitable to plant more corn and enable to cover
increased costs due to more intensive cultivation,
more seed, fertilizer and pesticide
• Beyond some quantity of production, manufacturers
encounter increases in marginal cost – added cost of
producing one more unit of output (additional
workers to wait to access machines)
 Shifts in Supply
• Factors of production
– Reduction in wages paid lowers labor cost and
increases supply
• Technological change
– Computerization lowers production costs &
increases supply
• Taxes and subsidies
 Shifts in Supply
• Prices of other goods
– Prices of related goods- if truck prices fall, supply of
cars rises
• Number of sellers
– The larger the number of seller, the greater the
market supply (supply curve shifts to the right)
• Producer expectations
– Substitution in production due to higher cost of
producing the other goods
 Shifts in Supply
• Importation
– Government policy – removing quotas & tariffs on
imported automobiles increases automobile
supply
• Interaction of shifts in supply and demand
• Shape of supply and demand curves
(elasticity)
Equilibrium of Supply and Demand
• Market equilibrium – comes at price and
quantity where forces of supply and demand
are in balance; no reason for price to rise or
fall
• Equilibrium price – market-clearing price; all
supply & demand orders are filled, books are
cleared of orders & demanders & suppliers are
satisfied
 Demand & Supply for Cornflakes
Possible Qty Qty supplied State of Pressure on
price/ box demanded (M of boxes/ Market Price
(M of yr)
boxes/yr)

A 5 9 18 Surplus downward

B 4 10 16 Surplus downward

C 3 12 12 Equilibrium Neutral

D 2 15 7 Shortage Upward

E 1 20 0 Shortage Upwad
 Market Equilibrium

Price

D0 D1 S0
An increase in demand
will cause the market
P1
equilibrium price and
P0 quantity to increase.

Quantity
Q0 Q1
 Market Equilibrium

Price

D1 D0 S0
A decrease in demand
will cause the market
P0
equilibrium price and
P1 quantity to decrease.

Quantity
Q1 Q0
 Market Equilibrium

Price An increase
in supply
D0 S0 S1 will cause
the market
equilibrium
price to
P0 decrease and
P1 quantity to
increase.

Quantity
Q0 Q1
 Market Equilibrium

Price A decrease in
supply will
D0 S1 S0 cause the
market
equilibrium
price to
P1 increase and
P0 quantity to
decrease.

Quantity
Q1 Q0
Equilibrium

• Law of supply and demand

– The claim that the price of any good adjusts to
bring the quantity supplied and the quantity
demanded for that good into balance.
• Equilibrium
When supply and demand are equal (i.e. when the
supply function and demand function intersect) the
economy is said to be at equilibrium. At this point, the
allocation of goods is at its most efficient because the
amount of goods being supplied is exactly the same as
the amount of goods being demanded. Thus,
everyone (individuals, firms, or countries) is satisfied
with the current economic condition. At the given
price, suppliers are selling all the goods that they have
produced and consumers are getting all the goods
that they are demanding.
• Equilibrium occurs at the
intersection of the demand and
supply curve, which indicates no
allocative inefficiency.
• In the real market place
equilibrium can only ever be
reached in theory, so the prices
of goods and services are
constantly changing in relation
to fluctuations in demand and
supply.
SUPPLY AND DEMAND TOGETHER
Demand Schedule Supply Schedule

At $2.00, the quantity demanded

is equal to the quantity supplied!
Three Steps to Analyzing Changes in Equilibrium

• Decide whether the event shifts the supply or

demand curve (or both).
• Decide whether the curve(s) shift(s) to the left
or to the right.
• Use the supply-and-demand diagram to see
how the shift affects equilibrium price and
quantity.
 How an Increase in Demand Affects the Equilibrium

Price of
Ice-Cream 1. Hot weather increases
Cone the demand for ice cream . . .

Supply

$2.50 New equilibrium

2.00
2. . . . resulting Initial
in a higher
equilibrium
price . . .
D

0 7 10 Quantity of
3. . . .and a higher Ice-Cream Cones
quantity sold.
Copyright©2003 Southwestern/Thomson Learning
Three Steps to Analyzing Changes in Equilibrium

• Shifts in Curves versus Movements along Curves

– A shift in the supply curve is called a change in
supply.
– A movement along a fixed supply curve is called a
change in quantity supplied.
– A shift in the demand curve is called a change in
demand.
– A movement along a fixed demand curve is called a
change in quantity demanded.
 How a Decrease in Supply Affects the Equilibrium

Price of
Ice-Cream 1. An increase in the
Cone price of sugar reduces
the supply of ice cream. . .
S2
S1

New
$2.50 equilibrium

2.00 Initial equilibrium

2. . . . resulting
in a higher
price of ice
cream . . . Demand

0 4 7 Quantity of
3. . . .and a lower Ice-Cream Cones
quantity sold.
Copyright©2003 Southwestern/Thomson Learning
• Disequilibrium
• Excess Supply
If the price is set
too high, excess
supply will be
created within the
economy and there
will be allocative
inefficiency.
• Disequilibrium
• Excess Demand
Excess demand is
created when price is
set below the
equilibrium price.
Because the price is so
low, too many
consumers want the
good while producers
are not making enough
of it.
Markets Not in Equilibrium

(b) Excess Demand

Price of
Ice-Cream Supply
Cone

$2.00

1.50
Shortage

Demand

0 4 7 10 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones

Copyright©2003 Southwestern/Thomson Learning

• Shortage
– When price < equilibrium price, then quantity
demanded > the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many buyers
chasing too few goods, thereby moving toward
equilibrium.
Effect on Price & Quantity of Different
Demand & Supply Shifts
Demand & supply shifts Effect on price &
quantity
If demand rises Demand curve shifts to P & Q increase
right

If demand falls Demand curve shifts to P & Q decrease

the left
If supply rises Supply curve shifts to P decrease; Q increases
right
If supply falls Supply curve shifts to the Price increases; Quantity
left decreases
Table 4 What Happens to Price and Quantity When Supply or
Demand Shifts?

Copyright©2004 South-Western
 Elasticity of Demand

• Measure the response of quantity demanded

when price changes
• Elasticity=% change in qty demand
% change in price
• Arc Elasticity = Δquantity/(Q1 + Q2)/2÷ Δ
price/ (P1 + P2)/2
Elasticity of Demand- Sample Problem
• Price(OLD)=9
Price(NEW)=10
QDemand(OLD)=150
QDemand(NEW)=110
• Arc elasticity:
• [[QDemand(NEW) - QDemand(OLD)] / [QDemand(OLD) +
QDemand(NEW)]]*2
• ([110 - 150] / [150 + 110]/2)/([10-9]/[10+9]/2)= [[-40]/[260]/2]/(1/9.5)
=0.3077/0.1053
• =2.92
 Elasticity of Demand
• Interpretations
– Less than 1 = inelastic; a reduction in price does
not increase quantity sold; raise in price leads to
less than proportionate reduction in quantity sold;
necessities, i.e., food, fuel, prescription drugs,
shoes
 Elasticity of Demand
• Interpretations
– Exceeds 1= elastic; a change in price can affect
quantity of sales significantly; it pays to reduce a
price but not raise it; goods with substitutes
– Equal 1 = unitary; proportionate gains (or losses)
in quantity sold is same as decrease (or increase)
in price; if demand is the only factor, the seller
would not benefit by raising or reducing the price
 Extreme Cases
• Perfectly inelastic – price change results in no
change in quantity demanded; price elasticity
coefficient is zero because there is no
response to change in price (acute diabetic’s
demand for insulin); line parallel to vertical
axis
 Extreme Cases
• Perfectly elastic – small price reduction causes
buyers to increase purchases from zero to all
they can obtain; elasticity coefficient is
infinite; line parallel to horizontal axis (mining
firm selling output in purely competitive
market)
 Elasticity and Revenue
• Revenue = P x Q
• When demand is price-inelastic, a price
decrease reduces total revenue
• When demand is price-elastic, a price
decrease increases total revenue
• In the borderline case of unit-elastic demand,
a price decrease leads to no change in total
revenue
 Determinants of Price Elasticity
• Substantiality – the larger the number of
substitute goods that are available, the
greater the price elasticity
• Proportion of income- other things equal, the
higher the price of good relative to
consumers’ incomes, the greater the price
elasticity (increase in high priced cars or
housing)
 Determinants of Price Elasticity
• Luxuries vs. Necessities – the more the good is
considered to be luxury rather than necessity,
the greater the price elasticity of demand’
price increase will not significantly reduce
amount of lighting and power used ina
household
 Determinants of Price Elasticity
• Time – product demand is more elastic the
longer the period under consideration (when
price of beef increases, consumers do not
reduce purchases but in time may shift to
chicken, pork or fish
 Elasticity of Supply
• = % change in Quantity Supplied/ % change in
Price
• Factors that determine elasticity
– Ease with which production in the industry can be
increased; elasticity is relatively large
– Production capacity is severely limited; inelastic
supply
– Time period; very brief periods after price
increases, firms maybe unable to increase price –
price inelastic
 Elasticity of Supply
• Fixed supply
– No increase in price can change supply
• Inelastic supply
– Rise in price leads to a smaller increase in quantity
• Elastic supply
– High response of quantity to price change
• Infinitely elastic supply
– Seller offers for sale any amount available at the
same price