UNIT 2

ECONOMICS
MEANING OF DEMAND
  In economics science, the term "demand" refers to the desire,
backed by the necessary ability to pay. There are three
important things about the effective demand:
 1. Desire to buy.

 2. Ability to pay.

 3. Willingness to pay

 Demand in economics means a desire to possess a good

supported by willingness and ability to pay for it
 "Demand means the various quantities of goods that
would be purchased per time period at different prices in
a given market".

 Quantity demanded refers to a specific quantity to be

purchased against specific price of a commodity.
DETERMINANTS OF DEMAND
 1. Price of the goods: The first and foremost determinant of the
demand for good is price. Usually, higher the price of goods,
lesser will be the quantity demanded of them.

 2. Income of the buyer: The size of income of the buyers also

influences the demand for a commodity. Mostly it is true that
"larger the income, more will be the quantity demanded".

 3. Prices of Related Goods: The prices of related goods also

affect the demand for a good. In some cases, the demand for a
good will go up as the price of related good rises. The goods so
inter-related arc known as substitutes, e.g. radio and gramophone.
In some other cases, demand for a good will comes down as the
price of related good rises. The goods so inter-related are
complements, e.g. car and petrol, pen and ink, cart and horse, etc.
 . Tastes of the buyer: This is a subjective factor. A commodity may not be
purchased by the consumer even though it is very cheap and useful, if the
commodity is not up to his taste or liking. Contrarily, a good may be purchased
by the buyer, even though it is very costly, if it is very much liked by him.

 5. Seasons prevailing at the time of purchase; In winter, the demand for

woolen clothes will rise; in summer, the demand for cool drinks rises
substantially; in the rainy season, the demand for umbrellas goes up.

 6. Fashion: When a new film becomes a success, the type of garments worn
by the hero or the heroine or both becomes an article of fashion and the
demand goes up for such garments.

 7. Advertisement and Sales promotion: Advertisement in newspapers and

magazines, on outdoor hoardings on buses and trains and in radio and
television broadcasts, etc. have a substantial effect on the demand for the good
and thereby improves sales
 Demand Function
 
 Demand function shows the functional relationship
between quantity demanded and determinants of
demand.
 Qd = f (determinants of demand)
 Demand Schedule
 It refers to the series of quantities an individual is ready
to buy at different prices.
 (Tabular representation of price and quantity demanded).
DEMAND CURVE
 Individual's Demand Curve

 The curve, which shows the relation between the price of

a commodity and the amount of that commodity the
individual consumer wishes to purchase is called
individual demand curve". It is a graphical
representation of the demand schedule.
 Market Demand Curve
 Market demand curve for a Commodity is the horizontal
sum of individual demand curves of all the buyers in a
market. This is illustrated with the help of the market
demand schedule.
 Other Types of Demand

 Joint demand: When several commodities are

demanded for a joint purpose or to satisfy a particular
want. It is a case of a joint demand. Milk , sugar and tea
dust are jointly demanded to make tea. Similarly, we
may demand paper, pen and ink for writing. Demand for
such commodities in bunch is known as joint demand.
Demand for land, labour, capital and organisation for
producing commodity is also a case of joint demand.
 Composite demand: The demand for a commodity
which can be put to several uses is a composite demand.
In this case a single product is wanted for a number of
uses. For example, electricity is used for lighting,
heating, for running the engine, for the fans etc.
Similarly coal is used in industries, for cooking etc.
 Direct and Derived demand: The demand for a commodity
which is for direct consumption, i.e.. Demand for ultimate
object, is called direct demand, e.g food, cloth, etc. Direct
demand is called autonomous demand. Here the demand is not
linked with the purchase of some main products.

 When the commodity is demanded as a result of the demand

for another commodity or service, it is known as the derived
demand or induced demand. For example, demand for cement
is derived from the demand for building construction; demand
for tires is derived from the demand for cars or scooters, etc.
LAW OF DEMAND

According to Prof. Samuelson:

 "The law of demand states that people will buy more

at lower prices and buy less at higher prices, other
things remaining the same".
 E. Miller writes:

"Other things remaining the same, the quantity

demanded of a commodity will be smaller at higher
market prices and larger at lower market prices".
 
 In simple we can say that when the price of a commodity
rises, people buy less of that commodity and when the
price falls, people buy more of it ceteris paribus* (other
things remaining the same).

 *Ceteris Paribus. In economics, the term is used as

shorthand for indicating the effect of one economic
variable on another, holding constant all other variables
that may affect the second variable.
 Assumptions of Law of Demand:
 According to Prof. Stigler and Boulding: There are three main
assumptions of the Law:

(i) There should not be any change in the tastes of the

consumers for goods

(ii) The purchasing power of the typical consumer must remain

constant

(iii) The price of all other commodities should not vary.

 
 In short, determinants of demand should not change except
price of the product.
Limitations/Exceptions of Law of Demand:
(i) Prestige goods:

(ii) Price expectations:

(iii) Ignorance of the consumer:

(iv) Giffen goods: If the prices of basic goods, (potatoes, sugar, etc) on which the poor

spend a large part of their incomes declines, the poor increase the demand for superior

goods, hence when the price of Giffen good falls, its demand also falls. There is a positive

price effect in case of Giffen goods.

(v) In case of emergency and necessity goods:

(vi) The law has been derived assuming consumers to be rational and knowledgeable

about market conditions. However, at times consumers tend to be irrational and make

impulsive purchases without any cool calculations about price and usefulness of the

product and in such contexts the law of demand fails.

 
WHY THE DEMAND CURVE SLOPES DOWNWARD TO THE
RIGHT SIDE OR REASONS FOR THE LAW OF DEMAND

 Income Effect
 Law of diminishing marginal utility

 Substitution Effect

 New Consumers

 Several Uses

 Psychological Effects. When the price of a commodity falls,

people favour to buy more which is natural and psychological.
Therefore, the demand increases with the fall in prices. For
example, when the price of silk falls, it is purchased for all the
members of the family.
 
 IMPORTANCE OF THE LAW OF DEMAND

 1. Price determination: With the help of law of demand a

monopolist fixes the price of his product. He is able to decide the
most profitable quantity of output for him.

 2. Useful to government: The finance minister takes the help of this

law to know the effects of his tax reforms and policies. Only those
commodities which have relatively inelastic demand should be taxed.
 3. Useful to farmers: From the law of demand, the farmer knows
how far a good or bad crop will affect the economic condition of the
fanner. If there is a good crop and demand for it remains the same,
price will definitely go down. The farmer will not have much benefit
from a good crop, but the rest of the society will be benefited.

 4. In the field of planning: The demand schedule has great

importance in planning for individual commodities and industries. In
such cases it is necessary to know whether a given change in the
price of the commodity will have the desired effect on the demand
for commodity within the country or abroad. This is known from a
study of the nature of demand schedule for the commodity.
EXTENSION AND CONTRACTION OF DEMAND
(MOVEMENT ALONG WITH THE DEMAND CURVE)
SHIFTS IN DEMAND CURVE
(INCREASE AND DECREASE IN DEMAND)
ELASTICITY OF DEMAND MEANING,
TYPES
 “Elasticity of demand is the responsiveness of the
quantity demanded of a commodity to changes
in one of the variables on which demand
depends. In other words, it is the percentage
change in quantity demanded divided by the
percentage in one of the variables on which
demand depends.”
ELASTICITY OF DEMAND
 According to Alfred Marshall: "Elasticity of demand” may be
defined as the percentage change in quantity demanded to the
percentage change in price."
 According to A.K. Cairncross : "The elasticity of demand for a
commodity is the rate at which quantity bought changes as the
price changes."
 According to J.M. Keynes : "The elasticity of demand is a
measure of the relative change in quantity to a relative change in
price."
 According to Kenneth Boulding : "Elasticity of demand
measures the responsiveness of demand to changes in price."
PRICE ELASTICITY OF DEMAND
 Price elasticity of demand is the ratio of percentage change in
quantity demanded to the percentage change in price. In other
words, price elasticity of demand is a measure of the relative
change in quantity purchased of a good in response to a
relative change in its price.
INCOME ELASTICITY OF DEMAND
According to Stonier and Hague: "Income elasticity of demand
shows the way in which a consumer's purchase of any good
changes as a result of change in his income.“
 It shows the responsiveness of a consumer's purchase of a
particular commodity to a change in his income. Income
elasticity of demand means the ratio of percentage change in the
quantity demanded to the percentage change in income. In brief
income elasticity
CROSS ELASTICITY OF DEMAND

 It is the ratio of proportionate change in the quantity

demanded of Y to a given proportionate change in the
price of the related commodity X. It is a measure of
relative change in the quantity demanded of a
commodity due to a change in the price of its substitute
complement.
INCOME ELASTICITY OF DEMAND
FACTORS DETERMINING PRICE ELASTICITY OF DEMAND

 Necessaries of Life. For necessaries of life the demand

is inelastic because people buy the required amount of
goods whatever their price. For example, necessaries
such as rice, salt, cloth are purchased whether they are
dear or cheap.
 Conventional Necessaries. The demand for
conventional necessaries is less elastic or inelastic.
People are accustomed to the use of goods like
intoxicants which they purchase at any price. For
example, drunkards consider opium and wine almost as a
necessity as food and water. Therefore, they buy the
same amount even when their prices are higher and
highest.
 Luxury Commodities. The demand for luxury is usually
elastic as people buy more of them at a lower price and less at
a higher price.

 For example, the demand of luxuries like silk, perfumes and

ornaments increases at a lower price and diminishes at a higher
price. Here, we must keep in mind that luxury is a relative
term, which varies from person to person, place to place and
from time to time. For example, what is a luxury to a poor man
is a necessity to the rich. The luxury of the past may become a
necessity of today. Similarly a commodity which is a necessity
to one class may be a luxury to another. Hence, the elasticity of
demand in such cases should have to be carefully expressed.
 Substitutes. Demand is elastic for those goods which
have substitutes and inelastic for those goods which have
no substitutes. The availability of substitutes, thus,
determines the elasticity of demand. For instance, tea
and coffee are substitutes. The change in the price of tea
affects the demand for coffee. Hence, the demand for
coffee and tea is elastic.
 Number of Uses. Elasticity of demand for any
commodity depends on its number of uses. Demand is
elastic; if a commodity has more uses and inelastic if it
has only one use. As coal has multiple uses, if its price
falls it will be demanded more for cooking, heating,
industrial purposes etc. But if its price rises, minimum
will be demanded for every purpose
 Postponement. Demand is more elastic for goods the
use of which can be postponed. For example, if the price
of silk rises, its consumption can be postponed. The
demand for silk is, therefore, elastic. Demand is inelastic
for those goods the use of which is urgent and, therefore,
cannot be postponed. The use of medicines cannot be put
off. Hence, the demand for medicines is inelastic.
 Income Level. The demand is inelastic for higher and
lower income groups and elastic for middle income
groups.
 The rich people with their higher income do not bother
about the price. They may continue to buy the same
amount whatever the price. The poor people with lower
incomes buy always only the minimum requirements
and, therefore, they are induced neither to buy more at a
lower price nor less at a higher price. The middle income
group is sensitive to the change in price. Thus, they buy
more at a lower price and less at higher price.
 IMPORTANCE OF ELASTICITY OF DEMAND

 1. Useful for Business: It enables the business in general and the

monopolists in particular to fix the price. Studying the nature of
demand the monopolist fixes higher prices for those goods which
have inelastic demand and lower prices for goods which have
elastic demand. In this way, this helps him to maximise his
profit.

 2. Fixation of Prices: It is very useful to fix the price of jointly

supplied goods. In the case of joint products like paddy and
straw, the cost of production of each is not known. The price of
each is then fixed by its elastic and inelastic demand.
 3. Helpful to Finance Minister: It helps the Finance Minister to levy
tax on goods. After levying taxes more and more on goods which
have inelastic demand, the Government collects more revenue from
the people without causing them inconvenience. Moreover, it is also
useful for the planning.

 4. Fixation of Wages: It guides the producers to fix wages for

labourers. They fix high or low wages according to the elastic or
inelastic demand for the labour.

 5. In the Sphere of International Trade: It is of greater significance

in the sphere of international trade. It helps to calculate the terms of
trade and the consequent gain from foreign trade. If the demand for
home product is inelastic, the terms of trade will be profitable to the
home country.
DEGREES OF PRICE ELASTICITY
 Perfectly Elastic Demand
 Perfectly elastic demand is said to be happen when a
little change or no change in price leads to an infinite
change in quantity demanded
 Perfectly inelastic Demand
 Perfectly inelastic demand is opposite to perfectly elastic
demand. Under the perfectly inelastic demand, irrespective of
any rise or fall in price of a commodity, the quantity demanded
remains the same. The elasticity of demand in this case will be
equal to zero.
 Unitary Elastic Demand.
 The demand is said to be unitary elastic when a given
proportionate change in the price level brings about an equal
proportionate change in quantity demanded, The numerical
value of unitary elastic demand is exactly one i.e., ed = 1.
 Relatively Elastic Demand

 Relatively elastic demand refers to a situation in which a small

change in price leads to a big change in quantity demanded. In
such a case elasticity of demand is said to be more than one.
 Relatively Inelastic Demand (Less than one)
 Under the relatively inelastic demand a given percentage
change in price produces a relatively less percentage change in
quantity demanded. In such a case elasticity of demand is said
to be less than one as shown in figure
TYPES OF ELASTICITY OF DEMAND
 Price Elasticity
 The price elasticity of demand is the response of the
quantity demanded to change in the price of a
commodity. It is assumed that the consumer’s income,
tastes, and prices of all other goods are steady. It is
measured as a percentage change in the quantity
demanded divided by the percentage change in price.
Therefore,
METHODS USED FOR MEASURING
ELASTICITY OF DEMAND
 Four methods used for measuring elasticity of
demand. The methods are:-

 1. The Percentage Method

  2. The Point Method 

 3. Total Outlay Method.

THE PERCENTAGE METHOD:

Where q refers to quantity demanded, p to price

and Δ to change.

If EP>1, demand is elastic.

If EP< 1, demand is inelastic,
and Ep= 1, demand is unitary elastic.
THE POINT METHOD:
 Prof. Marshall devised a geometrical method for measuring
elasticity at a point on the demand curve.
 With the help of the point method, it is easy to point out
elasticity at any point along a demand curve.
 Suppose that the straight line demand curve DC in Figure is 6
centimeters. Five points L, M, N, P and Q are taken on this
demand curve. The elasticity of demand at each point can be
known with the help of the above method. Let point N be in
the middle of the demand curve. So elasticity of demand at
point.
THE TOTAL OUTLAY METHOD:

 Marshall evolved the total outlay, or total revenue or

total ex­penditure method as a measure of elasticity.

 By comparing the total expenditure of a purchaser both

before and after the change in price, it can be known
whether his demand for a good is elastic, unity or less
elastic.
 Elastic Demand:
 Demand is elastic, when with the fall in price the total
expenditure increases and with the rise in price the total
expenditure decreases. 

 (Indirect relationship between price and total expenditure

)
 Unitary Elastic Demand:

 When with the fall or rise in price, the total expenditure

remains unchanged, the elasticity of demand is unity. 

 (fall or rise in price, the total expenditure remains

unchanged)
 Less Elastic Demand:

 Demand is less elastic if with the fall in price, the total

expenditure falls and with the rise in price the total
expenditure rises. 

 DIRECT RELATIONSHIP
 Price of a Product under
demand and supply forces
DEMAND FORECASTING
 Forecasting simply refers to estimating or anticipating
future events. It is an attempt to foresee the future by
examining the past.

 Thus demand forecasting means estimating or

anticipating future demand on the basis of past data
OBJECTIVES OF DEMAND
FORECASTING
Short Term Objectives
 1. To help in preparing suitable sales and production policies.

 2. To help in ensuring a regular supply of raw materials.

 3. To reduce the cost of purchase and avoid unnecessary

purchase.
 4. To ensure best utilization of machines.

 5. To make arrangements for skilled and unskilled workers so

that suitable labour force may be maintained.
 6. To help in the determination of a suitable price policy.

 7. To determine financial requirements.

 8. To determine separate sales targets for all the sales

territories.
 9. To eliminate the problem of under or over production.
Long term Objectives

 1. To plan long term production.

 2. To plan plant capacity.

 3. To estimate the requirements of workers for long period

and make arrangements.
 4. To determine an appropriate dividend policy.

 5. To help the proper capital budgeting.

 6. To plan long term financial requirements.

 7. To forecast the future problems of material supplies and

energy crisis.
FACTORS AFFECTING DEMAND
FORECASTING
 1. Prevailing business conditions:
 2. Conditions within the industry:

 3. Conditions within the firm:

 4. Factors affecting export trade:

 5. Market behaviour :

 6. Sociological conditions:

 7. Psychological conditions:

 8. Competitive conditions:
PROCESS OF DEMAND FORECASTING/ STEPS IN
DEMAND FORECASTING

 1. Determine the purpose for which forecasts are used.

 2. Subdivide the demand forecasting programme into
small I parts on the basis of product or sales territories
or markets.
 3. Determine the factors affecting the sale of each
product and their relative importance.
 4. Select the forecasting methods.
 5. Study the activities of competitors.
 6. Prepare preliminary sales estimates after, collecting
necessary data.
 7. Analyse advertisement policies, sales promotion plans,
personal sales arrangements etc. and ascertain how far
these programmes have been successful in promoting
the sales.
 8. Evaluate the demand forecasts monthly, quarterly, half
yearly or yearly and necessary adjustments should be
done.
 9. Prepare the final demand forecast on the basis of
preliminary forecasts and the results of evaluation.
 M ETHODS OF DEMAND FORECASTING (FOR
ESTABLISHED PRODUCTS

 (A) Survey methods

 Under this method surveys are conducted to collect information
about the future purchase plans of potential consumers. Survey
methods help in obtaining information about the desires, likes and
dislikes of consumers through collecting the opinion of experts or
by interviewing the consumers.
 Survey methods are used for short term forecasting. Important
survey methods are
(a) consumers interview method,

(b) collective opinion or sales force opinion methodic

(c) experts opinion method

(d) consumers clinic and

(e) end use method.

 Consumers' interview method (Consumers survey):
Under this method, consumers are interviewed directly and
asked the quantity they would like to buy. After collecting
the data, the total demand for the product is calculated. This
is done by adding up all individual demands. Under the
consumer interview method, either all consumers or
selected few are interviewed. When all the consumers are
interviewed, the method is known as complete enumeration
method. When only a selected group of consumers are
interviewed, it is known as sample survey method.
 Collective opinion method/ sales force
opinion method : Under this method the salesmen
estimate the expected sales in their respective territories
on the basis of previous experience. Then demand is
estimated after combining the individual forecasts (sales
estimates) of the salesmen. This method is also known as
sales force opinion method.
 Experts' opinion method: This method was
originally developed at Rand Corporation in 1950 by
Olaf Helmer, Dalkey and Gordon. Under this method,
demand is estimated on the basis of opinions of experts
and distributors other than salesmen and ordinary

consumers. This method is also known as Delphi

method. Delphi is the ancient Greek temple where
people come and prey for information about their future.
 Consumer clinics: In this method some selected

buyers are given certain amounts of money and

asked to buy the products. Then the prices are

changed and the consumers are asked to make fresh
purchases with the given money. In this way the
consumers" responses to price changes are observed.
Thus the behaviour of the consumers is studied. On this
basis demand is estimated. This method is an
improvement over consumer’s interview method.
 End use method: This method is based on the fact that a

product generally has different uses. In the end use

method, first a list of end users (final consumers,

individual industries, exporters etc.) is prepared.

Then the future demand for the product is found either
directly from the end users or indirectly by estimating
their future growth. Then the demand of all end users of
the product is added to get the total demand for the
product.
STATISTICAL METHODS
 Trend projection method: Future sales are based on the

past sales, because future is the grand-child of the past

and child of the present. Under the trend projection method
demand is estimated on the basis of analysis of past data. This
method makes use of time series (data over a period of time).
We try to ascertain the trend in the time series. The trend in the
time series can be estimated by using any one of the following
four methods: (a) Least-square method, (b) Free-hand method,
(c) Moving average method and (d) semi-average method.
 Regression and Correlation: These methods
combine economic theory and statistical technique of
estimation. Under these methods the relationship between the
sales (dependent variable) and other variables (independent
variables such as price of related goods, income,
advertisement etc.) is ascertained. Such relationship
established on the basis of past data may be used to analyse
the future trend. The regression and correlation analysis is
also called the econometric model building.
METHODS OF DEMAND FORECASTING FOR NEW
PRODUCTS

 Evolutionary approach: This method is based

on the assumption that the new product is the
improvement and evolution of the old product. The
demand is forecasted on the basis of the demand of the old
product. For example, the demand for black and white TV
should be taken in to consideration while forecasting the
demand for colour TV sets because the latter is an
improvement of the former.
 Substitute approach: Here the new product is
treated as a substitute of an existing product, e.g.
polythene bags for cloth bags. Thus the demand for a
new product is analysed as a substitute for some existing
goods or service.
 Growth curve approach: Under this method
the growth rate of demand of a new product is estimated
on the basis of the growth rate of demand of an existing
product. Suppose Pears soap is in use and a new
cosmetic is to be introduced in the market. In this case
the average sale of Pears soap will give an idea as to how
the new cosmetic will be accepted by the consumers.
Opinion poll approach: Under this method the
demand for a new product is estimated on the basis of
information collected from the direct interviews (survey)
with consumers.

 Sales Experience approach: Under this method,

the new product is offered for sale in a sample market,
i.e. by direct mail or through multiple shop or
departmental shop. From this the total demand is
estimated for the whole market.
 Vicarious approach: This method consists of
surveying consumers' reactions through the specialised
dealers who are in touch with consumers. The dealers are
able to know as to how the customers will accept the
new product. On the basis of their reports demand can be
estimated. The above methods are not mutually
exclusive. It is de desirable to use a combination of two
or more methods in order to get better results.