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Demand Analysis
Concept of Demand
Concept of Demand
Demand Curve
A demand curve is a graphical representation of a demand schedule.
It shows how the quantity demanded of a product will change as the price of that
product changes during a specified period of time, holding all other determinants of
quantity demanded constant.
The curve shows the highest quantity of a good at each price the consumer is
willing to buy, ceteris paribus.
Price
Demand Curve
Willing
to buy
The
demand
curve
slopes
downward: as the price of the
commodity decreases more people
would be willing to purchase the
commodity at larger quantities.
Unwilling
to buy
Quantity demanded
Demand Function
Where Qxis the quantity of good X, Pxis the price of price of good X, Ps & Pcare
prices of substitute & complementary goods, respectively, Y is income, W is wealth,
E is expectations, T is tastes & preferences, A is advertisement expenditure.
Price
Quantity demanded
Quantity demanded
Concepts of Elasticity
to know to what extent the demand for his product is going to change with the change
in any of the determinants.
An elasticity is a measure of the sensitivity of one variable to another.
Specifically, it is a number that tells us the percentage change that will occur in one
It measures the
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Price Elasticity
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Price Elasticity
Q 2 Q1
P2 P1
Q P1
ep (
) /(
)
Q1
P1
P Q1
Since the demand curve is downward sloping, and quantity demanded increases
with the fall in price, the measure has a negative sign. However, as a matter of
convention in economics, we show price elasticity by a positive number.
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Price Elasticity
For appreciable change in prices, arc elasticity is more appropriate.
In arc elasticity, average price and quantity is considered because
when there is appreciable change in price, the value of elasticity
calculated on the basis of two points on the arc.
e pArc (
Q2 Q1
( P P1 ) / 2
Q P1 P2
)* 2
P2 P1
(Q1 Q2 ) / 2 P Q1 Q2
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Price Elasticity
For a linear demand curve, the price elasticity depends not only on the slope of
the demand curve, but also on the price and quantity. The elasticity, therefore,
varies along the demand curve.
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Price Elasticity
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Greater the number of close substitutes, more will be the price-elasticity since
whenever there is a change in the price of the commodity, it will be substituted by and
for the substitutes depending on the increase and decrease of the price respectively.
2.
The nature of the commodity used whether luxury or necessity. For necessities,
like food, medicines, etc. the elasticity will be low enough. Changes in their prices are
not going to change quantities demanded appreciably. For luxuries, one can postpone
the consumption.
3.
The durability of goods particularly HH goods like TV, car, washing machines, etc.
also affects the elasticity. These goods are used for longer periods. If prices fall, there
may be considerable replacement activities causing an increase in the quantity
demanded, making elasticity higher.
4.
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Income Elasticity
Q Q1 Y 2 Y1
Q Y1
ey ( 2
) /(
)
Q1
Y1
P Q1
Generally, per capita disposable income is taken as a measure of income in
practice.
For most of the goods (normal goods) the income elasticity of demand will be
positive.
For inferior goods, income elasticity turns out to be negative. For luxury goods, it is
greater than one.
For necessities and semi-luxury goods, it may vary between zero and one.
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A firm whose demand functions show high income elasticity will have
good opportunities for business particularly for expansion. For certain
goods, there may be consumption limit from the consumers point of
view. A firm supplying such goods will be stagnant if it continues to
produce them. The firm in such situation can grow only through
diversification of its business.
The income elasticity helps in making such decisions. Even for future
assessment of demand, the firm will take income elasticity into account.
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Cross-Price Elasticity
ex .y
2
1
1
Qx2 Qx1 py py
Qx py
(
) /(
)
1
1
Py Qx1
Qx
py
Examples of substitutes: teas & coffee, coal & gas, petrol & diesel, etc.
Examples of complements: tea & sugar, petrol & car, pen & ink, etc.
For substitute goods, cross-elasticity will be positive and for complementary goods it
will be negative. It will be positive in case of derived demand also, i.e. when X is
used for production of Y.
If cross-elasticity is zero, then the two goods are unrelated.
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In case of different brands competing with each other, it is used to find the
effect of prices of other brands of commodities supplied by the competitors
on its own
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