DEMAND & SUPPLY

ANALYSIS
DEMAND & SUPPLY ANALYSIS
• SYLLABUS:
a) Meaning of Demand, Demand Equation, Factors affecting
Demand, Market Demand, Law of Demand, Exceptions to Law of
Demand, Changes in Demand, Elasticity of Demand – Price,
Income and Cross. Income Effect, Substitution Effect and Price
Effect.
b) Demand Forecasting- Meaning, Need, Objective.
c) Meaning, Factors affecting Supply, Law of Supply, Exceptions to
Law of Supply, Elasticity of Supply.
 DEMAND ANALYSIS
• LEARNING OUTCOMES:
a) calculate and interpret price, income and cross-price elasticities of
demand;
b) compare substitution and income effects;
c) describe factors that affect price, income, and cross-price
elasticities of demand;
d) distinguish between normal goods and inferior goods;
e) forecast demand.
 ECONOMICS is the study of PRODUCTION,
DISTRIBUTION & CONSUMPTION.

ECONOMICS

MACRO ECONOMICS MICRO ECONOMICS

Deals with markets and decision

Deals with AGGREGATE economic
making of INDIVIDUAL economic
quantities such as National Output,
units including consumers and
National Income
businesses

MACRO ECONOMICS is rooted in MICRO ECONOMICS

MICRO ECONOMICS is a logical starting point for the study of
ECONOMICS

MICRO
ECONOMICS

COUSUMERS or
FIRMS
HOUSEHOLDS

Theory of Consumer Theory of the Firm

DEMAND SUPPLY
Utility maximising individuals Profit maximising firms
 An Effective Need
• Effective need entails that there should be a need
supported by the capacity and readiness to shell out.
Hence, there are three basics of an effective need:

WILLINGN
ABILITY EFFECTIVE
NEED ESS TO
TO PAY NEED
PAY
HOW DO YOU STATE DEMAND???
• Specific Units:
– Demand of Umbrella is 10,000 units
• A Specific Price:
– Demand of Umbrella is 10,000 units at a price of Rs.
100 each.
• A Specific Time:
– Demand of Umbrella during rainy season is 10,000 units
at a price of Rs. 100 each.
• A Specific Place:
– Demand of Umbrella during rainy season at Nagpur is
10,000 units at a price of Rs. 100 each.
 DEMAND CONCEPTS
The quantity of a good that consumers are willing to buy
depends most significantly on an item’s own price.
Economists, generally, believe that as the price of a good
rises, buyers will choose to buy less of it, and as its prise
falls, they buy more. This opinion is so nearly universal
that it has come to be called as the LAW of DEMAND.
Other variables which also influence demand are:
CONSUMERS’ INCOME
CONSUMERS’ TASTES & PREFERENCES
Prices of SUBSTITUTES / COMPLEMENARY goods.
POPULATION and its DISTRIBUTION
CONSUMERS’ EXPECTATIONS
 ASSUMPTIONS of the LAW OF DEMAND
1. Income level should remain constant.
2. Tastes of the buyer/consumer should not alter.
3. Prices of other goods should remain constant.
4. No new substitutes and constant price of the
substitutes for the commodity.
5. A rise / fall in future Price should not be expected.
6. Advertising expenditure should remain the same.
 LAW OF DEMAND
• “The demand for a commodity increases with a fall
in its price and decreases with a rise in its price,
other things remaining the same”.
• Price and demand of a commodity are inversely
related, provided all other things remain
unchanged.
 DEMAND AS A FUNCTION
• Demand as a function of price
– PRICE DEMAND
• Demand as a function of income
– INCOME DEMAND
• Demand as a function of substitutes / complements
– CROSS DEMAND
 DEMAND FUNCTION
FUNCTION: A relationship that assigns a unique value
to a dependent variable for any given set of values of a
group of independent variables.
DEMAND FUNCTION: Economists try to assign a
unique value to DEMAND (a dependent variable) for any
given set of values of OWN PRICE, CONSUMERS’
INCOME and Prices of SUBSTITUTES /
COMPLEMENTARY goods (a group of independent
variables).
Qdx = f(Px, I, Py)
EXAMPLE of DEMAND FUNCTION
Qdx = f(Px, I, Py)
Qdx = the quantity demanded of some good X (such as per
household demand for tooth-paste per month)
Px = the price per unit of tooth-paste (such as INR per pack of 200
gms)
I = consumers’ income (as in INR 100,000 per household annually)
Py = the price of another tooth-paste, Y. (There can be many other
goods, not just one, and they can be complements or substitutes
such as another brand of tooth-paste or tooth-powder or mouth-
wash.)
Typical linear equation: Qdx = 84.5 – 6.39Px + 0.25I – 2Py
 OTHER FACTORS
Qdx = f(Px, I, E, T, U, Py)
E = the price expectation of the user
T = the taste or preference of the user
U = all other factors
 CASE EXAMPLE
• Dr. Ashok, a senior University Professor, has an impressive
collection of cards. He needs to sell his cards to collect money.
Three friends express interest in buying some cards. Dr. Ashok
determines that the individual demand equation of his three friends
(F1, F2 & F3) are as follows:
• QF1 = 30.00 – 1.00 P
• QF2 = 22.50 – 0.75 P
• QF3 = 37.50 – 1.25 P Price is measured in INR
• What is the market demand equation for Dr. Ashok’s cards?
• How many more cards can he sell for each one rupee
decrease in price of each card?
• If he has 60 cards, what price should he charge to sell his
entire collection?
 4.
3. DERIVED
COMPOSITE
DEMAND
DEMAND

5.
2. DIRECT
INDIVIDUAL
DEMAND
DEMAND

1. JOINT TYPES OF 6. MARKET

DEMAND DEMAND DEMAND
 TYPES OF DEMAND
• Joint Demand
– Several products demanded for a common purpose
• Direct Demand
– Demand for an ultimate object
• Derived Demand
– Demand derived from direct demand
• Composite Demand
– Can be put to several uses
• Individual Demand
– Demand from a customer
• Market Demand
– Aggregate of demands from a number of customers
 TYPES OF GOOD
• Substitute (competitive goods)
– Substitutes means either this or that
– Tea-coffee, vegetable ghee-pure ghee, ink pen-fountain
pen, wheat-rice
– Rise in price of A leads to rise in demand of B and vice
versa
• Complements
– Complements are required together
– Horse-carriage, tea powder-sugar-milk, bread-butter,
pen-paper
– Rise in price of A leads to fall in demand of both A & B
– Fall in price of A leads to rise in demand of both A & B
OTHER GOODS & DEMAND
• Consumer Goods & Producer Goods
– Final consumption & production of other goods
• Perishable & Durable Goods
– Unusable after sometime; consumed only once; largely to meet
current demand which depends on current conditions
– Only services are consumed; partly to satisfy new demand and
partly to replace old items; more expensive
• Autonomous & Derived Demand
– Whose demand is not tied with the demand for some other goods
• Company Demand and Industry Demand
• Total Demand and Segment Demand
Why does the demand curve slope downwards
• The downward slope of the demand curve reads the
law of demand i.e. the quantity of a commodity
demanded per unit of time increases as its price falls
and vice versa.
• New Buyers
• Existing buyers
• Increase in uses
• Income effect
• Substitution effect
 Substitution & Income Effects
Substitution Effect
Buy more because the
Normal
good is relatively cheaper
Good than its substitutes.
Inferior Buy more because the prompts the consumer to
good is relatively cheaper
Good than its substitutes.
Income Effect
Buy more because the
increase in purchasing
power raises the total
consumption level.
Buy less because the
increase in real income
buy less of the inferior
good in favor of its
preferred substitutes.
 OWN PRICE DYNAMICS
• The price effect is always negative for superior goods,

• The price effect is negative for inferior goods if the

negative substitution effect is greater then the positive
income effect and

• The price effect is positive for inferior goods if the negative

substitution effect is smaller than the positive income effect.
 CHOOSE THE RIGHT ANSWER
• When the price of a good decreases, and an
individual’s consumption of that good also
decreases, it is most likely that
a) Income effect and Substitution effect both are
negative
b) Substitution effect is negative and the Income
effect is positive
c) Income effect is negative and the Substitution
effect is positive
EXCEPTIONS of the LAW OF DEMAND
• Apprehensions about the future price
• Status Goods / Veblen Effect
• Giffen’s Paradox
– We get an upward sloping demand curve in case of
status goods and Giffen’s goods

Q. Give examples of VEBLEN GOODS and

GIFFEN GOODS with clear explanations about
the role of substitution effect and income effect on
each of these goods.
 GIFFEN GOODS & VEBLEN GOODS
• An inferior good for which the negative income
effect outweighs the positive substitution effect
when price falls is called a GIFFEN GOOD. At
lower prices, smaller quantity would be demanded.
• A good for which a higher price makes the good
more desirable is a VEBLEN GOOD. The idea is
that the consumer gets utility from being seen to
consume a good that has high status and that a
higher price of the good conveys more status and
increases its utility.
 LIMITATIONS of the LAW OF DEMAND
• A rise in Individual’s Income
• A rise in Individual’s Savings
• A change in Consumer’s Taste and Preference
• A change in the usage of a commodity
• Expectation of the consumers
 Effect on demand due to change in income
 Essential consumer goods
 Demand rises to certain limit with rise in income. Basic needs, food
grains, vegetable oil, cooking fuel, minimum clothing and housing
 Inferior goods
 Bajara is inferior to Rice and Wheat, travelling by Bus is inferior to
Taxi, Kerosene is inferior to Cooking gas
 Normal goods
 Demand rises with a rise in income: automobiles, household
furniture
 Luxurious goods
 If income rises beyond a certain limit then demand of luxurious
goods rises, upper class rail and air travel, luxury cars, decoration of
buildings, prestigious schools
 Determinants of Demand
1. Change in fashion
2. Change in weather
3. Change in quantity of money in circulation
4. Change in population
5. Change in wealth distribution
6. Change in real income
7. Change in habits, tastes and customs
8. Technical progress
9. Discovery of cheap (low priced) substitutes
10.Advertisement
11.Demonstration effect
 Shift in the Demand Curve
• When demand changes because of changes in
factors other than price
• Rightward shift
• Leftward shift
Movement along the demand curve

• Law of demand relates to simply extension and

contraction of demand
• Movement along the demand curves occurs
due to change in prices
• Extension
• Contraction
Q. Movement along the demand curve for
good Y occurs due to a change in:
a) income.
b) the price of good Y.
c) the price of a substitute for good Y.
Q. A wireless phone manufacturer introduced a
next-generation phone that received a high level of
positive publicity. Despite running several high-speed
production assembly lines, the manufacturer is still
falling short in meeting demand for the phone nine
months after introduction. Which of the following
statements is the most plausible explanation for the
demand/supply imbalance?
a) The phone price is low relative to the equilibrium price.
b) Competitors introduced next-generation phones at a
similar price.
c) Consumer incomes grew faster than the manufacturer
anticipated.
ELASTICITY
OF
DEMAND
 Elasticity of Demand
• Concept of Elasticity of demand
• Implication in business scenario
• Types of elasticity
• Measurement techniques
 Elasticity of Demand
• What is elasticity of demand?
– Sensitivity or responsiveness of demand to the
change in own price, income & price of related
goods

• What are the types of elasticity of demand?

– Price Elasticity of demand
– Income Elasticity of demand
– Cross Elasticity of demand
 Determinants of Price
Elasticity of Demand
Main factors which influence price elasticity of demand

1. The availability of substitutes

2. Nature of commodity

3. The proportion of consumers’ income spent on commodity

4. The number of uses of a commodity

5. Complementarity between goods

6. Time and elasticity

 Availability of Substitutes
 Closer the substitute, greater will be the elasticity.
 Toothpaste, soaps are available in different brands,
each of them being a close substitute of the other.
 Whichever is priced lower, its demand will rise and
cause a fall in the demand of the other.
 There is no substitute to salt, demand is inelastic or
elasticity is less.
 Nature of Commodity
• Commodities can be grouped as luxury, comfort and necessities.
• Demand for luxury goods (e.g. high price refrigerators, TV sets, cars) is
comparatively more elastic than the demand for necessities and comfort
because its purchase can be postponed when the price rises.
• On the other hand, consumption of necessary goods like sugar, clothes
and vegetables cannot be postponed hence inelastic demand.
• While comfort goods have elasticity in between that of necessities and
luxury items.
• Durable items will have more elasticity of demand than perishable
items. Old durable items will be repaired and used like washing
machine, refrigerator etc. instead of buying a new one with higher price.
 Proportion of Consumers’ Income Spent
• Allocation of budget on items of household
consumption will decide whether the demand of a
product is elastic or inelastic.
• On match-box there is very less monthly expenditure,
so its demand is relatively inelastic in nature. The other
examples can be salt, books, toothpastes, etc.
• Rise in prices of it will not affect the monthly budget.
• On housing there is comparatively more expenditure
per month, so its demand is relatively elastic in nature.
 Number of uses of a Commodity
• Greater the uses of a commodity, greater will be the
price elasticity of demand.
• As price of milk rises, its use will be limited to
consumption by kids and sick person and preparing
tea. But if its price decreases, then a variety of
dishes and items can be prepared from milk by the
consumers. Curd, ghee, cheese and sweets etc. can
be prepared from milk.
• Thus, degree of use of a commodity makes the
demand elastic and inelastic in nature.
 Complementarity between goods
• Complementary goods are less price sensitive.
• Even if edible oil price increases, it’s demand will
be inelastic in nature, as it is needed in less quantity
to prepare different recipes.
• Similarly a rise in fuel price will not effect its
demand as it continues to be more comfortable and
cost effective for the commuters to use their own
vehicles rather than opting for public transport.
• Coffee and Milk
 Time & Elasticity
• In the long run, substitute can be designed and
developed. Enterprise will gather the resources
and develop the substitutes. So, demand tends to
be more elastic in the long run.
• While in the short run substitutes / alternatives
can not be designed and developed. So, in the
short run, demand tends to be inelastic.
• Solar Energy, Wind Energy, Bio-Gas, Electric
Cars
Other Determinants of Elasticity

 Habits
 Durability of a commodity
 Possibility of postponement
 Influence of habits and customs
 Ranges of price