demand analysis

Created By:Archana

RBMI

Unit-2

DEMAND ANALYSIS

Demand Analysis

NEED, WANT AND DEMANDNEED- basic requirement

want- Desire

Demand- desire + Purcahsing power

Demand

What is Demand?“Demand means effective desire or want for a

commodity which is backed up by the ability (purchasing power) and willingness to pay for it”.

Demand = Desire + Ability to pay + Willingness to spend

Demand is a relative concept – not absolute It is related to price , time and place.

“The demand for a commodity refers to the amount of it which will be bought per unit of time at a particular price

( in a particular market)”.

DEMANDDemand is the effective desire or want for a commodity, which is backed up by the ability (i.e. money or purchasing power) and willingness to pay for it. Demand = Desire + Ability to pay + will to spendThe demand for a product refers to the amount of it which will be bought per unit of time at a particular price.

Essentials of DemandDesire for a commodity,Capacity to pay for it,Willingness to pay for it,Quantity bought and sold,A Specific Price,A Specific Time,A Specific Place.

Consumer DemandTwo levels: Individual Demand

Market Demand

Market Demand is the sum total of all individual demands.

Prices are determined based on Market Demand.

Demand Function. There is a functional relationship between

demand and its various determinants. I.e., a change in any determinant will affect the demand. When this relationship expressed mathematically, it is called Demand Function.

D = f (P, Y, T, Ps, U) Where, D= Quantity demanded, P= Price of the commodity Y= Income of the consumer, T= Taste and preference of

consumers. Ps = Price of substitutes, U= Consumers expectations

& others f = Function of (indicates how variables are related)

Demand Schedule Demand schedule is a schedule which shows

different quantities of commodity, purchased at different prices. It is a list of price and quantities.

Types:Individual demand Schedule ,Market demand schedule

Individual demand Schedule ,

An individual demand schedule is a list of quantities of a commodity purchased by an individual consumer at different prices

Price of Apple (In Rs.) Q2uantity demanded (Kg.)

10 18 26 34 42 5

Individual demand curve

Market demand scheduleMarket demand refers to the total demand

for a commodity by all the consumers. It is the aggregate quantity demanded for a commodity by all the consumers in a market.

Market Demand Schedule for egg.

Price per

dozen

A B C D Market demand

10 1 2 0 0 38 2 3 1 0 66 3 4 2 1 104 4 5 3 2 142 5 6 4 3 18

Market demand curve

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.

Demand Schedule: A demand schedule is a tabular presentation of the amount of goods consumers are willing and able to buy at different level of prices over a given period of time. Demand Curve: The graphical representation of demand schedule is the demand curve. The demand curve is a downward sloping curve from left to right. This characteristic of the demand curve is due to the inverse relationship between price and quantity demanded.

Price per cassette Rs.

ABCDE

A Demand TableDVD rentals

demanded per week

0.50 1.002.003.004.00

98642 Pr

ice

per D

VDs (

in ru

pees

)E

D

C

BA

G

1 2 3 4 5 6 7 8 9 10Quantity of DVDs demanded (per week)

Demand for DVDs

6.00 A Demand Curve

5.00

4.00 3.503.00

2.00

1.00

.50 F

17

Types of demand

Price DemandIncome DemandCross DemandJoint and complementary demandComposite demandDirect an derived demandIndividual demand & Market demandDemand for producer goods and demand

for consumer goodsDirect & indirect demand

Price Demand

Price demand shows the relationship between price of the goods and quantity demanded. If the price of goods is higher consumers will purchase less quantity of goods and if the price is lower, consumers will purchase more quantity of goods. It means there is inverse relationship between price and quantity demanded.

Income Demand

Income demand indicates the relationship between income of the consumer and quantity of demanded commodity. In others words, it relates to the various quantities of a commodity that will be bought by the consumer at various levels of income.

Cross Demand

where change in the price of one-commodity results in the change of the demand of other commodity (related goods).Substitute- tea and coffee,Complementary – car and petrol,

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 credit facility General std. of living and spending habits Climatic and weather conditions Savings

Factors influencing individual demands: Price of the products. Income of the buyer. Tastes, Habits and Preferences. Relative prices of other goods. Relative prices of substitute and

complementary products. Consumer’s expectations about future

price of the commodity. Advertisement effect.

Law of demandthere is an inverse relationship between

price and quantity demanded. 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”.

The Law of Demand

Other things equal:Quantity demanded rises as price fallsQuantity demanded falls as price rises

P D

P D

Assumptions to the Law of Demand:No change in Consumer’s income.

No change in consumer’s preferences.

No change in the Fashion.

No change in the Price of Related Goods.

No change in the distribution of income.

No change in government policy.

No change in weather conditions.

Why Demand Curve Slopes Downwards:

Factors behind Law of demandSubstitution effectIncome effectLaw of diminishing Marginal UtilityNew buyersDifferent uses

Exceptions to Law of demandExpectation regarding future pricesGiffen goodsArticles of snob appeal / Veblen effect Consumer’s psychological bias ( about quality

and price relationship)

What are the exceptions to the Law of Demand?

Sometimes it may be observed, that with a fall in price, demand also falls and with a rise in price, demand also rises. This is apparently contrary to the law of demand. The demand curve in such cases will be typically unusual and will be upward sloping.


1.Giffen Goods: In the case of certain Giffen goods, when price falls, quite often less quantity will be purchased because of the negative income effect and people’s increasing preference for a superior commodity with rise in their real income. E.g. staple foods such as cheap potatoes, cheap bread, pucca rice, vegetable ghee, etc. as against good potatoes, cake, basmati rice and pure ghee.


2. Giffen goods, Articles of Snob appeal (Veblen effect) : Sometimes, certain commodities are demanded just because they happen to be expensive or prestige goods and have a ‘snob appeal’. They satisfy the desire to preserve the exclusiveness for unique goods. These goods are purchased by few rich people who use them as status symbol. When prices of articles like diamonds rise, their demand rises. Rolls Royce car is another example.


Speculation: When people are convinced that the price of a particular commodity will rise further, they will not contract their demand; on the contrary they may purchase more for profiteering. In the stock exchange, people tend to buy more and more when prices are rising and unload heavily when prices start falling.

What are the exceptions to the Law of Demand?Consumer’s phychological bias or

illusion: When the consumer is wrongly biased

against the quality of a commodity with reduction in the price such as in the case of a stock clearance sale and does not buy at reduced prices, thinking that these goods on ‘sale’ are of inferior quality.

Variation & Changes In Demand(a) Variations i.e. extension and contraction

in demand due to price and (b) Changes i.e. increase and decrease in

demand due to other factors (Income, taste etc.)

(a) Variations i.e. extension and contraction in demand due to price Extension of Demand: This refers to rise in

demand due to a fall in price of the commodity. It is shown by a downwards movement on a given demand curve.

Contraction of Demand: This means fall in demand due to increase in price and can be shown by an upwards movement on a given demand curve.

Changes i.e. increase and decrease in demand due to other factorsIncrease in Demand: This refers to higher

demand at the same price and results from rise in income, population etc., this is shown on a new demand curve lying above the original one.Same price; More demand,Same demand; More price.Same price; More demand Same demand; More price

price demand price demand3 3 3 33 4 4 3

Decrease in demand: It means less quantity demanded at the same price. This is the result of factors like fall in income, population etc. this is shown on a new demand lying below the original one.

Same price; Less demand Same demand; Less priceprice demand price demand

3 3 3 33 2 2 3

Elasticity of Demand

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

Elasticity of demand is defined as the percentage change in quantity demanded caused one percent change in each of the determinants under consideration while the other determinants are held constant.

Ed = % change in quantity demanded / % change in the determinant.

Types of Elasticity of DemandThere are mainly five types of Elasticity of

Demand :

1.Price Elasticity of demand2.Income Elasticity of demand3.Cross Elasticity of demand

Price Elasticity of Demand :

Price Elasticity of Demand measures the degree of responsiveness of the quantity demanded of a commodity due to a change in its own price.

Ep = - (% change in quantity demanded) / ( % change in the Price).

Here we ignore the – ve sign as the relation between price and the quantity demanded is opposite.

Price Elasticity of Demand

Formula:

ep = Proportionate change in the Quantity demandedProportionate change in price

change in the quantity demandedQuantity demanded

= ----------------------------------------------------------------change in price

price

Price elasticity of demand (Q2 – Q1)

Q1 ep = -------------------------------

P2 – P1 P1Q1 = Original Quantity before price change.Q2 = Quantity demanded at the changed price.P1 = Original price.P2 = Changed price.

Illustration:If Q1 = 2000 Q2 = 2500 P1 = 10 and P2 = 9

(2500 – 2000)2000

ep = ----------------------------------------------------- = -- 2.5

9 – 1010

Price elasticity is negative showing inverse relationship.

Types/Degrees of Price Elasticity of demand1. Perfectly inelastic demand (ep = 0)2. Inelastic (less elastic) demand (e < 1)3. Unitary elasticity (e = 1)4. Elastic (more elastic) demand (e > 1)5. Perfectly elastic demand (e = ∞)

Perfectly inelastic demand (ep = 0)

In this case, even a large change in price fails to bring about a change in quantity demanded. I.e. the change in price will not affect the quantity demanded and quantity remains the same whatever the change in price. Here demand curve will be vertical line as follows and ep= 0

Inelastic (less elastic) demand (e < 1)

Here quantity demanded changes less than proportionate to changes in price. A large change in price leads to small change in demand. In this case demand curve will be steeper and ep=<1

Unitary elasticity (e = 1)

Here the change in demand is exactly equal to the change in price. When both are equal, ep= 1, the elasticity is said to be unitary.

Elastic (more elastic) demand (e > 1)

Here a small change in price leads to very big change in quantity demanded. In this case demand curve will be fatter one and ep=>1

Perfectly elastic demand (e = ∞)

When a small change in price leads to infinite change in quantity demanded, it is called perfectly elastic demand. In this case the demand curve is a horizontal straight line as given below. (Here ep= ∞)

The above five types of elasticity can be summarized as follows

SL Type numerical expression

description Curve shape

1 Perfectly elastic α infinity Horizontal

2 Perfectly inelastic 0 Zero Vertical

3 Unitary elastic 1 One Rectangular hyperbola

4 Relatively elastic >1

Less then one

Flat

5 Relatively inelastic <1

Greater then one

Steep

Measurement of price elasticity of demand

Graphical Method (point and Arc method)Point MethodExpenditure Method

Graphical MethodPerfectly Elastic Demand (ep= infinity)

P D

O X

Y

Q Q1

Quantity Demanded

price

Where no reduction in price is needed to cause an increase in demand. The firm can sell the quantity in wants to sell at the prevailing price but none at all at even slightly higher price.The shape of the demand curve is horizontal.The elasticity is = infinite.

Perfectly inelastic demand (ep = 0)

Y

XOQ

D

P

P1

Quantity Demanded

price

Less Elastic Demand (ep<1)

Y

XO

D

D

P1

P

Q1 QQuantity Demanded

price

Relative/Unitary Elastic Demand

O X

Y

D

D

P

P1

Q1 Q

Quantity Demanded

price

Highly Elastic Demand (ep>1)

Y

XO

D

DP

P1

Q1 Q

Quantity Demanded

price

Point Elasticity of Demand Point Elasticity of Demand at any point on the Linear Demand

Curve is measured as under :Lower segment of the Demand Curve

ep = --------------------------------------------------Upper Segment of the Demand Curve

e p = 1 Unitary elasticity

ep < 1 Inelastic range

ep > 1 Elastic rangeep = Infiniteelasticity

Point Elasticity of Demand

ep=1

ep=0

ep<1

ep=infinity

ep>1Formula :ep=lower segment upper segment

Expenditure Method

Elastic Demand ( ep>1)

P(Rs.)

Q(Nos.)

TE(Rs.)

6 10 60

5 13 65

P(Rs.)

Q(Nos.)

TE(Rs.)

6 10 60

5 11 55

Inelastic Demand (ep<1)

Unitary Elastic Demand (ep=1)

P(Rs.)

Q(Nos.)

TE(Rs.)

6 10 60

5 12 60

Percentage method

Pe= % change in Quantity demanded %change in Price

Average revenue method

E = AA-M

Arc method

Arc Definition 2 1 2 1

2 1 2 1PQ Q P PEP P Q Q

Factors determining Price Elasticity of DemandNature of the commodityVariety of useSubstitutes Range of priceIncome levelProportion of income spent on the

commodityJoint demandDurability

Income Elasticity Income Elasticity of Demand is defined as the ratio of the

percentage or proportionate quantity demanded to the percentage or proportionate change in income.

OR Q2 – Q1 ………… (effect)

Q2 + Q1 ey = ---------------------

Y2 – Y1 ………… (cause)

Y2 + Y1Q1 – Original Quantity demanded before Income changeQ2 - Quantity demanded after Income changedY1 - Original IncomeY2 - Changed new income.

Income Elasticity Of Demand =Proportionate change in Demand

Proportionate change in Income

i.e.Income Elasticity Of Demand =

∆q

Q Y

∆y +

Income Elasticity of Demand (Ey)Income elasticity of demand shows the

change in quantity demanded as a result of a change in consumers‟ income.

Ey = % change in Qd % change in Income

Kinds of Income Elasticity of demand Positive Income Elasticity of demand Negative Income Elasticity of demand Zero Income Elasticity of demand

Positive Income Elasticity of demand

- In this case, an increase in income may lad to an increase in the quantity demanded. i.e., when income rises, demand also rises. (Ey =>0) This can be further classified in to three types: • Income Elasticity of demand equal to unity• Income Elasticity of demand more than unityIncome Elasticity of demand less than unity

Positive Income Elasticity of demand

a) Unit income elasticity; Demand changes in same proportion to change in income.i.e, Ey = 1

b) Income elasticity greater than unity: An increase in income brings about a more than proportionate increase in quantity demanded.i.e, Ey =>1

c) Income elasticity less than unity: when income increases quantity demanded is also increases but less than proportionately. I.e., Ey = <1

Negative Income Elasticity of demand

In this case, when income increases, quantity demanded falls. E.g., inferior goods. Here Ey = < 0.

Zero income elasticity –In this case, quantity demanded remain

the same, eventhogh money income increases.ie, changes in the income doesn‟t influence the quantity demanded (Eg.salt,sugar etc). Here Ey (income elasticity) = 0

Income Elasticity of demand• Income Elasticity of demand equal to unity• Income Elasticity of demand more than unityIncome Elasticity of demand less than unity

IllustrationSuppose a consumer's income is Rs.1000 and he

purchases 10 kgs. of sugar. If income goes up to Rs.1100 he is prepared to buy 12 kgs. Calculate income elasticity of sugar.Q2-Q1 12 - 10Q2+Q1 12 + 10

ey = ---------- = --------------------Y2-Y1 1100 - 1000 Y2+Y1 1100 + 1000 = 2 -:- 100 = 1 x 21 22 2100 11 1 = 21 = 1.99

11 Demand for sugar is income elastic

Cross Elasticity of demand–

Cross elasticity of demand is the proportionate change in the quantity demanded of a commodity in response to change in the price of another related commodity. Related commodity may either substitutes or complements. Examples of substitute commodities are tea and coffee. Examples of compliment commodities are car and petrol.

Proportionate or %ge change Qx2 - Qx1ec = in the quantity demanded of X = Qx2 + Qx1

Proportionate or %ge change Px2 – Px1 in the quantity demanded of Y Py2 + Py1 If commodities are inter-related, a change in price of one may cause a change in the price of the other.This is known as Price elasticity of demand.

Py2 – Py1Py2 + Py1

PxEpy = --------------------Px2 – Px1Px2 + Px1

Kinds of Cross Elasticity of demand

Positive cross Elasticity of demand - substitutesNegative cross Elasticity of demand -

complementaryZero cross Elasticity of demand –independent

goods

Important functions of advertising are(a)To shift the demand curve to the right(b)To reduce the elasticity of demand.(c) However, advertising has a cost payable to the media.

Advertising elasticity of demand is the degree of responsiveness of demand to changes in advertising expenditure.

Q2-Q1 QQ2+Q1 Q Q A

eA = ------------------------------- = -------------------------- = ------- x -----

A2-A1 A A Q A2+A1 A

Q = Quantity of sales A = Advertisement expenditure.

At initial advertisement expenditure of Rs.50,000 the demandFor the firm’s product is 80,000 units. When the advertisementBudget is increased to Rs.60,000 the sales volume increasedto 90,000 units. What is the advertising elasticity?

A1 = Rs. 50000 A2 = Rs.60000 A = Rs.10000Q1 = 80000 units Q2 = 90000 units Q = 10000 units

eA = Q x A = 10000 x 50000 = 0.625

A Q 10000 80000Note: When price-quantity changes are very small, pointElasticity is used. When there is substantial change, arc elasticity is used.

If Arc elasticity is found for the above example,eAarc = Q x A1 + A2 = 10000 x 50000 + 60000 = 0.647 A Q1 + Q2 10000 80000 + 90000

Point Elasticity of Demand Point Elasticity of Demand at any point on the Linear Demand

Curve is measured as under :Lower segment of the Demand Curve

ep = --------------------------------------------------Upper Segment of the Demand Curve

e p = 1 Unitary elasticity

ep < 1 Inelastic range

ep > 1 Elastic rangeep = Infiniteelasticity

1. Nature of the commodity.2. Availability of Substitutes3. Number of Uses4. Consumer’s Income.5. Height of Price and Range of Price Change.6. Proportion of Expenditure.7. Durability of the Commodity.8. Habit.9. Complementary Goods.10.Time.11.Recurrence of Demand.12.Possibility of Postponement.

demand analysis

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