module-3 demand analysis

7/30/2019 Module-3 Demand Analysis

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MANAGERIAL ECONOMICS

FACULTY: Prof. Venugopal Naidu


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MODULE:3

DEMAND ANALYSIS


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Meaning of Demand

Demand implies 3 conditions :

Desire for a commodity or service

Ability to pay the price of it

Willingness to pay the price of it.

Further demand has no meaning withoutreference to time period such as a week, a month or ayear.

The demand for a product can be defined as theNumber of units of an commodity that consumer willpurchase at a given price during a specified period oftime in the market.


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Types of Demand

Demand can be broadly classified into

3 types :

They are,

Price Demand

Income Demand

Cross Demand


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Law of Demand

The law of demand expresses the

relationship between the price & quantity

demanded .It says that demand varies inversely

with price.

The Law can be stated in the following:

Other things being equal, a fall in the priceleads to expansion in demand and a rise inprice leads to contraction in demand.


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Assumptions- Law Of Demand

Consumers Income remains Constant

The Tastes & Preferences Of the

Consumers remain the same

Prices of other related Commodities remainConstant

No new Substitutes are available for the

Commodity. Consumers do not expect further change in

the price of the commodity.


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Continued

The Commodity is not of Prestigious

value

Eg: Diamond

The size of population is constant

The rate of taxes remain the same

Climate & Weather Conditions do notchange.


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DEMAND SCHEDULE

Individual Demand Schedule

Market Demand schedule

1.Individual Demand Schedule:It is a list of various quantities of a

commodity which an individual consumer

purchases at different prices at one instant oftime.

D= f (P) (or) D(x) = f(Px)


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Individual demand schedule

(Hypothetical)

Price per unit (Rs) Quantity demanded

for time period

(a week)5

4

32

1

10 apples

20 apples

30 apples40 apples

50 apples


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2. Market Demand Schedule

The market demand Schedule can

be obtained by adding all the individual

Demand Schedules of Consumers in themarket.

Hypothetical market demand

schedule is as follows:


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Hypothetical market demand

schedule

Price per

unit (Rs)

Quantity demanded by

individuals

Market

demand

A + B + C

5

4

3

2

1

60

90

120

150

180

A B C10

20

3040

50

20

30

4050

60

30

40

5060

70


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Market demand curve


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Exceptions to the law of demand


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Continued

Giffens Paradox (Robert Giffen-Irish

Economist)

Veblens Effect (Thorstein Veblen USA )

Price Illusion

Fear of Future Rise in Prices

Emergency

Necessaries


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Continued

Conspicious Necessaries (More Noticeable)

Eg:- TV, Watch, Scooters, Car etc

Fear of Shortage

Ignorance

Speculation (Stock Market)


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Why does the demand curve slope

downwards to right

OR

Why does demand curve has a negative

slope?

Operation of the Law of Diminishing Marginal Utility

Income Effect

Substitution Effect

Different Uses New Buyers


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CHANGES IN DEMAND

A. Extension & contraction ofdemand:

When demand changes due tochange in the price of the commodity, itis a case of either extension or

contraction of demand. The Law ofdemand relates to the Extension &Contraction of Demand.


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Extension and Contraction of

Demand


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2. Increase and decrease in demand:

When demand changes, not due to

changes in the price of the commodity or

service but due to other factors on whichdemand depends.

Eg:- Income, Population, Climate, Tastes& Habits etc.


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Increase and Decrease in Demand


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DEMAND DISTINCTIONS

Demand distinctions may be defined as

the difference in the forces acting on the

demand for different goods.

Demand for Producer goods and

Consumer Goods

Demand for Durable goods and Non-Durable Goods.


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Continued

Derived Demand and Autonomous

Demand.

Industry Demand and Company Demand

Short run Demand And Longrun demand

Total Market demand & Market Segment

Demand


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DETERMINANTS OF DEMAND (OR) FACTORS

AFFECTING DEMAND(Refer: Lekhi & Agarwal- Business Economics)

Price of Commodity

Price of Related Goods

Income of the Consumer Distribution of Wealth

Tastes & Habits

Population growth


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Continued

State of Business (Business Cycle)

Government Policy

Advertisement Level of Taxation


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Factors determining demand for

different types of goods.

Three main types of goods:-

1.Non durable consumer goods.

2.Durable consumer goods.3.Producer goods or capital goods.

1.Non durable consumer goods:-a) Purchasing power


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b) Pricec) Demography

Thus, demand for non durables can be

expressed in the form of following formula:d= f( Y,P,D)

Where ,d=demand,Y=disposable personal

income ,P=price ,D=demography and f isthe function.


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2.Durable consumer goods.

Demand of such goods is two types

a) Replacement demand- demand fora new product in place of an old one

which is worn out or obsolete.

b) Expansion demand-demand for

additional units of the same product.


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Factors influencing Replacement demand

Life of the product.

Obsolescence.

Value of the scrap. Change in price and quality.

Change in expansion demand.


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Factors influencing expansion demand.

Financial position of consumers.

Maintenance and operating costs.

Number of households.

Price and credit conditions.

3.Producers goods

Also called capitalgoods.


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Factors determining the demand for capital

goods.

No. of industrial undertakings.

Profitability.

Ratio of production to capacity utilization. Level of wage rates.

Growth prospects.

Price and quality of the produce.


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ELASTICITY OF DEMAND

Reference:

Mithani

(Pg131)


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Elasticity of Demand

Elasticity of demand measures theresponsiveness of demand for acommodity to a change in the variablesconfined to its demand.

For measuring the elasticity coefficient, aratio is made of two variables,

ED = %change in quantity demanded% change in determinants of demand


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Important Kinds of Elasticity ofDemand

1. Price ED:e = % change in quantity demanded

% change in price

2. Income ED:e = % change in quantity demanded

% change in income3. Cross ED:e = % change in quantity demanded

% change in price of Y


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Continued..

4. Advertising / Promotional ED:

eA = % change in sales

% change in advertisementexpenditure


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Types of Income Elasticity ofDemand

1. Negative Income Elasticity2. Zero Income Elasticity

3. Unitary Income Elasticity Of Demand4. Income Elasticity Greater Than One5. Income Elasticity Less Than One


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The following diagram showsdifferent types of income elasticity of

demand:

O X

Y

QUANTITY DEMANDED

PRICE

D1D2

D3D4

D5


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Factors Influencing Elasticity ofDemand

orDeterminants of Price Elasticity of

Demand

1. Nature of Commodity: Necessaries --- inelastic

Comforts and Luxuries --- elastic


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Continued..

2. Availability of Substitute: A commodity which has more substitutes

the demand is ------ more elastic.

Ex: Tea , Coffee, Milk ,Bournvita etc,

3. No of users of a commodity: More no of users ---elastic

Ex: Electricity, Iron and Steel etc.

Only one use --- inelastic

Ex: Printing machine , stitching machine


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4. Proportion of Income Spent on the

Goods: Small proportion of income --- inelastic

Ex: Salt, Match box, Postcard

5. Habit:Ex: Coffee ,Tea --- inelastic

6. Level of Income of the People:

Rich People --- inelastic Poor People --- elastic


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7. Period of time: Short period --- inelastic

Habit and prices of commodities do notchange much.

Long period --- elastic

8. Durability of a commodity:

Durable goods --- elastic

Ex: fan, table, Chair

Perishable goods --- inelastic

Ex: Milk, flower


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9. Postponement of Purchase:

Postponement --- elasticEx: Fan, TV, Fridge

Cannot be postponed --- inelastic

Ex: Medicine, Rice, Wheat

10. Level of Prices: High priced --- elastic

Ex: Cars, TV , Air conditioners

Low priced --- inelastic

Ex: Newspaper, Nails, Needle


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MEASUREMENT OFPRICE ELASTICITY OF

DEMAND


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Uses Of Price Elasticity of

Demand In DecisionMaking1.

To the businessmen2. To the trade unions

3. In international trade

4. To the government


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5. In the determination of the rate of

foreign exchange

6. In the declaring certain industries aspublic utilities


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Different Degrees of Price Elasticity

of Demand

1. Perfectly Elastic Demand

2. Perfectly Inelastic Demand

3. Relatively Elastic demand

4. Relatively Inelastic Demand

5. Unitary Elastic Demand


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There are three methods ofmeasurement of price elasticity ofdemand:

1. Mathematical (or) Ratio Method.

2. Total Outlay Method (or) Total

Expenditure Method.3. Point Method


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P f l El i D d


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Perfectly Elastic Demand

PEd=/0 =

QUANTITY DEMANDED

PRICE D D

OX

Y

P f l I l i D d


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Perfectly Inelastic Demand

O X

Y

M

D

QUANTITY DEMANDED

PRICE

P i El i i f D d


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Price Elasticity of Demandis = 1

The Elasticity is equal to one when thedemand changes by the same % as the price.

Suppose the price has fallen by 20% and the

quantity demanded has expanded by 20%, as aresult of fall in the price. The Elasticity ofdemand is = 1.PEd = % change in demand = 20% = 1

% change in price 20%PEd = 1

U i El i D d El i i


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Unitary Elastic Demand or Elasticity

Equal to Unity

QUANTITY

PRICE

D1

D

M M1

P1

P

O X

Y


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Price Elasticity of Demand > 1

If the % change in demand is more than the% change in price, then the Elasticity is = > 1.

Ex: If the price falls by 20% and demand

increases by 20%, then the elasticity is greaterthan one.

PEd = 40% = 4 = 2

20% 2

PEd > 1

M El i D d El i i


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More Elastic Demand or Elasticity

Greater Than Unity

OX

Y D

D1

M M1

P1

P

QUANTITY

PRICE


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Price Elasticity of demand


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Less Elastic Demand or Elasticity

Less Than Unity

D1

D

QUANTITY

PRICE

O X

Y

M M1

P1

P

V i D Of El ti it Of


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Various Degrees Of Elasticity Of

Demands

DD

D

D

D

DD

QUANTITY

PRICE

OX

Y

T t l E dit / O tl M th d


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Total Expenditure / Outlay Method

By Prof . Marshall

Under this method we measure theprice elasticity of demand by examining thechange in total expenditure as a result of change

in the price and quantity demanded for acommodity.

TE = Price / unit X Total quantity

purchased


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Illustration

PEd can be explained clearly with the help ofthe following example:

F ll in r th b r ti n b t


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Following are the observations about

the nature of PEd

1. In first case , with every fall in price the TEgoes on increasing. Therefore the PEd > 1.

2. In second case, whatever may be the change in

price the TE remains the same. Therefore thePEd = 1.

3. In third case, with every fall in price the TE

goes on decreasing. Therefore the PEd < 1

Diagrammatic /Graphical


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Diagrammatic /Graphical

Representation

ABCD is theTE curve.

A to B PEd >1

B to C PEd =1 C to D PEd


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Point MethodProf . Marshall

Point Ed = lower segment of the demandcurve below the given point

upper segment of the demand

curve above the given point

or PE = L ; PE = point elasticity

U L = lower segment

U = upper segment


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(1) Linear Demand Curve: PE = L = PB

U PA

Total length ofA and B is 5 cm

PB = 3 cm

PA = 2 cm

PE = 3 = 1.5

2


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(2) Non Linear Demand Curve:

(3) Elasticity at different points on a


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(3) Elasticity at different points on a

straight line demand curve:

Illustration:


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Illustration: At P1 PEd = P1D1 = 2 = 1 PE = 1

P1D 2

At P2 PEd = P2D1 = 3 = 3 PE = > 1P2D 1

At P3 PEd = P3D1 = 4 =P3D 0

At P4 PEd = P4D1 = 1 = < 1 PE = < 1P4D 3

At P5 PEd = P5D1 = 0 = 0 PE = 0P5D 4


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DEMANDFORECASTING

METHODSReference by M.M. Gupta


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Demand Forecasting

Meaning:Demand forecasting means estimating the

expected future demand for a product , related to a

particular period of time.Methods of forecasting:

The methods of forecasting can be broadly

classified into two categories. They are:1. Survey Method

2. Statistical Method

SIGNIFICANCE


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SIGNIFICANCE

OF DEMAND FORECASTING

SIGNIFICANCE OF SHORT TERMFORECASTING

To prepare appropriate production schedule.

Helping the firm in reducing costs of purchasingmaterials.

To determine appropriate price policy.

To fix sales targets and incentives.


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To evolve proper advertising policy. To forecast short term financial requirements.

SIGNIFICANCE OF LONG TERMFORECASTING To plan for new units or to expand the existing units.

To plan long term financial requirements.

To plan man power requirements.

LEVELS OF DEMAND


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LEVELS OF DEMAND

FORECASTING

1. Macro level

2. Industry level

3. Firm level

Criteria of a good forecasting


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Criteria of a good forecasting

method.

Accuracy

Plausibility

Simplicity

Economy

Availability

Flexibility

DEMAND FORECASTING METHODS


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DEMAND FORECASTING METHODS

Survey Method Statistical Method

Expert opinion Direct interview Trend Regression Barometric

method method projection method method(Collective opinion) method (Economic

indicator

method)

Complete Sample survey End User

enumeration method methodmethod


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(A) Survey Method

The survey method consists of two methods:

Survey of experts opinion

Survey of consumers intentions through directinterview with them.

(1) Experts Opinion Method (or)


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(1) Experts Opinion Method (or)

Collective Opinion Method

This method is also known as Sales ForceComposite Method.

Advantages:

1. It is a simple method of forecasting.2. It involves minimum statistical work.

3. It is less expensive.

4. It is based on the first hand knowledge of thesalesmen who are directly connected with thesales.

Contd


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Contd5. It is more useful for short term forecasting rather than

long term forecasting.

6. It is particularly useful in forecasting the sales of newproducts.

Disadvantages:

1. It is subjective approach.2. The salesmen may underestimate the demand.

3. The salesmen may not be able to judge the futuretrends in the economy and their impact on the sales

of the product of the firm.

(2) Direct Interview Method (or)


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(2) Direct Interview Method (or)

Customers Interview Method

Under this method ,consumers are directlyinterviewed to find out the future demand or demandtrends for a product by a firm. They are three types ofconsumers interview:

Complete Enumeration Method

Sample Survey Method

(Stratified = Society divided into differentclasses)

End Use Method

Continued


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Continued

A. Complete Enumeration Method

under this method ,almost all theconsumers of the product are interviewed and areasked to inform about their future plan of purchasingthe product in question.

Advantages:

This method is true from any bias of the salesmen ,asthey only collect the information and aggregate it.

This method seems to be ideal, since almost all theconsumers using the product are contacted.


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Contd

Disadvantages:1. This method is however very costly and tedious.

2. It is also too much time consuming, since everypotential customer is to be interviewed.

3. It would be very difficult and impractical if theconsumers who are spread over the entire country areto be contacted.

Hence this method is highly cumbersome innature.

C d


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Contd

B. Sample Survey Method:

When the demand of consumers is very large

this method is used by selecting a sample of consumers

for interview .Advantages:

1. This method is single and less costly and hence it is

widely used.2. It is less time consuming ,since only a few selected

consumers are contacted.

C d


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Contd

3. It is used to estimate short term demand bybusiness firms, governments departments andhousehold customers.

4. It is highly useful in case of new products.

5. This method is of greater use in forecasting whereconsumers behaviour is subject to frequent changes.

However the success if this method dependson the sincere co-operation of the selected consumers.

C d


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Contd

Disadvantages:1. This method is less reliable , because it does not give

opinion of all the consumers.

2. A sudden change in the price of the product in futuremay upset the calculations of consumers.

3. The rich consumers may not bother to fill the detailsin the questionnaire.

These are the practical problems faced inusing this method to forecast demand.

C d


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Contd

C. End Use Method:

Under this method, the sale of theproduct under consideration is projected on

the basis of the demand surveys of theindustries using this given product orintermediate product.

C d


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Contd

Advantages:1. This method is used to forecast the demand for

intermediate products only.

2. It is quite useful for industries which largelyproduces goods like aluminium, steel, etc.

Disadvantages:

The main limitation of this method is that , as the

number of end- users of a product increases, itbecomes more difficult to estimate demand underthis method.

(B) S i i l M h d


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(B) Statistical Method

Under these methods, statistical ormathematical techniques are used to forecast thedemand for a product in the long period. The followingare the important statistical methods used inforecasting:

1. Trend Projection Method

2. Regression Method

3. Barometric Method

(1) T d P j i M h d


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(1) Trend Projection MethodThis method is also known as Time Series Analysis.

Time series refers to the data over a period of time.During this time period, fluctuations and turningpoints may occur in demand conditions .Thesefluctuations in demand occur due to the followingfour factors. They are:

Secular Trends

Seasonal Variations

Cyclical Fluctuations Random Variations

Table - Sales of Transistors for 5 years


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Table - Sales of Transistors for 5 years

YEAR SALES inlakhs of Rs

1991 50

1992 60

1993 55

1994 70

1995 75

DIAGRAMATIC REPRESENTATION


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DIAGRAMATIC REPRESENTATION

Y

75

70 Trend line

65

60 Sales curve

55

50

0 X91 92 93 94 95

C d


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Contd

Advantages :1. Trend projection method is quite popular in

business forecasting, because it is a simplemethod.

2. The use this method requires only the simpleworking knowledge of statistics.

3. It is also less expensive , as its data

requirements are limited to the internalrecords.4. This method yields fairly reliable estimates if

future course of demand.

C td


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Contd

Disadvantages:

The most important limitation of this methodarises out of its assumption that the past rate

of change in the dependent variable ( demand).

This method is not useful for short runforecasting and cyclical fluctuations.

This method does not explain the relationshipbetween dependent and independent variables.

(2)R i M th d


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(2)Regression Method

It combines the economic theory andstatistical techniques of estimation.

(3) B t i M th d


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(3) Barometric Method

This method is also known as EconomicIndicators Method. Under this method , a feweconomic indicators become the basis for forecastingthe sales of a company.

Some of the most commonly used indicatorsare given below:

Construction contracts

Personal Income

Automobile registration

C td


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Contd

Limitations

It is difficult to find out an appropriateeconomic indicator

It is not suitable for new products as past datanot available

It is best suited where relationship of demand

with a particular indicator is characterized bytime-lag

Si ifi f D d F ti


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Significance of Demand Forecasting

Production planning

Sales Forecasting

Control of business

Inventory control

Growth and Long term Investment Programs

Stability Economic planning and Policy making

module-3 demand analysis

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