session 2-demand analysis

8/7/2019 Session 2-Demand Analysis

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Demand Analysis

Dr. Utpal ChattopadhyayAsst. Professor,NITIE, Mumbai


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Meaning of Demand

Desire to buy Willingness to pay

Ability to pay

Effective Demand has to fulfillthree basic characteristics

Demand for a commodity hasalways reference to:

A Price A Period of time

A Place


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Factors affectingDemand

Price of goods:o Own Price

o Prices of related productsPrices of substitute goodsPrices of complementary goods

Income of consumersConsumers tastes & preferences Future Expectationso Incomeo Price

No. of consumersDistribution of consumers


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Demand Function

A Typical demand function:

D x = f (P x ,P y , I, T,E,C,u)

Dx= Demand for good XPx= Price of good XPy= Price of other goodsI= IncomeT= Tastes & preferences

E= Future expectationsC= No. of consumers & their distributionu=residual factors

A simplified version:

D x = f (P x )

with ceteris paribus assumption


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Demand Curve

rice

Quantity

P1

P2

P3

Demand

Q1 Q3Q2

D

D

A Demand curve shows the amount of thecommodity buyers would like to purchase atdifferent prices . It depends on prices (ownas well as related commodities), income,tastes and no. of consumers.

D = F (P) with tastes, incomes, pricesof other goods and no. of consumers etc.held constant.

Law of Demand says More (less) willbought at lower (higher) price.


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Supply Curve

A Supply curve shows the amount of thecommodity sellers would like to offer atvarious prices . It depends on product price,input prices and technology.

S = F (P) with input prices andtechnology held constant.

Quantity

rice

Q1 Q2 Q3

3

2

1

S

S

Quantity suppliedincreases as theprice increases

Supply


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Equilibrium Price

Quantity

rice

S

S

D

D

Qe

e

Equilibrium price is that price where the quantitydemanded equals the quantity supplied (marketclearing price). In the short run market price may notequal equilibrium price. But in the long run marketprice approximates the equilibrium price

Equilibrium Price


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Market Mechanism

Quantity

rice

S

S

D

D

Qe

e

When market price (P m1 ) is above equilibrium price(P e ) there is Excess Supply (or Surplus). Producersreduce price. Quantity demanded increases andquantity supplied decreases. Market continues toadjust until P e is reached.

Excess Supply

Excess Demand

When P m2 < P e ,there is Excess

Demand (orshortages) in themarket. This putsupward pressureon price and itcontinues to risetill price reachesto P e .

m1

m2


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Stability of Equilibrium

Walarasian Vs. Marshallian Stability

Stability of a market based on price adjustment is called Walrasian Stability, while the one based

on quantity adjustment is called MarshallianStability

Quantity

rice

e

Qe

S

S

D

D

Q1

d

s

Market Equilibrium

At Q 1, demand price(P d) exceeds supplyprice (P s). Thus moreof the commodity willbe made available inthe market until Qreaches Q e . This is

Marshallian Stability .


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Change in Demand

Extension/contraction indemand (movement alonga demand curve)

caused by changes inown price

Increase/ decrease indemand (shift in demandcurve)

caused by changes inother determinants of demand


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Movement along aDemand Curve

Dx

Dx

1

D1

rice

Quantity

2

D2

3

D3

Income and Substitution Effects of a(own) price change

Impact of change in own priceon demand


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Shifts in Demand Curve

S

S

D1

D3

D2

D3

D2D1

Quantity

rice

2

1

3

Q3 Q2Q1

An rightward/upward (leftward/downward)shift in demand curve results in an increase(decrease) in equilibrium price.

Factors affecting shifts inDemand

Income

Price of related goods

Consumers tastes & preferences

Expectations

Others (bandwagon effect )


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Change in Income & Demand

For normal (superior) goods, if income increases demand alsoincreases

For inferior goods, demand fallswhen income increases (why?)

What is a Giffen good? An inferior good for which a rise in itsprice makes people buy even more of thatgood

This is because for such goods a strongincome effect outweighs the substitutioneffect of a price change

Law of Demand does not hold good incase of Giffen goods (Other exceptions tothe Law include: luxury/ status goods,expectations on future prices etc.)


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Engel Curve

Named after the 19 th century GermanStatistician Ernst EngelIt shows how the quantity demanded of a

good changes with change in consumers income levelIt states that the lower a familysincome, the greater is the proportion of itspent on foodThe conclusion was based on a budgetstudy of 153 Belgian familiesFor normal goods, the Engel curve has apositive slope. That is, as incomeincreases, the quantity demandedincreases. For inferior goods , the Engelcurve has a negative slope, meaning thatas a consumer earns more income,he/she will be able to buy better goodsand thus stop buying the inferior goods


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Change in Prices of Related Goods & Demand

For substitute goods, if price of one good (say X)increases demand for theother (say Y) also increases

In case of complementary goods, if price of one good(say A) increases demandfor the other (say B) falls


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Shifts in Supply

S1

S1

D1S3

S2

D1

Quantity

rice

3

12

Q3 Q2Q1S2

S3

An rightward (leftward) shift in supply curve results in an decrease (increase) inequilibrium price.

Factors affecting shifts insupply

Input Prices

Technology

Price of substitutes

Taxes

Market speculation

No. of firms

Others (e.g. weather for

agricultural products)


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Simultaneous Shifts in

Demand and Supply

D1

D1

S 1

S 1

Q1

1

Q2

D2

D2

S2

S 2

E1E2

Q1 Q1

A hypothetical case where bothdemand and supply shift rightward.

session 2-demand analysis

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