unit #2 demand analysis

8/10/2019 Unit #2 Demand Analysis

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Economic Analysis And Managerial Economics (1) M.com Prepared by Ali Haider

LAW OF DEMAND

Q #1 What is demand? Explain the law of demand.

Ans:In economics the term demand has a special meaning. It can be defined in the following words:

"Amount of a commodity or service which buyers are willing and able to buy at a given price during a given periodof time."

This definition shows that all desires are not demand. A desire becomes effective only when the consumer has the

purchasing power to buy a particular commodity or service at some given price. Hence demand is always with reference

to a particular price as well as to a given time period, may be a day, week or a month. It is clear that consumer's ability to

pay and willingness to buy a commodity will be different at different price levels and over different time period

Therefore demand changes with time and changes in price.

Law OF DemandThe law of demand states a relationship between price and quantity demanded. It can be defined in the following words;

"Other things being equal the quantity demanded of a commodity extends with a fall in its price and contracts with a

rise in its price."

In other words the quantity demanded of a commodity changes inversely with its price. The law of demand establishes a

definite inverse relationship between the price and quantity demanded of a commodity. Mathematically it is written as

Qd = f (P)

Where Qd means quantity demanded and P is the price of a commodity.

The law can be explained by using following table.

Table

P Q

1 10

2 8

3 6

4 4

5 2

In this table relationship

between price of a

commodity and its price is

established. The table shows

that when price is Rs. 1,

quantity demanded is 10

units, and when price

increased to 5 the quantity

quantity demanded decreased to 2 units, thus the table shows that quantity demanded of a commodity changes

inversely with its price.

The law of demand can also be explained with the help of following diagram.

In this diagram, price is taken on Y- axis and quantity demanded is measured on X-axis. By combining different

combinations of price and quantity demanded we get a demand curve DD that slopes downward from left to right.

It shows an inverse relationship between price and quantity demanded of a commodity. Thus the normal slope of a

demand curve is negative which explains relationship between price of a commodity and its quantity demanded


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In the law of demand the term "other things being equal"is very important. It means all the factors except price which

can cause a change in demand of a commodity. These factors are explained as assumptions of the law of demand. While

explaining the law of demand we assume all these factors as constant.

ASSUMPTIONS:Following are the important assumptions of law of demand.

1: Income remains same

An increase or decrease in the income of consumer may cause a change in demand for a commodity at the same price

On the other hand demand of a commodity may remain unchanged after the change in price because of a change in

income of consumer.

2: Prices of related commodities

Changes in the prices of substitutes and complements also affect the demand of a commodity. For example the increase

in price of Coke may lead to increase in the demand of Pepsi even though the price of Pepsi has not changed.

3: Fashion and Taste

The demand of a commodity that becomes a part of fashion and becomes popular with the people may not fall with an

increase in its price, therefore fashion and taste are considered to be constants.

4: New Commodities

If new cheaper substitutes of a commodity become available in the market then the demand of the commodity may fall at

the same constant price.

5. Expectations

The future expectations for the prices of the commodity may affect the demand at present. For example if people expect

an increase in the price of ghee they may increase demand of ghee at present prices.

6: Population

An increase in population causes increase in the demand at the same prices therefore it is assumed that population

remains constant.Any other psychological and physical factors, other than price that may cause a change in demand is included in phrase

"Other things."Any change in other things causes a shift in demand curve and therefore assumed as constant for the

purpose of defining law of demand.

EXCEPTIONS:A normal demand curve shows an inverse relationship between price and quantity demanded and it always slopes

downwards from left to right. Any exception to this will be a demand curve which has a positive slope and shows a

direct relationship between price and quantity demanded. This happens in the case of Giffen goods.These are a specia

type of inferior goods for which demand increases with increase in price and decreases with a decrease in price, so in

this case demand curve slopes upward from left to right. This is shown in the following diagram.

Exceptional Demand Curve

An exceptional demand curve slopes upward and it shows increase in demand of a good due to increase in its price and

vice versa.


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CHANGES IN DEMAND

Q #2 Distinguish between a "rise and fall " and an "extension and contraction" in demand.

Ans:

Demand for a commodity may change due to following two reasons.

(1) Changes in price(2) Changes in other thingsEconomists use different terms to make a difference between these two types of changes in demand. Following is the

explanation of these two types of changes in demand.

(1) Changes in demand due to changes in the price of the commodity

The changes in demand due to changes in price are called expansion or contraction in demand. These are explained as

under.

(i) Expansion in demand

Increase in demand of a commodity due to decrease in its price is called expansion in demand. Expansion in demand is

also called Increase in quantity demanded

(ii) Contraction in demand

Decrease in demand of a commodity due to increase in its price is called contraction in demand. Contraction in demandis also called Decrease in quantity demanded

When changes in demand are related to price then these change of demand are on the same demand curve and are called

movement on a demand curve.

The changes in demand due to price can be explained with following table and diagram

Table

Px Qx

1 10

2 8

3 6

4 4

5 2

This table relates changes

in demand to changes in

price. When price of the

commodity is Rs.1, its

demand is 10 units and

when price increased to Rs.

5 the demand for the

commodity contracted to 2units. On the other hand

this

table also shows that when price of a good falls, its demand expands.

We can draw a diagram to explain these changes in demand due to change in price.

In this diagram DD is the demand curve which shows different quantities of demand against various prices. The negative

slope of demand curve shows that quantity demanded of the commodity changes inversely with its price, and this change

in demand is along the same demand

curve. This is why it is called movement on the demand curve.


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(2) CHANGES IN DEMAND DUE TO CHANGES IN OTHER THINGS

The changes in demand due to changes in other things are called rise or fall in demand. These are explained as under

(i) Rise in demand

Increase in demand of a commodity due to changes in other things is called rise in demand. Rise in demand is also called

Increase in demand

(ii) Fall in demand

Decrease in demand of a commodity due to changes in other things is called fall in demand. Fall in demand is also called

Decrease in demand

When changes in demand are related to other things then these changes in demand are not on the same demand curve

rather the demand curve shits right ward or left ward.

The changes in demand due to change in other things can be explained with following table and diagram

This table explains the Rise and Fall in demand due to change in other things. The column Q shows changes in demand

due to change in price whereas the column Q1 shows Rise in demand because the demand for the commodity has

increased against the same prices. The last column Q2 shows fall in demand because the demand for the commodity has

decreased against the same prices and this is due to some changes in other things.

TableP Q Q1 Q2

1 10 12 8

2 8 10 6

3 6 8 4

4 4 6 2

5 2 4 0

We can draw a diagram to explain these changes in demand due to change in other things.

Diagram

In this diagram when price of the commodity is Rs. 3 the demand is 6 units, but when at the same price demand

increased to 8 then we get a new demand curve D2D2 on the right side. Similarly when demand falls to 4 at the same

price we get a new demand curve D1D1 on the left side of original demand curve DD. It is clear from the diagram tha

when demand of a commodity changes due to some change in other things, it causes shift of the demand curve. A rise in

demand shifts the demand curve rightward and a fall in demand shifts the demand curve leftward.

The factors due to which demand curve shifts leftward or rightward are called the shifts factors. These include income

fashion, taste, population etc.


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SUPPLY AND LAW OF SUPPLYQ #5 What is supply? Explain the law of supply.

Ans: In economics the term supply has a special meaning. It can be defined in the following words

"Amount of a commodity or service which seller are willing and able to sell at a given price during a given period oftime."

While discussing supply it is appropriate to differentiate between the concepts of stock and supply.

Difference between supply and stock:Supply means the quantity of a good which sellers are willing to sell at a given price and stock means quantity of a

commodity which exists in the market but not offered for sale at some given price. Stock may or may not be equal to

supply.

LAW OF SUPPLYThe law of supply states a relationship between price and quantity supplied. It states that

"Other things being equal the quantity supplied of a commodity extends with a rise in its price and contracts with a

fall in its price."

In other words the quantity supplied changes directly with price. The law of supply explains a definite relationship

between the price of a commodity and its quantity supplied. The law of supply can be explained with the help of

following table.

Table

P Q

1 2

2 4

3 6

4 85 10

The table shows that

when price is Rs. 1,

quantity of supply is 2

and when price

increased to 5 the

quantity supplied

increased to 10, thusthe table shows that

quantity supplied of a commodity changes directly with its price

The law of supply can also be explained with the help of following diagram.

In this diagram, price is taken on Y- axis and quantity

supplied is measured on X-axis. SS is a supply curve that

slopes upward from left to right. It shows a direct

relationship between price and quantity supplied.

Thus the normal slope of a supply curve is positive which explains relationship between price of a commodity and its

quantity supplied In the law of supply the term "other things being equal"is very important. It means all the factors

except price which can cause a change in supply of a commodity. These factors are explained as assumptions of the law

of supply. While explaining the law of supply we assume all these factors as constant.


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ASSUMPTIONS:Following are the important assumptions of law of supply.

1: Prices of factors of production

If there is a change in the prices of the factors then supply of a commodity may change ate the same constant price. E.g.

an increase in wages of labour may cause of decrease in supply of a commodity at the same price.

2: Changes in technology

When better technology is available then it becomes possible to increase the supply of a commodity at the same constan

price, because with improvement of technology the cost of production usually decreases.

3: Changes in Weather

Supply of agricultural products usually changes with changes in weather. When weather is suitable for agriculture then

more output is obtained and therefore supply of agricultural goods increase otherwise supply may decrease.

4: Discovery of New natural resources

If new natural resources are discovered then supply of these products increases at the same price. e.g if new oil reserves

are discovered then supply of oil will increase.

5: Taxes

Production activities and supply of different goods very much depends upon the system of taxation. If heavy taxes are

imposed on production of different goods then their supply may decrease. On the other hand concession in tax may help

to increase supply at the same price.

CHANGES IN SUPPLY

Q #6 Distinguish between a "rise and fall " and an "extension and contraction" in Supply.

Ans:

Supply for a commodity may change due to following two reasons

(1) Changes in price

(2) Changes in other things

Economists use different terms to make a difference between these two types of changes in supply. Following is the

explanation of these two types of changes in supply.

(1) CHANGES IN SUPPLY DUE TO CHANGES IN THE PRICE OF THE COMMODITYThe changes in supply due to changes in price are called expansion or contraction in supply. These are explained as

under.

(i) Expansion in supply

Increase in supply of a commodity due to increase in its price is called expansion in supply. Expansion in supply is also

called Increase in quantity supplied

(ii) Contraction in supply

Decrease in supply of a commodity due to decrease in its price is called contraction in supply. Contraction in supply is

also called Decrease in quantity supplied

When changes in supply are related to price then these changes of supply are on the same supply curve and are

called movement on a supply curve.


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The changes in supply due to price can be explained with following table and diagram.

Table

Px Qx

1 2

2 4

3 6

4 8

5 10

This table relates changes in

supply to changes in price. When

price of the commodity is Rs.1,

its supply is 2 units and when

price increased to Rs. 5 the

supply for the commodity

extended to 10 units. On the

other hand this

table also shows that when price of a good falls, its supply contracts and vice versa.

We can draw a diagram to explain these changes in supply due to change in price.

Diagram

In this diagram SS is the supply curve which shows different quantities of supply against various

prices. The positive slope of supply curve shows that quantity supplied of the commodity changes

directly with its price, and this change in supply is along the same supply curve

This is why it is called movement on the supply curve.

(2) CHANGES IN SUPPLY DUE TO CHANGES IN OTHER THINGS.The changes in supply due to changes in other things are called rise or fall in supply. These are explained as under

(i) Rise in supply

Increase in supply of a commodity due to changes in other things is called rise in supply. Rise in supply is also called

Increase in supply

(ii) Fall in supply

Decrease in supply of a commodity due to change in other things is called fall in supply. Fall in supply is also called

Decrease in supply

When changes in supply are related to other things then these change of supply are not on the same supply curve

but we get a different supply curve on the right or left side of the original supply curve therefore this is called shift of a

supply curve.

The changes in supply due to change in other things can be explained with following table and diagram

Table

P Q Q1 Q2

1 2 4 0

2 4 6 2

3 6 8 4

4 8 10 6

5 10 12 8

This table explains the Rise and Fall in supply due to change in other things. The column Q shows changes in supply due

to


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change in price whereas the column Q1 shows Rise in supply because the supply for the commodity has increased agains

the same prices. The last column Q2 shows Fall in supply because the supply for the commodity has decreased against

the same prices and this is due to some changes in other things.

We can draw a diagram to explain these changes in demand due to change in other things.

Diagram

In this diagram when price of the commodity is Rs. 3 the supply is 6 units, but when at the same price supply increased to

8 then we get a new supply curve S1S1 on the right side of the previous supply curve. Similarly when supply falls to 4 a

the same price we get a new supply curve S2S2 on the left side of original supply curve SS. It is clear from the diagramthat when supply of a commodity changes due to some change in other things, it causes a shift of the supply curve. A rise

in supply shifts the supply curve rightward and a fall in supply shifts the supply curve leftward.

The factors due to which supply curve shifts leftward or rightward are called the shifts factors. These include technology

prices of factors, weather etc.

MARKET EQUILIBRIUM

Q #8 What is market price? How is it determined?

Ans:The equality of demand and supply operating together establish market equilibrium. A market means buyers and

sellers of a commodity or service who can contact with one another. In competitive markets there are large number ofbuyers and sellers and no one can individually fix the market price of a product by deciding to buy or not to buy, sell or

not to sell the commodity. In this case the price is determined by the interaction of demand and supply.

Definition of Market Equilibrium.

The equilibrium of market can be defined in the following words.

Market is in equilibrium when quantity demanded of a commodity becomes equal to quantity supplied at some

price.

Graphically the market equilibrium is determined at a point where demand curve of a commodity intersects its supply

curve.

The relation of demand and price is explained as law of demand as given below. If other things do not change then quantity demanded of a commodity changes inversely with its price

This is further explained in the following table and diagram.


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Price Qd

1 10

2 8

3 6

4 4

5 2

The table shows that quantity demanded of a commodity changes inversely with its price. When price is 1, the quantity

demanded is 10 and when price is Rs. 5, the Qd is decreased to 1 unit. In the diagram the demand curve slopes

downward from left to right and it also shows that quantity demanded of a good changes inversely with price.

The relation of supply and price is explained as law of supply as given below.

If other things do not change then quantity supplied of a commodity changes directly with its price

This is further explained in the following table and diagram

Price Qs

1 2

2 4

3 6

4 8

5 10

The table shows that quantity supplied of a commodity changes directly with its price. When price is 1, the quantity

supplied is 2 and when price is Rs. 5, the Qs is 10. In the diagram the supply curve slopes upward from left to right and

it also shows that quantity supplied of a good changes directly with its price.

Explanation of Market EquilibriumA market is in equilibrium when quantity demanded is equal to quantity supplied or market is in equilibrium at a point

where demand curve of a commodity intersects its supply curve.

The equilibrium of market can be explained with the help of following table and diagram

Table

Price Qd Qs

1 10 2

2 8 4

3 6 6

4 4 8

5 2 10

The table shows that when price of the commodity increases its demand decreases, while the quantity supplied increases

with increase in price and vice versa. The equilibrium price is Rs. 3 where demand of the commodity is exactly equal to

supply and both are equal to 6. Any price less than 3 shows that demand is more than supply and this results in increase

in price and as a result changes in demand and supply.

On the other hand all prices more than 3 show more market supply than demand. In both the case price is not stable. Only

at price 3, demand is equal to supply and there is no tendency of demand or price to change.

The equilibrium of market is further explained with the help of following diagram. This diagram is constructed with the

help of above table. Diagram


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In the diagram equilibrium of the market takes place at point E where supply curve (SS) intersects demand curve

(DD). Thus equilibrium price is determined at 3 and equilibrium quantity is 6. At any price more than equilibrium

price there is excess supply in the market and for any price less than equilibrium price there is excess demand in the

market. Both excess demand or excess supply create instability or changes in price, demand and supply. Only at point E

market demand is equal to market supply showing the position of stability. Thus 6 is equilibrium quantity and 3 is

equilibrium price.


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ELASTICITY OF DEMAND

Q #1 Explain the concept of elasticity of demand. How is it measured?

Ans: In general terms elasticity refers to a measure of responsiveness of one variable to a change in other variable.

Price Elasticity of DemandPrice elasticity of demand may be defined in the following words.

The degree of responsiveness of quantity demanded of a good to a change in its price

The following mathematical definition of elasticity of demand can be used to calculate elasticity of demand.

"The ratio of the percentage change in quantity demanded to the percentage change in price."

This definition is expressed in the form of following formula.

DEGREES OF ELASTICITY OF DEMANDThere are two extreme values of elasticity of demand. If a very small changes in price brings about an infinite change in

quantity demanded the elasticity of demand is said to be infinity. On the other hand if quantity demanded does no

respond to any change in price then the elasticity of demand is said to be zero. In practice, elasticity of demand falls

between these two extremes.

(1) Elasticity of Demand is equal to Unity

If the percentage change in quantity demanded is equal to percentage change in price then Ed=1

(2) Elasticity of Demand is greater than Unity

If the percentage change in quantity demanded is more than percentage change in price then Ed>1

(3) Elasticity of Demand is less than Unity

If the percentage change in quantity demanded is less than percentage change in price then Ed


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Price Demand Expenditure Elasticity

4 2 8

2 4 8 Ed=1

The table shows that before and after the change in price of the commodity, total expenditure of consumer on the

commodity remain same i.e. Rs. 8, therefore elasticity of demand is equal to unity or 1.

In the diagram areas X and Y show expenditure of consumer

before and after change in price and it is same before and after

change in price, therefore demand curve shows elasticity of

demand equal to unity.

(b) Elasticity Of Demand Is Greater than Unity

If total expenditure of person on a commodity increases due to decrease in its price and total expenditure decreases due

to increase in its price then elasticity of demand of this commodity for the person will be greater than unity.This is explained in the following table and diagram.


4 2 8

2 6 12 Ed>1

The table shows that at price Rs. 4, expenditures are 8 and at price 2 expenditures are 12, therefore elasticity of demand

of the commodity is greater than 1.

In the diagram areas X and Y show expenditure of

consumer before and after change in price. Area Y is

greater than area X Thus the demand curve showselasticity of demand greater than unity.

(c) Elasticity Of Demand Is Less than Unity

If total expenditure of person on a commodity decreases due to decrease in its price and total expenditure increases due

to increase in its price then elasticity of demand will be less than unity. This is explained in the following table and

diagram.


4 2 8

2 3 6 Ed


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In the diagram areas X and Y show expenditure of consumer

before and after change in price. Area Y is less than area X

therefore demand curve shows elasticity of demand less than

unity.

(II) PROPORTIONATE METHODIn this method the elasticity of demand is calculated by using the following formula.

If answer of this calculation is 1 the elasticity of demand is equal to unity. In case the answer is more than one the

elasticity for the commodity is greater than unity or more elastic and if answer is less than one then elasticity of demand

is less than unity.

Two different types of mathematical formulas are used for calculating elasticity with this method.

(1) Formula for point Elasticity

When elasticity of demand is measured for a very small change in price and a resultant change in demand, it is called

point elasticity of demand. In this case elasticity of demand is measured on one point of a demand curve and therefore i

is called point elasticity of demand.

Following mathematical formula is used for measurement of point elasticity.

In this formula Q is change in demand and Q is the first demand. Similarly P is change in price and P is the firstprice.

(2) Formula for arc elasticity

When elasticity of demand is measured for a big change in price and a resultant change in demand, it is called Arc

elasticity of demand. In this case elasticity of demand is measured between two distinct points on a demand curve and

therefore it is called arc elasticity of demand.

Following mathematical formula is used to measure arc elasticity.

In this formula Q1 is the first quantity of demand and Q2 is the second quantity of demand. Similarly P1 is the first priceand P2 is the second price of the commodity.

FACTORS OR DETERMINENTS OF ELASTICITY:Following are some of the factors that determine the elasticity of demand.

1. Importance Of The Commodity

Demand for necessities of life is usually less elastic i.e., their demand does not change much with changes in price. eg

demand for Roti. On the other hand the elasticity of demand for luxuries is more elastic. eg. Demand for Pepsi or Coke.

2. Number Of Uses

Demand for commodities having many uses is elastic. eg., demand for electricity, iron, coal etc. If price of such

commodities rises, people will leave less important uses of it and if price falls the commodity may be put to other new

uses.


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3. Price Level Of A Commodity

Demand for very high and very low priced commodities is usually inelastic. eg. salt, diamonds.

4. Number OF Substitutes

Demand for commodities having many substitutes is usually more elastic. eg demand for any one type of tooth paste is

more elastic because when its price increases people will use other types of cheaper substitutes.

5. Nature Of Commodity

Demand for the durable commodities is more elastic than the perishable commodities. For example demand for furniture

is more elastic and demand for eggs is less elastic.

6. Share In Total Expenditure

Demand for a commodity would be inelastic if the total sum spent on a commodity forms only a small part of a persons

total income, e.g. elasticity of demand for match boxes.

Elasticity of demand also varies with changes in income, fashion and conventions. Thus there are many factors which

explain why there are variations in the elasticity of demand.

TYPES OF ELASTICITY OF DEMAND

Q #2 What are different types of elasticity of demand

Ans:

Elasticity of demand may be defined as degree of responsiveness of demand due to a change in some related variable.

Following are three common types of elasticity of demand.

(1) Price elasticity of demand

(2) Income elasticity of demand

(3) Cross price elasticity of demand

These types of elasticity of demand are discussed as under:

1. Price Elasticity Of Demand.Price elasticity of demand or commonly known as elasticity of demand is defined as

" The degree of responsiveness of quantity demanded of a commodity to a change in its price"

In other words price elasticity of demand is equal to proportionate change in demand for a commodity divided by

proportionate change in its price. This is written in terms of formula as under.

Two different types of mathematical formulas are used for calculating price elasticity of demand.

(i) Formula for point Elasticity

When elasticity of demand is measured for a very small change in price and a resultant change in demand, it is called

point elasticity of demand.

Following mathematical formula is used for measurement of point elasticity.


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In this formula Q is change in demand and Q is the first demand. Similarly P is change in price and P is the first

price.

(2) Formula for arc elasticity.

When elasticity of demand is measured for a big change in price and a resultant change in demand, it is called Arc

elasticity of demand. Following mathematical formula is used to measure arc elasticity

In this formula Q1 is the first quantity of demand and Q2 is the second quantity of demand. Similarly P1 is the first price

and P2 is the second price of the commodity.

Price Elasticity for Necessity and Luxury goods

The goods for which price elasticity of demand is less than unity are calledNecessitiesand the commodities for which

price elasticity is greater than unity are called luxuries.

2. INCOME ELASTICITY OF DEMANDIncome elasticity of demand can be defined in the following words.

" The measure of relative responsiveness of demand of a commodity due to a change in income of consumer is

called income elasticity of demand."

In other words income elasticity of demand is equal to:

Income elasticity of demand can be calculated by using following mathematical formoula:

Where Q is initial quantity demanded and Q is change in demand. M is initial income M is change in

income.

INCOME ELASTICITY FOR NORMAL AND INFERIOR GOODS

The sign of coefficient of income elasticity of demand makes a difference between the so called normal and inferiorgoods.

(i) Normal Goods

When the sign of the coefficient of income elasticity is positive then the good is called a normalgood.

In this case demand of the commodity increases with increase in the income and decreases with decrease in income of

consumer.

(ii) Inferior Goods

When the sign of the coefficient of income elasticity is negative then the good is called an inferior good.

In this case demand of the commodity increases with decrease in income and decreases with increase in income of

consumer.


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3. CROSS ELASTICITY OF DEMAND.Demand of a commodity may change due to change in the price of some related commodity. Related commodities may

be substitutes or complements of each other. The cross elasticity of demand is thus defined as:

"The degree of responsiveness of demand of one commodity due to a change in the price of related commodity."

In other words cross elasticity of demand between two commodities X and Y is equal to:

Following mathematical formula is used to calculate cross elasticity of demand.

Where Qx is initial quantity demanded of X commodity and Qx is change in demand of X. Whereas Py is

initial price of Y and Py is change in price of Y.

CROSS ELASTICITY FOR SUBSTITUTES AND COMPLEMENT GOODS

The sign of the coefficient of cross elasticity is important to determine the relationship between two commodities.

(i) Substitutes

When the sign of coefficient of cross price elasticity is positive, it shows that the goods are substituteof each other.

In this case, a rise in the price of one commodity causes an increase in the demand of the other commodity and vice

versa.

For example a rise in the price of Pepsi may cause an increase the demand of Coke.

(ii) Complements

When the sign of coefficient of cross price elasticity is negative, it shows that the goods are complementsof each other.

In this case, a rise in the price of one commodity causes a decrease in the demand of the other commodity and vice

versa.

For example a rise in the price of ink may result in a decrease in the demand of fountain pens.

ELASTICITY OF SUPPLY

Q #3 Explain the concept of elasticity of supply. How is it measured?

Ans: Elasticity of supply refers to the change in supply in response to a given change in price.

Elasticity of Supply

Elasticity of supply may be defined in the following words.

The degree of responsiveness of quantity supplied of a good to a change in its price

The following mathematical definition of elasticity of supply can be used to calculate elasticity of supply.

"The ratio of the percentage change in quantity supplied to a percentage change in price."


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This definition is expressed in the form of following formula.

Degrees of Elasticity of supplyThere are two extreme values of elasticity of supply. If a very small change in price brings about an infinite change inquantity supplied then the elasticity of supply is said to be infinity. On the other hand if quantity supplied does no

respond to any change in price then the elasticity of supply is said to be zero. In practice, elasticity of supply falls

between these two extremes.

(1) Elasticity of Supply is equal to Unity

If the percentage change in quantity supplied is equal to percentage change in price then Es=1

(2) Elasticity of Supply is greater than Unity

If the percentage change in quantity supplied is more than percentage change in price then Es>1

(3) Elasticity of Supply is less than UnityIf the percentage change in quantity supplied is less than percentage change in price then Es


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Market Research Approaches To Demand EstimationMany market research approaches are used for estimation of demand. Following are the most important

of these.

1. Consumer surveys and Observational Research

2. Consumer clinics, and

3. Market experiments.

Here we briefly examine these methods and point out their advantages and disadvantages and the

conditions under which they might he useful to managers and economists.

1. Consumer Surveys and Observational Research


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Consumer surveys involve questioning a sample of consumers about how they would respond to particular

changes in the price of the commodity, incomes, the price of related commodities, advertising expenditures,

credit incentives and other determinants of demand. These surveys can be conducted by simply stopping and

questioning people at a shopping center or by administering sophisticated questionnaires to a carefully

constructed representative sample of consumers by trained interviewers.

In theory, consumer questionnaires can provide a great deal of useful information to the firm. In fact, theyare often very biased because consumers are either unable or unwilling to provide accurate answers. For

example, do you know how much your monthly butter consumption would change if the price of butter rose by

10 cents per 100 gms.? If a butter producer doubled its advertising expenditures? If the fat content of butter were

reduced by 1 percent? Even if you tried to answer these questions as accurately as possible, your reaction migh

be entirely different if actually faced with any of the above situations. Sometimes consumers provide a response

that they deem more socially acceptable rather than disclose their true preferences.

Depending on the size of the sample and the elaborateness of the analysis, consumer surveys can also be

expensive.

Because of the shortcomings of consumer surveys, many firms are supplementing or supplanting consumersurveys with observational research. This refers to the gathering of information on consumer preferences by

watching them buying and using products. For example, observational research has led some automakers to

conclude that many people think of their cars as art objects that are on display whenever they drive them.

Observational research does not, however, render consumer surveys useless. Sometimes consumer surveys are

the only way to obtain information about possible consumers' responses. For example, if a firm is thinking of

introducing a new product or changing the quality of an existing one, the only way that the firm can test

consumers' reactions is to directly ask them since no other data are available. From the survey, the researcher

then typically tries to determine the demographic characteristics (age, sex, education, income, family size) of

consumers who are most likely to purchase the product. The same may be true in detecting changes in consumertastes and preferences and in determining consumers' expectations about future prices and business conditions.

Consumer surveys can also be useful in detecting consumers' awareness of an advertising campaign by the firm.

Furthermore, if the survey shows that consumers arc unaware of price differences between the firm's product

and competitive products, this may be a good indication that the demand for the firm's product is price inelastic.

2. Consumer Clinics

Another approach to demand estimation is consumer clinics. These are laboratory experiments in which the

participants are given a sum of money and asked (to spend it in a simulated store to see how they react to

changes in the commodity price, product packaging, displays, price of competing products, and other factorsaffecting demand. Participants in the experiment can be selected so as to closely represent the socioeconomic

characteristics of the market of interest. Participants have an incentive to purchase the commodities they want

the most.

The, consumer clinics are more realistic than consumer surveys. By being able to control the environment

consumer clinics also avoid the pitfall of actual market experiments which can be ruined by extraneous events.

Consumer clinics also have serious shortcomings, however. First, the results are questionable because

participants know that they are in an artificial situation and that they are being observed. Therefore, they are not

very likely to act normally, as they would in a real market situation. For example, suspecting that the researchers

might be interested in their reaction to price changes, participants are likely to show more sensitivity to price

changes than in their everyday shopping. Second, the sample of participants must necessarily be small because


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unit #2 demand analysis

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