Demand and Supply Analysis.pptx

Unit-II
Demand and Supply Analysis: Concept of Demand in economics --- Demand
Function and Law of Demand --- Marshall’s Cardinal View --- Determinants
of Demand -Advertising and Consumer Tastes-Population-Consumer
Expectations- -Consumer Surplus, Concept and Various kinds of Elasticity of
demand, Supply Function --Supply Shifters-Input Prices-Technology --The
Supply Function -Producer Surplus --- Elasticity of Supply, Changes in
Demand-Changes in Supply-Simultaneous Shifts in Supply and Demand,
Applications of Demand and Supply Analysis, price ceiling and price floor

Meaning of demand, Demand
equation, Factors affecting demand

Meaning of demand
Introduction
Demand and supply are two most fundamental concepts in
economics. Demand conveys a wider and definite meaning than in the
ordinary usage. Ordinarily, demand to you would mean your desire to
buy something, but in economic sense it is something more than a
mere desire. It is interpreted as your want backed up by your
purchasing power. Further demand is per unit of time such as per day,
per week etc. Moreover, it is meaningless to mention demand without
reference to price. Considering all these aspects the term demand can
be defined in the following words, “Demand for anything means the
quantity of that commodity, which is desired to be bought, at a given
price, per unit of time.”

Example: Suppose price of a pen is ` 10 per unit of time. At this price,
people are willing to buy 100 units of that pen at a specific point of
time. So, it is the demand for that pen.

Demand for a commodity refers to the quantity of the commodity
which an individual household is willing and able to purchase per unit of
time at a particular price.
Demand for a commodity implies:
1. Desire to acquire it,
2. Willingness to pay for it, and
3. Ability to pay for it.
Demand has a specific meaning. As stated earlier, mere desire to
buy a product is not demand.

Example: A miser’s desire for and his ability to pay for a car is not
demand because he does not have the necessary will to pay for it.
Similarly, a poor man’s desire for and his willingness to pay for a car is
not demand because he does not have the necessary ability to pay
(purchasing power).
One can also think of a person who has both the will and
purchasing power to pay for a commodity, yet this is not demand for that
commodity if he does not have desire to have that commodity.

Demand for a commodity has to be stated with reference to
time, its price and that of related commodities, consumer’s income and
taste, etc. Demand varies with changes in these factors.
Example: As demand for sweets go up, the demand for sugar also
goes up Or as your income increases, you demand for branded clothes
also goes up.

Determinants of Demand
The demand for a commodity arises from the consumer’s willingness
and ability to purchase the commodity. The demand theory says that
the quantity demanded of a commodity is a function of or depends on
not only the price of a commodity, but also on income of the person,
price of related goods – both substitutes and complements – tastes of
consumer, price expectation and all other factors. Demand function is a
comprehensive formulation which specifies the factors that influence
the demand for the product.

Dx = f(Px , Py , Pz , B, A, E, T, U)
Where,
Dx = Demand for item x
Px = Price of item x
Py = Price of substitutes
Pz = Price of complements
B = Income of consumer
E = Price expectation of the user
A = Advertisement expenditure
T = Taste or preference of user
U = All other factors

The impact of these determinants on demand is:
Price effect on demand
Substitution effect on demand
Complementary effect on demand
Price expectation effect on demand
Income effect on demand
Promotional effect on demand

Market Demand
Market demand refers to the demand of all consumers of a good
or service at a given price, with other factors as money income, tastes,
and preferences, prices of other goods constant. It is called ‘market’
demand because it depicts the market situation for a good or service. It
can be graphically obtained by aggregating the individuals’ consumer
demand for a commodity. In simple words, the horizontal summation
of all individual demand curves for a good or service gives you the
market demand curve.

Market Demand Curve
The pre-requisite for drawing a market demand curve is that all
individual demand curves must be known. It is simple to then draw the
market demand curve form the market demand schedule. By summing
the individual demands at different prices, we can get different price-
quantity combinations for the market demand curve.
The law of demand holds for the market demand curve also i.e. it
slopes downwards. If the market size is large, it is possible to take a
small group of representative consumers and multiply their average
quantities by the total number of consumers in the market to obtain
the market demand for that good.

Graphical Representation of Market Demand
Curve

In the graph above, we assume that there are only two
consumers in a market for purposes of understanding. Let them be
Person A and Person B. The individual demand curves for A and B can
be drawn from their choice of consumption at different prices. The
demand curves are drawn in blue and green for A and B respectively.
Note that A demands nothing at prices above Rs. 3 so his demand
curve coincides with the vertical axis. B demands some quantity at
these prices but nothing at Rs. 6. At prices below and equal to Rs. 3,
both consumers demand the good (here, bread).

Law of Demand
The Law of demand explains the functional relationship between price of a commodity and
the quantity demanded of the commodity. It is observed that the price and the demand are
inversely related which means that the two move in the opposite direction. An increase in the price
leads to a fall in quantity demanded and vice versa. This relationship can be stated as “Other things
being equal, the demand for a commodity varies inversely as the price”.

Elasticity of Demand
Elasticity of demand explains how demand changes for change in one
of the factors of demand
% Change in Quantity Demanded
Elasticity of Demand= -------------------------------------------------------
% Change in one of the factors of demand

Change in Quantity
------------------------- ×100
Original Quantity
Elasticity of Demand =_________________________________
Change in one of the factors of demand
---------------------------- ×100
Original one of the factors of demand

∆q Z ∆q Z
ED = ------- × ------- = ------- × -------
q ∆Z ∆Z q
Where
ED: Elasticity of Demand
Q Stands for quantity
Z Stands for factors
∆ Stands for very small change

Price Elasticity of Demand
Price Elasticity of demand explains how demand changes for change in
Price
Price Elasticity of Demand= -------------------------------------------------------
% Change in Price

Change in Quantity
------------------------- ×100
Original Quantity
Price Elasticity of Demand =_________________________________
Change in price
---------------------------- ×100
Original Price

∆q P ∆q P
ED = ------- × ------- = ------- × -------
q ∆P ∆P q
Where
P Stands for Price

Income Elasticity of Demand
Income Elasticity of demand explains how demand changes for change
in income
Income Elasticity of Demand= ------------------------------------------------------
% Change in Income

Change in Quantity
------------------------- ×100
Original Quantity
Price Elasticity of Demand =_________________________________
Change in Income
---------------------------- ×100
Original Income

∆q Y ∆q Y
ED = ------- × ------- = ------- × -------
q ∆Y ∆Y q
Where
Y Stands for Income

Cross Elasticity of Demand
Cross Elasticity of demand explains how demand changes for change in
Other good Price
Price Elasticity of Demand= -------------------------------------------------------
% Change in other good Price

Change in Quantity of X
------------------------- ×100
Original Quantity of X
Cross Elasticity of Demand =_________________________________
Change in price of Y
---------------------------- ×100
Original Price of Y

∆Q x Py ∆Qx Py
ED = ------- × ------- = ------- × -------
Q x ∆Py ∆Py Qx
Where
Qx Stands for quantity
Py Stands for other good Price

Types of Price Elasticity of Demand

1. Perfectly Elastic Demand
Perfectly elastic demand is when the price is constant but there is a
change in the demand i.e. increase or decrease of a commodity. Thus,
the demand curve is parallel to the X-axis.
Here, EP = ∞

2. Perfectly Inelastic Demand
Perfectly inelastic demand is when the demand is constant or
there is no change in the demand of a commodity even if the price
changes i.e. increases or decreases.
Thus, the demand curve is parallel to the Y-axis. Demand for salt
is an example of perfectly inelastic demand.
Here, EP = 0

3. Relatively Elastic Demand
Relatively elastic demand is when the proportionate change in
demand is more than the proportionate change in the price.
In other words, this means that a little change in the price shall
cause more change in demand. Thus, the demand curve slopes
downward from left to right. An example of this is luxury goods.
Here, EP ˃ 1

4. Relatively inelastic demand
Relatively inelastic demand is when the proportionate change in
demand is less than the proportionate change in the price.
In other words, this means that more change in price shall cause
less change in demand. Thus, the demand curve slopes downward from
left to right but is steeper. An example of this is the necessary goods.
Here, EP ˂ 1

5. Unitary Elastic Demand
Unitary elastic demand is when the proportionate change in
demand is equal to the proportionate change in price.
In other words, it means that the change in demand is the same
as the change in price it may increase or decrease.
Thus, the demand curve slopes downward from left to right but
it is a rectangular hyperbola. An example of this is comfort goods.
Here, EP = 1

Cardinal and Ordinal Utility
Cardinal utility gives a value of utility to different options. Ordinal utility
just ranks in terms of preference.

Cardinal Utility is the idea that economic welfare can be directly observable
and be given a value.
• For example, people may be able to express the utility that consumption
gives for certain goods. For example, if a Nissan car gives 5,000 units of
utility, a BMW car would give 8,000 units. This is important for welfare
economics which tries to put values on consumption. For example,
allocative efficiency is said to occur when Marginal cost = Marginal Utility.
• One way to try and put values on goods utility is to see what price they are
willing to pay for a good.
• If we are willing to pay £5,000 for a second-hand Nissan Car, we can infer
we must get 5,000 utils. In other words, the value of cardinal utility is
related to the price we are willing to pay.
• The idea of cardinal utility is important to rational choice theory. The idea
consumers make optimal choices to maximise their utility.

Demand curve showing cardinal utility

• Cardinal utility is an important concept in utilitarianism and neo-
classical economics. Jeremy Bentham talked about utility as
maximising pleasure and minimising pain.
• William Stanley Jevons, Léon Walras, and Alfred Marshall all
developed concepts of utility, usually linked to market prices.
However, proving exact measurement of utility proved elusive.

Ordinal Utility
• In ordinal utility, the consumer only ranks choices in terms of preference
but we do not give exact numerical figures for utility.
• For example, we prefer a BMW car to a Nissan car, but we don’t say by how
much.
• It is argued this is more relevant in the real world. When deciding where to
go for lunch, we may just decide I prefer an Italian restaurant to Chinese.
We don’t calculate the exact levels of utility.
• Carl Menger, an Austrian economist, developed concepts of utility which
rested on ranked preferences.
• In 1906 Vilfredo Pareto in 1906 concentrated on an indifference curve map.
This placed preferences on bundles of goods but did not attempt to say how
much.

Demand Forecasting
Demand forecasting is a combination of two words; the first one
is Demand and another forecasting. Demand means outside
requirements of a product or service. In general, forecasting means
making an estimation in the present for a future occurring event. Here
we are going to discuss demand forecasting and its usefulness.

Usefulness of Demand Forecasting
Demand plays a vital role in the decision making of a business. In
competitive market conditions, there is a need to take correct decision
and make planning for future events related to business like a sale,
production, etc. The effectiveness of a decision taken by business
managers depends upon the accuracy of the decision taken by them.
Demand is the most important aspect for business for achieving
its objectives. Many decisions of business depend on demand like
production, sales, staff requirement, etc. Forecasting is the necessity of
business at an international level as well as domestic level.

Following is the significance of Demand Forecasting
1. Fulfilling objectives of the business
2. Preparing the budget
3. Taking management decision
4. Evaluating performance etc.

Types of Forecasting
There are two types of forecasting:
1. Based on Economy
2. Based on the time period

1. Based on Economy
There are three types of forecasting based on the economy:
• Macro-level forecasting: It deals with the general
economic environment relating to the economy as measured by the Index
of Industrial Production(IIP), national income and general level of
employment, etc.
• Industry level forecasting: Industry level forecasting deals with the
demand for the industry’s products as a whole. For example demand for
cement in India, demand for clothes in India, etc.
• Firm-level forecasting: It means forecasting the demand for a particular
firm’s product. For example, demand for Birla cement, demand for
Raymond clothes, etc.

2. Based on the Time Period
Forecasting based on time may be short-term forecasting and long-term forecasting
• Short-term forecasting: It covers a short period of time, depending upon the
nature of the industry. It is done generally for six months or less than one year.
Short-term forecasting is generally useful in tactical decisions.
• Long-term forecasting casting: Long-term forecasts are for a longer period of
time say, two to five years or more. It gives information for major strategic
decisions of the firm. For example, expansion of plant capacity, opening a new
unit of business, etc.

Q. Which of the following is not correct about demand forecasting?
a) Predicts future demand for a product or service.
b) Based on the past demand for the product or service.
c) It is not based on scientific methods.
d) Helps in the managerial decision making.

Objectives of Demand Forecasting
1. Formulation of Production Policy
2. Regular Supply of Material
3. Maximum Utilization of Machines
4. Regular Availability of Labour
5. Price Policy Formulation
6. Proper Control of Sales
7. Arrangement of Finance
8. To Decide about Production Capacity
9. Labour Requirement
10. Long-Term Finances on Reasonable

Factors Affecting Supply
1. Price of the given Commodity
2. Prices of Other Goods
3. Prices of Factors of Production (inputs)
4. Related supply
5. State of Technology
6. Government Policy (Taxation Policy)
7. Goals / Objectives of the firm
8. Productivity of workers
9. Weather
10. More firms

Law Of Supply
What is the Law of Supply?
The law of supply is the microeconomic law that states that, all
other factors being equal, as the price of a good or service increases,
the quantity of goods or services that suppliers offer will increase, and
vice versa. The law of supply says that as the price of an item goes up,
suppliers will attempt to maximize their profits by increasing the
quantity offered for sale.

Key Takeaways
• The law of supply says that a higher price will induce producers to
supply a higher quantity to the market.
• Supply in a market can be depicted as an upward sloping supply curve
that shows how the quantity supplied will respond to various prices
over a period of time.
• Because businesses seek to increase revenue, when they expect to
receive a higher price, they will produce more.

Understanding the Law Of Supply

Description: Law of supply depicts the producer behavior at the
time of changes in the prices of goods and services. When the price of
a good rises, the supplier increases the supply in order to earn a profit
because of higher prices.
The above diagram shows the supply curve that is upward
sloping (positive relation between the price and the quantity supplied).
When the price of the good was at P3, suppliers were supplying Q3
quantity. As the price starts rising, the quantity supplied also starts
rising.

Exceptions of Law of supply
There are certain circumstances under which the law of supply may not hold true. It means that the price of the
commodity and its supply may not move in the same direction. Thus, the exceptions to the law of supply are as follows
• Closure of business
• Agricultural products
• Monopoly
• Competition
• Perishable Goods
• Rare goods
• Out of fashion goods
• Economic Slowdown
• Immediate requirement of funds

1. Closure of business
When a business is on the verge of closure, the seller may sell
the goods even at low prices in order to clear the stock. Thus, in this
case, the law of supply shall not hold true.
• Browse more Topics under Supply
• Law of supply
• Supply Function
• Movement and Shift of Supply Curve
• Elasticity of Supply

2. Agricultural products
We know that land is a limited resource and thus the agricultural
produce can also not be increased beyond a certain level. Hence, even
if the prices increase the supply cannot be increased.

3. Monopoly
Monopoly is a situation where there is only a single seller of a
commodity. Thus, he is the price maker and has control over the prices.
In such a case, the law of supply may not apply as he may not be
willing to increase the supply even if the prices are high.

4. Competition
When there is a cut-throat competition in the market, the sellers
may sell more quantity of goods even at low prices. This is a situation
where the law of supply will not apply.
5. Perishable Goods
A seller is willing to sell more goods that are perishable in nature
even at low prices because if they remain unsold they will yield
only loss.

6. Rare goods
The goods that are rare such as artistic or precious goods have a
limited supply. The supply of these goods cannot be increased
according to their demand or rising prices.
Thus, even if their price increases their supply cannot be
increased. In this case, also the law of supply shall not apply.

7. Out of fashion goods
The latest goods that are in fashion have high prices. But, the out
of fashion goods have low prices.
The sellers may sell them out of fashion goods even at low
prices. As these will become dead inventory and also in order to realize
the amount invested in the inventory.

8. Economic Slowdown
The businesses pass through different phases and the sellers
have to adapt to these business-related changes. During the
low economic phases, the sellers may not have an advantage of
incremental prices and hence during such tough times, they sell goods
even when they do not witness price rise in order to recover costs. So
the law of supply is not applicable in this case also.

9. Immediate requirement of funds
The seller may face a time when there is in immediate need of
funds. In this situation, he may supply the goods in the market even at
lower prices.

Elasticity of Supply: Types
According to Prof Thomas, “The supply of a commodity is said to
be elastic when as a result of a charge in price, the supply changes
sufficiently as a quick response. Contrarily, if there is no change or
negligible change in supply or supply pays no response, it is elastic.” It
can be calculated by dividing the percentage change in the quantity
supplied with percentage change in the price of a product.

The formula for calculating elasticity of supply (eS) is as follows:
Percentage change in quantity supplied
eS = _________________________________
Percentage change in price
Percentage change in quantity supplied =
New quantity supplied (∆S)/Original quantity supplied (S)
Percentage change in price = New price (∆P)/Original Price (P)
The symbolic representation of elasticity of supply is as follows:
eS = ∆S/S : ∆P/P
eS = ∆S/S * P/∆P
eS = ∆S/∆P * P/S

Types of Elasticity of Supply
The degree of change in the quantity supplied with respect to change
in the price of a product varies in different situations
Following are different types of elasticity of supply
i. Perfectly Elastic Supply
ii. Relatively Elastic Supply
iii. Relatively Inelastic Supply
iv. Unit Elastic Supply
v. Perfectly Inelastic Supply

i. Perfectly Elastic Supply
Refers to a situation when the quantity supplied completely increases or decreases
with respect to proportionate change in the price of a product. In such a case, the
numerical value of elasticity of supply ranges from zero to infinity (eS = 00)This situation is
imaginary as there is no as such product whose supply is perfectly elastic.
Therefore the situation does not have any practical implication. In such a case, the
price remains constant as the price of a product does not affect the quantity supplied. Let
us understand the concept of perfectly elastic demand with the help of an example

ii. Relatively Elastic Supply
Refers to a condition when the proportionate change in the
quantity supplied is more than proportionate change in the price of a
product. In such a case, the numerical value of elasticity of supply is
greater than one (eS>1) For example, if the quantity supplied increases
by 30% with respect to 10% change in the price of a product, it is called
relatively elastic supply. The concept of relatively elastic supply is
explained with the help of an example.

iii. Relatively Inelastic Supply
Refers to a condition when the proportionate change in the
quantity supplied is less than proportionate change in the price of a
product. In such a case, the numerical value of elasticity of supply is
less than one (eS<1). For instance, the elasticity of supply would be less
than unit, if the quantity supplied increases by 20% with respect to
30% change in the price of a product.

iv. Unit Elastic Supply
Refers to a situation when the proportionate change in the
quantity supplied is equal to the
Proportionate change in the price of a product. The numerical
value of unit elastic supply is equal to one (eS=1).

v. Perfectly Inelastic Supply
Refers to a situation when the quantity supplied does not change with
respect to proportionate change in price of a product. In such a case, the
quantity supplied remains constant in all the instances of change in price.
The numerical value of elasticity of supply is equal to zero. This situation is
imaginary as there is no as such product whose
Supply is perfectly inelastic. Therefore, this situation does not have
any practical implication.

Demand and Supply Analysis.pptx

Demand and Supply Analysis.pptx

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