This document provides an overview of demand analysis concepts including: - Defining supply, demand, and equilibrium price. - Describing the determinants of demand such as price, income, tastes. - Explaining the concepts of individual demand, market demand, demand curves, and how demand is influenced by price changes versus other factors. - Introducing the key elasticity concepts including price elasticity, income elasticity, and cross elasticity and how they measure responsiveness of demand. The document lays out the essential framework for understanding how the interaction of supply and demand determines market prices in the short and long run.

1. Chapter 2
Demand Analysis

2. Learning Objectives
 Define supply, demand, and equilibrium price.
 List and provide specific examples of non-price
determinants of demand.
 Distinguish between short-run rationing function and
long-run guiding function of price
 Illustrate how concepts of supply and demand can be
used to analyze market conditions in which
management decisions about price and allocations
must be made.
 Use supply and demand diagrams to show how
determinants of supply and demand interact to
determine price in the short and long run

3. Introduction and objectives
Necessity is the mother of invention,
demand is the mother of production.
Demand is essential for creation, survival
and profitability of the firm.
Business decisions such as future
production,inventories of raw materials,
advertisement, setting up of sales outlets
etc depend upon the magnitude of current
and future demand

4. Cont.
Utility is the basis of demand.
Understanding concepts of demand,
demand schedule, demand curve and
demand function.
Characteristics of the LOD, exceptions to
LOD, Individual demand and market
demand.

5. Demand Analysis
 The demand for a commodity is the amount of it
that a consumer will purchase or will be ready to
take off from the market at various given prices
in a period of time.
 Demand is desire backed by ability and
willingness to pay.
 Individual demand is the demand for a good by
a single consumer while market demand is the
sum total of demand by individual consumers for
a particular good at a given price at a given time.

6. Demand Function, Schedule & Graph
 The mathematical representation of the
relationship between demand and its
determinants is called as demand function.
Dx = f(Px) or Dx = f(Px, Py, Y, T, A, -------, n)
 The tabular representation of the quantity
demanded of a good at various possible prices at
a given moment of time is called demand
schedule.
 The diagrammatic representation of the quantity
demanded at various prices is called as a
demand curve.

7. Law of Demand
The inverse
relationship
between price
and the quantity
demanded of a
good or service is
called the Law of
Demand.

8. Law of Demand
 The Law of demand states that other things
being equal if price of a commodity falls, the
quantity demanded of it will rise, and if price of
the commodity rises its quantity demanded will
decline.
 The law of demand indicates an inverse
relationship between price and quantity
demanded.
 It is due to the operation of the law of demand
that the demand curve for a good is downward
sloping.

9. Exceptions to the Law of Demand
The Law of demand has certain exceptions:
Goods having prestige value – Veblen
Effect.
Giffen goods i.e., inferior goods.
Consumer’s psychological bias / illusion.

10. Demand Distinctions
 Individual demand & Market demand
 Demand for consumer goods & Producer goods
 Demand for Perishable goods & Durable goods
 Industry demand & Firm demand
 Autonomous demand & Derived demand
 Joint demand and Composite demand

11. Individual Consumer’s Demand
QdX = f(PX, I, PY, T)
quantity demanded of commodity X
by an individual per time period
price per unit of commodity X
consumer’s income
price of related (substitute or
complementary) commodity
tastes of the consumer
QdX =
PX =
I =
PY =
T =

12. Market Demand
It is Demand for a good or service is
defined as quantities of a good or service
that all people are ready (willing and able)
to buy at various prices within some given
time period, other factors besides price
held constant.

13. Market Demand Curve
 Horizontal summation of demand curves of
individual consumers only when individual
consumers are independent. People however
are influenced by each other’s buying behaviour.
 When consumers tend to buy the same goods
as are possessed by their friends it is known as
Bandwagon Effect.
 Some people do not consumer some goods
because they are consumed by lower status
people. This is known as Snob Effect.

14. Horizontal Summation: From
Individual to Market Demand

15. Determinants of Demand
The determinants of demand are:
 Price of the commodity
 Distribution of income and wealth
 General standard of living and spending habits
 Community’s Scale of preferences
 No. of buyers and growth of population
 Age & Sex composition of population
 Government’s Taxation policy
….contd..

16. Determinants of Demand ….contd..
Innovations and Inventions
Customs & Traditions
Climatic Conditions
Future expectations
Advertisement effect.

17. Extension & Contraction and Increase & Decrease of Demand
 When demand changes
to a change in the price of
the product it is extension
or contraction of demand.
 It is referred as change in
quantity demanded.
 It is represented by
movement along the
demand curve.
 When demand changes to a
change in factors other than
price it is increase or
decrease of demand.
 It is referred as change in
demand.
 It is represented by shifts in
the demand curve.

18. Concept of Network Externalities
 In reality individual demand depends on demand
of other people. This situation is called ‘network
externalities’. This is of 2 types:
 Bandwagon effect – Also called as
demonstration effect wherein demand is
influenced by consumption of trend setters or
pace setters like film stars, models, group
leaders, neighbors, friends etc. E.g., Pepsi,
Cadbury’s, Titan etc.
 Snob Effect – Refers to desire of a person to
own exclusive or unique products. Demand is
purely because of its high price or exclusivity.
E.g., Rolls Royce cars, Ray Ban glasses etc.

19. Producer & Consumer Goods
 Producers’ goods: Machines, tools and
implements, locomotives,etc,.
 Producers’ goods can be classified into
consumables such as coal, oil, etc,. and
durables such as machines and other fixed
assets.
 Determinants of demand for producers’ goods
differ from product to product and to a great
extent demand for such goods depend on the
goods produced with the help of PGs.
 Personal income is displaced by business profits
as one of the important determinant.

20. Contd……
 The demand for cement is dependent on Construction.
 Producers’ goods demand is distinct for:
 Buyers are professionals and hence more discriminating
price wise and sensitive to substitutes.
 The motives are more purely economic as products are
bought for their profit prospects and as such their
purchases are less susceptible to pressure advertising.
 Demand being derived from consumption or from
production, fluctuates more violently.

21. Consumers’ goods
 Used for final consumption they satisfy
consumer wants directly.Example:ready made
garments, shoes,houses,furniture, cars, services
of doctors,.
 Consumer durables, consumer non-
durables.Durable goods utility is not exhausted
in a single shot and are used repeatedly.
 CDs demand sometimes is dependent on the
existence of some facilities.

22. Contd….
 CDs are consumed by more than one
person:Television
 CDs demand is irregular as against CNDs
 For Consumer goods buyers’ income is
important universal determinant.
 The relation of demand to price, advertising,
competition and speculation, expected price
hinges more on the nature of the product.
 Durable goods create replacement demand.

23. Contd….
Non-durables goods on the other hand are
those which can be used only once.
All food items, drinks, cooking fuel belong
to this category.
The demand for such goods depends on
their current prices, consumers’ income
and fashion and is subject to frequent
change.

24. Derived demand(DD) and
autonomous(AD) demand
D D or indirect demand for a product is tied to
parent product.Cement, raw materials, land,
fertilizers, steel, bricks, money etc.
Demand for producers’ goods or industrial goods
is derived demand.
Demand for complementary goods and
supplementary goods is derived demand.
 Derived demand is generally supposed to have
less price elasticity than autonomous demand.It
depends on the AD.

25. Autonomous Demand
AD or direct demand for a commodity is
one that arises on its own directly from the
biological or physical needs of human
beings.
AD may also arise as a result of
demonstration effect, rise in income,
increase in population and advt.

26. Shot-term and long-term demand
 Fashion consumer goods, goods of seasonal
use, inferior substitutes during scarcity of
superior goods have a short term demand.
 Short term demand depends on the price of the
good, price of the substitutes, current disposable
income etc.
 Most generic goods have long term demand.
 For example demand for consumer and
producers' goods, durable and non-durable
goods, though their different varieties or brands
may have only short term demand.

27. Industry demand and company
demand
 Steel Industry vis-à-vis TISCO
 Among companies products are differentiated by
brand names.
 Products are close substitutes.
 Industry demand can be further classified
customer group-wise.
 Market share of individual company is important.
Industry demand gives lead to firm demand

28. Elasticities of Demand
 LOD tells you about the direction but not about
the extent which is however very important from
managerial point of view.
 Manipulating of prices with a view to making
larger profits could be one of the objectives of
firm.
 Due to the increase in input price, increase in
excise duty, sales tax, the firm wants to raise
price and pass on the same to the consumer.
Can it do so.The answer lies with the price
elasticity of the product.

29. The Economic Concept of Elasticity
Elasticity: the percentage change in one
variable relative to a percentage change in
another.
B
in
change
percent
A
in
change
percent
Elasticity
of
t
Coefficien 

30. Elasticity of Demand
Elasticity of demand measures the
responsiveness of demand to a change in
its determinant. Some types of elasticity
are:
Price Elasticity
Income Elasticity
Cross Elasticity &
Promotional or Advertisement Elasticity.

31. The Price Elasticity of Demand
Price elasticity of demand: The
percentage change in quantity demanded
caused by a 1 percent change in price.
Price
%
Quantity
%
E



p

32. Price Elasticity of Demand
 Price Elasticity measures the responsiveness of
quantity demanded to a change in its price.
 ep = Percentage change in quantity demanded
Percentage change in price
 Or = ∆Q x P
Q ∆P
Types of Price Elasticity –
 Perfectly Elastic – ep = ∞ Vertical St. line curve
 Perfectly Inelastic – ep = 0 Horizontal St. line Curve
 Unitary Elasticity – ep = 1 Rectangular hyperbola Curve
 Relatively Elastic – ep > 1 Flatter sloping curve
 Relatively Inelastic – ep <1 Steeper sloping curve

33. The Price Elasticity of Demand
 Arc elasticity: Elasticity which is measured
over a discrete interval of a demand (or a
supply) curve.
 Ep = Coefficient of arc price elasticity
 Q1 = Original quantity demanded
 Q2 = New quantity demanded
 P1 = Original price
 P2 = New price
2
/
)
(
2
/
)
( 2
1
1
2
2
1
1
2
P
P
P
P
Q
Q
Q
Q
Ep







34. The Price Elasticity of Demand
The point elasticity of a linear demand
function can be expressed as:
1
1
Q
P
P
Q




p


35. The Price Elasticity of Demand
 Elasticity differs along
a linear demand
curve.

36. The Price Elasticity of Demand
Factors affecting demand elasticity
Ease of substitution
Proportion of total expenditures
Durability of product
Possibility of postponing purchase
Possibility of repair
Used product market
Length of time period

37. Income Elasticity of Demand
 Income determines purchasing power.
 Price of the product and its substitutes are
significant in the short run.
 Income is important both in the short and long
run.
 Income-demand relationship varies from goods
to goods across inferior, essential, normal
goods, prestige or luxury goods
 Unlike price elasticity which is negative,income
elasticity is positive except for inferior goods.

38. Contd…..
 For essential goods income elasticity is less than
one. For comforts it is unity whereas for luxuries
it is more than one.
 Choice and preference of consumer, time and
their susceptibility to demonstration effect also
effect income elasticity.

39. Income Elasticity
Income Elasticity of Demand: The
percentage change in quantity demanded
caused by a 1 percent change in income.
Y is shorthand for Income
Y
Q
EY



%
%

40. Income Elasticity
Point Definition
 Arc Elasticity
2
/
)
(
2
/
)
( 2
1
1
2
2
1
1
2
Y
Y
Y
Y
Q
Q
Q
Q
EY






/
/
I
Q Q Q I
E
I I I Q
 
  
 

41. Income Elasticity
 Categories of income
elasticity
 Superior goods: EY > 1
 Normal goods: 0 >EY >1
 Inferior goods – demand
decreases as income
increases: EY < 0

42. Income Elasticity of Demand
 Types of Income Elasticity –
 Unitary Income Elasticity – ey = 1 45o upward
sloping curve
 Income Elasticity greater than Unity – ey > 1 Flatter
upward sloping curve
 Income Elasticity less than Unity – ey < 1 Steeper
upward sloping curve
 Zero Income Elasticity – ey = 0 Vertical St. line
curve
 Negative Income Elasticity – ey < 0 Downward
sloping curve

43. The Cross-Elasticity of Demand
Cross-elasticity of demand: The
percentage change in quantity consumed
of one product as a result of a 1 percent
change in the price of a related product.
B
A
X
P
Q
E



%
%

44. The Cross-Elasticity of Demand
Arc Elasticity
2
/
)
(
2
/
)
( 2
1
1
2
2
1
1
2
B
B
B
B
A
A
A
A
x
P
P
P
P
Q
Q
Q
Q
E







45. The Cross-Elasticity of Demand
Point Elasticity
B
B
A
A
X
P
P
Q
Q
E





46. The Cross-Elasticity of Demand
The sign of cross-elasticity for substitutes
is positive.
The sign of cross-elasticity for
complements is negative.
Two products are considered good
substitutes or complements when the
coefficient is larger than 0.5.

47. Promotional or Advertising Elasticity of Demand
It measures the degree of responsiveness
demand to changes in advertising or
promotional expenditure of the firm.
eA = Percentage change in sales
Percentage change in advertisement expenditure
eA = ∆Q x A
Q ∆A