BUSINESS ECONOMICS

(22MBACC102)
Module-1
Demand & Supply Analysis

Dr. Salma Begum

 Course Outcome
Sl. Course Description Bloom’s
No. Outcom Taxonomy Level
e
1. CO1 Explain the concepts and theories of demand, Understand (2)
supply, production and cost.

2. CO2 Differentiate competitive market structures Apply (3)

for price-output determination.

3. CO3 Use the theories of demand elasticity in Analyse (4)

business decision making.

4. CO4 Assess performance of business firms through Evaluate (5)

Break-even analysis.

5. CO5 Examine macroeconomic concepts of National Analyse (4)

income, inflation, exchange rate and business
cycle.
 Assessment Scheme (CA: UE - 50: 50)
Sl. Assessment Details Formative / Frequency Weightag CO
No. Summative e

1 Class Participation Formative Continuous 10% CO1, CO2, CO3,

CO4 and CO5

2 Group Assignment: Formative 1 10% CO1, CO3 and

Case study analysis CO4
3 Group Assignment: Mini Formative 1 10% CO2,CO3,
project CO4,CO5

4 Individual Assignment: Formative 1 10% CO1,CO2, CO3,

MCQs-Quiz CO4 and CO5
5 Summative 1 10% CO1, CO2, CO3,
Block End Test CO4 and CO5

6 End Semester Summative 1 50% CO1, CO2, CO3,

Examination (UE) CO4 and CO5
 DEMAND ANALYSIS

Meaning of Demand Analysis:

• Ordinarily, by demand is meant the desire or want for something.

• In economics, it is effective demand i.e. the amount buyers are
willing to purchase at a given price and over a given period of time.
• Ability (i.e. money or purchasing power) and willingness to pay for
it

Demand = Desire + Ability to pay + Willingness to pay

 TYPES OF DEMAND

Individual Demand Firm and industry Joint demand and

demand Composite demand

Total market and Price demand,

Market Demand market segment income demand
demand: and cross demand

Durable and
non-durable
goods demand
 TYPES OF DEMAND
Individual Demand Market Demand
Individual Demand Schedule Market demand Schedule
Price Individual Quantity Demanded Price of Demand Demand Market
1 4 Commodity of person of person Demand
2 3 X (Rs.) (A) (B) Person
3 2 (A+B+……=
4 1 market
demand)
1 4 5 4 + 5= 9
2 3 4 3+4= 7
3 2 3 2+3= 5
4 1 2 1+2= 3
 DETERMINANTS OF DEMAND

Distribution of
Price of the Product State of Business Income and
Wealth

Price of related Advertisement and

goods Future trend of Salesmanship
prices
Inventions and
Innovation
Taste, habit and
Climate and weather
preference of
conditions
consumer
 LAW OF DEMAND

• The Law of demand expresses the relationship between price

and quantity demanded of a commodity.
• According to the law of demand the demand of a commodity
extends with fall in its price and contracts with rise in the
price, other things being constant.
• 'Other things being constant' means that the other determinates
of demand except price remain unchanged.
• it explains the inverse relationship between price and
quantity demanded.
• Statement of law of demand:- “Ceteris paribus, the higher the
price of a commodity, the smaller is the quantity demanded
and lower the price, larger the quantity demanded”.
 DEMAND SCHEDULE

• The law of demand can be illustrated with the help of a demand

schedule.
• The demand schedules shows that with the fall in the price of
the commodity its demand is increasing.

Price of Commodity 'X' (in Quantity demanded of

Rs.) commodity 'X' (in Kgs)

5 10
4 20
3 30
2 40
1 50
 Y

3
Prices of X

1 D

O 10 20 30 40 50 X
Quantities Demanded in X
ASSUMPTION OF LAW OF DEMAND

No change in taste, habits,

preferences No change in taxation

No change in the income level:

No introduction of new product
No change in population

No change in prices of related No change in technology

goods
No change in weather
No expectation of future change conditions
in the price
EXCEPTIONS TO THE LAW OF DEMAND

Prestigious goods/Veblen Effect

Change in Fashion

Giffen goods
Demonstration effect
Ignorance

Snob effect
Speculative goods

Seasonal goods
Conspicuous Necessities
 ELASTICITY OF DEMAND

• According to Alfred Marshall: "Elasticity of demand may be

defined as the percentage change in quantity demanded to the
percentage change in price."
• In other words, it is the percentage change in quantity
demanded divided by the percentage in one of the variables on
which demand depends.
(Q1 – Q2) / (Q1 + Q2)
Ed = (P1 – P2) / (P1 + P2)

Type of Elasticity of Demand :

 PRICE ELASTICITY OF DEMAND
• A measure of the extent to which the quantity demanded of a
good changes when the price of the good changes.
• To determine the price elasticity of demand, we compare the
percentage change in the quantity demanded with the percentage
change in price.
Ep = % change in Qty. dd.
% change in its price

Ep = Δ Q ΔP
Q P
• Where, % change in Quantity Demanded=Q1-Q0/Q0 * 100
• Q1 = Quantity Demanded after the change in the price
• Q0 = Quantity Demanded before the change in the price
• % change in the Price of the product = P1-P0/P0 * 100
• P1= Current Price. P0= Previous Price
 PRICE ELASTICITY OF DEMAND

• For Example: Raju sell Banana for ₹40 a dozen. He sells 50

dozen and decides to charge more. He raises the price to ₹60 a
dozen and sells 40 bananas. In this case, the price elasticity of
demand for Banana will be; Ep = % change in Qty. dd.
% change in its price

Ep = Q1-Q0/Q0 * 100
P1-P0/P0 * 100
40-50/50 * 100
Ep = 60-40/40 * 100

= -0.4
 TYPES OF PRICE ELASTICITY OF
DEMAND
1. RELATIVELY ELASTIC DEMAND
•An elastic demand is one in which the change
in quantity demanded due to a change in price
is large.
•If the price elasticity of demand for a good is
greater than one (Ed >1), the demand is price
elastic.
•Example-Luxury goods, like TVs and
designer brands.
 TYPES OF PRICE ELASTICITY OF
DEMAND
2. RELATIVELY INELASTIC DEMAND
•Relatively inelastic demand is one when the
percentage change produced in demand is
less than the percentage change in the price
of a product. Example- essential goods.
•For example, if the price of a product
increases by 30% and the demand for the
product decreases only by 10%, then the
demand would be called relatively inelastic.
•The numerical value of relatively
elastic demand ranges between zero to one
(ep<1).
 TYPES OF PRICE ELASTICITY OF
DEMAND
3. UNIT ELASTIC DEMAND
•If price elasticity of demand for a
good is equal to one (Ed =1), the
demand is unit price elastic which
means that a change in the price will
lead to the same
percentage/proportionate change in
the quantity demanded.
•Demand is unitarily elastic as shown
in Figure. For example, a 10%
quantity change divided by a 10%
price change is one. This means that a
1% change in quantity occurs for
every 1% change in price.
 TYPES OF PRICE ELASTICITY OF
DEMAND
4. PERFECTLY ELASTIC
DEMAND
•If the price elasticity of demand for a
good is infinity(Ed =∞), the demand
is perfectly price elastic which means Ed =∞
that a rise in the price will lead to an
infinite decrease in the quantity
demanded.
•A good with a perfectly price elastic
demand has a horizontal demand
curve
 TYPES OF PRICE ELASTICITY OF
DEMAND
5. PERFECTLY INELASTIC
DEMAND
•If the price elasticity of demand for a
good is zero (Ed =0), the demand is Ed =0
perfectly price inelastic which means
that a change in the price will not
lead to any change in the quantity
demanded. A good with a perfectly
price inelastic demand has a vertical
demand curve.
 INCOME ELASTICITY OF DEMAND
• The income elasticity of demand is the percentage change in
quantity demanded divided by the percentage change in
income
• ey = Proportionate change in quantity demanded/Proportionate
change in income.
• Income elasticity, may be positive or negative. For most goods
it will be positive, i.e., if income rises, demand for the
commodity also rises, whereas, if income falls, demand for the
commodity falls.
• But, for inferior goods, income elasticity will be negative, i.e.,
if income rises, demand for an inferior good will fall, whereas,
if income falls, demand for an inferior good will rise.
 EXAMPLE OF INCOME ELASTICITY OF
DEMAND
When the consumer’s real income is 40,000, the quantity demanded for
economy seats in the flight are 400 seats. When the consumer’s real income is
increased to 45,000, the quantity demanded decreases to 350 seats. Mr.
Newman wants to study this behavior as an economist student and wants to
know why the seat demand decreased even though there was an increase in the
consumer’s real income. calculate the Income Elasticity of Demand.
– Solution:
• Quantity at Beginning: 400,Quantity at End: 350
• Income Level at Beginning: 40000,Income Level at End: 45000
• Income Elasticity of Demand = (350 – 400) / (350 + 400) / (45000 – 40000) / (45000
+ 40000)
• Income Elasticity of Demand = (-50 / 750) / ( 5000 / 85000 )
• Income Elasticity of Demand = -1
• The Income Elasticity of Demand will be -1.00, which indicates a unitary inverse
relationship between the quantity demanded economy seats of the flight and the
consumer’s real income.
 CROSS ELASTICITY OF DEMAND
• A change in the price of one good can shift the quantity demanded
for another good. If the two goods are complements, like bread and
peanut butter, then a drop in the price of one good will lead to an
increase in the quantity demanded of the other good.
• However, if the two goods are substitutes, like plane tickets and
train tickets, then a drop in the price of one good will cause people
to substitute toward that good, reducing consumption of the other
good. Cheaper plane tickets lead to fewer train tickets and vice
versa.
• Specifically, the cross-price elasticity of demand is the percentage
change in the quantity of good A that is demanded as a result of a
percentage change in the price of good B.
Cross elasticity of demand= %change in quantity demanded of A
%change in price of good B
 TYPES OF CROSS ELASTICITY OF
DEMAND
• Negative
•Positive Complementary
Substitutes • Zero
No relation

For example, a 5 per cent rise in the price of tea might result in a
6 per cent increase in the demand for coffee, in which case cross
elasticity is (6/100) (5/100) = 1.2.
 PROMOTIONAL ELASTICITY OF
DEMAND
It refers to the extent of change in Qty. demanded of a product
due to the change in its advertisement expenditure keeping
other factors constant.
EA = % change in Qty dd ÷ % change in Advertisement Expdr.

= ΔQx Δ PA
Qx PA

= ΔQx PA
Δ PA Qx
 MEASUREMENT OF PRICE ELASTICITY
OF DEMAND
1. Ratio/Percentage Method
2. Total outlay/Total Revenue Method
3. Point/Geometrical Method
4. Arc Method
 PERCENTANGE METHOD

Also known as proportionate method

Ep = % change in Qty dd ÷ % change in Price

= ΔQ ΔP
Q P

= ΔQ P = ΔQ P
Q ΔP ΔP Q
 Numerical practice

1. Let us measure elasticity by moving in the reverse direction.

Suppose the price of A rises from Rs. 3 per kg. to Rs. 5 per kg.
and the quantity demanded falls from 30 kgs. to 10 kgs. Ep =?

2. P1 =Rs. 100 Q1 = 1000 units

P2 = Rs. 150 Q2 = 500 units find Ep.

3. When the price of a commodity was Rs. 10 per unit, its

demand in the market was 50 units per day. When the price of the
commodity fell to Rs. 8, the demand rose to 60 units. Ep=?
 TOTAL OUTLAY METHOD
• Total outlay method, also known as total expenditure method of measuring
price elasticity of demand was developed by Professor Alfred Marshall.
– According to this method, price elasticity of demand can be measured by comparing total
expenditure on a commodity before and after the price change.
– While comparing the revenue/expenditure, we may get one of three outcomes. They are
• Elasticity of demand will be greater than unity (Ep > 1)
– When total expenditure increases with fall in price and decreases with rise in price, the value
of PED will be greater than 1. Here, rise in price and total outlay or expenditure move in
opposite direction.
• Elasticity of demand will be equal to unity (Ep = 1)
– When total expenditure on commodity remains unchanged in response to change in price of
the commodity, the value of PED will be equal to 1.
• Elasticity of demand will be less than unity (Ep < 1)
– When total expenditure decreases with fall in price and increases with rise in price, the value
of PED will be less than 1. Here, price of commodity and total outlay move in same
direction.
 POINT METHOD

Ep = L
A
U
P1

At ‘A’ Ep = ∞ P
At ‘B’ Ep = 0
P2
At ‘P’ Ep= 1
At ‘P1’ Ep > 1
At ‘P2’ Ep < 1 O B
 ARC METHOD
We have discussed the measurement of elasticity at a point on a demand curve.
But when elasticity is measured between two points on the same demand
curve, it is known as arc elasticity.
Prof. Baumol defines, “Arc elasticity is a measure of the average
responsiveness to price change exhibited by a demand curve over some finite
stretch of the curve.”

Any two points on a demand curve make an

arc. The area between P and M on the DD
curve in Figure above is an arc which
measures elasticity over a certain range of
price and quantities. On any two points of a
demand curve, the elasticity coefficients are
likely to be different
 DEMAND FORECAST

• Anticipation of demand implies demand forecasting.

• Demand forecasting refers to estimation or projection of future demand for
goods and services.
• Demand forecasting is the scientific and analytical estimation of demand
for a product or service for particular period of time.
• Demand forecasting is a process of determining what products are needed,
where, when and in what quantities – Customer-focused activity
• The process of demand estimation/forecasting can be broken into two parts
i.e. analysis of the past conditions and analysis of current conditions with
reference to a probable future trend.
• It helps in estimating the most likely demand of a good or service under
given business conditions.
 FEATURES OF DEMAND FORECAST

• Demand Forecasting is a process to investigate and measure the forces that

determine sales for existing and new products.
• It is an estimation of most likely future demand for a product under given
business conditions.
• It is basically an educated and well thought out guesswork in terms of
specific quantities
• Demand Forecasting is done in an uncertain business environment.
• Demand Forecasting is done for a specific period of time (i.e. the sufficient
time required to take a decision and put it into action).
• It is based on historical and present information and data.
• It tells us only the approximate expected future demand for a product based
on certain assumptions and cannot be 100% precise.
 Specifying the Objective

Steps in Demand Forecasting

Determining the time
perspective

Making choice of method of DF

Collection of Data and Data

adjustment

Estimation and Interpretation

of results
 OPINION POLLING METHOD

1. Consumer Survey methods

▪ Survey methods help us in obtaining information about the future
purchase plans of potential buyers through collecting the opinions of
experts or by interviewing the consumers.
▪ These methods are extensively used in short run and estimating the
demand for new products.
▪ There are different approaches under survey methods. They are –
▪ Consumer interview method
▪ Survey of buyer’s intentions or preferences:
▪ Direct Interview Method:
▪ Complete enumeration method
Consumers interview method
▪ Under this method, efforts are made to collect the relevant information
directly from the consumers with regard to their future purchase plans.
▪ In order to gather information from consumers, a number of alternative
techniques are developed from time to time.-
Survey of buyer’s intentions or preferences:
▪ Under this method, consumer-buyers are requested to indicate their
preferences and willingness about particular products.
▪ They are asked to reveal their ‘future purchase plans with respect to
specific items.
Direct Interview Method:
▪ Under this method, customers are directly contacted and interviewed.
Direct and simple questions are asked to them.
Complete enumeration method:
▪ Under this method, all potential customers are interviewed in a particular
city or a region
 OPINION POLLING METHOD (Cont.)
2. Sales Force Opinion Method:
▪ This is also known as collective opinion method. In this method,
instead of consumers, the opinion of the salesmen is sought.
▪ It is sometimes referred as the “grass roots approach” as it is a
bottom-up method that requires each sales person in the company to
make an individual forecast for his or her particular sales territory.
▪ These individual forecasts are discussed and agreed with the sales
manager.
▪ The advantages of this method are that it is easy and cheap.
▪ It does not involve any elaborate statistical treatment.
▪ The main merit of this method lies in the collective wisdom of
salesmen. This method is more useful in forecasting sales of new
products.
 OPINION POLLING METHOD (Cont.)

3. Expert Opinion Polling Method

▪ Apart from salesmen and consumers, distributors, the outside experts
opinion may also be used for forecasting.
▪ Under this method, the salesmen have to report to the head office their
estimates of expectations of sales in their territories.
▪ Such information can also be obtained from retailers and wholesalers
by the company.
▪ In fact, expert opinion poll is very much popularized methods of
demand forecasting in the advanced countries.
▪ Delphi method is expert opinion method.
• Delphi Method
▪ Delphi method of demand forecasting is an extension of the expert
opinion poll method. Olaf Helmer originated the Delphi method in the
late 1940s.
▪ The Delphi method requires a panel of expert or group of experts, who
are interrogated through a sequence of questionnaires in which the
responses to one questionnaire are used to produce the next
questionnaire.
▪ Under this method, a group of experts have been repeatedly questioned
for their opinion/comments on some issues & their agreements &
disagreements are clearly identified.
▪ It is a highly sophisticated statistical method and It is a time saving
device
 STATISTICAL METHOD

▪ Statistical method is used for long run forecasting. Statistical

& mathematical techniques are used to forecast demand.

▪ Statistical methods have been used to explain time-series &

cross-section data for estimating long-term demand.

▪ Statistical methods are considered to be superior techniques of

demand estimation for the following reasons
1. In the statistical methods, the element of subjectivity (baised) is
minimum
2. It is based on the theoretical relationship between the dependent and
independent variables
3. Estimates are relatively more reliable
4. Estimation involves smaller cost
 STATISTICAL METHOD

1. Trend Projection Method:

▪ Many forecasting techniques can help predict future demand for a
product. Trend projection is a technique that uses data from past trends
to project future markets. They are instrumental in retail settings
because they allow retailers and consumers to plan for upcoming
seasons.

▪ The trend can be estimated by using any one of the following methods:
a. The Graphical Method,
b. The Least Square Method
 STATISTICAL METHOD
2. Barometric Technique:
▪ This method is based on the notion that “the future can be predicted
from certain happenings in the present.”
▪ In other words, barometric techniques are based on the idea that
certain events of the present can be used to predict the directions of
change in the future.
3. Regression Analysis:
▪ It attempts to assess the relationship between at least two variables
(one or more independent and one dependent), the purpose being to
predict the value of the dependent variable from the specific value of
the independent variable.
4. Econometric Models:
▪ Econometric models are an extension of the regression technique
whereby a system of independent regression equation is solved.
 SUPPLY ANALYSIS

• In economics, supply means the amount of that commodity

which producers are able to and willing to offer for sale at a
given price.

• Supply analysis is related to the behavior of the producer.

• In the ordinary language supply means the stock of goods &

services in existence.

• One important point worth noting is that supply is related to

scarcity. This means that it is only the scarce goods which
have a supply price.
 FACTORS DETERMINING SUPPLY

• The cost of production

• Weather condition
• Price of related commodities
• The prices of factors production – land , labour & capital
• The goal of producers – profit
• Government policies
• The state of technology – capital intensive or labour intensive
Supply Function: It refers to the functional relationship between
the Supply & its determinants.

Sx = f (Px,Pyz..,C,T,…)
Simplified S f: Sx = f ( Px)
 THE LAW OF SUPPLY
▪ Law of supply explains the relationship between price of a
commodity and its quantity supplied.

▪ Other things remaining the same, as the price of a commodity

rise, its supply increases and as the price falls, its supply
declines.

▪ Price and supply are directly related. A rise in price induces

producers to supply more quantity of the commodity and a fall
in prices, makes them to reduce the supply.

▪ Thus the quantity offered for sale varies directly with price i.e.,
the higher the price, the larger is the supply and vice-versa.
 ASSUMPTIONS OF THE LAW

• The number of firms in the market remains the same.

• The scale of production do not change.
• Market prices of related goods remains constant over a period
of time.
• Cost of Production does not change.
• Climatic conditions remains same.
• Taste and preferences of consumers remains constant.
• Government polices such as taxation policy, trade policy
remains same
• No changes in transport costs
 Y S

4
Prices

O 300 60 900 1,200 X

0
Quantities of Supplied
 INDIVIDUAL SUPPLY SCHEDULE

Prices (per kgs) in Rs Quantities of supplied

4 300
6 400
8 500
10 600
12 700
14 900
 MARKET SUPPLY SCHEDULE OF
PRODUCT
Commodity is identical
Price ( in Rs.) Aggregate of A,
A Firm B Firm C Firm
B, and C

4 300 100 50 450

6 400 200 200 800
8 500 400 300 1200
10 600 500 400 1500
12 700 600 500 1800
14 900 800 750 2450
 MARKET EQUILIBRIUM

• Market equilibrium refers to the stage where the quantity

demanded for a product is equal to the quantity supplied for
the product.

• The price when the quantity demanded is equal to the quantity

supplied for the product is known as equilibrium price.

• Equilibrium price is that price at which quantity demanded is

equal to the quantity supplied at given price – both buyers and
sellers satisfied
EQUILIBRIUM BETWEEN DEMAND AND
SUPPLY
Price of commodities Pressure on price
(price of Rice) Demand Supply

5 12 01
Excess Demand
10 10 02
15 08 04
20 06 06 Equilibrium
25 04 08
Excess Supply
30 02 10
35 01 12
 Y
D
S

Excess Supply

D1 S1
P1

P E

Excess Demand
Price

P2 S2 D2

D
S

O X
Demand & Supply

Graphical representation of equilibrium of demand and supply

If demand > supply there will be shortage
If demand < there will be surplus