DEMAND ANALYSIS

INTRODUCTION:
Demand in common means the desire for an object. The demand becomes effective only it if
is backed by the purchasing power in addition to this there must be willingness to buy a
commodity.
DEMAND DEFINITION:
“Demand means the various quantities of goods that would be purchased at a particular price
and not merely the desire of a thing.”
Demand is the desire backed by ability to buy and willingness to buy.
The demand for a good at a given price, is the quantity of it that can be bought per unit of
time at the price.
There are three important things about the demand: Quantity, price and Time
For instance, the demand is stated as, say, 90 litres of milk per month or 3 litters of milk per
day.

LAW OF DEMAND:
Law of demand shows the relation between price and quantity demanded of a commodity in
the
market. In the words of Marshall, “the amount of demand increases with a fall in price and
diminishes with a rise in price”. The law of demand may be explained with the help of the
following demand schedule.
Demand Schedule.
When the price falls from Rs. 10 to 8 quantity demand increases from 1 to 2. In the same way
as price
falls, quantity demand increases on the basis of the demand schedule we can draw the
demand curve.

Price of Apple (In. Rs.) Quantity Demanded

10 1
8 2
6 3
4 4
2 5
The demand curve DD shows the inverse relation between price and quantity demand of

apple. It is downward sloping.

Assumptions:
Law is demand is based on certain assumptions
1. This is no change in consumers taste and preferences.
2. Income should remain constant.
3. There should be no substitute for the commodity
4. The commodity should not confer at any distinction
5. The demand for the commodity should be continuous
6. People should not expect any change in the price of the commodity

Market demand and individual demand

EXCEPTIONS TO THE LAW OF DEMAND:
1. Giffen paradox:
The Giffen good or inferior good is an exception to the law of demand. When the price of an
inferior
good falls, the poor will buy less and vice versa. For example, when the price of rice falls, the
poor are willing to spend more on superior goods than on rice. if the price of rice increases,
he has to increase the quantity of money spent on it.
2. Veblen or Demonstration effect:
‘Veblan’ has explained the exceptional demand curve through his doctrine of “conspicuous
consumption”. Rich people buy certain good because it gives social distinction or prestige for
example diamonds are bought by the richer class for the prestige.
the practice of buying and using goods or services that are more expensive, higher quality, or
in greater quantity than is practical, in order to display wealth or social status

3. Ignorance:
Sometimes, the quality of the commodity is Judge by its price. Consumers think that the
product is superior if the price is high. As such they buy more at a higher price.
4.Speculative effect:
If the price of the commodity is increasing the consumers will buy more of it because of the
fear that it increases still further, Thus, an increase in price may not be accomplished by a
decrease in demand. In an inflationary situation, prices rise fast and the buyers anticipate
further rise in prices. So, they rush to the market to purchase additional quantities of goods
required.
 In a depression or 'Even a recessionary situation, prices decline and, in anticipation of
further decline in prices, people may postpone purchases of goods and take advantage of the
fall in prices
5. Fear of shortage:
During the times of emergency of war People may expect shortage of a commodity. At that
time, they may buy more at a higher price to keep stocks for the future.
6.Necessaries:
In the case of necessaries like rice, vegetables etc. people buy more even at a higher price.

FACTORS EFFECTING THE DEMAND:

▪ Price of the Commodity:
The relation between price and demand is called the Law of Demand. It is not only the
existing price but also the expected changes in price, which affect demand.
▪ Income of the Consumer:
The second most important factor influencing demand is consumer income. The demand for a
normal commodity goes up when income rises and falls down when income falls. But in case
of Giffen goods the relationship is the opposite.
▪ Prices of related goods:
The demand for a commodity is also affected by the changes in prices of the related goods
also. Related goods can be of two types:
(i). Substitutes which can replace each other in use; for example, tea and coffee are
substitutes. The change in price of a substitute has effect on a commodity’s demand in the
same direction in which price changes. The rise in price of coffee shall raise the demand for
tea;
(ii). Complementary foods are those which are jointly demanded, such as pen and ink. If the
price of pens goes up, their demand is less as a result of which the demand for ink is also less.
The price and demand go in opposite direction. The effect of changes in price of a
commodity on amounts demanded of related commodities is called Cross Demand.
▪ Tastes of the Consumers:
The amount demanded also depends on consumer’s taste. Tastes include fashion, habit,
customs, etc.
A consumer’s taste is also affected by advertisement. If the taste for a commodity goes up, its
amount
demanded is more even at the same price. This is called increase in demand. The opposite is
called decrease in demand.
▪ Population:
Increase in population increases demand for necessaries of life. A change in composition of
population
has an effect on the nature of demand for different commodities.
▪ Government Policy:
Government policy affects the demands for commodities through taxation. Taxing a
commodity increases its price and the demand goes down. Similarly, financial help from the
government increases
the demand for a commodity while lowering its price.
▪ Expectations Price in the future:
If consumers expect changes in price of commodity in future, they will change the demand at
present
even when the present price remains the same. Similarly, if consumers expect their incomes
to rise in
the near future they may increase the demand for a commodity just now.
▪ Climate and weather:
The climate of an area and the weather prevailing there has a decisive effect on consumer’s
demand. In
cold areas woollen cloth is demanded. During hot summer days, ice is very much in demand.
On a rainy
day, ice cream is not so much demanded.

Movement along demand curve vs shift in demand curve

Change in quantity demanded due to change in price of a good alone, are called as
extension or contraction of demand represented by movement along the same demand curve
Change in demand or shifts in demand curve or increase or decrease in demand take place
on account of determinants other than price such as changes in income, fashion, tastes, etc.
other factors than price influence demand and the impact of these factors on demand is
described as changes in demand or shifts in demand, showing increase or decrease in demand

ELASTICITY OF DEMAND
Elasticity of demand explains the relationship between a change in price and consequent
change in
amount demanded.
Elastic demand: A small change in price may lead to a great change in quantity demanded.
In this case,
demand is elastic.
In-elastic demand: If a big change in price is followed by a small change in the quantity
demanded, then the demand in “inelastic”.

Types of Elasticity of Demand:

1. Price elasticity of demand:
Marshall was the first economist to define price elasticity of demand.
Price elasticity of demand measures changes in quantity demand to a change in Price.
It is the ratio of percentage change in quantity demanded to a percentage change in price.
𝑷𝒓𝒊𝒄𝒆 𝒆𝒍𝒂𝒔𝒕𝒊𝒄𝒊𝒕𝒚 =𝒑𝒓𝒐𝒑𝒐𝒓𝒕𝒊𝒐𝒏𝒂𝒕𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒕𝒉𝒆 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚
𝒅𝒆𝒎𝒂𝒏𝒅 𝒐𝒇 𝒄𝒐𝒎𝒎𝒐𝒅𝒊𝒕𝒚/
𝒑𝒓𝒐𝒑𝒐𝒓𝒕𝒊𝒐𝒏𝒂𝒕𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒕𝒉𝒆 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇
𝒄𝒐𝒎𝒎𝒐𝒅𝒊𝒕𝒚

% chnge ∈quantity demanded

Ep=
%change∈ price
 Change∈Quantity
X 100
Original Quantity
Ep=
Change∈ Price
X 100
Original Price

Change∈Quantity Original Price

Ep= X
Original Quantity Change∈ price

Δq p
Ep= X
Δp q
Ep = Price Elasticity
q = Original quantity
p = Original Price
Δ = Change

Q- The price of a commodity decreases from Rs 6 to 4 and QD increases from 10 to 15. Find
out co-efficient of price elasticity.
Q- a 5% fall in the price of a good leads to 15% rise in its demand. Find out co-efficient of
price elasticity.
Q – the price of a good decreases from 100 to 60 per unit. Price elasticity for the good is 1.5
and the original quantity demanded is 30 units. Calculate new quantity demanded.
Q- qd by a consumer at price 9 per unit is 800 units. Its price falls by 25 % and quantity
demanded rise by 160 units. Calculate its price elasticity of demand.

There are five cases of price elasticity of demand

▪ Perfectly elastic demand
▪ Perfectly inelastic
▪ Relatively elastic demand
▪ Relatively inelastic demand
▪ Unitary demand
2. Income elasticity of demand:
Income elasticity of demand shows the change in quantity demanded as a result of a change
in income.
Income elasticity of demand may be slated in the form of a formula.
𝑖𝑛𝑐𝑜𝑚𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 =𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑
𝑜𝑓 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦/
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑖𝑛𝑐𝑜𝑚𝑒

% chnge ∈quantity demanded

Ei =
%change∈income
Δq y
Ep= X
Δy q
Ei = Income Elasticity
q = Original quantity
y = Original income
Δ = Change

Car type price Quantity (No)

New 6.5 lakhs 4000
Used 60,000 4000

during the previous year other things remaining the same the real income of the customers
rose
an average by 10%. During the last year sales of new cars increased to 5000, but sales of
used cars declined to 3850
what is the income elasticity of demand for new as well as used cars? What is your inference?

3. Cross elasticity of Demand:

A change in the price of one commodity leads to a change in the quantity demanded of
another
commodity. This is called a cross elasticity of demand. The formula for cross elasticity of
demand is:
cross 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 =𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑜𝑓
𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 𝑥/
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 price of commodity y

% chnge ∈quantity demanded of x

Ec =
%change∈ price of y
Δ qx p y
Ec = X
Δ p y qx
Ei = Income Elasticity
q = Original quantity
y = Original income
Δ = Change

Q- the cross-price elasticity between two goods X and Y is known to be -0.8 if the price of
good Y rises by 20% how will the demand for X change?
Q the price of 1kg of tea is rs 30. At this price 5 kg of tea is demanded. If the price of coffee
rises from 25 to 35 per kg. the quantity demanded of tea rises from 5kg to 8 kg. find out the
cross elasticity of tea.
Q- the price of 1 kg sugar is rs 50. At this price 10 kg is demanded. if the price of tea falls
from 30 to 25 per kg. the consumption of sugar rises from 10 kg to 12 kg. find out the cross-
price elasticity and comment on its value.
a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea
When the price of coffee increases, Quantity demanded of tea increases. Both are substitutes.
Price of Coffee

b. In case of compliments; cross elasticity is negative. If increase in the price of one

commodity leads to a decrease in the quantity demanded of another and vice versa.
When price of car goes up from OP to OP1, the quantity demanded of petrol decreases from
OQ to OQ1
The cross-demand curve has a positive slope in case of substitutes goods and negative
slope in case of complementary goods.

4. Advertisement elasticity of Demand:

A change in the advertisement cost for a commodity leads to the change in the quantity
demanded for a commodity.
𝐴𝑑𝑣𝑒𝑟𝑡𝑖𝑠𝑒𝑚𝑒𝑛𝑡𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 =
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 quantity demanded 𝑜𝑓
𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦/
𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 advertisement of commodity

% chnge∈quantity demanded
EA=
%change∈ spending on advertising
ΔQ A
EA= X
ΔA Q

Measures of elasticity of demand:

A. Perfectly elastic demand:
When small change in price leads to an infinitely large change is quantity demand, it is called
perfectly
elastic demand. In this case (E=∞)
The demand curve DD1 is horizontal straight line. It shows the at “OP” price any amount is
demand and if price increases, the consumer will not purchase the commodity.
B. Perfectly Inelastic Demand
In this case, even a large change in price fails to bring about a little or no change in quantity
demanded.

When price increases from ‘OP’ to ‘OP’, the quantity demanded remains the same. In other
words the
response of demand to a change in Price is nil. In this case (‘E’=0)

C. Relatively elastic demand:

Demand changes more than proportionately to a change in price. i.e. a small change in price
loads to a very big change in the quantity demanded. In this case (E > 1). This demand
curve will be flatter.
When price falls from ‘OP’ to ‘OP1’, amount demanded increase from “OQ’ to “OQ1’ which
is larger than the change in price.
D. Relatively in-elastic demand.
Quantity demanded changes less than proportional to a change in price. A large change in
price leads to small change in amount demanded. Here (E < 1) Demanded carve will be
steeper.

When price falls from “OP’ to ‘OP1 amount demanded increases from OQ to OQ1, which is
smaller than the change in price.

E. Unit elasticity of demand:

The change in demand is exactly equal to the change in price. When both are equal E=1 and

elasticity if said to be unitary.

When price falls from ‘OP’ to ‘OP1’ quantity demanded increases from ‘OQ’ to ‘OQ1’.
Thus, a change in price has resulted in an equal change in quantity demanded so price
elasticity of demand is equal to unity.

SIGNIFICANCE OF ELASTICITY OF DEMAND

The concept of elasticity is very useful to the producers and the policy makers. It is very
valuable tool to decide the extent of increase or decrease in price for a desired change in the
quantity demanded for the products and services in the firm or the economy.
The following are its applications
a. To fix the prices of factors of production.
b. To fix the prices of goods and services provided rendered
c. To formulate or revise govt policies.
d. To forecast demand
e. To plan the level of output and price.
1. Prices of factors of production:
The factors of production are land, labour, capital and organization and technology. we need
to pay
rent, wages, interest, profits and price for the factors of production.
2. Price fixation:
The manufacturer can decide the amount of prices that can be fixed for his product based on
the concept
of elasticity, if the manufacturer is monopoly, the manufacturer is free to fix as long as it does
not attract
the attention of the govt. If the demand for the product is inelastic, he can fix a higher price.
3. Govt policies
I. Tax policies: Govt extensively depends on this concept to finalise its policies relating to
the taxes and revenue, where the product is such that the people cannot postpone its
consumption, the govt tend to increase the prices. Eg: Petrol prices.
II. Raising bank deposits: If the govt wants to attract larger deposits from the customers, it
proposes to raise the rates of fixed deposits marginally and vice versa.
III. Public Utilities: Govt uses the concept of elasticity in fixing charges for the public
utilities such as electricity tariff, water charges.
IV. Revaluation or devaluation of currency: The govt has to study the impact of
revaluation and devaluation on the interests of the exporter and importer.
4. Forecasting Demand:
The trade can estimate the quantity of goods to be sold at different income levels to raise the
targeted revenue. The impact of changing income levels on the demand of the product can be
assessed with the help of income elasticity.
5. Planning the level of output and price:
It helps the producer to evaluate whether a change in price will bring in adequate revenue or
not, in general for items whose demand is elastic, it would benefit him to charge relatively
low prices. If the demand for the product is inelastic, a little higher price may be helpful to
him to get huge profits without losing sales

Factors affecting elasticity of Demand

1. Availability of substitute: in the case of close substitutes like any brand of car or soft
drinks, the elasticity can be very high (i.e. People may switch to substitutes). But the
products which do not have close substitutes the elasticity will be less.
2. Position of commodity in the income budget: greater spent on that commodity,
higher the elasticity and vice versa.
3. Number of uses to which a commodity can be put. When the price of multi used
item decreases the elasticity will be high like milk.
4. Consumer habits: habitual consumer will buy irrespective of the price (less elastic)
5. Tied demand: if the demand on a product is connected with other product like printer
and cartridge the demand of such items will be less elastic compared to autonomous
products.
6. Price range: products with high price range and lower price range are less elastic
compared to middle range price items.
Law of Diminishing Marginal Utility

Utility is a physiological fact that implies the want satisfying power of a good or service. It
differs from person to person, as it relies on a person's mental attitude.
Marginal utility can be defined as a measure of relative satisfaction gained or lost from an
increase or decrease in the consumption of that good or service
“The law of diminishing marginal utility states that, “as a consumer consumes more and
more units of a specific commodity, utility from the successive units goes on
diminishing”

These assumptions are –

• Various units of goods are homogenous.
• There is no time gap between consumption of the different units.
• Consumer is rational (So aims at maximization of utility of the product)
• Tastes, preferences, and fashion remain unchanged.
• Consumers possess perfect knowledge of the price in the market
• No price change
• Utilities of different commodities are independent of each other

Total Utility and marginal utility

Positive marginal utility
A type of marginal utility that occurs when additional consumption of a good or service
increases the total level of satisfaction is called positive marginal utility
Zero marginal utility
A type of marginal utility that occurs when additional consumption of a good or service does
not change the total level of satisfaction is called zero marginal utility
Negative marginal utility
A type of marginal utility that occurs when additional consumption of a good or service
decreases the total level of satisfaction is called positive marginal utility

Approaches to Utility

Many traditional economists proposed a view that utility is measured quantitatively like
length, height, weight, temperature, etc. This concept is termed a Cardinal Utility. On the
other hand, Ordinal Utility expresses the utility of a commodity in terms of more than or less
than i.e. it cannot be expressed in numerical terms.

Why does the Demand Curve slope downwards?

The demand curve is only a geometrical representation of the law of demand with quantity
demanded in the horizontal axis and price in the vertical axis; hence the shape of the demand
curve has to be one
of downward slope, showing that more quantity is demanded at a lower price. This shape is
explained by the following causes:
1. Operation of the Law of Diminishing Marginal Utility: It is in consonance with the law
of diminishing marginal utility that the law of demand operates. In fact, the Law of Demand
is only a corollary from the Law of Diminishing Marginal Utility. Even though an average
consumer does not measure exactly the marginal utility, he is no doubt influenced by the fact
that additional expenditure on a given commodity yields him lesser and lesser satisfaction or
utility as he purchases more and more
units of it. The consumer will never pay for a good more than the money value of its
marginal utility to him. It is clear, therefore, that he will not purchase a large quantity
unless the price is low.
2. Operation of the Principle of Different uses: There are certain commodities which have
several uses. If the price of that good is too high, the demand will be restricted to that purpose
which the consumer considers to be the most important. When the price falls, the good will
be utilised in less important uses and as a result the demand will rise. To give an example,
when the electricity charge is very high, it will be used for lighting only. As it becomes
cheaper, it will be used for fans, air-conditioners, refrigerators, cooking range etc.
3. New purchasers: If the price of a good falls, some people who were unable to purchase
it would now be able to buy it. Therefore, the new purchasers will add to the total demand
4. Income Effect: A decline in the price of a good gives rise to an increase in the consumers’
real income. He can, therefore, buy more of the good. On the other hand, a rise in the price of
a good results in a fall in his real income. Hence, he will buy less of the good. Generally, a
consumer does not spend a major portion of his income on any single good and so the income
effect is not very strong. However, in the case of any single essential good in whose purchase
the buyer spends a large part of his income, the income effect will be very strong.
5. Substitution Effect: The decline in the price of a good not followed by a decline in the
prices of its substitutes makes the good more attractive to the consumers. They now use more
of the good and this leads to an extension or expansion of its demand. Thus, the substitution
effect operates.
The contrary is also valid. The change in the demand for a good, caused by a change in
price is the combined result of these two effects. Normally the substitution effect will be
stronger than income effect because the consumer would not prefer the same good; rather
he would go in for other goods.
Consumer surplus
Proposed by Alfred Marshall
Consumers demand is affected by the utility they derive from the product.
If the consumer gains more utility from a product or service, he is ready to pay more and
vice versa.
The consumer surplus is the difference between the total amount the consumer is willing
and able to pay and the actual amount he pays for the product or service.
It is also called consumer welfare.

Consumer surplus according to Marshall

So when the price decreases the consumer surplus increases, and vice versa.
Indifference curve (iso-utility curve or equal utility curve)
all the combination of two goods which gives the consumer same level of satisfaction.
Consumer is indifferent to any combination in a indifference curve, because all give same
satisfaction

a consumer having 12 units of food and one unit 1 cloth, he is asked about how much unit of
food he will sacrifice for one unit of additional cloth.

diminishing marginal rate of substitution. Marginal rate of substitution = dy/dx

Indifference map
A set of indifference curves
Higher indifference curve gives higher satisfaction

Properties of indifference curve

1. Indifference curve slopes downwards to the right.
When the amount of one commodity is increased the amount of the other commodity
is to be decreased.
2. ICs are always convex to the origin
Due to the diminishing marginal rate of substitution.
Intensity of want of additional unit decreases.

Two extreme cases of indifference curve

a) Indifferent curve of perfect substitutes:
 Here consumer willing to exchange one unit of x for one unit of y.
 Indifference curve of perfect substitutes is a straight line.
 MRS of perfect substitute is constant.

b) Indifference curve of perfect complements

 Two good are perfect complement when consumer prefers them in equal proportion.
Eg. Right shoe and left shoe
 An extra right shoe without left shoe is waste for him. Which will not add utility for
him.
 So the indifference curve for perfect complements will be two straight line with a
right angle ie. L shaped
 The MRS is undefined in the case of perfect complements as the consumer will not
substitute one for another.
 A- Perfect substitutes. B- Perfect complements

3. A higher-level indifference curve yields higher level of satisfaction than lower

4. Indifference curves can never intersect each other
5. Indifference curve will not touch either axis
It is assumed that consumer wants both of the commodities either in the smaller or
larger quantities
Budget line
Consumer always prefer the higher Indifference curve, because it gives the higher
satisfaction.
but has a budget constrain. (limited income)
the budget line shows various combination of two goods that consumer can afford to buy
with his given money income and price of the two goods.
the budget constraint for two goods
Px Qx + Py Qy = B
(100*5) + (50*10) = 1000
(100*7) + (50*6) = 1000
Slop of budget line = Px/Py
 A shift line budget line can happen due to
1. A change in the price of the products, as nominal income (budget) of the
consumer remains the same.
2. A change in the nominal income of the consumer, as the price remains the same.
3. Change in both price of the products and nominal income of the consumers.

Consumer equilibrium
A consumer is in equilibrium position when he deriving maximum satisfaction from the
purchase, so he is not willing to change the pattern of consumption.
To find out the equilibrium of a consumer for buying two goods, the budget line and
indifference map is brought together.
As there is budget constraint, consumer is forced to stick on to the budget line. So, he choice
of consumption will be based on two criteria:
1. It will be a point on budget line.
2. It will be a point on the highest indifference curve.

Assumptions
1. The consumer has a given indifference map. Which shows his scale of preference for various
combination of goods.
2. He has a fixed money income which he has to spend holly on goods X and Y.
3. Prices of goods X and Y are given and are fixed.
4. All goods are homogeneous and divisible and
5. Consumer acts rationally and maximises his satisfaction.