UNIT-II

DEMAND & SUPPLY ANALYSIS

DEMAND:
Demand: In general is the need attached to a particular product or service form consumers.
In economics terminology it refers to the desire for that particular commodity or service on the
part of consumers who are willing to buy and also able to buy that commodity or service
Demand for a product implies:
1. Desire of the consumer to buy the product,
2. Willingness to buy the product and
3. Sufficient purchasing power in his possession to buy the product.
Demand = Desire + Ability to pay + Willingness to pay

DEMAND DETERMINANTS:
All those factors which will have their impact on the demand or increase or decrease demand for
a given product are called demand determinants. They are:
1. Price of the commodity: Demand for a product is inversely related to its price. In other words, if
price rises, the demand falls and vice versa

2. Prices of substitutes: the higher the price of substitute goods, the higher the demand will be for this
good. If the price of coffee rises then demand for tea will increase
3. Prices of Complementary Products: as the price of complements rises, demand for the
complement falls and so too will demand for the good in question. If the price of petrol rises then
demand for cars will fall.
4. Income of the consumer: A rise in a person’s income will lead to an increase in demand; a fall will
lead to a decrease in demand for normal goods. Goods whose demand varies inversely with income
are called inferior goods.
5. Size and composition of the population: The size and makeup of the population affect demand. If
there is a growing population more food is demanded. If the population is stable but is ageing
(young) things that young people need will increase in demand.
6. Tastes and Fashion: Taste and fashion of consumers change significantly. If a product becomes
more fashionable, the demand for it increases and if the same product becomes outdated, the
demand for it will fall.
7. Advertisements and Sales promotion: More advertisements and sales promotions like discounts,
seasonal offers & combo pack will increase demand for goods.
8. Quality of the product: Higher the quality the better the demand for product and vice versa.
9. Season and Weather: Seasons like winter rain and summer will create more demand for various
goods. For example in the summer there will be more demand for ice cream and coolers and less in
winter and rainy seasons.
10. Alternative uses: If a product can be used for more than one use it will have more demand and if it
can be used for specific purpose will have limited demand. For example electricity will be having
more demand.

DEMAND FUNCTION:
The mathematical function explaining the quantity demanded in terms of its various determinants,
including income and price etc.
Mathematical expression of relation between the quantity demanded and its determinants.
Dx = f ( PX, PS, PC, I, T, A, O)
Among all, important demand determinants need to be studies in detail are:
1. Price of the commodity
2. Income of the consumers and

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3. Prices of related goods. (Substitutes and Complementary products)
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 demand increases with a fall in price and diminishes with a rise
in price”.
Demand Schedule:
Price of Apple (In. Rs.) Quantity Demanded
10 1
8 2
6 3
4 4
2 5
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.

The demand curve DD shows the inverse relation between price and quantity demand of apple. It is
downward sloping.
Assumptions: Law of demand is based on certain assumptions:
1. No change in consumer’s income
2. No change in prices of related goods
3. This is no change in consumers taste and preferences.
4. No perfect substitute products
5. No change in fashion
6. No expectation of future price changes
7. No changes in size, age, composition and sex ratio of the population
8. No change in the range of goods available to consumers
9. No change in government policy
10. No change in weather conditions
Exceptions to the Law of Demand (Exceptional demand curve):
The basic feature of demand curve is negative sloping. The law of demand does not apply in
every case and situation. The circumstances when the law of demand does not apply are known as
exceptions to the law. In this case the demand curve has a positive slope. The exceptions are

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 When price increases from OP to Op1 quantity demanded also increases from OQ to OQ1 and
vice versa.
Geffen Paradox: The Geffen goods are inferior goods is an exception to the law of demand. When the
price of inferior good falls, the poor will buy less and vice versa. When the price of maize falls, the poor
will not buy it more but they are willing to spend more on superior goods like meat. Thus fall in price
will result into reduction in quantity. This paradox is first explained by Sir Robert Geffen.
Veblen effect: According to Veblen, rich people buy certain goods because of its social distinction or
prestige. Diamonds and other luxurious articles are purchased by rich people due to its high prestige
value. Hence higher the price of these articles, higher will be the demand. These goods are called
Veblen goods.
Ignorance: Sometimes consumers think that the product is superior or quality is high if the price of that
product is high. As such they buy more at high price.
Speculative Effect: When the price of commodity is increasing, then the consumer buy more of it
because of the fear that it will increase still further.
Fear of Shortage: During the time of emergency or war, people may expect shortage of commodity and
more at higher price to keep stock for future.
Brand Loyalty: When consumer is brand loyal to particular product or psychological attachment to
particular product, they will continue to buy such products even at a higher price.
Festivals, Marriage etc: In certain occasions like festivals, marriage ect., people will buy more even at
high price.
ELASTICITY OF DEMAND

“Marshall” introduced the concept of Elasticity of Demand. Elasticity of demand shows the extent of
change in quantity demanded to a change in price.
In the words of “Marshall”, “The elasticity of demand in a market is great or small as the amount
demanded increases much or little for a given fall in the price and diminishes much or little for a given
rise in Price”
The word Elasticity refers to both elastic & in elastic. I.e. increase or decrease and constant

Elastic demand: It refers to a small change in price may leads to a great change in quantity demanded.
In-elastic demand: If any change in price leads to a small/no change in demand, it is called inelastic.

MEASUREMENT OF ELASTICITY OF DEMAND:

A. Perfectly Elastic Demand ( )

B. Perfectly Inelastic Demand (=0 )
C. Relatively Elastic Demand (>1)
D. Relatively Inelastic Demand (<1)
E. Unity Elasticity Demand (=1)
A. Perfectly elastic demand:
If any product can be sold at a given price or a small change in price leads to an infinitely large
change in quantity demand, it is called perfectly or infinitely elastic demand. In this case E=∞

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 The demand curve DD1 is horizontal straight line. It shows the at “OP” price, any quantity is
demand and if price increases, the consumer will not purchase the commodity.

B. Perfectly Inelastic Demand:

` The response of demand to a change in price is nil or even a large change in price will not
change the quantity demanded.

When price increases/decreases from ‘OP’ to ‘OP 1/OP2’, the quantity demanded remains the same. The
shape of demand curve is vertical. In this case ‘E’=0.
C. Relatively elastic demand:
The proportionate change in quantity demanded is greater than that of price or a small change in
price leads to a large change in demand. (Demand changes more than proportionately to a change in
price). In this case E > 1. This demand curve will be flatter.

When price falls from ‘OP’ to ‘OP1’, quantity demanded increased 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 quantity 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.

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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.

Types of Elasticity of Demand:

There are three types of elasticity of demand:
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertisement or Promotional 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.

Proportionate change in the quantity demand of commodity

Price elasticity = ------------------------------------------------------------------
Proportionate change in the price of commodity
Price elasticity of demand further divided into
a. Perfectly Elastic Demand ( )
b. Perfectly Inelastic Demand (0)
c. Relatively Elastic Demand (>1)
d. Relatively Inelastic Demand (<1)
e. Unity Elasticity Demand (=1)

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 stated in the form of a formula.

Proportionate change in the quantity demanded of commodity

Income Elasticity Ei= -----------------------------------------------------------------------------
Proportionate change in the income of the consumers

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Income elasticity of demand can be classified in to:
.A. Zero income elasticity:
Quantity demanded remains the same, even though money income increases. Symbolically, it
can be expressed as Ei=0. It can be depicted in the following way:

As income increases or decreases from OP to OP1/OP2, quantity demanded never changes.

B. Negative Income elasticity:

If a rise in income leads to a decrease in demand, the good or service has a negative income elasticity of
demand. Negative income elasticity is associated with inferior goods. i.e. Ei< 0.

When income increases demand falls

C. Positive Income elasticity:

If an increase in income leads to an increase in demand, the income elasticity of that good or
service is positive. Positive income elasticity is associated with normal goods.

Positive & Negative income elasticity of demand can be further divided into:

i. Unit income elasticity:

When an increase/decrease in income brings about a proportionate increase/decrease in quantity
demanded, is called unit income elasticity of demand. Ei = 1

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When income increases from OY to OY1, Quantity demanded also increases from OQ to OQ1.

ii. Income elasticity greater than one:

When, an increase/decrease in income brings about a more than proportionate increase/decrease
in quantity demanded is called Income elasticity greater than one. Ei> 1.

It shows high-income elasticity of demand. When income increases from OY to OY 1, Quantity

demanded increases from OQ to OQ1.

iii. Income elasticity less than one:

When, an increase/decrease in income brings about a less than proportionate increase/decrease in
quantity demanded is called Income elasticity greater than one. Ei< 1.

An increase in income from OY to OY1, brings what an increase in quantity demanded from OQ
to OQ1, But the increase in quantity demanded is smaller than the increase in income. Hence, income
elasticity of demand is less than one.

3. Cross elasticity of Demand:

The measure of responsiveness of the demand for a good towards the change in the price of a
related good is called cross elasticity of demand. It is always measured in percentage terms. The
formula for cross elasticity of demand is:

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 Proportionate change in the quantity demand of commodity “X”
Cross elasticity = ------------------------------------------------------------------------------
Proportionate change in the price of commodity “Y”

a.In case of substitutes, cross elasticity of demand is positive. Ex: 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-
demanded
curve has negative
slope.

ADVERTISEMENT or PROMOTIONAL ELASTICITY OF DEMAND:

Advertising elasticity is a measure of an advertising campaign's effectiveness in generating new
sales. It is calculated by dividing the percentage change in the quantity demanded by the percentage
change in advertising expenditures. A positive advertising elasticity indicates that an increase in
advertising leads to an increase in demand for the advertised good or service.

% change in quantity demanded

ADE = ---------------------------------------------------
% change in spending on advertisement

FACTORS INFLUENCING THE ELASTICITY OF DEMAND

Elasticity of demand depends on many factors like

1. Nature of commodity:
Elasticity or in-elasticity of demand depends on the nature of the commodity i.e. whether a commodity
is a necessity, comfort or luxury, normally; the demand for Necessaries like salt, rice etc is inelastic. On
the other hand, the demand for comforts and luxuries is elastic.

2. Availability of substitutes:

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Elasticity of demand depends on availability or non-availability of substitutes. In case of commodities,
which have substitutes, demand is elastic, but in case of commodities, which have no substitutes,
demand is in elastic.
3. Variety of uses: If a commodity can be used for several purposes, than it will have elastic demand.
i.e. electricity. On the other hand, demanded is inelastic for commodities, which can be put to only one
use.
4. Postponement of demand:
If the consumption of a commodity can be postponed, than it will have elastic demand. On the contrary,
if the demand for a commodity cannot be postponed, than demand is in elastic. The demand for rice or
medicine cannot be postponed, while the demand for Cycle or TV can be postponed.
5. Amount of money spent:
Elasticity of demand also depends on the proportion of income spent on different goods. The demand
for those goods on which a negligible amount of the total income of the consumer is spent is said to be
inelastic. Ex: Salt, match box. Even when price of salt or matchbox goes up, demanded will not fall.
Demand is in case of clothing, a consumer spends a large proportion of his income and an increase in
price will reduce demand for clothing. So the demand is elastic.
6. Time:
Elasticity of demand varies with time. Generally, demand is inelastic during short period and elastic
during the long period. Demand is inelastic during short period because the consumers do not have
enough time to know about the change is price. Even if they are aware of the price change, they may not
immediately switch over to a new commodity.
7. Level of Prices:
The demand for high priced commodities is elastic and the low priced goods are said to have inelastic
demand. For example if the price of a color TV falls from Rs 15000 to Rs 5000 the price comes to the
reach of the people, who were unable to buy at the old price can now buy color TV. Thus with a rise or
fall in price the amount demanded of color TV remarkably falls or rise. But if the price of salt raises
from Rs 2.00 to Rs 5.00 it account for no such remarkable fall in the quantity demanded of salt.
8. Durability of Commodities:
The demand for durable commodities is elastic whereas the demand for less durable commodity is
inelastic. Durable commodity is used over a long period of time. Once a durable good is bought the
buyer feels no want of it for a long period of time. Thus the change (rise or fall) in price can't influence
the demand. Thus the demand becomes elastic. On the other hand less durable or perishable goods are
consumed repeatedly. Any change in price affects the demand. Thus the demand for perishable goods is
less elastic.
10. Future expectations about price changes:
The future expectations about the price of any commodity also influence the elasticity of demand for it.
For instance, if the price of any commodity is expected to rise in future, then demand for it said to be
elastic and vice versa
11. Income level: Elasticity of demand depends on income level. The rich and the poor are not equally
affected at the change in price. Poor people are more affected than the rich. Because of high income rich
people buy the same amount of an expensive commodity in response to a rise in price.

ELASTICITY OF DEMAND IN DECION MAKING: (SIGNIFICANCE)

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The concept of elasticity of demand is of much practical importance.

1. Price fixation:
Each seller under monopoly and imperfect competition has to take into account elasticity of demand
while fixing the price for his product. If the demand for the product is inelastic, he can fix a higher
price.
2. Production:
Producers generally decide their production level on the basis of demand for the product. Hence
elasticity of demand helps the producers to take correct decision regarding the level of cut put to be
produced.
3. Distribution:
Elasticity of demand also helps in the determination of rewards for factors of production. For example,
if the demand for labor is inelastic, trade unions will be successful in raising wages. It is applicable to
other factors of production.
4. International Trade:
Elasticity of demand helps in finding out the terms of trade between two countries. Terms of trade refers
to the rate at which domestic commodity is exchanged for foreign commodities. Terms of trade depends
upon the elasticity of demand of the two countries for each other goods.
5. Public Finance:
Elasticity of demand helps the government in formulating tax policies. For example, for imposing tax on
a commodity, the Finance Minister has to take into account the elasticity of demand.
6. Nationalization:
The concept of elasticity of demand enables the government to decide about nationalization of
industries.

DEMAND FORECASTING

Definition:
It is a systematic process of predicting the future demand for a firm’s product. Simply,
estimating the potential demand for a product in the future is called as demand forecasting.
Demand forecasting is the activity of estimating the quantity of a product or service that consumers
will purchase.

Characteristics of good demand forecasting methods:

1. Accuracy: Accuracy is the most important criterion of a demand forecast, even though cent percent
accuracy about the future demand cannot be assured. It is generally measured in terms of the past
forecasts on the present sales and by the number of times it is correct.
2. Plausibility: The techniques used and the assumptions made should be intelligible to the
management. It is essential for a correct interpretation of the results.
3. Simplicity: It should be simple, reasonable and consistent with the existing knowledge. A simple
method is always more comprehensive than the complicated one.
4. Durability: Durability of demand forecast depends on the relationships of the variables considered
and the stability underlying such relationships, as for instance, the relation between price and demand,
between advertisement and sales, between the level of income and the volume of sales, and so on.
5. Flexibility: There should be scope for adjustments to meet the changing conditions. This imparts
durability to the technique.

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6. Availability of data: Immediate availability of required data is of vital importance to business. It
should be made available on an up to date basis. There should be scope for making changes in the
demand relationships as they occur.
7. Economy: It should involve lesser costs as far as possible. Its costs must be compared against the
benefits of forecasts
8. Quickness: It should be capable of yielding quick and useful results. This helps the management to
take quick and effective decisions

Steps in Demand Forecasting

1. Specifying the Objective: The objective for which the demand forecasting is to be done must be
clearly specified. The objective may be defined in terms of; long-term or short-term demand, the
whole or only the segment of a market for a firm’s product, overall demand for a product or only for
a firm’s own product, firm’s overall market share in the industry, etc. The objective of the demand
must be determined before the process of demand forecasting begins as it will give direction to the
whole research.
2. Nature of product: The next important consideration is the nature of product for which you are
attempting a demand forecast. You have to examine carefully whether the product is consumer goods
or producer goods, perishable or durable, final or intermediate demand, new demand or replacement
demand type etc.
3. Determinants of demand: Once you have identified the nature of product for which you are to build
a forecast, your next task is to locate clearly the determinants of demand for the product. Depending
on the nature of product and nature of forecasts, different determinants will assume different degree
of importance in different demand functions.

4. Determining the Time Perspective: On the basis of the objective set, the demand forecast can either
be for a short-period, say for the next 2-3 year or a long period. While forecasting demand for a short
period (2-3 years), many determinants of demand can be assumed to remain constant or do not
change significantly. While in the long run, the determinants of demand may change significantly.
Thus, it is essential to define the time perspective, i.e., the time duration for which the demand is to
be forecasted.
5. Making a Choice of Method for Demand Forecasting: There are several methods of demand
forecasting. Each method varies from one another in terms of the purpose of forecasting, type of data
required, availability of data and time frame within which the demand is to be forecasted. Thus, the
forecaster must select the method that best suits his requirement.
6. Collection of Data and Data Adjustment: Once the method is decided upon, the next step is to
collect the required data either primary or secondary or both. The primary data are the first-hand data
which has never been collected before. While the secondary data are the data already available.
Often, data required is not available and hence the data are to be adjusted, even manipulated, if
necessary with a purpose to build a data consistent with the data required.
7. Estimation and Interpretation of Results: Once the required data are collected and the demand
forecasting method is finalized, the final step is to estimate the demand for the predefined period.
Usually, the estimates appear in the form of equations, and the result is interpreted and presented in
the easy and usable form.

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METHODS OF FORECASTING:
Several methods can be employed for forecasting demand. All these methods can be grouped under
survey method, statistical method and other methods.

I. SURVEY METHODS:

i. survey of Buyers Intentions:

a. Census method: The survey of buyers can be conducted either by covering the whole population o by
selecting a sample group of buyers. If the company consider the opinion of all the buyers, this method is
called census method or total enumeration method. This is most effective method. But it is time
consuming and expensive.
b. Sample method: Instead of total consumers, if the company consider group of consumers to estimate
the demand than this method is called sample method. This method is easy and simple to estimate
demand.
ii. Sales force opinion method: The sales people are those who are in constant touch with the main and
large buyers of a particular market, and hence they constitute another valid source of information about
the likely sales of a product. The sales force is capable of assessing the likely reactions of the customers
of their territories quickly, given the company’s strategy. It is less costly.
This method is appropriate when, Sales persons are likely to be most knowledgeable and the salesmen
are cooperative.

II. STATISTICAL METHODS:

a. Trend line by observation: This method of forecasting trend is elementary, easy and quick as it
involves merely the plotting the actual sales data on a chart and then estimating just by observation
where the trend line lies. The line can be extended towards a future period and corresponding sales
forecast read from the graph.
b. Time series analysis
A well-established firm would have accumulated data. These data are analyzed to determine the nature
of existing trend. Given significantly large data, the cause and effect relationships can be discovered
through quantitative analysis. The following are the four major components analyzed from time series
while forecasting the demand.
Trend (T): also called long term trend, is the result of basic developments in the population, capital
formation and technology over a long period say 5-10 years.
Cyclic Trend (C): wave like movement of sales. The sales data is quite often affected by swings in the
levels of general economic activity, which tend to be somewhat periodic. These could be business
cycles such as inflation, boom recession etc.
Seasonal Trend (S): refers to a consistent pattern of sales movements within the year. More goods are
sold during the festival seasons. The seasonal component may be related to weather factors, holidays
and so on.
Erratic Trend (E): Results from the occurrence of strikes, riots and so on. These erratic components
can even damage the impact of more systematic components and thus make the forecasting process
much more complex.
Classical time series analysis involves procedures for decomposing the original sales series (Y) into the
components T, C, S&I. There are different models in the time series analysis. While one model states
that these components interact linearly, i.e. Y=T+C+S+E, another model states that Y is the product of
all these components i.e. Y=T*C*S*E.

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c. Moving Average Method: This method considers that the averages of past events determine the
future events. As the name itself suggests, under this method, the average keeps on moving depending
up on the number of years selected. Selection of the number of years is the decisive factor in this
method. Moving averages get updated as new information flows in.
d. Exponential smoothing: It is useful for short for forecasts. This method is an improvement over
moving averages method. Unlike in moving averages method, all time periods here are given varying
weights, i.e. the values of the given variable in the recent times are given higher weights and the values
of the given variable in the distant past are given relatively lower weights for further processing. The
reason is that it is assumed that the nearest future is more or less based on the recent past
The formula used for exponential smoothing is: St+1 = c St+ (1-C) Smt
Where
St+1 = exponentially smoothed average for New Year
St = actual data in the most recent past
Smt = most recent smoothed forecast
C = smoothing constant

e. Barometric Technique: Where forecasting based on time series analysis or extrapolation may not
yield significant results, barometric techniques can be made use of. Under the barometric technique, one
set of data is used to predict another set. In other words, to forecast demand for a particular product or
service, use some other relevant indicator (Which is known as a barometer) of future demand.
The demand for cable TV may be linked to the number of new houses occupies in a given area.

III OTHER METHODS:

a. Expert Opinion: Well informed persons are called experts. Experts constitute yet another source of
information. These persons are generally the outside experts and they do not have any vested interest
in the results of a particular survey. An expert is good at forecasting and analyzing the future trends
in a given product or service at a given level of technology.
b. Test Marketing: In test marketing, the entire product and marketing programme is tried out for the
first time in a small number of well-chosen and authentic sales environment. The primary objective,
here is to know whether the customer will accept the product in the present form or not. If sales are
not encouraging in the markets so tested, it is clear that the product has certain defects, which are to
be looked into seriously. The company can work further to identify these defects, correct them and
then test the product again, if necessary. One of the factors determining the success of the test
marketing is the relevance of small market chosen.
c. Controlled Experiments: It refer to such exercises where some of the major determinants of
demand are manipulated to suit to the customers with different tastes and preference, income groups
and so on. It is further assumed that all other factors remain the same. In this method, the product is
introduced with different packages, different process in different market or same markets to assess
which combination appeals to the customer most. This method cannot provide better results unless
these markets are homogeneous in terms of tastes and preferences of the customers, their income and
so on. This method is used to gauge the effect of a change in some demand determinant like price,
product design, advertisement, packaging and so on.
d. Judgmental Approach: When none of the above methods are directly related to the given product or
service, the management has no alternative other than using its own judgment. Even when the above
methods are used, the forecasting process is supplemented with the factor of judgment.

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 SUPPLY

Supply of a commodity refers to the various quantities of the commodity which a seller is
willing and able to sell at different prices in a given market at a point of time, other things remaining the
same. Supply is what the seller is able and willing to offer for sale

Supply Curve: A graphical representation of how much of a commodity a firm sells at different prices.
The supply curve is upward sloping from left to right. The price of the product and quantity supplied are
directly related to each other.

Determinants of Supply:

 Price of the product: Increase in price will increase supply and vice versa.
 Prices of factors of production: When the prices of factors rise, cost of production will increase.
This will result
in a decrease in supply.
 Prices of other products: Any change in the prices of other products will influence the supply. An
increase in the price of other products will influence the producer to shift the production in favour of
that product. Supply of the original product will be reduced.
 Production technology: State of production technology affects the supply function. If advanced
technology is used in the country, large scale production is possible. Hence supply will increase. Old
technology will not increase the supply.
 Number of producers or firms: If the number of producers producing the product increases, the
supply of the product will increase in the market.
 Future price expectations: If producers expect that there will be a rise in the prices of products in
future, they will not supply their products at present.
 Taxes and subsidies: If tax is imposed by the government on the inputs of a commodity, cost of
production will go up. Supply will be reduced. When subsidy is given to the producer, it will
encourage them to produce and supply more. Subsidy means a part of the cost of a commodity will be
borne by the government.
 Non-economic factors: Non-economic factors like, war, political climate and natural calamities
create scarcity in supply.
 Transportation facilities: Better transport facilities will increase the supply.

Supply Function: The supply function is the mathematical expression of the relationship between
supply and those factors that affect the willingness and ability of a supplier to offer goods for sale

Sx = f( P , P , Pf, O…T, t, S)
x y

Where
Sx Supply of products x Py Prices of other products Pf Prices of factors of production
Px Price of product x O External factors T Taxes t Technology S Subsidy

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Law of Supply:

The law of supply establishes a direct relationship between price and supply. Firms will supply
less at lower prices and more at higher prices.

“Other things remaining the same, as the price of commodity rises, its supply expands and as
the price falls, its supply contracts”.

Assumptions to the Law of Supply:

No change in Prices of factors of production

No change in Prices of other products
No change in Production technology
No change in Number of producers or firms
No change in Future price expectations
No change in Taxes and subsidies
No change in Non-economic factors
No change in Transportation facilities

Exceptions to the Law of Supply:

Expectations regarding future prices: When the sellers expect the prices to rise in the future then they
may adopt wait and watch policy and withhold their supply of goods. Even though the price may be
higher the sellers may want to supply the goods when the prices rise even more which would fetch them
good returns. Also if the sellers expect the prices to fall in the coming days then they may sell off their
goods at existing lower prices in order to avoid losses.

Farm produce: In case of farm products it is nothing but a play of climate. Such products may not obey
the law of supply as they may not react to changes in prices due to heavy dependency on weather
conditions.

Perishable commodities: The commodities fall in different classes and not all of them can be stored for a
longer period of time. Certain commodities have very short shelf life and they need to be made available
in the market before they perish. The common examples of perishable goods are fruits, sea produce,
flowers, meat, and vegetables and so on. So for such goods the sellers cannot simply wait for a longer
time and supply these in the market even when the prices are not rising.

Out of fashion goods: When goods are in fashion then the sellers can command a high price. But there
are certain goods that go out of fashion and are no longer in vogue. Such goods are supplied by the
sellers at low prices in order to clear these goods.

Economic Slowdown: The businesses pass through different phases and the sellers have to adapt to these
changes. During the low economic phases the sellers may not have advantage of high prices and hence
during such tough times goods are sold even when they do not witness price rise in order to recover their
costs. So the law of supply is not applicable in this case.

Change in business: It may happen that the seller may plan to enter into an entirely new area of business
by exiting the current one. So when the present business is on the verge of closure then the seller may
sell the goods at lower prices simply to clear them off. So here too the law of supply is not followed.

Immediate requirement of funds: The seller may face a time when he is in immediate need of funds. At
such situation he may supply the goods in the market even at lower prices.

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