DEMAND ANALYSIS

Meaning of Demand

 The term demand is used in economics in a special

sense. Ordinarily we use terms ‘desire’, ‘want’ and
‘demand’ to convey the same meaning.
 Demand is the quantities that buyers are willing
and able to buy at alternative prices during a given
period of time.
 Economists distinguish between demand and
quantity demanded. Demand is as given above.
Whereas quantity demanded is a specific amount
that buyers are willing and able to purchase at a
given price.
 Purpose of Demand Analysis

 The purpose of the theory of demand is to

determine the various factors that affect demand.
Some of the most important determinants of the
market demand for a particular product are its own
price, price of related commodities, consumers’
tastes, total population, consumers’ wealth, credit
availability, past levels of demand, etc. Demand is
the quantities that buyers are willing and able to
buy at alternative prices during a given period of
time.
 TYPES OF DEMAND

There are different types of demand are available:

1. Direct Demand
 Goods that yield direct satisfaction to the
consumers are said to have a direct demand.
 This demand comes from the consumers side.
 Demand for food, cloth and house etc. are the
examples of direct demand.
 All the finished goods have a direct demand.
 TYPES OF DEMAND

2. Indirect or Derived Demand

 Goods that are needed by the producers are
said to have derived demand.
 This demand comes from the producers side.
 Demand for land, labor, capital, etc. are the
examples of derived demand.
 All factors of production (or inputs) have
derived demand.
 TYPES OF DEMAND

3. Price Demand
Other things remaining constant, it expresses the relationship
between price of a good and its demand.
Dx = f (Px)
4. Income Demand
Other things remaining constant, it expresses the relationship
between income of the consumer and demand of a good.
Dx = f (Y)
5. Cross Demand
Other things remaining constant, it expresses the relationship
between demand for good ‘X’ due to change in price of its related
good ‘Y’.
Dx = f (Py)
 TYPES OF DEMAND
6. Recurring and Replacement Demand
Recurring demand is for goods which are consumed
at frequent intervals such as food items, clothes.
Producers of such goods know that consumers make
purchases on short term basis; hence pricing should be
done accordingly.
Durables, like TVs, bike, mobile phones, watches, etc.,
are purchased to be used for a long period of time. Wear
and tear of such goods over time needs replacement
which is called replacement demand. This type of
demand is also made in industry when capital goods, like
machinery, get obsolete.
 TYPES OF DEMAND

7. Complementary and Competing Demand

Some goods are jointly demanded hence are
complementary in nature, e.g. software and
hardware, car and petrol.
This is similar to cross demand. Some goods
compete with each other for demand because
they are substitutes to each other, e.g. soft drinks
and juices.
 TYPES OF DEMAND

8. Individual and Market Demand

Demand for an individual customer is
normally considered as individual demand. The
theory of demand is based on individual demand.
On the other hand, market demand is the
demand by all the customers for a particular
product. A firm will be interested in market
demand for its product rather than individual
demand.
 Individual and Market Demand

Price Demand of A Demand of B Market

Demand
1 4 5 9
2 3 4 7
3 2 3 5
4 1 2 3
 DETERMINANTS OF DEMAND

The factors which affect the quantity demanded

of a customer.
1. Price of the commodity (Px)
2. Price of the related good (Pr)
3. Income of the consumer (Y)
4. Tastes and preferences of the consumers (T)
5. Future Expectations (E)
6. Advertising (A)
7. Population and Economic Growth (N)
 DEMAND FUNCTION

Demand function is a function which

shows the relationship between demand
various factors that affect it. Hence
demand function can be written as:

Dx = f (Px, Pr, Y, T, E, A, N)
ANY QUERY????
LAW OF DEMAND
 Meaning of Law of Demand

 When other things remaining same, there is inverse

relationship between price and demand of a commodity. In
functional terms it can be written as:
Dx = f(Px)
 However, this relationship is not proportional. It simply
indicates the direction of change in demand as a result of
change in price.
 Assumptions of law of demand are that all the determinants
of demand other than the Px remain unchanged.
 When different prices of a good and quantity of that good
demanded at each of these prices are shown in a tabular
form, then it is called demand schedule, e.g. individual and
market demand schedules.
 Demand Schedule and Individual Demand
Curve

Point e
on
Demand Price of X Demand 35
Curve (in Rs.) (in units) d
30

Price of X
a 15 50 c
b 20 40 25
c 25 30 b
20
d 30 20 a
e 35 10 15
O
10 20 30 40 50
Quantity of X
Law of Demand in the Form of Linear Equation

 The demand curve has a negative slope, which shows that

demand is a negative function of price.
 The relationship between demand and price can be written
in the form of a linear equation as:
Dx = a - bPx where a>0, b>0.
In this linear demand function ‘a’ , a constant, represents
the level of demand when price is zero. The slope ‘b’,
another constant, measures the change in demand per unit
change in price.
 For instance, if b is 10, then one unit increase in the price
will result in a fall in demand by 10 units.
 Meaning of Law of Demand
 If a = 100, b = 10, then find the corresponding levels of
demand for price, given below:

Price Quantity
1 Q = 100 - 10 (1) = 90
2 Q = 100 - 10 (2) = 80
3 Q = 100 - 10 (3) = 70
4 Q = 100 - 10 (4) = 60
5 Q = 100 - 10 (5) = 50
 Market Demand Function

 Suppose, there are two individual demand functions as

below:
D1 = 10 – 2 P
D2 = 15 – 3 P
 Now, the market demand function will be
Dm = (10 – 2P) + (15 – 3P)
Dm = 25 – 5P
 Suppose, a firm wants to sell 20 units of its product. How it
will set the price by using the following demand functions:
D1 = 25 – 1.0 P
D2 = 20 – 0.5 P
D3 = 15 – 0.5 P
 Market Demand Function

 Now, the market demand function will be

Dm = (25 – 1.0 P) + (20 – 0.5 P) + (15 – 0.5 P)
Dm = 60 – 2.0 P

If demand is 20 units, then

20 = 60 – 2.0 P
P = 20

Similarly, the respective demand by each of the three buyers is:

D1 = 5, D2 = 10, D3 = 5
 Market Demand Function
 Three individual demand functions are as follow:
D1 = 30 – 1.0 P, D2 = 25 – 0.5 P, D3 = 45 – 1.5 P
 Suppose, a firm wants to sell 25 units of its product. How it
will set the price by using these demand functions. With
this price also find out the individual demands.
 Solution:
Dm = (30 – 1.0 P) + (25 – 0.5 P) + (45 – 1.5 P)
Dm = 100 – 3.0 P
If demand is 25 units, then
25 = 100 – 3.0 P
P = 25
Similarly, the respective demand by each of the three buyers is:
D1 = 5, D2 = 12.5, D3 = 7.5
ANY QUERY????
DEMAND ANALYSIS
Why Does Demand Curve Slope Downward?

 Law of Diminishing Marginal Utility

 Income Effect (Real Income)
 Substitution Effect
 Different Uses
 Size of Consumer Group
 Types of Commodities

 Normal Goods: Those goods whose demand – price

relationship is negative.
 Inferior Goods: Those goods in case of which the
relationship between demand and income of the
customer is negative.
 Giffen Goods: Those goods whose demand – price
relationship is positive. It is a special type of inferior
good.
 Exceptions of Law of Demand

 Giffen Goods
 Veblen Goods: Those goods which have snob value,
for which the consumer derives satisfaction not by
their utility but by their social status. For example,
antique painting, diamonds, etc.
 Demonstration Effect
 Future Expectations of Prices
 Insignificant Proportion of Income Spent
 Goods with no Substitutes
 Movement along the Demand Curve
Or
Extension and Contraction of Demand

 Other things remaining the same, when quantity

demanded changes due to change in price only,
then this change is shown by different points along
the same demand curve.
 Fall in price is followed by extension of demand and
rise in price is followed by contraction of demand.
 Such movements assume that other determinants
of demand remain unchanged.
 Shift in Demand Curve
Or
Increase & Decrease in Demand

 A change in any determinant of the demand other

than price will shift the entire demand curve to the
right or to the left.
 An increase in demand is shown as rightward shift.
A decrease in demand is shown as leftward shift.
 Changes in income, preferences, price of the
related goods may cause such a change in demand.
ANY QUERY????
SUPPLY ANALYSIS
 Meaning of Supply

 Demand analysis is incomplete without the

analysis of supply. Demand and supply are
like two sides of the coin.

 “It indicates the quantities of a good or

service that the seller is willing and able to
provide at a price, at a given point of time,
other things remaining the same”.
The Supply Schedule and The Supply Curve

• Supply schedule—shows quantities of a good

or service firms would choose to produce and
sell at different prices, with all other variables
held constant
• Supply curve—graphical depiction of a supply
schedule
– Shows quantity of a good or service supplied at
various prices, with all other variables held
constant
 Law of Supply states that other things remaining the same, the higher the price
of a commodity the greater is the quantity supplied.
Price of the product is revenue to the supplier; therefore higher price means
greater revenue to the supplier and hence greater is the incentive to supply.
Hence, supply bears a positive relation to the price of the commodity.

Price per When the price is $2.00

Bottle per bottle, 40,000 bottles
S
are supplied (point F).

$4.00 G

At $4.00 per bottle,

2.00 F quantity supplied is
60,000 bottles (point G).

40,000 60,000 Number of Bottles

Fig- 4. per Month
Shifts vs. Movements Along the Supply Curve

• A change in the price of a good causes a movement

along the supply curve
– In Figure 4
• A rise (fall) in price would cause a rightward (leftward) movement
along the supply curve
• A drop in transportation costs will cause a shift in the
supply curve itself
– In Figure 5
• Supply curve has shifted to the right of the old curve (from Figure
4) as transportation costs have dropped
• A change in any variable that affects supply—except for the good’s
price—causes the supply curve to shift
 Figure 5: A Shift of The Supply Curve

• s
Price per A decrease in transportation
Bottle costs shifts the supply curve for
maple syrup from S1 to S2. S1 S2
At each price, more bottles
are supplied after the shift
$4.00 J
G

60,000 80,000 Number of Bottles

per Month
Factors That Shift the Supply Curve
• Input prices
– A fall (rise) in the price of an input causes an increase
(decrease) in supply, shifting the supply curve to the right
(left)
• Technology
– Cost-saving technological advances increase the supply of
a good, shifting the supply curve to the right
Factors That Shift the Supply Curve
• Number of Firms
– An increase (decrease) in the number of sellers—
with no other changes—shifts the supply curve to
the right (left)
• Expected Price
– An expectation of a future price increase
(decrease) shifts the current supply curve to the
left (right)
Factors That Shift the Supply Curve
• Changes in weather
– Favorable weather
• Increases crop yields
• Causes a rightward shift of the supply curve for that crop
– Unfavorable weather
• Destroys crops
• Shrinks yields
• Shifts the supply curve leftward
• Other unfavorable natural events may effect all firms
in an area
– Causing a leftward shift in the supply curve
 Figure 6(b): Changes in Supply and in
Quantity Supplied
• s

Price Entire supply curve shifts S1

rightward when: S2
• price of input ↓
• number of firms ↑
• expected price ↓
• technological advance
• favorable weather

Quantity
 Figure 6(c): Changes in Supply and in
Quantity Supplied
•Price
Entire supply curve shifts S2
rightward when: S1
• price of input ↑
• number of firms ↓
• expected price ↑
• unfavorable weather

Quantity
 Figure 6(a): Changes in Supply and in
Quantity Supplied
• t

Price Price increase moves S

us rightward along
supply curve

P2

P1
Price decrease
moves us leftward
P3 along supply curve

Q3 Q1 Q2 Quantity
 Supply Function

 Supply of a product X (Sx) depends upon:

o Price of the product (Px)
o Cost of production (C)
o State of technology (T)
o Government policy regarding taxes and subsidies
(G)
o Number of firms (N)
 Hence the supply function is given as:
Sx = (Px, C, T, G, N)
 Linear Supply Equation

 A linear supply equation can be written as:

Qs = c + dP
C>0, d>0
Here, c and d are constants. ‘c’ represents the quantity
supplied when price is zero. ‘d’ measure the change
in quantity supplied due to change in price per unit.
 Change in Supply

 Shift in the supply curve from S0

to S1
Price S2
 More is supplied at each price
S0
(Q1>Q0)
S1
 Increase in supply caused by:
 Improvements in the
technology
 Fall in the price of inputs
P  Shift in the supply curve from S0
to S2
 Less is supplied at each price
(Q2<Q0)
 Decrease in supply caused by:
O  A rise in the price of inputs
Q2 Q0 Q1 Quantity  Change in government policy
(VAT)
MARKET EQUILIBRIUM
 Market Equilibrium
 Equilibrium occurs at the price where the quantity demanded and the
quantity supplied are equal to each other.
 At point E demand is equal to supply hence 25 is equilibrium price

Price Demand
(‘000 cups/
Supply month)
Price (‘000 cups/
S (Rs) month)

15 10 50

E 20 15 40
25
25 30 30
30 45 15

D 35 70 10
O 30 Quantity
 Market Equilibrium
 For prices below the equilibrium, Quantity demanded exceeds quantity
supplied (D>S)
– Price pulled upward
 For prices above the equilibrium, Quantity demanded is less than
quantity supplied (D<S)
– Price pulled downward.
 At point E demand is equal to supply hence 25 is equilibrium price.

Price
Demand
S Supply (‘000 cups/
Price (‘000 cups/ month)
30 (Rs) month)
E 15 10 50
25
20 15 40
20
25 30 30
30 45 15
D
35 70 10
O
30 Quantity
 Changes in Market Equilibrium
(Shifts in Supply Curve)
 The original point of equilibrium is at
E, the point of intersection of curves
D1 and S1, at price P and quantity Q.
Price
 An increase in supply shifts the supply S0
curve to S2 .
D1 S1
 Price falls to P2 and quantity rises to
Q2, taking the new equilibrium to E2 . S2
P0 E0
 A decrease in supply shifts the supply E
curve to S0. Price rises to P0 and P E2
S0
P2
quantity falls to Q0 taking the new S1
equilibrium to E0 S2 D1
 Thus an increase in supply raises
quantity but lowers price, while a O
Q0 Q Q2 Quantity
decrease in supply lowers quantity
but raises price; demand being
unchanged.
 Changes in Market Equilibrium
(Shifts in Demand Curve)

• The original point of equilibrium is at

E, the point of intersection of curves
Price D1 and S1, at price P and quantity Q
• An increase in demand shifts the
D2
demand curve to D2
S1
D1 • Price rises to P1 and quantity rises to Q1
D0 taking the new equilibrium to E1
P1
E1 • A decrease in demand shifts the
E demand curve to D0
P
E2 • Price falls to P2 and quantity falls to Q2
P2
D2 taking the new equilibrium to E2.

D1
• Thus, an increase in demand raises
S1 D0
both price and quantity, while a
O decrease in demand lowers both price
Q2 Q Q1
Quantity and quantity; when supply remains
same.
 Change in Both Demand and Supply
• Initial equilibrium is at E1, with price
quantity combination (P1, Q1).
Price D’2
D2 • An increase in both demand and supply
takes place;
D1
S1 – demand curve shifts to the right
S2 from D1 D1 to D2 D2
– supply curve also shifts to the right
P2 E2 from S1 S1 to S2 S2.
P1 E1 E0 – The new equilibrium is at E2, and
price quantity is (P2, Q2).
D2 • An increase in both supply and demand
S1 D’2
S2 will cause the sales to rise, but
D1
– the price will increase if increase in
O D>increase in S (as at E2 )
Q1 Q2 Quantity
– No change in price if increase in
D=increase in S (as at E0 )