Demand Analysis

Introduction• Demand is one of the most critical economic decision variables.

• It reflects the size and pattern of market. Business activity is always market-driven.

• The manufacturers’ inducement to invest in a given line of production depends on the size of market.

• The demand for output and inputs, the demand for firm and the industry, the demand by the consumer and the stockiest, and the similar becomes, therefore , relevant for managerial decision making.

 

Concept of Demand

• The demand for anything, at a given price, is the amount of it, which a person desires to buy per unit of time at a given place.

• Demand, thus, has three important elements:• First, it is a desired quantity and the phrase quantity demanded is

used for it.

• Second, it must be backed with enough money. So demand in economics is effective demand.

• Thirdly, quantity demanded is a flow and not a stock.Thus, the demand for a product implies : (i) desire to acquire it, (ii) willingness to pay for it and, (iii) ability to pay for it.

All the three must be checked to identify and establish demand.

Determinants of Demand

Demand for a commodity, say X, may be the function of the following variables:

Dx = f (Px, Py, Pz, Y, W, Di, De, A, C, E, P, T, ) 

• Price of the product• Price of other related goods• Consumer income and wealth• Distribution of income and wealth• Demonstration effect • Advertisement expenditure• Availability of credit facility to consumer• Price expectation of the consumer• Size of population• Taste, preferences and fashion

Demand Function

• Demand, as a function of the above variables, becomes a very complicated relationship.

• It would be difficult to formulate any demand theory. Therefore, we presume that all variables, except the price of a commodity, which we are considering, remain constant.

• Now we can state the relationship between the quantity demanded of a commodity and its price.

Dx = f (Px) • In the slope and intercept form, the demand function may be

stated as; 

Dx = a - b Px (linear)Dx = a Px

-b (log-linear)

 

Demand function (Laptops)

Law of Demand

• The law of demand states:

If other things remain the same (ceteris paribus), price of a commodity and its demand have inverse relationship. If the price increases, its demand decreases and vice versa.

• When the demand-price relation is shown in the form of a table, it is called demand schedule and when it is plotted on a graph, it is called demand curve.

• The demand curve is downward slopping indicating the inverse relationship between the price of the product and its demand.

Non-Linear demand Curve

Why does demand curve slope downward?

There are various reasons for it. • First, when the price is reduced, new buyers of the commodity

enter the market.• Second, when the price falls, the old consumers buy more of it

because of income and substitution effects.• Third, the principle of different uses is also responsible for the

downward slope of demand curve. When the commodity is costly, it is used only in more important uses but when the price falls, the commodity is also demanded for less important uses.

• Lastly, the law of demand operates because of the principles of different desires.

Change in Demand and Change in Quantity Demanded

• The law of demand has reference to extension or contraction of demand (change in quantity demanded) but the change in demand (increase or decrease in demand) is associated with the change in other variables that affect the demand.

• When there is a movement on the same demand curve due to change in the price of the product, the quantity demanded of the product changes, which is called change in quantity demanded.

• The movement of consumer from one demand curve to another due to change in all other variables, except the price of the product, is known as change in demand. 

The Impact of a Change in Income• Higher income decreases the

demand for an inferior good• Higher income increases the

demand for a normal good

Exceptions of Law of Demand

• Giffen Paradox• Conspicuous consumption• Fear of future rise in prices

Types of Demand

• Direct and Derived Demand• Autonomous and Induced Demand• Perishable and Durable Goods Demand• New and Replacement Demand• Final and Intermediate Demand• Firm and Industry Demand• Individual and Market Demand

Market Demand: Horizontal Summation of Individual demands

Law of Supply

• Supply refers to the quantity of a commodity that a producer is willing and able to offer for sale at each possible price per unit (period) of time.

• A supply schedule is a table showing how much of a product firm will supply at different prices.

Price

(in Rs.)

Quantity Supplied

per month

(in thousand)

4 50

6 80

8 100

10 120

12 140

Why Supply Curve Slopes Upwards?

• The law of diminishing marginal returns is the main force behind the law of supply as law of diminishing marginal utility is for law of demand.

• The law of diminishing marginal returns states that productivity of a variable input declines as more is used in short run production function, holding one or more inputs fixed.

• This means the marginal cost of production increases. Therefore, a producer is willing to produce more only if the price rises. This explains the direct relation between price and quantity produced and supplied.

Determinants of Supply

• Price of the product• The prices of related products.• Technology and productivity• Number of producers• Cost of inputs • Taxes and subsides.

A change in supply versus a change in quantity supplied

Market Supply (Horizontal Summation)

Market Equilibrium

Increase in Demand and Supply

Higher demand leads to higher equilibrium price and higher equilibrium quantity.

Higher supply leads to lower equilibrium price and higher equilibrium quantity.