THE THEORY OF DEMAND AND SUPPLY

DEMAND ANALYSIS

Managerial Economics (Econ605)

Aarushi
Amity Business School
 INTRODUCTION

• Supply and demand are the forces that make market economies work.
• They determine the quantity of each good produced and the price at which it is sold.
• We now introduce the theory of supply and demand. It considers how buyers and
sellers behave and how they interact with one another.
• It shows how supply and demand determine prices in a market economy and how
prices, in turn, allocate the economy’s scarce resources.
• A market is a group of buyers and sellers of a particular good or service.
• The buyers as a group determine the demand for the product, and the sellers as a
group determine the supply of the product.

2
 DEMAND

• Demand analysis is needed basically for three purposes:

• (a) to provide the basis for analysing market influences on the demand
• (b) to provide the guidance for manipulating the demand
• (c) to guide in production planning through forecasting the demand

• Quantity demanded - the amount of a good that buyers are willing

and able to purchase.

3
WHAT DETERMINES THE QUANTITY
AN INDIVIDUAL DEMANDS?

For instance, consider your demand for chocolate bars. How do

you determine how much chocolate to buy each month? Which
factors affect your demand?

4
 DETERMINANT OF DEMAND - PRICE

• If the price of fine chocolate rose to Rs 500 per chocolate bar, you would buy less
chocolate.You might buy chocolate chips instead. If the price of chocolate fell to Rs 200
per chocolate bar, you would buy more.
• The quantity demanded falls as the price rises and rises as the price falls, thus
quantity demanded is negatively related to the price.
• This inverse relationship between price and quantity demanded is true for most goods
in the economy.
• Law of demand - the claim that, other things equal, the quantity demanded of a good
falls when the price of the good rises.

5
 DETERMINANT OF DEMAND - INCOME

• In the context of low disposal income, the quantity demanded of chocolate would fall.
• If the demand for a good falls when income falls, the good is called a normal good. It
is a good for which, other things equal, an increase (decrease) in income leads to an
increase (decrease) in demand.
• If the demand for a good rises when income falls, the good is called an inferior good.
It is a good for which, other things equal, an increase in income leads to a decrease in
demand.
• Example of inferior good – bus rides. As your income falls, you are less likely to buy a
car or take a cab, and more likely to ride the bus.

6
 DETERMINANT OF DEMAND – PRICES
OF RELATED GOODS

• If the price of chocolate chips falls, the law of demand claims you would buy more
chocolate chips.You would perhaps, buy less chocolate bars (as chocolate bars and
chocolate chips satisfy similar desires)
• When a fall in the price of one good reduces the demand for another good, the two
goods are called substitutes. Substitutes are pairs of goods that are used in place of
each other, such as buying movie tickets or streaming on Netflix, Tea or Coffee.
• Suppose, the price of biscuits fall. Law of demand claims that you will buy more tea as
biscuits are used together with tea.
• When a fall in the price of one good raises the demand for another good, the two
goods are called complements. Complements are pairs of goods that are used
together, such as petrol/diesel and automobiles, computers and software.

7
 DETERMINANTS OF DEMAND – TASTES
AND EXPECTATIONS

• The most obvious determinant of demand is tastes. Tastes are based

on historical and psychological forces.
• If you like chocolate, you buy more of it.
• Expectations about the future may affect demand for a good or
service today.
• For instance, if you expect to earn a higher income next month, you
may be more willing to spend some of your current savings buying
chocolate.
• Or, if you expect the price of chocolate to fall tomorrow, you may be
less likely to buy chocolate at today’s price.

8
 DETERMINANTS OF DEMAND –
ADVERTISING

• Advertising often provides consumers with information about the

existence or quality of a product, which in turn induces more
consumers to buy the product (informative advertising).
• Advertising can also influence demand by altering the underlying tastes
of consumers (persuasive advertising).
• For example, advertising that promotes the latest premium chocolate
(or high fashion clothing or a new model of a car) may increase the
demand for it by making consumers perceive it as “the” thing to buy.

9
 DETERMINANTS OF DEMAND –
POPULATION

• The demand for a product is also influenced by changes in the size and
composition of the population.
• As the population rises, more and more individuals wish to buy a given
product
EXAMPLES
• Middle-aged consumers desire different types of products than retirees
• As a greater proportion of the population ages, the demand for
medical services will tend to increase.

10
 DEMAND SCHEDULE

• Demand schedule is a table that shows the relationship between the price of
a good and the quantity demanded.
• Many variables determine the quantity demanded. If we hold all these variables
constant except one—the price, how does it affects the quantity demanded?
EXAMPLE
Suppose a clothing manufacturer desires information about the impact of its
pricing decisions on the demand for its jeans in a small foreign market. To obtain
this information, it might engage in market research to determine how many pairs
of jeans consumers would purchase each year at alternative prices per unit.

11
 The market
research reveals
that if jeans were
priced at $10 per
pair, 60,000 pairs
of jeans would be
sold per year; at
$30 per pair,
20,000 pairs of
jeans would be
sold annually.

Reference: Baye, M. R., & Prince, J.(2021). Managerial economics and business strategy. Tenth edition. McGraw-Hill, Pg 42.

12
 DEMAND CURVE

• A demand curve shows how the quantity demanded of the good

changes as its price varies (holding constant all other determinants of
quantity demanded).
• A downward-sloping demand curve illustrates that consumers demand
a larger quantity of a good when its price is low and a smaller quantity
when its price is high.
• By convention, the price is on the vertical axis, and the quantity
demanded is on the horizontal axis.

13
 DEMAND CURVE

• A demand curve is drawn holding all variables other than price

constant.
• ceteris paribus - a Latin phrase, translated as “other things being
equal,” used as a reminder that all variables other than the ones being
studied are assumed to be constant.
• The demand curve slopes downward because, ceteris paribus, lower
prices mean a greater quantity demanded.

14
 Considering the previous
example, the demand curve
interpolates the quantities
consumers would be willing
and able to purchase at
prices not explicitly dealt
with in the market research.

For eg. Consumers would

be willing and able to
purchase 35,000 pairs of
jeans when the price is
$22.50.

Reference: Baye, M. R., & Prince, J.(2021). Managerial economics and business strategy. Tenth edition. McGraw-Hill, Pg 42.

15
 MARKET DEMAND

• The demand for a good by an individual buyer is called individual’s

demand while the demand for a good by all buyers in a market is
called market demand.
• Market demand is the sum of all the individual demands for a
particular good or service.
• Market demand also depends on all those factors that determine the
demand of individual buyers. Such as, buyers’ incomes, tastes,
expectations, and the prices of related goods. It also depends on the
number of buyers.

16
 MARKET DEMAND CURVE

• A market demand curve is a curve indicating the total quantity of a

good all consumers are willing and able to purchase at each possible
price, holding the prices of related goods, income, advertising, and
other variables constant.
• It is found by horizontally adding the individual demand curves, i.e. to
find the total quantity demanded at any price (add the individual
quantities found on the horizontal axis of the individual demand
curves).

17
 DEMAND BY MARKET SEGMENTS

• If the market is large in terms of geographical spread, product uses,

distribution channels, customer sizes or product varieties,
• If significant differences were observed in terms of product price, profit
margins, competition, seasonal patterns or cyclical sensitivity,
• then it may be worthwhile to distinguish the market by specific
segments for a meaningful analysis.
• The total market demand would mean the total demand for the
product from all market segments while a particular market
segment demand would refer to demand for the product in that
specific market segment.

18
 DEMAND BY MARKET SEGMENTS

• The distinction is useful particularly in finding out the problem

areas. If a classification is made between domestic and foreign demand,
one can analyze the causes of poor foreign market, and find out the
ways of augmenting that market.
• For example, domestic demand for Maruti cars versus the export
demand for that product, demand for Maruti cars in Western India vis-
à-vis demand for Maruti cars in Southern, Eastern and Northern
regions.

19
 SHIFTS IN THE DEMAND CURVE

• Whenever any determinant of

demand changes, other than the Price
good’s price, the demand curve
shifts.
• Any change that raises the
quantity that buyers wish to
purchase at a given price shifts
the demand curve to the right.
• Any change that lowers the
quantity that buyers wish to
purchase at a given price shifts
the demand curve to the left.
Quantity demanded
20
 SHIFTS IN THE DEMAND CURVE

• As price is on the vertical axis, a

change in price does not shift Price
the curve but represents a
movement along it.
• By contrast, when there is a
change in income, the prices of
related goods, tastes,
expectations, or the number of
buyers, the quantity demanded
at each price changes; this is
represented by a shift in the
demand curve.
Quantity demanded
21