A ANTHI INSTITUTE OF ENGINEERING& TECHNOLOGY

GUNTHAPALLY (V), HAYAT NAGAR (M), R. R (D) – 501512

Subject Name : Business Economics & Financial Analysis
Subject Code : SM504MS
Program/Course : B.Tech
Year/Semester : III-I (R-18)
Branch : ECE
Section : A&B
Academic Year : 2020 – 2021
Subject Faculty : Mr. N. RAMANA REDDY, Associate Professor.
M.Tech, MBA(Ph.D)

Unit –II: Demand and Supply Analysis

Elasticity of Demand: Elasticity, Types of Elasticity, Law of Demand, Measurement and
Significance of Elasticity of Demand, Factors affecting Elasticity of Demand, Elasticity of Demand
in decision making, Demand Forecasting: Characteristics of Good Demand Forecasting, Steps in
Demand Forecasting, Methods of Demand Forecasting.
Supply Analysis: Determinants of Supply, Supply Function and Law of Supply.
Elasticity: The concept of Elasticity has a very importance in economic theory. The term
Elasticity is derived from Physics. It is an index (or) nature of reaction. Elasticity of demand
explains the relationship between a change in price and consequent change in amount
demanded.
Elasticity of Demand: “Marshall” is introduced the concept of elasticity of demand.
Elasticity of demand shows the extent of change in quantity demanded to a change in price.
The changes in the quantity demand as a result of changes in the price of products.
“Elasticity of demand is defined as the degree of responsiveness of the demand to changes in
the price”.
A change in the price of a commodity affects its demand. We can find the elasticity of
demand, or the degree of responsiveness of demand by comparing the percentage price
changes with the quantities 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 demanded
then the demand in “inelastic”.
Types of Elasticity:
There are three types of elasticity of demand:
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertising elasticity of demand

Figure: Types of Elasticity of Demand.

1). Price Elasticity of Demand:-
Elasticity of demand in general refers to price elasticity of demand. It refers to the quantity
demanded of a commodity in response to a given change in price.

It is expressed as mathematically,
(Q2 - Q1)/ Q1
Edp (or) P = ----------------
(P2 - P1)/ P1
Where;
Q1 = quantity demand price before change
Q2 = quantity demand price after change
P1 = price before change
P2 = price after change

2). Income elasticity of demand:-

Income elasticity of demand refers to the quantity demand of a commodity (Product) in
response (increase or decrease) to a given change in income of the consumer.

It is expressed as mathematically,
(Q2 - Q1)/ Q1
Edi (or) I = ----------------
(I2 - I1)/ I1

Where;
Q1 = quantity demand price before change
Q2 = quantity demand price after change
I1 = income before change
I2 = income after change
3). Cross elasticity of demand:-
Cross elasticity of demand refers to the quantity demanded of a commodity in response to a
change in the price of a related good, which may be substitute or complement.
The changes (increase or decrease) in the demand for one product in response to the changes
(substitute) in price of other related products are called Cross elasticity of demand.
Ex:- Due to increase in price of Sugar, the demand of other products like tea, coffee and milk
products are decreases.

It is expressed as mathematically,
(Q2 - Q1)/ Q1
Edc (or) C = ----------------
(P2B -P1 B)/ P1B
Where;
Q1 = quantity demand price before change
Q2 = quantity demand price after change
P1 = price before change product B
P2 = price after change product B

4). Advertising elasticity of demand:-

It is also known as promotional elasticity of demand. Advertising elasticity is always positive.
It refers to increase in the sales revenue because of change in the advertising expenditure. In
other words, there is a direct relationship between the amount of money spent on advertising
and its impact on sales.

It is expressed as mathematically,
(Q2 - Q1)/ Q1
Eda (or) A = ----------------
(A2 -A1)/ A1
Where;
Q1 = quantity demand price before change
Q2 = quantity demand price after change
A1 = Advertising before change product
A2 = Advertising after change product
Types of Price Elasticity of Demand:
The Types of Price Elasticity of Demand is generally classified into 5 types ;
1) Perfectly elastic demand.
2) Perfectly inelastic demand.
3) Relatively elastic demand.
4) Relatively inelastic demand.
5) Unitary elastic demand.

1. Perfectly elastic demand:-

Perfectly elastic demand means when the percentage of change in quantity demanded is
infinite even if the percentage of change in price is zero, the demand is said to be perfectly
elastic.

2. Perfectly inelastic demand:-

Perfectly inelastic demand is the situation where there no change in quantity demanded even
there is change in price of the goods, the demand is said to be perfectly inelastic. Simply mean
no change in demand for change in price.
3. Relatively elastic demand:-
When a small changes in price lead to more than proportionate change in demand is called
relatively elastic demand. Relatively elastic Demand (e > 1).
Ex:- If the price of a product is down by 3% and the demand increases by 9%.

4. Relatively inelastic demand:-

Relatively inelastic demand is one when the percentage change produced in demand is less
than the percentage change in the price of a product. Relatively inelastic Demand (e < 1).
For example, if the price of a product increases by 30% and the demand for the product
decreases only by 10%, then the demand would be called relatively inelastic.

5. Unitary elastic demand:-

The proportionate change in demand is equal to the proportionate change in price is Unitary
elastic demand. Unitary Elastic Demand (e = 1).
10
Ed = ----- = 1
10

Figure: Unitary elastic demand

Law of Demand:
Law of demand states the relationship between price and quantity demanded. As per the law
when price is increased demand will decrease, and similarly, when price is decrease demand
will increase. This is called Law of Demand. The law of demand may be explained with the
help of demand schedule.
Law of Demand can operate and remain valid only if certain things like income, population
size, climate, consumer's tastes and expectations, etc., are assumed to remain constant (or)
equal. Qdx = f ( p)
Here;
Qdx = A quantity demanded of commodity x.
f = A function of independent variables.
P = Price of product.
The Law of demand is represent the functional relationship between quantity demanded and
price of a product.
Ex: The graphical presentation of the demand schedule is called as Demand curve.
Demand Schedule.
Price per Unit (Rs.) Quantity Demanded (Units)
10 1
8 2
6 3
4 4
2 5

In the above graph, the quantity demanded (Units) on X-axis and Price per product (Rs.) on Y-
axis are respectively. Customer buying products at different prices are shown by points A, B,
C, D, E.
The six basic assumptions of law of demand are as follows:
➢ No change in the income.
➢ No change in size and composition of the population.
➢ No change in prices of related goods.
➢ No change in consumer's taste, preference, etc.
➢ No expectation of a price change in future.
➢ No change in the climatic conditions.
Measurement and Significance of Elasticity of Demand:
Measurement of Elasticity of Demand:-
The price elasticity of demand measures the responsiveness of percentage change in price to
percentage change in quantity demanded.
There are three popular types for measuring price elasticity of demand;
(i) Unitary Elasticity (e = 1).
(ii) Greater than Unitary Elasticity (e > 1).
(iii) Less than Unitary Elasticity (e < 1).
Percentage change in quantity
Ep = -------------------------------------
Percentage change in price
It is expressed as mathematically,
ΔQ P
Ep = ---- x ---
ΔP Q
Here;
P = Price of the product
Q = Quantity of demand
ΔP = Change in price
ΔQ = Change in quantity
The following are the important of four methods used for measuring elasticity of demand ;
1). Total Expenditure Method
2). Percentage Method
3). Point elasticity Method
4). Arc elasticity Method
Significance of Elasticity of Demand:-
The concept of elasticity for demand is great importance for determining prices of various
factors of production. The following are the important Significance of Elasticity of Demand ;
1) Elasticity of demand in Production
2) Elasticity of demand in Price Fixation
3) Elasticity of demand Government policies
➢ Tax policies
➢ Raising bank deposits
➢ Public utilities
4) Elasticity of demand in Distribution
5) Elasticity of demand in International Trade
6) Elasticity of demand in foreign Exchanges
7) Elasticity of demand in Finance
Factors affecting Elasticity of Demand:

The following are the various factors which affect the elasticity of demand of a commodity
are:
➢ Nature of commodity (or) goods
➢ Availability of substitutes
➢ Income level
 ➢ Level of price
➢ Number of Uses
➢ Time Period
➢ Postponement of Consumption
➢ Share in Total Expenditure
➢ Habits.
Elasticity of Demand in decision making:
The business firms take into account the price elasticity of demand when they take decisions
regarding pricing of the goods. We shall explain below the various uses, applications and
importance of the elasticity of demand. The following are the useful sources of Elasticity of
Demand in decision making ;
1. The determination of output level
2. The determination of price of the product
3. The determination of income level of customer
4. The determination of taste and preferences of customer
5. The determination of demand planning
6. The determination of government policies
7. The determination of gains from national or international trade.

Demand Forecasting:
Demand forecasting refers to an estimate of future demand for the product under the
given conditions. Demand forecasting has an important influence on production planning. It is
essential for a firm to produce the required quantities at the right time.
According to J. Donglas, “Demand forecasting defined as the process of identifying or
estimating for demand in the feature time period”.
Demand forecasting analyze with When, Where, and How much will be the demand for a
product in the future.
Characteristics of Good Demand Forecasting:
The estimation of future demand for the product is known as demand forecasting. However,
the following are the Characteristics of a good demand forecasting ;
1) Accuracy
2) Acceptability
3) Simplicity
4) Flexibility
5) Availability
6) Economy
7) Effectiveness
8) Durability
9) Quick Results
10) Maintenance of timeliness.
Steps in Demand Forecasting:
Demand forecasting may be defined as the process of finding values for demand in future time
periods.
The following are Steps in demand forecasting are ;

1. Identification of Objectives
2. Nature of Product and Market
3. Determinants of Demand
4. Analysis of Factors
5. Choice of Method
6. Testing Accuracy and Estimation Results

Methods of Demand Forecasting:

Definition: Demand Forecasting is a systematic and scientific estimation of future demand for
a product. Simply, it estimating the sales process or demand for a product in the future is
called as demand forecasting.
Demand Forecasting is a highly complicated process as it is deals with the estimation of future
demand. Methods of Demand Forecasting are require the opinion of business experts in the
various field or areas.
The different Methods of Demand Forecasting are shown in the below figure ; Mainly there
are 3 types of methods ;
(1). Survey Methods
(2). Statistical Methods
(3). Other Methods

Figure: Methods of Demand Forecasting

(1). Survey Methods: - Survey Method is also called as Opinion Polling Method.
The Survey Method is mainly divided into two parts are ;
1). Survey of buyers intentions
a). Census method
b). Sample method
2). Survey of sale force

(2). Statistical Methods:- Statistical method is used for long run forecasting. In this method,
statistical and mathematical techniques are used to forecast demand. This relies on past data.
The following are the different Statistical Methods are ;
1) Trend projection method: These are generally based on analysis of past sales patterns.
a) Trend line by observation
b) Least squares methods
c) Time series analysis
d) Moving average method
e) Exponential smoothing
2) Barometric Technique
3) Simultaneous equation method
4) Correlation and regression methods.

(3). Other Methods:-

The following are the Other methods are ;
1) Expert opinion methods
2) Test marketing
3) Controlled experiments
4) Judgmental approach
Supply Analysis:
The supply of a product depends on its price and cost of production. In simple terms, Supply is
the function of price and cost of production.
Determinants of Supply:-
The following are the some of the determinants (factors) influencing of Supply ;
➢ Time period
➢ Prices of Related Goods
➢ Cost of Production
➢ Natural Conditions
➢ Technology and Innovation
➢ Transport Conditions
➢ Government’s Policies

Supply Function:-
Supply function is the mathematical expression of the quantity supplied. Supply Function is
the relationship between quantity supplied and price of a product, while keeping the other
factors at constant.
The supply function can be expressed as:

Figure: Supply Function.

Law of Supply:-
Law of supply states that other factors remaining constant, price and quantity supplied of a
good are directly related to each other. In other words, when the price paid by buyers for a
goods, then suppliers increase the supply of that goods in the market.
(or)
The law of supply shows a direct relationship between price and supply of goods. The law
states that as the price of goods increases, the quantity of the goods supplied per unit of time
increases and vice-versa, assuming all other factors influencing supply remains unchanged.
The supply function can be expressed as:
Sx = f (Px)
Where:
Sx = Quantity supplied for product X
Px = Price of product X
f = Function of product.
The following graph represent the changes in supply of goods are depends on price of
products.

Figure: Law of Supply Curve.

In the above graph clearly observed that the product price increases automatically the supply
of quantity product increases and vice-versa.
The law of supply is one of the most fundamental concepts in economics. It works with the
law of demand to explain how market economies allocate resources and determine the prices
of goods and services.

Prepared by,
Mr. N. RAMANA REDDY
M.Tech, MBA(Ph.D)
Associate Professor.
Ph. No: 9640789300
 Questions
1. Explain in law of demand with the help of an Illustration?
2. What is meant by elasticity of demand? How do you measure it? What are determinates of elasticity of
demand?
3. Describe briefly various types of Elasticity of Demand with the help of Graphs?
4. What is cross elasticity of demand? Is it positive for substitute or complements? Show in a diagram
relating to the demand for coffee to the price of tea?

5. What is Demand Forecasting? Explain various Demand Forecasting Techniques?

6. Discuss briefly various factors determining Demand Forecasting?
7. Define Supply and explain Law of Supply?

Objective Questions
1. Who explained the “Law of Demand”? [ ]
(a) Joel Dean (b) Cobb-Douglas (c) Marshall (d) C.I.Savage & T.R.Small
2. Demand Curve always ________ sloping. [ ]
(a) Positive (b) Straight line (c) Negative (d) Vertical
3. Giffen goods, Veblan goods and speculations are exceptions to___. [ ]
(a) Cost function (b) Production function (c) Law of Demand (d) Finance function
4. Who explained the “Law of Demand”? [ ]
(a) Cobb-Douglas (b) Adam smith (c) Marshall (d) Joel Dean
5. When PE = (Price Elasticity of Demand is infinite), we call it ___. [ ]
(a) Relatively Elastic (b) Perfectly Inelastic (c) Perfectly Elastic (d) Unit Elastic
6. Income Elasticity of demand when less than ‘O’ (IE = O), it is termed as ______. [ ]
(a) Income Elasticity less than unity (b) Zero income Elasticity (c) Negative Income Elasticity
(d) Unit Income Elasticity
7. The other name of inferior goods is _______. [ ]
(a) Veblen goods (b) Necessaries (c) Geffen goods (d) Diamonds
8. Estimation of future possible demand is called ______. [ ]
(a) Sales Forecasting (b) Production Forecasting (c) Income Forecasting (d) Demand Forecasting
9. When a small change in price leads great change in the quantity demand, We call it ________. [ ]
(a) Inelastic Demand (b) Negative Demand (c) Elastic Demand (d) None
10. When a great change in price leads small change in the quantity demand, We call it ________. [ ]
(a) Elastic Demand (b) Positive Demand (c) Inelastic Demand (d) None
11. “Coffee and Tea are the ________ goods”. [ ]
(a) Relative (b) Complementary (c) Substitute (d) None
12. When PE = 0 (Price Elasticity of Demand is Zero), we call it ___. [ ]
(a) Relatively Elastic demand (b) Perfectly Elastic demand (c) Perfectly Inelastic demand
(d) Unit Elastic demand

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