Economics – Unit 2

Demand Analysis – Individual, Market & firm demand –

Determinants of Demand Elasticity measures and
Business Decision making – demand function – demand
forecasting - Law and Elasticity of supply

Reference : Managerial Economics by

Maheswari & Varshini
Demand analysis : Demand for a product depends
upon many reasons
1.Price
2.Income
3.Price of competitive Product
4.Price of substitute Product
5.Status of Consumer
6.Changes in Consumer Taste
7.Availability of Credit Facility
8.Geographic Location of the buyer
9.Weather season and climate
10..Population in the area & 11.Advt and Sales Promotion
Influence will be more in case of Price, Income, Advt,.
and Price of the Competitive and substitute products
than any other buyer factors.

Analysing these factors are more important on

determining a demand.

Some are within the control of a firm and others are

not under the control of a firm.
Demand :
Desire to buy backed by adequate purchasing
power.

Here desire to have a Product cannot buy goods.

Demand should be accompanied by necessity in many

cases .

Demand also refers to various quantities the

consumer buy.
Law of Demand :

The relation of price to demand is known as the Law

of Demand.
Higher the Price, Lower the Demand and Vice versa.
Demand Schedule :
Price Demand
5 80
4 100
3 150
2 200
Demand Curve :

Curve slopes downwards lift to right

Negative Slope
Inverse Relationship
Price – Independent variable, demand dependent variable
Other things remain the same
Reasons Underlying Law of Demand:

1.Income Effect
2.Substitution Effect

Exceptions to Law of Demand:

1.Snob Appeal - diamonds

2. Giffen case – Potato and meat(inferior goods)
3. Speculative market
Individual Demand and Market Demand :
Individual Demand :

Quantity demanded by an individual purchaser at a

given price is - Individual Demand

Quantity demanded by all the purchaser together is

known as Market Demand
 Price Elasticity of Demand

Law of Demand states that Price increases Demand decreases

It gives only the direction of change but not the rate at which the
change takes place.

The rate of change is denoted as Elasticity of Demand

The degree of responsiveness of a quantity demanded to a change

in price is defined as Elasticity of Demand.
ep = Proportionate change in Quantity Demanded
Proportionate change in Price
ep = Change in Quantity Demanded
Quantity Demanded
____________________________

Change in Price
Price

ep = Q2 –Q1
Q1
------------------
P2 –P1
P1
 Types of Price Elasticity

1. Perfectly Elastic

2. Perfectly In elastic

3. Unity Elastic

4. Relatively Elastic or Elasticity more than unity

5. Relatively In Elastic or Elasticity less than unity

Factors Determining Price Elasticity of Demand :
1. Nature of commodity
Elastic - affected by price -- eg. Luxury articles
consumption not necessary , sofa, dining table

In Elastic - not affected by price -- eg. Necessary articles

consumption necessary –rice ,wheat, oil

2. Extent of use
Single use commodity – in elastic – Iron Box – hike in price
doesn’t doing to affect the purchase
Multiple use commodity – elastic –Electricity – price reduction
more usuage.
3. Range of Substitutes
Commodity having large number of substitutes – Elastic
Commodity having less number of substitutes – In Elastic

4. Income level
People – high income – less affected by price
People – low income – greatly affected by price
Eg. Milk
5. Proportion of income spent on the commodity
less amount spent on commodity – price change doesn’t
affect the individual – inelastic
More amount spent on commodity – price change
affect the individual - elastic
6. Urgency of Demand
Urgency product – inelastic – not price sensitive
less urgent product – elastic - price sensitive eg. Soap

7. Durability of a commodity
Durable Product – elastic - affected by price changes
Non durable product – inelastic – not affected by price change
8. Purchase Frequency of the Product
Frequency of purchase more – demand is more elastic
Frequency of purchase less – demand is less inelastic
Some business application of Price Elasticity:

Price Discrimination – Railway pricing

Public Utility Pricing

Product replacing its substitutes.

Elasticity of Demand and Total Revenue:
Revenue = Income Generated through sales
Total Revenue(TR)= Selling Price × Quantity sold
Average Revenue(AR)= TR/Quantity Sold
Incremental Revenue(IR)=Difference Between New Total Revenue
and Old Total Revenue
NTR – OTR
IR = R2-R1 = R
Marginal Revenue(MR)= Additional Revenue generated by selling
Additional Product
MR=R2-R1/q2-q1 = R/ Q

Price increases – TR decreases

Price decreases – TR increases
Income Elasticity of Demand:
It is defined as the degree of responsiveness of quantities
demanded to a given change in income. The income elasticity can
be expressed in the following formula:
ey = Proportinate change in quantity demanded /
Proportinate change in Income.

= (q2-q1/q2+q1) / (y2-y1/y2+y1)
 Cross Elasticity of Demand
The demand for certain products may be influenced by changes
in the prices of related goods.

The products are of two kinds:

Substitutes – A product can be replaced by another – Coffee Tea,

Laptop PC, CBSC Samacheer Education, Pant Jean, Sari Chudi.

Complements – product which cannot be used without the other

Product. Car Petrol, ink Pen, system UPS, mobile sim,
The effect of a change in the prices of related goods upon the
demand for a particular commodity may be determined by
measuring the Cross Elasticity of the demand.

Substitutes: A change in the price of one commodity would lead

to
a change in the demand for the commodity at the cost of some
other commodity.

Complements: A change in the demand for one commodity leads

to a change in the demand for some other commodity in the same
direction.
Cross Elasticity of demand may be defined as the “Proportionate
change in quantity demanded of a particular commodity in
response to a change in the price of another related commodity.

The price of one commodity x is an independent variable

The price of another commodity y is a dependent variable

Ep = Proportionate change in the quantity purchased of x

___________________________________________
Proportionate change in the price charged for of y

ep = Qx2 –Qx1 Py2 – Py1

-------------- / --------------
Qx2 + Qx1 Py2 + Py1