Professional Documents
Culture Documents
2 Demand Analysis
2 Demand Analysis
2 Demand Analysis
Ch - 2
Demand Analysis
2
The Concept of Demand. . .
Market refers to the interaction between
seller and buyers of a good or services at a
mutually agreed upon price.
Demand is defined as that want, need or
desire which is backed by willingness and
ability to buy a particular commodity, in a
given period of time.
Demand is the quantity of a commodity
which consumers are willing to buy at a
given price for a particular unit of time.
Demand
Demand indicates how much of a
product consumers are both willing and
able to buy at each possible price
during a given period, other things
remaining constant.
4
The Concept of Demand. . .
Quantity Demanded P
refers to the amount
Unwilling to
(quantity) of a good
buy
that buyers are
willing to purchase at
alternative prices for Willing
a given period. to buy
Q
Definition of Demand
The demand for a product refers to the
amount of it which will be bought per unit
of time at a particular price
Demand = Desire + Ability to pay (i.e.,
Money or Purchasing Power) + Will to
spend
Demand is an effective desire, as it is
backed by willingness to pay and ability
to pay.
A complete statement of Demand
must state
► market dimension – whose demand
► price dimension – at what price
► time dimension – for how long.
Gopal demands 30 litres of milk, at Rs
20/- per litre, per month.
Types of Demand
1. Demand for consumers’ goods and producers’
goods
2. Demand for perishable and durable goods
3. Autonomous (direct) and derived (indirect)
demand
4. Normal/superior and inferior goods
5. Necessary, comforts and luxury goods
6. Related goods: Substitutes and complementary
goods
7. Individual buyer’s demand and all buyers’
(aggregate / market) demand.
8. Firm and Industry demand
9. Demand by market segments and by total market
Consumers’ Goods and Producers’ Goods
Goods and Services used for final
consumption are called consumers’
goods.
These include those consumed by
human-beings (e.g. food items, clothes,
kitchen tools, residential houses,
medicines, and services of teachers,
doctors, lawyers, washer men and shoe-
makers), animals (e.g. dog food and fish
food), birds (e.g. grains), etc.
Producers’ goods refer to the goods used for
production of other goods.
Thus, producers’ goods consist of plant and
machines, factory buildings, services of
business employees, raw-materials, etc.
The distinction is somewhat arbitrary. This
is because, whether a good is consumers’ or
producers’ depends on its use.
For ex., if a sofa set is used in the drawing
room of a house - it is a consumers’ good;
while if is a used in the reception room of a
business house – it is a producers’ good.
But,the distinction is useful for a proper
demand analysis for while the demand for
consumers’ goods depends on
households’ income, that for producers’
goods varies with the production level,
among other things.
Perishable and durable goods
Both consumers’ and producers’ goods
are further classified into perishable (non-
durable) and durable goods.
In laymen’s language, perishable goods
are those which perish or become
unusable after sometime, the rest are
durable goods.
In economics, perishable goods refer to
those goods which can be consumed only
once while in case of durable goods, their
services only are consumed.
Perishable goods include all services (e.g.
services of teachers and doctors), food
items, raw-materials, coal, and electricity,
while durable goods include plant and
machinery, buildings, furniture,
automobiles, refrigerators, and fans.
Durable goods pose more complicated
problems for demand analysis than do
non-durables.
Sales of non-durables are made largely to
meet current demands which depends on
current conditions.
In contrast, sales of durable goods go
partly to satisfy new demand and partly to
replace old items.
Further, the letter set of goods are
generally more expensive than the former
set, and their demand alone is subject to
preponment and postponement, depending
on current market conditions vis-à-vis
expected market conditions in future.
Autonomous (direct) and
Derived (Indirect) Demand
The goods whose demand is not tied with
the demand for some other goods are said to
have autonomous demand, while the rest
have derived demand.
Thus, the demands for all producers’ goods
are derived demands, for they are needed in
order to obtain consumers or producers
goods.
Thus, the demand for goods which fulfill
our basic Physiological requirements, are
generally included in autonomous
demand.
For example; Demand for soap, clothing
etc
While the demand for goods for the
production of other goods and services are
included in derived.
For example; Demand for raw material
like steel, cement, plant and machinery
etc,
Demand for money which is needed not
for its own sake but for its purchasing
power, which can buy goods and
services.
Similarly, demand for car’s battery or
petrol is a derived demand, for it is linked
to the demand for a car.
There is hardly anything whose demand is
totally independent of any other demand.
But the degree of this dependence varies
widely from product to product.
For ex: Demand for petrol is totally linked to
the demand for petrol driven vehicles, while
the demand for sugar is only loosely linked
with the demand for milk.
Goods that are demanded for their own sake
have direct demand while goods that are
needed in order to obtain some other goods
possess indirect demand.
In this sense, all consumers’ goods have
direct demands while all producers’ goods,
including money, have indirect demand.
Normal/Superior and Inferior Goods
Normal goods, also called as superior
goods.
The former are those whose demand
increases as income increases, and the
latter are those whose demand falls as
income goes up, and vice versa.
For example, milk, refrigerator,
television, education, and the good quality
of food grains and clothes are superior
goods while the poor quality of food
grains and clothes are inferior goods.
In other words, the superior goods are the
ones which the rich people consume while
the inferior goods are for the poor
people’s consumption.
Further, these are relative concepts.
Thus, for example, scooter/bike is a
superior good in relation to a cycle, while
it is an inferior good relative to a car.
Necessary, comforts and Luxury Goods
In common sense, the necessary goods are essential
for existence, comforts goods make the life
comfortable and luxury goods are luxuries of life.
However, in economics they have special
meanings.
These all are considered as superior goods but of
different degrees.
Thus, as the consumers income rise, more of each
of these three kinds of goods is consumed but the
proportion of the consumption budgets differ.
In case of necessary goods, as income
increases, while the consumption
expenditure on them increases, the
percentage of total expenditure/income
spent on each of them goes down.
In case of comforts, the said percentage
remains the same, while in case of luxuries,
it goes up.
In general, ordinary foods, drinks, clothing,
some education and medical aids are
considered as necessary.
Some means of transport, good quality of
food, drinks and clothing, tourism, etc. are
taken as comforts.
Luxuries include foods in high end hotels,
designers clothing, specious residences,
foreign touruism, and so on.
Substitute and Complementary Goods
Goods which crated joint demand are
complementary goods.
Therefore demand for one commodity is dependent
upon demand for the other one.
For ex: pen and ink, printer and ink cartridge,
computer and software, car and petrol(diesel) etc.
Goods that complete with each other to satisfy any
particular want are called substitute.
Also, note that the degree of substitution might vary
form product to product.
Substitute and Complementary Goods
Example of Close substitutes: Coke and
Pepsi, WagonR and Santro, petrol driven car
or diesel driven car, saving a/c with SBI or
ICICI bank, investing in govt bonds or
company deposits, and so on.
On the other hand, there are products which
are not so good substitutes of each other, for
example, car and bike, airways and railways.
This categorization of goods helps producers
in taking decisions related to price, output,
advertising, etc.
Individual’s Demand and 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.
For ex, if the milk market consisted of,
say, only three buyers, then individuals
and market demand (monthly) could be as
follows.
Individual firm Demand
Amul’s Demand: Ice Cream Cones
Price/cones Daily
quantity
_________________________________
Rs10.00 12
Rs15.00 10
Rs20.00 8
Rs25.00 6
Rs30.00 4
Individual Demand for Pizzas
(a) Ram (b) sanjeeve (c) komal
8 8 8
Price
4 4 4
d d d
H B C
1 2 3 Pizzas 1 2 1
(per week)
28
Market Demand
Market demand is the sum of all individual
demands at each possible price.
Assume the ice cream market has two
buyers as follows:
Price Per Cone Amul Vadilal Market
Demand
Rs10.00 12 + 7 = 19
Rs15.00 10 + 6 = 16
Rs20.00 8 + 5 = 13
Rs25.00 6 + 4 = 10
Rs30.00 4 + 3 = 7
Firm and Industry Demand
Most goods today are produced by more
than one firm and so there is a difference
between the demand facing an individual
firm and that facing an industry (all firms
producing a particular good constitute an
industry engaged in the production of that
good).
For ex: Cars in India are manufactured by
Maruti Suzuki, TATA motors, Hindustan
Motors, Premier Automobiles, and
Standard Motor Products of India.
Demand for Maruti car alone is a firm’s
(company) demand where as demand for
all kinds of cars is industry’s demand.
d d d D
H + B + C =
$12
8
Price
1 2 3 6 Pizzas
(per week)
32
Demand by Market Segments and by
Total Market
Dx =Demand of goods x
Y =Income of consumers
Px =Price of x
Ps =Price of substitute of x
Pc =Price of complements of x
T =Taste of consumers
Ep =Consumers’ expectations about future price
Ey = Consumers’ expectations about future income
N =No. of consumers
D =Distribution of consumers
The first five determinants affect the
demand for all goods, the next two are
influence mainly on the demand for
durable and expensive goods, and the next
tow are arguments only in the demand
functions for a group of consumers.
The impact of these determinants on
Demand is
1) Price effect on demand: Demand for x
is inversely related to its own price.
2) Substitution effect on demand: If y is a
substitute of x, then as price of y
increases, demand for x also increases.
3) Complementary effect on demand: If z
is a complement of x, then as the price of
z falls, the demand for z goes up and thus
the demand for x also tends to rise.
4)Price expectation effect on demand:
Here the relation may not be definite as
the psychology of the consumer comes
into play.
5) Income effect on demand: As income
rises, consumers buy more of normal
goods (positive effect) and less of inferior
goods (negative effect).
6) Promotional effect on demand:
Advertisement increases the sale of a firm
up to a point.
Socio-psychological determinants of
demand like tastes and preferences,
custom, habits, etc.
Demand Curve
Demand curve considers only the price
demand relation, other factors remaining
the same.
An individual’s demand schedule for
commodity x
Price x (per unit) Quantity of x
demanded (in units)
2.0 1.0
1.5 2.0
1.0 3.0
0.5 4.5
The demand curve is negatively sloped,
indicating that the individual purchases
more of the commodity per time period at
lower prices.
The inverse relationship between the
price of the commodity and the quantity
demanded per time period is referred to as
the law of demand.
A fall in Px leads to an increase in Dx
because of the substitution effect and
income effect.
Determinants of Demand
46
Assumptions.
There is no change in the tastes and
preferences of the consumer
The income of the consumer remains
constant
There is no change in customs
The commodity to be used should not
confer distinction on the consumer
There should not be any substitutes of the
commodity
Assumptions.
There should not be any change in the
prices of other products
There should not be any possibility of
change in the price of the product being
used
There should not be any change in the
quality of the product; and
The habits of the consumers should
remain unchanged.
Given these conditions, the law of
demand operates. If there is change even
in one of these conditions, it will stop
operating.
Law of Demand
Law of demand states that, ceteris paribus, demand
for a product is inversely proportional to its price.
Price of the product is the most important variable
of a product’s demand. i.e. Dx = f(Px)
Law of Diminishing Marginal Utility:
51
Demand Schedule and Demand
Curve
Demand Schedule is the list or tabular
statement of the different combinations of
price and quantity demanded of a
commodity.
Demand curve shows the relationship
between price of a good and the quantity
demanded by consumers.
Demand Schedule
Price Quantity Demanded
per Pizza per Week (millions)
a $15 8
b 12 14
c 9 20
d 6 26
e 3 32
53
Demand Curve for Pizza
a
$15
b
Price per pizza
12
c
9
d
6
e
3
D
0
8 14 20 26 32
Millions of pizzas per week
54
Demand Schedule and Individual
Demand Curve
Point on e
Demand Demand 35
Curve Price (Rs (‘000 d
Price of Coffee
per cup) cups)
30
a 15 50 c
b 20 40 25
b
c 25 30 20
d 30 20 a
15
e 35 10
O
10 20 30 40 50
Quantity of coffee
55
Exceptions to the Law of Demand
In certain cases, the
demand curve slopes
up from left to right,
i.e., it has a positive
slope. Under certain
circumstances,
consumers buy more
when the price of a
commodity rises, and
less when price falls
Reasons for Exceptions
War: If shortage is feared in anticipation
of war, people “may start buying for
building stocks or for hoarding even when
the” price rises.
Depression: During a depression, the
prices of commodities are very low and
the demand for them is also less. This is
because of the lack of purchasing power
with consumers.
Giffen Paradox: 1
1. Perception of quality
In Veblen’s analysis of conspicuous consumption, the
economist noted that for certain luxury goods and services,
a higher price was often associated with the perception of
higher quality.
For example, the demand for a designer handbag rises
with an increase in its price. The price increase is viewed
by consumers as evidence that the producer of the designer
handbag has improved the quality of the handbag.
2. Positional goods
Veblen goods are often positional goods.
The quantity demanded of a positional
good depends on how the good is
distributed in society.
For example, the utility gained by a
consumer from owning a diamond-
encrusted handbag might arise primarily
from the fact that few other people in
society can afford to own such an object.
Thus, for this consumer, the diamond-
encrusted handbag acts as a positional
Shift in Demand Curve
Shift of demand curve due to a change in any
of the factors other than price is a change in
demand.
When demand increases without any change
in price, the demand curve will shift to the
right, and with a reduction in demand, the
curve will shift to the left.
Demand curve shifts to the right if income
rises and shifts to the left if income falls,
ceteris paribus.
Speculation
% change in price of X
Price Elasticity of Demand is negative since
there is an inverse [negative] relationship
between price and the demand of the
product. If price increase, demand decrease,
if price decrease, demand increases.
Types of price elasticity
1. Perfectly elastic demand ( e = α)
When an insignificant or minor change in the
price will result in an extra ordinary large
change in demand, the demand is said to be a
perfectly elastic. A slight change means a
slight decrease in the price will result in the
increase in demand to infinity and a slight
increase in the price will lead to the decrease
in demand to ‘0’. But in actual situation the
demand cannot be perfectly elastic.
Perfectly elastic demand ( e = α)
% change in Price of Y
It is positive if goods x and y are substitutes in the
consumption basket, negative if they are complements, and
zero if the two goods are unrelated.
The greater the magnitude of this elasticity, the stornger is
the relationship between two goods.
Positive Cross Elasticity:-
Substitute goods are those which compact with each
other. For, e.g., tea, coffee etc. For substitutes
goods the cross elasticity is positive.
Generally if the price of tea falls, the demand of tea
rise and at the same, time tea become cheaper than
coffee. So, some of the customer currently
consuming coffee will start consuming tea instead of
coffee. So the demand of coffee reduces.
For substitutes quantity demanded of one good
moves in the same direction as the price of the other.
Ex : coke and pepsi, zen and santro, etc.
Negative Cross Elasticity:
Complementary goods are those goods which have to
be consumed simultaneously it means if a consumer
wants to consume one product he has to consume
other product.
For complements, quantity demanded of one good
moves in the opposite direction as the price of the
other.
For, e.g., car & petrol. Elasticity for complementary
goods is negative. If the price of car reduces, the
demand for it increases and at the same time the
requirement of petrol also increases, which will
increases the demand for it.
Ex: bread and butter, tea and sugar, pen and ink, etc.
Zero Cross elasticity:
Ec for unrelated goods is zero because
one commodity does not affect the other
commodity if the price of one commodity
changes it will not affect the demand for
other commodity. If the price of tea
changes by 2% it will not create any
affect on the demand of clothes.
Promotional Elasticity of Demand
Advertising and promotion are vital tools in
the competitive market to generate awareness
about its products.
Promotional elasticity of demand measures
the degree of responsiveness of demand to a
given change in advertising expenditure.
It must obviously be positive, for
advertisement expenditures are supposed to
boost up the market.
Some goods (like consumer goods) are more
responsive to advertising than others (like
heavy capital equipments)
When Ea > 1, a firm should go for heavy
expenditure on advertisement.
When Ea < 1, a firm should not spent too
much on advertisement because the
product is not sensitive to promotion.
For Ex: we find the advertisement for
lubricants, generators, inverters, etc. but
would not find advertisements for
electricity, petrol or diesel.