6. Demand Analysis

8/8/2019 6. Demand Analysis

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By: Malik Abrar Altaf

Lecturer, Management

Dr.S.M.Iqbal Business School.


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Demand. Desire. Need.

A person when desiring is willing and able to pay for what

he/she desires , the desire is changed into demand.

Demand is always: @ Price , Per Unit Time.

Demand refers to the quantity of a good or service thatbuyers are willing to buy during a particular period at a given

price.

Bobers Definition: By Demand we mean the various quantities of a given commodityor a service which consumers would buy in one market in a givenperiod of time at various prices , or at various incomes, or atvarious prices of related goods.


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Demand in economics means desire to buybacked by Purchasing Power. Mere wish or desire cannot buy goods.

Sellers point of view : Demand price is theaverage revenue or income he expects toearn from the sale of a unit of a commodity.

Demand price is identical with AverageRevenue(AR).


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1. Price Demand.

It refers to various quantities of a commodity or service that

consumer would purchase at a given time in a market at various

hypothetical prices.

It shows the relation between Price & Quantity Demanded.

2. Income Demand.

It refers to various quantities of a commodity or service that

consumer would purchase at a given time in a market at various

income levels.

It shows the relation between income & Quantity Demanded.

3. Cross demand.

It refers to the quantities of a commodity or a service which will be

purchased with reference to change in price not of this good but

of the inter -related goods.

E.g.: Demand for Tea and Coffee.


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The relationship of Price to Sales or Demand or alternatively

, the Price Quantity Relationship , is shown arithmetically in

the form of a table showing prices & corresponding

quantities. This table is known as Demand Schedule.

Price Quantity Demanded

5 804 100

3 150

2 200

Demand Schedule


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Income of the consumer is given and constant.

No change in tastes, preference, habits etc.

Constancy of the price of other goods.

No change in the size and composition of

population.

These Assumptions are expressed in the phrase other things remaining equal.


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More the price of the commodity or Service less is the quantity demandedand

Vice Versa.


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The Law of Demand states that there is

an inverse relationship between the price

of a good and the quantity demanded of

that good (other things being equal) .


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Inverse Relation between Price & Quantity, butmay or may not be proportional.

Price an independent variable and Demand adependable variable.

Other things remain same: it is assumed that

there should be no change in other factors (Income, Substitutes Price, Consumers Tastes & Preferences,Advertising Outlays) influencing demand except price.


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Substitution effect. Income effect.

Substitution effect:When the commodity becomes cheaper , it tendsto be substituted wholly or partly for other commodities.

Income effect:A unit of money goes farther and a consumer can

afford to buy more . He is able & willing topurchase the thing being cheaper, his real incomeincreases.


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Giffen Paradox:In case of Inferior goods,Demand is Strengthened

with a rise or weakened with a fall in the price.

Cases of Upward Rising Demand Curve:(Benham);

1. Serious Shortage .

2. If Commodity confers distinction.( ConspicuousConsumption).

3. Ignorance Effect.

4. If the commodity is a necessity of life.


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Man tries to give the least & wants the maximum in return.

Man tries to weigh between what he is giving & what he is getting inreturn

Unit of measurement is Money and the Utility.

G = what he is giving.(In terms of money).R = what he is receiving .(In terms of goods & their marginal

utilities).IfGG (Trade or exchange goes on).IfG=R, (Point where trade stops or Equillibrium Point).

IfG>R ,(Will there be trade?)


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Income.

Population.

Tastes & Habits.

Other Prices.

Advertisement.

Fashion.


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Variations in demand refer to those which occur due

to changes in the price of a commodity.

Extension of Demand:

This refers to rise in demand due to a fall in price of the

commodity. It is shown by a downwards movement on a

given demand curve.

Contraction of Demand:

This means fall in demand due to increase in price and can

be shown by an upwards movement on a given demand

curve.


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Extension (Q to Q2) & Contraction ( Q to Q1) of Demand.


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Changes in demand imply the rise and fall dueto factors otherthan price.

Increase in Demand: This refers to higherdemand at the same price and

results from rise in income, population etc., this isshown on a new demand curve lying above theoriginal one.

Decrease in demand: It means less quantity demanded at the same price.

This is the result of factors like fall in income,population etc. This is shown on a new demand lyingbelow the original one.


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Increase ( D to D1) & Decrease ( D to D2) in Demand


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Law of demand explains the functional relationship between price and demand.(

Other things Being Equal).

The law of demand explains the direction of a change as it states that with a rise in

price the demand contracts and with a fall in price it expands.

The law of demand fails to explain the extent or magnitude of a change in demand

with a given change in price.

The law of demand merely shows the direction in which the demand changes as a

result of a change in price, but does not throw any light on the amount by which the

demand will change in response to a given change in price.

The law of demand explains the qualitative but not the quantitative aspect of price-

demand relationship.


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It explains the degree of responsiveness of demand to a change in price.

It elaborates the price-demand relationship.

E.O.D means the sensitiveness or responsiveness of demand to a change

in price.

According to Marshall,

the elasticity (or responsiveness) of demand in athe elasticity (or responsiveness) of demand in a

market is great or small accordingly as the demand changes (rises ormarket is great or small accordingly as the demand changes (rises or

falls) much or little for a given change (rise or fall) in price.falls) much or little for a given change (rise or fall) in price.

Elasticity of demand is a measure of relative changes in the amount demanded

in response to a small change in price.

Elastic Demand: when a small change in price brings about considerable

change in demand.Inelastic Demand : when a change in price fails to bring about significantchange in demand.


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Ep=Percentage change in quantity demanded /Ep=Percentage change in quantity demanded /

Percentage change in the price.Percentage change in the price.


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Perfectly inelastic demand (ep = 0)

Inelastic (less elastic) demand (ep < 1)

Unitary elasticity (ep = 1)

Elastic (more elastic) demand (ep > 1)

Perfectly elastic demand (ep = )


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This describes a situation in which demand shows no response to a

change in price.

In other words, whatever be the price the quantity demanded remains the

same.It can be depicted by means of the alongside diagram.


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In this case the proportionate change in demand is

smaller than in price.


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When the percentage change in price produces equivalent

percentage change in demand, we have a case of unit

elasticity.


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In case of certain commodities the demand is relatively

more responsive to the change in price. It means a small

change in price induces a significant change in, demand.


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This is experienced when the demand is extremely sensitive

to the changes in price. In this case an insignificant change

in price produces tremendous change in demand.


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Nature of the Commodity:

The demand for necessities is inelastic and for comforts and luxuries it is elastic.

Number ofSubstitutes Available:

The availability of substitutes is a major determinant of the elasticity of demand. The

large the number of substitutes, the higher is the elastic. It means if a commodity has

many substitutes, the demand will be elastic.

Number Of Uses:

If a commodity can be put to a variety of uses, the demand will be more elastic.

When the price of such commodity rises, its consumption will be restricted only to

more important uses and when the price falls the consumption may be extended to

less urgent uses, e.g. coal electricity, water etc.


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Range of prices:

The demand for very low-priced as well as very high-price commodity is

generally inelastic. When the price is very high, the commodity is consumed

only by the rich people. A rise or fall in the price will not have significant effect in

the demand. Similarly, when the price is so low that the commodity can bebrought by all those who wish to buy, a change, i.e., a rise or fall in the price, will

hardly have any effect on the demand.

Proportion ofIncome Spent:

Income of the consumer significantly influences the nature of demand. If only asmall fraction of income is being spent on a particular commodity, say

newspaper, the demand will tend to be inelastic.

According to Taussig, unequal distribution of income and wealth makes the

demand in general, elastic.


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Demand for durable goods, is usually elastic.

The nature of demand for a commodity is also influenced by the

complementarities of goods.


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In this method, the percentage change in demand and percentagechange in price are compared.

ep = [Percentage change in demand / Percentage change in price]

In this method, three values of ep can be obtained. Viz.,ep =1, ep > 1, ep 1, it means the demand is elastic.

If percentage change in demand is less than that in price, e


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The elasticity of demand can be measuredby considering the changes in price and theconsequent changes in demand causingchanges in the total amount spent on thegoods.

The change in price changes the demand

for a commodity which in turn changes thetotal expenditure of the consumer or totalrevenue of the seller.


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If a given change in price fails to bring about any change in the total outlay,

it is the case of unit elasticity. It means if the total revenue (price x Quantity

bought) remains the same in spite of a change in price, ep is said to be

equal to 1.

If price and total revenue are inversely related, i.e., if total revenue falls

with rise in price or rises with fall in price, demand is said to be elastic or e

> 1.

When price and total revenue are directly related, i.e. if total revenue rises

with a rise in price and falls with a fall in price, the demand is said to be

inelastic pr e


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The income effect suggests the effect of change inincome on demand.

The income elasticity of demand explains the extent

of change in demand as a result of change in income.

In other words, income elasticity of demand meansthe responsiveness of demand to changes in income.

Income elasticity of demand can be expressed as:EY = [Percentage change in demand / Percentagechange in income]


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Income Elasticity of Demand Greater than One: When the percentage change in demand is greater than

the percentage change in income, a greater portion of income is being spent on a commodity with an increase in

income- income elasticity is said to be greater than one.

Income Elasticity is unitary: When the proportion of income spent on a commodity

remains the same or when the percentage change inincome is equal to the percentage change in demand, EY =1 or the income elasticity is unitary.

Income Elasticity Less Than One (EY< 1): This occurs when the percentage change in demand is

less than the percentage change in income.


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Zero Income Elasticity of Demand (EY=o): This is the case when change in income of the consumer

does not bring about any change in the demand for acommodity.

Negative Income Elasticity of Demand (EY< o): It is well known that income effect for most of the

commodities is positive. But in case of inferior goods, theincome effect beyond a certain level of income becomesnegative. This implies that as the income increases theconsumer, instead of buying more of a commodity, buysless and switches on to a superior commodity. The incomeelasticity of demand in such cases will be negative.


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The demand for a commodity depends not only on the priceof that commodity but also on the prices of other relatedgoods. Thus, the demand for a commodity X depends notonly on the price of X but also on the prices of other

commodities Y, Z.N etc.

The concept of cross elasticity explains the degree of change in demand for X as, a result of change in price of Y.

This can be expressed as:

EC = [Percentage Change in demand for X / Percentagechange in price of Y]


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The relationship between any two goods is of two types. The goodsX and Y can be complementary goods (such as pen and ink) or substitutes (such as pen and ball pen).

In case of complementary commodities, the cross elasticity will be

negative. This means that fall in price of X (pen) leads to rise in itsdemand so also rise in its demand for Y (ink) .

On the other hand, the cross elasticity for substitutes is positivewhich means a fall in price of X (pen) results in rise in demand for Xand fall in demand for Y (ball pen).

If two commodities, say X and Y, are unrelated there will be nochange i. Demand for X as a result of change in price of Y. Crosselasticity in cad of such unrelated goods will then be zero.

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6. Demand Analysis