Demand analysis

Theory Of Demand

Introduction

• A market economy functions through:» Demand» Supply.

• Market is an arrangement by which buyers and sellers contact each other to make any transaction.

• People demand goods because they satisfy their wants.

• The amount of satisfaction which a person derives from consuming a commodity is called as Utility.

• The greater the utility he expects from the commodity, the greater his desire for that commodity

Definition of Demand

“ Quantities of a good or services that people are

ready to buy at various prices within some given

time period, other factors besides price held

constant.”

it Implies:• The consumers have a desire to purchase• Ability to pay for the goods and services.

• Sometimes the quantity demanded is not necessarily equal to quantity bought by the consumer.

• It is flow concept i.e- its measured by the amount the consumers wish to buy per unit of time.

The Law of Demand

The Law of Demand -

“It expresses the functional relationship

between price and quantity demanded.”

• There is an inverse relationship between price and

quantity demanded, If the other things being equal

Other things –

Taste or preferences

Income

Price of related goods.

Demand Curve

Demand Curve:

It is graphic statement or presentation of quantities demanded

by the consumer at various possible prices in a period of time.

(Demand curve does not tell us the price of the product)

Price (Rs)

Quantity Demanded (Units)

5 2

4 3

3 4

2 6

1 10

Y D

2 3 4 6 100

1

2

3

4

5

6PRICE & DEMAND

QUANTITY

PR

ICE

Market Demand

Market Demand:

It is sum total of demands of all consumers in the market

for a commodity at various prices.

Price QD1 QD2 QD3 MD

1 16 11 15 42

2 11 7 12 30

3 7 5 10 22

4 4 4 7 15

5 2 3 5 10

6 1 2 2 5

P

O a1 b1 c1 Q

Reason for the Law of Demand

Income Effect:– With the fall in price of commodity the

consumer can buy more of the commodity with his given income.

– Fall in prices leads to consumers purchasing power to increase.

Substitution Effect:– When the price of commodity falls it becomes

relatively cheaper than other commodities.– So consumer substitute the commodity and the

quantity demanded rises.

No of consumer Increases:– Fall in prices leads more number of consumer

to demand the commodity and hence rise in quantity demanded.

Why does the demand curve slope downwards?

Exception to The Law of Demand

1. Veblen Effect: Conspicuous Consumption» Goods having prestige value» Some consumers measure the utility of a

commodity by its price i.e greater the price , greater the utility.

2. The Giffen Case: » When the price of essential goods

increases, it demands also increases.» A fall in its price, quantity demanded

decreases.

3. Speculative Market» Rise in prices is followed by larger

purchases and fall in price by smaller purchases.

Factors determining Demand

1. Tastes and Preferences of the consumers: Goods for which the tastes and preferences are

greater , the demand would be large and demand curve will lie at a higher level.

Consumers tastes keeps on changing and as result there is a change in demand for them.

2. Income of the people: Greater the income greater the demand

(purchasing power)• Change in income also lead to change in

demand curve for Normal and Inferior Goods

Normal and Inferior Goods

Effect of Increase in Incomeon Demand for a Normal Good

O Q Q’

P

D

D

D’

D’

D’

D’

D

D

P

QQ’

Effect of Increase in Incomeon Demand for a Inferior Good


3. Changes in the prices of the related GoodsDemand for goods also changes with the change in prices of “other” goods

a) Substitute Goods – Different goods that, at least partly, satisfy the sameneeds of the consumers and, therefore, can beused to replace one another.

– The rise in prices causes the increase in demand of another goods

– Good A is a substitute of Good B if a rise / fall in the price of good B causes increase / decrease in the demand for good A respectively.

Substitute Goods

OQ Q’

P

Quantity Demanded

D

D

D’

D’

Rightward Shift with rise in price of Substitute goods

Leftward Shift with fall in price of Substitute goods

OQQ’

Quantity Demanded

P

D

D

D’

D’


b) Complementary Goods –

Goods whose use is interrelated with the use of an

associated or paired good such that a demand for one (tyres) generates demand for the other (gasoline).

– The change in prices causes the change in demand of another goods

– Good A is complement of Good B if a rise / fall in the price of good B causes decrease / increase respectively in the demand for good A

Complementary Goods

OQ Q’

P

Quantity Demanded

D

D

D’

D’

OQQ’

Quantity Demanded

P

D

D

D’

D’

Leftward Shift- Rise in price ofcomplementary goods

Rightward Shift- Fall in price of complementary goods


4. The Number of Consumers in the Market. Greater the number of consumers of a good, greater

the market demand Increase in consumers is dependent upon growth in

population and exploration of new markets

5. Consumer Expectations Demand is dependent upon what is the consumer

expectation about the future. If buyers are expecting the price to increase in future,

the current demand increases.

6. Income Distribution Distribution of income in the society also effects

demand If distribution is equal, the propensity to consume of

the society would be high, so demand would be high.

Movement along Demand curve

Extension or Contraction in Demand:

• When the quantity demanded rises/ falls as a result of changes in price and we move along a given demand curve.

• The other determinants remain constant. (Demand curve remain the same)

• Extension : When quantity demanded rise due to fall in price.

• Contraction: When quantity demanded fall due to rise in prices.

Movement along Demand curve

As a result of changes in price of a good the consumers move along the given demand curve.The demand curve remains the same and does not change its position.A shift in demand curve happen by change in factors other than in its own price.

MO

P

P’

P”

NL

Expansion

Contraction

Shifts in Demand

Shift in Demand curve:

When the demand changes due to the factor other than price.

a) Increase in Demand:

With the other factor increasing say income, it will cause a shift in demand curve.

The consumers demand more of the commodity than before

Q1 Q3Q2

P1

P2

P3

D

D D’

D’

Shifts in Demand

B) Decrease in Demand:

It there are adverse changes in the factors

It will cause a shift in demand curve to the left

The consumers demand less of the commodity than before

Q1Q3 Q2

P1

P2

P3

D

DD’

D’

Demand Function

Qd = f ( Px, I, Pr, T, A)

Where Px = Own price of the commodity X I = Income of the Individual Pr = Prices of related commodities T = Tastes and preferences of the individual consumer A = Advertising expenditure made by the producers of the

product

Keeping other factor as constant

Qd = f (Px)

It implies that quantity demanded of good X is function of its own price. Otherdeterminants remaining constant

Demand Function

• The level / position of demand curve depends on the other factors

• To show how much quantity demanded changes with a unit change in price

Qd = a- bPx

where a= Constant intercept term on the X- axisb = Co-efficient showing the slope of the demand curvePx = Independent VariableQd = Dependent variable

Theory Of Supply

SUPPLY

• Supply refers to the schedule of the quantities of a good that the firms are able and willing to offer a various prices.

How much of a commodity the firms are able to

produce depends on:

– The resources available – Technology they employ– Profits they expect to make

Definition of Supply

“ Quantities of a good or services that people are ready to sell at various prices within some given time period, other factors besides price held constant.”

• Sometimes the quantity supplied is not necessarily equal to quantity actually sold by the consumer.

• It is flow concept i.e- its measured by the amount of a commodity that the firm produces and offer for sale in the market per period of time.

Supply Function

Qs = S ( Px, F1, Pr, W,E )

Where Px = Own price of the commodity X F1= Price of Inputs Pr = Prices of other products related in

production W = Weather, strikes and other short –run

forces E = Firms expectation about future prospects

for prices, cost, sales and state of economy Keeping other factor as constant

Qs = f (Px)

Supply Function

• The level / position of supply curve depends on the other factors

• To show how much quantity supply changes with a unit change in price

Qs = a + bPx

where

a= Constant intercept term on the X- axis

b = Co-efficient showing the slope of the supply curve

The Law of Supply

The Law of Supply –

“It expresses the functional relationship between

price and quantity demanded.”

There is an direct relationship between price and

quantity supplied, If the other things being equal

Supply Curve

Supply Curve:

It is graphic statement or presentation of quantities

supplied by the firm at various possible prices in a period

of time.

Price (Rs)

Quantity Supplied (Units)

500 100

510 150

520 200

530 225

540 275

Y

100 150 200 225 250 275470

480

490

500

510

520

530

540

550

560Price & Supply

QUANTITY

PR

ICE

Reason for the Law of Supply

Why does the Supply curve slope Upwards?

• Firms are driven by profit motive

– Higher the price of the product, more profitable to produce them.

– Greater the incentives of the firm to produce– It also depends upon possibilities of substitution– More production also leads to more profits

Factors determining Supply

1. Production Technology

2. Price of Inputs

3. Prices of Related products

4. Number of producers (or firms)

5. Future price expectations

6. Taxes and Subsidies

Shifts in Supply

Shift in Supply curve:

When the Supply changes due to the factor other than price.

a) Increase in Supply:

With the increase in other factor

The producers supply more of the commodity

Q1 Q3Q2

P1

P2

P3

SS’

Shifts in Supply

B) Decrease in Supply :

It there are adverse changes in the factors

It will cause a shift in Supply curve to the left

The producers supply less of the commodity

Q1 Q3Q2

P1

P2

P3S

S’

Market Equilibrium

S

Q

P

D

Q1

P1

Surplus

Shortage

Equilibrium Price: The price that Qd = QsEquilibrium Quantity:

The amount that people are willing to buy and seller are willing to offer.Shortage: Qd > QsSurplus: Qd < Qs

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Demand analysis