Demand Analysis, Supply Analysis & Equilibrium concept Prof.S.K.Roy

Demand, concept & Analysis Supply & Demand are two important component of Market along with Price. Success of any business is determined by two factors:-  Demand of the product at a price & the rate of growth of demand  Supply capability of the business to match the demand. It is therefore essential to understand Demand & Supply concept. Demand Demand can be defined as “ want desire or need of an individual backed with ability to pay and willingness to pay in a given period of time” Demand can also be defined as “ effective desire which is backed by ability and willingness to pay” Demand can also be defined as “ quantity of a commodity which consumers are willing to buy at a given price for a particular unit of time.”

Demand continued: Types of Demand Types of demand can be categorized on following bases:-  Nature of commodity demanded ( Consumer goods or capital goods)  Time unit (Short run or Long Run)  Relation between two goods . Demand can be of following types on the basis of above categories:- Direct & Derived Demand Recurring & Replacement Demand Complementary & Competing Demand Individual & Market Demand Direct Demand: When a product is demanded for its own use by final consumers then it is known as “Consumer Goods” & its demand is known as “Direct Demand” Examples are household items like T.V Etc. Derived Demand: When a product is demanded for producing another commodity then it is called “Capital Goods” & its demand is called “Derived Demand” e.g demand for A.C creates demand for its parts and components

Contd. Recurring & Replacement Demand Recurring Demand: Consumer goods having direct demand are purchased frequently and hence known as Recurring Demand. E.g newspaper, snacs etc Replacement Demand: Durables like T.V, Fridge etc are purchased to be used for a long time but they need replacement at a particular time. Such Durable goods are called to have Replacement Demand. Complementary & Competing Demand Complementary Demand: Goods which create joint demands that are complementary goods e.g pen & ink , computer & software, car & diesel etc. Competing Demand: Goods that compete with each other is called competing goods or substitutes e.g coke and pepsi , Vagonar and Santro. When a consumer is indifferent between two goods , they are called as closed substitutes e.g saving account at ICICI bank or at SBI. Individual and market demand Individual Demand: Demand for an individual consumer is called individual demand. Market Demand: Demand for the product produced by all the manufacturers in the industry is called market demand.

Determinants of Demand There are eight determinants of demand: Price of the product: The single most important determinant of demand is the price of the product. Normally price has a negative effect on Demand, it means that with all other determinants of demand being unchanged , the demand of a product will increase if the price of the product is reduced or vice a versa. This is also known as price effect. Income of the consumer: Another important determinant of demand is the income of the consumer. Normally income has a positive relationship with demand. It means that demand of the product will increase with the increase in income of the consumer and vice a versa . This is also known as income effect. This income effect gives rise to two types of product  Normal Goods & Inferior Goods. If demand of goods rises with the income and falls with the income then such type of goods are called normal goods e.g fruits , higher class journey, ornaments etc.  Goods whose demand goes down with the rise in income are called inferior goods.

Contd. Price of related goods: Demand for a product not only depends upon price and income but it also depends upon prices of the related product e.g Car and Petrol. Demand of car will also depend upon price of petrol. Taste and preferences: This is also an important determinant of demand. Demand of a product also depends upon taste and preferences of consumers e.g whatever price is fixed by road hawkers for its eatables , it will not be demanded by rich people. Advertising: This is equally important determinant of demand. Advertising creates awareness and interest in consumers which is converted to demand. More advertising is likely to generate more demand. Consumers expectation of future income and future price: Expected future income and price is also an important determinant of demand e.g demand of a product will increase if price of the product is likely to rise in future. This equally holds true for future income. Population: Size of population , age distribution etc determind the demand. If the population is increasing demand for any product will increase. Growth of economy: Growth of economy that is GDP also affects the demand of the product.

Demand Function We have seen various determinants of Demand. “Demand function” is a mathematical presentation of various determinants of Demand. Demand function can be represented as : Dx = f(Px, Y, Po, T, A, Ef, N) where Px is price of the product x, Y is income of the individual, Px is the price of related product, A is Advertising, Et is future expectations of income or price. N is population & economy growth. As clearly seen, Demand function is a Multi-Variate Demand Function where there are many variables. Income, price of other products ,advertisements, future expectations, population etc have POSITIVE EFFECT on Demand WHEREAS Own price of the product, Price of the complementary products have NEGATIVE EFFECT on Demand.

Law of Demand Law of Demand states that “ All other things remain same, Demand of a product is inversely proportional to its Price”. More specifically, Demand of a product increases if price goes down and it decreases if price of the product goes up. It can be stated mathematically as follows: Dx =f(Px) , where Dx is demand of product x, f stands for function & Px stands price of the product. Hence Demand is a negative function of Price. It can be expressed in two mathematical ways:  Linear demand function:- Dx, = a- bPx where a> 0 & b> 0 “a “is a slope & constant which represents the level of demand when price is Zero where as “b” is another slope & constant which measures the change in demand per unit change in price. e.g if “b” is 20 then it means with a change in price of the product by one unit, the demand of the product falls by 20 units.  Non-Linear Demand Function:- D = A p-b or Log D = a –b Log P Where a,b> 0

Law of Demand continued. Law of Demand is the cause of 4 effects 1) Price Effect 2) Income Effect 3) Substitution effect 4) Law of diminishing Marginal Utility. Price Effect: This effect explains why a fall in price results in rise in Demand and vice versa. Income effect: With the fall in price, money income remains same but Real income rises hence purchasing power of individual increases so the demand of the product increases. Substitution Effect: Fall in price of the product, makes substitutes more expensive & hence demand increases. Law of diminishing marginal utility: As per this effect, the utility derived from every marginal unit (additional one unit) of a commodity consumed goes on falling. Numerical 1: There is a fruit seller who has 20 Kgs of Apples. He wants to sell it. What price per kg of apple should be fixed? There are three customers in the market whose demand function is given as follows: Consumer no. 1  D1 = 25- 1.0 P Consumer no. 2  D2 = 20- 0.5 P Consumer no. 3  D3 = 15 -0.5 P

Law of demand continued Numerical solution: “Market Demand is the sum of all individual demand” Hence Dm = (25 – 1.0 P ) + ( 20 – 0.5 P) + ( 15 – 0.5 P) = 60 – 2.0 P As he wants to sell a total of 20 apples hence Dm = 20 Keeping this in equation we get 20 = 60 – 2.0 P  P = 20 Keeping this value in respective demand function of individuals, we get respective demand to be as follows: D1 = 5, D2 = 10 & D3 = 5 -------------------------------------------------------------------------------------------------------------------

Demand Schedule & Demand Curve Demand Schedule: “Demand schedule is a tabular statement of the different combinations of price and quantity demanded at that price.” Law of demand can also be explained with the help of Demand schedule. An hypothetical example of Demand schedule is given in following table: Point on Demand Curve Price of the product per unit Demand of the product at that price a b c d e 15 20 25 30 35 50 40 10

Demand Curve “ Demand Curve “ is the graphical representation between price of a product and demand of that product at various price of the product. It is graphical presentation of the Demand Schedule. Quantity demanded is plotted at X-Axis i.e horizontal axis & Price of the product is plotted at Y-Axis i.e vertical axis. Slope of Demand curve is always negative & convex to origin because of following effects: - Negative relation between price & demand Law of Diminishing marginal utility Demand curve can be shown by Straight line or by rectangular hyperbola. Price Price 30 ---- Demand Demand

continued Movement along the same Demand Curve due to increase or fall in prices is called Expansion or Contraction of demand i.e with respect to change in prices. If price of the product remain same but there is a shift in demand curve then it means that demand of the product has changed due to any other factors like Income, price of related goods, Advertisements etc. Demand curves shift to right if income rises and other things remain same however demand curve shifts to left if income falls and all other variables remain same. Price A change in any of the Determinants of demand will cause the demand curve to shift to right or left with no change in price. Demand Change in Demand

Exceptions of Demand There are few cases where Law of Demand does not apply therefore these situations are known as EXCEPTIONS OF DEMAND. These are those products where Demand increases with the increase in prices and demand falls with the fall in prices. Some of the exceptions are as follows:  Giffen Goods : These goods have a positive relation of Price and demand. E.g Essential items like Bread, milk etc which are must for livelihood will have a positive effect of demand and price. E.G of chicken & bread.  Snob Appeal: There are some goods which have snob value where consumers evaluate satisfaction not by its utility but by its social status. Consumers want to show it off to others and as a result they buy less at a lower price and buy more at a higher price. E.g Diamonds, exclusive paintings, antique pieces. These goods are also known as VEBLEN GOODS.

Exceptions of demand continued Future expectation of prices: When prices rise and it is expected that it will rise further then people buy in panic therefore law of demand does not hold. E.g Shares in rising market. Insignificant proportion of income spent: Law of demand does not hold good if insignificant proportion of income is spent on that good. E.g Salt, spices etc Goods with no substitutes: Law of demand also does not hold good if the product has no substitutes. e.g life saving drugs, Petrol, Disel etc  Demonstration effect: There are goods where price rise does not matter as people demand by seeing others e.g Fashion goods, celebrirty endorsement etc