Samir K Mahajan, M.Sc, Ph.D.,UGC-NET

Assistant Professor (Economics)

DEMAND ANALYSIS

MEANING OF DEMAND

Demand is effective desire which can be fulfilled. Demand must satisfy the following pre-requisites:

• Desire for a specific commodity

• Ability to pay or sufficient resources to purchase the desired commodity• Willingness to spend on the commodity

• Availability of the commodity at particular price, time andplace.

All these mentioned requisites must be satisfied simultaneously to satisfy the meaning ofdemand.

DEMAND DETERMINANTS

Demand determinants refer to the factors that affect demand forcommodity (a consumer good), such as:

Price of the CommodityIncome of the ConsumerPrice of related goods Taste and preference of consumer

Growth of populationGovernment policyClimatic conditions Income distributionExpected change in priceFuture expectation about income etc.

DEMAND DETERMINANTS

Some important determinants of demand are discussed as follows:

Price of the CommodityNormally, quantity demanded of a commodity varies inversely with its price, ceterisparibus ( i.e. other things remaining the same). As price of a commodity rises,quantity demanded of it falls and as price of the commodity falls, quantity demandedof it rises .

Income of the ConsumerChange in income of the consumer also brings about changes in demand for acommodity.Demand for a normal good varies directly with income of the consumer, other things

remaining the same. Normal goods are those goods whose demand increases withincrease in income of the consumer and vice versa. Demand for inferior goodsdecreases with increases in income of the consumer .

DETERMINANTS OF DEMAND(contd)

Price of Related GoodsGoods are said to be related when they are either substitute goods or complementarygoods. Substitute goods are those goods which compete with each other to satisfy aparticular want. E.g. railways and airways, branded mobiles and Chinese mobile. etc .Complementary goods are those goods which are jointly demanded to satisfy aparticle want. Examples of complementary goods are car and petrol, etc.In case of substitute goods: Quantity demanded of a commodity varies directly withthe price of its substitute. In case of complementary goods: Quantity demanded of acommodity varies inverselywith the price of its complementary goods.

Taste And PreferencesDemand for goods is affected by taste and preferences of the consumer which aresubjective in nature, and are shaped by individual like and dislikes, faith and belief,fashions, habits, trends etc.

KINDS OF DEMAND

There are three kinds of demand relations which are usually studied under demand analysis such as: Price Demand, Income Demand and Cross Demand.

Price Demand: Price demand studies how demand for a commodity ( Dx) changes with respect to change in price(Px) , ceteris paribus (other things remaining the same). Dx= f (Px)

Income Demand: Income Demand examines how demand for commodity ( Dx) changes as a result of change in income of the consumer(Y) , other things remaining the same. Dx= f (Y)

Cross Demand: Cross demand studies how quantity demand of a commodity ( Dx) changes as a result of change in price of its related goods ( PR ), ceteris paribus . Cross demand function can be denoted as follows: Dx= f ( PR )

LAW OF DEMAND

The law of demand states that normally quantity demanded

of a commodity varies inversely with price, ceteris paribus.

In other words, the law of demand states that other things

reaming the same, lesser quantity of a commodity will be

demanded at higher prices, and more quantity of it will be

demanded at lower prices.

Demand Curve

0 Quantity demand

Price

D

D

Demand curve

Demand curve is the graphical representation of the relationship between demand for a commodity (Dx) and its price (Px) .

Normally, a demand curve slopes downwardfrom left to right indicating the operation of thelaw of demand.

Here demand curve DD curve is known as an exceptional demand curve.

Exceptional Demand Curves/Exception to Demand curve or Law of Demand

In some rare situations, the law of

demand does not hold good.

In such situations, the demand

curve slopes upward instead ofsloping downward suggesting a

rise in demand with rising price.

Cases in which this tendency is

observed are referred to asexceptions to the general law of

demand.

Exceptions to law of demand are

Giffen goods,

conspicuous consumption

conspicuous necessities, expected changes in price,

extraordinary situations like natural disasters, famine, riots etc

Exceptional Demand Curves contd.

Giffen goods:

In case of certain inferior goods called Giffen goods, when the price falls, quiteoften less quantity will be purchased than before because of the negativeincome effect and people’s increasing preference for a superior commoditywith the rise in their real income. Few examples of giffen goods are cheappotatoes, coarse cloth, coarse grain, etc.

Conspicuous consumption:

Some expensive commodities like diamonds, expensive cars, exorbitantlyhigh priced mobile phones etc., are used as status symbols to display one’swealth or , to distinguish oneself from average people. The more expensivethese commodities become, the higher their value as a status symbol andhence, the greater the demand for them. Law of demand does not apply here.

Conspicuous necessities:

certain things become necessities of modern life. These are purchased even iftheir prices rise. E.g. TV, refrigerators, mobile phones, automobiles.

Exception to Demand curve contd.

Expected Changes in Price:

Expected or anticipated changes in price of a commodity in future also can affect quantitydemanded of it at present. If it is expected that the price of a commodity will rise infuture, the demand for it rise and vice versa.

Extraordinary situations:

War, famines, riots, natural calamities are extra ordinary situations whenpeople’s behavior becomes abnormal. Law demand does not apply inabnormal situations.

Exception to Demand curve contd.

ELASTICITY OF DEMAND

Elasticity of demand is the measure of the responsiveness of quantity demandedof a commodity in response to change in a particular demand determinant (sayprice) while keeping other determinants constant( such as:, income, or price ofrelated good , advertisement, growth of population and so on). Algebraically, it isdefinedas

Where eD is elastic of demandQ is quantity demanded ()Z is any demand determinant (initial)dQ is change in quantity demanded dZ is change in demand determinant

CONCEPTS OF ELASTICITY OF DEMAND

There may be as many as concepts of elasticity of demand as thenumber of demand determinants. Most important concepts ofelasticity of demand are:

Price elasticity of demand (here the demand determinant is priceof the commodity)

Income elasticity of demand (here the demand determinant isincome of consumer)

Cross elasticity of demand (here the demand determinant is priceof related goods)

PRICE ELASTICITY OF DEMAND

Where eP is elastic of demandQ is quantity demanded (initial)P is price of the commodity (initial) dQ is change in quantity demanded dP change in price

Price Elasticity of demand is the measure of the responsiveness of quantitydemanded of a commodity in response to change in price , ceteris paribus.

𝐞𝐏 =𝒑𝒆𝒓𝒄𝒅𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅

𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆

𝐞𝐏 =

𝒅𝑸𝑸𝒅𝑷𝑷

𝐞𝐏 =𝒅𝑸

𝒅𝑷𝑥(𝑝

𝑄)

***Price elasticity usually carries a negative sign because of inverse relationship between price and demand. However, it is absolute value of price elasticity of demand that determines the different degrees/kinds of price elasticity of demand.

KINDS OF PRICE ELASTICITY OF DEMAND

Perfectly elastic demand :

Elastic Demand /Relatively Elastic Demand:

Unit Elastic Demand:

Inelastic Demand / Relatively Inelastic Demand :

Perfectly inelastic Demand:

PRICE ELASTICITY OF DEMAND (cntd.)

𝑒𝑃 > 1

𝑒𝑃 < 1

PERFECTLY ELASTIC DEMAND

Price

0 Quantity Demand

Perfectly elastic

demand curve

PD

When quantity demanded ofthe commodity changesthough there is no change inprice, it is known as perfectelastic demand.

Incase of Perfectly elasticdemand,

PRICE ELASTICITY OF DEMAND (cntd.)

Q1 Q2

ELASTIC DEMAND

Elastic demand curve

0 Quantity demanded

Price

D

D

When the proportionatechange in demand is morethan the proportionatechanges in price, it is knownas relatively elastic demand.E.g. luxury goods

Incase of elastic demand,

PRICE ELASTICITY OF DEMAND (cntd.)

Q1 Q2

P2

P1

𝑒𝑃 > 1

UNIT ELASTIC DEMAND

Unit elastic demand equal

0Quantity Demand

Price D

D

When the proportionate change in demand is equal to proportionate changes in price, it is known as unitary elastic demand.

Incase of unit elastic demand,

PRICE ELASTICITY OF DEMAND (cntd.)

P2

P1

Q1 Q2

INELASTIC DEMAND

Inelastic demand curve

Quantity Demanded O

PriceD

D

When theproportionate changein demand is less thanthe proportionatechanges in price, it isknown as relativelyinelastic demand. e.g.necessities, electricityetc.

Incase of inelastic demand,

PRICE ELASTICITY OF DEMAND (cntd.)

P2

Q2Q1

P1

𝑒𝑃 < 1

PERFECTLY INELASTIC DEMAND

D

Perfectly inelastic

demand curve

0

Price

Quantity Demanded

When a change in price,howsoever large, changeno changes in qualitydemand, it is known asperfectly inelastic demand.E.g. salts

Incase of perfectly inelasticdemand,

PRICE ELASTICITY OF DEMAND (cntd.)

P1

P2

Q

Income Elasticity Of Demand

Income Elasticity of demand is the measure of the responsiveness of quantitydemanded of a commodity in response to change in income of the consumer, ceterisparibus.

or,

or,

,

is income elasticity of demand Q is the quantity demanded (initial)Y is the income of the consumer (initial)dQ is the change in quantity demanded dY is the change in income

Where

𝐞𝒀 =𝒑𝒆𝒓𝒄𝒅𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅

𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒊𝒏𝒄𝒐𝒎𝒆 𝒐𝒇 𝒄𝒐𝒎𝒖𝒔𝒎𝒆𝒓

KINDS OF INCOME ELASTICITY OF DEMAND

Positive Income elasticity of demand which includes o Unitary Income Elasticity ( ey=1 ) indicates that a proportionate (percentage or relative

)change in quantity demanded is equal to proportionate change in money income.

o High Income Elasticity (ey > 1 ) indicates that a proportionate change in quantity demanded is more than proportionate change in money income. E.g. luxuries

o Income elasticity less than unity / Low Income Elasticity (eY < 1 ) indicates that a proportionate change in quantity demanded is less than proportionate relative change in money income. e.g. necessities

Zero Income elasticity /Perfectly Inelastic Income demand (ey = 0 ) indicates achange in income will have no effect on the quantity demanded e.g. salts

Negative income elasticity (eY < 0 ) [in case of inferior goods] indicates that less is bought at higher incomes and more is bought at lower incomes.

INCOME ELASTICITY OF DEMAND (cntd.)

Cross Elasticity Of Demand

Cross Elasticity of demand is the measure of the responsiveness of quantitydemanded of a commodity in response to change in price of its related goods, ceterisparibus. It can be written as:

or,

or,

,

eAB is cross elasticity of demand QA is the quantity demanded of commodity A (initial)PB is the Price of the commodity B(initial)d QA is the change in quantity demanded of commodity Ad PB is the change in price

Where

𝐞𝑨𝑩 =𝒑𝒆𝒓𝒄𝒅𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅 𝒐𝒇 𝒈𝒐𝒐𝒅𝑨

𝒑𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇 𝒓𝒆𝒍𝒂𝒕𝒆𝒅 𝒈𝒐𝒐𝒅 𝑩

KINDS OF CROSS ELASTICITY OF DEMAND

Positive Cross elasticity of demand (eAB > 0 ) when the goods A and B are substitutes] e.g. Coca cola and Pepsi, Chinese mobile phones and smart phones.

Negative Cross elasticity of demand (eAB < 0 ) [when the goods A and B are complementary] e.g. vehicle and petrol

Zero Cross elasticity of (eAB = 0 ) [when the goods A and B are independent/unrelated] e.g. gold and rice.

INCOME ELASTICITY OF DEMAND (cntd.)

SUPPLY

Supply indicates quantities of a commodity of a offered for sale at each possible price at a given time period, other things constant

Determinants of Supply

Price of the product

State of technology

Prices of relevant resources

Prices of alternative goods

Producer expectations

Number of producers/sellers in the market

LAW OF SUPPLY

Law of supply states that normally, the quantity supplied varies directly with itsprice, other things constant.

In other words , law of supply states that lower the price, the smaller thequantity supplied and higher the price, the greater the quantity supplied.