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DEMAND
Chapter 2
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INTRODUCTION
Have you ever wondered why inessential thingslike diamonds are expensive and essentials likewater are at low cost
Why land in some parts of countries are moreexpensive than the other parts?
The answer to the above que can be found fromthe theory of Demand & Supply.
The theories will show how consumerpreferences determines the demand whilebusiness costs determines the supply
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DEM ND N LYSIS Demand means the Desire backed up by
abi l i ty pay and w i l lingness buy.
Demand = Desire + Ab i l i ty to pay +
Will ingness to buy
Prices are the too ls by which the market
coord inates ind iv idual desires.
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INDIVIDUAL AND MARKET DEMAND
Ind ividu al Demand : Individual demand for a product is thequantity of it a consumer would buy at a given price, during
a given period of time.
Market demand: Market demand for a product is the total
demand of all the buyers in the market taken together at agiven price during a given period of time.
Demand Schedule: A tabular statement of price quantity
(demanded) relationship at a given period of time
Individual demand scheduleMarket demand schedule.
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LAW OF DEMAND
Statement of Law: Other things being equal, the higher the price of a
commodity, the smaller is the quantity demanded and lower the price,larger the quantity demanded.
There is an inverse relationship between the Price of the product and its
quantity demanded, other things being equal.
The other thing that are assumed to be constant:
Prices of related products
Income of consumers
Tastes and preferences of consumers
If these factors undergoes a change the relationship of demand-supply
may not hold good.
Demand Schedule & Demand Curve:
Market Demand Schedule and Market Demand Curve:
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RATIONALE FOR LAW OF DEMAND
Substitution effectthe commodity withfallen price is preferred over the othercommodities.
Income Effectpurchasing power increases,consumer can buy the same quantity at alesser money or can buy more of the samecommodity with same money
Also, some consumers who could not affordpreviously are being able to purchase it now
Utility Maximizing behavior
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EXCEPTIONS
Conspicuous goods/ Articles of Distinction
Giffen Goods
HabitsComposite DemandComplimentary goods
Population
Conspicuous NecessityFridge, AC, TV Future Expectation
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FACTORS BEHIND LAW OF DEMAND
Price
Income & Income Distribution
Number & Prices of Substitutes
Consumers Preferences, Tastes and Needs
Number of ConsumersPopulation
Expectation of Consumers
Advertisement
Other FacilitiesAfter Sales Services,Warranty
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INCREASE AND DECREASE IN DEMAND
What happens if there is a change in,
consumers tastes & preferences, income &
price of related goods.
Two demand schedules for commodity X
Rightward Shift In Demand Curve:
When more is demanded at each price
Leftward Shift In Demand Curve:
When less is demanded at each price
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GENERAL DEMAND FUNCTION
Six variables that influence Qd
Price of good or service (P)
Incomes of consumers (M)
Prices of related goods & services (PR)
2-11
Expected future price of product (Pe) Number of consumers in market (N)
General demand function
( )Taste patterns of consumers ( )Taste patterns of consumers
( , , , , , )d R eQ f P M P P N ( , , , , , )d R eQ f P M P P N
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GENERAL DEMAND FUNCTION
Inverse for complements
2-12
Variable Relation to Qd
Sign of Slope Parameter
P
Pe
N
M
PR
Inverse
Direct
Direct
Direct
Direct for normal goods
Inverse for inferior goods
Direct for substitutes
b = Qd/P is negativec = Qd/M is positivec = Qd/M is negatived = Qd/PRispositived = Qd/PRisnegative
f = Qd/Peis positive
g = Qd/N is positive
e = Qd/ is positive
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ELASTICITY OF DEMAND Consider the following situation
1) Price of Radio falls from 500 to 400, Quantitydemanded Increases from 100 to 150
2) Price of wheat falls from 10/kg to 9/kg, Quantitydemanded Increases from 500 kgs to 520 kgs
3) Price of Salt falls from 3 to 2.5, Quantity demandedIncreases from 1000 kgs to 1005 kgs
We notice that as a result of fall in the price of allthree, the respective demand increases.
Then what is the differences? The difference lies in degree of response of demand
which can be found out by comparing the percentageschanges in prices & quantities demanded.
Here lies the concept of Elasticity
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ELASTICITY OF DEMAND
Elasticity of demand is the degree of responsiveness ofdemand to the changes in its determinants.
(A) PRICE ELASTICITY O DEMANDThe extent of response of demand for a
commodity to the changes in its price, otherdeterminants of demand remaining constantis called price elasticity of demand.
Except for few cases the price elasticity is
negative. But for sake of convenience, weignore the negative signE.g. if 1% change in price leads to 2% change in
quantity of A & 4% change in Quantity of B.
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TYPES OF PRICE ELASTICITY OF DEMAND1. Perfectly elastic demand refers to the situation where a
slightest rise in price causes an infinite increase in Qd.Demand is Hypersensitive and elasticity is Infinity
2. Perfectly inelastic demand refers to the situation wherethe demand is unaffected even after substantial change inprice. Qd remains unchanged and elasticity of demand is
zero3. Relatively/Highly elastic demand when a small
percentage change in price is accompanied by a largepercentage change in its Qd.
4. Relatively inelastic demand when a large percentagechange in price is followed by a small percentage change inits Qd.
5. Unitary elastic demand when percentage change in priceis accompanied by an equal percentage change in Qd.
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METHODS OF MEASURING PRICE ELASTICITY
Point methodDr. Marshall
Measure elasticity at a given point on a demandcurve
Makes use of derivativeArc method
Takes an arc of the demand curve rather thanpoint
Total Revenue or total Expenditure Method
If a slight fall in the price leads to sizeableincrease in demand, it will cause in increase in
total revenue
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PRACTICAL APPLICATION- Pricing decisions - Policy Formulation by Govt.
- Terms of trade - Foreign exchange rates
- Resource Prices - Public utilities
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B)INCOME ELASTICITY OF DEMANDThe degree of responsiveness of demand for a
commodity to the changes in the consumersincome is known as income elasticity ofdemand
Types of income elasticity1. Unitary income elasticity2. Income elasticity grater than one
3. Income elasticity less than one4. Zero income elasticity5. Negative income elasticity
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PRACTICAL APPLICATION
- Economic Development
- Growth rate of firm
- Demand forecasting- Economic/Production planning
- Foreign Trade
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(C) CROSS ELASTICITY OF DEMAND
The degree of responsiveness of demandfor a commodity to a given change in the
price of some other related commodity is
known as cross elasticity of demand.
The relation of complementary and
substitute product
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DEMAND FORECASTING
Demand forecasting is predicting or anticipating the
future demand for a product.Micro levelIndustry levelMacro level
USES OF DEMAND FORECASTING DATA Short term demand forecasting
1) Evolving production policy
2) Determining price policy
3) Evolving purchase policy
4) Fixation of sales targets
5) Short term financial policy ong term demand forecasting
1) Business planning
2) Man power planning
3) Long term financial planning
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METHODS OF DEMAND ESTIMATION
Consumers Interview
Market Experiment Method
Regression Method
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NECESSITY OF FORECASTING DEMAND
Achievement of planned objectives
Preparing a Budget
Stabilization of Production and Employment
Future Expansion
Long-term Investment Programs.
Sales BudgetingControl of Inventories
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NATURE AND SCOPE OF DEMAND FORECASTING
Time frame Short-term Forecast Long-term Forecast
Secular Forecast
Level of forecast Level of the Economy
Level of the Industries
Level of a Firm
General & Specific Forecast
Established & New Products
Classification of Products
Special factorsuncertainties, Fashion change
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CRITERIA FOR A GOOD METHOD OF DF
Plausibility Simplicity
Economy
Accuracy
Availability
Durability
Flexibility
Consistency
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METHODS OF DF OF AN ESTABLISHED PRODUCT
Interview and survey approach Buyers Interview Sales force polling
Consumer field survey
Panel or Experts
Delphi Method Forecast based on composite management opinion
Projecting Past Experience Correlation Analysis
Regression Analysis
Projection of Trends into Future
Some other methods Barometric Techniques
Controlled Experiments
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DF FOR NEW PRODUCT
Evolutionary Approach
Substitute Approach
Growth curve Approach
Opinion-Polling Approach
Sales Experience Approach
Vicarious Approach