Module 2

Demand and Supply Analysis

Demand
 Demand comes from the behavior of buyers.
 Conceptually, it implies “Desire backed by
ability & willingness to pay”.
 The quantity demanded of any good is the
amount of the good that buyers are willing and
able to purchase.
 It has always reference to price, Time, Place, &
Quantity.
 Various quantities of a given good which
consumers buy in one market in a given period
of time at various prices / incomes. 2
Nature of demand

 Not merely a desire but a desire with capacity &

willingness to purchase.
 Always related to price

 Should be referred to per unit of time

 Varies from commodity to commodity

 Varies along with income of consumers

 Varies with prices of related goods

3
Law of demand

 Law of demand: the demand for goods

increases when its prices decreases and it falls
when the price of the good rises, other things
being equal.
 It shows:
1. Inverse relationship b/n price & qty
demanded
2. Based on Law of Diminishing Marginal
Utility
4
Other things being equal - Variables

•Price of the product

•No. of buyers / Population
•Income of the consumer
•Price of related goods
•Tastes & preferences
•Expectations of consumers
•Advertisement
•Consumer credit facility
•Demonstration effect / Band wagon 5
The Demand Schedule

 Demand schedule: Price Quantity

A table that shows the of of oranges
oranges demanded
relationship between the price of
a good and the quantity 1.00 14
demanded. 2.00 12
 Example: kiran’s demand for 3.00 10
Oranges. 4.00 8
5.00 6
 Notice that kiran’s 6.00 4
preferences obey the
Law of Demand.
6
Demand Schedule & Demand Curve

 Demand schedule is a series of prices placed in

ascending or descending order and the
corresponding quantities which consumers
would like to buy per unit of time.
 It can be:
1. Individual demand schedule
2. Market demand schedule
 Demand Curve is a locus of points showing
various alternative price-quantity
combinations
7
Demand Function

 Is a mathematical expression of the

relationship between quantity demanded and
its determinants.
 It is expressed as:

Qdx = f (Px, Y, T, A, Ey, Ep ………n)

8
Demand Curve slopes downwards?

 Operation of Law of Diminishing Marginal

Utilities
 Substitution effect
 Income effect
 New consumers
 Several uses of the same product
 Psychological effects

9
Exceptions to the Law of Demand

 Veblen effect: for prestigious goods

 Giffen paradox: for inferior goods

 Market speculation

 Demand for necessaries

 Scarcity, inflation, war etc

10
Changes in demand curve

 Demand refers to a schedule of quantities of a

good that will be bought per unit of time at
various prices, other things constant.
 Graphically, it refers to the entire demand
curve.
 Quantity demanded refers to a specific amount
that will be demand per unit of time at a
specific price.
 Graphically, it refers to a specific point on the
demand curve.
 Changes in demand curve occur in two ways.
They are:
1. Movement along the demand curve or
change in quantity demanded ( Extension or
Contraction) reason: change in its own
price.
2. Shift in demand or change in demand
reason: non price determinants

12
Change in Quantity Demanded
A movement along a demand curve is the graphical
representation of the effect of a change in price on the
quantity demanded.

$2 B
Price (per unit)

Change in quantity demanded

(a movement along the curve)

A
$1

D1
0
100 200
Quantity demanded (per unit of time)
Shift in Demand
A shift in demand is the graphical representation of
the effect of anything other than price on demand.

Change in demand
(a shift of the curve)
$2
Price (per unit)

B A
$1

D0

D1
100 200 250
Quantity demanded (per unit of time)
Types of Demand
Major Classifications of Demand

1. Individual and Market Demand

2. Industry and Firms’ Demand
3. Autonomous and Derived Demand
4. Demand for Durables’ and Non-Durables
5. Short-term and Long-term Demand
Elasticity
 Elasticity measures how much one variable
(price) responds or varies to changes in
another variable (quantity demanded).

 Elasticity measures the sensitiveness of

demand for changes in price.

Elasticity is a numerical measure of the

responsiveness of Qd (Quantity demanded)
to one of its determinants.
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Methods of Measuring Price Elasticity of Demand

 There are basically four ways by which we can

measure price elasticity of demand. These
methods are
1. Percentage method
2. Total outlay method
3. Point method
4. Arc method
Types of elasticity

 Price elasticity
 Income elasticity
 Cross elasticity
 Promotional / Advertising elasticity
 Elasticity of Price expectations
Price Elasticity of Demand
Price elasticity Percentage change in Qd
=
of demand (ep) Percentage change in P
where, Q is original qty demanded
δQ P P is original price
 Ep = ______ X ___

δP Q δ Q is change in qty (Q- Q 1)

δ P is change in price (P-P1)
Q1 & p1 are new price & Qty

 Price elasticity of demand measures how much Qd responds

to a change in P.
25
Computing the Price Elasticity of
Demand
 Example: If the price of an ice cream cone increases from
20/- to 30/- and the amount you buy falls from 10 to 8
cones, then your elasticity of demand would be calculated
as:

Price elasticity Percentage change in Qd

=
of demand (ep) Percentage change in P

10-8 20
______ * ____ = 0.4
30-20 10
Use the following
information to
calculate the price
elasticity of demand
for hotel rooms:
when P = 700/- p.day, Qd
= 5000 rooms
when P = 1000/- p.day,
Qd = 3000 rooms
2727
Types of Price Elasticity

1. Perfectly elastic

2. Perfectly inelastic

3. Relatively elastic

4. Relatively inelastic

5. Unitary elastic
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 Perfectly elastic demand
% change in Q any % = infinity
Price elasticity
of demand = = 0%
% change in P
D curve: horizontal P
Little change in price leads to
infinite change in qty P2 = P1 D
Consumers’ price sensitivity:
extreme. They will stop buying
Elasticity value:
P changes Q
infinity Q1 Q2
by 0%
Q changes
by any %
29
 Perfectly inelastic demand
Price elasticity = % change in Q 0% =0
=
of demand % change in P 10%

D curve: vertical. Coz no P

D
change in price affects qty
demanded. P1
Consumers’ price P2
sensitivity: 0

P falls Q
Elasticity: 0 by 10% Q1
Q changes
by 0%
30
 Relatively Elastic demand”
Price elasticity = % change in Q = > 10% > 1
of demand % change in P 10%

D curve: relatively flat. P

Small change in price
leads to big change in qty P1
demanded
Consumers’ price P2 D
sensitivity: relatively high
P falls Q
Elasticity: > 1 by 10% Q1 Q2
Q rises more
than 10%
31
 Relatively Inelastic demand
Price elasticity % change in Q < 10%
= <1
of demand = 10%
% change in P
D curve: relatively steep. P
Big change in price leads
to small change in qty P1
demanded
Consumers’ price P2
sensitivity: relatively low D
P falls Q
Elasticity: < 1 by 10% Q1 Q2

Q rises less
than 10%
32
Unit elastic demand
Price elasticity = % change in Q = 10%
=1
of demand % change in P 10%

D curve: P
Rectangular Hyperbola
P1
Consumers’
price sensitivity: P2
D
intermediate
P falls Q
Elasticity: by 10% Q1 Q2
1
Q rises by 10%
Importance of Price Elasticity of
demand
 To adopt price discrimination
 To do forward planning & demand
estimations.
 To do break even analysis
 To do international trade & foreign exchange
 To fix taxation policies