DEMAND ANALYSIS

Meaning of Demand

Demand implies 3 conditions :

Desire for a commodity or service

Ability to pay the price of it

Willingness to pay the price of it.

Further demand has no meaning without reference to time period such as a week, a month or a year.

The demand for a product can be defined as the “Number of units of an commodity that consumer will purchase at a given price during a specified period of time in the market.”

Types of Demand

Demand can be broadly classified into 3 types :

They are,

Price Demand

Income Demand

Cross Demand

Law of Demand

The law of demand expresses the

relationship between the price & quantity

demanded .It says that demand varies inversely

with price.

The Law can be stated in the following:

“ Other things being equal, a fall in the price leads to expansion in demand and a rise in price leads to contraction in demand.”

Assumptions- Law Of Demand

Consumers Income remains Constant

The Tastes & Preferences Of the Consumers remain the same

Prices of other related Commodities remain Constant

No new Substitutes are available for the Commodity.

Consumers do not expect further change in the price of the commodity.

The Commodity is not of Prestigious value

Eg: Diamond

The size of population is constant

The rate of taxes remain the same

Climate & Weather Conditions do not change.

DEMAND SCHEDULE

Individual Demand Schedule

Market Demand schedule

1. Individual Demand Schedule:

It is a list of various quantities of a commodity which an individual consumer purchases at different prices at one instant of time.

D= f (P) (or) D(x) = f(Px)

2. Market Demand Schedule

The market demand Schedule can be obtained by adding all the individual

Demand Schedules of Consumers in the market.

Hypothetical market demand schedule is as follows:

Hypothetical market demand schedule

Giffen’s Paradox (Robert Giffen-Irish Economist)

Veblen’s Effect (Thorstein Veblen – USA )

Price Illusion

Fear of Future Rise in Prices

Emergency

Necessaries

Conspicious Necessaries (More Noticeable)

Eg:- TV, Watch, Scooters, Car etc

Fear of Shortage

Ignorance

Speculation (Stock Market)

Why does the demand curve slope downwards to right

OR

Why does demand curve has a negative

slope?

Operation of the Law of Diminishing Marginal Utility

Income Effect

Substitution Effect

Different Uses

New Buyers

CHANGES IN DEMAND

A. Extension & contraction of demand:

When demand changes due to change in the price of the commodity, it is a case of either extension or contraction of demand. The Law of demand relates to the Extension & Contraction of Demand.

2. Increase and decrease in demand:

When demand changes, not due to

changes in the price of the commodity or

service but due to other factors on which

demand depends.

Eg:- Income, Population, Climate, Tastes & Habits etc.

1. DETERMINANTS OF DEMANDChange in population

2. Change in climatic conditions

3. Change in Fashions

4. Change in tastes & Habits

5. Change in Quantity of money in circulation

6. Change in Distribution of income & wealth

7. 7. Availability of Substitutes

8. 8. Advertisements & Salesmanship

9. 9. Complementary Goods

10. 10. Technical Progress

DEMAND DISTINCTIONS

“Demand distinctions may be defined as the difference in the forces acting on the demand for different goods.”

Demand for Producer goods and Consumer Goods

Demand for Durable goods and Non-Durable Goods.

Derived Demand and Autonomous Demand.

Industry Demand and Company Demand

Short run Demand And Longrun demand

Total Market demand & Market Segment Demand

DETERMINANTS OF DEMAND (OR) FACTORS AFFECTING DEMAND (Refer: Lekhi & Agarwal- Business Economics)

Price of Commodity

Price of Related Goods

Income of the Consumer

Distribution of Wealth

Tastes & Habits

Population growth

State of Business (Business Cycle)

Government Policy

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Level of Taxation

Factors determining demand for different types of goods.

Three main types of goods:-

1.Non durable consumer goods.

2.Durable consumer goods.

3.Producer goods or capital goods.

1.Non durable consumer goods:-

a) Purchasing power

b) Price

c) Demography

Thus, demand for non durables can be expressed in the form of following formula:

d= f( Y,P,D)

Where ,d=demand,Y=disposable personal income ,P=price ,D=demography and f is the function.

2.Durable consumer goods.

Demand of such goods is two types

a) Replacement demand- demand for a new product in place of an old one which is worn out or obsolete.

b) Expansion demand-demand for additional units of the same product.

Factors influencing expansion in demand.

Financial position of consumers.

Maintenance and operating costs.

Number of households.

Price and credit conditions.

3.Producers’ goods

Also called capital goods.

Factors determining the demand for capital goods.

No. of industrial undertakings.

Profitability.

Ratio of production to capacity utilization.

Level of wage rates.

Growth prospects.

Price and quality of the produce.

ELASTICITY OF DEMAND

Elasticity of Demand

Elasticity of demand measures the responsiveness of demand for a commodity to a change in the variables confined to its demand.

For measuring the elasticity coefficient, a ratio is made of two variables,

%change in quantity demanded

% change in determinants of demand

Important Kinds of Elasticity of Demand

1. Price ED:

e = % change in quantity demanded

% change in price

2. Income ED:

e = % change in quantity demanded

% change in income

3. Cross ED:

e = % change in quantity demanded of X

% change in price of Y

4. Advertising / Promotional ED:

% change in sales

% change in advertisement expenditure

Types of Income Elasticity of Demand

1. Negative Income Elasticity

2. Zero Income Elasticity

3. Income Elasticity Less Than One

4. Unitary or Income Elasticity Of Demand is equal to 1.

5. Income Elasticity Greater Than One

Factors Influencing Elasticity of Demandor

Determinants of Price Elasticity of Demand

1. Nature of Commodity:

Necessaries --- inelastic

Comforts and Luxuries --- elastic

2. Availability of Substitute:

A commodity which has more substitutes the demand is ------ more elastic.

Ex: Tea , Coffee, Milk ,Bournvita etc,

3. No of users of a commodity:

More no of users ---elastic

Ex: Electricity, Iron and Steel etc.

Only one use --- inelastic

Ex: Printing machine , stitching machine

4. Proportion of Income Spent on the Goods:

Small proportion of income --- inelastic

Ex: Salt, Match box, Postcard

5. Habit:

Ex: Coffee ,Tea --- inelastic

6. Level of Income of the People:

Rich People --- inelastic

Poor People --- elastic

7. Period of time:

Short period --- inelastic

Habit and prices of commodities do not change much.

Long period --- elastic

8. Durability of a commodity:

Durable goods --- elastic

Ex: fan, table, Chair

Perishable goods --- inelastic

Ex: Milk, flower

9. Postponement of Purchase:

Postponement --- elastic

Ex: Fan, TV, Fridge

Cannot be postponed --- inelastic

Ex: Medicine, Rice, Wheat

10. Level of Prices:

High priced --- elastic

Ex: Cars, TV , Air conditioners

Low priced --- inelastic

Ex: Newspaper, Nails, Needle

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

Practical ApplicationUses Of Price Elasticity of Demand In Decision MakingRef: Jhingan & Stephen Pg: 81 D.M.Mithani Pg: 157

1. To the businessmen

2. To the trade unions

3. In international trade

4. To the government

5. Helpful in Adopting the Policy of Protection

6. In the declaring certain industries as public utilities

Different Degrees of Price Elasticity of Demand

1. Perfectly Elastic Demand

2. Perfectly Inelastic Demand

3. Relatively Elastic demand

4. Relatively Inelastic Demand

5. Unitary Elastic Demand

There are four methods of measurement of price elasticity of demand:

1. Mathematical (or) Ratio Method.

2. Total Outlay Method (or) Total Expenditure Method.

3. Point Method

4. Arc Method

Mathematical Method

Under this method price elasticity of demand is measured by using the formula given below:

PEd = % change in quantity demanded

% change in the price

= % change in Q

% change in P

Price Elasticity of Demand is = 1

The Elasticity is equal to one when the demand changes by the same % as the price.

Suppose the price has fallen by 20% and the quantity demanded has expanded by 20%, as a result of fall in the price. The Elasticity of demand is = 1.

PEd = % change in demand = 20% = 1

% change in price 20%

PEd = 1

Price Elasticity of Demand > 1

If the % change in demand is more than the % change in price, then the Elasticity is = > 1.

Ex: If the price falls by 20% and demand increases by 20%, then the elasticity is greater than one.

PEd = 40% = 4 = 2

20% 2

PEd > 1

Price Elasticity of demand <1

If the % change in demand is less than the % change in the price, then the Elasticity is < 1.

Ex: If the price falls by 20% and the demand increases by only 10%, then the E is = ½ i.e less than one.

PEd = 10% = 1 = 0.5

20% 2

PEd < 1

Total Expenditure / Outlay MethodBy Prof . Marshall

Under this method we measure the price elasticity of demand by examining the change in total expenditure as a result of change in the price and quantity demanded for a commodity.

TE = Price / unit X Total quantity purchased

Following are the observations about the nature of PEd

1. In first case , with every fall in price the TE goes on increasing. Therefore the PEd > 1.

2. In second case, whatever may be the change in price the TE remains the same. Therefore the PEd = 1.

3. In third case, with every fall in price the TE goes on decreasing. Therefore the PEd < 1

Point MethodProf . Marshall

Point Ed = lower segment of the demand curve below the given point

upper segment of the demand curve above the given point

or PE = L ; PE = point elasticity

U L = lower segment

U = upper segment

ARC METHOD

In arc elasticity, the change in price is expressed asa proportion or average of the old price & theprevious quantity and the new quantity. Thus, the arc elasticity is called as average elasticity.Any two points of the demand curve makes an arc. An arc is a curved line of a section or a segment of a demand curve. Arc elasticity is the elasticity at the mid point of an arc of a demand curve.

DEMAND FORECASTING METHODS

Demand Forecasting

Meaning:

Demand forecasting means estimating the

expected future demand for a product , related to a

particular period of time.

Methods of forecasting:

The methods of forecasting can be broadly

classified into two categories. They are:

1. Survey Method

2. Statistical Method

SIGNIFICANCEOF DEMAND FORECASTING

SIGNIFICANCE OF SHORT TERM FORECASTING

To prepare appropriate production schedule.

Helping the firm in reducing costs of purchasing materials.

To determine appropriate price policy.

To fix sales targets and incentives.

To evolve proper advertising policy.

To forecast short term financial requirements.

SIGNIFICANCE OF LONG TERM FORECASTING

To plan for new units or to expand the existing units.

To plan long term financial requirements.

To plan man power requirements.

LEVELS OF DEMAND FORECASTING

1. Macro level

2. Industry level

3. Firm level

Criteria of a good forecasting method.

Accuracy

Plausibility

Simplicity

Economy

Availability

Flexibility

(A)Survey MethodThe survey method consists of two methods:

Survey of experts opinion Survey of consumers intentions through direct interview with them.

Experts Opinion Method (or) Collective Opinion Method This method is also known as Sales Force Composite Method.

Advantages:

It is a simple method of forecasting.

It involves minimum statistical work.

It is less expensive.

It is based on the first hand knowledge of the salesmen who are directly connected with the sales.

5. It is more useful for short term forecasting rather than long term forecasting.

6. It is particularly useful in forecasting the sales of new products.

Disadvantages:

1. It is subjective approach.

2. The salesmen may underestimate the demand.

3. The salesmen may not be able to judge the future trends in the economy and their impact on the sales of the product of the firm.

(2) Direct Interview Method (or) Customers Interview Method

Under this method ,consumers are directly interviewed to find out the future demand or demand trends for a product by a firm. They are three types of consumers’ interview:

Complete Enumeration Method

Sample Survey Method

(Stratified = Society divided into different classes)

End Use Method

A. Complete Enumeration Method

under this method ,almost all the consumers of the product are interviewed and are asked to inform about their future plan of purchasing the product in question.

Advantages:

This method is true from any bias of the salesmen ,as they only collect the information and aggregate it.

This method seems to be ideal, since almost all the consumers using the product are contacted.

Disadvantages:

1. This method is however very costly and tedious.

2. It is also too much time consuming, since every potential customer is to be interviewed.

3. It would be very difficult and impractical if the consumers who are spread over the entire country are to be contacted.

Hence this method is highly cumbersome in nature.

B. Sample Survey Method:

When the demand of consumers is very large

this method is used by selecting a sample of consumers

for interview .

Advantages:

1. This method is single and less costly and hence it is widely used.

2. It is less time consuming ,since only a few selected consumers are contacted.

3. 3. It is used to estimate short term demand by business firms, governments departments and household customers.

4. 4. It is highly useful in case of new products.

5. 5. This method is of greater use in forecasting where consumers behaviour is subject to frequent changes.

6. However the success if this method depends on the sincere co-operation of the selected consumers.

7. 3. It is used to estimate short term demand by business firms, governments departments and household customers.

8. 4. It is highly useful in case of new products.

9. 5. This method is of greater use in forecasting where consumers behaviour is subject to frequent changes.

10. However the success if this method depends on the sincere co-operation of the selected consumers.

11. End Use Method:

Under this method, the sale of the product under consideration is projected on the basis of the demand survey’s of the industries using this given product or intermediate product.

Advantages:

1. This method is used to forecast the demand for intermediate products only.

2. It is quite useful for industries which largely produces goods like aluminium, steel, etc.

Disadvantages:

The main limitation of this method is that , as the number of end- users of a product increases, it becomes more difficult to estimate demand under this method.

(B) Statistical Method

Under these methods, statistical or mathematical techniques are used to forecast the demand for a product in the long period. The following are the important statistical methods used in forecasting:

1. Trend Projection Method2. Regression Method 3. Barometric Method

(1) Trend Projection Method

This method is also known as Time Series Analysis.

Time series refers to the data over a period of time. During this time period, fluctuations and turning points may occur in demand conditions .These fluctuations in demand occur due to the following four factors. They are:

Secular Trends

Seasonal Variations

Cyclical Fluctuations

Random Variations

Advantages :

1. Trend projection method is quite popular in business forecasting, because it is a simple method.

2. The use this method requires only the simple working knowledge of statistics.

3. It is also less expensive , as its data requirements are limited to the internal records.

4. This method yields fairly reliable estimates if future course of demand.

Disadvantages:

• The most important limitation of this method arises out of its assumption that the past rate of change in the dependent variable ( demand).

• This method is not useful for short run forecasting and cyclical fluctuations.

• This method does not explain the relationship between dependent and independent variables.

(2)Regression Method

It combines the economic theory and statistical techniques of estimation.

(2) Barometric MethodThis method is also known as Economic Indicators Method. Under this

method , a few economic indicators become the basis for forecasting the sales of a company.

Some of the most commonly used indicators are given below:

Construction contracts

Personal Income

Automobile registration

Limitations

It is difficult to find out an appropriate economic indicator

It is not suitable for new products as past data not available

It is best suited where relationship of demand with a particular indicator is characterized by time-lag

Significance of Demand Forecasting

Production planning

Sales Forecasting

Control of business

Inventory control

Growth and Long term Investment Programs

Stability

Economic planning and Policy making

SUPPLY ANALYSIS

Meaning:

Supply of a commodity may be defined as the quantity of that commodity which the sellers or producers are able and willing to offer for sale at a particular price during a certain period of time.

For eg: At the price of Rs.10 per litre , diary farms’ daily supply of milk is 200 liters.

Distinction between stock & supply

Stock refers to total quantity of output kept in the warehouse which can be offered for sale in the market by the seller.

On the other hand, the term supply refers to that part of the stock which is actually offered for sale in the market at a price per unit of time.

Law of supply

“ Other things remaining the same, the supply of a commodity expands (rises) with a rise in its price and contracts (falls) with a fall in its price.”

Thus supply varies directly with the price. In other words, the relationship between supply & price is direct.

Assumptions underlining the Law of Supply:

1. Cost of Production is Unchanged

2. No Change in techniques of Production

3. Fixed scale of Production

4. Government policies are unchanged

5. No change in Transport Cost

6. The prices of related goods are constant

INCREASE & DECREASE IN SUPPLY

The 2 terms are introduced to explain the

changes in Supply without any change in

price are:

1. Increase in Supply

2. Decrease in Supply

Determinants of supply

1.Price of the commodity

2. Price of the related goods

3. Cost of production

4. Technology

5. Natural factors

6. Tax & subsidy

7. Development of transport & communication

8. Agreement among producers

9. Future Expectations

1. Factors determining Elasticity of Price of Commodity

2. Cost of Production

3. Price of Other Products

4. Change in Technology

5. Time Period

6. Objective of the Firm

7. Size of the Firm

8. Imposition of Taxes

9. Number of Producers

10. Agreement among Producers

11. Political Disturbances

12. Mobility of factors of Production

13. Availability of Markets

14. Nature of Commodities (perishable &

Durable goods)

15. Improvement in the means of Communication

16. Nature of production (paintings)