118393674-Demand

Demand

Concept of Demand •

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Ordinarily, the terms, desire and demand are used interchangeably. But in economics, demand has a distinct meaning. Supposing, you desire to have a car say Mercedes, but you do not have enough money to buy it. Then, this desire will remain just a wishful thinking; it will not be called demand.

Concept of Demand •

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Ordinarily, the terms, desire and demand are used interchangeably. But in economics, demand has a distinct meaning. Supposing, you desire to have a car say Mercedes, but you do not have enough money to buy it. Then, this desire will remain just a wishful thinking; it will not be called demand.

Contd……. •

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And, if having enough money, you are not willing to spend it on Car, demand does not emerge. The desire becomes demand only when one ready to spend spe nd money to buy a Mercedes Mercedes car. car. Thus, Demand for a commodity refers to the desire to buy a commodity backed with sufficient purchasing power power and willingness to spend.

Demand’s Constituents

Desire to have a good

Willingness to pay for that good

Ability to pay for that good

Demand

Demand and Quantity Demanded •

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Demand for a commodity is always expressed with reference to price. Ask anybody how much of Good-X he will buy. “It depends upon price of Good-X”, is likely to be the obvious answer. At higher price quantity demanded will be low,, and at lower low lower price quantity demanded dem anded will be high.

Contd…. •

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Here comes the distinction between demand and quantity demanded. The term demand refers to various quantities of a commodity that the consumer is ready to buy at different possible prices of a commodity. On the other hand, quantity demanded refers to a specific quantity to be purchased against a specific price of the commodity.

Types of Demand •

Individual & Market Demand: The quantity of

individual which an Individual is willing to buy at a particular price of the commodity during a specific time period given his money income, taste and prices of other commodities (mainly substitute) is known as Individual’s demand. •

While the total quantity which all the consumers of a commodity are willing to buy at a given price per time unit given their money income, taste and prices of other commodities (mainly substitute) is known as Market demand.

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Demand for Firm’s product and Industry’s products: The quantity of a firm’s produce

that can be disposed of at a given price over a time period denotes the demand for the firm’s •

product. While the aggregate of demand for the product of all the firms of an industry is known as the demand for industry’s product.

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For e.g., Maruti car alone is a firm’s (company) demand where as demand for all kinds of cars is Industry’s demand.

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Autonomous and Derived Demand:

Autonomous Demand for a commodity is one that arises independent of the demand for any other commodity whereas derived demand is one that is tied to the demand for some parent product. Demand for food, clothes, shelter etc. is Autonomous demand. Demand for land, fertilizers and agricultural tools are derived demands.

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Consumers’ goods and Producers’ goods: Goods

and services used for final consumption are called consumers’ goods. These include those

consumed by human beings (e.g., food items, clothes, kitchen utensils, residential houses, medicines and services of teacher, doctor and lawyers), animals (e.g., god food and fish food), birds (e.g., grains) etc. •

In contrast, Producers’ goods refer to the ones

used for production of other goods. Thus, producers‘ goods consist of plant and machinery,

factory building, services of business employee and raw-materials,etc.

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Demand for Durable and Perishable goods: Both Consumers’ and Producers’ goods are

further classified into perishable(non-durable) goods and durable goods. In layman’s language,

perishable goods are those goods which perish or become unusable after sometimes, the rest are durable goods. •

Thus the former would include items like milk, fish, eggs and paper cups and plates; and the later would include furniture, cars, refrigerators, clothes and shoes.

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In economics, the meaning of these terms is different. Here perishable goods refer to those goods which can be consumed only once. While in case of durable goods, their services alone are consumed. Thus, perishable goods include all services (e.g., services of teachers and doctors), food items, raw materials, coal and electricity, while durable goods include plant and machinery, buildings, furniture, automobiles, refrigerators etc.

Contd…. •

Illustration: A consumer’s demand is 2 ice

creams if the price per ice cream is Rs. 15, and 4 ice creams if the price per ice cream is Rs. 10. •

Quantity demanded is 4 ice cream if price

happens to be Rs. 10 per ice creams.

Demand Schedule •

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Demand schedule is that schedule which express the relation between different quantities of the commodity demanded. According to Samuelson, “The Table relating to price and quantity demanded is called the demand schedule.” Demand schedule is of two types: (1) Individual demand schedule, (2) Market demand schedule.

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Individual Demand Schedule is a table showing different quantities of a commodity that one particular buyer in the market is ready to buy at

different possible prices of the commodity at a point of time. Market Demand Schedule is a table showing different quantities of a commodity that all the buyers in the market are ready to buy at different possible prices of the commodity at a point of time.

Demand Schedule Format

Milk Price (Rs. Per Litre)

Milk Demand (Litre)

8

5

7

8

6

12

5

20

4

30

3

45

Demand Curve •

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Demand curve is simply a graphic representation of demand. In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule.

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Demand curves are used to estimate behaviors in competitive markets. The demand curve usually slopes downwards from left to right; that is, it has a negative association.

Demand Curve

Factors Affecting Demand Determinants of Demand

When price changes, quantity demanded will change. That i s a movement along the same demand curve. When factors other than price changes, demand curve will shift. These are the determinants of the demand curve. 1. Income: A rise in a person’s income will lead to an increase in demand (shift demand curve to the right), a fall will lead to a decrease in demand for normal goods. Goods whose demand varies inversely with income are called inferior goods (e.g. Hamburger Helper). 2. Consumer Preferences: Favorable change leads to an increase i n demand, unfavorable change lead to a decrease. 3. Number of Buyers: the more buyers lead to an increase in demand; fewer buyers lead to decrease. 4. Price of related good s: a. Substitute goods (those that can be used to replace each other): price of s ubstitute and demand for the other good are direc tly related. Example: If the price of coffee rises, the demand for tea should increase. b. Complement goods (those that can be used together): price of complement and demand for the other good are inversely related. Example: if the price of ice cream rises, the demand for ice-cream toppings will decrease. 5. Expectation of future: a. Future price: consumers’ current demand will increase if they expect higher future prices; their demand will decrease if they expect lower future prices. b. Future income: consumers’ current demand will increase if they expect higher future income; their demand will decrease if they expect lower future income.

The Law of Demand •

The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more. The chart below shows that the curve is a downward slope.

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A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the negative relationship between price and quantity demanded. The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C).

Assumptions to the Law of Demand •

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Law of demand hold good when other things remain the same. It means factor influencing demand other than price are assumed to be constant. The main assumptions are as follows: Taste and preferences of the consumers remain constant. There is no change in the income of the consumer. Price of the related goods do not change. Consumers do not expect any change in the price of the commodity in the near future.

Exceptions to the Law of Demand •

Law of demand has some exceptions as well. There are some commodities whose demand increases when their price rises and decreases when their price falls. First of all, this fact was analyzed by Sir Robert Giffen. So, it is also called Giffen’s Paradox. The main causes of the demand curve being exceptional are as under:

1. Articles of Distinction •

This exception was first of all discussed by Veblan. According to him, articles of distinction have more demand only if their prices are sufficiently high. Diamond,  jewellery, costly carpets, etc., have more demand because their prices are abnormally high. If their prices fall, they will no longer be considered as articles of distinction and so their demand will decrease.

2. Ignorance •

Sometimes, out of ignorance, the consumers feel that a good is worthless if its price is low. Accordingly, they buy less of it at a low price. More is purchased only if the price is high.

3. Giffen Goods •

Giffen goods may be defined as those goods whose price effect is positive and income effect is negative. Positive price effect means that demand falls with a fall in price and rises with the rise in price. The Giffen goods are highly inferior goods, showing a very high negative income effect. As a result, when price of such commodities falls, their demand also falls.

4. Emergencies •

Law of demand does not apply in case of emergencies such as war, famine, curfew etc., for example price of all most all the commodities increase but still their demand increases.

5. Misconception of consumer •

Prof. Benham stated that misconception consumer is also a factor that induces him to purchase more of a commodity at a higher price. Some of the consumer who feel that high priced goods are better than low priced one and they will buy the goods more even at higher price.

Demand Function or Determinants of Demand •

Demand function shows the relationship between demand for a commodity and its various determinants. Dx = f(Px, Pr, Y, T, E)

Where, Dx: Quantity demanded for commodity-X Px: Price of commodity-X Pr : Price of related goods, Y: Consumer’s Income T: Consumer’s Taste and preferences,

E: Consumer's Expectations

Types of Goods 1. Related Goods: Goods are said to be related

when demand for one changes in response to change in price of the other. For example, increase in the price of coffee is expected to cause increase in demand for tea. So, tea and coffee are related goods. 2. Unrelated Goods: Goods are unrelated when demand for one is independent of any change in price of the other. Demand for shoes, for example, is not affected by change in price of sugar.

3. Normal Goods: Normal goods are those in

case of which there is a positive relationship between income and quantity demanded. Other things remain constant, quantity demanded increases in response to increase in consumer’s income and vice versa.

4. Inferior Goods: Inferior goods are those in

case of which there is a negative(or inverse) relationship between income and quantity demanded. Other things remain constant, quantity demanded decreases in response to increase in consumer’s income and vice versa.

Elasticity Concept •

Elasticity is a measure of a sensitiveness of one variable to changes in some other variable. It is expressed in terms of a percentage and is devoid of any unit of measurement. For example, elasticity of a variable X with respect to variable Y (ex,y) is expressed as: ex,y = Percentage change in X Percentage change in Y

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Elasticity could be measured at a point or on arc (line).

Demand Elasticity •

Demand elasticities refer to elasticities of demand for a good with respect to the determinants of its demand. There is one demand elasticity with respect to each demand determinant and thus there are as many demand elasticities as the number of demand determinants. The important ones are the following:

a) Price elasticity of demand b) Income elasticity of demand c) Cross elasticity of demand d) Promotional elasticity of demand

Price elasticity of demand •

Price elasticity of demand  is a measure of how

much the quantity demanded of a good responds to a change in the price of that good. •

Price elasticity of demand is the percentage change in quantity demanded given a percent change in the price.

The Price Elasticity of Demand and Its Determinants •

Demand tends to be more elastic :  –

the larger the number of close substitutes.

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if the good is a luxury.

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the more narrowly defined the market.

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the longer the time period.

Computing the Price Elasticity of Demand •

The price elasticity of demand is computed as the percentage change in the quantity demanded divided by the percentage change in price.

Price elasticity of demand =

Percentage change in quantity demanded Percentage change in price

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities •

The midpoint formula is preferable when calculating the price elasticity of demand because it gives the same answer regardless of the direction of the change. It is nothing but the Arc method.

Price elasticity of demand =

(Q 2  Q1 ) / [(Q2 (P2  P1 ) / [(P2



Q1 ) / 2 ]

 P1

) / 2]

The Midpoint Method: A Better Way to Calculate Percentage Changes and Elasticities •

Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:

(10  8) (10  8) / 2 (2.20  2.00) (2.00  2.20) / 2

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22% 9.5%

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2.32

Computing the Price Elasticity of Demand

Types of Price Elasticity of Demand •

Perfectly Inelastic  –

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Perfectly Elastic  –

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Quantity demanded changes by the same percentage as the price.

Greater than Unitary Elastic  –

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Quantity demanded changes infinitely with any change in price.

Unit Elastic  –

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Quantity demanded does not respond to price changes.

Quantity demanded changes by the high percentage as the price.

Less than Unitary Elastic  –

Quantity demanded changes by the low percentage as the price.

Income Elasticity of Demand •

Income elasticity of demand (Ied  ) is an elasticity used to show the responsiveness of the quantity demanded of a good or service to a change in income of consumer. It can be defined as proportionate change in the quantity demanded of a commodity in relation to a proportional change in the income of a consumer.

Income Elasticity of Demand Income Elasticity of Demand = Proportionate change in demand ÷ Proportionate change in income Ied = (∆Q ÷ ∆I) × (I ÷ Q) Where, ∆Q = Proportionate change in demand ∆I = Proportionate change in income

Q = Original demand I = Consumers’ original Income

Cross Elasticity of Demand •

As stated earlier, the demand of a commodity is affected by a change in the prices of related commodities also. Cross elasticity of demand measures a change in the quantity demanded of a particular commodity in response to a change in the price of some related commodities.

Cross Elasticity of Demand •

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It can be defined as proportionate change in the demand of commodity X in response of a proportionate change in the price of a related commodity Y. It can be presented as follows: Cross Elasticity of Demand = Proportionate change in the demand of commodity X ÷ Proportionate change in the price of commodity Y

Cross Elasticity of Demand Ced = (∆QX÷∆PY) × PY÷QX Where, ∆QX = Change in quantity demanded of commodity X  ∆PY = Change in price of commodity Y 

PY

= Original Price of commodity Y 

QX

= Original quantity demanded of commodity X 

Uses of concept of Elasticity of Demand in managerial Decision The concept of elasticity of demand is of great significance to the producers or sellers, workers and government in formulating their policies. It has practical implications in managerial decision making. The practical importance of this concept will be clear from the following applications: 1. Determination of Price Policy: While fixing the price of the product. A businessman has to consider the elasticity of demand for the product. He should consider whether lowering of price will stimulate demand for his product and if so to what extent and whether his profit will also increase a result thereof. •

2. Price Discrimination: Price discrimination refers to the act

of selling the technically same product at different prices to different section of consumers or different in different sub-markets. The policy of price-discrimination is profitable to the monopolist when elasticity of demand for his product is different in different sub-markets. 3. Shifting of Tax Burden: To what extent a producer can shift the burden of indirect tax to the buyers by increasing price of his product depends upon the degree of elasticity of demand. 4. Taxation and Subsidy Policy: The government can impose higher taxes and collect more revenue if the demand for the commodity on which a tax is levied is inelastic. On the other hand, in case of a commodity with elastic demand high tax rates may fail to bring in the required revenue for the government. Government should provide subsidy on those goods whose demand is elastic.

5. Importance in International Trade: The concept of

elasticity of demand is of crucial importance in many aspects of international trade. The success of the policy of devaluation to correct the adverse balance of payment depends upon elasticity of demand for export and import of the country. 6. Pricing of Joint Supply Product: The goods that are produced by a single production process are joint products. The cost of production of these goods is also joint. Therefore, while determining the prices of these products their elasticity of demand is considered. The price of joint supply product is fixed high if its demand is inelastic and low price is fixed for that joint supply whose demand is elastic.

7. Effect on Use of Machine on Employment:

Ordinarily it is thought that use of machines reduced the demand for labor. Therefore, trade unions often oppose the use of machines fearing unemployment. But this fear is not always true because use of machines ay not reduce demand for labor. It depends on the price elasticity of demand for the products. 8. Output Decisions: The elasticity of demand helps the businessman to decide about production. A businessman chooses the optimum product-mix on the basis of elasticity of demand for various products.