Analysis of Demand & Supply

Concept of demand/ factors/

elasticity/ durables & non-durables/
short run and long run demand/
autonomous demand/ demand for
firm and industry/ Supply/ Law of
Supply/ factors/ shortage/ Surplus/
Market equilibrium
 Theory of Demand
• Desire/ need Vs. Demand
• Simultaneous existence of:
– Willingness to buy
– Ability to Pay
• Factors on which the quantity demanded
depends:
– Own price, prices of substitutes/compliments,
Income of consumer, population and its
composition, tastes and preferences, Advertisement
expenses of the firm/ its rivals, seasons, fashions
etc. (quality/ advt/ promotions, etc)
 Law of Demand
• Law of Demand: Other things remaining same, a rise
in price of a commodity generally leads to a fall in
its quantity demanded and vice versa.
• Reasons:
– Income Effect
– Substitution Effect
– New buyers
– Multiple uses by old buyers
 Types of Demand
– Price Demand; Cross Price Demand; Income Demand

• Meaning of these three types of demand

• Variation in Demand and Shift in Demand (fig.
follows)
• Demand Curve and Demand Schedule (next slide)
• Potential Vs. Actual Demand (eg:)
• Individual Demand and Market Demand (eg:)
 Types of Goods
• Durable Vs Non-durable or single-use
• Durable goods yield services to their owners over
a number of future time periods.
• Obsolescence in style, convenience, and prestige
value are likely to play a greater role on durable
good demand than physical deterioration
• Eg: PC, Cars/ Motorbikes/ Handset of mobile
phones/ Wrist watches
• Concept of “reserve price” exists for durable good
but not for perishable commodity
Variation and shift in demand
• Any change in demand due to the own price
alone, as reflected by a movement along the
same demand curve is called variation of
demand. It could be extension or contraction.
• Factors other than own price (like income/
fashion/ season, etc) cause the demand curve
to shift to the right or left.
• It is called increase/ decrease in demand.
Market demand for Mangoes (monthly)
100
Point Price Market demand
(Rs.per kg) (tonnes 000s)
80
A 20 700
60
Price (Rs.per kg)

40

20

0
0 100 200 300 400 500 600 700 800

Demand

Quantity (tonnes: 000s)

Market demand for Mangoes (monthly)
100
Point Price Market demand
( Rs. per kg) (tonnes 000s)
80
A 20 700
60 B 40 500
Price (Rs. per kg)

40

20

B
0
0 100 200 300 400 500 600 700 800

Demand

Quantity (tonnes: 000s)

Market demand for Mangoes (monthly)
100
Point Price Market demand
(Rs. per kg) (tonnes 000s)
80
A 20 700
60 B 40 500
Price (Rs. per kg)

C 60 350
40
C

20

B
0
0 100 200 300 400 500 600 700 800

Demand

Quantity (tonnes: 000s)

Market demand for Mangoes (monthly)
100
Point Price Market demand
(Rs. per kg) (tonnes 000s)
80
A 20 700
D
60 B 40 500
Price (Rs. per kg)

C 60 350
40
C D 80 200

20

B
0
0 100 200 300 400 500 600 700 800

Demand

Quantity (tonnes: 000s)

Market demand for Mangoes (monthly)
100
E Point Price Market demand
(Rs. per kg) (tonnes 000s)
80
A 20 700
D
60 B 40 500
Price (Rs. per kg)

C 60 350
40
C D 80 200
E 100 100
20

B
0
0 100 200 300 400 500 600 700 800

Demand

Quantity (tonnes: 000s)

Market demand for Mangoes (monthly)
100
E Point Price Market demand
(Rs. per kg) (tonnes 000s)
80
A 20 700
D
60 B 40 500
Price (Rs. per kg)

C 60 350
40
C D 80 200
E 100 100
20

B
0
0 100 200 300 400 500 600 700 800

Demand

Quantity (tonnes: 000s)

 An increase in demand

P
Price

D1
D0

O Q0 Q1
Quantity
 Law of DD using ICs
• Law of Demand deals with inverse
relationship between Price and Quantity
• Price Effect=Income +Substitution effect
• Diagrammatic representation of Price effect
with the use of IC
• Income and Substitution Effects for normal,
superior and inferior goods/ Giffen goods
 Exceptions
• Panic buying (Eg: Gold)
• Commodity conferring distinction
• Sheer ignorance makes to buy more at
higher prices
• If necessity’s price goes up, consumer
readjusts his expenditure in its favour
• Changes in tastes/ fashion
• Giffen’s Paradox
 Consumption Curves
• Price Consumption Curve (PCC)
– Meaning and graph
• Income Consumption Curve (ICC)
– Meaning and graph
• ICC for Normal goods
– Graph
• ICC for One Normal goods & the other Inferior
Good
– Graph
 Consumption Curves
• Price Consumption Curve (PCC)
– Meaning and graph
• Income Consumption Curve (ICC)
– Meaning and graph
• ICC for Normal goods
– Graph
• ICC for One Normal goods & the other Inferior
Good
– Graph
 Consumption Curves
• Price Consumption Curve (PCC)
– Meaning and graph
• Income Consumption Curve (ICC)
– Meaning and graph
• ICC for Normal goods
– Graph
• ICC for One Normal goods & the other Inferior
Good
– Graph
The Price-consumption Curve
Deriving the demand curve
Income-consumption curve
 The Engel Curve
• A curve that shows the quantity demanded for different
levels of income.
• Similar to a demand curve (which relates quantity to
price).
• Named after Ernst Engel, a German statistician &
economist (1821-1896).
• The Engel Curve is derived using the income-
consumption curve.
Deriving the Engel Curve
Deriving the Engel Curve
 Elasticity of Demand
• Elasticity refers to the degree of responsiveness
of quantity demanded due to a given change in
price/ other prices/ income of consumers.
• A given percentage change in price of two
commodities may not result in an equal change
in their quantity demanded. (eg)
• The reason for it is varying sensitiveness of the
demand to price change.
• We can precisely measure such responsiveness
in quantity with the help of a simple ratio.
 Elasticity…contd.
• Types of Elasticity of Demand
– Price, Income and Cross Price elasticity
• Price elasticity of demand refers to the
proportionate change in Qd to a given
proportionate change in Price, ceteris paribus.
Generally, it has a negative value.
• Different values of Price elasticity:
– Perfectly elastic (infinity)
– Perfectly inelastic (zero)
 Price Elasticity: Types..contd
• Relatively Elastic (between 1 and infinity)
• Relatively inelastic (between zero and 1)
• Unitary elastic (Equal to 1)
• Examples and implications
• The Outlay Method
• For same demand curve, price elasticity varies from
point to point
• Graphical representation of types of price elasticity of
demand
 Cross Elasticity
• Quantity demanded of some goods is
affected not merely due to its own price
change, but due to price change of other
related goods.
• Cross elasticity of demand refers to
proportionate change in quantity demanded
of one good (X) for a given proportionate
change in price of a related good (Y),
ceteris paribus.
 Elasticity…contd
• Value of cross elasticity would be Positive for
substitutes, while Negative for compliments.
(Eg:------)
• Income elasticity refers to percentage change in
quantity demanded of a good to a given
percentage change in income of the consumer,
ceteris paribus.
• Generally, income elasticity would be positive
for Normal/ Superior goods; while negative for
inferior and Giffen goods. (eg:-------)
 Point and Arc Elasticity
• In each of the variables, namely price, income
and cross price; there are two ways of
estimating the elasticity of demand, viz. Point
and Arc elasticity.
• While point elasticity gives idea about
responsiveness of demand due to the change
in one of the variable at the GIVEN point,
Arc elasticity gives the average elasticity over
a given RANGE along a demand curve.
 Firm and Industry
• Industry as a whole might be having high
demand; but a given firm can face shortage of
demand
• Quality/ brand/ price/ marketing methods/
incentives/ etc. may cause the discrepancy
• Examples where a select few firms may have
high demand but industry as a whole may be
languishing
• CMIE/ CRISINFAC/ Share prices of one sector
vis-à-vis Index movements give us an idea
about it.
 Applications of DD & elasticity
• Demand is the major factor that determines price
in a market. It also decides fortunes of producers,
workers, governments for taxes etc. In short/
medium run, it is the major factor affecting price.
• Monopolist
• Taxation
• Fruits/ Perishable products during bumper crops
• Recessionary conditions Vs consumer demand
(sensitive to incomes)
• International trade
 Supply-Meaning
• Supply refers to quantity of output offered
for sale at a given price during a given
market and at a given period of time.
• Generally, firms would be prepared to
supply more as price goes up.
• Reason being, increase in average cost will
be less than increase in price, hence each
extra unit supplied gives additional profit.
 Supply curve
• The supply curve shows the relationship between
the price and the quantity that producers are
willing to sell in a given time period, other things
remaining the same.
• Quantity supplied refers to the amount sellers
plan to offer for sale, not the quantity they
actually sell.
• The supply curve is drawn with quantity on the
horizontal axis and price on the vertical.
• The supply curve slopes up and to the right.
 A Typical Supply Curve
• Price

Quantity
 The Law of Supply
• The law of supply: the higher the price, the
larger the quantity supplied (the more
producers want to sell) in a given time period,
other things remaining equal.
• Higher prices make it profitable to produce
units with higher opportunity costs that were
not profitable to produce when prices were
lower.
 Other factors--supply side
• The supply curve shows producer reactions to
changes in the price of the good itself so long as
nothing else is changing.
• A change in one of the following will shift the
supply curve:
• Costs of inputs used to produce the product; taxes
• Technology
• Weather
• The number of producers
• The price of alternatives in production
• Producer expectations about future prices.
Supply Curve and Time Period
• Shape of typical Supply curve will be
• Vertical during very short period
• Steep curve during short period
• Flat/ horizontal/ downward sloping in the long run.
• Examples:
– Market period supply curve
– Short period supply curve
– Long period supply curve
 Market Equilibrium
• An equilibrium is a position of rest; there are no
forces leading to a change.
• The equilibrium price is that at which quantity
supplied equals quantity demanded
• No unsatisfied buyers pushing prices up to get the
good
• No unsatisfied sellers cutting prices to sell
• The equilibrium is shown graphically by the point at
which the supply and demand curves intersect.
 Shortage

• A shortage exists when consumers are willing to

buy more than producers are willing to sell
(quantity demanded exceeds quantity supplied)
• Shortages occur at prices below the equilibrium.
• An increase in the price will eliminate the shortage
because consumers will cut back on the quantitiy
they want to buy as the price rises plus the higher
price will induce for-profit firms to supply more.
 Surplus

• A surplus exists when producers want to

sell more than consumers are willing to buy.
• Surpluses occur when the price is above the
equilibrium level.
• Falling prices eliminate the surplus; falling
prices discourage firms from producing so
much and induce buyers to purchase more.
 Making predictions
• Usually only one curve shifts. In these cases,
you can predict the direction of change of
both price and quantity.
• Sometimes both curves shift due to
independent and simultaneous change in 2
determinants. (coincidence happens)
• In these cases, you can predict the direction
of change in price OR quantity but NOT both.
 Pricing Strategies
• In the competitive market conditions,
strategies and tactics of pricing are followed
on the basis of observed elasticity of
demand of a firm’s product vis-à-vis the
closest rival’s demand.
• To achieve the original demand back, a firm
makes use of arc elasticity formula, if
elasticity and price-quantity information is
available.
 Summary
• Demand means desire and ability to pay
• Potential demand enable advance action
• Demand is a complex variable and is influenced by
several factors-economic & Non-economic
• Concept of elasticity is useful to measure degree of
responsiveness of Qd
• Demand and supply together determine market
equilibrium
• For pricing strategies, the firms need to clearly
understand DD, and apply the elasticity to know
impact of its own and rivals’ decisions.