Demand and Supply
Analysis
Demand
The process to satisfy human wants/needs/desires.
Demand is that desire which backed by willingness and
ability to buy a particular commodity.
Demand is the quantity of the commodity which consumers
are willing to buy per unit of time at that price.
Things necessary for demand:
Time
Price of the commodity
Quantity of the commodity consumers are willing to
purchase at the price
Types of Demand
Direct and Derived Demand
Direct demand is for the goods as they are such as
Consumer goods
Derived demand is for the goods which are demanded to
produce some other commodities; e.g. Capital goods
Types of Demand
Recurring and Replacement Demand
Recurring demand is for goods which are consumed at
frequent intervals such as food items, clothes.
Durables are purchased to be used for a long period of time
Wear and tear over time needs replacement
Complementary and Competing Demand
Some goods are jointly demanded hence are complementary
in nature, e.g. software and hardware, car and petrol.
Some goods compete with each other for demand because
they are substitutes to each other, e.g. soft drinks and juices.
Determinants of Demand
Price of the product
Single most important determinant
Negative effect on demand
Higher the price-lower the demand
Income of the consumer
Normal goods: demand increases with increase in consumer’s
income
Inferior goods: demand falls as income rises
Price of related goods
Substitutes
If the price of a commodity increases, demand for its substitute
rises.
Complements
If the price of a commodity increases, quantity demanded of its
complement falls.
Determinants of Demand
Contd…
Tastes and preferences
Very significant in case of consumer goods
Expectation of future price changes
Gives rise to tendency of hoarding of durable
goods
Population
Size, composition and distribution of
population will influence demand
Advertising and promotion
Very important in case of competitive markets
Determinants of Demand
Contd…
Credit Facilities
Very significant in case of high value goods
Channels of distribution
Ease of purchase , especially in case of
recurring/ frequent purchase
Fashion and Trends
Significantly increase demand
Government Policy
Very important in case of competitive markets
Seasonal Factors
Impact on the basis of climatic conditions
Demand Function
Interdependence between demand for a product and its
determinants can be shown in a mathematical functional
form
Dx = f(Px, Y, Py, T, A, N)
Independent variables: Px, Y, Py, T, A, N
Dependent variable: Dx
Px: Price of x
Y: Income of consumer
Py: Price of other commodity
T: Taste and preference of consumer
A: Advertisement
N: Macro variable like inflation, population growth, economic
growth
Law of Demand
A special case of demand function which shows relation between
price and demand of the commodity
Dx = f(Px)
Other things remaining constant, when the price of a commodity
rises, the demand for that commodity falls or when the price of a
commodity falls, the demand for that commodity rises.
Price bears a negative relationship with demand
Reasons - Law of Demand
Substitution Effect : as the price of good X falls, it
becomes relatively less expensive. Therefore, assuming
other alternative products stay at the same price, at lower
prices good X appears cheaper, and consumers will switch
from the expensive alternative to the relatively cheaper
one.
Reasons - Law of Demand
Income Effect: When the price of a particular commodity falls, the
consumer’s real income rises, hence the purchasing power of the
individual rises.
Law of Diminishing Marginal Utility: as a person consumes
successive units of a commodity, the utility derived from every next
unit (marginal unit) falls.
Demand Schedule and Individual
Demand Curve
Point on e
Demand Price (Rs Demand 35
Curve per cup) (‘000 cups) d
a 15 50 30
c
b 20 40 25
c 25 30 b
20
d 30 20 a
15
e 35 10
10 20 30 40 50
Quantity of coffee
Changes in Quantity Demanded
Price
In increase in price results in a movement
along the demand curve.
C
Rs. 4.00
A
Rs.2.00
D1
0 12 20 Number of units per Day
Change in Demand
Contd…
Shift in demand curve from D0 to
D1
D1
Price More is demanded at same price.
D0
D2
Increase in demand caused by:
A rise in the price of a
substitute
A fall in the price of a
complement
A rise in income
A change in tastes that
favours the commodity
Shift in demand curve from D0
to D2
0 Less is demanded at each
Quantity
price.
Exceptions to the Law of Demand
Bandwagon effect : the person tries to emulate the buying behavior
and patterns of the group to which he belongs irrespective of the
price of the commodity.
Future Expectation of Prices (Panic buying) :If a consumer
anticipates that the price of a commodity will rise in future he will
purchase more of that commodity now. The consumer will purchase
more even if current price is high.
Addiction
Basic necessities
Life saving drugs
Salt
Amount of income spent
Match box
Exceptions to the Law of Demand
Giffen Goods :Some special varieties of inferior goods are termed
as Giffen goods. Cheaper varieties of this category like bajra,
cheaper vegetable like potato come under this category. Sir Robert
Giffen of Ireland first observed that people used to spend more their
income on inferior goods like potato and less of their income on
meat. When the price of potato increased, after purchasing potato
they did not have so many surpluses to buy meat. So the rise in
price of potato compelled people to buy more potato and thus
raised the demand for potato. This is against the law of demand.
This is also known as Giffen paradox.
Snob Appeal : People sometimes buy certain commodities like
diamonds at high prices not due to their intrinsic worth but for a
different reason. The basic object is to display their riches to the
other members of the community to which they themselves belong.
This is known as ‘snob appeal’, which induces people to purchase
items of conspicuous consumption. Such a commodity is also
known as Veblen good (named after the economist Thorstein
Veblen) whose demand rises when its price rises.
Market Demand
Market: interaction between sellers and buyers of a
good (or service) at a mutually agreed upon price.
Market demand
Aggregate of individual demands for a commodity at a
particular price per unit of time.
Sum total of the quantities of a commodity that all
buyers in the market are willing to buy at a given price
and at a particular point of time (ceteris paribus)
Market demand curve: horizontal summation of
individual demand curves
