Demand Analysis
The Objective of this Chapter-
The fundamental objective of demand theory is to
identify and analyze the basic determinants of
consumer needs and wants.
This chapter explains how markets determine
prices.
Three elasticity measures are discussed: price
elasticity, income elasticity; and cross elasticity.
OUTLINE OF THIS CHAPTER
1. The relationship between demand and price
2. The law of demand- Reasons for the law
Income effect, Substitute effect
3. Demand definition
4. Quantity demand – definition
5. Differences between Quantity demand and Demand
6. Market demand
7. Individual Demand Curve & Market Demand Curve
OUTLINE OF THIS CHAPTER
8. Determinants/factors of demand
9. Demand function
10. Demand equation
11. Supply equation
12. Determination of equilibrium price-
mathematically.
13. Elasticity of demand
14. Types of elasticity- definitions, formulae, some
calculations
The relationship between demand and price
The headlines announced
“Major crop failures in Brazil and East Africa: coffee prices
soar.”
“India shut down onion export to Bangladesh: forces onion
prices soar.
Shortly afterwards you find that coffee & onion prices have doubled in the
shops.
What do you do?
Presumably you will cut back on the amount of coffee you drink.
Perhaps you will reduce it from, say, six cups per day to two.
Perhaps you will give up drinking coffee altogether.
This is simply an illustration of the general relationship between
price and consumption: when the price of a good rises, the quantity
demanded will fall.
This relationship is known as the law of demand.
The Law of Demand
The law of demand states:
Other things remaining the same, the higher the price of a good, the
smaller is the quantity demanded; and
the lower the price of a good, the larger is the quantity demanded.
The law of demand results from
Income effect
Substitution effect
Income Effect
When the price of a good or service rises relative to income, people
cannot afford all the things they previously bought, so the quantity
demanded of the good or service decreases.
Substitution Effect
When the relative price (opportunity cost) of a good or service rises,
people seek substitutes for it, so the quantity demanded of the good
or service decreases.
If you demand something, then you
1. want it,
2. can afford it, and
3. have made a definite plan to buy it.
Then one can find effective demand if all the three components are present.
Demand definition:
Demand is a schedule that shows the various quantities of a good or service that
a consumer is willing and able to buy at various prices in a given time period,
ceteris paribus (if other things remain constant).
Quantity demanded
The quantity demanded of a good or service is
the amount that consumers plan to buy during a
particular time period, and at a particular price.
Differences between demand & QUANTITY Demand
Demand Quantity demanded
Demand is a schedule that shows the The quantity demanded of a good or
various quantities of a good or service that service is the amount that consumers plan to
a consumer is willing and able to buy at buy during a particular time period, and at a
various prices in a given time period, particular price.
ceteris paribus (if other things remain
constant).
Changes in quantity demanded means
Change in demand means change in
change in the quantity purchased due to
demand due to the factors of demand other change in the price of a product.
than price.
Graphically, changes in quantity demanded
Graphically, changes in demand would be
represents movement along the demand
represented by a shift in the demand curve curve with changes in price.
to the right or left.
Differences between demand & QUANTITY Demanded
Demand Quantity demanded
Demand table
Price of Quantity Points
Onion demanded On
(Per kg) (per month) Demand
curve
0 10 A
50 8 B
100 4 C
150 1 D
200 0 E
Market Demand
The market demand for a good or service is the sum of
all individual demands.
A table showing the different total quantities of a
good that consumers are willing and able to buy
at various prices over given period of time, if
other things remaining the same.
Individual demand and market demand
Points Price of Tracey’s Darren’s Total quantity
Tomatoes quantity quantity demanded
(tk per kg) demanded demanded
A 20 28 16 44
B 40 15 11 26
C 60 5 9 14
D 80 1 7 8
E 100 0 6 6
Individual demand curves and market demand curve:
Tracey’s demand curve Darren’s demand curve Total/ Market demand curve
Price Price Price
Quantity of tomatoes Quantity of tomatoes Quantity of tomatoes
Determinants of demand
Price determinants-
Price, in many cases, is likely to be the most fundamental determinant of
demand since it is often the first thing that people think about when
deciding how much of an item to buy.
Price (P) quantity demanded (Qd)
P Qd
Determinants of demand
Non-price determinants-
i. Income-
ii. The prices of other goods-
(For substitute goods and complementary goods)
iii. Tastes-
iv. Distribution of income-
v. Expectations of future price changes- etc.
Some Definitions
Normal good is a good whose demand rises as people’s incomes rise and vice-
versa.
Inferior good is a good whose demand falls as people’s incomes rise and vice-
versa.
Substitute goods is a pair of goods which are considered by consumers to be
alternatives to each other. As the price of one goes up, the demand for the
other rises.
Complementary goods is a pair of goods consumed together. As the price of one
goes up, the demand for both goods will fall.
Movement along and shifts in the demand curve
Movement Along the
Demand Curve
When the price of the good
changes and everything else
remains the same, the
quantity demanded changes
and there is a movement
along the demand curve.
Movement along and shifts in the demand curve
A Change in Demand
When some influence on buying plans
other than the price of the good changes,
there is a change in demand for that good.
The quantity of the good that people plan
to buy changes at each and every price, so
there is a new demand curve.
When demand increases, the demand
curve shifts rightward.
When demand decreases, the demand
curve shifts leftward.
Demand function-
Demand function shows the relationship between
price and quantity demanded. Mathematically,
QdA=f(PA) where, QdA= Dependent variable;
PA= Independent variable.
QdA=f(PA , PB, PC,…..PZ, I, W, T….etc.)
Demand equation-
A demand equation shows the relationship between price and
quantity demanded. Moreover it shows the nature of the
relationship.
Qd=a-bP
where, a=interception of the demand curve,
OR
quantity demanded at zero price;
b= slope of the demand curve; OR
the change of quantity demanded to the change of price;
(dQd/dP).
Supply function and equation
Supply function shows the relationship between price and quantity
supplied. i.e.
QsA=f(PA)
Where supply equation shows the relationship between price and quantity
supplied. Moreover it shows the nature of the relationship.
QsA=c+dP
Exercise -1
A market consists of three persons, Abiul (A), Bablu (B) and Chandrima (C), whos
demand equations are as follows:
A: P=35-0.5QA
B: P=50-0.25QB
C: P=40-2QC
The industry supply equation is given by-Q S=40+3.5P
i. Compute the equilibrium price and quantity
ii. Which individual does purchase the maximum amount?
Supply
If a firm supplies a good or service, then the firm
1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is possible to produce. Supply
reflects a decision about which technologically feasible items to produce.
The quantity supplied of a good or service is the amount that
producers plan to sell during a given time period at a particular price.
The Law of Supply
The law of supply states:
Other things remaining the same, the higher the price of a
good, the greater is the quantity supplied; and
the lower the price of a good, the smaller is the quantity
supplied.
The law of supply results from the general tendency for the
marginal cost of producing a good or service to increase as the
quantity produced increases.
Producers are willing to supply a good only if they can at least
cover their marginal cost of production.
The six main factors that change supply of a good are
The prices of factors of production
The prices of related goods produced
Expected future prices
The number of suppliers
Technology
State of nature
