Economics for

Managers

Demand & Supply Analysis

 Agenda

 Demand Analysis

 Elasticity of Demand

 Theory of Consumer
Behavior

 Supply Analysis

20XX SAMPLE FOOTER TEXT 2

Demand
analysis
 Concept of Demand
An economic principle refers to a consumer’s desire to purchase goods and services and
willingness to pay a price for a specific good or service.

Demand refers to the willingness and ability of a consumer to buy goods and services at a
specific price.

Economists use the term demand to indicate that consumers need particular goods or services and
are willing to buy them at the price they are at the time of demand.

The law of demand concerns consumers' changing desire to purchase goods and services at given
prices.

Demand can refer to either market demand for a specific good or aggregate demand for the total
20XX of all goods in an economy. 4
 Determinants of
Demand

Product price Tastes and preferences

Levels of income Consumer expectation

Population The number of buyers

End market indicators Government policies

Availability of and price Climate changes

of substitute goods
 Demand function

Dx=f(Px, I, Pr, E, T)

Demand of Commodity x (Dx)

Function of commodity x (f)

Price of good or service (Px)

Incomes of consumers (I)

Prices of related goods & services (PR

)

Future Expectation of product (E)

Taste patterns of consumers (T)

 Law of Demand
 The law of demand is a fundamental principle of economics that states that at a higher price

consumers will demand a lower quantity of a good.

 Prof. Alfred Marshall defined the law “The greater the amount to be sold, the smaller must be the

price at which it is offered in order that it may find purchases or in other words the amount

demanded increases with a fail in price and diminishes with a rise in price”

 The law of demand states that quantity purchased varies inversely with price. In other words, the

higher the price, the lower the quantity demanded.

 Thus there is an inverse relationship between price and quantity demanded, the other things which

are assumed to be equal or constant are the prices of related commodities, income of consumers,

tastes and preferences of consumers, and all the factors other than price which influence demand.
 For example, if a consumer is hungry and buys a slice of pizza, the first
slice will have the greatest benefit or utility. With each additional slice,
the consumer becomes more satisfied, and utility declines. In theory, the
first slice might fetch a higher price from the consumer. However, by the
fourth slice, the consumer might be less willing to pay for a slice because
of declining utility. In other words, if the pizza restaurant lowered the
price of their slices, it would have less of an impact on demand because
the utility has decreased—their customers were full or satisfied.
 Demand Schedule

Demand schedule is a table that shows the

quantity demanded of a good or service at different price
levels. A demand schedule can be graphed as a continuous
demand curve on a chart where the Y-axis represents price
and the X-axis represents quantity.

The demand schedule shows exactly how many units of a

good or service will be purchased at various price points.
 Quantity
​Price
demanded​

10 600

15 460​

20 350​

25 270

30 220

35 150

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 Demand Curve

A graphical representation of the relationship between the price of a good or

service and the quantity demanded for a given period of time

The price will appear on the left vertical axis, the quantity demanded on the
horizontal axis.

With few exceptions, the demand curve is delineated as sloping downward from left
to right because price and quantity demanded are inversely related (i.e., the lower
the price of a product, the higher the demand or number of sales).

There may be rare examples of goods that have upward sloping demand curves. A
good whose demand curve has an upward slope is known as a Giffen good.

A shift to the left indicates a decrease in demand, while a movement to the right an
increase.
 Demand curve

 Demand curve has two types individual demand curve and market demand curve.

 It displays a graphical representation of demand schedule.

Individual demand curve

 The graphical representation of individual demand schedule is called individual demand

curve.

Market demand curve

 The graphical representation of market demand schedule is called market demand curve.
 Market demand
schedule

The market demand for a commodity thus

depends on all the factors that determine
the individual’s demand in addition on the
number of buyers of the commodity in the
market.

We add up the various quantities demanded

by different consumers in the market, we
can obtain the market demand schedule.
Price of Good X in A B Total market
(rs) Demand

0 3 2 5

10 2 1 3

20 1 0 1

30 0 0 0
Market Demand Curve for Good X
 Rationale of the
Law Demand

We shall now try to understand why do demand curves slopes

downwards?

 Utility maximising behaviour of consumers

 Arrival of new consumers

 Different uses

 Price effect of a fall in price

The price effect which indicates the way the consumer's

purchases of good X change, when its price changes, is the sum of
its two components namely: substitution effect and income effect.
Substitution effect
Hicks and Allen have explained the law in terms of substitution effect and income
effect.
The substitution effect describes the change in demand for a product when its relative
price changes. When the price of a commodity falls, the price ratio between items
change and it becomes relatively cheaper than other commodities.
Assuming that the prices of all other commodities remain constant, it induces
consumers to substitute the commodity whose price has fallen for other commodities
which have now become relatively expensive.
The result is that the total demand for the commodity whose price has fallen
increases.
The substitution effect will be stronger when:

(a)the goods are closer substitutes

(b)there is lower cost of switching to the substitute good

(c)there is lower inconvenience while switching to the substitute good

 John eats rice that costs Rs.50 per kg and pasta that costs Rs.100 per
kg. The relative price of 1 kg of pasta is 2 kgs of rice. At their current
prices, John consumes 1 kg of pasta and 2 kgs of rice.

 Due to some technological advances in rice cultivation, there has been

a fall in rice prices from Rs.50 a kg to Rs.20 a kg. The relative price of 1
kg of pasta has now increased from 2 kgs of rice to 5 kgs of rice.
Therefore, John switches away from pasta and to rice.

 The change in consumption occurs purely due to the changes in the

relative price of the goods and not because of a change in income.
Income effect
 The increase in demand on account of an increase in real income is
known as income effect.

 When the price of a commodity falls, the consumer can buy the same
quantity of the commodity with lesser money or he can buy more of the
same commodity with the same amount of money.

 In other words, as a result of fall in the price of the commodity,

consumer’s real income or purchasing power increases.
 John earns Rs.10,000 a month and spends his entire income on only two
commodities, apples (priced at Rs.10 each) and cheese (priced at Rs.50).
We can make the following statements about John’s income:

• John earns 1,000 units of apples a month.

• John earns 200 units of cheese a month.

 Therefore, a 100% increase in John’s monthly income (Rs10,000 to

Rs20,000) results in the

• John earns 2,000 units of apples a month.

• John earns 400 units of cheese a month.

Utility maximising behaviour of consumers
 A consumer is in equilibrium (i.e. maximises his satisfaction) when the marginal
utility of the commodity and its price equalize.

 According to Marshall, the consumer has diminishing utility for each additional unit
of a commodity and therefore, he will be willing to pay only less for each additional
unit.

 A rational consumer will not pay more for lesser satisfaction. He is induced to buy
additional units only when the prices are lower.

 The operation of diminishing marginal utility and the act of the consumer to
equalize the utility of the commodity with its price result in a downward sloping
demand curve.
Arrival of new consumers
 When the price of a commodity falls, more consumers start buying it because
some of those who could not afford to buy it earlier may now be able to buy it.

 This raises the number of consumers of a commodity at a lower price and

hence the demand for the commodity in question increases
Different uses
 Many commodities have multiple uses. When the price of such commodities are
high (or rises) they will be put to limited uses only.

 If the prices of such commodities fall, they will be put to more number of uses
and therefore their demand will increase.

 Thus, the increase in the number of uses consequent to a fall in price make
the buyer demand more of such commodities making the demand curve slope
downwards.

 For example: Electricity

Exceptions to the Law of Demand
Conspicuous goods
 Articles of prestige value or snob appeal or articles of conspicuous consumption are
used by the rich people as status symbol for enhancing their social prestige or /and for
displaying wealth.

 These articles will not conform to the usual law of demand as they become more
attractive only if their prices are high or keep going up.

 This was found out by Veblen in his doctrine of “Conspicuous Consumption” and hence
this effect is called Veblen effect or prestige goods effect.

 Veblen effect takes place as some consumers measure the utility of a commodity by
its price i.e., if the commodity is expensive they think that it has got more utility.

 Diamonds, Designer clothes, expensive jewellery, luxury cars, etc are often given
as an example of this case
 Exceptions to the Law of Demand

Giffen goods
 Sir Robert Giffen, a Scottish economist and statistician, was surprised to find out that as the
price of bread increased, the British workers purchased more bread and not less of it.
 This was something against the law of demand. Why did this happen?
 The reason given for this is that, when the price of bread went up, it caused such a large
decline in the purchasing power of the poor people that they were forced to cut down the
consumption of meat and other more expensive foods. Since bread, even when its price
was higher than before, was still the cheapest food article, people consumed more of it and
not less when its price went up.
 Generally those goods which are inferior, with no close substitutes available and which
occupy a substantial place in consumers’ budget are called ‘Giffen goods’.
 Examples of Giffen goods are coarse grains like bajra, low quality rice and wheat etc.
Exceptions to the Law of Demand
Conspicuous necessities

 The demand for certain goods is affected by the demonstration effect of the
consumption pattern of a social group to which an individual belongs.

 These goods, due to their constant usage, become necessities of life.

 For example, in spite of the fact that the prices of television sets, refrigerators, air-
conditioners etc. have been continuously rising, their demand does not show any
tendency to fall.

 TV, mobile phone, fridge, have become a part of life, despite the fact
that they are expensive
Exceptions to the Law of Demand

Future expectations about prices

 It has been observed that when the prices are rising, households, expecting that the
prices in the future will be even higher, tend to buy larger quantities of such
commodities.

 For example, when there is wide-spread drought, people expect that prices of food
grains would rise in future. They demand greater quantities of food grains even as
their price rises. On the contrary, if prices are falling and people anticipate further
fall, rather than buying more, they postpone their purchases.
Exceptions to the Law of Demand
Incomplete information and irrational behavior
 The law has been derived assuming consumers to be rational and knowledgeable
about market-conditions.
 However, at times, consumers have incomplete information and therefore make
inconsistent decisions regarding purchases.
 Similarly, in practice, a household may demand larger quantity of a commodity
even at a higher price because it may be ignorant of the ruling price of the
commodity.
 Sometimes, consumers tend to be irrational and make impulsive purchases
without any rational calculations about the price and usefulness of the
product and in such contexts the law of demand fails.
Exceptions to the Law of Demand

Demand for necessaries

The law of demand does not apply much in the case of necessaries of life.

Irrespective of price changes, people have to consume the minimum quantities of

necessary commodities.

Speculative goods
In the speculative market, particularly in the market for stocks and shares, more will
be demanded when the prices are rising and less will be demanded when prices
decline.
 Expansion and Contraction of
Demand

When, as a result of decrease in price, the quantity

demanded increases, in Economics, we say that there is
an expansion of demand and when, as a result of
increase in price, the quantity demanded decreases, we
say that there is a contraction of demand.

It should be noted that expansion and contraction of demand

take place as a result of changes in the price while all other
determinants of price viz. income, tastes, propensity to
consume and price of related goods remain constant.
 Increase and Decrease in Demand
 The‘ other factors remaining constant’ means that the position of the
demand curve remains the same and the consumer moves downwards or
upwards on it.
 There are factors other than price (non-price factors) or conditions of
demand which might cause either an increase or decrease in the quantity of
a particular good or service that buyers are prepared to demand at a given
price.
 What happens if there is a change in consumers’ tastes and preferences,
income, the prices of the related goods or other factors on which demand
depends?
 As an example, let us consider what happens to the demand for commodity
X if the consumer’s income increases:
 Quantity of ‘X’ Quantity of ‘X’
Pri demanded demanded when
when average average
ce
household household income
(R income is Rs is
s) 5,000 per Rs 10,000 per
month month
A 5 10 15 A
1

B 4 15 20 B
1

C 3 20 25 C
1

D 2 35 40 D
1

E 1 60 6 E
5 1
 Movement along Demand Curve vs. Shift of
Demand Curve
 A movement along the demand curve indicates changes in the quantity demanded
because of price changes, other factors remaining constant.

 A shift of the demand curve indicates that there is a change in demand at each
possible price because one or more other factors, such as incomes, tastes or the
price of some other goods, have changed.

 Thus, when an economist speaks of an increase or a decrease in demand, he refers

to a shift of the whole curve because one or more of the factors which were assumed
to remain constant earlier have changed.

 When the economists speak of change in quantity demanded he means movement

along the same curve (i.e., expansion or contraction of demand) which has happened
due to fall or rise in price of the commodity.