UNIT II

Demand Analysis
Demand
Demand is the quantity of good and services that customers are willing
and able purchase during a specified period under a given set of economic
conditions. The period here could be an hour, a day, a month, or a year.
The conditions to be considered include the price of good, consumer’s
income, the price of the related goods, consumer’s preferences,
advertising expenditures and so on. The amount of the product that the
costumers are willing to by, or the demand, depends on these factors.

There are two types of demand. The first of these is called direct
demand. This model of demand analysis individual demand for goods and
services that directly satisfy consumers desires. The prime determinant
of direct demand is the utility gained by consumption of goods and
services. Consumers budget, product characteristics, individuals
preferences are all important determinants of direct demand.

The other type of demand is called “derived demand”. Derived

demand is the demand resulting from the need to provide the final goods
and services to the consumers. Intermediate goods, office machines are
examples of derived demand. An other good example is mortgage credit.
Mortgage credit demand is not demanded directly, but derived from the
demand for housing.

Determinants of demand.
• Price of the good

• Income and wealth

• Prices of substitutes and complements

• Population

• Preferences (tastes)

• Expectations of future prices

Demand
Demand is the willingness and ability to purchase a particular good or service The demand
curve specifies a range of quantities (or amounts) of a good or service that a person or
business is willing to purchase at each particular price. For example, if the price of coffee is
$2.00 a cup, you would be willing to buy 3 cups a week. If the price of coffee is $.50 a cup,
you would be willing to buy 10 cups a week. At every price a consumer is willing to
purchase some quantity of a good or service.

Concept of Demand
In economics, the word ‘demand’ consists of 4 main concepts:

 It refers to both the ability to pay and a willingness to buy by the consumer (s).
Demand is sometimes called effective demand.
 Demand can be shown by a demand schedule which shows the maximum
quantity demanded (willing & able to buy) at all prices.
 Demand is a flow concept. Our willingness and ability to buy is subjected to a
time
period. At different times, we may have different demand schedules.
 There are many factors affecting our demand. In order to explore the effect of
price on
quantity demanded, economists like to assume other factors unchanged so as
to make the
analysis easier.
In Latin, the term ‘ceteris paribus’ means ‘ holding other factors constant
or unchanged’.

* An individual demand refers to the quantity of a good a consumer is willing to

buy and
able to buy at all prices within a period of time, ceteris paribus.

Demand Schedule & Demand Curve

A demand schedule is a table showing the quantities of a good that a consumer would
buy at all
different prices within a time period, ceteris paribus.
In mathematics, price & quantity demanded have a functional relationship. (In a
demand function, price is called the independent variable and quantity demanded the
dependent variable.)
A demand curve shows the above relationship in a graph.

The following example gives a demand schedule and a demand curve.

Label the X-axis & Y-axis first, then draw the curve.
 A Demand Schedule for A Good of A Consumer

Price ($ per uint) Quantity Demanded

30 2
20 4
15 6
12 8
10 10
8 12

A Demand Curve for A Good of A Consumer (within a time period)

Price
30

20

10

0 2 4 6 8 10 12 Quantity

The demand curve slopes downward from _____________ to ____________.

This slope implies that price and quantity demanded are inversely related, i.e. the
lower the
price, the greater the quantity demanded, and vice versa, ceteris paribus.
 Market Demand Curve
It refers to the demand for a good by all the consumers in the market, within a time
period.

The following example gives a demand schedule in a market consisting of only 2

consumers, Tom & Mary. Plot and name the market demand curve in the graph.

A Demand Schedule of A Market Consisted of only 2 Consumers

Price Quantity Demanded

($ per unit) Tom Mary Market (i.e. T + M)
30 2 1
20 4 3
15 6 5
12 8 7
10 10 9

Demand Curve For Tom Demand Curve For Mary

Market Demand Curve

30

20

10

0 2 4 6 8 10 1 3 5 7 9 5 10 15 20

The market demand curve is obtained by summing up the individual demand curves
of the
good in the market. That is, at the same price, the total quantity demanded from all
consumers
is added up and the value is plotted in the graph.
 The technique used is called ‘horizontal summation’ in economics.

Law of Demand

The market demand curve also slopes downwards from ____________ to

____________ .
The slope implies that price and quantity demanded are inversely related, ceteris
paribus.
The relationship between prices and quantity demanded is called the ‘law of demand’
in
economics.
(Economics argue that they have observed the reality and found that people behave as
described above according to the law. Such a common behaviour is believed to be a
general phenomenon of human behaviour. As a result, it is regarded as a law.)

III.Concept of Supply

The word ‘supply’ bears 4 similar concepts with demand:

 It refers to both the ability to sell (produce) and the willingness to sell by the
producer(s). Supply implies an effective supply.
 Supply can be shown by a supply schedule which shows the maximum quantity
supplied at all different prices.
 Supply is also a flow concept. Time is an important factor affecting the
condition of supply.
 There are again many factors affecting the supply of a firm. Economics hold the
ceteris
paribus condition in order to analyze the relationship between price and
quantity supplied by a firm or producer.

The Law Of Demand (Most recent revision June 2006)

Markets are places (physical or otherwise) where buyers come to buy and sellers come
to sell. In this chapter, we will focus on the quantity of a given product that buyers wish to
buy --- called the demand. What factors explain the quantity demanded of a given product
by buyers? In Chapter 6, we will look at the behavior of the sellers.

The Law of Demand

What determines the quantity demanded of a product? One of the key factors is certainly
the price of the product. Think of buying soft drinks. You go into the market. A six-pack
sells for $1.99. You buy a given number --- say two six-packs. Next week, there is a sale
--- the price is $0.99 a six-pack. You stock up and buy five six-packs. The following
week, the price has risen to $2.99 per six-pack. This is just too expensive --- you don't buy
any. The result is familiar to anyone who shops for anything regularly. We can generalize
it with the following statement: as the price of the product rises (falls), the quantity
demanded of that product falls (rises). The statement is typically referred to as the law of
demand. While one can perhaps think of an exception (if the price of a life saving drug
that has no substitute rises, what would happen to your quantity demanded?), they are so
few that we can assume safely that the statement is true in all cases.

The following demand schedule for new homes illustrates the law of demand:

Price Quantity Demanded Per Month

$340,000 0
1 $320,000 1000
2 $300,000 2000
3 $280,000 3000
4 $260,000 4000
5 $240,000 5000
6 $220,000 6000
7 $200,000 7000
8 $180,000 8000
9 $160,000 9000
10 $140,000 10000
11 $120,000 11000

Note that, in this example, at any price above $320,000, no one will buy any homes.
Then, as the price falls, people buy more homes in the month. We can then picture this in
the graph on the next page. The graph allows us to analyze more clearly because we can
see visually what is occurring. Notice the downward-sloping line. As the price of homes
falls, people buy more homes.

DEMANDCURVE

350

300 2

4
250
The Price Elasticity of Demand
The law of demand tells us some information that is useful. If we, as a company, charge
a higher price, we know that people will buy less of our product. But this information is
not enough. We want to know precisely what will happen to the quantity demanded of our
product if we raise the price by a given amount. In particular, we want to know what is
called the price elasticity of demand. As a formula, this is:

Percentage Change in Quantity Demanded

Percentage Change in Price

In words, this is the percentage change in the quantity demanded of a given product that
results because of a given percentage change in the price of that product. It measures
how much buyers respond to a percentage change in the price. (Notice that we use
"percentage change" instead of "change in amount". This allows us to compare different
products. People will respond much differently to a ten cent increase in the price of a
candy bar than to a ten cent increase in the price of an automobile. So we measure the
change in percentage terms to allow comparison.)
When we calculate our formula, we get a number. (The number is actually negative, but
we will ignore the minus sign.) If the number is more than zero but less than one, we say
that demand is relatively inelastic. This means that buyers reduce their buying, but very
little, as the price of the product rises. If the number is more than one, we say that
demand is relatively elastic. This means that buyers not only reduce their buying, but they
reduce it considerably, as the price rises. If the number exactly equals one, we say that
demand is unit elastic. "Unit" means one. If the number exactly equals zero, we say that
demand is perfectly inelastic. This means that buyers do not change their quantity
demanded at all if the price rises. Perfectly inelastic demand would be a violation of the
law of demand. We shall not encounter any examples of perfectly inelastic demand.
Finally, if the number is infinitely large, we say that the demand is perfectly elastic. We
will encounter several examples of this. It means that the market is infinitely large; the
seller can sell as much as he or she wants at the price that exists in the market.

In summary, If the number is: Demand is:

Between 0 and 1 Relatively Inelastic
Greater than 1 Relatively Elastic
=1 Unit Elastic
=0 Perfectly Inelastic
Infinitely Large Perfectly Elastic

Remember that the demand curve was drawn as a downward-sloping line. Below are
two demand curves for two different products, X and Y. Both are downward-sloping lines.
For which of the two is the demand relatively inelastic?

Price Price
$11 B $11 B

$10 .A $10 .A

Demand Demand
0 95100 Quantity 0 30 100 Quantity
(X) (Y)

The answer is X. In both cases, the price starts at $10 and the quantity demanded is 100
(Point A). In both cases, the price rises to $11. For X the quantity demanded only falls to
95 while for Y the quantity demanded falls to 30 (Point B). The demand for X is more
inelastic than the demand for Y. Or we can say it differently: the demand for Y is more
elastic than the demand for X. We can generalize: the more inelastic (elastic) is the
demand for the product, the steeper (flatter) is the demand curve.

Below are two graphs. Which represents perfectly inelastic demand and which
represents perfectly elastic demand?

Price Demand Price

_____________________ Demand

________________________ ____________________________
0 (X) Quantity 0 (Y) Quantity

The answer is that X (the vertical line) represents perfectly inelastic demand. The
quantity demanded stays the same regardless of the price. Y (the horizontal line)
represents perfectly elastic demand. At the given price, the company can sell all it
desires.

Determinants of Demand Elasticity

 Availability of substitutes: The greater the availability of substitutes for a good,

the greater the good’s elasticity of demand
 Share of consumer’s budget spent on the good:Increase in prices reduced the
demand because people are not both willing and able to purchase @ higher prices
 A matter of time: The longer the adjustment period, the greater the consumer’s
ability to substitute
 Some elasticity estimates: The elasticity of demand is greater in the long run
because consumers have more time to adjust

Relation Between Price Elasticity of Demand and Total Revenue

The dividing line between relatively inelastic demand and relatively elastic demand
occurs when the number is equal to one (unit elastic demand). There is a reason for this.
The reason has to do with total revenue. Total revenue is the amount of money received
from selling the product. It is the product of price times quantity. (In the first graph, if
the price is $10 and the quantity demanded is 100, the total revenue is 10 times 100 or
$1,000.) If the price rises, what will happen to the total revenue? The answer depends on
the price elasticity of demand. If the demand is relatively inelastic, the number is less than
one. For this to occur, the percentage change in the quantity demanded must be less
than the percentage change in the price (review the formula). Since the price is rising
and the quantity demanded is falling, the fact that the percentage change in the quantity
demanded is less than the percentage change in the price means that total revenue must be
increasing. Using the numbers above, if the price rises to $11, the quantity demanded falls
only to 95, and the total revenue rises to $1,045 ($11 x 95). On the other hand, if the
demand is relatively elastic, the number must be greater than one. This means that the
percentage change in the quantity demanded must be greater than the percentage
change in the price (again, review the formula). Since the quantity demanded is falling
and the price is rising, the fact that the percentage change in the quantity demanded is
greater than the percentage change in the price means that the total revenue must fall.
Using the numbers above, if the price rises to $11, quantity demanded falls to 30. Total
revenue falls to $330 ($11 x 30). Finally, assume that the demand is unit elastic. Since the
number equals one, the percentage change in quantity demanded must be the same as
the percentage change in the price. The result is that, if the price rises, the total revenue
stays the same. (If the price rises to $11, quantity demanded falls to about 91. Total
revenue stays $1,000.)

In summary, if the price rises (falls), and demand is:

relatively inelastic, total revenue rises (falls).
relatively elastic, total revenue falls (rises).
unit elastic, total revenue stays the same.

Factors Affecting the Price Elasticity of Demand

These examples illustrate that it is important to know if the demand for your product is
relatively inelastic or relatively elastic. One can do detailed statistical studies. But these
are expensive to do and may not be totally accurate. However, if one knows that factors
that determine whether demand for a particular good is relatively inelastic or relatively
elastic, one can make a good guess as to what the true number is likely to be. There are
three such factors.

First, consider the demand for electricity? Is this demand likely to be relatively elastic
or relatively inelastic (that is, if the price of electricity rises by 10%, will the quantity
demanded fall very little or fall greatly)? Now consider the demand for baseball tickets. Is
this demand likely to be relatively elastic or relatively inelastic (that is, if the price of
baseball tickets rises by 10%, will the quantity demanded fall very little or fall greatly)?
Most likely you said that the demand for electricity is relatively inelastic and the demand
for baseball tickets is relatively elastic. (If you did not say this, go back and review the
definitions.) What accounts for the difference? The answer is substitutes available --- how
many substitutes are there and how close are they as substitutes? If the price of
electricity rises, what will buyers do? They can reduce their buying by turning off the
lights, closing the refrigerator door, insulating their homes, and so forth. But these options
are limited. There are simply not good substitutes for electricity. People will reduce their
buying very little, making the demand relatively inelastic. If the price of baseball tickets
rises, what will buyers do? They can reduce their buying greatly because there are many
substitutes for baseball tickets --- movies, beach, parks, camping, television, watching
baseball on TV, and so forth. Therefore, the demand for baseball tickets is relatively
elastic.
After substitutes, a second factor affecting the price elasticity of demand is time. By this
we mean the time to develop substitutes. Suppose that, in the last hour, the price of gasoline
rose to $5 per gallon. Your tank is almost empty. What will you do today? The answer is
that you will probably fill your tank, pay the higher price, and complain loudly. But as
time goes on, you will find ways to substitute. You will change your driving habits. You
will arrange car-pooling. You may even buy a bicycle for shorter trips. Given a long
enough time, you will buy a new car that gets much better gasoline mileage (perhaps a
hybrid).

A third of the factors affecting the price elasticity of demand is the price of the
product in relation to one's income. More loosely, we are asking how expensive the
product is. People will respond more to an increase in the price of an expensive product
than an inexpensive one. Assume that the price of a can of Pepsi Cola in the machine rises
by 8%. This would be a dime. For most people, a dime is not much money. If you want
the Cola, you will just pay the higher price. Quantity demanded will fall slightly. Now
assume that the price of an automobile rises by the same 8%. On an average car, this would
be over $1,600. For most people, this is expensive. People are more likely to considerably
reduce their buying of cars.
At low prices, the demand is likely to be relatively inelastic because the product is not
expensive. As the price rises, the demand will become more and more elastic.

Price

. Elastic Section
 . Inelastic Section

Demand
_______________________________
0 Quantity

The demand for a given product will be relatively more elastic (buyers will respond more
if the price rises) if:
(1) there are many good substitutes for the product, including doing without
(2) there is a longer time under consideration
(3) the price of the product is relatively high is relation to buyers' incomes.
The reverse would cause the demand to be relatively more inelastic.

V Change In Demand & Quantity Demanded

The Movement Along A Demand Curve: Change In Quantity Demanded

Whenever the price changes, a consumer will change its quantity demanded
accordingly. According to the law of demand, when the price rises, the quantity
demanded will fall. Such a change can be expressed by a movement along a demand
curve.
P

D For example, when price rises

from $10 to $15,
quantity demanded falls from 120 to 90, i.e.
from point E to E’ in the diagram.
A This movement shows the response of a
consumer or all consumers in a market to a
change in market price, ceteris paribus.
0 90 120 Q

The Shift Of A Demand Curve: Change In Demand

A change in demand refers to a change of the whole demand schedule, i.e. the quantity
demanded (Qd ) changes at EVERY price. The change may be an increase or decrease.

The example below gives a demand schedule and an increase in demand.

 A Demand Schedule

Price ($/unit) New Quantity Demanded

Original Quantity Demanded
30 200 400
20 400 600
15 600 800
12 800 1000
10 1000 1200
8 1200 1400

A Demand Curve

30

20

10

0 400 800 1200

The new demand curve is at the ________ of the original demand curve, showing an
increase in quantity demanded at all prices.

It is called a shift of a demand curve to the right or and increase in demand.

In case of a decrease in demand, the demand curve will shift to the _____________.

 It is very important to distinguish between a change in quantity demanded

(Qd) & a change in demand.
A change in quantity demanded (Qd) must be caused by a change in market
price. A change in demand is caused by some other factors other than a change
in price.
 Factors affecting a change in Demand : A Shift of
Demand Curve
1) Prices of Related Goods
When the price of a good (X) rises, it does not only affect its Qd, but also the Qd
of another related good (Y).If a rise in price of good X leads to a in demand of
good Y, these 2 goods are called substitutes in economics. (There involves a
movement along the demand curve of X and a shift of the demand curve of Y.)
If a rise in price of good X leads to a fall in demand of good Y, these 2 goods are
called complements or complementary goods. They are in joint demand.

2) Income
A rise in income leads to a higher purchasing power or ability to buy of the
consumers.( If nominal income and prices increase by the same percentage, the
real income is unchanged.) If a rise in income leads to a rise in demand of a
good by a consumer, the good is called a normal good or superior good.
If a rise in income leads to a fall in demand of a good, the good is called an
inferior good. “Inferior” does not refer to the quality of the good.

3) Taste
It refers to the subjective choice of consumers. It may be affected by our
knowledge, friends, education, culture and advertising.

4) Weather
We may demand different goods on different seasons or weather, e.g. umbrella,
heater and even food.

5) Expectations of Future Price

Consumers would change their demand if they expect the future price changes.

6) Derived Demand
An increase in demand (e.g. for more university seats) of a good or service may
also lead to a demand for another good or service (e.g. for more lecturers,
student hostels, and other facilities). The demand for these related services is a
derived demand from the university seats.

7) Size of Population
A larger population would mean more consumers. The market demand curve
would shift
to the right, i.e. an increase in quantity demand at all prices.