Вы находитесь на странице: 1из 15

DEMAND ANALYSIS

INTRODUCTION

The analysis of demand focuses on the consumer’s (buyer’s) side of the market. It
seeks to explain what demand is and how it affects market price and quantity. The
modern theory of demand rests on the structure built by Alfred Marshall. In
economics the term demand is used in a particular sense. Demand is the amount of
some commodity or service which an individual is able and willing to purchase in a
given market, in a given period of time, at a given price. According to Stonier and
Hague, “demand in economics means demand backed up by enough money to pay
for the good demanded.” In the absence of purchasing power, demand is not
effective. Thus, demand in economics has the following essential elements:

 An Effective Need
 Price – The demand is always at a price.
 Time – Demand is always at a given point of time – demand per day, per
week, or per month etc.
 Market – Demand is always held in a market – market is a set of points of
contact between buyers and sellers of a product or service where they make
exchanges for a price.
 Amount – Demand is not an approximation, it is always a specific amount.

DEMAND FUNCTION

In a given market, in a given period of time, the demand function for a commodity
can be defined as the functional relationship between the amount demanded and its
determinants. Generally, the determinants of the demand for a commodity are the
following:

(i) The price of the commodity,

(ii) The price of related goods - substitutes or complements.

(iii) The income of the consumer,

(iv) Tastes and Preferences of the consumer,

(v) Expectations about future prices,


(vi) Other relevant factors like the population, income distribution, etc.

Symbolically, the demand function can be written as:

Dx = f (Px, Pr, Y, T, E, Z) where,

Px = price of commodity X

Pr = price of related goods – substitutes or complements.

Y = the income of the consumer.

T = the tastes and preferences of the consumer.

E = Expectations about future changes in price.

Z = Other relevant factors like the population, income distribution etc.

The price of the good is an obvious and important influence on purchases. Demand
for a commodity is a function of its own price, assuming other things remain the
same. At higher prices people will purchase less and vice versa. The income or the
purchasing power is another important influence on the quantity demanded.
Generally, as the income increases, people tend to buy many goods and services
since they can afford to buy more. Yet there are goods that people would buy less of
as their income rises. This happens in the case of inferior goods or low quality
goods.

Preferences determine the relative importance of other variables in determining how


much of each product will be bought at each price. Tastes and preferences are not
always easy to explain, but economists regard them as a crucial influence on
demand. The companies selling consumer goods also recognize the importance of
preferences; they spend lakhs of rupees a year on advertising in attempts to direct
consumer preferences towards their own products.

The quantity demanded is influenced by the price of related goods. It can be


substitutes or complements. A substitute is a good that can be used in the place of
another commodity. For example, tea and coffee are widely recognized as substitutes
for each other. If the price of coffee increases, consumers may substitute tea. Thus,
the amount of tea purchased will change because of the price change of coffee. In
contrast, goods that are complements are used together – example: cars and petrol.
As the price of petrol increases and people buy less of it, demand for cars tend to
diminish. People may depend on public transport system or may move closer to their
job sites.

Population will also affect the amount of a good purchased. More consumers means
that more of a good will be purchased, other things being equal. Patterns of
consumption will also be affected by income distribution in the economy.

All of these conditions can influence the quantity of each good that consumers will
purchase. The economist’s task is to disentangle all of these different factors. In
order to isolate the effect of just one of these factors, the economists assume Ceteris
Paribus – means all other factors are constant. The procedure is fairly simple. First,
hold all the influences constant at a given level and measure the quantity that the
consumers want to buy. Then allow one influence to vary, while still holding the
other influences constant. For example, hold all influences except price constant.
Since price is the only variable influence on demand, any changes in quantity must
be caused by the changes in price. Thus, it is possible to define and isolate the
specific relation between price and quantity. It is important to note that the other
factors are not ignored; their influence is simply held constant.

Assuming ceteris paribus, demand for a commodity is a function of its own price. It
can be written as:

Dx = f (Px), ceteris paribus.

Now it is possible to derive an important tool of economic analysis, the demand


curve.

Demand Schedule: A demand schedule is a list of prices and quantities. It states the
relation between the two variables, price and quantity demanded. A typical demand
schedule is illustrated in the following table.
Individual Demand Schedule for Oranges

Price per kg. Quantity of oranges


(in rupees) purchased
(in kgs.)
40 1
35 2
30 3
20 5

Demand curve: A demand curve is a graphical illustration of the demand schedule. It


relates the quantities of the good that consumers wish to buy to the price of the good.
A demand curve can represent the price-quantity relation either for an individual
consumer or for an entire market. The demand curve is illustrated below.

THE LAW OF DEMAND – The law states that the quantity demanded and price are
inversely related. At higher prices, people will want to buy less of a good; at lower
prices, they would be willing to buy more. The quantity of a product demanded
varies inversely with the price. Alfred Marshall defines the law of demand s follows:
“The greater the amount to be sold, the smaller must be the price at which it is
offered in order that it may find purchasers; or, in other words, the amount
demanded increases with a fall in price, and diminishes with arise in price.” Here it
is assumed that all the other influences on demand are constant.
The law of demand is a generalization to which there are some exceptions. In those
cases the law of demand does not hold good and the demand curve will not confirm
to the usual shape of downward sloping from left to right. They are called
exceptional demand curves or perverse demand curves.

1. Articles of prestige value or snob appeal are an exception to the law of


demand. These articles become more attractive when their prices go up. This
part of consumer behaviour was observed by Veblen in his doctrine of
Conspicuous Consumption and hence this effect is called Veblen Effect.

2. Speculative goods: In the speculative market, particularly in stocks and shares,


law of demand does not hold good.

3. Giffen Paradox: The low income groups tend to substitute inferior goods with
superior ones when their income increases. When the price of an inferior good
decreases, the real income (purchasing power) of the low income groups
increases. They may substitute the inferior good with a superior one. Thus, the
demand for inferior good decreases even after a reduction in the price. This
strange behaviour was discovered by Sir Robert Giffen and the phenomenon
is called Giffen’s Paradox.

4. Demand for absolute necessaries: The law of demand does not apply in the
case of necessaries of life. Irrespective of price changes, people have to
consume minimum quantities of necessary commodities. Example: common
salt.
Reasons for the downward slope of Demand Curve

There are two major reasons for the downward slope of the demand curve:

1. Substitution Effect. As the price of a commodity increases, the substitutes for


it (with their relatively lower prices) look more attractive. Consumers are
therefore likely to buy more of substitutes and less of the good whose price
has gone up.
2. Income Effect. As the price of a good increase, the consumers’ purchasing
power decreases. Consumers can afford to buy less of all goods, including the
one whose price has risen. If the price of razor blades increases, the income
effect will be insignificant. But for goods like housing that account for a large
percentage of people’s budgets, the income effect may be substantial.
3. Law of Diminishing Marginal Utility. According to law of DMU, as a
consumer consumes mare of a given commodity, the marginal utility of
additional units will diminish. Further, the price of a commodity that the
consumer is ready to pay will not be greater than the marginal utility of it.
Therefore, a consumer will buy more units of a commodity only if its price
goes down.
For these reasons, the inverse relation between price and quantity is sound.

Difference between ‘Change in Demand’ and ‘Change in Quantity Demanded’

According to Friedman, in the demand analysis, it is necessary to make a clear


distinction between change in quantity demanded and change in demand. Quantity
demanded refers to a specific price quantity combination – a particular point on a
demand schedule. The difference between quantity demanded and demand is crucial
in analyzing changes in a particular market. Since quantity demanded refers to a
particular point on a demand curve, a change in quantity demanded refers to a
movement along the demand curve from one price-quantity combination to another.
Along a given demand curve, the only change that can cause a change in quantity
demanded is a change in price.

A change in demand refers to a shift in the entire demand curve. Such a shift in
demand can be caused by a change in any influence on quantity except price. For
example, a change in preferences makes consumers dislike the commodity, and then
consumers would demand less of that commodity at every price. This shift in
demand will be represented by a leftward shift of the demand curve. The result of a
price change is a movement along the demand curve, not a shift in the entire
schedule. This distinction is crucial when we analyze changes in market with the
help of demand. The difference between change in demand and a change in quantity
demanded is illustrated in the following diagram.
ELASTICITY OF DEMAND

Under the demand function it is clear that demand for a commodity is a function of
its own price, the prices of related goods, the income of the consumer, the tastes and
preferences of the consumer, expectations about future prices, and other relevant
factors. A change in any of these independent variables will lead to a change in the
demand for the said commodity or the dependent variable. A change in price causes
changes in quantity demanded. But the law of demand does not tell about the
quantum of change. This is explained by the elasticity of demand. In other words,
the difference in consumer response in demand to changes in various influences is
expressed with the concept of elasticity of demand.

Any elasticity is simply a ratio between a cause and an effect, always in percentage
terms. The cause goes in the bottom half or denominator of the ratio, while the effect
is in the top half or numerator. In the modern analysis of consumer behaviour, the
following types of elasticities are considered important and their relative importance
may vary in different situations.

1. Price Elasticity of Demand


2. Income Elasticity of Demand
3. Cross Elasticity of Demand
4. Demand Elasticity of Substitution
5. Advertising Elasticity.

Price Elasticity of Demand

The degree to which quantity demanded responds to a change in price is known as


price elasticity of demand. It measures the relative responsiveness of quantity
demanded to a change in price. It is important to note that we are concerned with
proportionate change in price and quantity, and not with absolute changes. The
concept of elasticity of demand was mainly developed by Dr. Alfred Marshall.
According to him, “The elasticity (or responsiveness) of demand in a market is great
or small, according to the amount demanded increases much or little for a given fall
in price, and diminishes much or little for a given rise in price.” Thus, price elasticity
of demand may be defined as the ratio of the percentage change in quantity
demanded to percentage change in price.
Let Ed stand for price elasticity of demand. Then, mathematically, the formula for
calculating the price elasticity of demand can be written as:

Percentage change in quantity demanded

Ed = ------------------------------------------------------

Percentage change in price

∆Q

----- ×100

Q ∆Q / ∆P ∆Q P ∆Q P

= --------------- = ------ ----- = ------ × ---- or Ed = ------ . ---


-

∆P Q/ P Q ∆P ∆P Q

----- ×100

Note that since price and quantity are inversely related, price elasticity will always
be a negative number. However, the custom is to ignore the negative sign. Ed is also
called the coefficient of elasticity of demand. Based on the responsiveness of
demand to changes in price, it is possible to discuss price elasticity under five
categories:

1. Perfectly Elastic Demand: It refers to that situation where people are willing to
consume any amount from zero to infinity for a given price. Even a slight price
increase will cut their purchases to zero. The horizontal demand curve is perfectly
elastic and the numerical value of the coefficient Ed will be infinite. ( Ed = ∞ )
because ∆P = 0
2. Elastic Demand: It refers to that situation where the proportionate change in
quantity demanded is much greater than the proportionate change in price. The
numerical value of the coefficient Ed will be greater than one. ( Ed ›1 ) because
∆Q / Q › ∆P / P. For example, a 10% change in price leads to 20% change in
quantity demanded, then Ed = 2.

3. Unit Elasticity of Demand: If the percentage change in quantity demanded is


exactly equal to the percentage change in price, it is called unit elasticity of demand.
Here the numerical value of the coefficient Ed will be equal to unity. (Ed = 1)
because ∆Q /Q = ∆P/P

4. Inelastic Demand: When the relative change in quantity demanded is less than
relative change in price, the demand curve is said to be inelastic. The numerical
value of the coefficient Ed will be less than one. (Ed ‹ 1) because ∆Q / Q ‹ ∆P / P.
For example, a 10% change in price leads to only 5% change in quantity demanded,
then Ed = 0.5

5. Perfectly Inelastic Demand: It refers to that situation where quantity demanded is


independent of price changes. The vertical demand curve is perfectly inelastic. In
this case no price change is large enough to influence the quantity demanded. (Ed =
0) because ∆Q = 0

It should be noted that the two extremes of elasticity are only in theory and they are
unrealistic situations. Thus, a demand curve can be elastic, unitary elastic, or
inelastic.
Determinants of Price Elasticity of Demand

There are several factors determining the price elasticity of demand. Some of the
important factors are the following:

1. Degree of necessity – Certain elementary things are necessary for life, such as
food, water, clothing and shelter. The demand for necessities is inelastic,
while the demand for comforts and luxuries will be elastic. The more demand
for necessities, the harder it is to cut back on purchases when the price
increases. This would make the demand for necessities relatively inelastic.

2. Availability and closeness of substitutes – If a good has many close


substitutes, it is easy to reduce the purchases in response to a hike in prices.
This would make the demand for such goods relatively elastic.

3. Time – The demand for a commodity always exists in some period of time. As
price changes, consumers plan to adjust the quantity they purchase, but this
takes time. Plans must be changed; other purchases must be altered. The
longer the interval, the greater the changes can be. Therefore, demand over
longer time periods tends to be more elastic.

4. The percentage of income spent on a good – The proportion of consumer’s


income which is spent on the commodity is an important determinant of price
elasticity of demand. For instance, hostel fees or house rent probably account
for much of the student budget. If those fees or rentals increase, students may
be forced to buy less living space by sharing the room with more members.
This would tend to make the demand for that good more elastic. When the
proportion of income spent is very low, demand will tend to be inelastic.

5. Habit of the consumers – Some commodities are habit forming, e.g. tobacco
and alcohol. The demand for such goods tends to be inelastic.
Income Elasticity of Demand

The income elasticity of demand measures the responsiveness of quantity demanded


to changes in money income. It may be defined as the ratio of percentage change in
quantity demanded to percentage change in money income. The formula for income
elasticity is:

Percentage change in quantity demanded

Ey = ----------------------------------------------------

Percentage change in money income

∆Q / ∆Y ∆Q Y

= ----- ----- = ------ . -----

Q / Y ∆Y Q

Where Q = Commodity, Y = Money income, ∆ = Symbol for “a change in”

In the case of income elasticity, all influences on demand other than money income
are held constant. Unlike price elasticity where the relationship between price and
quantity demanded is always negative, income elasticity may have either a positive
or a negative relationship. Normally, income elasticity of demand for a commodity
is positive. If the quantity of a good purchased moves in the same direction as
income – increasing as income increases and decreasing as income decreases - then
income elasticity will be positive. Goods with positive income elasticity are called
normal goods. In the case of an inferior good, the demand varies inversely with
income, and as a result, the income elasticity of demand is negative. The five
possible income demand curves are shown in the following diagram.
(a) High Income elasticity of Demand – In this case change in income is
accompanied by relatively larger change in quantity demanded. (Ey › 1)

(b) Unitary Income elasticity of Demand – The proportionate change in quantity


is equal to proportionate change in money income. (Ey = 1). Here the value of
the coefficient Ey is equal to unity.

(c) Low Income elasticity – Here the relative change in quantity is less than
relative change in money income. (Ey ‹ 1)

(d) Zero Income elasticity – In this case the quantity demanded is constant
regardless of changes in money income. (Ey = 0)

(e) Negative Income elasticity – The value of the coefficient Ey is less than zero
or negative. In the case of an inferior good, the income elasticity of demand is
negative.
Cross Elasticity of Demand

Cross elasticity of demand measures how responsive one good’s quantity demanded
is to changes in the price of another good. A pair of goods may be related because
they are substitutes for each other (Tea & Coffee), or because they are used together
as complements (Pen & Ink). The formula for cross elasticity is:

Cross elasticity of demand for Good A

Percentage change in quantity of Good A

= -----------------------------------------------------

Percentage change in price of Good B

% ∆ QA

= ------------------ Where QA = Quantity demanded for


Good A

% ∆ PB PB = Price of Good B

First, consider two goods that are substitutes, such as Maruti and Hyundai cars. If
the price of Hyundai raises, other things remaining the same, some people who
would have bought Hyundai will now buy Maruti. Thus, an increase in the price of
Hyundai would cause an increase in the quantity of Maruti cars purchased. With the
price of Hyundai and the quantity purchased of Maruti changing in the same
direction (both increasing), the cross elasticity will be positive. A positive cross
elasticity indicates that two goods are substitutes. The higher the value of cross
elasticity, the closer will be the degree of substitution.
For two goods that are complements, such as automobiles and fuel, the cross
elasticity will be negative. If the price of fuel increases, people will purchase both
less fuel and less number of automobiles used with fuel. Since the increase in the
price of fuel causes a decrease in the quantity of automobiles purchased, the cross
elasticity will be negative.

Sometimes it is possible that the two goods are neither substitutes nor complements,
i.e., they are unrelated or independent goods. In such a situation the cross elasticity
of demand for the independent goods will be zero.

The above three situations of cross elasticity of demand can be illustrated


diagrammatically.
Significance of the concept of Elasticity of Demand

The theory of elasticity of demand plays an important role in the solution of


economic problems and the determination of various economic policies. The
following points highlight the importance of the concept of elasticity of demand.

1. Determination of Price by business firms or Government.


2. Determination of the prices of public utilities.
3. Determination of various government policies like subsidy, taxation etc.
4. Decision making regarding international trade policies, terms of trade, tariff
policy etc.
5. Decision regarding Devaluation of Currency.
6. Determination of rate of exchange.

Вам также может понравиться