Definition of Demand

Demand is always related price and quantity. Demand for a commodity

with reference to a particular price and specific time period such as per
day, per week, per month or per year.
In short
Demand=desire + ability to pay money +will to spend.

Law of demand
Demand for a commodity is defined as the quantity of that commodity
which a consumer is willing and able to pay at a particular price during a
particular period of time. For example, a consumer demands 2 KG of Rice
in a month at the price of Rs. 20 per Kg. This is the complete example of
demand.
That is when the price rise, the quantity purchased decrees, and when the
price falls, the quantity of purchase increase. On the other hand, when a
consumer’s income rises, he or she usually purchases more of most goods.
(Shoes, movies travel, education, automobile, and so on). These are
known as normal goods.
There are two types of demand
1. Individual demand
2. Market demand
Individual Demand Schedule
Let us study it the help of an example.
Price per unit of commodity x (Px) Quantity demanded of commodity x
(Dy)
100 50
200 40
300 30
400 20
500 10
We can see that when the price of the commodity is ₹100, its demand is 50
units. Similarly, when its price is ₹500, its demand decreases to 10 units.
Thus, we can conclude that as the price falls the demand increases and as
the price raises the demand decreases. Hence, there exists an
inverse relationship between the price and quantity demanded.
Individual Demand Curve

It is a graphical representation of the individual demand schedule. The X-axis

represents the demand and Y-axis represents the price of a commodity.

When the price of gasoline is $3.5 per liter, its demand is 50 liters and when
the price is $0.5 per liter, its demand is250 liters.
Market Demand Schedule

Price per unit of Quantity Quantity Market

commodity X demanded by demanded by Demand QA + QB
consumer A (QA) consumer B (QB)

100 50 70 120

200 40 60 100

300 30 50 80

400 20 40 60

500 10 30 40
It is a summation of the individual demand schedules. Market demand is
more important from the business point of you sales depends on the
market demand business policies and planning.

Let us study it with the help of an example.

The above schedule shows the market demand for commodity X. When the
price of the commodity is ₹100, customer A demands 50 units while the
customer B demands 70 units. Thus, the market demand is 120 units.
Similarly, when its price is ₹500, Customer A demands 20 units while
customer B demands 30 units. Thus, its market demand decreases to 40
units. Thus, we can conclude that whether it is the individual demand or the
market demand, the law of demand governs both of them.

Assumptions of the law of demand

A. The income of the consumers no change.

B. No change in fashion.
C. No change in the price of the goods.
D. Commodity should be normal goods.
E. Tastes of the consumers remain the same.
F. No change in government policies.
G. No change in weather condition.

Types of elasticity of demand

1) Perfectly elastic demand
2) Perfectly inelastic demand
3) Relatively elastic demand
4) Unitary inelastic demand
5) Relatively inelastic demand
1. Perfectly Elastic Demand:

When a small change in price of a product causes a major change in its

demand, it is said to be perfectly elastic demand.

In perfectly elastic demand, the demand curve is represented as a

horizontal straight line, which is shown in Figure-2:

2. Perfectly Inelastic Demand:

A perfectly inelastic demand is one when there is no change produced in

the demand of a product with change in its price. The numerical value for
perfectly inelastic demand is zero (ep=0).
In case of perfectly inelastic demand, demand curve is represented as a
straight vertical line, which is shown in Figure-3:

It can be interpreted from Figure-3 that the movement in price from OP1
to OP2 and OP2 to OP3 does not show any change in the demand of a
product (OQ). The demand remains constant for any value of price. In case
of essential goods, such as salt, the demand does not change with change
in price.
3. Relatively Elastic Demand:

Relatively elastic demand refers to the demand when the proportionate

change produced in demand is greater than the proportionate change in
price of a product.

The demand curve of relatively elastic demand is gradually sloping, as

shown in Figure-4:

For example, the price of a particular brand of cold drink increases from
Rs. 15 to Rs. 20. In such a case, consumers may switch to another brand of
cold drink. However, some of the consumers still consume the same
brand.

4. Relatively Inelastic Demand:

If the price of a product increases by 30% and the demand for the product
decreases only by 10%, then the demand would be called relatively
inelastic.
Example
The demand schedule for milk is given in Table-

PRICE OF MILK {Per Lit} Quantity DEMAND

15 100
20 90
5. Unitary Elastic Demand
The proportion of change in demand is equal to proportion of change in
price.

Example:
The price of digital cameras increases by 10%, the quantity of digital
cameras demanded decreases by 10%.

Income elasticity of demand

Income elasticity of demand measures the relationship between a change
in quantity demanded for good X and a change in real income.
THE FORMULA FOR CALCULATING INCOME ELASTICITIY
% change in quantity demanded
% change in income

Importance of income elasticity

Luxury goods

Increase in income increases the demand for luxury goods in rich

countries. The percentage change in demand is greater than percentage
change in income.

Required of life

Increase in income increases demand for required of life in poor countries.

The percentage change in demand is greater than percentage change in
income.
Types of Income Elasticity of Demand:

1. Unitary income elasticity of demand {Ey = 1}

There is unity income elasticity of demand when percentage change in

demand is equal to the percentage change in price. The demand curve for
this income elasticity has upward slope.
The increase in quantity demanded is equal to increase in income. The
demand for commodity increases by 20% while increase in income is 20%.
The diagram shows that increase in demand is equal to increase in income.
It is a case of unitary income elasticity of demand or Ey = 1. It takes the
shape of 45 degrees.

2. Income elasticity of demand greater than unity {Em>1}

The income elasticity is greater than unity when percentage change in
demand is greater than percentage change in price. The income of a
consumer increases by 20% and demand for commodity increases by 40%.
The diagram shows that quantity demanded is more than rise in income of
consumer.
3. Income elasticity of demand less than unity{Em<1}
The income elasticity is less than unity when percentage change in
demand is less than percentage change in price. The income of consumer
increases by 20% the demand for commodity increases by 8%. The
diagram shows that increase in demand is less than increase in income.

4. Zero income elasticity of demand {Em=0}

His income of a consumer increases (say) 20% but there is no change in
demand for commodity. The demand curve for zero income elasticity is
vertical straight line. It is a case of zero income elasticity of demand or Ey =
0. The income elasticity of demand is zero (ey = 0) in case of essential
goods. For example, salt is demanded in same quantity by a high income
and a low income individual.
5. Negative Income elasticity of demand {Em<0}

There is negative income elasticity when increase in income brings

decrease in demand. The consumer can reduce his purchase of inferior
commodity when there is increase in income. The demand for commodity
decreases by 8% while there is increase in income by 20%. The diagram
shows that less is purchased at higher income. It is a case of negative
income elasticity of demand or Ey < 0

When income is Rs. 10, then the demand for goods is 4 units. On the other
hand, when the income increases to Rs. 20, then the demand is 2 units.

Classification of commodities

Normal goods

Income elasticity is positive for normal type of goods. When there is

increase in income there is increase in demand for these goods. In case of
decrease in income there is decrease in demand for these goods. The
examples of these goods are shampoo, soap, and toothpaste.

Inferior goods

When income elasticity is negative the commodity is inferior. The pulses

are inferior goods as compared to meat. Increase in income brings
decrease in demand for such goods.
Cheap goods

Income elasticity is zero for cheap or natural type of goods. Increase in

income does not affect the demand for goods like salt, newspapers,
matches, and postcards.

Luxury goods

When income elasticity is positive and greater than one the commodity is
luxury. The demand for cars, jewelry, and television is highly income
elastic.

Necessity goods

When income elasticity is positive and less than one the commodity is
necessity of life. The demand for food articles is income elastic

Cross price elasticity demand

Related goods are of two kinds, i.e. substitutes and complementary

goods. In case the two goods are substitutes for each other like tea and
coffee, the cross price elasticity will be positive, if the price of coffee
increases, the demand for tea increases. On the other hand, in case the
goods are complementary in nature like pen and ink, then the cross
elasticity will be negative; demand for ink will decrease if prices of pen
increase

Formula:-
Cross elasticity of demand can be calculated using the following formula:

% change in quantity demanded of

% change in price of product
Cross elasticity, substitutes, and complements
Cross elasticity of demand indicates any two products are substitutes or
complements.

Substitute goods

Since A, say Coke, and B, say Sprite, are substitutes, an increase in price of
product B means that more people will consume A instead of B, and this
will increase the quantity demanded of product A. Increase in quantity
demanded of product A relative to increase in price of product B gives us a
positive cross elasticity of demand.

Complimentary Goods

As A, say car, and B, say gas, are complimentary goods, and an increase in
price of B will reduce the quantity demanded of A. This is because people
consume both A and B as a bundle and an increase in price reduces their
purchasing power and decreases quantity demanded.

Example:-

The initial price and quantity of widgets demanded is (P1 = 12, Q1 = 8). The
subsequent price and quantity is (P2 = 9, Q2 = 10). This is all the
information needed to compute the price elasticity of demand.

The price elasticity of demand is defined as follows:

Percent change in quantity

=Q2−Q1/ (Q2+Q1) ÷2×100=10−8/ (10+8)÷2×100=2/9×100=22.2
And:
Percent change in price
=P2−P1/ (P2+P1) ÷2×100=9−12/ (9+12)÷2×100=−3/10.5×100= −28.6
Therefore:
Price Elasticity of Demand=22.2 percent/−28.6 percent= −0.77
Substitution Effect:

If the price of a good rises, consumers will buy less of that good and more
of others because it is now relatively more expensive than other goods. If
the price of good falls, consumers will buy more of that good and less of
others. These changes in quantity demanded due to the relative change in
prices are known as substitution effect of a price change
Normal Goods:

Normal good, also called necessary good, Normal goods are a type of
goods whose demand shows a direct relationship with a
consumer’s income. It means that the demand for normal goods increases
with the increase in the consumer’s income. A normal good is a product or
service whose quantity demanded increases as consumer income
increases.

Normal Goods

Examples of normal goods include food, clothing, and household

appliances. Meat, milk, eggs, rice, fruits, and vegetables. Normal goods are
demand of LCD and plasma television, demand for more expensive cars,
branded clothes, expensive houses etc… increases when the income of the
consumers increases.

Inferior Good

A classic example of inferior good is public transportation. When

consumer income is low, people use the bus. If the economy grows and
consumer income increases, people stop using the bus and buy cars
instead. It makes sense to use the bus when people cannot afford a taxi or
a car. But when they can afford a car, they stop using the bus.
Indifference Curve Analysis

It is a curve that represents all the combinations of goods that give the same
satisfaction to the consumer. Since all the combinations give the same
amount of satisfaction,
Consider again the situation of Sameer, who can buy Mangoes or Orange.
If Sameer likes Mangoes but hates Orange, he will spend all of his money
on Mangoes and nothing on orange. In other words, he will select bundle
P.
If Sameer likes oranges but hates Mangoes, he will spend all of his money
on orange and none on Mangoes.
Usually, consumers prefer a mix of both goods. Where they consume
depends on the strength of their preferences, measured by a concept
known as utility.

Table: Indifference schedule

Combination Mangoes Orange

A 1 14
B 2 9
C 3 6

D 4 4
E 5 2.5
Table: Indifference schedule
Combination Cigarette Coffee

A 1 12
B 2 8
C 3 5
D 4 3
E 5 2

The above table represents various combination of coffee and cigarette

that gives a man same level of utility. When the man drinks 12 cup of
coffee, he consumes 1 cigarette every day. When he started consuming
two cigarettes a day, his coffee consumption dropped to 8 cups a day. In
the same way, we can see other combinations as 3 cigarettes + 5 cup
coffee, 4 cigarettes + 3 cup coffee and 5 cigarettes + 2 cup coffee.

Assumptions of Indifference Curve

1. Only two goods are taken into the consideration.

2. The satisfaction level cannot be measured
3. It is assumed that the customer is not saturated with both the
commodities
Demand Forecasting
Demand forecasting is a combination of two words; the first one is Demand
and another forecasting. Demand means requirements of
a product or service. Forecasting means making estimation in the present for
a future occurring event.

Usefulness of Demand Forecasting

1. There is a need to take correct decision and make planning for future
events related to business like a sale, production, etc.
2. Demand is the most important aspect for business for achieving its
objectives.
3. Demand forecasting reduces risk related to business activities and helps
it to take efficient decisions.
Techniques of Demand Forecasting
Survey and Statistical Methods

Survey Method:

Survey method is one of the most common and direct methods of

forecasting demand in the short term. This method encompasses the
future purchase plans of consumers and their intentions.

Experts’ Opinion Poll:

A method in which experts are requested to provide their opinion about

the product. Group decision-making technique of forecasting demand. In
this method, questions are individually asked from a group of experts to
obtain their opinions on demand for products in future.

Market Experiment Method:

Involves collecting necessary information regarding the current and future

demand for a product.
Statistical Methods:

Statistical methods are complex set of methods of demand forecasting.

These methods are used to forecast demand in the long term. In this
method, demand is forecasted on the basis of historical data and cross-
sectional data.

Procedures

Determining the objectives

The first step in this regard is to consider the objectives of sales

forecasting carefully. The company has to decide the period of forecasting.
Whether it is a short-term forecast or long-term research.

Determining the Time Perspective

On the basis of the objective set, the demand forecast can either be for a
short-period, say for the next 2-3 year or a long period. While forecasting
demand for a short period (2-3 years),

Making a Choice of Method

Once the objective is set and the time perspective has been specified the
method for performing the forecast is selected. There are several methods
of demand forecasting falling under two categories; survey
methods and statistical methods.

Collection of Data

Once the method is decided upon, the next step is to collect the required
data either primary or secondary or both

Estimation and Interpretation of Results

Once the required data are collected and the demand forecasting method
is finalized, the final step is to estimate the demand for the predefined
years of the period.