Analysis of Demand & Supply

Concept of demand/ factors/ elasticity/ durables & non-durables/ short run and long run demand/ autonomous demand/ demand for firm and industry/ Supply/ Law of Supply/ factors/ shortage/ Surplus/ Market equilibrium

Theory of Demand
Desire/ need Vs. Demand Simultaneous existence of:
Willingness to buy Ability to Pay

Factors on which the quantity demanded depends:

Own price, prices of substitutes/compliments, Income of consumer, population and its composition, tastes and preferences, Advertisement expenses of the firm/ its rivals, seasons, fashions etc. (quality/ advt/ promotions, etc)

Law of Demand
Law of Demand: Other things remaining same, a rise in price of a commodity generally leads to a fall in its quantity demanded and vice versa. Reasons:
Income Effect Substitution Effect New buyers Multiple uses by old buyers
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Types of Demand
Price Demand; Cross Price Demand; Income Demand

Meaning of these three types of demand

Variation in Demand and Shift in Demand (fig. follows)

Demand Curve and Demand Schedule (next slide)

Potential Vs. Actual Demand (eg:)

Individual Demand and Market Demand (eg:)

Types of Goods
Durable Vs Non-durable or single-use Durable goods yield services to their owners over a number of future time periods. Obsolescence in style, convenience, and prestige value are likely to play a greater role on durable good demand than physical deterioration Eg: PC, Cars/ Motorbikes/ Handset of mobile phones/ Wrist watches Concept of reserve price exists for durable good but not for perishable commodity
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Variation and shift in demand

Any change in demand due to the own price alone, as reflected by a movement along the same demand curve is called variation of demand. It could be extension or contraction. Factors other than own price (like income/ fashion/ season, etc) cause the demand curve to shift to the right or left. It is called increase/ decrease in demand.
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Market demand for Mangoes (monthly)

E
100

Point A

Market demand Price (Rs. per kg) (tonnes 000s) 20 40 60 80 100 700 500 350 200 100

D
Price (Rs. per kg)
80

C
60

B C D E B

40

20

Demand
0 0 100 200 300 400 500 600 700 800
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Quantity (tonnes: 000s)

An increase in demand

P Price

D1
D0
O Q0 Q1 Quantity

Law of DD using ICs

Law of Demand deals with inverse relationship between Price and Quantity Price Effect=Income +Substitution effect Diagrammatic representation of Price effect with the use of IC Income and Substitution Effects for normal, superior and inferior goods/ Giffen goods

Exceptions
Panic buying (Eg: Gold) Commodity conferring distinction Sheer ignorance makes to buy more at higher prices If necessitys price goes up, consumer readjusts his expenditure in its favour Changes in tastes/ fashion Giffens Paradox
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Consumption Curves
Price Consumption Curve (PCC)
Meaning and graph

Income Consumption Curve (ICC)

Meaning and graph

ICC for Normal goods

Graph

ICC for One Normal goods & the other Inferior Good
Graph
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Consumption Curves
Price Consumption Curve (PCC)
Meaning and graph

Income Consumption Curve (ICC)

Meaning and graph

ICC for Normal goods

Graph

ICC for One Normal goods & the other Inferior Good
Graph
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The Price-consumption Curve

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Deriving the demand curve

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Income-consumption curve

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The Engel Curve

A curve that shows the quantity demanded for different levels of income. Similar to a demand curve (which relates quantity to price). Named after Ernst Engel, a German statistician & economist (1821-1896). The Engel Curve is derived using the incomeconsumption curve.

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Deriving the Engel Curve

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Deriving the Engel Curve

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Elasticity of Demand
Elasticity refers to the degree of responsiveness of quantity demanded due to a given change in price/ other prices/ income of consumers. A given percentage change in price of two commodities may not result in an equal change in their quantity demanded. (eg) The reason for it is varying sensitiveness of the demand to price change. We can precisely measure such responsiveness in quantity with the help of a simple ratio.
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Elasticitycontd.
Types of Elasticity of Demand
Price, Income and Cross Price elasticity

Price elasticity of demand refers to the proportionate change in Qd to a given proportionate change in Price, ceteris paribus. Generally, it has a negative value. Different values of Price elasticity:
Perfectly elastic (infinity) Perfectly inelastic (zero)
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Price Elasticity: Types..contd

Relatively Elastic (between 1 and infinity) Relatively inelastic (between zero and 1) Unitary elastic (Equal to 1) Examples and implications The Outlay Method For same demand curve, price elasticity varies from point to point Graphical representation of types of price elasticity of demand
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Cross Elasticity
Quantity demanded of some goods is affected not merely due to its own price change, but due to price change of other related goods. Cross elasticity of demand refers to proportionate change in quantity demanded of one good (X) for a given proportionate change in price of a related good (Y), ceteris paribus.
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Elasticitycontd
Value of cross elasticity would be Positive for substitutes, while Negative for compliments. (Eg:------) Income elasticity refers to percentage change in quantity demanded of a good to a given percentage change in income of the consumer, ceteris paribus. Generally, income elasticity would be positive for Normal/ Superior goods; while negative for inferior and Giffen goods. (eg:-------)
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Point and Arc Elasticity

In each of the variables, namely price, income and cross price; there are two ways of estimating the elasticity of demand, viz. Point and Arc elasticity. While point elasticity gives idea about responsiveness of demand due to the change in one of the variable at the GIVEN point, Arc elasticity gives the average elasticity over a given RANGE along a demand curve.
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Firm and Industry

Industry as a whole might be having high demand; but a given firm can face shortage of demand Quality/ brand/ price/ marketing methods/ incentives/ etc. may cause the discrepancy Examples where a select few firms may have high demand but industry as a whole may be languishing CMIE/ CRISINFAC/ Share prices of one sector vis--vis Index movements give us an idea about it.

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Applications of DD & elasticity

Demand is the major factor that determines price in a market. It also decides fortunes of producers, workers, governments for taxes etc. In short/ medium run, it is the major factor affecting price. Monopolist Taxation Fruits/ Perishable products during bumper crops Recessionary conditions Vs consumer demand (sensitive to incomes) International trade
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Supply-Meaning
Supply refers to quantity of output offered for sale at a given price during a given market and at a given period of time. Generally, firms would be prepared to supply more as price goes up. Reason being, increase in average cost will be less than increase in price, hence each extra unit supplied gives additional profit.
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Supply curve
The supply curve shows the relationship between the price and the quantity that producers are willing to sell in a given time period, other things remaining the same. Quantity supplied refers to the amount sellers plan to offer for sale, not the quantity they actually sell. The supply curve is drawn with quantity on the horizontal axis and price on the vertical. The supply curve slopes up and to the right.
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A Typical Supply Curve

Price

Quantity
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The Law of Supply

The law of supply: the higher the price, the larger the quantity supplied (the more producers want to sell) in a given time period, other things remaining equal. Higher prices make it profitable to produce units with higher opportunity costs that were not profitable to produce when prices were lower.
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Other factors--supply side

The supply curve shows producer reactions to changes in the price of the good itself so long as nothing else is changing. A change in one of the following will shift the supply curve: Costs of inputs used to produce the product; taxes Technology Weather The number of producers The price of alternatives in production Producer expectations about future prices.

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Supply Curve and Time Period

Shape of typical Supply curve will be Vertical during very short period Steep curve during short period Flat/ horizontal/ downward sloping in the long run. Examples:
Market period supply curve Short period supply curve Long period supply curve
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Market Equilibrium
An equilibrium is a position of rest; there are no forces leading to a change. The equilibrium price is that at which quantity supplied equals quantity demanded No unsatisfied buyers pushing prices up to get the good No unsatisfied sellers cutting prices to sell The equilibrium is shown graphically by the point at which the supply and demand curves intersect.
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Shortage vs. Surplus

A shortage exists at a market price when the quantity demanded exceeds the quantity supplied. (i.e., excess demand)
A surplus exists at a market price when the quantity supplied exceeds the quantity demanded. (i.e., excess supply)

Increase in Demand
Winter Blizzard! The price of rock salt skyrockets to $17/bag. Initial equilibrium price was $2.79/bag. With the forecast of a blizzard, consumers expect a lack of future availability for rock salt. Result = an increase in the demand for rock salt creating a shortage. Market cure = a higher equilibrium price - $17/bag

P S 17 2.7 9
Shortage D1

D q q
1

Decrease in Demand
Recession caused a decrease in the demand for cars (a normal good) Manufacturers discounted sticker prices and offered a zero interest rate, along with other incentives. When the demand fell there was a surplus of cars at the original price. Market cure = lower the equilibrium price; resulting in fewer cars being purchased and sold. Q

P Surplus S

18,0 00
p
1

D
D1 q
1

Remember!
When demand increases, equilibrium price and quantity both increase.

&

When demand decreases, equilibrium price and quantity both decrease.

&

Increase in Supply
Advancement in computer technology and production methods Increased the supply of laptop computers = surplus of laptops Market cure allow the price to fall = more demand.
D
q
q1

P
4000 p1

Surplus

S
1

Decrease in Supply
Geopolitical conflict in the Middle East usually shows the production of crude oil. A decrease in the global supply of oil = a shortage of crude oil in the global market Result = higher prices

P
p1

S
S1

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Shortage

D
q1

Remember!
When supply increases, equilibrium price decreases and quantity increases.

&Q

When supply decreases, equilibrium price increases and quantity decreases.

&Q

Making predictions
Usually only one curve shifts. In these cases, you can predict the direction of change of both price and quantity. Sometimes both curves shift due to independent and simultaneous change in 2 determinants. (coincidence happens) In these cases, you can predict the direction of change in price OR quantity but NOT both.
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Pricing Strategies
In the competitive market conditions, strategies and tactics of pricing are followed on the basis of observed elasticity of demand of a firms product vis--vis the closest rivals demand. To achieve the original demand back, a firm makes use of arc elasticity formula, if elasticity and price-quantity information is available.
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Summary
Demand means desire and ability to pay Potential demand enable advance action Demand is a complex variable and is influenced by several factors-economic & Non-economic Concept of elasticity is useful to measure degree of responsiveness of Qd Demand and supply together determine market equilibrium For pricing strategies, the firms need to clearly understand DD, and apply the elasticity to know impact of its own and rivals decisions.
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