B.

Com
I Semester
Business ECONOMICS
Unit-III
Theory of Demand

Prof. Shivakumar Prabhayyanavaramath,

Assistant Professor,
SJMVS Arts and Commerce College for Women,
J.C. Nagar, Hubballi, Karnataka.
 Unit 3: Theory of demand
 Meaning,
 Law of Demand,
 Individual and Market Demand Schedule,
 Exceptions,
 Increase and Decrease in Demand, Extension and
Contraction of Demand,
 Elasticity of Demand:
 Meaning and Types,
 Demand Forecasting:
 Meaning and Trend Projection Method.
MEANING OF DEMAND
The demand refers to the amount of which will be bought per unit of time at a
particular price.

Demand is the amount of a particular economic good or service that a consumer or

group of consumers will want to purchase at a given price.

Demand = Desire + Ability to pay + Willingness to pay.

The demand curve is usually downward sloping, since consumers will want to buy
more as price decreases.

Demand for a good or service is determined by many different factors other than
price, such as the price of substitute goods and complementary goods.

In extreme cases, demand may be completely unrelated to price, or nearly infinite at

a given price.

Along with supply, demand is one of the two key determinants of the market price.
 DEMAND ANALYSIS
Demand analysis is a foundation topic in managerial economics.

It seeks to search out and measures the determinants of demand, thus, forces governing sales
of a product.

Demand analysis serves the following managerial purposes.

i. It is an important technique for sales forecasting with a sound base and greater accuracy.
ii. It provides a guideline for demand manipulation through advertising and sales promotion
programmes.
iii. It shows direction to product planning and product improvement.
iv. It is useful in determining the sales quotas and appraisal of performance of the personnel in
sales department.
v. It is an anchor for the pricing policy.
vi. It indicates the size of the market for given product and the market share of the concerned
firm.
vii. It reflects the scope of business expansion and competitive position of the firm in market
trend.
viii.Demand analysis is essential for successful production planning and business expansion in
managerial decision making.
Law of Demand:
• According to Prof. Samuelson:
“The law of demand states that people will buy more at lower prices
and buy less at higher prices, other things remaining the same”.

• E. Miller writes:
• “Other things remaining the same, the quantity demanded of a
commodity will be smaller at higher market prices and larger at lower
market prices”.

• “Other things remaining the same, the quantity demanded increases

with every fall in the price and decreases with every rise in the price”.

• In simple we can say that when the price of a commodity rises, people
buy less of that commodity and when the price falls, people buy more
of it ceteris paribus (other things remaining the same).
Explanation of the Law:
• The relationship between price of a commodity and its demand depends upon many
factors. The most important factor is nature of commodity.

• The demand schedule shows response of quantity demanded to change in price of that
commodity. This is the table that shows prices per unit of commodity ands amount
demanded per period of time.

• The demand of one person is called individual demand. The demand of many persons is
known as market demand.

• The experts are concerned with market demand schedule. The market demand schedule
means 'quantities of given commodity which all consumers want to buy at all possible
prices at a given moment of time'.

• The demand schedules of all individuals can be added up to find out market demand
schedule.
Demand Schedule
Diagram
Individual Demand Schedule
• An individual demand schedule is a tabular representation of the list of
quantities of a commodity demanded by an individual at different price levels,
during a certain period of time.
• For Example, Given are the price per kg of oranges and the quantity demanded
by a consumer.
Individual Demand Curve
• An individual demand curve represents the quantity demanded by the individual
household at various prices. We can also say that it is the graphical representation of the
individual demand schedule. It can be constructed by observing consumer behaviour when
there is a change in price.
• For Example: Considering the above example, the curve will be drawn as follows:
Mathematically, individual demand function
can be expressed as,

Dx= f (Px, Pr, Y, T, F)

Where,
Dx= Demand for commodity
Px= Price of the given commodity
Pr= Price of related goods;
Y= Income of the individual consumer;
T= Tastes and preferences;
F= Expectation of change in price in the
future.
Market Demand

• Market Demand refers to the sum total of the individual

demands of all the consumers for a commodity in a market
over a period of time, at given prices, other factors being
constant.
Market Demand Schedule
• A market demand schedule is a tabular representation indicating how much quantity of
a commodity the consumers are willing and able to buy in a market at different prices,
during a specified period of time. Basically, it is a sum of the individual demand schedules,
indicating the preference scale of different consumers taken together, at different price
levels.
• For Example: Given are the price per kg of sugar and the quantity demanded by all four
consumers in the market – A, B, C and D.
Market Demand Curve
• The market demand curve graphically indicates the horizontal sum of the individual
demand curves. With the help of market demand, the firm can understand the entire market
and not just individual customers.
• For Example: Considering the above example, the curve will be plotted as under:
 Mathematically, market demand function can be expressed as,

• Dx= f (Px, Pr, Y, T, F, Po, S, D)

• Where, Dx= Demand for commodity
• x; Px= Price of the given commodity
• x; Pr= Price of related goods;
• Y= Income of the individual consumer;
• T= Tastes and preferences;
• F= Expectation of change in price in the future;
• Po= Size and composition of population;
• S= Season and weather;
• D= Distribution of income.
Expansion and Contraction of Demand
and
Shift in Demand
 Expansion and Contraction of Demand

• Expansion and Contraction of Demand means changes in quantity

demanded or movement along a demand curve.
• Thus, expansion and contraction of demand means changes in
quantity demanded due to change in the price of the commodity
other determinants like income, tastes, etc. remaining constant or
unchanged.
 When price of a commodity falls, its quantity demanded rises.
This is called expansion of demand.
 When price of a commodity rises, its quantity demanded falls.
This is called contraction of demand.
 Increase and Decrease in Demand
(Shift in Demand)

• Shift in demand means changes in quantity demanded or shift in demand

curve.
• Thus, Shift in demand means changes in quantity demanded due to change in
other determinants like income, tastes, etc. remaining constant or unchanged.
 The consumer will move upwards or downwards.
 Increases in demand are shown by a shift to the right in the demand curve. This
could be caused by a number of factors, including a rise in income, a rise in the
price of a substitute or a fall in the price of a complement.
 Conversely, demand can decrease and cause a shift to the left of the demand
curve for a number of reasons, including a fall in income, assuming a good is a
normal good, a fall in the price of a substitute and a rise in the price of a
complement.
 Exceptional Demand Curve:
Sometimes the demand curve slopes upwards from left to right. In
this case the demand curve has a positive slope.

The reasons for exceptional demand curve are as follows.

• 1. Giffen Paradox:
• 2. Veblen or Demonstration effect:
• 3. Ignorance:
• 4. Speculative effect:
• 5. Fear of shortage:
• 6. Necessaries:
1. Giffen Paradox:
• The Giffen good or inferior good is an exception to the law of demand.

• When the price of an inferior good falls, the poor will buy less and vice versa.

• For example, when the price of maize falls, the poor are willing to spend more
on superior goods than on maize.

• if the price of maize increases, he has to increase the quantity of money spent
on it. Otherwise he will have to face starvation.

• Thus a fall in price is followed by reduction in quantity demanded and vice

versa.

• Sir Robert Giffen, Scottish Economist, first explained this and therefore it is
called as Giffen‟s paradox.

• Note: Giffen Paradox is relatively rare and has limited real world
applications.
2. Veblen or Demonstration effect:

• Vebeln Effect named after American economist Thorstein Veblen.

• „Veblan‟ has explained the exceptional demand curve through his

doctrine of conspicuous consumption.

• Rich people buy certain good because it gives social distinction or

prestige for example diamonds are bought by the richer class for
the prestige it possess.

• Therefore, rich people may stop buying this commodity.

3. Ignorance:

• Sometimes, the quality of the commodity is judge by its

price.
• Consumers think that the product is superior if the price
is high. As such they buy more at a higher price.
4. Speculative effect:

• If the price of the commodity is increasing the

consumers will buy more of it because of the fear that it
increase still further, thus, an increase in price may not be
accomplished by a decrease in demand.
5. Fear of Shortage:

• During the times of emergency of war people may

expect shortage of a commodity. At that time, they may
buy more at a higher price to keep stocks for the future.
6. Necessaries:

• In the case of necessaries like rice, vegetables etc. people

buy more even at a higher price.
 DETERMINANTS OF DEMAND
The several factors influencing individual and market
demand for different goods and services are as follows:
A. Determinants of Individual Demand
B. Determinants of Market Demand
A) Determinants of
Individual Demand
1. Price:
• Price is the basic factor.
• A consumer usually decides to buy with
consideration of price.
• More quantity is demanded at low prices and less is
purchased at high prices.
2. Income:
• A buyer‟s income determines his/her purchasing
capacity.
• Income is, therefore, an important determinant of
demand.
• The increase in income one can buy more goods.
• Rich consumers usually demand more and more goods
than poor customers.
• Demand for luxuries and expensive goods are related to
income.
3. Tastes, Habits and Preferences:
• Demand for many goods depends on the person‟s
tastes, habits and preferences.
• Demand for several products like ice-cream,
chocolates, beverages and so on depends on
individual‟s tastes.
• Demand for tea, betel, cigarettes, tobacco, etc. is a
matter of habits.
4. Different Preferences for Different Goods:

• A strict vegetarian will have no demand for meat at

any price, whereas a non-vegetarian who has liking
for chicken may demand it even at a high price.
• Similar is the case with demand for cigarettes by
non-smokers and smokers.
5. Relative Prices of Substitute and Complementary
Products:

• How much consumer would like to buy of a given

commodity, however, also depends on the relative
prices of other related goods such as substitute or
complementary goods to a commodity.
6. Consumer’s Expectation:
• A consumer‟s expectation about the future changes
in the prices of a given commodity also may affect
its demand.
• When he expects its prices to fall in future, he will
tend to buy less at the present prevailing low price.
Similarly, if he expects its price to rise in future, he
will tend to buy more at present.
7. Advertisement Effect:
• In modern times, the preferences of a consumer can
be altered by advertisement and sales propaganda.
• In fact, demand for many products like toothpaste,
soaps, washing powder, processed foods, etc., is
partially caused by the advertisement effect in a
modern life.
B). Determinants of
Market Demand
 1. Scale of Preferences:
• The market demand for a product is greatly
influenced by the scale of preferences of the buyers
in general.

• For example, when a large section of population

shifts its preferences from vegetarian foods to non-
vegetarian food, the demand for the former will tend
to decrease and that for the latter will increase.
 2. Distribution of Income and Wealth in the
Community:

• If there is equal distribution of income and wealth,

the market demand for many products of common
consumption tends to be greater than in the case of
unequal distribution.
3. Price of the Product:

• At a low market price, market demand for the

product tends to be high and vice versa.
4. General Standard of Living and Spending Habits of
the People:

• When people in general adopt a high standard of

living and are ready to spend more, demand for
many comforts and luxury items will tend to be
higher than otherwise.
5. Number of Buyers in the Market and the Growth of
Population:

• The size of market demand for a product obviously

depends on the number of buyers in the market.

• A large number of buyers will usually constitute a large

demand and vice versa.

• As growth of population over a period of time tends to

imply a rising demand for essential goods and services in
general.
6. Age Structure and Sex Ratio:

• Age structure of population determines market demand for many

products in a relative sense.

• If the population pyramid of a country is broad based with a large

proportion of juvenile population, then the market demand for
goods and services required by children will be much higher than
the market demand for goods needed by the elderly people.

• Similarly, sex-ratio has its impact on demand for many goods.

7. Future Expectations:
• If buyers in general expect that prices of a
commodity will rise in future, then present market
demand would be more as most of them would like
to hoard the commodity.

• The reverse happens if a fall in the future prices are

expected.
8. Level of Taxation and Tax Structure:
• A progressively high tax rate would generally mean a
low demand for goods in general and vice versa.

• But, a highly taxed commodity will have a relatively

lower demand than an untaxed commodity.
9. Inventions and Innovations:
• Introduction of new goods or substitutes as
a result of inventions and innovations in a
dynamic modern economy tends to
adversely affect the demand for the
existing products, which as a result of
innovations, definitely become obsolete.
10. Fashions:
• Market demand for many products is affected by
changing fashions.
• For example, demand for commodities like jeans,
salwar-kameej, etc., is based on current fashions.
11. Climate Conditions:
• Demand for certain products is determined by
climatic or weather conditions.
• For example, in summer, there is a greater demand
for cold drinks, fans, coolers, etc. Similarly, demand
for umbrellas and rain coats are seasonal.
12. Culture:
• Demand for certain goods is determined by social
customs, festivals, etc.
• For example, during Dipawali days, there is a
greater demand for sweets and crackers, and

during Christmas, cakes are more in demand.

ELASTICITY OF
DEMAND
Introduction:
• Elasticity of demand explains the relationship between a change in price and consequent
change in amount demanded.
• “Marshall” introduced the concept of elasticity of demand. Elasticity of demand shows
the extent of change in quantity demanded to a change in price.
• In the words of “Marshall”,
• “The elasticity of demand in a market is great or small according as the amount
demanded increases much or little for a given fall in the price and diminishes much or
little for a given rise in Price”
• Elastic Demand:
• A small change in price may lead to a great change in quantity demanded. In this case,
demand is elastic.
• In-elastic Demand:
• If a big change in price is followed by a small change in demanded then the demand in
“inelastic”.
 Types of Elasticity of Demand:
• There are three types of elasticity of demand:
• 1. Price Elasticity of Demand
• 2. Income Elasticity of Demand
• 3. Cross Elasticity of Demand
 1. Price Elasticity of Demand:
 Price elasticity of demand is the measure of a change in the
quantity demanded of a product due to change in the price of the
product in the market.
 In other words, Price elasticity of demand can be defined as the
ratio of the percentage change in quantity demanded to the
percentage change in price.
 Marshall was the first economist to define price elasticity of
demand.
 Price elasticity of demand measures changes in quantity demand
to a change in Price.
 1. Price Elasticity of Demand:
 Price Elasticity of Demand Formula can be mathematically expressed as:
Proportionate change in the quantity demand of commodity
• Price elasticity (ep) = ------------------------------------------------------------------------
Proportionate change in the price of commodity

• Thus, the formula for calculating the price elasticity of demand is as

follows:

ep = Price elasticity of demand

P = Initial price
ΔP = Change in price
Q = Initial quantity demanded
ΔQ = Change in quantity demanded
 Price Elasticity of Demand Example
• Assume that a business firm sells a product at the price
of 450.
• The firm has decided to reduce the price of the product
to 350. Consequently, the demand for the product is
raised from 25,000 units to 35,000 units.
Price Elasticity of Demand is Calculated as follows:

P = 450
• ΔP = 100 (a fall in price; 450 – 350 = 100)
Q = 25,000 units
ΔQ = 10,000 (35,000 – 25,000)

Δ𝑄 𝑃 10,000 450 45 9
• 𝑋 = 𝑋 = = =1.8
ΔP 𝑄 100 25,000 25 5

• Substituting these values in the above

formula, ep = 1.8
There are Five Cases of Price Elasticity of Demand
 A. Perfectly Elastic Demand:
• When small change in price leads to an infinitely large change is quantity
demand, it is called perfectly or infinitely elastic demand. In this case E=∞

• The demand curve DD1 is horizontal straight line. It shows the at “OP” price
any amount is demand and if price increases, the consumer will not purchase
the commodity.
 B. Perfectly Inelastic Demand
• In this case, even a large change in price fails to bring about a
change in quantity demanded. When price increases from „OP‟ to
„OP‟, the quantity demanded remains the same. In other words the
response of demand to a change in Price is nil. In this case „E‟=0.
 C. Relatively Elastic demand:
• Demand changes more than proportionately to a change in price.
i.e. a small change in price loads to a very big change in the quantity
demanded. In this case E > 1.
• This demand curve will be flatter.

When price falls from „OP‟ to „OP‟, amount demanded increase from
“OQ‟ to “OQ1‟ which is larger than the change in price.
 D. Relatively In-elastic Demand.
• Quantity demanded changes less than proportional to a change in
price. A large change in price leads to small change in amount
demanded. Here E < 1.
• Demanded carve will be steeper.

When price falls from “OP‟ to „OP1

amount demanded increases from OQ to
OQ1, which is smaller than the change in
price.
 E. Unit Elasticity of Demand:
• The change in demand is exactly equal to the change in
price. When both are equal E=1 and elasticity if said to be
unitary.
When price falls from „OP‟ to „OP1‟
quantity demanded increases from
„OP‟ to „OP1‟, quantity demanded
increases from „OQ‟ to „OQ1‟. Thus a
change in price has resulted in an equal
change in quantity demanded so price
elasticity of demand is equal to unity.
Measurement of Price Elasticity of Demand
• An organisation needs to estimate the numerical value of change in
demand with respect to change in the given price for making various
business decisions. The numerical value of elasticity of demand can only
be estimated by its measurement.
• Organisations use various methods for measuring price elasticity of
demand.
• Commonly used methods of measuring price elasticity of demand:
1. Total Outlay Method
2. Percentage Method
3. Point Elasticity Method
a. Linear Demand Curve
b. Non Linear Demand Curve
4. Arc Elasticity Method
 1. Total Outlay Method
• Price elasticity of a product is measured on the basis of the total amount
of money spent (total expenditure) by consumers on the consumption of
that product.
• Using this method, price elasticity is determined by comparing
consumers‟ expenditure or outlay before the change in the price with
that of after change in the price.
• In the total outlay method, three cases are considered, which are:
 If the total outlay remains unchanged after there is a change in the price
of the good, the price elasticity equals one (ep = 1).
 When a fall in the price of the good results in a small increase in the
quantity demanded leading to a decline in total outlay, the elasticity of
demand is less than one (ep < 1).
 When a fall in the price of the good brings a large increase in the
quantity demanded resulting in the rise of total expenditure, elasticity of
demand is greater than one (ep >1).
Total Outlay Method Example-1
• The quantity demanded for notebooks at the original price and changed price are given
as follows:
Price 15 9 15 9 15 9

Quantity Demanded 30 50 20 25 40 70

• Calculate the price elasticity using the total outlay method.

• Solution: Table shows the calculation of price elasticity of demand using the total outlay method:
Original New Original New
Original New Price Elasticity of Demand
Price Price Quantity Quantity

Here, outlay is equal in both cases;

15 9 30 50 450 450 therefore, ep = 1

Here, a change in outlay is less than the

15 9 20 25 300 225 original outlay; therefore, ep < 1

Here, a change in outlay is greater than

15 9 40 70 600 630 the original outlay; therefore,
ep > 1
 2. Percentage Method
• Percentage method is also known as the ratio method.
Using this method, a ratio of proportionate change in
quantity demanded to the price of the product is
calculated to determine the price elasticity.
𝑸𝟐−𝑸𝟏 𝑷𝟐−𝑷𝟏
• 𝐞𝐩 = 𝑸𝟏 ÷ 𝑷𝟏

• Where,
• Q1 = Original quantity demanded
Q2 = New quantity demanded
P1 = Original price
P2 = New price
 Percentage Method Example
• Suppose there is a change in demand of
plastic bottles from 700 units to 1000 units
as a result of fall of price from ₹15 to ₹10.

• Calculate the price elasticity of demand of

plastic bottles.
 Solution: As per the formula,
𝑸𝟐−𝑸𝟏 𝑷𝟐−𝑷𝟏
• 𝐞𝐩 = 𝑸𝟏 ÷ 𝑷𝟏
• Substituting the values in the formula:
• ep = (1000 - 700) / 700 ÷ (₹10 - ₹15) / ₹15
• ep = 300 / 700 ÷ (-₹5) / ₹15
• ep = 0.4286 ÷ (-0.3333)
• ep ≈ -1.28
• In this example, the value of the denominator is negative.
However, price and demand are inversely related and move in
opposing directions. Therefore, the negative sign is ignored.
Thus, the elasticity is greater than one (ep > 1).

• The calculated price elasticity of demand for plastic bottles is approximately -1.2858. Since the
value is negative, it indicates that demand is elastic, meaning that quantity demanded is highly
responsive to changes in price.
 3. Point Elasticity Method
• Definition: In this method, different points are taken on the demand
curve to find the price elasticity of demand at different prices. The
points at which elasticity is measured are lower and upper segments of
the curve.
• ep = L / U
• L is a lower segment of the demand curve
• U is the upper segment of the demand curve.
• The point price elasticity of demand is measured on linear curves and
non-linear curves.
• This method is used to measure the elasticity at a specific point on a
demand curve.
• The point elasticity method is also known as geometric method or slope
method.
 a. Linear Demand Curve
• Linear demand curve is a curve where demand is
represented as a straight line.

Example:
Assume that Figure is drawn to scale, if MP is greater than NP i.e. MP = 10 cms and NP
= 8 cms. Calculate the point elasticity at the point P?
Solution
• In this figure, MN is the demand curve. The elasticity at
the point P can be measured as:
𝑳
• ep = 𝑼
• Here L= NP = 8 cms,
• U= MP = 10 cms,
• Substituting the values in the formula
• ep = 8 / 10
• ep = 0.8
• Thus, e is 0.8 which is less than one (ep < 1).
 b. Non Linear Demand Curve
• In Non Linear Demand Curve, a tangent is drawn that touches point P (price
elasticity) at the demand curve.

• By drawing the tangent, the curve is separated into two parts, namely the upper
segment and the lower segment. Let us understand the calculation of price
elasticity on a non-linear demand curve.

Non Linear Demand Curve Example

In Figure, DD is a demand curve, and tangent BC meets DD at the point Q dividing into two parts
AQ and QB. Assume, QC = 15 and QB = 10.
Solution:
• ep = L / U
• ep = QC/BQ
• Substituting the values in the formula we get,
• ep = 15/10 = 1.5
• Here, e is 1.5, thus greater than one (ep > 1).
 4. Arc Elasticity Method
• Arc elasticity method is used to calculate the elasticity of demand at the midpoint of
an arc on the demand curve.

• In this method, the average of prices and quantities are calculated for finding
elasticity. It is assumed that the elasticity would be same over a range of values of
variables considered.

• The formula of the arc elasticity method is:

• ep= [(ΔQ/ ΔP) X (P+ P1 / Q+Q1)]

• Where,
ΔQ is change in quantity (Q1– Q)
• ΔP is change in price (P1 – P)
• Q is Original quantity demanded
• Q1 is New quantity demanded
• P is Original price
• P1 is the New price
 Calculating Arc Elasticity of Demand
• To calculate arc elasticity of demand we first take the midpoint in
between.

• Once we have the midpoint, we calculate the PED in the usual

way
Calculate Arc Elasticity of Demand

Example-1
Calculate Arc Elasticity of Demand

Example-2
Calculating Arc Elasticity of Demand
Solution for Example-1

•The mid point of Q = (80+88)/2 = 84

•The mid-point of P =(10+14)/2 =12
•% change in Q = 88-80/84 = -0.09524
•% change in price = (14-10)/12 = 0.3333

•PED = -0.09524 /0.3333 = -0.28571

As price and demand are inversely related
and move in opposing directions. Therefore,
the negative sign is ignored.

Thus, the price elasticity of

demand is less than one (ep<1).
Calculating Arc Elasticity of Demand
Solution for Example-2

Change in Q (20) /midpoint (30) = – 0.66666

Change in p (70) /midpoint (85) = 0.823529
PED = – 0.809
 2. Income Elasticity of Demand:
• Income elasticity of demand shows the change in quantity demanded as a result of a
change in income.

• An increase in the income of consumers increases the demand for the product even
if the price remains constant. The responsiveness of quantity demanded with respect
to the income of consumers is called the income elasticity of demand.

• Income elasticity of demand may be slated in the form of a formula.

Proportionate change in the quantity demand of commodity

• Income Elasticity = ------------------------------------------------------------------
Proportionate change in the income of the people

• Percentage change in income =

 Formula for Income Elasticity of Demand
• Thus, the formula for calculating the income elasticity of demand
is as follows:

• Where,
Q is original quantity demanded
Q1 is new quantity demanded
∆Q = Q1–Q
Y is original income
Y1 is new income
∆Y = Y1 – Y
 Example
• Suppose the monthly income of an individual increases
from 5,000 to 15,000. Now, his demand for clothes
increases from 35 units to 70 units. Calculate the income
elasticity of demand.
Solution:
• Given that:
• Y = 5,000 Y1= 15,000
• ∆Y = 15,000-5,000 = 10,000
• Q = 35 units
• Q1 = 70 units
• ∆Q = 70 – 35 = 35

• The formula for calculating the income elasticity of demand is:

• Substituting the values:

 Types of Income Elasticity of Demand:
1. Positive Income Elasticity of Demand

2. Negative Income Elasticity of Demand

3. Zero Income Elasticity of Demand

 1. Positive Income Elasticity of Demand
• When a proportionate change in the income of a consumer increases the demand for
a product and vice versa. Income elasticity of demand is said to be positive.

• In case of Normal Goods, the income elasticity of demand is generally found positive,
which is shown in Figure.

• In Figure, DYDY is the curve representing positive income elasticity of demand.

The curve is sloping upwards from left to the right, which shows an increase in
demand (OQ to OQ1) as a result of rise in income (OB to OA).
 Types of Positive Income Elasticity of Demand
a) Unitary income elasticity of demand

b) Less than unitary income elasticity of demand

c) More than unitary income elasticity of demand

 Types of Positive Income Elasticity of Demand
a) Unitary Income Elasticity:

• When an increase in income brings about a proportionate increase in quantity demanded, and then income
elasticity of demand is equal to one.

• Ey = 1

• For example, if there is 25% increase in the income of a consumer, the demand for milk consumption would also
be increased by 25%. Thus ey = 25/25 =1.

b) Income Elasticity Leas Than Unity:

• When income increases quantity demanded also increases but less than proportionately. In this case E < 1.

• For example, if there is an increase of 25% in consumer‟s income, the demand for milk is increased by only 10%.
Thus ey = 10/100 = 0.1 < 1.

c) Income Elasticity Greater Than Unity:

• In this case, an increase in come brings about a more than proportionate increase in quantity demanded.
Symbolically it can be written as Ey > 1.

• For example, if there is an increase of 25% in consumer‟s income, the demand for milk is increased by only 35%.
Thus ey = 35/25 = 1.4 >
 2. Negative Income elasticity:
• When income increases, quantity demanded falls. In this case, income elasticity of demand is
negative.

• In Figure, DYDY is the curve representing negative income elasticity of demand. The curve is
sloping downwards from left to the right, which shows a decrease in the demand as a result of a rise
in income.

• As shown in Figure, with a rise in income from 10 to 30, the demand falls from 3 to 2.
 3. Zero Income Elasticity:
• Quantity demanded remains the same, even though money income increases.
• Symbolically, it can be expressed as Ey=0.

• In Figure, DY is the curve representing zero income elasticity of demand. The

curve is parallel to Y-axis that shows no change in the demand as a result of a
rise in income.
• As shown in Figure with a rise of income from 10 to 20, the demand remains
the same i.e. 4.
 3. Cross Elasticity of Demand
• The cross elasticity of demand can be defined as a measure of a proportionate
change in the demand for goods as a result of a change in the price of related
goods.
• Cross Elasticity of Demand Formula
•

• Where,
Percentage change in quantity demanded of X=
•

• Percentage change in price of Y=

• Where,
ec is the cross elasticity of demand
QX = Original quantity demanded of product X
• Thus, mathematically, the cross elasticity of demand is stated as: ΔQX = Change in quantity demanded of
product X

• Py = Original price of product Y

ΔPy = Change in the price of product Y
 Types of Cross Elasticity of Demand
• Cross elasticity of demand can be categorised into three
types, which are as follows:

a) Positive Cross Elasticity of Demand

b) Negative Cross Elasticity of Demand

c) Zero Cross Elasticity of Demand

 1. Positive Cross Elasticity of Demand:
• When an increase in the price of a related product results in an increase in the
demand for the main product and vice versa, the cross elasticity of demand is said to
be positive.
• Cross-elasticity of demand is positive in the case of substitute goods.
•
For example, the quantity demanded tea has increased from 200 units to 300 units
with an increase in the price of coffee from ₹25 to ₹30.
• In this case, the cross elasticity would be:
• ec = [ (ΔQx/ ΔPy) × (Py / Qx) ]
• Where, Py = ₹25; Qx = 200;
• ΔQx = Qx1 – ΔQx = 300 – 200 = 100 units
ΔPy = Py1 – Py= ₹30 – ₹25 = ₹5

• Substituting the values in the formula:

• ec = 100/5 × 25/200 = 2.5 > 1.
• Here, the Cross Elasticity is Positive.
 2. Negative cross elasticity of demand
• When an increase in the price of a related product results in the decrease of the
demand of the main product and vice versa, the negative elasticity of demand is said
to be negative. In complementary goods, cross elasticity of goods is negative.

• For example, if the price of butter is increased from 20 to 25, the demand for bread
is decreased from 200 units to 125 units. In such a case, cross elasticity will be
calculated as:
• ec = ΔQX/ ΔPY × PY/QX
• Where, PY = ₹20; QX = 200 units
ΔQX = QX1 – QX= 125 – 200= – 75 units
• ΔPY = PY1 – PY = ₹25 – ₹20 = ₹5
• Substituting the values in the formula,
ec = -75/5 × 20/200 = – 1.5 <1
• Thus, Cross Elasticity is Negative.
 Zero Cross Elasticity of Demand
• When a proportionate change in the price of a related
product does not bring any change in the demand for the
main product.

• In simple words, cross elasticity is zero in case of

independent goods.
Factors Influencing the
Elasticity of Demand
 1. Nature of Commodity:
• Elasticity or in-elasticity of demand depends on the
nature of the commodity i.e. whether a commodity is a
necessity, comfort or luxury, normally, the demand for
necessaries like salt, rice etc is inelastic.

• On the other band, the demand for comforts and luxuries

is elastic.
 2. Availability of Substitutes:
• Elasticity of demand depends on availability or non-
availability of substitutes.

• In case of commodities, which have substitutes, demand

is elastic, but in case of commodities, which have no
substitutes, demand is in elastic.
 3. Variety of Uses:
• If a commodity can be used for several purposes, than it
will have elastic demand. i.e. electricity.

• On the other hand, demanded is inelastic for

commodities, which can be put to only one use.
 4. Postponement of Demand:
• If the consumption of a commodity can be postponed,
than it will have elastic demand.

• On the contrary, if the demand for a commodity cannot

be postpones, than demand is in elastic.

• The demand for rice or medicine cannot be postponed,

while the demand for Cycle or umbrella can be
postponed.
 5. Amount of Money Spent:
• Elasticity of demand depends on the amount of money spent on
the commodity.
• If the consumer spends a smaller for example a consumer
spends a little amount on salt and matchboxes.
• Even when price of salt or matchbox goes up, demanded will
not fall.
• Therefore, demand is in case of clothing a consumer spends a
large proportion of his income and an increase in price will
reduce his demand for clothing. So the demand is elastic.
 6. Time:
• Elasticity of demand varies with time. Generally,
demand is inelastic during short period and elastic during
the long period.
• Demand is inelastic during short period because the
consumers do not have enough time to know about the
change is price.
• Even if they are aware of the price change, they may not
immediately switch over to a new commodity, as they are
accustomed to the old commodity.
 7. Range of Prices:
• Range of prices exerts an important influence on
elasticity of demand.
• At a very high price, demand is inelastic because a slight
fall in price will not induce the people buy more.
• Similarly at a low price also demand is inelastic.
• This is because at a low price all those who want to buy
the commodity would have bought it and a further fall in
price will not increase the demand.
 Importance of Elasticity of Demand:
1. Price Fixation:
• Each seller under monopoly and imperfect competition has to take into
account elasticity of demand while fixing the price for his product.
If the demand for the product is inelastic, he can fix a higher price.

2. Production:
• Producers generally decide their production level on the basis of demand for
the product.
• Hence elasticity of demand helps the producers to take correct decision
regarding the level of cut put to be produced.

3. Distribution:
• Elasticity of demand also helps in the determination of rewards for factors of
production.
• For example, if the demand for labour is inelastic, trade unions will be
successful in raising wages. It is applicable to other factors of production.
 Importance of Elasticity of Demand:
4. International Trade:
• Elasticity of demand helps in finding out the terms of trade between two
countries.
• Terms of trade refers to the rate at which domestic commodity is exchanged
for foreign commodities.
• Terms of trade depends upon the elasticity of demand of the two countries for
each other goods.

5. Public
Finance:
• Elasticity of demand helps the government in formulating tax policies.
• For example, for imposing tax on a commodity, the Finance Minister has to
take into account the elasticity of demand.

6. Nationalization:
• The concept of elasticity of demand enables the government to decide about
nationalization of industries.
 Demand
Forecasting
Introduction:
• The information about the future is essential for both new firms and those
planning to expand the scale of their production.

• In recent times, forecasting plays an important role in business decision-

making.

• It is essential for a firm to produce the required quantities at the right time.

• It is essential to distinguish between forecasts of demand and forecasts of

sales.

• Sales forecast is important for estimating revenue, cash requirements and

expenses.

• Demand forecasts relate to production, inventory control, timing, reliability of

forecast etc.
 Meaning and Types of Demand Forecasting
• Meaning of Demand Forecasting:

• Demand forecasting refers to an estimate of future demand for the

product. It is an „objective assessment of the future course of demand”.

• Demand forecasting has an important influence on production planning.

• Types of Demand Forecasting:

• Based on the time span and planning requirements of business firms,

demand forecasting can be classified as

• 1. Short-term Demand Forecasting and

• 2. Long – term Demand Forecasting.

 1. Short-term Demand Forecasting:
• Short-term demand forecasting is limited to short periods, usually for one
year. It relates to policies regarding sales, purchase, price and finances.

• It relates to existing production capacity of the firm.

• Short-term forecasting is essential for formulating a suitable price policy.

• If the business people expect of rise in the prices of raw materials of

shortages, they may buy early. This price forecasting helps in sales policy
formulation. Production may be undertaken based on expected sales and not
on actual sales.

• Further, demand forecasting assists in financial forecasting also.

• Prior information about production and sales is essential to provide additional

funds on reasonable terms.
 2. Long-term Forecasting:
• In long-term forecasting, the businessmen should know about
the long-term demand for the product.
• Planning of a new plant or expansion of an existing unit
depends on longterm demand.
• Similarly a multi-product firm must take into account the
demand for different items.
• When forecast are made covering long periods, the probability
of error is high. It is vary difficult to forecast the production,
the trend of prices and the nature of competition may get
change.
 Methods of Forecasting:
• Several methods are employed for
forecasting demand.
1.Survey Method.

2.Statistical Method.
 Survey Method:
• Under this method, information about the desires of the
consumer and opinion of exports are collected by
interviewing them.
• Survey method can be divided into four type’s viz.
i. Option Survey Method;

ii. Expert Opinion;

iii. Delphi Method and

iv. Consumers Interview Methods.

 i. Opinion Survey Method:
• This method is also known as sales-force composite method (or)
collective opinion method.
• Under this method, the company asks its salesman to submit estimate
of future sales in their respective territories.
• Since the forecasts of the salesmen are biased due to their optimistic
or pessimistic attitude ignorance about economic developments etc.
these estimates are consolidated, reviewed and adjusted by the top
executives.
• This method is more useful and appropriate because the salesmen are
more knowledge. They can be important source of information. They
are cooperative. The implementation within unbiased or their basic
can be corrected.
 ii. Expert Opinion Method:
• Apart from salesmen and consumers, distributors or outside
experts may also use for forecasting.

• Firms in advanced countries make use of outside experts for

estimating future demand.

• Various public and private agencies call periodic forecasts of short

or long term business conditions.

• Eg. In the United States of America, the automobile companies get

sales estimates directly from their dealers.
 iii. Delphi Method:
• It is a sophisticated method to arrive at a consensus.
• Under this method, a panel is selected to give suggestions to solve the problems in
hand.
• Both internal and external experts can be the members of the panel. Panel members
one kept apart from each other and express their views in an anonymous manner.
• There is also a coordinator who acts as an intermediary among the panelists. He
prepares the questionnaire and sends it to the panelist.
• At the end of each round, he prepares a summary report.
• On the basis of the summary report the panel members have to give suggestions.
• This method has been used in the area of technological forecasting. It has proved
more popular in forecasting. It has provided more popular in forecasting non-
economic rather than economic variables.
 iv. Consumers Interview Method:
• In this method the consumers are contacted personally to know
about their plans and preference regarding the consumption of
the product.
• A list of all potential buyers would be drawn and each buyer
will be approached and asked how much he plans to buy the
listed product in future.
• He would be asked the proportion in which he intends to buy.
• This method seems to be the most ideal method for forecasting
demand.
 2. Statistical Methods:
• Statistical method is used for long run forecasting. In
this method, statistical and mathematical techniques are
used to forecast demand. This method relies on post
data.
a. Time series analysis or Trend Projection Methods:

b. Barometric Technique:

c. Regression and Correlation Method:

 a) Time Series Analysis or Trend Projection Method:

• A well-established firm would have accumulated data. These

data are analyzed to determine the nature of existing trend.
Then, this trend is projected in to the future and the results
are used as the basis for forecast. This is called as time series
analysis. This data can be presented either in a tabular form
or a graph.

• In the time series data of sales are used to forecast future.

 b) Barometric Technique:
• Simple trend projections are not capable of forecasting turning points.
• Under Barometric method, present events are used to predict the directions of
change in future. This is done with the help of economics and statistical
indicators.
• Those are
• (1) Construction Contracts awarded for building materials (2) Personal income
• (3) Agricultural Income.
• (4) Employment
• (5) Gross National Income
• (6) Industrial Production
• (7) Bank Deposits etc.
 c) Regression and Correlation Method:
• Regression and correlation are used for forecasting demand. Based on
data the future data trend is forecasted.
• If the functional relationship is analyzed with the independent variable it
is simple correction.
• When there are several independent variables it is multiple correlation.
• In correlation we analyze the nature of relation between the variables;
• While in regression, the extent of relation between the variables is
analyzed.
• The results are expressed in mathematical form. Therefore, it is called as
econometric model building.
• The main advantage of this method is that it provides the values of the
independent variables from within the model itself.
 Trend Projection Method
• The Trend Projection Method is the most classical method of business
forecasting, which is concerned with the movement of variables through time. This
method requires a long time-series data.

• The trend projection method is based on the assumption that the factors liable
for the past trends in the variables to be projected shall continue to play their role in
the future in the same manner and to the same extent as they did in the past while
determining the variable‟s magnitude and direction.

• In predicting demand for a product, the trend projection method is applied to the
long time-series data. A long-standing firm can obtain such data from its
departments (such as sales) and the books of accounts. While the new firms can
obtain data from the old firms operating in the same industry.
 HowTrend Projection Methodwork
• trend projection methods Businesses typically take a five-step approach when using trend
projections to forecast sales:
• 1. Data collection.
• The first step in sales trend projection is to gather past sales records. Collect sales data at regular
intervals, such as daily, monthly, or yearly. A data management tool can simplify this process.
• 2. Data analysis.
• Once you collect the data, organize it in a time series data format, where data points are recorded at
successive points in time. Examine the statistical data for patterns, fluctuations, and trends.
• 3. Trend identification.
• The simplest statistical method for trend analysis involves charting data on a graph and looking for
a linear trend, be it upward (positive trend line), downward (negative trend line), or flat (no trend
line). More sophisticated trend projection methods include moving averages, linear regression, and
exponential smoothing.
• 4. Projection.
• Once you identify a trend, extrapolate it into the future to make predictions. For example, if you
spot past trends about holiday shopping, you may be able to forecast seasonal customer demand for
upcoming holidays.
• 5. Preparation and adjustment.
• Adjust your strategies to capitalize on observed trends. For instance, if your data reveals people buy
more footballs during the September-to-January NFL season, start stocking up on footballs in July
in anticipation of future sales.
The trend projection method includes three techniques
based on the time-series data. These are:
 Graphical Method:
• It is the most simple statistical method in which the annual sales
data are plotted on a graph, and a line is drawn through these
plotted points.

• Under this method, it is assumed that future sales will assume the
same trend as followed by the past sales records.

• Although the graphical method is simple and inexpensive, it is not

considered to be reliable.

• This is because the extension of the trend line may involve

subjectivity and personal bias of the researcher.
 Fitting Trend Equation or Least Square Method:
• The least square method is a formal technique in which the trend-line is fitted
in the time-series using the statistical data to determine the trend of demand.
• The form of trend equation that can be fitted to the time-series data can be
determined either by plotting the sales data or trying different forms of the
equation that best fits the data. Once the data is plotted, it shows several trends.
• The most common types of trend equations are:
 Linear Trend:
 When the time-series data reveals a rising or a linear trend in sales, the
following straight line equation is fitted:
S = a + bT
 Where S = annual sales; T = time (years); a and b are constants.
 Exponential Trend:
 The exponential trend is used when the data reveal that the total sales have
increased over the past years either at an increasing rate or at a constant rate per
unit time.
 Box-Jenkins Method:
Box-Jenkins method is yet another forecasting method used
for short-term predictions and projections.
This method is often used with stationary time-series
sales data.
A stationary time-series data is the one which does not
reveal a long term trend.
In other words, Box-Jenkins method is used when the time-
series data reveal monthly or seasonal variations that
reappear with some degree of regularity.
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