MANAGERIAL ECONOMICS

FACULTY: Prof. Venugopal Naidu

MODULE:3

DEMAND ANALYSIS

Meaning of Demand
Demand implies 3 conditions :

Desire for a commodity or service Ability to pay the price of it Willingness to pay the price of it. Further demand has no meaning without reference to time period such as a week, a month or a year. The demand for a product can be defined as the Number of units of an commodity that consumer will purchase at a given price during a specified period of time in the market.
3

Types of Demand
Demand can be broadly classified into 3 types : They are, Price Demand Income Demand Cross Demand

Law of Demand
The law of demand expresses the relationship between the price & quantity demanded .It says that demand varies inversely with price. The Law can be stated in the following: Other things being equal, a fall in the price leads to expansion in demand and a rise in price leads to contraction in demand.
5

Assumptions- Law Of Demand

Consumers Income remains Constant The Tastes & Preferences Of the Consumers remain the same Prices of other related Commodities remain Constant No new Substitutes are available for the Commodity. Consumers do not expect further change in the price of the commodity.
6

Continued
The Commodity is not of Prestigious value Eg: Diamond The size of population is constant The rate of taxes remain the same Climate & Weather Conditions do not change.

DEMAND SCHEDULE

Individual Demand Schedule Market Demand schedule

1. Individual Demand Schedule:

It is a list of various quantities of a commodity which an individual consumer purchases at different prices at one instant of time. D= f (P) (or) D(x) = f(Px)
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Individual demand schedule (Hypothetical)

Price per unit (Rs) Quantity demanded for time period (a week)

5 4 3 2 1

10 apples 20 apples 30 apples 40 apples 50 apples

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2. Market Demand Schedule

The market demand Schedule can be obtained by adding all the individual Demand Schedules of Consumers in the market. Hypothetical market demand schedule is as follows:

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Hypothetical market demand schedule

Price per unit (Rs)
5 4 3 2 1

Quantity demanded by Market individuals demand

A B C A+B+C 60 90 120 150 180
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10 20 30 40 50

20 30 40 50 60

30 40 50 60 70

Market demand curve

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Exceptions to the law of demand

13

Continued
Giffens Paradox (Robert Giffen-Irish Economist) Veblens Effect (Thorstein Veblen USA ) Price Illusion Fear of Future Rise in Prices Emergency Necessaries

14

Continued

Conspicious Necessaries (More Noticeable)

Eg:- TV, Watch, Scooters, Car etc

Fear of Shortage Ignorance Speculation (Stock Market)

15

Why does the demand curve slope downwards to right

OR Why does demand curve has a negative slope?

Operation of the Law of Diminishing Marginal Utility Income Effect Substitution Effect Different Uses New Buyers

16

CHANGES IN DEMAND
A. Extension & contraction of demand:
When demand changes due to change in the price of the commodity, it is a case of either extension or contraction of demand. The Law of demand relates to the Extension & Contraction of Demand.
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Extension and Contraction of Demand

18

2. Increase and decrease in demand:

When demand changes, not due to changes in the price of the commodity or service but due to other factors on which demand depends. Eg:- Income, Population, Climate, Tastes & Habits etc.
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Increase and Decrease in Demand

20

DEMAND DISTINCTIONS
Demand distinctions may be defined as the difference in the forces acting on the demand for different goods.
Demand for Producer goods and Consumer Goods Demand for Durable goods and NonDurable Goods.

21

Continued
Derived Demand and Autonomous Demand. Industry Demand and Company Demand Short run Demand And Longrun demand Total Market demand & Market Segment Demand

22

DETERMINANTS OF DEMAND (OR) FACTORS AFFECTING DEMAND

(Refer: Lekhi & Agarwal- Business Economics)

Price of Commodity Price of Related Goods Income of the Consumer Distribution of Wealth Tastes & Habits Population growth

23

Continued
State

of Business (Business Cycle) Government Policy Advertisement Level of Taxation

24

Factors determining demand for different types of goods.

Three main types of goods:1.Non durable consumer goods. 2.Durable consumer goods. 3.Producer goods or capital goods.

1.Non durable consumer goods:a) Purchasing power

b) Price c) Demography Thus, demand for non durables can be expressed in the form of following formula: d= f( Y,P,D) Where ,d=demand,Y=disposable personal income ,P=price ,D=demography and f is the function.

2.Durable consumer goods. Demand of such goods is two types a) Replacement demand- demand for a new product in place of an old one which is worn out or obsolete. b) Expansion demand-demand for additional units of the same product.

Factors influencing Replacement demand

Life of the product. Obsolescence. Value of the scrap. Change in price and quality. Change in expansion demand.

Factors influencing expansion demand.

Financial position of consumers. Maintenance and operating costs. Number of households. Price and credit conditions.

3.Producers goods
Also called capital

goods.

Factors determining the demand for capital goods. No. of industrial undertakings. Profitability. Ratio of production to capacity utilization. Level of wage rates. Growth prospects. Price and quality of the produce.

ELASTICITY OF DEMAND
Reference: Mithani (Pg131)

Elasticity of Demand

Elasticity of demand measures the responsiveness of demand for a commodity to a change in the variables confined to its demand. For measuring the elasticity coefficient, a ratio is made of two variables, ED = %change in quantity demanded % change in determinants of demand

Important Kinds of Elasticity of Demand

1. Price ED:
e = % change in quantity demanded % change in price 2. Income ED: e = % change in quantity demanded % change in income 3. Cross ED: e = % change in quantity demanded % change in price of Y

Continued..
4. Advertising / Promotional ED: eA = % change in sales % change in advertisement expenditure

Types of Income Elasticity of Demand

1. 2. 3. 4. 5.
Negative Income Elasticity Zero Income Elasticity Unitary Income Elasticity Of Demand Income Elasticity Greater Than One Income Elasticity Less Than One

The following diagram shows different types of income elasticity of demand: Y

D1 D2 D3 D4 D5

PRICE

QUANTITY DEMANDED

Factors Influencing Elasticity of Demand or Determinants of Price Elasticity of Demand

1. Nature of Commodity: Necessaries --- inelastic Comforts and Luxuries --- elastic

Continued..
2. Availability of Substitute: A commodity which has more substitutes

3.

the demand is ------ more elastic. Ex: Tea , Coffee, Milk ,Bournvita etc, No of users of a commodity: More no of users ---elastic Ex: Electricity, Iron and Steel etc. Only one use --- inelastic Ex: Printing machine , stitching machine

4. Proportion of Income Spent on the

5. 6.

Goods: Small proportion of income --- inelastic Ex: Salt, Match box, Postcard Habit: Ex: Coffee ,Tea --- inelastic Level of Income of the People: Rich People --- inelastic Poor People --- elastic

7. Period of time: Short period --- inelastic

Habit and prices of commodities do not change much. Long period --- elastic

8. Durability of a commodity: Durable goods --- elastic Ex: fan, table, Chair Perishable goods --- inelastic Ex: Milk, flower

9. Postponement of Purchase: Postponement --- elastic

Ex: Fan, TV, Fridge Cannot be postponed --- inelastic Ex: Medicine, Rice, Wheat

10. Level of Prices: High priced --- elastic

Ex: Cars, TV , Air conditioners Low priced --- inelastic Ex: Newspaper, Nails, Needle

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

Uses Of Price Elasticity of Demand In Decision Making

1.
2. 3. 4.

To the businessmen To the trade unions In international trade To the government

5. In the determination of the rate of foreign exchange 6. In the declaring certain industries as public utilities

Different Degrees of Price Elasticity of Demand

1. 2. 3. 4. 5.

Perfectly Elastic Demand Perfectly Inelastic Demand Relatively Elastic demand Relatively Inelastic Demand Unitary Elastic Demand

1. 2. 3.

There are three methods of measurement of price elasticity of demand: Mathematical (or) Ratio Method. Total Outlay Method (or) Total Expenditure Method. Point Method

Mathematical Method
Under this method price elasticity of demand is measured by using the formula given below: PEd = % change in quantity demanded % change in the price = % change in Q % change in P

Perfectly Elastic Demand PEd=/0 =

Y

PRICE D

X O

QUANTITY DEMANDED

Perfectly Inelastic Demand

D Y

PRICE

M QUANTITY DEMANDED

Price Elasticity of Demand is = 1

The Elasticity is equal to one when the demand changes by the same % as the price. Suppose the price has fallen by 20% and the quantity demanded has expanded by 20%, as a result of fall in the price. The Elasticity of demand is = 1. PEd = % change in demand = 20% = 1 % change in price 20% PEd = 1

Unitary Elastic Demand or Elasticity Equal to Unity

Y

PRICE

P1

D1

M1

QUANTITY

Price Elasticity of Demand > 1

If the % change in demand is more than the % change in price, then the Elasticity is = > 1. Ex: If the price falls by 20% and demand increases by 20%, then the elasticity is greater than one. PEd = 40% = 4 = 2 20% 2 PEd > 1

More Elastic Demand or Elasticity Greater Than Unity

Y D P

P1 PRICE D1

M1

QUANTITY

Price Elasticity of demand <1

If the % change in demand is less than the % change in the price, then the Elasticity is < 1. Ex: If the price falls by 20% and the demand increases by only 10%, then the E is = i.e less than one. PEd = 10% = 1 = 0.5 20% 2 PEd < 1

Less Elastic Demand or Elasticity Less Than Unity

Y

D P
PRICE

P1
D1

M1
QUANTITY

Various Degrees Of Elasticity Of Demands

Y D D

D PRICE D D D O QUANTITY D X

Total Expenditure / Outlay Method

By Prof . Marshall Under this method we measure the price elasticity of demand by examining the change in total expenditure as a result of change in the price and quantity demanded for a commodity. TE = Price / unit X Total quantity purchased

Illustration

PEd can be explained clearly with the help of the following example:

Following are the observations about the nature of PEd

1.

2.

3.

In first case , with every fall in price the TE goes on increasing. Therefore the PEd > 1. In second case, whatever may be the change in price the TE remains the same. Therefore the PEd = 1. In third case, with every fall in price the TE goes on decreasing. Therefore the PEd < 1

Diagrammatic /Graphical Representation

ABCD is the TE curve. A to B PEd >1 B to C PEd =1 C to D PEd <1

Point Method
Prof . Marshall

Point Ed = lower segment of the demand curve below the given point upper segment of the demand curve above the given point or PE = L ; PE = point elasticity U L = lower segment U = upper segment

(1) Linear Demand Curve:

PE = L = PB U PA Total length of A and B is 5 cm PB = 3 cm PA = 2 cm PE = 3 = 1.5 2

(2) Non Linear Demand Curve:

(3) Elasticity at different points on a straight line demand curve:

Illustration:

At P1 PEd = P1D1 = 2 = 1 PE = 1 P1D 2

At P2 PEd = P2D1 = 3 = 3 PE = > 1 P2D 1

At P3 PEd = P3D1 = 4 = P3D 0 At P4 PEd = P4D1 = 1 = < 1 P4D 3 At P5 PEd = P5D1 = 0 = 0 P5D 4 PE = < 1 PE = 0

DEMAND FORECASTING METHODS

Reference by M.M. Gupta

Demand Forecasting
Meaning:
Demand forecasting means estimating the

expected future demand for a product , related to a particular period of time. Methods of forecasting:
The methods of forecasting can be broadly

classified into two categories. They are: 1. Survey Method 2. Statistical Method

SIGNIFICANCE OF DEMAND FORECASTING

SIGNIFICANCE OF SHORT TERM FORECASTING To prepare appropriate production schedule. Helping the firm in reducing costs of purchasing materials. To determine appropriate price policy. To fix sales targets and incentives.

To evolve proper advertising policy. To forecast short term financial requirements.

SIGNIFICANCE OF LONG TERM FORECASTING

To plan for new units or to expand the existing units. To plan long term financial requirements. To plan man power requirements.

LEVELS OF DEMAND FORECASTING

1. Macro level 2. Industry level 3. Firm level

Criteria of a good forecasting method.

Accuracy Plausibility Simplicity Economy Availability Flexibility

DEMAND FORECASTING METHODS

Survey Method

Statistical Method

Expert opinion Direct interview method method (Collective opinion)

Trend projection method

Regression method

Barometric method (Economic indicator method)

Complete enumeration method

Sample survey method

End User method

(A) Survey Method

The survey method consists of two methods: Survey of experts opinion Survey of consumers intentions through direct interview with them.

(1) Experts Opinion Method (or) Collective Opinion Method

This method is also known as Sales Force Composite Method. Advantages: 1. It is a simple method of forecasting. 2. It involves minimum statistical work. 3. It is less expensive. 4. It is based on the first hand knowledge of the salesmen who are directly connected with the sales.

Contd
5. It is more useful for short term forecasting rather than long term forecasting. 6. It is particularly useful in forecasting the sales of new products. Disadvantages: 1. It is subjective approach. 2. The salesmen may underestimate the demand. 3. The salesmen may not be able to judge the future trends in the economy and their impact on the sales of the product of the firm.

(2) Direct Interview Method (or) Customers Interview Method

Under this method ,consumers are directly interviewed to find out the future demand or demand trends for a product by a firm. They are three types of consumers interview: Complete Enumeration Method Sample Survey Method (Stratified = Society divided into different classes) End Use Method

Continued
A. Complete Enumeration Method
under this method ,almost all the consumers of the product are interviewed and are asked to inform about their future plan of purchasing the product in question. Advantages: This method is true from any bias of the salesmen ,as they only collect the information and aggregate it. This method seems to be ideal, since almost all the consumers using the product are contacted.

Contd
Disadvantages: 1. This method is however very costly and tedious. 2. It is also too much time consuming, since every potential customer is to be interviewed. 3. It would be very difficult and impractical if the consumers who are spread over the entire country are to be contacted. Hence this method is highly cumbersome in nature.

Contd
Sample Survey Method: When the demand of consumers is very large this method is used by selecting a sample of consumers for interview . Advantages: 1. This method is single and less costly and hence it is widely used. 2. It is less time consuming ,since only a few selected consumers are contacted.
B.

Contd
3. It is used to estimate short term demand by business firms, governments departments and household customers. 4. It is highly useful in case of new products. 5. This method is of greater use in forecasting where consumers behaviour is subject to frequent changes. However the success if this method depends on the sincere co-operation of the selected consumers.

Contd
Disadvantages: 1. This method is less reliable , because it does not give opinion of all the consumers. 2. A sudden change in the price of the product in future may upset the calculations of consumers. 3. The rich consumers may not bother to fill the details in the questionnaire. These are the practical problems faced in using this method to forecast demand.

Contd
C.

End Use Method: Under this method, the sale of the product under consideration is projected on the basis of the demand surveys of the industries using this given product or intermediate product.

Contd
Advantages: 1. This method is used to forecast the demand for intermediate products only. 2. It is quite useful for industries which largely produces goods like aluminium, steel, etc. Disadvantages: The main limitation of this method is that , as the number of end- users of a product increases, it becomes more difficult to estimate demand under this method.

(B) Statistical Method

Under these methods, statistical or mathematical techniques are used to forecast the demand for a product in the long period. The following are the important statistical methods used in forecasting: Trend Projection Method Regression Method Barometric Method

1. 2. 3.

(1) Trend Projection Method

This method is also known as Time Series Analysis. Time series refers to the data over a period of time. During this time period, fluctuations and turning points may occur in demand conditions .These fluctuations in demand occur due to the following four factors. They are: Secular Trends Seasonal Variations Cyclical Fluctuations Random Variations

Table - Sales of Transistors for 5 years

YEAR

SALES in lakhs of Rs

1991 1992 1993 1994

50 60 55 70

1995

75

DIAGRAMATIC REPRESENTATION Y
75
70 Trend line

65
60
Sales curve

55
50

0
91 92 93 94 95

Contd
Advantages : 1. Trend projection method is quite popular in business forecasting, because it is a simple method. 2. The use this method requires only the simple working knowledge of statistics. 3. It is also less expensive , as its data requirements are limited to the internal records. 4. This method yields fairly reliable estimates if future course of demand.

Contd
Disadvantages: The most important limitation of this method arises out of its assumption that the past rate of change in the dependent variable ( demand). This method is not useful for short run forecasting and cyclical fluctuations. This method does not explain the relationship between dependent and independent variables.

(2)Regression Method
It combines the economic theory and statistical techniques of estimation.

(3) Barometric Method

This method is also known as Economic Indicators Method. Under this method , a few economic indicators become the basis for forecasting the sales of a company. Some of the most commonly used indicators are given below: Construction contracts Personal Income Automobile registration

Contd
Limitations It is difficult to find out an appropriate economic indicator It is not suitable for new products as past data not available It is best suited where relationship of demand with a particular indicator is characterized by time-lag

Significance of Demand Forecasting

Production planning Sales Forecasting Control of business Inventory control Growth and Long term Investment Programs Stability Economic planning and Policy making