Demand by p.rai87@Gmail

8/8/2019 Demand by p.rai87@Gmail

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Term Paperof

Managerial Economics

Topic: Demand, Determinants of Demandand its Analysis

Submitted By:Praveen Rai

Institute of Business Management,C. S. J. M. U., Kanpur.

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INDEX

S.No.

Topic

P

ageNo.

1.

Demand

I. Meaning of DemandII. Business Significance of Demand

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2. Types of Demand4 -5

3. Determinants of Demand5 -6

4. Demand Function 6

5.

Law of DemandI. Assumption of the Law ofDemand

II. Demand ScheduleIII. Demand CurveIV. Rationale for Law of DemandV. Exception of the Law of Demand

6 10

6.

Demand AnalysisI. Meaning of Demand Analysis

II. Marginal Utility ApproachIII. Indifference Curve AnalysisIV. Revealed Preference ApproachV. Objectives of Demand Analysis

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13

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7. Conclusion13-

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8. Bibliography 14

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Demand

Meaning of Demand:-Conceptually, the term Demand implies a desire for a

commodity backed by the ability and willingness topay for it.

The concept of demands refers to the quantity of a goodor service that consumers are willing and able to purchase atvarious prices dealing a period of time. The demand ineconomics is something more than desire to purchase thoughdesire is one element of it. A beggar for instance, may desirefood, but due to lack of means to purchase it, his demand isnot effective. In economics, demands refer to effectivedemand, which implies three things (i) Desire (ii) means topurchase and, (iii) on willingness to use those means for thatpurchase. The demand for a commodity at a given price is theamount of it, which will be bought per unit of time at thatprice.

A meaningful statement regarding the demand for acommodity should contain the following information:

I. the quantity demanded of a commodity,II. the price at which a commodity is demanded,

III. the time period over which a commodity is demandedand

IV. the market area in which a commodity is demanded.

For example, saying, the annual demand for TV sets inDelhi at an average price of Rs. 15,000 a piece is 50,000 is ameaningful statement.

Business Significance of Demand:-The market for a firms product cannot be analyzed

without reference to the demand condition. For a firm or anindustry consisting of several firms, the extent of demanddetermines the size of market. Successful business firms,therefore, spend considerable time, energy and effort inanalyzing the demand for their products. Without a clear

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understanding of consumers behavior and a clear knowledgeof the market demand conditions, the firm is handicapped inits attempt towards profit planning or any other businessstrategy planning. For example, estimating present demandand forecasting future demand constitutes the first steptowards measuring and determining the flow of sales

revenues and profits which generate internal resources tofinance business. The stability and growth of business islinked to size and structure of demand.

Types of Demand

1. Individual and Market Demand: The quantity of acommodity which an individual is willing to buy at aparticular price of the commodity during a specific timeperiod, given his money income, his taste, and prices ofother commodities (particularly substitutes andcomplements), is known as individuals demand for acommodity.

The total quantity which all the consumers of acommodity are willing to buy at a given price per time unit,given their money income, taste, and prices of othercommodities (mainly substitutes) is known as marketdemand for the commodity. In other words, the marketdemand for a commodity is the sum of individual demandsby all the consumers (or buyers) of the commodity, over atime period, and at a given price, other factors remainingthe same.

2. Demand for Firms Product and Industrys

Products: The quantity of a firms produce that can bedisposed of at a given price over a time period, and at agiven price, other factors remaining the same.

3. Autonomous and Derived Demand: AutonomousDemandfor a commodity is one that arises independent ofthe demand for any other commodity whereas deriveddemandis one that is lied to the demand for some parent

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product. Demand for food, clothes, shelter etc. isautonomous demand. Demand for land, fertilizers, andagricultural tools and implements are a derived demand,for these goods are demanded because food is demanded.

4. Demand for Durable and non-durable Goods:

Demand is often classified also under demand for durableand non-durable goods. Durable goods are those. Whosetotal utility (or use) is not exhausted by a single use. Suchgoods can be used repeatedly or continuously over aperiod. Durable goods may be consumer as well as producergoods. Durable consumer goods include clothes, shoes,owner occupied residential houses, furniture, utensils,refrigerators, scooters, cars, etc. The durable producergoods include mainly the items under fixed assets, such as

building, paint, machinery, etc.

Non-durable goods on the other hand, are those, whichcan be used or consumed only once (for example, fooditems) and their total utility is exhausted in a single use.

5. Short-term and Long-term Demand: Short-termdemand refers to the demand for such goods as aredemanded over a short period. In this category fall mostly

the fashion consumer goods, goods of seasonal use, inferiorsubstitutes during the scarcity period of superior goods,etc.

The long-term demand, on the other hand, refers to thedemand, which exists over a long period. The change inlong-term demand is perceptible only after a long period.Most generic goods have long-term demand. Forexample, demand for consumer and producer goods,

durable and non-durable goods, is long-term demand,though their different varieties or brands may have onlyshort-term demand.

Determinants of Demand

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1. Price of the commodity: Ceteris paribus i.e., otherthings being equal, the demand of a commodity is inverselyrelated to its price. It implies that a rise in price of acommodity brings about a fall in its purchase and vice-versa. This happens because of income and substitutioneffects.

2. Income of the households: Other things being equal,the demand for a commodity depends upon the income ofthe household. In most cases, the larger the averageincome of the household, the larger is the quantitydemanded of a particular good.

3. Price of the related goods:Related commodities areof two types: (a) Complementary goods and (b) Completing

goods or substitutes. Complementary goods are thosegoods, which are consumed together or simultaneously. Forexample, tea and sugar, automobiles and petrol, pen andink are used together. When commodities are complements,a fall in the price of one (other things being equal) willcause the demand of the other to rise.

4. Tastes and preferences of consumers:The demandfor a commodity also depends upon tastes and preferences

of consumers and changes in them over a period of time.Goods, which are more in fashion command higher demandthan goods, which are out of fashion.

5.Other factors:I. Size of population: Generally, larger the size of

population of a country or region, greater is the demand forcommodities in general.

II. Composition of population: If there are more oldpeople in a region, the demand for spectacles, walking sticks,etc. will be high. Similarly, if the population consists of moreof children, demand for toys, baby foods, toffees, will bemore.

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III. Distribution of Income: The wealth of the countrymay be so distributed that there are a few exceptionally richpeople while the majority are exceedingly poor. Under suchconditions, the propensity to consume of the country will berelatively less, for the propensity to consume of the richpeople is less than that of the poor people. Consequently, the

demand for consumer goods will be comparatively less. If thedistribution of income is more equal, then the propensity toconsume of the country as a whole will be relatively highindicating higher demand for goods.

Apart from the above factors such as class, group,education, marital status and weather conditions, also play animportant role in influencing household demand.

Demand Function

The above listed factors can easily be presented in theform of a demand function as follows:

Qdc = f (Pc, Pr, Y, T, D,)Where Qdc is the quantity demanded of commodity c, Pc isthe price of commodity c, Pr is the price of commodities, Y isthe money income of the household, T is the taste of thehousehold, D represent size of the population and otherremaining factors.

Law of Demand

The demand for a commodity increases with fall in itsprice and decreases with the rise in its price, other thing

remaining the same. The law of demand thus merely statesthat the price and the demand of a commodity are inverselyrelated, provided all other things remain unchanged.

Assumptions of the Law of Demand:-

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1. Income level should remain constant: The law ofdemand operates only when the income level of thebuyer remains constant. If the income rises while theprice of the commodity in question does not fall, it isquite likely that the demand may increase. Therefore,stability in income is an essential condition for the

operation of the law of demand.

2. Tastes of the buyer should not change:Any changethat takes place in the tastes of the consumers will in allprobability prevent the working of the law of demand. Itoften happens that when tastes or fashions changepeople revise their preferences.

3. Price of other goods should remain constant:

Changes in the prices of other goods often affect thedemand for a particular commodity. If prices ofcommodities for which demand is inelastic rise, thedemand for a commodity other than these in allprobability will decline even though there may not be anychange in its price. Therefore, for the law of demand tooperate it is very necessary that prices of other goods donot change.

4.

No New substitutes for the commodity:If some newsubstitutes for a commodity appear in the market, itsdemand generally decline. This is quite natural, becausewith the availability of new substitutes some buyers willbe attracted towards new product and the demand forthe older product will fall even though price remainsunchanged. Hence, the law of demand operates onlywhen the market for a commodity is not threatened bynew substitutes.

5. Price rise in future should not be expected: If thebuyers of a commodity expect that its price will rise infuture they raise its demand in response to an initialprice rise. This behaviour of buyers violates the law ofdemand. Therefore, for the operation of the law ofdemand it is necessary that there must not be anyexpectations of price rise in future.

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The law of demand may be illustrated with the help of ademand schedule and a demand curve.

Demand Schedule:-The demand schedule thus shows the effect of price

changes on the quantity sold in the market to the exclusion of

all the factors.

CommodityPrice of

Commodity (Rs.)

QuantityDemanded

(Units)A 5 10B 4 15C 3 20D 2 35E 1 60

Demand Curve:-The graphical representation of the demand schedule is

the demand curve. Individual demand curve indicates thequantity of the commodity that an individual will buy atdifferent prices. It is customary in economics to measure aprice along Y axis and quantity demanded on X axis.

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Y

D

C

B

A5

4

3

2

1

010 20 30 40 50 60

Pr

ice

Quantity

X

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The curve slopes downward. Any point on the graphindicates a single price quantity relation. The whole demand

curve DD1 shows the quantity of commodity N that would bebought by an individual at different prices.

Rationale for Law of Demand: Why does demandcurve slope downwards?

1. Substitution Effects: When the price of a commodityfalls, it becomes relatively cheaper than othercommodities. It includes consumers to substitute thecommodity whose price has fallen for other commodities,

which have now become relatively expensive. The resultis that total demand for the commodity whose price hasfallen increases. This is called substitution effect.

2. Income Effects:When the price of commodity falls, theconsumer can buy the same quantity of the commoditywith lesser money or he can buy more of the samecommodity with the same money. In other words, as aresult of fall in the price of the commodity, consumers

real income or purchasing power increases. This increasein the real income includes him to buy more of thatcommodity. Thus demand for that commodity (whoseprice has fallen) increases. This is called income effect.

3. New Consumer Creating Demand:When the price ofa commodity falls, more consumers start buying itbecause some of those who could not afford to buy itpreviously may afford to buy it. This raises the number of

consumers of a commodity at a lower price and hence thedemand for the commodity in question.

Exception of the Law of Demand:-According to law of demand, more of a commodity will be

demanded at lower prices, than at higher prices, other thingsbeing equal. The law of demand is valid in most of the cases;however there are certain cases where this law does not hold

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Fig. 1: Demand Curve


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good. The following are the important exceptions to the law ofdemand.

1. Conspicuous goods: Some consumers measure theutility of a commodity by its price i.e., if the commodity isexpensive they think that it has got more utility. As such,

they buy less of this commodity at low price and more of itat high price. Diamonds are often given as example of thiscase. Higher the price of diamonds, higher is the prestigevalue attached to them and hence higher is the demand forthem.

2. Giffen goods: Sir Robert Giffen, and economist, wassurprised to find out that as the price of bread increased,the British workers purchased more bread and not less of it.

This was something against the law of demand. Why didthis happen? The reason given for this is that when theprice of bread went up, it caused such a large decline in thepurchasing power of the poor people that they were forcedto cut down the consumption of meat and other moreexpensive foods. Since bread even when its price washigher than before was still the cheapest food article,people consumed more of it and not less when its pricewent up.

Such goods which exhibit direct price-demand relationshipare called Giffen goods. Generally, those goods which areconsidered inferior by the consumers and which occupy asubstantial place in consumers budget are called Giffengoods. Examples: such goods are coarse grains like bajra,low quality of rice and wheat etc.

3. Conspicuous necessities: The demand for certaingoods is affected by the demonstration effect of the

consumption pattern of a social group to which anindividual belongs. These goods, due to their constantusage, have become necessities of life. For example, inspite of the fact that the prices of television sets,refrigerators, coolers, cooking gas etc. have beencontinuously rising, their demand does not show anytendency to fail.

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4. Future expectations about prices: It has beenobserved that when the price are rising, householdsexpecting that the prices in the future will be still higher,tend to buy larger quantities of the commodities. Forexample, when there is wide-spread drought, people expectthat prices of food-grains would rise in future. They demand

greater quantities of food-grains as their price rise.

5. Impulsive purchases: At times consumers tend tomake impulsive purchases without any cool calculationsabout price and usefulness of the product and in suchcontexts the law of demand fails.

6. Ignorance effect: Generally, it is assumed thathouseholds have perfect knowledge about price and quality

of goods. However, in practice, a household may demandlarger quantity of a commodity even at a higher pricebecause it may be ignorant of the ruling price of thecommodity.

Demand Analysis

Meaning of Demand Analysis:-There are a large number of factors, which have a direct

impact on the demand of a commodity or service. Demandanalysis means the study of factors, which influence thedemand of a commodity or service. It is only on the basis ofthese factors or determinants of demand one can forecastdemand. Under demand analysis we study elasticity ofdemand and methods of its measurement, sales forecasts anddifferent methods to forecast sales or demand, manipulating

demand and appropriate change in allocation of resources.Analysis of demand enables the producer to adjust hisproduction to the demand to maximize the objective function.

Economists have developed several techniques ofanalyzing demand. Econometricians have tested some of thepropositions underlying the economic theory of demand asdeveloped by the economists. Of late, in the name of

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psychological economics, the behavioral scientists haveattempted explanation as well as psychometric measure ofconsumers behavior. Following are the approaches foranalyzing the demand:

1. Marginal Utility (Neo-Classical)Approach:-

It is a traditional approach used by Marshall andJevonsto explain the consumer behavior. Consumers demand

commodity because they derive or expect utility from theconsumption of that commodity. The utils (utility-content ofproduct) indicate value-in-use and they command price inthe market; the price paid indicates the value-in-exchange.Sometimes we observe that products with tremendous value-

in-use do not command any value-in-exchange i.e., thoseare free goods like air, water available in plenty at noprice because there is no scarcity. Utility along with scarcitydetermines price. Diamond is not that useful, but being rare itis very valuable; therefore, such economic goods commanda high price.

Economists assume that the utils are cardinallymeasurable and comparable in terms of a measuring unit ofmoney, provided the utility of that money is held constant. A

consumer, while purchasing a commodity often compares hissacrifice (in terms of price paid0, i.e., value-in-exchange with

his satisfaction. If price exceeds marginal utility, hereduces his purchase. If marginal utility exceeds price,he enhances his purchase. Ultimately when price equalsmarginal utility, he is in an equilibrium state of hispurchase decision.

Marginal utility of productMarginal Utility of money spent =---------------------------------------

Price of the product

MUx [MUm = ----------]

Px

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2. Indifference Curve (Ordinal Utility)Approach:-

This approach has been developed by the economists likeHicks and Allen to overcome some of the limitations of Neo-Classical approach. Assuming ordinal measurement of utility

and relatedness of goods and relaxing the assumption ofconstant marginal utility of money, the technique ofindifference analysis has been developed.

We start with a multi-commodity consumer rather than asingle commodity consumer, typical of traditional utilityapproach. Thus, the utility function is stated as: U = U (X, Y)where x and y stand for two products.

The consumer wants to purchase of combination of x(say, cereals) and y (say, vegetables). With given resourcesand given need, whenever he buys more of x he has to besatisfied with less of y. The rate at which this substitutiontakes place is termed as the Marginal Rate of Substitution,MRS which measures the slope of the Indifference curve

Y dY MRSxy = ---------- OR -------

X dX

Even if the consumer moves from combination A to Bthere is no change in his satisfaction level, because theutility-content of the bundle as a whole is intact; more of xmay reduce the utility of x, but less of y may have increased

the utility of y. This follows from the Law of DiminishingUtility. Each indifference curve can, therefore, be treated asan iso-utility curve.

3. Revealed Preference Approach:-Indifference curve analysis is a powerful tool, but beyond

a point it cannot be stretched. Today, the businessmen haveto understand the buyers behavior from the standpoint ofmore of psychology than of economics.

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A consumer buys a combination of x and y; his choicetakes care of his preferences as well as his constraints.What is desirable may not always be available and feasible.Therefore while choosing, he balanced the two. Does thischoice reveal his preference? Yes it does, provided thefollowing axioms are satisfied:

1. Choice set is complete. Before the buyer exercises hischoice, he takes into account all available choices.

2. Choice is rational. Rationality on the part of thechooser implies that he is never satisfied (non-satisfied) and that he wants to get the bestsatisfaction out of his least scarifies.

3. Choice is optimal. Optimally means that either hemaximizes his satisfaction or he minimizes hissacrifice, if there is no constraint.

4. Choice is strongly ordered.

5. Choice is transitive.

6. Choice is consistent.

It the above axioms are satisfied, then only Choicereveals preference. It should now be clear that the demandanalyst cannot use terms like demand, need preference,ordering, choice, etc., interchangeably.

Objectives of Demand Analysis:-1. To study and analyze the determinants of demand.2. To measure the elasticity of demand.

3. To prepare sales or demand forecasts.4. Manipulating demand.5. To make appropriate changes in allocation of resources.

Conclusion

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Demand implies a desire for a commoditybacked by the ability and willingness to pay forit.

The Law of Demandholds that other things equal, asthe price of a good or service rises, its quantity

demanded will fall, and vice versa.

A Demand Curve is a graphical depiction of the lawof demand. It has a negative slope.

A change in price results in a movement along afixed demand curve. A change in any variable other thanprice that influences quantity demanded produces a shiftin the demand curve.

A shift in the demand curve to the right (left) resultsin a higher (lower) equilibrium price and quantity.

The demand curve shifts to the right when incomesrise, population increases, preferences increase, theprice of a substitute rises, or the price of a complementfalls.

Under Demand Analysis we study elasticity ofdemand and methods of its measurement, sales forecastsand different methods to forecast sales or demand,manipulating demand and appropriate change inallocation of resources. Analysis of demand enables theproducer to adjust his production to the demand tomaximize the objective function.

BibliographyS.No.

Book Name Author PublisherPageNo.

1. Business Economics 178 182, 199

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- 208

2.Managerial

Economics

D. N.

Dwivedi

VikasPublishing

House Pvt.Ltd.

104,115,120

126, 131

133,153,160 163

3. www.Wikipedia.org - - -

4.www.OnlineTexts.com

- - -

5.http://www.bized.co.uk

- - -

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