Demand + Analysis

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Demand Analysis

Dr. Utpal ChattopadhyayAsst. Professor,NITIE, Mumbai

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Meaning of Demand

• Desire to buy• Willingness to pay• Ability to pay

Effective Demand has to fulfill three basic characteristics

Demand for a commodity has always reference to:

•A Price

•A Period of time

•A Place

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Types of Demand

Demand for Consumers’ & Producers’ Goods

Demand for Perishable & Durable Goods

Autonomous & Derived Demand

Individual & Market Demand Firm & Industry Demand Short-term & long-term

Demand Domestic & Overseas Demand

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Factors affecting Demand

Price of goods:o Own Price o Prices of related products

Prices of substitute goods Prices of complementary goods

Income of consumers Consumers’ tastes & preferences Future Expectations

o Incomeo Price

No. of consumers Distribution of consumers

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Demand Function

A Typical demand function:

Dx= f (Px,Py, I, T,E,C,u)

Dx= Demand for good XPx= Price of good XPy= Price of other goodsI= IncomeT= Tastes & preferencesE= Future expectationsC= No. of consumers & their distributionu=residual factors

A simplified version:

Dx= f (Px)

with ceteris paribus assumption

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Demand Curve

Price

Quantity

P1

P2

P3

Demand

Q1 Q3Q2

D

D

A Demand curve shows the amount of the commodity buyers would like to purchase at different prices. It depends on prices (own as well as related commodities), income, tastes and no. of consumers.

D = F (P) with tastes, incomes, prices of other goods and no. of consumers etc. held constant.

Law of Demand says ‘More (less) will bought at lower (higher) price.’

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Supply Curve

A Supply curve shows the amount of the commodity sellers would like to offer at various prices. It depends on product price, input prices and technology.

S = F (P) with input prices and technology held constant.

Quantity

Price

Q1 Q2 Q3

P3

P2

P1

S

S

‘Quantity supplied increases as the price increases ‘

Supply

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Equilibrium Price

Quantity

Price

S

S

D

D

Qe

Pe

Equilibrium price is that price where the quantity demanded equals the quantity supplied (market clearing price). In the short run market price may not equal equilibrium price. But in the long run market price approximates the equilibrium price

Equilibrium Price

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Market Mechanism

Quantity

Price

S

S

D

D

Qe

Pe

When market price (Pm1) is above equilibrium price (Pe) there is Excess Supply (or Surplus). Producers reduce price. Quantity demanded increases and quantity supplied decreases. Market continues to adjust until Pe is reached.

Excess Supply

Excess Demand

When Pm2 < Pe, there is Excess Demand (or shortages) in the market. This puts upward pressure on price and it continues to rise till price reaches to Pe.

Pm1

Pm2

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Stability of Equilibrium

Walarasian Vs. Marshallian Stability

Stability of a market based on price adjustment is called Walrasian Stability, while the one based on quantity adjustment is called Marshallian Stability

Quantity

Price

Pe

Qe

S

S

D

D

Q1

Pd

Ps

Market Equilibrium

At Q1, demand price (Pd) exceeds supply price (Ps). Thus more of the commodity will be made available in the market until Q reaches Qe. This is ‘Marshallian Stability’.

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Change in Demand

Extension/contraction in demand (movement along a demand curve)

caused by changes in own price

Increase/ decrease in demand (shift in demand curve)

caused by changes in other determinants of demand

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Movement along a Demand Curve

Dx

Dx

P1

D1

Price

Quantity

P2

D2

P3

D3

Income and Substitution Effects of a (own) price change

Impact of change in own price on demand

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Shifts in Demand Curve

S

S

D1

D3

D2

D3

D2

D1

Quantity

Price

P2

P1

P3

Q3 Q2Q1

An rightward/upward (leftward/downward) shift in demand curve results in an increase (decrease) in equilibrium price.

Factors affecting shifts in Demand

•Income

•Price of related goods

•Consumers’ tastes & preferences

•Expectations

•Others (bandwagon effect )

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Change in Income & Demand

For normal (superior) goods, if income increases demand also increases

For inferior goods, demand falls when income increases (why?)

What is a Giffen good?• An inferior good for which a rise in

its price makes people buy even more of that good

• This is because for such goods a strong income effect outweighs the substitution effect of a price change

• Law of Demand does not hold good in case of Giffen goods (Other exceptions to the Law include: luxury/ status goods, expectations on future prices etc.)

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Engel Curve

Named after the 19th century German Statistician Ernst Engel

It shows how the quantity demanded of a good changes with change in consumers’ income level

It states that the lower a family’s income, the greater is the proportion of it spent on food

The conclusion was based on a budget study of 153 Belgian families

For normal goods, the Engel curve has a positive slope. That is, as income increases, the quantity demanded increases. For inferior goods , the Engel curve has a negative slope, meaning that as a consumer earns more income, he/she will be able to buy better goods and thus stop buying the inferior goods

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Change in Prices of Related Goods & Demand

For substitute goods, if price of one good (say X) increases demand for the other (say Y) also increases

In case of complementary goods, if price of one good (say A) increases demand for the other (say B) falls

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Shifts in Supply

S1

S1

D1S3

S2

D1

Quantity

Price

P3

P1P2

Q3 Q2Q1S2

S3

An rightward (leftward) shift in supply curve results in an decrease (increase) in equilibrium price.

Factors affecting shifts in supply

•Input Prices

•Technology

•Price of substitutes

•Taxes

•Market speculation

•No. of firms

•Others (e.g. weather for agricultural products)

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Simultaneous Shifts in Demand and Supply

D1

D1

S1

S1

Q1

P1

Q2

P1”

D2

D2

S2

S2

E1E2

P1’

Q1’ Q1”

A hypothetical case where both demand and supply shift rightward.