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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.
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