Demand Supply Analysis Demand Demand effective desire Demand

Demand Supply Analysis

Demand § Demand: effective desire § Demand is that desire which backed by willingness and ability to buy a particular commodity. § Amount of the commodity which consumers are willing to buy per unit of time, at that price. § Things necessary for demand: § Time § Price of the commodity § Amount (or quantity) of the commodity consumers are willing to purchase at the price

Types of Demand § Direct and Derived Demand § Direct demand is for the goods as they are such as Consumer goods § Derived demand is for the goods which are demanded to produce some other commodities; e. g. Capital goods § Recurring and Replacement Demand § Recurring demand is for goods which are consumed at frequent intervals such as food items, clothes. § Durables are purchased to be used for a long period of time § Wear and tear over time needs replacement § Complementary and Competing Demand § Some goods are jointly demanded hence are complementary in nature, e. g. software and hardware, car and petrol.

Determinants of Demand § Price of the product § Single most important determinant § Negative effect on demand § Higher the price-lower the demand § Income of the consumer § Normal goods: demand increases with increase in consumer’s income § Inferior goods: demand falls as income rises § Price of related goods § Substitutes § If the price of a commodity increases, demand for its substitute rises. § Complements

Determinants of Demand Contd… § Tastes and preferences § Very significant in case of consumer goods § Expectation of future price changes § Gives rise to tendency of hoarding of durable goods § Population § Size, composition and distribution of population will influence demand § Advertising § Very important in case of competitive markets

Demand Function § Interdependence between demand for a product and its determinants can be shown in a mathematical functional form § Dx = f(Px, Y, Py, T, A, N) § Independent variables: Px, Y, Py, T, A, N § Dependent variable: Dx § Px: Price of x § Y: Income of consumer § Py: Price of other commodity § T: Taste and preference of consumer § A: Advertisement

Law of Demand § A special case of demand function which shows relation between price and demand of the commodity Dx = f(Px) § Other things remaining constant, when the price of a commodity rises, the demand for that commodity falls or when the price of a commodity falls, the demand for that commodity rises. § Price bears a negative relationship with demand §

Demand Schedule and Individual Demand Curve Price (Rs per cup) Demand (‘ 000 cups) a 15 50 b 20 40 c 25 30 d 30 20 e 35 10 e 35 Price of Coffee Point on Demand Curve d 30 c 25 b 20 a 15 O 10 20 40 50 30 Quantity of coffee

Shift in Demand Curve Price n Shift in demand curve from D 0 to D 1 n More is demanded at same D 1 D 2 D 0 P 0 Q 2 Q Q 1 Quantity price (Q 1>Q) n Increase in demand caused by: n A rise in the price of a substitute n A fall in the price of a complement n A rise in income n A redistribution of income towards those who favour the commodity n A change in tastes that favours the commodity n Shift in demand curve from D 0 to D 2 n Less is demanded at each price (Q 2<Q)

Exceptions to the Law of Demand Law of demand may not operate due to the following reasons: § Giffen Goods § Snob Appeal § Demonstration Effect § Future Expectation of Prices (Panic buying) § Addiction § Neutral goods § Life saving drugs § Salt § Amount of income spent § Match box

Market Demand § Market: interaction between sellers and buyers of a good (or service) at a mutually agreed upon price. § Market demand § Aggregate of individual demands for a commodity at a particular price per unit of time. § Sum total of the quantities of a commodity that all buyers in the market are willing to buy at a given price and at a particular point of time (ceteris paribus) § Market demand curve: horizontal summation of individual demand curves

Supply • Indicates the quantities of a good or service that the seller is willing and able to provide at a price, at a given point of time, other things remaining the same. • Supply of a product X (Sx) depends upon: – Price of the product (Px) – Cost of production (C) – State of technology (T) – Government policy regarding taxes and subsidies (G) – Other factors like number of firms (N) • Hence the supply function is given as:

Law of Supply § Law of Supply states that other things remaining the same, the higher the price of a commodity the greater is the quantity supplied. § Price of the product is revenue to the supplier; therefore higher price means greater revenue to the supplier and hence greater is the incentive to supply. § Supply bears a positive relation to the price of the commodity. Supply Schedule Price (Rs. Per cup) 15 20 25 30 35 Supply (‘ 000 cups per month) 10 20 30 45 60 Price of Coffee Point on Supply Curve a b c d e Supply Curve 35 e 30 25 c 20 b 15 0 d a 10 20 30 40 50 60 Quantity of Coffee

Change in Supply Price S 2 S 0 S 1 P O Q 2 Q 0 Q 1 Quantity § Shift in the supply curve from S 0 to S 1 § More is supplied at each price (Q 1>Q 0) § Increase in supply caused by: § Improvements in the technology § Fall in the price of inputs § Shift in the supply curve from S 0 to S 2 § Less is supplied at each price (Q 2<Q 0) § Decrease in supply caused by: § A rise in the price of inputs § Change in government policy (VAT)

Market Equilibrium § Equilibrium occurs at the price where the quantity demanded and the quantity supplied are equal to each other. § At point E demand is equal to supply hence 25 is equilibrium price Price S 25 E D O 30 Quantity Demand (‘ 000 cups/ month) Price (Rs) Supply (‘ 000 cups/ month) 15 10 50 20 15 40 25 30 30 30 45 15 35 70 10

Market Equilibrium § For prices below the equilibrium, Quantity demanded exceeds quantity supplied (D>S) – Price pulled upward § For prices above the equilibrium, Quantity demanded is less than quantity supplied (D<S) – Price pulled downward. Price § At point E demand is equal to supply hence 25 is equilibrium price. S 30 25 E 20 D O 30 Quantity Price (Rs) Supply (‘ 000 cups/ month) Demand (‘ 000 cups/ month) 15 10 50 20 15 40 25 30 30 30 45 15 35 70 10

Changes in Market Equilibrium (Shifts in Supply Curve) n The original point of equilibrium is n n at E, the point of intersection of curves D 1 and S 1, at price P and quantity Q An increase in supply shifts the supply curve to S 2 Price falls to P 2 and quantity rises to Q 2, taking the new equilibrium to E 2 A decrease in supply shifts the supply curve to S 0. Price rises to P 0 and quantity falls to Q 0 taking the new equilibrium to E 0 Thus an increase in supply raises quantity but lowers price, while a decrease in supply lowers quantity but raises price; demand being unchanged Price S 0 S 1 D 1 P 0 P P 2 S 2 E 0 E S 0 E 2 S 1 S 2 O D 1 Q 0 Q Q 2 Quantity

Changes in Market Equilibrium (Shifts in Demand Curve) • The original point of equilibrium is at E, the point of intersection of curves D 1 and S 1, at price P and quantity Q Price D 2 • S 1 D 0 E P P* • E 2 D 2 S 1 O • Price rises to P 1 and quantity rises to Q 1 taking the new equilibrium to E 1 P 1 D 0 Q* Q Q 1 An increase in demand shifts the demand curve to D 2 • Price falls to P* and quantity falls to Q* taking the new equilibrium to E 2. D 1 Quantity A decrease in demand shifts the demand curve to D 0 • Thus, an increase in demand raises both price and quantity, while a decrease in demand lowers both price and quantity; when supply remains same.

Change in Both Demand Supply Price D 2 • Initial equilibrium is at E 1, with price quantity combination (P 1, Q 1). D 2 D 1 S 2 P 1 E 1 S 1 O S 2 – demand curve shifts to the right from D 1 to D 2 – supply curve also shifts to the right from S 1 to S 2. E 2 E 0 D 1 Q 1 • An increase in both demand supply takes place; Q 2 D 2 – The new equilibrium is at E 2, and price quantity is (P 2, Q 2). • An increase in both supply and demand will cause the sales to rise, but Quantity – the price will increase if increase in D>S (as at E 2 ) – No change in price if increase in

Summary • Demand is defined as the desire to acquire a commodity to satisfy human wants, which is backed by ability to pay the price. • Categories of demand are made on the basis of the nature of commodity demanded (consumer goods and capital goods); time unit for which it is demanded (short run and long run); relation between two goods (substitutes and complements), etc. • The law of demand states that the consumers will buy more of the commodity when prices are high and less when prices are low, provided all the other factors of demand remains constant. • Demand for a product X (Dx) is a function of price of the commodity X (Px), income of the consumer (Y), price of related (substitutes or complements) commodities (Po), tastes and preference of the consumer (T), advertising (A), future expectations (Ef), population and economic growth (N). • A change in quantity demanded denotes movements along the demand curve due to a change in price, while a change in demand denotes a rightwards or leftward shift of the demand curve due to a change in the

Summary • Supply is defined as the willingness to produce and sell the commodity by production units or firms. • The law of supply states that firms will sell more of the commodity when prices are high and less of the commodity when prices are low provided all the other factors of supply remains constant. • Supply of a product X (Sx) is a function of price of the product (Px), cost of production (C), state of technology (T), Government policy regarding taxes and subsidies (G), other factors like number of firms (N). • Change in quantity supplied refers to movements along the same supply curve due to change in the price of the commodity. However when change in supply is associated with change in the factors like costs of production, technology, etc. it causes a shift of the supply curve upwards or downwards • Market equilibrium occurs where demand supply are equal. This equilibrium determines the price in the market through the forces of demand supply. Comparative statics is the process of comparison between two equilibrium situations. • An increase in both supply and demand will cause the sales to rise, but the effect on price can be positive, negative or equal to zero, depending on the extent of the shifts in the demand supply curves.