ECON 2: Managerial Economics
Demand
and Supply
Analysis
Prepared by Group 1
Objectives
Understand the concept of demand and supply
functions;
Identify the factors that influence demand and supply;
Familiarize with the mechanics of demand as well as
supply;
Discuss the different types of demands and supply;
Differentiate the elasticity of demand and elasticity of
supply;
Introduction
The concepts of demand and supply are useful for explaining what is happening in the
market place. Every market transaction involves an exchange and many exchanges are undertaken in
a single day. The circular flow of economic activity explains clearly that every day there are a
number of exchanges taking place among the major sectors.
A market is a place where we buy and sell goods and services. A buyer demands goods and
services from the market and the sellers supply the goods in the market. In economics, demand is
“the quantity of goods and services that will be bought for a given price over a period of time”.
This chapter describes demand and supply which is the driving force behind a market
economy. This is one of the most important managerial factors because it assists the managers in
predicting changes in production and input prices. The manager can take better decisions regarding
the kind of product to be produced, the quantity, the cost of the product and its selling price. Let us
understand the concept of demand and its importance in decision making.
DEMAND:
DEMAND SCEDULE:
The ability and willingness to buy a
Table 1 – The Demand Schedule for Coke
specific quantity of a commodity at the
prevailing price in a given period of time.
Therefore, demand for a commodity implies
the desire to acquire it, willingness and the Price of Coke Quantity Demand
ability to pay for it. 50 1
45 2
40 3
35 4
DEMAND SCHEDULE: 30 5
A table showing the quantities of a good 25 6
that a consumer is willing and able to buy at
20 7
the prevailing price in a given time period.
15 8
10 9
DEMAND CURVE:
A curve indicating the total quantity of a LAW ON DEMAND:
product that all consumers are willing and The quantity of a commodity demanded in
able to purchase at the prevailing price level, a given time period increases as its price falls,
holding the prices of related goods, income ceteris paribus. (I.e. other things remaining
and other variables as constant. constant).
A demand curve is a graphical representation
of a demand schedule.
60
50
40
The demand curve, (DD) is downward
sloping curve from left to right showing that
30
as price falls, quantity demanded rises.
20
10
This inverse relationship between price
0 and quantity is called as the law of demand.
1 2 3 4 5 6 7 8 9
Y
SHIFTS IN DEMAND:
Price
Shift of the demand curve occurs when Extension of Demand
the determinants of demand change. When P a
tastes and preferences and incomes are P2
P1
b
c
altered, the basic relationship between price Contraction of Demand
and quantity demanded changes (shifts). X
Q Q2 Q1
0 Quantity Demand
Y
EXTENSION AND CONTRACTION OF
Increase in Demand DEMAND CURVE:
When with a fall in price, more of a
Price
commodity is bought, then there is an
Decrease in D1 extension of the demand curve. When lesser
D
Demand
quantity is demanded with a rise in price,
D2
there is a contraction of demand.
0 Quantity Demand X
DEMAND FUNCTION is a function that describe how much of a commodity will be
purchased at the prevailing prices of that commodity and related commodities, alternative income
levels, and alternative values of other variables affecting demand.
Price is not the only factor which determines the level of demand for a good. Other
important factor is income. The rise in income will lead to an increase in demand for a normal
commodity. A few goods are named as inferior goods for which the demand will fall, when income
rises. Another important factor which influences the demand for a good is the price of other goods.
Other factors which affect the demand for a good apart from the abovementioned factors are:
Changes in Population
Changes in Fashion
Changes in Taste
Changes in Advertising
A Change in Demand occurs when one or more of the determinants of
demand change and it is expressed in the following equation:
𝑄𝑑 𝑋 = 𝑓(𝑃𝑥 , 𝑃𝑟 , 𝑌, 𝑇, 𝐸𝑦 , 𝐸𝑝 , 𝐴𝑑 … )
Where,
𝑄𝑑 𝑋 = 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑜𝑓 𝑔𝑜𝑜𝑑
𝑃𝑥 = 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑋
𝑃𝑟 = 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑟𝑒𝑙𝑎𝑡𝑒𝑑 𝑔𝑜𝑜𝑑
𝑌 = 𝑖𝑛𝑐𝑜𝑚𝑒 𝑙𝑒𝑣𝑒𝑙 𝑜𝑓 𝑎 𝑐𝑜𝑠𝑡𝑢𝑚𝑒𝑟
𝑇 = 𝑡𝑎𝑠𝑡𝑒 𝑎𝑛𝑑 𝑝𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒𝑠 𝑜𝑓 𝑡ℎ𝑒 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑟𝑠
𝐸𝑦 = 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒
𝐸𝑝 = 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑝𝑟𝑖𝑐𝑒
𝐴𝑑𝑣 = 𝑎𝑑𝑣𝑒𝑟𝑡𝑖𝑠𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡
Determinants of Demand
There are various factors affecting the demand for a commodity. They are:
o Price of Good
o Price of related goods
o Consumer’s Income
o Taste, preference, fashions and habits
o Population
o Money in Circulation
o Value of Money
o Weather Condition
o Advertisement and Salesmanship
o Consumer’s future price expectation
o Government policy (taxation)
o Credit facilities
o Multiplicity of uses of goods
Demand Distinctions: Types of Demand
DIRECT and INDIRECT DEMAND:
DURABLE and NON-DURABLE
Demand for goods that are directly used
DEMAND:
for consumption by the ultimate consumer is
Durable goods are those that can be used
known as direct demand. On the other hand,
more than once, over a period of time. Non-
demand for goods that are used by producers
durable goods can be used only once.
for producing goods and services.
DERIVED and AUTONOMOUS
DEMAND: FIRM and INDUSTRY DEMAND:
When a produce derives its usage from Firm demand is the demand for the
the use of some primary product it is known product of a particular firm. The demand for
as derived demand. Autonomous demand is the product of a particular industry is
the demand for a product that can be industry demand.
independently used.
Demand Distinctions: Types of Demand
TOTAL MARKET and MARKET JOINT and COMPOSITE DEMAND:
SEGMENT DEMAND: When two goods are demanded in
A particular segment of the markets conjunction with one another at the same
demand is called as segment demand. The time to satisfy a single want, it is called as
sum total of the demand for laptops by joint or complementary demand. A composite
various segments in India is the total market demand is one in which a good is wanted for
demand. . several different uses.
SHORT RUN and LONG RUN DEMAND: PRICE, INCOME and CROSS DEMAND:
Short run demand refer to demand with Demand for commodities by the consumers at
its immediate reaction to price changes and alternative prices are called as price demand.
income fluctuations. Long run demand is that Quantity demanded by the consumers at
which will ultimately exist as a result of the alternative levels of income is income demand.
changes in pricing, promotion or product Cross demand refers to the quantity demanded of
improvement after-market adjustment with commodity ‘X’ at a price of a related commodity ‘Y’
sufficient time. which may be a substitute or complementary to X.
MARKET DEMAND:
PRICE DEMAND:
The total quantity of a good or service
The ability and willingness to buy
that people are willing and able to buy at
specific quantities of a good at the
prevailing prices in a given time period. It is
prevailing price in a given time period.
the sum of individual demands.
CROSS DEMAND:
The ability and willingness to buy a
INCOME DEMAND:
commodity or service at the prevailing price
The ability and willingness to buy a
of the related commodity i.e. substitutes or
commodity at the available income in a given
complementary products. For example,
period of time.
people buy more of wheat when the price of
rice increases.
Exceptional demand curve: The demand curve slopes from left
to right upward if despite the increase in price of the commodity, people tend to buy more
due to reasons like fear of shortages or it may be an absolutely essential good. The law of
demand does not apply in every case and situation. The circumstances when the law of
demand becomes ineffective are known as exceptions of the law.
Some of these important exceptions are as under:
1. Giffen Goods 7. Changes in Fashion
2. Conspicuous Consumption / Veblen 8. Demonstration Effect
Effect 9. Snob Effect
3. Conspicuous Necessities 10. Speculative Goods/ Outdated Goods/
4. Ignorance Seasonal Goods
5. Emergencies 11. Seasonal Goods
6. Future Changes in Prices 12. Goods in Short Supply
elasticity of Demand
is a technical term used by economists to describe the degree of
responsiveness of the demand for a commodity due to a fall in its price. A fall in
price leads to an increase in quantity demanded and vice versa
The elasticity of demand may be as follows:
o Price Elastic
o Income Elasticity
o Cross Elasticity
price elasticity: The price elasticity of demand is measured by dividing the
percentage change in quantity demanded by the percentage change in price.
price elasticity= Proportionate change in the Quantity Demanded
/ Proportionate change in price
Percentage change in quantity demanded
= -----------------------------------------------
Percentage change in price
ΔQ / Q 10
= --------- = -------- = 0.5
ΔP / P 20
ΔQ = change in quantity demanded
ΔP = change in price
P = price
Q = quantity demanded
the determinants of price elasticity of demand:
The exact value of price elasticity for a commodity is determined by a wide variety of
factors. The two factors considered by economists are the availability of substitutes and
time. The better the substitutes for a product, the higher the price elasticity of demand. The
longer the period of time, the more the price elasticity of demand for that product. The
price elasticity of necessary goods will have lower elasticity than luxuries.
The elasticity of demand depends on the following factors:
1. Nature of the commodity 6. Urgency of demand/ postponement of
2. Extent of use purchase
3. Range of substitutes 7. Durability of a commodity
4. Income level 8. Purchase frequency of a product/
5. Proportion of income spent on the recurrence of demand
commodity 9. Time
income elasticity: Income elasticity of demand measures the responsiveness
of quantity demanded to a change in income. It is measured by dividing the percentage change in
quantity demanded by the percentage change in income.
The following are the various types of income elasticity:
o Zero Income Elasticity
o Negative Income Elasticity
o Unitary Income Elasticity
o Income Elasticity is Greater than 1
o Income Elasticity is Less than 1
Various Types of income elasticity
Zero Income Elasticity:
Negative Income Elasticity:
The increase in income of the
The increase in the income of consumers
individual does not make any difference in
leads to less purchase of those goods.
the demand for that commodity.
Unitary Income Elasticity: Income Elasticity is Greater than 1:
The change in income leads to the same The change in income increases the
percentage of change in the demand for the demand for that commodity more than the
good. change in the income.
Various Types of income elasticity
Income Elasticity is Less than 1:
The change in income increases the
demand for the commodity but at a lesser
percentage than the change in the Income.
cross elasticity:
Cross elasticity measures the responsiveness of the quantity demanded of a
commodity due to changes in the price of another commodity.
The responsiveness of the quantity of one commodity demanded to a change in the
price of another good is calculated with the following formula:
% change in demand for commodity A
Ec = ---------------------------------------------------
% change in price of commodity B
significance of elasticity of demand:
The concept of elasticity is useful for the managers for the following decision-making activities
1. In production i.e. in deciding the quantity 5. In foreign exchange
of goods to be produced 6. For nationalizing an industry
2. Price fixation i.e. in fixing the prices not 7. In public finance
only on the cost basis but also on the basis
of prices of related goods.
3. In distribution i.e. to decide as to where,
when, and how much etc.
4. In international trade i.e. what to export,
where to export
Supply function:
SUPPLY: a commodity refers to the various quantities of the commodity which a seller is willing and
able to sell at different prices in a given market at a point of time, other things remaining the same.
Supply is what the seller is able and willing to offer for sale. The Quantity supplied is the amount of a
particular commodity that a firm is willing and able to offer for sale at a particular price during a given
time period.
Law of Supply:
Supply Schedule: is the relationship between price of the
is a table showing how much commodity and quantity of that commodity
of a commodity, firms can sell at supplied. i.e. an increase in price will lead to
differentprices. an increase in quantity supplied and vice
versa.
Supply Curve:
a graphical representation of how much of a
commodity a firm sells at different prices. The
supply curve is upward sloping from left to
right. Therefore the price elasticity of supply
will be positive.
1. The cost of factors of production: Cost depends on the price of factors. Increase in factor
cost increases the cost of production, and reduces supply.
2. The state of technology: Use of advanced technology increases productivity of the
organization and increases its supply.
3. External factors: External factors like weather influence the supply. If there is a flood, this
reduces supply of various agricultural products.
4. Tax and subsidy: Increase in government subsidies results in more production and higher
supply.
5. Transport: Better transport facilities will increase the supply.
6. Price: If the prices are high, the sellers are willing to supply more goods to increase their
profit.
7. Price of other goods: The price of other goods is more than ‘X’ then the supply of ‘X’
will be increased.
elasticity of supply: Elasticity of supply of a commodity is defined
as the responsiveness of a quantity supplied to a unit change in price of that commodity.
ΔQs / Qs
Es = -----------------
ΔP / P
ΔQs = change in quantity supplied
Qs = quantity supplied
ΔP = change in price
P = price
Kinds of supply elasticity
Price elasticity of supply:
Perfectly inelastic:
Price elasticity of supply measures
If there is no response in supply to a
the responsiveness of changes in quantity
change in price. (Es = 0)
supplied to a change in price.
Inelastic supply: Unitary elastic:
The proportionate change in supply The percentage change in quantity
is less than the change in price supplied equals the change in price
(Es =0 1) (Es=1)
Kinds of supply elasticity
Elastic: Perfectly elastic:
The change in quantity supplied is Suppliers are willing to supply any
more than the change in price (Ex= 1- ∞) amount at a given price (Es=∞)
Factors influencing elasticity of supply
1. Nature of the commodity:
If the commodity is perishable in nature then the elasticity of supply will be less. Durable goods have
high elasticity of supply.
2. Time period:
If the operational time period is short then supply is inelastic. When the production process period is
longer the elasticity of supply will be relatively elastic.
3. Scale of production:
Small scale producer’s supply is inelastic in nature compared to the large producers.
4. Size of the firm and number of products:
If the firm is a large-scale industry and has more variety of products then it can easily transfer the
resources. Therefore, supply of such products is highly elastic.
5. Natural factors:
Natural calamities can affect the production of agricultural products so they are relatively inelastic.
6. Nature of production:
If the commodities need more workmanship, or for artistic goods the elasticity of supply will be high.
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