SHAH SIR’S

ARIHANT COMMERCE CAREER ACADEMY

-a step towards excellence
Campus 1: C/o Mahatma Fule School, Mudholkar Peth, Amravati.
Campus 2: Raghunandan Terminal, Opp. Govt. Polytechnic,Amravati.

Class: - MBA 1st 1SEM Subject:- MANAGERIAL ECONOMICS

Demand Analysis

Q1. Define Demand

Ans- Meaning-
 In ordinary language, demand means a desire. Desire means an urge to have something.
 In Economics, demand means a desire which is backed by a willingness and ability to pay.
For example, if a person has the desire to purchase a television set but does not have adequate
purchasing power then it will be simply a desire and not a demand.
Thus, demand is an effective desire. All desires are not demand.
 Effective demand for a thing depends on -
1. Desire
2. Means to purchase (Ability to pay)
3. Willingness to use those means for that purpose (Willingness to pay)
 In short, Demand = Desire + Willingness to Purchase + Ability to Pay.

Definition-
 According to Benham, “the demand for anything at a given price is the amount of it, which
will be bought per unit of time at that price.”
Thus, following are the features of demand :
1) Demand is a relative concept.
2) Demand is essentially expressed with reference to time and price.
 In the, words of Waugh, “The demand for any commodity is the relationship between the
price and the quantity that will be purchased at that price.”
 Prof. Mill has expressed: “We must mean by the word demand the quantity demanded and
remember that this is not a fixed quantity but in general varies according to value.”

Q2. What are determinants of demands ?

Ans- The important factors that determine the demand are given below.
I. Price of the commodity –
Ceteris paribus i.e. other thing being equal, the demand for a commodity is inversely
related to its price. It implies that a rise in the price of of a commodity brings about a fall
in the quantity purchased and vise versa.
II. Price of releated commodities –
Related commodities are of two types
a. Complementary goods and
 b. Competing goods or substitute.

a) Complementary goods –
A fall in the price of one ( other thing being equal ) will cause the demand for the
other to rise. Thus, we find that , there is an inverse releation between the demand for goods and
the price of its complement.
b) Competing goods or substitute –
A fall in the price of one (ceteris paribus) leads to fall in the quantity demanded of
its substitutes . Therefore , there is direct or positive relation between the demand for a product
and the price of its substitues.
III. Income of the consumer -
Other thing being equal , the demand for a commodity depends upon the money
income of the consumer . In most cases , the larger the average money income of the
consumer, the larger is the quantity demanded of a particular good.
IV. Tastes and preference of consumers –
The demand for a commodity also depends upon the tastes and preferences of the
consumers and changes in them over a period of time.Goods which are modern or more
in fashion command higher demand than goods which are of old design and out of
fashion. Consumer may perceive a product as obsolete and discard it before it is fully
utilized and prefer another good which is currently in fashion .
 Demonstration effect or bandwagon effect:
Plays an import role in determining the demand for a product . An individual’s
demand for LCD/LED television may be affected by his seeing one in his
neighbour’s or friend’s house, either because he likes what he sees or because he
figures out that if his neighbor or friend can afford it, he too can.
 Snob effect:
A person may develop a taste or preference for wine after tasting some, but he
may also develop it after discovering that serving it enhances his prestige. On the
contrary , when a product becomes common among all , some people together
stop its consumption.
 Veblen effect:
Highlyb priced goods are consumerd by status seeking rich bpeopleto satisfy their
needs for conspicuous consumption (named after the American Economist ,
V. Consumers’ expectations –
Consumers, expectations regarding future price , income , supply conditions etc.
influence current demand . If the consumers expect increase in future prices, increase in
income and shortages in supply , more quantities will be demanded. If they expect a fall
in price, they will postpone their purchases of nonessential commodities and therefore,
the current demand for them will fall.

Other factors: Apart from the above factors, the demand for a commodity depends upon the
following factors:
a. Size of population: Generally, larger the size of population of a country or a region , greater
is the demand for commodities in general.
b. Composition of population: If there are more old people in a region , the demand for
spectacles, walking sticks, etc. will be high . Similarly, if the population consists of more of
children , demand for toys, baby foods, toffees, etc. will be more.
c. The level of National Income and its Distribution: The level of national income is a
crucial determinant of market demand. Higher the national income , higher will be the
demand for all normal goods and services.
d. Consumer-Credit facility and interest rates: Availability of credit facilities induces people
to purchase more than what their current income permit them.
e. Income distribution: Unequal distribution of income results in differences in the income
status of different individuals in a nation.

f. Climatic factors: The demand for commodities depends on the climatic conditions of a
region such as cold, hot, humid, and dry.

g. Government policy: Government policies have direct impact on the demand for various
commodities.

Q3.Explain types of demand?

Ans- 7 Types of Demand in Economics are:
1. Price Demand
2. Income Demand
3. Cross Demand
4. Individual demand and Market demand
5. Joint Demand
6. Composite Demand
7. Direct and Derived Demand
Price Demand
Price demand is a demand for different quantities of a product or service that consumers intend
to purchase at a given price and time period assuming other factors, such as prices of the related
goods, level of income of consumers, and consumer preferences, remain unchanged.
Price demand is inversely proportional to the price of a commodity or service. As the price of a
commodity or service rises, its demand falls and vice versa.

Therefore, price demand indicates the functional relationship between the price of a commodity
or service and the quantity demanded. It can be mathematically expressed as follows:

Therefore, price demand indicates the functional relationship between the price of a commodity
or service and the quantity demanded. It can be mathematically expressed as follows:

DA= f (PA) where,

DA = Demand for commodity A
f = Function
PA =Price of commodity A
Income Demand
Income demand is a demand for different quantities of a commodity or service that consumers
intend to purchase at different levels of income assuming other factors remain the same.
Generally, the demand for a commodity or service increases with an increase in the level of
income of individuals except for inferior goods. Therefore, demand and income are directly
proportional to normal goods whereas demand and income are inversely proportional to inferior
goods.

The relationship between demand and income can be mathematically expressed as follows

DA = f ( YA ), where,
DA = Demand for commodity A
f = Function
YA = Income of consumer A

Cross Demand
Cross demand is refers to the demand for different quantities of a commodity or service whose
demand depends not only on its own price but also the price of other related commodities or
services.
For example, tea and coffee are considered to be the substitutes of each other. Thus, when the
price of coffee increases, people switch to tea. Consequently, the demand for tea increases. Thus,
it can be said that tea and coffee have cross demand.

Mathematically, this can be expressed as follows:

DA = f (PB), where,
DA = Demand for commodity A
f = Function
PB = Price of commodity B
Individual demand and Market demand
Individual demand and market demand: This is the classification of demand based on the
number of consumers in the market. In dividual demand refers to the quantity of a commodity or
service demanded by an individual consumer at a given price at a given time period.
For example, the quantity of sugar that an individual or household purchases in a month is the
individual or household demand. The individual demand of a product is influenced by the price
of a product, the income of customers, and their tastes and preferences.

On the other hand, market demand is the aggregate of individual demands of all the consumers
of a product over a period of time at a specific price while other factors are constant.

Joint Demand
Joint demand is the quantity demanded two or more commodities or services that are used
jointly and are, thus demanded together.
For example, car and petrol, bread and butter, pen and refill, etc. are commodities that are used
jointly and are demanded together.

Composite Demand
Composite demand is the demand for commodities or services that have multiple uses. For
example, the demand for steel is a result of its use for various purposes like making utensils, car
bodies, pipes, cans, etc.
For example, the demand for steel is a result of its use for various purposes like making utensils,
car bodies, pipes, cans, etc. In the case of a commodity or service having composite demand, a
change in price results in a large change in the demand. This is because the demand for the
commodity or service would change across its various usages

Direct and Derived Demand

Direct and derived demand: Direct demand is the demand for commodities or services meant
for final consumption. This demand arises out of the natural desire of an individual to consume a
particular product.
For example, the demand for food, shelter, clothes, and vehicles is direct demand as it arises out
of the biological, physical, and other personal needs of consumers.

On the other hand, derived demand refers to the demand for a product that arises due to the
demand for other products.

For example, the demand for cotton to produce cotton fabrics is derived demand.

Q4.Explain the law of demand?

Ans - The law of demand expresses a relationship between the quantity demanded and its price.
It may be defined in Marshall’s words as “the amount demanded increases with a fall in price,
and diminishes with a rise in price”. Thus it expresses an inverse relation between price and
demand. The law refers to the direction in which quantity demanded changes with a change in
price.
On the figure, it is represented by the slope of the demand curve which is normally
negative throughout its length. The inverse price- demand relationship is based on other
things remaining equal. This phrase points towards certain important assumptions on
which this law is based.

The above table shows that when the price of say, orange, is Rs. 5 per unit, 100 units are
de-manded. If the price falls to Rs.4, the demand increases to 200 units. Similarly, when the
price declines to Re.1, the demand increases to 600 units. On the contrary, as the price increases
from Re. 1, the demand continues to decline from 600 units.
In the figure, point P of the demand curve DD1 shows demand for 100 units at the Rs. 5. As the
price falls to Rs. 4, Rs. 3, Rs. 2 and Re. 1, the demand rises to 200, 300, 400 and 600 units
respectively. This is clear from points Q, R, S, and T. Thus, the demand curve DD1 shows
increase in demand of orange when its price falls. This indicates the inverse relation between
price and demand.

Q5. Explain the demand curve and demand schedule?

Ans- Demand Curve:
Demand curve shows a graphical representation of demand schedule. It can be made by plotting
price and quantity demanded on a graph. In demand curve, price is represented on Y-axis, while
quantity demanded is represented on X-axis on the graph. R.G Lipsey has defined demand curve
as “the curve which shows the relationship between the price of a commodity and the amount of
that commodity the consumer wishes to purchase is called Demand Curve.”
Demand curve can be of two types, namely, individual demand curve and market demand
curve. Individual demand curve is the graphical representation of individual demand
schedule, while market demand curve is the representation of market demand schedule.
Figure-3 shows the individual demand curve for the individual demand schedule
(represented in Table-1):

In Figure-3 points a, b, c, d, and e demonstrates the relationship between price and quantity
demanded at different price levels. By joining these points, we have obtained a curve, DD, which
is termed as the individual demand curve. The slope of an individual demand curve is downward
from left to right that indicates the inverse relationship of demand with price.

Let us understand the individual demand curve with the help of an example.
Prepare a demand curve for the individual demand schedule of product X.

Demand Schedule:
Demand schedule refers to a tabular representation of the relationship between price and quantity
demanded. It demonstrates the quantity of a product demanded by an individual or a group of
individuals at specified price and time.

Demand schedule can be categorized into two types, which are shown in Figure-2:

The two types of demand schedules (as shown in Figure-2) are explained as follows:
i. Individual Demand Schedule:
Refers to a tabular representation of quantity of products demanded by an individual at different
prices and time.

Table-1 shows the individual demand schedule of product a purchased by Mr. Ram:

Following are the characteristics of individual demand schedule:

a. Demonstrates the effect of changing price on the buying behavior of customers rather than
change in the demand for a product

b. Expresses the disparity in demand with the difference in the product’s price
c. Represents that at higher prices the quantity demanded reduces and vice versa

ii. Market Demand Schedule:

Shows a tabular representation of quantity demanded in aggregate by individuals at different
prices and time. Therefore, it demonstrates the demand of a product in the market at different
prices. The market demand schedule can be derived by aggregating the individual demand
schedules.

Table-2 represents the market demand schedule prepared through the individual demand
schedule of three individuals:

Market demand schedule also demonstrates an inverse relation between the quantity demanded
and price of a product.

Q6. Explain demand function ?

Ans- A function can be defined as a mathematical expression that states a relationship between
two or more variables containing cause and effect relationship. Similarly, demand function refers
to the relationship between the quantity demanded (dependent variable) and the determinants of
demand for a product (independent variables). In other words, demand function states the
influence of various factors of demand, such as price, customer’s income and habits, and
standard of living, on the demand of a product.

In the short run, the demand function states the relationship between the aggregate demand of a
product and the price of the product, while keeping other determinants of demand at constant.

In such a case, the demand function can be expressed as follows:

Dx = f (Px)
Where, Dx= dependent variable
Px = independent variable
It can be interpreted from the preceding equation that quantity demanded (Dx) is the
function of price (Px) for product X. This states that if there is any change in the price of
product X, then the demand of product X would also show changes. However, the
demand function does not interpret the amount of change produced in demand due to
change in the price of the commodity.
Therefore, to understand the quantitative relationship between demand and price of
a commodity, we use the following equation:
 Dx = a – b (Px)
Where a = constant (represents total demand at zero price)
b = ∆D/∆P (constant, which represents the change in Dx produced by Px)
On the other hand, in the long run, demand function shows a relationship between the
aggregate demand of a product and a number of determinants of demand, such as price,
consumer’s income, standard of living, and price of substitutes.
On the basis of time period, the demand function has been classified as follows:
i. Linear Demand Function:
Refers to the demand function in which the change in dependent variable remains constant for a
unit change in the independent variable, regardless the level of the dependent variable. In the
linear demand function, AD/AP is constant and the resultant demand curve is a straight line.

For example, if a=100 and b=5, then the demand function can be represented by the
following equation:
Dx = 100 – 5 (Px)

With the help of the preceding equation, we can get the values of Dx by substituting the different
values of Px, as shown in Table-6:

The linear demand function has been represented on graph (for Table-6) in Figure-7:

Price function can be obtained with the help of demand function by the following equation:
Px = a – Dx/ b

Px = a/b-(1 /b) Dx
Let us assume that a/b = a1 and 1/b = b1, then the price function would be:
Px = a1 – b1Dx
ii. Non-Linear Demand Function:
Refers to the demand function in which the dependent variable keeps changing with the change
in the independent variable. In the non-linear demand function, the slope of the curve changes
throughout the curve.

The equation for non-linear demand function is as follows:

Dx = a (Px)-b and
Dx = (a/Px + c)-b

Where, a or b or c >0

The non-linear demand curve is shown in Figure-8:

iii. Multivariate or Dynamic Demand Function:

Expresses a relationship between a dependent variable, such as demand, and more than one
independent variable, such as price and income. In the long-run, individual or market demand
cannot be derived by using only one variable because other determinants are not constant and
they do affect the demand for a product. In addition, in long-run, demand for a product can be
determined by the composite demand of all the determinants affecting the demand for a product.

The multivariate demand function can be expressed as follows:

Dx = f (Px, M, Py, Pc, T, A)

Where, Px = Price

M = Consumer’s income

Py = Price of substitutes

Pc = Price of complementary goods

T = Consumer’s taste

A= Advertisement expenditure

If the relationship between the demand and its determinants is a straight or linear line,
then demand function can be expressed as follows:
Dx = a + b Px + cM + dPy + ePc + g T + jA

Where, a = constant and b, c, d, e, g, and j = coefficients of relation between demand and its
determinants.

Q7.Explain exceptions to law of demand?

Ans- i. Giffen Paradox:

Refer to one of the major criticism of law of demand. Giffin Paradox was given by Sir Robert
Giffen, who classified goods into two types, inferior goods and superior goods, generally called
Giffen goods. The inferior goods are those whose demand decreases with increase in consumer’s
income, such as cheap potatoes and vegetable ghee.

These goods are of low quality; therefore, the demand for these goods decreases with increase in
consumer’s income. In addition, if the price of these goods increases, then the demand for these
goods increases assuming that the high price good would be of good quality tor example, coffee
is considered as superior and tea as inferior. In case tile price of both of these goods increases the
consumers would increase the demand of tea to satisfy their need by paying tile same amount.

ii. Necessity Goods:

Refer to goods that are considered as essential for consumer. The demand of necessity goods
does not increase or decrease with increase or decrease in their prices. For example, salt is a
necessity good whose consumption cannot be increased in case its price decreases. In such a
scenario, the law of demand is not applicable.

iii. Prestige Goods:

Refers to goods that are perceived as a status symbol, such as diamond and Johny Walker Scotch
Whisky. The demand for these goods remains same in case of increase or decrease in their price.
In such a case, the law of demand is not applicable.

iv. Speculation:

Refers to an assumption of consumers about the change in prices of a product in future. If the
price of a product IS expected to rise in future, then the demand for the product increases in the
present situation. However, this is against the law of demand.
v. Psychologically Bias Customers:

Refer to one of the important exceptions to the law of demand. Different customers have
different perceptions about the price of a product. Some customers have perceptions that low
price means bad quality of a particular product, which is not true in all cases. Therefore, if there
is a fall in the price of a product, then the demand for that product decreases automatically.

vi. Brand Loyalty:

Refers to the preference of a consumer towards a particular brand. Consumers do not prefer to
change a brand with increase in the price of that brand. For example, if a consumer prefers, to
wear Levi’s jeans, he would continue to purchase it, irrespective of increase in its price. In such a
situation, the law of demand cannot be applied.

vii. Emergency Situations:

Refers to a condition for which the law of demand is not applicable. In emergencies, such as war
flood, earthquake, and famine, the availability of goods become scarce and uncertain. Therefore,
in such situations, consumer.’ prefer to store a large quantity of goods, regardless of their prices.

Q8.Explain Elasticity of demand?

Ans- It is the demand for a commodity that moves in the contrary direction of its price.
However, the influence of the price change is not always constant . Sometimes, the demand for a
commodity changes substantially, even for smaller price changes. On the other hand, there are
some commodities for which the demand is not impacted much by price changes.

The demands for some commodities are receptive to the change in its price, while the demands
for others are not so receptive to the price changes. The price elasticity of demand is the quantity
of the receptiveness of the demand for a commodity to change in its price.

The price elasticity of demand for a commodity is defined as the percentage of change in
demand for the commodity divided by the percentage change in its price. The price elasticity of
demand for a good is derived as follows:

Elasticity of demand = Percentage change in demand for the goods ÷ Percentage change in price
for the goods.
TYPES OF ELASTICITY OF DEMAND –

1. Price Elasticity of Demand: The price elasticity of demand, commonly known as the
elasticity of demand refers to the responsiveness and sensitiveness of demand for a
product to the changes in its price. In other words, the price elasticity of demand is equal

to Numerically,

Where,
ΔQ = Q1 –Q0, ΔP = P1 – P0, Q1= New quantity, Q2= Original quantity, P1 = New price,
P0 = Original price.
The following are the main Types of Price Elasticity of Demand:

 Perfectly Elastic Demand

 Perfectly Inelastic Demand
 Relatively Elastic Demand
 Relatively Inelastic Demand
 Unitary Elastic Demand
1. Perfectly elastic ( PED = ∞):
The demand is said to be perfectly elastic when a small rise in price would result in a fall in
demand to zero, while a small fall in price results in demand to become infinite. Therefore, It is
also known as infinite elasticity. It is a theoretical concept only as it has no importance in the
practical world.
This can be shown by a straight-line demand curve parallel to the horizontal axis.
Example:
Suppose the price of a commodity is rs 10 and its demand is 50 units. As the price falls to Rs 9,
its demand increases to infinity.
In fig, the x-axis shows the quantity demanded and the y-axis shows the price. Dd curve is the
demand curve. The initial demand at price P is Q units. When the price is slightly decreased, it
leads to an increase in demand by a large amount i.e. Q1. It shows a perfectly elastic demand.
2. Perfectly inelastic (PED=0):
When demand doesn’t change with change in price( whether rising or fall), then demand is said
to be perfectly inelastic. It implies that the demand remains constant for any value of the price.
Hence, It is rarely found in real but the closest example we can take is water and other necessity
goods.
It is represented by a straight line parallel to the vertical axis.
Example:
Suppose the price of a bottle of water is Rs. 15 and its demand is 200 units. As the price
increases to Rs 20, the demand remains constant at 200 units. It implies the demand is perfectly
inelastic.
In fig, the x-axis shows the quantity demanded and the y-axis shows the price. Dd is the demand
curve. At the price P, the quantity demanded is Q units. As the price increases to P 1, there is no
effect on the quantity demanded. It remains constant at the initial quantity Q. This implies that
the demand is perfectly inelastic.
Relatively Elastic ( PED > 1):
Relatively elastic demand occurs when a proportionate change in demand is greater than the
proportionate change in price. It means that there will be a greater change in demand due to a
small change in price. It is also known as highly elastic demand and more than unitary elastic
demand.
Example:
Suppose, the price of a commodity is Rs. 40 and the quantity demanded is 20 units. As the price
declines to Rs 30, its demand increases to 30 units. It implies a relatively elastic demand.
In fig, the X-axis shows the quantity demanded and the Y-axis shows the price. Dd is the
demand curve. At the price P, the quantity demanded is Q units. As the price is increased to P 1,
the quantity demanded is decreased to Q1 units. Here, the change in price is less than the change
in quantity demanded. Therefore, it can be said as perfectly elastic demand.
5.Relatively inelastic demand ( PED <1):
The demand can be said as relatively inelastic when a proportionate change in quantity
demanded is less than proportionate change in price. It means that the greater change in price
leads to a smaller change in demand.
Example:
Suppose, the price of a commodity is Rs 10 and the quantity demanded is 20 units. As the price
increases to Rs 15, the quantity demanded declines to 15 units. It implies a relatively inelastic
demand.

In fig, the X-axis shows the quantity demanded and the Y-axis shows the price. Dd is the
demand curve. At the price P, the quantity demanded is Q units. As the price increases to P 1, the
quantity demanded falls to Q1 units. Here, the change in price is more than the change in quantity
demanded. Therefore, it shows a relatively inelastic demand.

3. Unitary elastic ( PED = 1):

The demand can be said as unitary elastic when the percentage change in quantity demanded is
equal to the percentage change in price. It is also known as unitary elasticity. It is an imaginary
concept as rarely found in the practical world.
Example:
 Suppose, the price of a commodity is Rs. 50 and the quantity demanded in a specific market is
200 units. As the price increases to Rs. 60, its demand declines to 160 units. It implies the unitary
elastic demand.

In fig, the X-axis shows the quantity demanded and the Y-axis shows the price. Dd is the
demand curve. At the price P, the quantity demanded is Q units. As the price increases to P 1, the
quantity demanded decreases to Q1 by an equal proportion. It implies that the demand is unitary
elastic.

2. Income Elasticity of Demand: The income is the other factor that influences the demand
for a product. Hence, the degree of responsiveness of a change in demand for a product
due to the change in the income is known as income elasticity of demand. The formula to
compute the income elasticity of demand is:

For most of the goods, the income elasticity of demand is greater than one indicating that
with the change in income the demand will also change and that too in the same
direction, i.e. more income means more demand and vice-versa.
Types of Income Elasticity of Demand
The income elasticity of demand shows the responsiveness of quantity demanded of a
certain commodity to the change in income of the consumer. The income elasticity of
 demand is also defined as ‘ the ratio of the percentage change in the demand for a
commodity to the percentage change in income’.
There are five types of income elasticity of demand as follows:
Income elasticity greater than unity (ey > 1)
The income elasticity of demand is greater than the unity when the demand for a
commodity increases more than percentage rise in income. For example, if the income
increases by 50% and demand rises by 100%. In such a case, the numerical value of
income elasticity of demand would be more than one (ey>1).
Income elasticity less than unity(ey < 1)
Income elasticity of demand is less than the unity when the demand for a commodity
increases less than proportionate to the rise in income. Implies that positive income
elasticity of demand would be less than unitary when the proportionate change in, the
quantity demanded is less than proportionate change in income.
Income elasticity equal to unity (ey = 1)
Income elasticity is unity when the demand for a commodity increases in the same
proportion as the rise in income. For example, if income increases by 50% and demand
also rises by 50%, then the demand would be called as unitary income elasticity of
demand. In such a case, the numerical value of income elasticity of demand is equal to
one (ey = 1).
Zero income elasticity (ey = 0)
If the rise in income, the quantity demanded remains unchanged, the income elasticity is
called zero income elasticity. Refers to the income elasticity of demand whose numerical
value is zero. This is because there is no effect of increase in consumer’s income on the
demand of product. The income elasticity of demand is zero (ey = 0) in case of essential
goods. For example, salt is demanded in same quantity by a high income and a low
income individual.
Negative income elasticity (ey < 0 >)
In the case of inferior goods, the income elasticity of demand is negative. The consumer
will reduce his purchase of it when income rises and vice versa. For example, if the
income of a consumer increases, he would prefer to purchase wheat instead of millet. In
such a case, the millet would be inferior to wheat for the customer.

3. Cross Elasticity of Demand: The cross elasticity of demand refers to the change in
quantity demanded for one commodity as a result of the change in the price of another
commodity. This type of elasticity usually arises in the case of the interrelated goods such
as substitutes and complementary goods. The cross elasticity of demand for goods X and
Y can be expressed as:

The two
commodities are said to be complementary, if the price of one commodity falls, then the
demand for other increases, on the contrary, if the price of one commodity rises the
 demand for another commodity decreases. For example, petrol and car are
complementary goods.
While the two commodities are said to be substitutes for each other if the price of one
commodity falls, the demand for another commodity also decreases, on the other hand, if the
price of one commodity rises the demand for the other commodity also increases. For example,
tea and coffee are substitute goods.

4. Advertising Elasticity of Demand: The responsiveness of the change in demand to the

change in advertising or rather promotional expenses, is known as advertising elasticity
of demand. In other words, the change in the demand as a result of the change in
advertisement and other promotional expenses is called as the advertising elasticity of
demand. It can be expressed as:

Numerically,

Where,
Q1 = Original Demand
Q2= New Demand
A1= Original Advertisement Outlay
A2 = New Advertisement Outlay
These are some of the important types of elasticity of demand that helps in understanding the
criteria of demand for the goods and services and the factors that influence the demand.

Q9.Explain demand forcasting?

Ans- Meaning-
 Forecasting , in general , refers to knowing or measuring the status or nature of an
event or variable before it occurs.
 Forecasting of demand is the art and science of predicting the probable demand for a
product or a service at some future date on the basis of certain past behavior patterns
of some related events and the prevailing trends in the present.
 It should be kept in mind that demand forecasting is no simple guessing , but it refers
to estiomating demand scientifically and objectively on the basis of certain facts and
events relevant to forecasting.
Usefulness:
 The effectiveness of the plans of business managers depends upon the level of accuracy
with which future events can be predicted.
  Forecasting of demand plays a vital role in the process of the planning and decision making
, weather at the national level or at the level of a firm.
 The importance of demand forecasting has increased all the more on account of mass
production and production in response to demand.
 A good forecast enables the firm to perform efficient business planning . Forecasts offer
information for budgetary planning and cost control in functional areas of finance and
accounting.
 It is said that no forecast is completely fool-proof and correct. However, the very process of
forecasting helps in evaluating various forces which affect demand and is in itself a reward
because it enables the forecasting authority to know about various forces relevant to the
study of demand behavior.

Scope of forecasting
 The scope of demand forecasting depends upon the operated area of the firm, present as well
as what is proposed in the future. Forecasting can be at an international level if the area of
operation is international. If the firm supplies its products and services in the local market
then forecasting will be at local level.
 The scope should be decided considering the time and cost involved in relation to the benefit
of the information acquired through the study of demand. Cost of forecasting and benefit
flows from such forecasting should be in a balanced manner.

Significance and measures of demand forecasting -

The significance of demand forecasting is shown in the following points:

i. Fulfilling objectives:

Implies that every business unit starts with certain pre-decided objectives. Demand forecasting
helps in fulfilling these objectives. An organization estimates the current demand for its
products and services in the market and move forward to achieve the set goals.
For example, an organization has set a target of selling 50, 000 units of its products. In such a
case, the organization would perform demand forecasting for its products. If the demand for the
organization’s products is low, the organization would take corrective actions, so that the set
objective can be achieved.

ii. Preparing the budget:

Plays a crucial role in making budget by estimating costs and expected revenues. For instance, an
organization has forecasted that the demand for its product, which is priced at Rs. 10, would be
10, 00, 00 units. In such a case, the total expected revenue would be 10* 100000 = Rs. 10, 00,
000. In this way, demand forecasting enables organizations to prepare their budget.

iii. Stabilizing employment and production:

Helps an organization to control its production and recruitment activities. Producing according to
the forecasted demand of products helps in avoiding the wastage of the resources of an
organization. This further helps an organization to hire human resource according to
requirement. For example, if an organization expects a rise in the demand for its products, it may
opt for extra labor to fulfill the increased demand.

iv. Expanding organizations:

Implies that demand forecasting helps in deciding about the expansion of the business of the
organization. If the expected demand for products is higher, then the organization may plan to
expand further. On the other hand, if the demand for products is expected to fall, the organization
may cut down the investment in the business.

v. Taking Management Decisions:

Helps in making critical decisions, such as deciding the plant capacity, determining the
requirement of raw material, and ensuring the availability of labor and capital.

vi. Evaluating Performance:

Helps in making corrections. For example, if the demand for an organization’s products is less, it
may take corrective actions and improve the level of demand by enhancing the quality of its
products or spending more on advertisements.

vii. Helping Government:

Enables the government to coordinate import and export activities and plan international trade.

Q10.What are Methods of demand forcasting?

Ans- Time series forecasting
Time series forecasting is one of the most applied data science techniques in business, finance,
supply chain management, production and inventory planning. Many prediction problems
involve a time component and thus require extrapolation of time series data, or time series
forecasting. Time series forecasting is also an important area of machine learning (ML) and can
be cast as a supervised learning problem. ML methods such as Regression, Neural Networks,
Support Vector Machines, Random Forests and XGBoost — can be applied to it. Forecasting
involves taking models fit on historical data and using them to predict future observations.
Time series forecasting means to forecast or to predict the future value over a period of time. It
entails developing models based on previous data and applying them to make observations and
guide future strategic decisions.
The future is forecast or estimated based on what has already happened. Time series adds a time
order dependence between observations. This dependence is both a constraint and a structure that
provides a source of additional information. Before we discuss time series forecasting methods,
let’s define time series forecasting more closely.
Time series forecasting is a technique for the prediction of events through a sequence of time. It
predicts future events by analyzing the trends of the past, on the assumption that future trends
will hold similar to historical trends. It is used across many fields of study in various applications
including:
Astronomy
Business planning
Control engineering
Earthquake prediction
Econometrics
Mathematical finance
Pattern recognition
Resources allocation
Signal processing
Statistics
Weather forecasting
Time series forecasting starts with a historical time series. Analysts examine the historical data
and check for patterns of time decomposition, such as trends, seasonal patterns, cyclic patterns
and regularity. Many areas within organizations including marketing, finance and sales use some
form of time series forecasting to evaluate probable technical costs and consumer demand.
Models for time series data can have many forms and represent different stochastic processes.

Barometric Method of Forecasting

Definition:
The Barometric Method of Forecasting was developed to forecast the trend in the overall
economic activities. This method can nevertheless be used in forecasting the demand prospects,
not necessarily the actual quantity expected to be demandedOften, the barometric method of
forecasting is used by the meteorologists in weather forecasting. The weather conditions are
forecasted on the basis of the movement of mercury in a barometer. Based on this logic,
economists use economic indicators as a barometer to forecast the overall trend in the business
activities.
The Barometric Method of forecasting was first developed in 1920’s, but, however, was
abandoned due to its failure to predict the Great Depression in 1930’s. The Barometric technique
was, however, revived, reformed and developed further by the National Bureau of Economic
Research (NBER), USA in the late 1930’s.
The barometric method is based on the approach of developing an index of relevant
economic indicators and forecasting the future trends by analyzing the movements in
these indicators. A time-series of several indicators is developed to study the future trend.
These can be classified as:
 1. Leading Series: The leading series is comprised of indicators which move up or down
ahead of some other series The most common examples of leading indicators are- net
business investment index, a new order for durable goods, change in the value of
inventories, corporate profits after tax, etc.
2. Coincidental Series: The coincidental series include indicators which move up and
down simultaneously with the general level of economic activities. The examples of
coincidental series – the rate of unemployment, the number of employees in the non-
agricultural sector, sales recorded by manufacturing, retail, and trading sectors, gross
national product at constant prices.
3. Lagging Series: A series consisting of those indicators, which after some time-lag
follows the change. Some of the lagging series are- outstanding loan, labor cost per unit
production, lending rate for short-term loans, etc.

Q11.Explain Law of Supply ?

Ans-The law of supply is the microeconomic law that states that, all other factors being equal, as
the price of a good or service increases, the quantity of goods or services that suppliers offer will
increase, and vice versa.
The law of supply says that as the price of an item goes up, suppliers will attempt to maximize
their profits by increasing the number of items for sale.
 The law of supply says that a higher price will induce producers to supply a higher
quantity to the market.
 Because businesses seek to increase revenue, when they expect to receive a higher price
for something, they will produce more of it.
 Meanwhile, if prices fall, suppliers are disincentivized from producing as much.
 Supply in a market can be depicted as an upward-sloping supply curve that shows how
the quantity supplied will respond to various prices over a period of time.
 Together with demand, it forms half of the law of supply and demand.
The law of supply is also a fundamental principle of economic theory like the law of demand. It
was introduced by Prof. Alfred Marshall in his book, 'Principles of Economics' which was
published in 1890. The law explains the functional relationship between price and quantity
supplied.

Statement of the Law:

"Other things being constant, higher the price of a commodity, more is the quantity supplied and
lower the price of a commodity less is the quantity supplied".
In simple words, "other factors remaining constant, a rise in price results in a rise in the quantity
supplied and vice-versa. Thus, there is a direct relationship between price and quantity supplied.
 Symbolically,
Sx = f (Px)
S = Supply
x = Commodity
f = Function
P = Price of the commodity

Supply of Rice/day
Price of Rice/Kg Price quantity combinations
(In Kg)

10 5 A

11 6 B

12 7 C

13 8 D

14 9 E

15 10 F

16 11 G
The law of supply is well substantiated through the table above, which shows that the supply of
rice increases with the increase in the price. Such as when the price of rice is Rs 14/ kg the
supply of rice is 9/Kg and as the price rise to Rs 15/kg the supply also increases to 10/kg.
The supply curve is the graphical representation of the supply schedule which shows different
combinations between the price and the quantity supplied.
SS’ is the upward sloping supply curve, which depicts the law of supply, i.e. the supply of rice
increases with the increase in its price.
Q12.Explain elasticity of supply?
Ans- Elasticity of supply is a measure of the degree of change in the quantity supplied of a
product in response to a change in its price.
As discussed previously, the law of supply states that the quantity supplied of a product
increases with a rise in the price of the product and vice versa, while keeping all other factors
constant.
However, an organisation needs to determine the impact of change in the price of a product on
its supply in numerical terms. The concept of elasticity of supply helps organisations to estimate
the impact of change in the supply of a product with respect to its price.
Elasticity of Supply Definition
“The supply of a commodity is said to be elastic when as a result of a change in price, the supply
changes sufficiently as a quick response. Contrarily, if there is no change or negligible change
in supply or supply pays no response, it is elastic.”
- Prof. Thomas
Elasticity of Supply Formula
Mathematically, the elasticity of supply is expressed as:
Percentage change in quantity supplied =
Percentage change in quantity supplied =

The elasticity of supply can be calculated with the help of the following formula:

Where,
ΔS = S1 – S
ΔP = P1 – P
Types of Elasticity of Supply
Similar to elasticity of demand, elasticity of supply also does not remain same. The degree of
change in the quantity supplied of a product with respect to a change in its price varies under
different situations.
Based on the rate of change, the types of price elasticity of supply is grouped into five main
categories as follows:
1. Perfectly elastic supply
2. Perfectly Inelastic Supply
3. Relatively Elastic Supply
4. Relatively Inelastic Supply
5. Unitary Elastic Supply
Perfectly elastic supply
When a proportionate change (increase/ decrease) in the price of a product results in an
increase/decrease of quantity supplied, it is called a perfectly elastic supply.
In such a case, the numerical value of elasticity of supply would be infinite (es =∞). This
situation is imaginary as there is no such product whose supply is perfectly elastic.
Therefore, this situation does not have any practical implication.
Perfectly Inelastic Supply
In this situation, the quantity supplied does not change with respect to a proportionate change in
the price of a product.
In other words, the quantity supplied remains constant at the change in price when supply is
perfectly inelastic.
Thus, the elasticity of supply is equal to zero ( es =0). However, this situation is imaginary as
there can be no product whose supply could be perfectly inelastic.
Relatively Elastic Supply
When a percentage change in the quantity supplied is more than a percentage change in the price
of a product, it is called relatively elastic supply.
In this case, the elasticity of supply is less than 1, i.e. es < 1.
In other words, the proportionate change in quantity supplied is more than the proportionate
change in the price of product P.
Therefore, the supply of product P is highly elastic (es>1).
Relatively Inelastic Supply
When a percentage change in the quantity supplied is less than the percentage change in the price
of a product, it is called relatively inelastic supply.
In this case, the elasticity of supply is greater than 1, i.e. es < 1.
Unitary Elastic Supply
When the proportionate change in the quantity supplied is equal to the proportionate change in
the price of a product, the supply is unitary elastic.
In this case, elastic supply is equal to one ( es =1).

Q13.What are price of a product under demand and supply forces?

Ans- Market equilibrium refers to the stage where the quantity demanded for a product is equal
to the quantity supplied for the product.
The price when the quantity demanded is equal to the quantity supplied for the product is known
as equilibrium price.
Equilibrium price is also termed as market clearing price, which is referred to a price when there
is neither an unsold stock nor an unsupplied demand.
The market price refers to a current price at which a product is sold in the market. It is
determined by the collaboration of two functions, namely, demand and supply. According to
economic theory, the market price of a product is determined at a point where the forces of
supply and demand meet. The point where the forces of demand and supply meet is called
equilibrium point. Conceptually, equilibrium means state of rest. It is the stage where the balance
between two opposite functions, demand and supply is achieved.
Let us understand the concept of market equilibrium with the help of an example.
the market demand and supply for talcum powder in Mumbai with their varying prices of
a week:
Determination of Market Price:
The equilibrium price of a product is determined when the forces of demand and supply meet.
For understanding the determination of market equilibrium price, let us take the example of
talcum Powder shown in Table. In Table we have taken the initial price of talcum powder as Rs.
100.
In this case, the quantity demanded is 80,000, while the supply is 10,000. This results in the
shortage of 70,000 of talcum powder in the market. Due to this shortage, the sellers get a chance
to earn more by increasing the price of the talcum powder and consumers are ready to purchase
at the price quoted by sellers due to shortage of talcum powder.
This increase in profit results in increase in the production of a product to earn more profit,
which, in turn, increases the supply of the product. The process of increase in prices goes on till
the price of talcum powder reaches to Rs. 300. At this price, the demand and supply is equal to
40,000. Therefore, equilibrium is achieved and the equilibrium price is Rs. 300.
The graphical representation of equilibrium of demand and supply is shown

Shifts in Market Equilibrium:

If there is a shift in supply or demand curve, then the equilibrium point also gets shifted.
The shift in demand curve and equilibrium is shown

initially the equilibrium price is found at PQ and quantity at OQ. However, when the demand
curve shifted from DD to D1D1, then equilibrium also shifts from PQ to MN. Now, the
equilibrium price is at MN and the quantity is at ON. In this case, the supply does not show any
changes. It can also be interpreted from Figure that the equilibrium price has increased with an
increase in quantity, when demand curve shifts.
The shift in supply curve and equilibrium is shown

initially the equilibrium price is found at PQ and quantity at OQ. However, when the supply
curve shifted from SS to S1S1, then equilibrium also shifts from PQ to MN. Now, the
equilibrium price is at MN and the quantity is at ON. In this case, the demand does not show any
changes. It can also be interpreted from Figure that the equilibrium price has decreased and
quantity has increased, when supply curve shifts.
Now, let us determine the effect of simultaneous shifts in the demand and supply curve on the
equilibrium point. It basically depends on the extent of shift in the demand and supply curves. In
case the shift in supply curve is greater than the demand curve, then equilibrium price decreases
and output increases.
It can be better explained with the help of Figure

initially equilibrium position. E1 is obtained by balancing demand curve, D1D1 and supply
curve, S1S1. Equilibrium price at E1 is P1 and quantity is OQ1. When the demand curve shifts
from D1D1 to D2D2 and supply curve shifts from S1S1 to S3S3, then equilibrium also shifts
from E1 to E3.
In this case, supply shift is greater than the shift in demand; therefore, equilibrium price falls
down to PO and output increases to OQ3. However, if the shift in demand and supply curve is
equal that is D2D2 and S2S2 respectively, then the equilibrium price remain constant and output
increases to Q2.
In case, shift in demand curve is greater than the shift in supply curve, then the both,
equilibrium price and quantity, increase, as shown in Figure

initially equilibrium position, E1 is obtained by balancing the demand curve, D1D1 and supply
curve, S1S1. Equilibrium price at E1 is P1 and quantity is OQ1. When the demand curve shifts
from D1D1 to D2D2 and supply curve shifts from S1S1 to S2S2, then equilibrium also shifts
from E1 to E2. In this case, demand shift is greater than the shift in supply; therefore,
equilibrium price increases to P2 and output increases to OQ2.

Q14.What is price restriction and market equilibrium?

Ans- Price Ceilings and Price Floors:
Controversy sometimes surrounds the prices and quantities established by demand and supply,
especially for products that are considered necessities. In some cases, discontent over prices
turns into public pressure on politicians, who may then pass legislation to prevent a certain price
from climbing “too high” or falling “too low.”
The demand and supply model shows how people and firms will react to the incentives provided
by these laws to control prices, in ways that will often lead to undesirable consequences.
Alternative policy tools can often achieve the desired goals of price control laws, while avoiding
at least some of their costs and tradeoffs.
Price Ceilings
Laws that government enacts to regulate prices are called Price controls. Price controls come in
two flavors. A price ceiling keeps a price from rising above a certain level (the “ceiling”), while
a price floor keeps a price from falling below a certain level (the “floor”). This section uses the
demand and supply framework to analyze price ceilings. The next section discusses price floors.
In many markets for goods and services, demanders outnumber suppliers. Consumers, who are
also potential voters, sometimes unite behind a political proposal to hold down a certain price. In
some cities, such as Albany, renters have pressed political leaders to pass rent control laws, a
price ceiling that usually works by stating that rents can be raised by only a certain maximum
percentage each year.
Rent control becomes a politically hot topic when rents begin to rise rapidly. Everyone needs an
affordable place to live. Perhaps a change in tastes makes a certain suburb or town a more
popular place to live. Perhaps locally-based businesses expand, bringing higher incomes and
more people into the area. Changes of this sort can cause a change in the demand for rental
housing, as Figure 1 illustrates. The original equilibrium (E0) lies at the intersection of supply
curve S0 and demand curve D0, corresponding to an equilibrium price of $500 and an
equilibrium quantity of 15,000 units of rental housing. The effect of greater income or a change
in tastes is to shift the demand curve for rental housing to the right, as shown by the data
in Table 10 and the shift from D0 to D1 on the graph. In this market, at the new equilibrium E 1,
the price of a rental unit would rise to $600 and the equilibrium quantity would increase to
17,000 units.

Figure 1. A Price Ceiling

Example—Rent Control. The original intersection of demand and supply occurs at E 0. If demand
shifts from D0 to D1, the new equilibrium would be at E1—unless a price ceiling prevents the
price from rising. If the price is not permitted to rise, the quantity supplied remains at 15,000.
However, after the change in demand, the quantity demanded rises to 19,000, resulting in a
shortage.
Original Quantity Original Quantity New Quantity
Price
Supplied Demanded Demanded

$400 12,000 18,000 23,000

$500 15,000 15,000 19,000

$600 17,000 13,000 17,000

$700 19,000 11,000 15,000

$800 20,000 10,000 14,000

Table 10. Rent Control

Suppose that a rent control law is passed to keep the price at the original equilibrium of $500 for
a typical apartment. In Figure 1, the horizontal line at the price of $500 shows the legally fixed
maximum price set by the rent control law. However, the underlying forces that shifted the
demand curve to the right are still there. At that price ($500), the quantity supplied remains at the
same 15,000 rental units, but the quantity demanded is 19,000 rental units. In other words, the
quantity demanded exceeds the quantity supplied, so there is a shortage of rental housing. One of
the ironies of price ceilings is that while the price ceiling was intended to help renters, there are
actually fewer apartments rented out under the price ceiling (15,000 rental units) than would be
the case at the market rent of $600 (17,000 rental units).
Price ceilings do not simply benefit renters at the expense of landlords. Rather, some renters (or
potential renters) lose their housing as landlords convert apartments to co-ops and condos. Even
when the housing remains in the rental market, landlords tend to spend less on maintenance and
on essentials like heating, cooling, hot water, and lighting. The first rule of economics is you do
not get something for nothing—everything has an opportunity cost. So if renters get “cheaper”
housing than the market requires, they tend to also end up with lower quality housing.
Price ceilings have been proposed for other products. For example, price ceilings to limit what
producers can charge have been proposed in recent years for prescription drugs, doctor and
hospital fees, the charges made by some automatic teller bank machines, and auto insurance
rates. Price ceilings are enacted in an attempt to keep prices low for those who demand the
product. But when the market price is not allowed to rise to the equilibrium level, quantity
demanded exceeds quantity supplied, and thus a shortage occurs. Those who manage to purchase
the product at the lower price given by the price ceiling will benefit, but sellers of the product
will suffer, along with those who are not able to purchase the product at all. Quality is also likely
to deteriorate.
Price Floors
A price floor is the lowest legal price that can be paid in markets for goods and services, labor,
or financial capital. Perhaps the best-known example of a price floor is the minimum wage,
which is based on the normative view that someone working full time ought to be able to afford
a basic standard of living. The federal minimum wage at the end of 2014 was $7.25 per hour,
which yields an income for a single person slightly higher than the poverty line. As the cost of
living rises over time, the Congress periodically raises the federal minimum wage.
Price floors are sometimes called “price supports,” because they support a price by preventing it
from falling below a certain level. Around the world, many countries have passed laws to create
agricultural price supports. Farm prices and thus farm incomes fluctuate, sometimes widely. So
even if, on average, farm incomes are adequate, some years they can be quite low. The purpose
of price supports is to prevent these swings.
The most common way price supports work is that the government enters the market and buys
up the product, adding to demand to keep prices higher than they otherwise would be. According
to the Common Agricultural Policy reform passed in 2013, the European Union (EU) will
spend about 60 billion euros per year, or 67 billion dollars per year, or roughly 38% of the EU
budget, on price supports for Europe’s farmers from 2014 to 2020.
Figure 2 illustrates the effects of a government program that assures a price above the
equilibrium by focusing on the market for wheat in Europe. In the absence of government
intervention, the price would adjust so that the quantity supplied would equal the quantity
demanded at the equilibrium point E0, with price P0 and quantity Q0. However, policies to keep
prices high for farmers keeps the price above what would have been the market equilibrium
level—the price Pf shown by the dashed horizontal line in the diagram. The result is a quantity
supplied in excess of the quantity demanded (Qd). When quantity supplied exceeds quantity
demanded, a surplus exists.
The high-income areas of the world, including the United States, Europe, and Japan, are
estimated to spend roughly $1 billion per day in supporting their farmers. If the government is
willing to purchase the excess supply (or to provide payments for others to purchase it), then
farmers will benefit from the price floor, but taxpayers and consumers of food will pay the costs.
Numerous proposals have been offered for reducing farm subsidies. In many countries, however,
political support for subsidies for farmers remains strong. Either because this is viewed by the
population as supporting the traditional rural way of life or because of the lobbying power of the
agro-business industry.
For more detail on the effects price ceilings and floors have on demand and supply, see the
following Clear It Up feature.

Key Concepts and Summary

Price ceilings prevent a price from rising above a certain level. When a price ceiling is set below
the equilibrium price, quantity demanded will exceed quantity supplied, and excess demand or
shortages will result. Price floors prevent a price from falling below a certain level. When a price
floor is set above the equilibrium price, quantity supplied will exceed quantity demanded, and
excess supply or surpluses will result. Price floors and price ceilings often lead to unintended
consequences.
Q14.Explain tax and subsidy under price restriction and market equilibrium?
Ans- The government can influence markets and its citizens in many ways. Two of these types
of tools are taxes and subsidies. Let's start off by establishing the difference between taxes and
subsidies!
Taxes are a charge the government imposes on individuals' and firms' income and revenue. At
the same time, subsidies are grants or tax breaks given to individuals and firms to incentivize
them to pursue a social objective that the government that issues the subsidy wishes to promote.
These policies shift the supply or demand curve depending on who and how they're
implemented.
Definition-
Taxes are monetary costs levied by governments on individuals and firms that are collected from
their income or revenue to be transferred to the public sector.
Subsidies are direct and indirect payments provided by the government to individuals and firms
to give the recipients a financial incentive to pursue a certain objective.
Difference between Taxes and Subsidies
How does the differences between taxes and subsidies affect the outcome of a policy? Taxes and
subsidies are two financial mechanisms the government uses; we'll cover why these exist and
what implications they have for the government, citizens, and businesses.
Effect of Tax and Subsidy on Supply and Demand
Let's establish the difference of outcome subsidies and taxes can have on supply and demand.
Government intervention can alter outcomes in a marketplace; let's analyze these effects.
Analyzing how a market responds to these policies will give a better framework to understand
why they may be implemented and their intentions.
Tax and Subsidy Effect on Supply
Policies like taxes and subsidies can alter supply significantly; the difference occurs whether it's
used to correct competitive forces or address externalities, the market will shift accordingly.
Policies can affect supply whether they're placed on producers or consumers, as changes in
demand will change the equilibrium between supply and demand.
Determinants of supply and taxes and subsidies
Determinants of supply are many factors that affect a firm's quantity and price supplied. Check
out this list below to see major factors that affect supply.
 Price of a good - Price changes has a direct supply and demand response.
 Price of substitute goods - Changes in the price or quality of competing goods.
 Price of inputs - Changes in the cost of production.
 Competitive forces - The more competition in the market, the more sharply supply is
affected.
 Technology - Changes in technology affect productivity and the cost of production.
When a subsidy is applied, this is a benefit to the suppliers, receiving either a reduction in cost or
cash. Either way, the subsidy is distributed, and it will increase returns for producers. Producers
supply a quantity where marginal revenue (MR) equals marginal cost (MC); the subsidy raises
marginal revenue, allowing producers to increase to a higher quantity. On a graph, this would
appear as a rightward shift in the supply curve.
When a tax is imposed on suppliers, this increases their operating costs which will limit their
production. Like above, they produce to MR=MC; however, the marginal cost is higher due to
the tax. This means that firms' production quantities will not be too costly at higher quantity
levels, so they will have to reduce the quantity to match the increased cost. A tax like this will
shift supply to the left, resulting in lower quantity supplied and higher prices.

Tax and Subsidy Effect on Demand

It doesn't need to be said that consumption is taxed, as anyone who bought anything already
knows. It may not seem like it, but demand often receives subsidies in various forms from the
government, whether it's unemployment benefits or tax breaks for energy efficiency.
Government interventions can affect demand even when imposed on producers, as changing the
supply curve alters the equilibrium point with demand.
A subsidy can affect demand in multiple ways, usually for the better in the short run. A subsidy
can make goods cheaper or more available, whether the subsidy is given to consumers or
producers. A subsidy to consumers, such as the Covid-19 stimulus checks, increases disposable
income, shifting the demand curve to the right. A rightward shift means an increase in quantity
demanded and willingness to pay.
For as long as anyone has been alive, we've witnessed taxes affecting demand for sales, gas, or
property. Any tax decreases disposable income and shifts the demand curve leftward, reducing
the quantity demanded and lowering the willingness to pay higher prices.

Tax and Subsidy Graph

By graphing the effects of taxes and subsidies, we can easily observe the differences and how it
interacts with supply and demand and how these policies change the market. In the graphs
below, the following abbreviations and definitions are used:
 CS=Consumer Surplus: is the difference between a customer's willingness to pay and the
actual price. In other words, a customer's excess value by buying at the equilibrium price.
 PS=Producer Surplus: is the difference between how much it costs producers to supply a
good or service, and what they receive for a price on the market. The excess value
producers get for selling up to the equilibrium price.
 DWL=Dead Weight Loss: Is the difference between the total surplus at competitive
market equilibrium, and the new surplus after government intervention.

Below in figure 1 is a supply and demand graph that depicts the effects of a tax imposed on the
market. A tax will reduce consumer and producer surplus in exchange for tax revenue, creating a
market loss.
Fig 1. Tax effect on the market
The graph above in figure 1 shows a supply and demand curve at an equilibrium price and
quantity. A tax is imposed on the market; this decreases the price received by producers (P 1) and
increases consumer costs (P2).

Both of these changes in a price reduce the quantity supplied and demanded (Q 2). Because the
quantity exchanged is reduced, it lowers the total efficiency in the market; this is represented by
the blue triangle (DWL). The pink rectangle represents the government's revenue from the tax.

The graph below represents how a subsidy impacts a market's supply and demand at equilibrium.
A subsidy is implemented by the government, which pays producers to supply the product at a
lower price.

Fig 2. Subsidy effect on the market

Figure 2 above shows a supply and demand curve and a market at equilibrium quantity (Q1) and
price (P1). A governing body implements a subsidy that pays producers to provide a lower price;
this causes producers to receive a higher price (P3) and consumers to pay a lower price (P2).

Because of this, both consumers and producers receive the regular market surplus and an
additional surplus created from the subsidy. Because both parties receive a better price, they
exchange a higher quantity.

However, this quantity is not as efficient as the free market. Not every dollar spent on the
subsidy results in an increased surplus, some of the subsidy doesn't create value (DWL).

In summary, subsidies do create a large benefit. Still, some of the benefits are lost to what can be
considered disinterested customers. The big benefit only creates value if the loss used to collect
tax revenue is less efficient. That is what an efficiency maximization lens will consider;
however, the social efficiency may be greater. Unfortunately, social efficiency is hard to
quantify; maybe you'll be the economist who discovers a social efficiency theory.