UNIT 2
Demand and
Supply
DEMAND - MEANING
Demand in economics is refers to the
consumers' willingness and ability to
purchase a commodity or service.
Without demand, no business would
ever bother producing anything.
DETERMINANTS OF
DEMAND
The demand for any commodity mainly
depends on the PRICE of that commodity.
The other determinants include
Price of related commodities,
Income of consumers,
Tastes and preferences of consumers,
Wealth of consumers
DEMAND FUNCTION
Dx = F (P x , Ps, Y, T, W)
where Dx = Demand for commodity x
Px = Price of commodity X
Ps = Price of related commodities
Y = Income
T = Tastes and preferences
W = Wealth of the consumer.
LAW OF DEMAND
The Law of Demand states that the quantity
demanded for a commodity or service rises as the
price falls, ceteris paribus
The other-things-being-equal assumption is very
important in law because the demand for goods also
varies with several other factors than just the price.
The law of demand states that there is a negative or
inverse relationship between the price and quantity
demanded of a commodity over a period of time.
DEMAND -DEFINITION
Alfred Marshall stated that “ the greater
the amount sold, the smaller must be
the price at which it is offered, in order
that it may find purchasers; or in other
words, the amount demanded increases
with a fall in price and diminishes with
ASSUMPTIONS OF THE
LAW
1.No change in the consumer’s income
2. No change in consumer’s tastes and
preferences
3. No changes in the prices of other goods
4. No new substitutes in the market
DEMAND SCHEDULE
Price Qty
Demand schedule Demanded
50 10
is a tabular
40 20
statement showing
how much of a 30 30
commodity is 20 40
demanded at
10 50
different prices.
DEMAND CURVE
The demand schedule can be converted
into a demand curve by measuring
price on Y axis and
quantity on X axis
The demand curve slopes downwards
mainly due to the Law of Diminishing
Marginal Utility.
INDIVIDUAL & MARKET
DEMAND
Individual Market Demand
Demand Market demand
represents the provides the total
quantity of a quantity
demanded by all
good that a single
consumers.
consumer would In other words, it
buy at a specific
represents the
price point at a
aggregate of all
specific point in individual
time. demands.
EXCEPTIONS TO LAW OF
DEMAND
Exceptions
Giffen Paradox Veblen Effect
ELASTICITY OF DEMAND
In Economics elasticity refers to
“responsiveness”.
The concept of elasticity of demand
measures the rate of change in demand.
ELASTICITY OF DEMAND
The law of demand explains that
demand will change due to a change in
the price of the commodity.
But it does not explain the rate at which
demand changes to a change in price.
The concept of elasticity of demand
measures the rate of change in demand.
The concept of elasticity of demand was
introduced by Alfred Marshall.
TYPES OF ELASTICITY OF
DEMAND
Elasticity of Demand
Price Income Cross
Elasticity Elasticity Elasticity
PRICE ELASTICITY
“The degree of responsiveness of
quantity demanded to a change in price
is called price elasticity of demand”.
i.e
Price Elasticity = % Change in Qty
Demanded
% Change in Price
MEASUREMENT OF PRICE
ELASTICITY OF DEMAND
Price Elasticity of Demand
Percentag Point Total Outlay Arc
e Method Method Method Method
PERCENTAGE METHOD
Percentage change in demand divided
by Percentage change in price.
ep = % q
% p
EXAMPLE
Example 1
Assume that the price of rice rises by 10% and the
demand for rice falls by 15%,
Then ep = 15/10 = 1.5
This means that the demand for rice is elastic.
i.e the demand for a product is sensitive to price changes.
Example 2
Assume that the price of LPG Cylinder rises by 10% and
the demand for LPG Cylinder falls by 5%,
Then ep = 5/10 = 0.5
This means that the demand for LPG Cylinder is inelastic.
I.e the demand for a product is not sensitive to price
changes.
Relatively elastic means that relatively
small changes in price cause relatively large
changes in quantity. (more substitutes)
Relatively inelastic means that relatively
large changes in price cause relatively small
changes in quantity. (fewer Substitutes)
Unitary elastic means that any change in the
price of a good leads to an equally proportional
change in quantity demanded.
Perfectly inelastic means that a change in
price, how so ever large, no change in quantity
demanded.
Perfectly elastic means, even a small
change in price causes an infinite change in
the quantity demanded.
MEASURES OF PRICE
ELASTICITY
Value of Type of Demand Example
Elasticity
>1 Relatively Elastic demand Motor Vehicles,
Professional
Services
<1 Relatively Inelastic LPG Cylinder,
demand Drinking Water,
Electricity
=1 Unitary elastic demand Milk
Clothing
=0 Perfectly inelastic demand Table Salt
Perfectly elastic demand Pepsi
∞ Coke
Relatively Elastic Relatively Inelastic
Unitary Elastic
Perfectly Elastic Perfectly Inelastic
DEMAND FORECASTING
Demand forecasting is the process of
making estimations about future
customer demand over a defined
period, using historical data and other
information.
In other words, Predicting future market
demand magnitude on the basis of
statistical data and empirical
measurement of functional relationship
between demand and its determinants.
WHY IT IS IMPORTANT?
Sales forecasting helps with business planning, budgeting, and goal
setting. Once a firm have a good understanding of what the future
sales could look like, it can begin to develop an informed
procurement strategy to make sure the supply matches customer
demand.
It allows businesses to more effectively optimize inventory,
increase inventory turnover rates and reduce holding costs.
It provides an insight into upcoming cash flow, meaning businesses
can more accurately budget to pay suppliers and other operational
costs, and invest in the growth of the business.
Through sales forecasting, a firm can also identify and rectify any
kinks in the sales pipeline ahead of time to ensure your business
performance remains robust throughout the entire period. When it
comes to inventory management, most e
Commerce business owners know all too well that too little or too
much inventory can be detrimental to operations.
Anticipating demand means knowing when to increase staff and
other resources to keep operations running smoothly during peak
periods.
LEVELS OF FORECASTING
Micro Level
• Demand forecasting by individual business form for estimating the
demand for its product.
Industry Level
• Demand estimate for the product of the industry as a whole. It is undertaken
by an Industrial or Trade Association. It refers to the Market Demand.
Macro Level
• It refers to the aggregate demand for the industrial output by the national
as a whole. It is based on the National Income of the country.
SHORT TERM & LONG TERM FORECASTING
Short Term Forecasting
• Relates to a period not exceeding a year.
• Purpose: Evolving a Sales Policy, Determining Price Policy, Evolving a Purchase
Policy, Fixation of Sales Target and Determining Short Term Financial Planning
Long Term Forecasting
• Relates to a period 3-5 years.
• Purpose: Business Planning, Manpower Planning and Long
Term Financial Planning.
SOURCE OF DATA
Primary Data
• Primary data are originally in character which are collected for
the first time for the purpose of analysis. Primary data are raw
data and require statistical processing.
Secondary Data
• Secondary data are those which are obtained form someone else’s records. These
data re already in exist in published forms. Secondary data are like finished
products since they have been processed statistical in some form or the other.
SOURCE OF DATA
Primary Data - Source
• Consumer Survey
• Market Survey.
Secondary Data - Source
• Official publications of the
Central, State and Local
Governments.
• Journals
• Market Reports
SUPPLY
Supply means the quantities that a
seller is willing and able to sell at
different prices.
The supply of a commodity at a given
price can be defined as the amount of it
which is actually offered for sale per unit
of time at that price.
LAW OF SUPPLY
The law of supply establishes a direct
relationship between price and supply.
Firms will supply less at lower prices and
more at higher prices.
“Other things remaining the same, as
the price of commodity rises, its supply
expands and as the price falls, its supply
contracts”.
SUPPLY FUNCTION
Sx = F (Px, Pf, Py,…Pz, O, T, t, s)
where Sx = Supply of commodity x
Px = Price of commodity X
Pf = Set prices of the factors inputs
employed for producing X.
O = Factors outside the economic shpere
T = Technology
t = Tax
s = Wealth of the consumer.
EXCEPTION TO THE LAW
Exceptio
ns
Anticipat
Auction e Price
fall
SUPPLY SCHEDULE &
CURVE
Supply schedule Supply Curve has
is a list of prices a positive slope.
and quantities of It moves upward
a given to the right.
commodity The price of the
offered for sale product and
by an individual quantity supplied
seller or are directly
producer. related each
other.
EXTENSION & CONTRACTION
OF SUPPLY CURVE
When the quantity offered for sale
increases or decreases merely because
price has risen or fallen, the terms
extension and contraction of supply is
used.
When more units are supplied at a
higher price, it is called ‘expansion of
supply’.
When fewer units are supplied at a
lower price it is called ‘contraction in
supply’.
EXTENSION & CONTRACTION
OF SUPPLY CURVE
SHIFT IN SUPPLY CURVE
The change in the quantity offered for
sale is caused, not by a change in price,
but by a change in the conditions of
supply, it is referred as shift in supply.
The change in the condition of supply
implies a change in the technical
conditions: perhaps a new process or a
new material has been discovered, a
new labour-saving device has been
discovered, or raw materials and other
factors have become cheaper.
SHIFT IN SUPPLY CURVE
FACTORS DETERMINING
SUPPLY
Technology in Production
Price
Price of other Products
No. of Firms
Future Price Anticipation
Tax Rate
Other Factors
TECHNOLOGY IN
PRODUCTION
State of production technology affects
the supply function.
If advanced technology is used in the
country, large scale production is
possible. Hence supply will increase.
Old technology will not increase the
supply.
PRICE
When the prices of factors rise, cost of
production will increase.
This will result in a decrease in supply.
Price of other Products
•Any change in the prices of other
products will influence the supply.
•An increase in the price of other products
will influence the producer to shift the
production in favour of that product.
•Supply of the original product will be
reduced.
NUMBER OF FIRMS
If the number of producers producing
the product increases, the supply of the
product will increase in the market.
Future Price Expectations
If producers expect that there will be a rise
in the prices of products in future, they will
not supply their products at present.
TAXES AND SUBSIDIES
If tax is imposed by the government on the
inputs of a commodity,
cost of production will go up.
Supply will be reduced.
When subsidy is given to the producer, it will
encourage them to produce and supply more.
Subsidy means a part of the cost of a
commodity will be borne by the government.
Non-economic factors
Non-economic factors like, war, political
climate and natural calamities create
scarcity in supply.
ELASTICITY OF SUPPLY
The law of supply tells us that quantity
supplied will respond to a change in price.
The concept of elasticity of supply explains
the rate of change in supply as a result of
change in price.
It is measured by the formula mentioned
below
Elasticity of supply =
Proportionate change in quantity supplied
Proportionate change in price
ELASTIC SUPPLY
Elastic supply means an increase in
price causes a bigger % change in
supply.
It means firms can easily increase
supply in response to a change in price.
Example
Firms operating below full capacity.
If a car factory is operating at 70%
capacity, then it can easily increase
supply and produce more cars in
response to changes in price.
INELASTIC SUPPLY
Inelastic supply means an increase in
price causes a smaller % change in
supply.
It means firms have difficulty increasing
supply in response to a rise in price.
Example
Nuclear Power. It would take
considerable time to increase the supply
of nuclear power because you need
skilled labour, and it would take a long
time to build.
PERFECTLY ELASTIC
SUPPLY
Perfectly elastic supply is an imaginary situation.
If cost of production increases with rise in output,
then the supply will increase with rise in prices.
Example
Say many agriculturists produce apples Add all
the costs incurred in the production such as land,
seeds, fertiliser and labour and the costs is Rs
1000 to produce apples.
Here the price cannot decline below Rs 1000. If
consumers are not willing to pay Rs 1000, then
the supply will become zero because it is not
profitable to produce apple.
