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					      Term Paper
  Managerial Economics

Topic: Demand, Determinants of Demand
           and its Analysis

 S.                                           Page
No.                                           No.
1.      I. Meaning of Demand                    3
       II. Business Significance of Demand
2.    Types of Demand                          4-5
3.    Determinants of Demand                   5-6
4.    Demand Function                           6
      Law of Demand
         I. Assumption of the Law of Demand
        II. Demand Schedule
5.                                            6 – 10
       III. Demand Curve
       IV. Rationale for Law of Demand
        V. Exception of the Law of Demand
      Demand Analysis
         I. Meaning of Demand Analysis
        II. Marginal Utility Approach
6.                                            10 – 13
       III. Indifference Curve Analysis
       IV. Revealed Preference Approach
        V. Objectives of Demand Analysis
7.    Conclusion                              13 - 14
8.    Bibliography                              14

Meaning of Demand:-
        Conceptually, the term „Demand‟ implies a „desire for a commodity
backed by the ability and willingness to pay for it‟.
       The concept of demands refers to the quantity of a good or service that
consumers are willing and able to purchase at various prices dealing a period of
time. The demand in economics is something more than desire to purchase though
desire is one element of it. A beggar for instance, may desire food, but due to lack
of means to purchase it, his demand is not effective. In economics, demands refer
to effective demand, which implies three things (i) Desire (ii) means to purchase
and, (iii) on willingness to use those means for that purchase. The demand for a
commodity at a given price is the amount of it, which will be bought per unit of
time at that price.

      A meaningful statement regarding the demand for a commodity should
contain the following information:

   I.   the quantity demanded of a commodity,
  II.   the price at which a commodity is demanded,
 III.   the time period over which a commodity is demanded and
 IV.    the market area in which a commodity is demanded.

      For example, saying, „the annual demand for TV sets in Delhi at an average
price of Rs. 15,000 a piece is 50,000‟ is a meaningful statement.

Business Significance of Demand:-
      The market for a firm‟s product cannot be analyzed without reference to the
demand condition. For a firm or an industry consisting of several firms, the extent
of demand determines the size of market. Successful business firms, therefore,
spend considerable time, energy and effort in analyzing the demand for their
products. Without a clear understanding of consumers‟ behavior and a clear
knowledge of the market demand conditions, the firm is handicapped in its attempt
towards profit planning or any other business strategy planning. For example,
estimating present demand and forecasting future demand constitutes the first step
towards measuring and determining the flow of sales revenues and profits which
generate internal resources to finance business. The stability and growth of
business is linked to size and structure of demand.

                          Types of Demand
1. Individual and Market Demand: The quantity of a commodity which an
  individual is willing to buy at a particular price of the commodity during a
  specific time period, given his money income, his taste, and prices of other
  commodities (particularly substitutes and complements), is known as
  „individual‟s demand for a commodity‟.

     The total quantity which all the consumers of a commodity are willing to buy
  at a given price per time unit, given their money income, taste, and prices of
  other commodities (mainly substitutes) is known as „market demand for the
  commodity‟. In other words, the market demand for a commodity is the sum of
  individual demands by all the consumers (or buyers) of the commodity, over a
  time period, and at a given price, other factors remaining the same.

2. Demand for Firm‟s Product and Industry‟s Products: The quantity of a
  firm‟s produce that can be disposed of at a given price over a time period, and at
  a given price, other factors remaining the same.

3. Autonomous and Derived Demand: Autonomous Demand for a
  commodity is one that arises independent of the demand for any other
  commodity whereas derived demand is one that is lied to the demand for some
  „parent product‟. Demand for food, clothes, shelter etc. is autonomous demand.
  Demand for land, fertilizers, and agricultural tools and implements are a derived
  demand, for these goods are demanded because food is demanded.

4. Demand for Durable and non-durable Goods: Demand is often classified
  also under demand for durable and non-durable goods. Durable goods are
  those. Whose total utility (or use) is not exhausted by a single use. Such goods
  can be used repeatedly or continuously over a period. Durable goods may be
  consumer as well as producer goods. Durable consumer goods include clothes,
  shoes, owner occupied residential houses, furniture, utensils, refrigerators,
  scooters, cars, etc. The durable producer goods include mainly the items under
  „fixed assets‟, such as building, paint, machinery, etc.

     Non-durable goods on the other hand, are those, which can be used or
     consumed only once (for example, food items) and their total utility is
     exhausted in a single use.

5. Short-term and Long-term Demand: Short-term demand refers to the
  demand for such goods as are demanded over a short period. In this category
  fall mostly the fashion consumer goods, goods of seasonal use, inferior
  substitutes during the scarcity period of superior goods, etc.

     The long-term demand, on the other hand, refers to the demand, which exists
     over a long period. The change in long-term demand is perceptible only after
     a long period. Most generic goods have long-term demand. For example,
     demand for consumer and producer goods, durable and non-durable goods,
     is long-term demand, though their different varieties or brands may have only
     short-term demand.

                  Determinants of Demand
1. Price of the commodity: Ceteris paribus i.e., other things being equal, the
  demand of a commodity is inversely related to its price. It implies that a rise in
  price of a commodity brings about a fall in its purchase and vice-versa. This
  happens because of income and substitution effects.

2. Income of the households: Other things being equal, the demand for a
  commodity depends upon the income of the household. In most cases, the
  larger the average income of the household, the larger is the quantity demanded
  of a particular good.

3. Price of the related goods: Related commodities are of two types: (a)
  Complementary goods and (b) Completing goods or substitutes.
  Complementary goods are those goods, which are consumed together or
  simultaneously. For example, tea and sugar, automobiles and petrol, pen and
  ink are used together. When commodities are complements, a fall in the price of
  one (other things being equal) will cause the demand of the other to rise.

4. Tastes and preferences of consumers: The demand for a commodity also
  depends upon tastes and preferences of consumers and changes in them over a
  period of time. Goods, which are more in fashion command higher demand than
  goods, which are out of fashion.

5. Other factors:
     I. Size of population: Generally, larger the size of population of a
         country or region, greater is the demand for commodities in general.

    II.   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, will be more.

   III.   Distribution of Income: The wealth of the country may be so
          distributed that there are a few exceptionally rich people while the
          majority are exceedingly poor. Under such conditions, the propensity to
          consume of the country will be relatively less, for the propensity to
          consume of the rich people is less than that of the poor people.
          Consequently, the demand for consumer goods will be comparatively
          less. If the distribution of income is more equal, then the propensity to
          consume of the country as a whole will be relatively high indicating
          higher demand for goods.

     Apart from the above factors such as class, group, education, marital status
and weather conditions, also play an important role in influencing household

                       Demand Function
      The above listed factors can easily be presented in the form of a demand
function as follows:
             Qdc = f (Pc, Pr, Y, T, D,)
Where Qdc is the quantity demanded of commodity c, Pc is the price of
commodity c, Pr is the price of commodities, Y is the money income of the
household, T is the taste of the household, D represent size of the population and
other remaining factors.

                         Law of Demand
      The demand for a commodity increases with fall in its price and decreases
with the rise in its price, other thing remaining the same. The law of demand thus
merely states that the price and the demand of a commodity are inversely related,
provided all other things remain unchanged.

Assumptions of the Law of Demand:-
  1. Income level should remain constant: The law of demand operates only
     when the income level of the buyer remains constant. If the income rises
     while the price of the commodity in question does not fall, it is quite likely
     that the demand may increase. Therefore, stability in income is an essential
     condition for the operation of the law of demand.

  2. Tastes of the buyer should not change: Any change that takes place in
     the tastes of the consumers will in all probability prevent the working of the
     law of demand. It often happens that when tastes or fashions change people
     revise their preferences.

  3. Price of other goods should remain constant: Changes in the prices of
     other goods often affect the demand for a particular commodity. If prices of
     commodities for which demand is inelastic rise, the demand for a commodity
     other than these in all probability will decline even though there may not be
     any change in its price. Therefore, for the law of demand to operate it is very
     necessary that prices of other goods do not change.

  4. No New substitutes for the commodity: If some new substitutes for a
     commodity appear in the market, its demand generally decline. This is quite
     natural, because with the availability of new substitutes some buyers will be
     attracted towards new product and the demand for the older product will fall
     even though price remains unchanged. Hence, the law of demand operates
     only when the market for a commodity is not threatened by new substitutes.

  5. Price rise in future should not be expected: If the buyers of a
     commodity expect that its price will rise in future they raise its demand in
     response to an initial price rise. This behaviour of buyers violates the law of
     demand. Therefore, for the operation of the law of demand it is necessary
     that there must not be any expectations of price rise in future.

      The law of demand may be illustrated with the help of a demand schedule
and a demand curve.

Demand Schedule:-
       The demand schedule thus shows the effect of price changes on the quantity
sold in the market to the exclusion of all the factors.

                             Price of Commodity           Quantity Demanded
                                     (Rs.)                      (Units)
            A                           5                            10
                 B                                            4            15
                 C                                            3            20
                 D                                            2            35
                 E                                            1            60

Demand Curve:-
      The graphical representation of the demand schedule is the demand curve.
Individual demand curve indicates the quantity of the commodity that an
individual will buy at different prices. It is customary in economics to measure a
price along „Y‟ axis and quantity demanded on „X‟ axis.


                     5            A

                     4                B


                     2                              D


                             10       20       30       40   50   60   X

                         Fig. 1: Demand Curve
     The curve slopes downward. Any point on the graph indicates a single price
quantity relation. The whole demand curve DD1 shows the quantity of commodity
N that would be bought by an individual at different prices.

Rationale for Law of Demand: Why does demand curve slope
  1. Substitution Effects: When the price of a commodity falls, it becomes
     relatively cheaper than other commodities. It includes consumers to
     substitute the commodity whose price has fallen for other commodities,
     which have now become relatively expensive. The result is that total demand
      for the commodity whose price has fallen increases. This is called
      substitution effect.

   2. Income Effects: When the price of commodity falls, the consumer can buy
      the same quantity of the commodity with lesser money or he can buy more of
      the same commodity with the same money. In other words, as a result of fall
      in the price of the commodity, consumer‟s real income or purchasing power
      increases. This increase in the real income includes him to buy more of that
      commodity. Thus demand for that commodity (whose price has fallen)
      increases. This is called income effect.

   3. New Consumer Creating Demand: When the price of a commodity falls,
      more consumers start buying it because some of those who could not afford
      to buy it previously may afford to buy it. This raises the number of consumers
      of a commodity at a lower price and hence the demand for the commodity in

Exception of the Law of Demand:-
       According to law of demand, more of a commodity will be demanded at
lower prices, than at higher prices, other things being equal. The law of demand is
valid in most of the cases; however there are certain cases where this law does not
hold good. The following are the important exceptions to the law of demand.

1. Conspicuous goods: Some consumers measure the utility of a commodity by
   its price i.e., if the commodity is expensive they think that it has got more utility.
   As such, they buy less of this commodity at low price and more of it at high
   price. Diamonds are often given as example of this case. Higher the price of
   diamonds, higher is the prestige value attached to them and hence higher is the
   demand for them.

2. Giffen goods: Sir Robert Giffen, and economist, was surprised to find out that
   as the price of bread increased, the British workers purchased more bread and
   not less of it. This was something against the law of demand. Why did this
   happen? The reason given for this is that when the price of bread went up, it
   caused such a large decline in the purchasing power of the poor people that they
   were forced to cut down the consumption of meat and other more expensive
   foods. Since bread even when its price was higher than before was still the
   cheapest food article, people consumed more of it and not less when its price
   went up.

   Such goods which exhibit direct price-demand relationship are called „Giffen
   goods‟. Generally, those goods which are considered inferior by the consumers
   and which occupy a substantial place in consumer‟s budget are called „Giffen
   goods‟. Examples: such goods are coarse grains like bajra, low quality of rice
   and wheat etc.

3. Conspicuous necessities: The demand for certain goods is affected by the
   demonstration effect of the consumption pattern of a social group to which an
   individual belongs. These goods, due to their constant usage, have become
   necessities of life. For example, in spite of the fact that the prices of television
   sets, refrigerators, coolers, cooking gas etc. have been continuously rising, their
   demand does not show any tendency to fail.

4. Future expectations about prices: It has been observed that when the price
   are rising, households expecting that the prices in the future will be still higher,
   tend to buy larger quantities of the commodities. For example, when there is
   wide-spread drought, people expect that prices of food-grains would rise in
   future. They demand greater quantities of food-grains as their price rise.

5. Impulsive purchases: At times consumers tend to make impulsive purchases
   without any cool calculations about price and usefulness of the product and in
   such contexts the law of demand fails.

6. Ignorance effect: Generally, it is assumed that households have perfect
   knowledge about price and quality of goods. However, in practice, a household
   may demand larger quantity of a commodity even at a higher price because it
   may be ignorant of the ruling price of the commodity.

                         Demand Analysis
Meaning of Demand Analysis:-
      There are a large number of factors, which have a direct impact on the
demand of a commodity or service. Demand analysis means the study of factors,
which influence the demand of a commodity or service. It is only on the basis of
these factors or determinants of demand one can forecast demand. Under demand
analysis we study elasticity of demand and methods of its measurement, sales
forecasts and different methods to forecast sales or demand, manipulating demand
and appropriate change in allocation of resources. Analysis of demand enables the
producer to adjust his production to the demand to maximize the objective

     Economists have developed several techniques of analyzing demand.
Econometricians have tested some of the propositions underlying the economic
theory of demand as developed by the economists. Of late, in the name of
psychological economics, the behavioral scientists have attempted explanation as
well as psychometric measure of consumer‟s behavior. Following are the
approaches for analyzing the demand:

1. Marginal Utility (Neo-Classical) Approach:-
       It is a traditional approach used by Marshall and Jevons to explain the
consumer behavior. Consumers demand commodity because they derive or expect
utility from the consumption of that commodity. The utils (utility-content of
product) indicate „value-in-use‟ and they command price in the market; the price
paid indicates the „value-in-exchange‟. Sometimes we observe that products with
tremendous „value-in-use‟ do not command any „value-in-exchange‟ i.e., those are
“free goods” like air, water available in plenty at „no price‟ because there is no
scarcity. Utility along with scarcity determines price. Diamond is not that useful,
but being rare it is very valuable; therefore, such “economic goods” command a
high price.

      Economists assume that the utils are cardinally measurable and comparable
in terms of a measuring unit of money, provided the utility of that money is held
constant. A consumer, while purchasing a commodity often compares his sacrifice
(in terms of price paid0, i.e., value-in-exchange with his satisfaction. If price
exceeds marginal utility, he reduces his purchase. If marginal utility
exceeds price, he enhances his purchase. Ultimately when price equals
marginal utility, he is in an equilibrium state of his purchase decision.

                                    Marginal utility of product
Marginal Utility of money spent = ---------------------------------------
                                         Price of the product

                             [MUm = ----------]

2. Indifference Curve (Ordinal Utility) Approach:-
      This approach has been developed by the economists like Hicks and Allen to
overcome some of the limitations of Neo-Classical approach. Assuming ordinal
measurement of utility and relatedness of goods and relaxing the assumption of
constant marginal utility of money, the technique of indifference analysis has been

      We start with a multi-commodity consumer rather than a single commodity
consumer, typical of traditional utility approach. Thus, the utility function is stated
as: U = U (X, Y) where x and y stand for two products.

       The consumer wants to purchase of combination of x (say, cereals) and y
(say, vegetables). With given resources and given need, whenever he buys more of x
he has to be satisfied with less of y. The rate at which this substitution takes place
is termed as the Marginal Rate of Substitution, MRS which measures the slope of
the Indifference curve

                        ΔY                dY
            MRSxy = ----------       OR -------
                        ΔX                dX

      Even if the consumer moves from combination A to B there is no change in
his satisfaction level, because the utility-content of the bundle as a whole is intact;
more of x may reduce the utility of x, but less of y may have increased the utility of
y. This follows from the Law of Diminishing Utility. Each indifference curve
can, therefore, be treated as an iso-utility curve.

3. Revealed Preference Approach:-
       Indifference curve analysis is a powerful tool, but beyond a point it cannot be
stretched. Today, the businessmen have to understand the buyer‟s behavior from
the standpoint of more of psychology than of economics.

       A consumer buys a combination of x and y; his choice takes care of his
“preferences” as well as his “constraints”. What is desirable may not always be
available and feasible. Therefore while choosing, he balanced the two. Does this
choice reveal his preference? Yes it does, provided the following axioms are

      1. Choice set is complete. Before the buyer exercises his choice, he takes
         into account all available choices.

      2. Choice is rational. Rationality on the part of the chooser implies that he
         is never satisfied (non-satisfied) and that he wants to get the best
         satisfaction out of his least scarifies.

      3. Choice is optimal. Optimally means that either he maximizes his
         satisfaction or he minimizes his sacrifice, if there is no constraint.

      4. Choice is strongly ordered.
       5. Choice is transitive.

       6. Choice is consistent.

      It the above axioms are satisfied, then only Choice reveals preference. It
should now be clear that the demand analyst cannot use terms like demand, need
preference, ordering, choice, etc., interchangeably.

Objectives of Demand Analysis:-
  1.   To study and analyze the determinants of demand.
  2.   To measure the elasticity of demand.
  3.   To prepare sales or demand forecasts.
  4.   Manipulating demand.
  5.   To make appropriate changes in allocation of resources.

       „Demand‟ implies a „desire for a commodity backed by the ability and
       willingness to pay for it‟.
       The Law of Demand holds that other things equal, as the price of a good or
       service rises, its quantity demanded will fall, and vice versa.

       A Demand Curve is a graphical depiction of the law of demand. It has a
       negative slope.

       A change in price results in a movement along a fixed demand curve. A
       change in any variable other than price that influences quantity demanded
       produces a shift in the demand curve.

       A shift in the demand curve to the right (left) results in a higher (lower)
       equilibrium price and quantity.

       The demand curve shifts to the right when incomes rise, population
       increases, preferences increase, the price of a substitute rises, or the price of a
       complement falls.

       Under Demand Analysis we study elasticity of demand and methods of its
       measurement, sales forecasts and different methods to forecast sales or
       demand, manipulating demand and appropriate change in allocation of
       resources. Analysis of demand enables the producer to adjust his production
       to the demand to maximize the objective function.

           Book Name                 Author            Publisher       Page No.
                                                                        178 – 182,
1.    Business Economics
                                                                        199 - 208
                                                                         104, 115,
                                                                        120 – 126,
                                                    Vikas Publishing
2.    Managerial Economics      D. N. Dwivedi                           131 – 133,
                                                    House Pvt. Ltd.
                                                                        160 – 163
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