law of demand

LAW OF DEMAND

COMMODITY

MARKET

GOODS PRODUCED FOR SALE IN THE MARKET

ALL AREAS IN WHICH BUYERS AND SELLERS ARE IN CONTACT WITH EACH OTHER FOR THE PURCHASE AND SALE OF THE COMMODITY

FACTORS AFFECTING DEMAND

1. PRICE OF THE COMMODITY

2. THE MONEY INCOME OF THE INDIVIDUAL HOUSEHOLD

3. THE TASTES AND PREFERENCES OF THE INDIVIDUAL HOUSEHOLD

4. THE PRICES OF OTHER COMMODITIES

Dn = f(Pn , Pı .....‚ Pn-ı‚Y‚T)

Dn is the demand for commodity n. Pn is the price of commodity n Pı.....Pn-ı is the prices of all other commodities (other than Pn) Y is the income of the household T stands for tastes and preferences of the household

GENERAL DEMAND FUNCTION QD = f(P)

SPECIFIC DEMAND FUNCTION Dn = f(Pn)

Y = Yº T = Tº Pºı……Pn- ıº

º means there is no change in these variables ; their value is being held constant

DEMAND FUNCTION

TYPES OF DEMAND

PRICE DEMAND

INCOME DEMAND

CROSS DEMAND

DEMAND CHANGES WITH THE CHANGE IN PRICES PROVIDED INCOME, TASTES & PREFERENCES AND PRICES OF OTHER GOODS REMAIN CONSTANT

WHEN THE CONSUMER’S INCOME GOES UP, THE DEMAND FOR SUPERIOR QUALITY GOODS GOES UP. WHEN IT FALLS THE DEMAND FOR INFERIOR GOODS TEND TO RISE

CHANGE IN THE QUANTITY DEMANDED FOR ONE PRODUCT AS A RESULT OF CHANGE IN THE PRICE OF ANOTHER COMMODITY

MANAGERIAL USES

DEMAND ANALYSIS

FORECASTING DEMAND

MANIPULATING DEMAND

Serves Two Major Purposes

Ancillary Functions

1. Appraisal of performance of a salesman 2. Fixing sales quota 3. Company’s competitive position

DEMAND ELASTICITY

DEFINITION

ELASTICITY OF DEMNAND IS A CONCEPT WHICH MEASURES RELATIVE CHANGE IN DEMAND BECAUSE OF A CHANGE IN PRICE

PERCENTAGE CHANGE IN QUANTITY DEMANDED DIVIDED BY THE PERCENTAGE CHANGE IN PRICE

ELASTICITY OF DEMANDP

rice

Per

Un

it O

f X

Quantity Demanded Of X

AB

P

Pı

M Mı N NıO

Market A : Expansion in the demand is lowMarket B : Expansion in the demand is high

MORE ELASTICWhen the demand is proportional or more to the change in price

LESS ELASTIC

When there is a negligible response for the quantity demanded despite a considerable change in price

MORE ELASTIC

LESS ELASTICWhen the elasticity is less than one or less than unity

When the elasticity is more than one or more than unity

FORMULA FOR MEASURING ELASTICITY OF DEMAND

Price Elasticity Of Demand (E)

Proportionate Change In Quantity Demanded Proportionate Change In Price

=

= Change In Quantity Demanded÷

Change In PriceInitial PriceInitial Quantity Demanded

= PQ

× ΔQ

ΔP

E =ΔQQ

÷ΔPP

= ΔQ ×Q ΔP

P

Q = Original Quantity Demanded P = Original Price ΔQ =Change In Quantity ΔP = Change In Price

ORIGINAL PRICE (P) = RS. 3

ORIGINAL DEMAND (Q) = 1

CHANGE IN PRICE (ΔP) = RS. 2

CHANGE IN DEMAND (ΔQ) = 3

ELASTICITY = ?

TYPES OF DEMAND

PRICE DEMAND

INCOME DEMAND

CROSS DEMAND

DEMAND CHANGES WITH THE CHANGE IN PRICES PROVIDED INCOME, TASTES & PREFERENCES AND PRICES OF OTHER GOODS REMAIN CONSTANT

WHEN THE CONSUMER’S INCOME GOES UP, THE DEMAND FOR SUPERIOR QUALITY GOODS GOES UP. WHEN IT FALLS THE DEMAND FOR INFERIOR GOODS TEND TO RISE

CHANGE IN THE QUANTITY DEMANDED FOR ONE PRODUCT AS A RESULT OF CHANGE IN THE PRICE OF ANOTHER COMMODITY

TYPES OF ELASTICITY

THE EFFECT OF CHANGE IN PRICE ON QUANTITY DEMANDED IS CALLED THE PRICE ELASTICITY ODF DEMAND

PRICE ELASTICITY

% Change (Δ) In The Quantity Demanded

% Change (Δ) In The PriceE =

% Change ΔQ = 4

% Change ΔP = 2

PRICE ELASTICITY (Ep) = ?

DETERMINANTS OF PRICE ELASTICITY OF DEMAND

Availability of substitutes

Nature of commodity

Weightage in total consumption

Adaptability of consumption

pattern

Range of commodity use

Proportion of market supplied

INCOME ELASTICITY OF DEMAND

MEANS THE RATIO OF THE PERCENTAGE CHANGE IN QUANTITY DEMANDED TO THE PERCENTAGE CHANGE IN INCOME

Ey =Percentage Change In Quantity Demanded

Percentage Change In Income

Ey = YQ

× ΔQΔY

USE OF INCOME ELASTICITY OF DEMAND

Production Planning & Management

Estimating Future Demand

Helps In Avoiding Over-Production And Under-Production

GROSS NATIONAL PRODUCT

Income Of The Relevant class

Income Of The Relevant Region

Normal Goods/Inferior Goods

CROSS ELASTICITY

IS THE MEASURE OF RESPONSIVENESS OF DEMAND FOR A COMMODITY TO THE CHANGES IN THE PRICES OF SUBSTITUTES AND COMPLEMENTARY GOODS

Eе =Proportionate Change in the Quantity Of X

Proportionate Change in the Q Price Of Y

Eе = ΔQx

Qx÷

ΔPQx

USES OF CROSS ELASTICITY OF DEMAND

CROSS ELASTICITY OF TWO GOODS ARE

POSITIVE OR GREATER THAN ONE

CROSS ELASTICITY OF TWO GOODS ARE NEGATIVE IS LESS THAN ONE

Perfect Substitutes Complementary

Inadvisable to increase the price rather a reduction in price will be proper

Reducing the price may help in maintaining demand

ADVERTISING ELASTICITY OR PROMOTIONAL ELASTICITY OF DEMAND

×= ΔS ΔA

AS

S = Sales

ΔS = Increase In Sales

A = Original Advertisement Cost

ΔA = Additional Expenditure On Advertisement

ΔS S ÷

ΔA AEA =

PRICE OF X = RS. 1.25

NUMBER OF UNITS BOUGHT = 4

OUTLAY = RS. 1.25 X 4 = RS. 5.00

NOW PRICE OF X = RS. 1.00

NUMBER OF UNITS BOUGHT = 5

TOTAL OUT LAY = RS. 1.00 X 5

= RS. 5.00

MEASUREMENT OF ELASTICITY

1. TOTAL OUTLAY METHOD

2. PROPORTIONAL METHOD

3. GEOMETRIC METHOD

TOTAL OUTLAY METHOD

PROPORTIONAL METHOD

Under this method, the percentage change in price is compared to the percentage change in the quantity demanded; in other words, the ratio is the change in quantity demanded to the change in price. The formula is written as follows: Price Elasticity

Proportionate change in the quantity demanded

Proportionate change in price =

Alternatively

=Change in demand

Quantity demanded÷ Change in price

Price

ΔP ΔQ=Q P

÷

PROBLEM

A Company which generally sells a product for Rs. 200, decides to cut price to Rs. 160. As a result, the demand goes up from 40,000 units to 60,000 units. Calculate the elasticity

SOLUTION

Original Price = Rs. 200

New Price = Rs. 160

Change in Price = Rs. 40

Original Sales (Demand) = 40,000 Units

New Sales (Demand) = 60,000 Units

= ?

GEOMETRIC METHOD

The elasticity of demand can also be worked out geometrically The elasticity of demand has been considered as UNITY, as LESS than UNITY and as MORE than UNITY

..

.E1

E2

E3

D

D'

Y

0 x

D E2

DE2= 1

Hence the elasticity at E2 is Unity

The elasticity between D E2 and DE2 is equal

Therefore D E2 = DE2

or

Similarly the elasticity at point E1 is written as :

D E1

DE1

And the distance between D and E1 is less than the distance between D and E1 In other words D E1< DE1

D E1

DE1= is < 1 ( Elasticity at E1 less than unity )

At Point E3 the elasticity is

D E3

DE3

In this case the distance between D and E3 is greater than the distance between D and E3 . That is

D E3 is > DE3

HenceD E3

DE3= = > 1

Elasticity is greater than Unity

..

.E1

E2

E3

D

D'

Y

O X

The elasticity between D E2 and DE2 is equal

Therefore D E2 = DE2

D E2

DE2

or = 1

Hence the elasticity at E2 is Unity

UNITY

..

.E1

E2

E3

D

D'

Y

O X

Similarly the elasticity at point E1 is written as :

D E1

DE1

And the distance between D and E1 is less than the distance between D and E1 In other words D E1< DE1

D E1

DE1= is < 1 ( Elasticity at E1 less than unity )

LESS than UNITY

..

.E1

E2

E3

D

D'

Y

O X

In this case the distance between D and E3 is greater than the distance between D and E3 . That is

D E3 is > DE3

HenceD E3 =DE3

= > 1

Elasticity is greater than Unity

MORE than UNITY