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Demand:
(Managerial Economics by R.Cauvery page no 44)
Demand in common parlance means the desire for an object. But in economics
demand is something more than this. According to Stonier and Hague, Demand
in economics means demand backed up by enough money to pay for the goods
demanded. This means that the demand becomes effective only if it is backed up
by purchasing power. In addition there must be willingness to buy a commodity.
Thus Demand in economics means desire backed up by willingness to buy a
commodity and the purchasing power to pay. Thus demand is always at a price for a
definite quantity at a specified time. Thus demand has three essentials price,
quantity demanded and time. Without these, demand has no significant in
economics.
Definition:
The Demand for anything at a given price is the amount of it which will be bought
per unit of time at that price
Benham.
Law of Demand:
(Managerial Economics by R.Cauvery page no 44)
Statement:
The amount demanded increases with a fall in price and diminishes with a rise in
price.
Marshall
Explanation:
Law of Demand shows the relation between price quantity demanded of a
commodity in the market. A rise in the price of a commodity is followed by a
reduction in demand and a fall in price is followed by an increase in demand, if
condition of demand remains constant.
The law of demand may be explained with the help of a demand schedule. Demand
schedule is a list of quantities of a commodity purchased by a consumer at different
prices.
Demand Schedule
Price of Apple Quantity
(In Rs) Demanded
10 1
8 2
6 3
4 4
2 5
When the price falls from Rs. 10 to 8, quantity demanded increase from one to two.
In the same way as price falls, quantity demanded increases. On the basis of the
demand schedule we can draw the demand curve.
The demand curve DD shows the inverse relation between price and quantity
demanded of apple
Assumptions:
(Managerial Economics by R.Cauvery page no 47)
Law of demand is based on certain assumptions:
1. There is no change in consumers taste and preferences.
2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity.
5. The commodity should not confer any distinction.
6. The demand for the commodity should be continuous.
7. People should not expect any change in the price of the commodity.
Determinants of demand:
(Economics for Managers by ICFAI page no 19)
The demand for a product largely depends on its price. But price is not the only
factor that influences demand. The demand for a product also depends on other
factors, let us try to understand these factors in detail.
1. Income of the consumers.
Consumption is influenced by the income of a consumer. With every increase in the
income of a consumer, his consumption pattern changes i.e., the purchasing power
of the consumer increases.
2. Price of the substitute product.
A substitute product is one that provides the same level of satisfaction as the
product already being consumed by the consumer. Assume that two products A and
B are perfect substitutes for each other. If the price of a product A goes up, while B
remains constant, consumer will switch to product B.
3. Price of complimentary product.
Complimentary products are products that are consumed together. For example, car
and petrol or shoe and polish, etc. in this case, if the price of one product goes up
the demand for the other product decreases.
4. Changes in policy.
The demand of a particular product also depends upon government policies. For
example, if the government increases taxes on products, prices increase and hence
the demand decreases in short run. Change in government policies may also have a
negative impact on the demand for a particular product. The AP governments ban
on gutkha (Tobacco) had a negative impact on the demand for tobacco in
Andrapradesh. Now the tobacco industry in AP is facing over supply as a result of
lack of demand for tobacco products and hence the companies operating in this
industry have to search for newer markets in other states.
5. Population.
(Business Economics by V.G.Mankar page no 38)
If there is any change (increase or decrease) in the total population, sex-ratio or
occupational structure, the demand for a commodity will change. For example,
when children are born, the demand for milk, milk foods etc., will increase. Again ,
every year, there is an increase in the number of school-going children, college
students, etc., more quantities of school uniform, books, etc., are brought by
people, even though the price of these goods do not fall.
6. Advertisement Effect. (Economics for
managers by D.M.Mithani page no 74)
In modern times, the preferences of a consumer can be altered by advertisement
and sales propaganda, albeit to a certain extent only. In fact, demand for many
products like toothpaste, toilet soap, washing powder, processed foods, etc., is
partially caused by the advertisement effect in a modern mans life.
Demand Forecasting:
(Managerial Economics by R.Cauvery page no 83)
The information about the future is essential for both new firms and those planning
to expand the scale of their production. Most firms are confronted with the problem
of forecasting the demand for their product. Therefore it is indispensable for the firm
to have at least a rough estimate of the demand prospects as they have to acquire
inputs, both men and material, organize production, advertise the product and
organize sales channel s. these functions can hardly be performed satisfactorily in
an atmosphere of uncertainty regarding demand for the product.
In the modern competitive environment, an organization must have some idea
about the demand for its products. The high degree of business uncertainty makes
it difficult for an organization to predict future sales volumes of their products and
decide how a company can use its scare resources effectively. Demand forecasting
helps an organization to solve this problems to a large extend.
Demand forecasting refers to an estimate of future demand for the product. It is an
objective assessment of the future course of demand. In recent times, forecasting
plays an important role in business decision making. The survival and prosperity of
a business firm depends on its ability to meet the consumers needs efficiently and
adequately.
3. Delphi Method.
A variant of the survey method is Delphi method. Under this method a panel is
selected to give suggestion to solve the problems in hand. Both internal and
external experts can be the members of the panel. Panel members are kept from
each other and express their views in an anonymous manner. There is also a
coordinator who acts as an intermediary among the panelist. He prepares the
questionnaire and sends it to the panelists. At the end of each round, he prepares a
summary report. On the basis of the summary report the panel members have to
give suggestions. This method has been used in the area of technological
forecasting. It has proved more popular in forecasting non-economic rather than
economic variable.
2. Moving Average.
This method is based on the assumption that the future is the average of past
achievements. Hence based on past achievement future is predicted. When the
demand is stable this method can provide good forecast
3. Barometric technique.
Simple trend projections are not capable of forecasting turning points. Under
barometric method, present events are used to predict the directions of change in
future. This is done with the help of economic and statistical indicators.
Most commonly used indicators are
(i) Personal income
(ii) Agricultural income
(iii) Employment
(iv) Gross National income etc
Law:
The additional benefit which a person derives from a given increase of his stock of
a thing diminishes with every increase in stock that he already has.
Marshell
00 00 --
01 08 08
02 14 06
03 18 04
04 20 02
05 20 00
06 18 -02
07 15 -03
Certain Assumption related to Law of Diminishing Marginal Utility
The units of the commodity must be relevantly defined e.g., a cup of tea, a
bottle of soft drink etc.
The unit s must not be excessively small or large.
The consumers taste or preference must not change during the period of
consumption.
The consumption must be continues.
A break in continuity is necessary, the time interval between the
consumption of two units must be appropriately short.
The mental condition of the consumer must remain normal during the period
of consumption.
Elasticity of Demand:
(Managerial Economics by R.Cauvery page no 51)
Law of demand explains the direction of change in demand. A fall in price leads to a
increase in quantity demanded and vice-versa. But it does not tell us the rate at
which demand changes in price. Elasticity of demand explains the relationship
between a change in price and consequent change in amount demanded. Elasticity
of demand shows the extent of change in quality demanded to a change in price.
Definition.
The elasticity of demand in a market is great or small according as the amount
demanded increases much or little for a given fall in the price and diminishes much
or little for a given rise in price.
- Marshall
Elastic Demand
A small change in price may lead to a great change in quantity demanded. In this
case, demand is elastic.
Price in Rs. Quantity
Demanded of
Milk(in litres)
5.00 1
4.75 2
5.25 0.5
When price falls from Rs. 5.00 to Rs. 4.75, quantity demanded doubles from one
litre to two litres. On the other hand, when price increases from Rs. 5.00 to Rs. 5.25,
amount demanded falls to half litres. Therefore, demand is said to be more elastic.
Inelastic Demand
If a big change in price is followed by a small change in demand then the demand is
inelastic.
The demand curve DD1 is a horizontal straight line. It shows that at OP price any
amount is demanded and if price increases, the consumer will not purchase the
commodity.
2. Perfectly inelastic demand.
In this case, even a large change in price fails to bring about a change in quantity
demanded.
When price increases from OP to OP1 the quantity demanded remains the same. In
other words, the response of demand to a change in price is Nil. In this case E=0.
3. Relatively elastic demand.
Demand changes more than proportionately to a change in price. i.e., a small
change in price leads to a very big change in the quantity demanded. In this case E
> 1. The demand curve will be flatter.
When price falls from Op to OP1, quantity demanded increases from OQ to OQ 1. Thus
a change in price has resulted in an equal change in quantity demanded. So price
elasticity of demand is equal to unity.
Measurement of Elasticity:
(Managerial Economics by R.Cauvery page no 55)
For practical purpose, it is not enough to know whether the demand is elastic or
inelastic. It is more useful to find out the extent to which demand is elastic or
inelastic. Generally four methods are used to measure elasticity of demand.
1. Percentage Method.
It measures elasticity of demand by comparing the ratio of percentage of change in
the amount demanded to the percentage of change in the price of a commodity.
Marshell gives the following formula for measuring elasticity of demand.
Ed = Relative change in the amount demanded
Relative change in price
If the Demand curve is not a straight line the same method may be used by drawing
a tangent to the curve at the required point.
PB
Elasticity of demand at P is unity.
Elasticity at point P1 = P1A < 1. Hence elasticity of demand at P1 is less than
one.
P 2B
Elasticity at demand at point P2 is greater than one since P2A > 1.
P 2B
4. Arc Method.
According to Baumol,
Arc elasticity is a measure of average responsiveness to price change exhibited by
a demand curve over some infinite stretch of the curve.
Since point method gives different results for the same change in price, economists
have devised Arc Method for measuring price elasticity of demand. The formula for
Arc elasticity of demand is
Original Quantity New Quantity
Elasticity of = Original Quantity + New Quantity
Demand Original Price New Price
Original Price + New Price
Q1 Q2 P1 P2
Q 1 + Q2 P1 + P2
or
Q P
Q 1 + Q2 P1 + P2
P1 and Q1 are the initial price and Quantity;
P2 and Q2 are the price and Quantity after change
Arc method is useful only when we have full information about the changes in price
and quantity demanded. Since only limited information is available about these
factors, midpoint formula has been suggested by economists to measure elasticity
of demand. This method uses the average of two prices and two quantities (initial
and final data) under consideration. The formula may be stated as follows:
Changes in Quantity Demanded
Sum of the Quantity
Elasticity of = 2
Demand Changes in Price
Sum of Price
2
i.e.,
q p
q 1 + q2 p 1 + p2
2 2
q p 1 + p2
q 1 + q2 2
2 p
= q p 1 + p2
q 1 + q2 p
= q(p1 + p2)
p(q1 + q2)