Project report on Demand and supply

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Table of Contents
Introduction ..................................................................................................................................... 4 Demand & supply ........................................................................................................................... 4 Law of Demand............................................................................................................................... 5 Types of Demand ............................................................................................................................ 6 Price Demand .............................................................................................................................. 6 Income Demand .......................................................................................................................... 6 Cross demand .............................................................................................................................. 7 Supply ............................................................................................................................................. 7 The Law of Supply ...................................................................................................................... 7 Interaction between Demand and Supply ....................................................................................... 7 Price Controls .............................................................................................................................. 8 Effect of Change in Demand and Supply ....................................................................................... 8 Elasticity of Demand..................................................................................................................... 10 Types of Elasticity ........................................................................................................................ 10 Degrees of Elasticity ................................................................................................................. 11 Measurement of Elasticity of Demand ......................................................................................... 11 Total Expenditure Method ........................................................................................................ 12 Unity Elasticity.......................................................................................................................... 12 Greater than Unity ..................................................................................................................... 12 Less than Unity.......................................................................................................................... 12 Proportional Method ................................................................................................................. 12 Geometrical Method .................................................................................................................. 12

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Tax Incidence ................................................................................................................................ 13 Cases of Demand and Supply in UAE .......................................................................................... 14 Case Study 1 ................................................................................................................................. 14 Oil Demand and Supply ............................................................................................................ 14 Case Study 2 ................................................................................................................................. 14 Water Requirement ................................................................................................................... 14 Case Study 3 ................................................................................................................................. 14 Food Imports ............................................................................................................................. 14 Managerial Decision ..................................................................................................................... 15 Bibliography ................................................................................................................................. 16

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Introduction
This is a demand and supply analysis report written with the objective of understanding the theories and application of the concept. Demand & supply are basic concept of economics. The

economy of the country and different production functions run on this concept only. Whereas, supply is how much the producer can supply to their customers. Demand and supply help in understanding the economic growth. This concept is not only related to the core products it is also related to other aspects such as demand of money when interest rate falls or rise. This report will help in understanding effect of demand and supply on the economy with example of oil industry of UAE. This will help the management in understanding the movement of demand and supply in the country.

Demand & supply

Demand & supply are fundamental concept of economics. In normal parlance desire & demand are often confused but demand implies that person is willing and able to pay. A beggars desire to eat in big restaurant has no significance as he cannot pay it (Marshall, 2009). On the hand a big businessmans desire of eating out in a big restaurant is demand, as he is able to pay for it and willing to do so. Thus demand of a product means the amount of it which will be bought per unit of time at a particular price. He buys more at low price and less at high price. Similarly demand, his demand varies with the period of time. A familys demand for wheat is much more for a month than for a day. With the help of demand schedule we can draw a demand curve. When we write down the different quantities that an individual would buy at different prices, we get that individuals demand schedule (E., 2007). Following is the Demand Schedule of imaginary consumer of oranges

Demand 12 oranges 24 oranges 36 oranges 42 oranges

Price $ 4/Dozen $ 3/Dozen $ 2/Dozen $ 1/Dozen

Now with the help of this we can draw demand curve:

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From the above analysis it is very much clear that demand draft slope downward. This is in accordance with Law of Diminishing Marginal Utility. When the price falls, new purchaser enters the market and old purchaser will probably purchase more. Again this commodity as become cheaper than people will purchase it in preference to other commodities. There are certain reasons why people tend to buy more at decreased price: I. II. III. A unit of money goes farther and one can afford to buy more. When a relatively becomes cheaper people tends to buy it more. A commodity is put to more uses when it becomes cheaper.

Law of Demand
From the demand schedule it is very much clear that demand varies with the price. Now we can explain law of demand. This law says that inverse relationship exists between price and demand i.e., when price rises, demand decreases and when price falls demand increases. This law of demand merely relates to contraction and extension of demand (Baumol & Blinder, 2011). Demand curve exhibits the relationship between quantity demanded and price of such commodity. However there are certain exceptions to the law of demand. Conspicuous Consumption. Where a consumer consumes a product as a matter of pride, he will go in high price commodity. For example, Diamonds, Latest model of cell etc. For stocking purpose, when a price of a commodity is rising and people have this fear that it will continue rising then for stocking purpose they buy at higher price. Trade Cycles. At a time of economic prosperity people tend to buy more even if the prices are soaring up. Other miscellaneous situations like if fashion changes than a product goes out of fashion than despite of decreasing prices people are least interested in consuming those product. In all above cases, demand curve will slope upward.

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Price

Quantity Demanded

Increase and Extension: - If a person buys more oranges because its price has fallen, it is an extension of demand. But if he buys more due to any other reason (other than price) then it is increase in demand. Decrease and Contraction: - If a person buys less orange because its price has increased, it is a contraction of demand. But he buys less due to any other reason (other than price) then it is decrease in demand

Types of Demand
Demand may be distinguished into a) Price Demand b) Income Demand c) Cross Demand

Price Demand
This refers to the various quantities of a commodity or service that a consumer would purchase at a given time in a market at various hypothetical prices (Sexton, 2010).

Income Demand
This refers to the various quantities of goods & services which would be purchased by consumer at different level of income. Here we assume that price for the commodity or service, as well as price of related goods and services and the taste and desires of consumers do not change (Sexton, 2010). Normal goods, demand increases with increases in income of the consumer. Thus when income increases, other thing remaining constant demand curve shifts towards right.

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Cross demand
This means the quantities of a good or service which will be purchased with reference to changes in the price not of this good but of other related goods. A change in price of tea will affect demand of coffee (Sexton, 2010).

Supply
Supply refers to the amount of goods and services that a supplier is willing and able to supply at a particular price. Supply curve illustrate the relationship between price and quantity demanded at a particular price. Supply Curve Slopes upward this means that higher the price, higher the quantity supplied. Supply curve exhibits the relationship between price and quantity supplied (ceteris paribus) (McConnell & Brue, 2008). It is to be noted that supply is factor of time. Producer will not be able to supply increased quantity of goods at reduced price. So it is important to find out whether change in price is permanent or temporary.

The Law of Supply

The Law of Supply states that when the price of a product rises, everything else remaining the same, the quantity of the good supplied will also rise (Wessels, 2006). Shift in Supply occurs when one of the determinants other than price changes. Examples: The price of a factor of production increase or the price of alternative good increases. This leads to leftward movement of supply curve. An improvement in technology or increase in price of substitute good, causes rightward movement of supply curve.

Interaction between Demand and Supply

Demand and Supply is a model for determination of the price of a product in the market. Market Price is the interaction of these two curves and is the price at which the amount of quantity supplied by the producers will exactly match the quantity that consumer will buy (Hirschey, 2008). It is not the demand and supply of the single buyer and firm respectively that determine the price but it is the demand of all the buyers taken together and the supply of all the firms taken together that determine the price by their interaction (Reisman, 2002). The price at which both quantity demand and supplied are equal is known as Equilibrium Price. This can be very well explained with the help of schedule and diagram. By plotting the demand and supply curve simultaneously on a graph, we get a point on where both the curves cut each other. At , this point both supply and quantity demanded are equal and price determined at this level known as Equilibrium Price.

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D P

Price Controls
Price Floors and Price ceiling are government mandated price that attempt to control the price of a good and service (Taylor & Weerapana, 2007). A price ceiling is usually imposed to keep down the price of a product which is considered too expensive. To have effect it must be imposed below market price. A price floor is usually imposed to keep the price of something perceived too cheap. To have any effect, it must be set above the market price (McEachern, 2011).

Effect of Change in Demand and Supply

The equilibrium price will change if either the demand or the supply curve changes due to changes in demand or supply. Suppose demand curve shifts rightward. This could be caused by many reasons such as an increase in income, higher price of substitute, lower price of complimentary goods etc (Hubbard & O'Brien, 2007). Such a shift will tend to have two effects; raising equilibrium and raising equilibrium quantity.

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D1

P1 P S D Q Q1 D1

Example; suppose income of the consumer rises as a result of which he is able to spend much. This causes a rightward shift of demand curve. A leftward shift of demand would reverse the effects; a fall in both price and quantity. As a result, demand shifts cause price and quantity to move in the same direction. Now take an example of a rightward shift of supply curve caused by lower factor price, better technology, etc. this will tend to have two effects; raising equilibrium quantity and lowering equilibrium.

S S1

P1 P2

Q1

Q2

Example; lower the price of steel causes rightward in the supply of cars, so the price of cars decreases and quantity increases.

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A leftward shift of supply would reverse the effect, that is price increases and quantity decreases. So what happens when both demand and supply curve shifts simultaneously at a time. The two changes have reinforcing effects on either the price or quantity, and offsetting effects on the other. From the above analysis, it is clear that price is determined by the interaction of demand and supply. But it is to be remembered that demand and supply are themselves governed by a host of other factors.

Elasticity of Demand
Concept of Elasticity is one of the most important concepts in demand and supply analysis. In formulizing business strategy Elasticity plays a vital role. Price elasticity for a product predicts the percentage change in quantity demanded for a percentage change in price. Thus this helps in estimating how much and in what direction will revenue change with a change in price (Tucker, 2007). However it must be admitted that it does not provide full information for decision making process. Increase in revenue does not denote increase in profit. Moreover this information is more useful for a firm which enjoys large market share. Thus from above discussion it is very much clear that Elasticity of Demand refers to responsiveness of demand to the change in any of the determinants of the demand. As a result of change in price, demand of particular commodity changes but it changes to what extent can be measured by having the knowledge of degree of elasticity of demand. E= % Change in Quantity Demanded % Change in Determinants of Demand

Types of Elasticity
Price Elasticity of demand measures the responsiveness of quantity demanded of a good when the price of that good changes. Income Elasticity of demand measures the responsiveness of quantity demanded of a good when the income of the consumer changes. Income Elasticity of normal goods is positive i.e., with increases in price demand for goods increases. But for inferior good, it is negative i.e., with increase in income demand for theses goods decreases. Cross Elasticity of demand measures the responsiveness of consumption one good when the price of another good changes.

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Cross Elasticity in case of Complements and Substitutes. Complements: Complementary good have negative cross- price elasticity. For example Substitutes: Substitutes goods have positive cross- price elasticity.

Degrees of Elasticity
Perfectly Elastic Demand Perfectly Inelastic Demand Very Elastic Demand

Perfectly Elastic Demand: - With a slight changes in the price of a commodity, demand changes considerably. Thus when a price falls negligibly, demand increases many fold (McGuigan & Moyer, London). Perfectly Inelastic Demand: - This is another extreme limit when demand is perfectly inelastic. Whatever changes happens in the price of a commodity, demand remains constant. Very elastic Demand: - With a small change in the price of a commodity, considerable extension/contraction takes place for the quantity demanded.

Measurement of Elasticity of Demand

Only knowing whether demand for a product is elastic or inelastic is not enough. Rather in practical life when we can measure it then it becomes fruitful for us. From previous discussion we have knowledge about Zero Elasticity and Infinite Elasticity. In real life we seldom come across these elasticitys (Maurice, 2010). The following three methods are usually used by economists for measuring it. Total Expenditure Method Proportional Method Geometrical Method

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Total Expenditure Method

Under this method by examining the change in total expenditure due to change in price, elasticity is measured. Price Per Pen $6 $4 $2 $1 Demand 1 3 6 20 Total amount spent $6 $12 $12 $20

Unity Elasticity
When the amount spent remains equal (e.g., between 2 and 3 above), the elasticity is said to be one or unity.

Greater than Unity

When the total amount spent increases with a fall in a price (or decreases with an increase in price), the elasticity is said to be greater than unity.

Less than Unity

When the total amount spent decreases with a fall in a price (or increases with decrease in a price), the elasticity is said to be less than unity.

Proportional Method
Under this method elasticity is measured by comparing the percentage in price with change in demand. This also of three types i) Unit Elasticity, ii) Greater than unity and iii) Less than unity.

Geometrical Method
This method is used to measure the elasticity of demand at any given point of the demand curve.

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Tax Incidence
Elasticity is important for many reasons. It helps immensely in formulation of business strategy, decision making etc. one of the most important area in which it helps in determining distribution of the burden of taxes over different groups. For instance take sales tax on tobacco. First we have to understand that sales tax is a tax on transaction not a tax on person (Png & Lehman, 2007). If there is $1 tax on cigarettes, it means that there is difference of $1 in what buyer pays and what trader gets. Cost of producing of beer per bottle is $5.50 but with the imposition of tax cost has gone up by $1. Now consider the following graph to see the result. Stax S

P2

----------------------------------------P1 -----------------D

Q2

Q1

The vertical distance between S and Stax is the amount of tax. As a result of tax quantity demanded decreases from Q1 to Q2 and price increases from P1 to P2. And trader gets price less tax. When we see the above diagram there is triangle between old S and D and between Q1 and Q2. This triangle represents dead weight loss. DWL corresponds to those units which should have been sold , because they would have been mutually beneficial .But the profit from selling those unit though positive , is not large enough to cover the tax so trade do not take place. But buyer and seller the tax burden by way of changes in their demand and supply price. The division of tax payment between buyers and seller depends upon the relative price elasticity of demand and supply. If the demand curve is less elastic than the supply curve, then buyers pays a larger share of the tax or vice-versa. In the extreme, buyers pay the entire tax only if the demand curve is perfectly inelastic. Alternatively sellers pay the entire tax only if the supply curve is perfectly inelastic.

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Cases of Demand and Supply in UAE

Case Study 1
Oil Demand and Supply
Oil is of the inputs which impacts the economy. Its falling and raising price controls the financial markets to larger extent. As oil prices rises, cost goes up for the transportation companies, squeezing their profit margins and forcing them to raise prices. Similarly affecting all other companies that rely on them for transporting there product and people. As a result of rising price of oil, demand of other substitute source of energy increases like ethanol and natural gas rises (Kilian, 2006).

Case Study 2
Water Requirement
UAE is witnessing unprecedented growth and development in all spheres of life. This expansion was accompanied by increased demand on natural resources to fulfill the requirements of economy. In mid 1960 Abu Dhabi, the capital of UAE uses to get water directly from the water production plant (Qdais & Nassay, 2001). The water at that time was supplied free of charge. Since then population of city has grown rapidly and accompanied with increased demand of water. As a consequence of increased demand, the water and Electricity Department of Abu Dhabi, who is responsible for water distribution across the city, decided to charge the consumer a flat rate of 50 Dhs regardless of consumption. Effect of Increases in Price: 90 consumers were selected for analysis. 73% of consumer reduced their consumption and 27% did not change their consumption significantly. Than if we calculate elasticity we get -.01, which means that the household demand is inelastic.

Case Study 3
Food Imports
UAE imports more than 80% of its food product requirements and potential for import substitution is severely limited. The countrys food supply security is closely tied to developments in the international market. The country is also exposed to food supply interruptions, as occurred during 2008 food crisis. In that regard, food supply requires uninterrupted availability of food at affordable and stable prices. Therefore for business analysis of food pricing, elasticitys are essential inputs. Since UAE food production is not significant share of total domestic consumption, the import demand elasticitys are a good approximation

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for domestic demand elasticitys. When demand is inelastic for a product in a country like UAE, the country is more susceptible to food price inflation.

Managerial Decision
The price elasticity of demand is useful in forecasting the response of quantity demanded to price changes; it also helps in predicting changes revenue. Total revenue moves in the direction of quantity change if demand is price elastic and does not change if demand is unit price elastic. Other important determinants are availability of substitutes, the importance of the item in household budget and time. Knowledge of income Elasticity of demand for different products helps firm to predict the effect of business cycle on sales. All countries experience business cycle where actual GDP moves up and down causing boon and recession. Luxury products with high income elasticity experience greater sales volatility over the business cycle than necessities where demand from consumers is less sensitive to changes in business cycle. In case of cross elasticity the stronger the relationship between two products, higher the coefficient of cross price elasticity of product. Pricing strategy for complementary goods for example bread and butter have high negative value for cross elasticity they are strong compliments. Many business houses by expending huge amount of money on advertising tries to create brand loyalty of consumer and tries to shift demand curve of consumer to rightward direction. When the consumer becomes addicted to that particular product, the cross elasticity of product against rival product will decrease. This reduces the size of the substitution effect following price change and makes demand less sensitive to price.

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Bibliography
Baumol, W. J., & Blinder, A. S. (2011). Economics: Principles and Policy. Mason: Cengage Learning. E., C. K. (2007). Principles Of Economics, 8/E. New Delhi: Pearson Education India. Hirschey, M. (2008). Managerial economics. London: Cengage Learning. Hubbard, R. G., & O'Brien, A. P. (2007). Economics. NewYork: Pearson Prentice Hall. Kilian, L. ( 2006). Not All Oil Price Shocks are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market. Ann Arbor: University of Michigan. Marshall, A. (2009). Principles of Economics. New York: Cosimo, Inc.,. Maurice, T. &. (2010). Managerial Economics 9E (Sie). Nepal: Tata McGraw-Hill Education. McConnell, C. R., & Brue, S. L. (2008). Economics: principles, problems, and policies. London: McGrawHill Irwin. McEachern, W. A. (2011). Economics: A Contemporary Introduction. London: Cengage Learning. McGuigan, J. R., & Moyer, R. C. (London). Managerial Economics. 2010: Cengage Learning. Png, I., & Lehman, D. (2007). Managerial economics. Victoria: Wiley-Blackwell. Qdais, H. A., & Nassay, H. A. (2001). Eect of pricing policy on water conservation: a case study. Water Policy , 207-214. Reisman, D. A. (2002). The institutional economy: demand and supply. Northampton: Edward Elgar Publishing. Sexton, R. L. (2010). Exploring Economics. Mason: Cengage Learning. Taylor, J. B., & Weerapana, A. (2007). Economics. London: Cengage Learning. Tucker, I. B. (2007). Microeconomics for Today. Mason: Cengage Learning. Wessels, W. J. (2006). Economics. Mason: Barron's Educational Series.

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