MEFA Unit – 2 Notes- 3RD Sem.

JECRC Foundation

UNIT-II
INTRODUCTION TO DEMAND AND SUPPLY

Demand is the rate at which consumers want to buy a product. Economic theory holds that
demand consists of two factors: taste and ability to buy. Taste, which is the desire for a good,
determines the willingness to buy the good at a specific price. Ability to buy means that to
buy a good at specific price, an individual must possess sufficient wealth or income.

Demand for desire implies three things

1) Desire to acquire the commodity

2) Willingness to pay for commodity
3) Ability to pay for the commodity

Willingness and ability to supply goods determine the seller’s actions. At higher prices, more
of the commodity will be available to the buyers. This is because the suppliers will be able to
maintain a profit despite the higher costs of production that may result from short-term
expansion of their capability.

Demand is defined as the quantity (or amount) of a good or service people are willing and
able to buy at different prices, while supply is defined as how much of a good or service is
offered at each price. How do they interact to control the market? Buyers and sellers react in
opposite ways to a change in price. When price increases, the willingness and ability of
sellers to offer goods will increase, while the willingness and ability of buyers to purchase
goods will decrease. To illustrate more clearly how the market works, we will look at the
following example from the clothing industry. The same information can be shown with a
graph. On the graph, the equilibrium price and quantity are indicated by the intersection of
the supply and demand curves.

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What is demand and its types:

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 it if
is backed by the purchasing power in addition to this there must be willingness to buy a
commodity. Thus demand in economics means the desire backed by the willingness to buy a
commodity and the purchasing power to pay.
In the words of “Benham” “The demand for anything at a given price is the amount of it which
will be bought per unit of time at that Price”. (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 to significance in economics.
It deals with four aspects:
1. Consumption
2. Production
3. Exchange
4. Distribution
5.
Factors Affecting Demand
There are factors on which the demand for a commodity depends. These factors are economic,
social as well as political factors. The effect of all the factors on the amount demanded for the
commodity is called Demand Function. These factors are as follows:
1. Price of the Commodity: The most important factor-affecting amount demanded is the price
of the commodity. The amount of a commodity demanded at a particular price is more properly
called price demand. The relation between price and demand is called the Law of Demand. It is
not only the existing price but also the expected changes in price, which affect demand.

2. Income of the Consumer: The second most important factor influencing demand is consumer
income. In fact, we can establish a relation between the consumer income and the demand at
different levels of income, price and other things remaining the same. The demand for a normal
commodity goes up when income rises and falls down when income falls. But in case of Giffen
goods the relationship is the opposite.
3. Prices of related goods: The demand for a commodity is also affected by the changes in
prices of the related goods also. Related goods can be of two types:
(i). Substitutes which can replace each other in use; for example, tea and coffee are substitutes.
The change in price of a substitute has effect on a commodity s demand in the same direction in
which price changes. The rise in price of coffee shall raise the demand for tea;
(ii). Complementary foods are those which are jointly demanded, such as pen and ink. In such
cases complementary goods have opposite relationship between price of one commodity and the
amount demanded for the other. If the price of pens goes up, their demand is less as a result of
which the demand for ink is also less. The price and demand go in opposite direction. The effect
of changes in price of a commodity on amounts demanded of related commodities is called Cross
Demand.
4. Tastes of the Consumers: The amount demanded also depends on consumer s taste. Tastes
include fashion, habit, customs, etc. A consumer s taste is also affected by advertisement. If the

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taste for a commodity goes up, its amount demanded is more even at the same price. This is
called increase in demand. The opposite is called decrease in demand.
5. Wealth: The amount demanded of commodity is also affected by the amount of wealth as well
as its distribution. The wealthier are the people; higher is the demand for normal commodities. If
wealth is more equally distributed, the demand for necessaries and comforts is more. On the
other hand, if some people are rich, while the majorities are poor, the demand for luxuries is
generally higher.
6. Population: Increase in population increases demand for necessaries of life. The composition
of population also affects demand. Composition of population means the proportion of young
and old and children as well as the ratio of men to women. A change in composition of
population has an effect on the nature of demand for different commodities.
7. Government Policy: Government policy affects the demands for commodities through
taxation. Taxing a commodity increases its price and the demand goes down. Similarly, financial
help from the government increases the demand for a commodity while lowering its price.
8. Expectations regarding the future: If consumers expect changes in price of commodity in
future, they will change the demand at present even when the present price remains the same.
Similarly, if consumers expect their incomes to rise in the near future they may increase the
demand for a commodity just now.
9. Climate and weather: The climate of an area and the weather prevailing there has adecisive
effect on consumer’s demand. In cold areas woolen cloth is demanded. During hot
Summer days, ice is very much in demand. On a rainy day, ice cream is not so much demanded.
10. State of business: The level of demand for different commodities also depends upon the
business conditions in the country. If the country is passing through boom conditions, there will
be a marked increase in demand. On the other hand, the level of demand goes down during
depression

DETERMINANTS OF DEMAND:
Determinants of demand are as follows
1. No. of buyers
2. Income
3. Normal Good
4. Inferior good
Among the many causal factors affecting demand, price is the most significant and the price-
quantity relationship called as the Law of Demand is stated as follows: "The greater the amount
to be 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 a rise
in price" (Alfred Marshall). In simple words other things being equal, quantity demanded will be
more at a lower price than at higher price. The law assumes that income, taste, fashion, prices of
related goods, etc. remain the same in a given period. The law indicates the inverse relation
between the price of a commodity and its quantity demanded in the market. However, it should
be remembered that the law is only an indicative and not a quantitative statement. This means
that it is not necessary that such variation in demand be proportionate to the change in price.

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Definitions

1 "Law of Demand states that people will buy more at lower prices and buy less at higher
prices, if other things remaining the same."- Prof. Samuelson.

2 The Law of Demand states that amount demanded increases with a fall in price and
diminishes when price increases." - Prof. Marshall

3 "According to the law of demand, the quantity demanded varies inversely with price." –
Ferguson

4 Benham:-“Usually a larger quantity of commodity will demanded at lower price that a

higher price”

Characteristics of law of demand

 Inverse relationship between price and demand.

 Price is independent variable
 Demand is dependent variable on price of goods.
Assumptions

Every law will have limitation or exceptions.This law operates when the commodity’s price
changes and all other prices and conditions do not change. The main assumptions are

 Habits, tastes and fashions remain constant

 Money, income of the consumer does not change.
 Prices of other goods remain constant
 The commodity in question has no substitute
 The commodity is a normal good and has no prestige or status value.
 People do not expect changes in the prices.

DEMAND FUNCTION

The term „micro means small. The study of an individual consumer or a firm is called
microeconomics (also called the Theory of Firm). Micro means „one millionth .
Microeconomics deals with behavior and problems of single individual and of micro
organization. Managerial economics has its roots in microeconomics and it deals with the micro
or individual enterprises. It is concerned with the application of the concepts such as price
theory, Law of Demand and theories of market structure and so on.

Micro-economic theory takes the total quantity of resources as given and seeks to explain how
they are assigned to the production of different goods. Allocation of resources determines what
goods shall be produced and how they shall be produced. In a free market economy, the

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allocation of resources to the production of various goods depends upon the prices of the various
goods and prices of the various resources or factors of production. Hence, micro-economics
proceeds to analyses how the relative prices of goods and factors are determined in order to
explain how the allocation of resources is determined. Therefore, the theory of product pricing
and theory of factor pricing or the theory of distribution fall within the domain of micro-
economics.
Classification of Demand

1. Individual demand:-

A commodity or good demanded by a single person is called individual demand.

Individual Demand Schedule

Price Individual Quantity
Demanded
1 4
2 3
3 2
4 1

Application: when the price is very high, a low-income buyer may not buy anything, though a
high-income buyer may buy something. In such a case, we may distinguish between the demand
of an individual buyer and that of the market which is the aggregate of individuals.

2. Market Demand
A demand for a particular product by all customers and added, is called market demand. (Total
all individual demand is called as the market demand)
Table is the market demand schedule. This schedule, from the angle of simplification, is based
on the assumption that there are two buyers, A and B for X commodity. By adding up their
individual demand, the market demand schedule has been estimated:

Market demand Schedule

Price of Demand of Demand of Market Demand
Commodity X person A person B
(Rs.) Person (A+B+……=
market demand)
1 4 5 4 + 5= 9
2 3 4 3+4= 7
3 2 3 2+3= 5
4 1 2 1+2= 3

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Factors affecting market demand

Market or aggregate demand is the summation of individual demand curves. In addition to the
factors which can affect individual demand there are three factors that can affect market demand
(cause the market demand curve to shift):
a change in the number of consumers,
a change in the distribution of tastes among consumers,
a change in the distribution of income among consumers with different tastes

3 Derive Demand

The increase in demand for one particular good causes increase in the demand for other good is
called derived demand. Complementary goods are those goods which are jointly used to satisfy a
want. In other words, complementary goods are those which are incomplete without each other.
These are things that go together, often used simultaneously. For example, pen and ink, Tennis
rackets and tennis balls, cameras and film, etc.

For example, demand for coal leads to derived demand for mining, as coal must be mined for
coal to be consumed.

Examples:

 Increasing demand for use computers in various fields will cause increase in demand for
the operating systems like Microsoft windows products.
 Increase in the demand for automobiles like bikes, cars and large & heavy vehicle will
cause increase in the demand for the fuel like petrol and diesel.
 Increase in the demand for the cellular phone will cause increase in the demand for the
memory cards for the multimedia purpose.
 Increase in the demand for the education will cause increase in the demand for the text
books for the various subjects.

5. Cross Demand: When the demand of one commodity is related with the price of other
commodity is called cross demand. The commodity may be substitute or complementary.
Substitute goods are those goods which can be used in case of each other. For example,
tea and coffee, Coca-cola and Pepsi. In such case demand and price are positively related.
This means if the price of one increased then the demand for other also increases and vise
versa.

Cross elasticity demand:

There is a mutual relationship between change in price and quantity demanded of two
related goods. Change in the price of one goods can cause change in the demand for the
related good. For example, change in the price of tea ordinarily causes change in demand

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for coffee. Likewise, change in the price of cars causes change in demand for petrol.
Mutual relationship between quantity demanded of a good due to change in the price of
another goods can be measured by cross elasticity of demand.

ELASTICITY OF DEMAND:
Elasticity of Demand Elasticity of demand explains the relationship between a change in price
and consequent change in amount demanded. “Marshall” introduced the concept of elasticity of
demand. Elasticity of demand shows the extent of change in quantity demanded to a change in
price. In the words of “Marshall”, “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” Elastic demand: A small change in price may
lead to a great change in quantity demanded. In this case, demand is elastic. In-elastic demand: If
a big change in price is followed by a small change in demanded then the demand in “inelastic”.

Measurement of Elasticity of Demand

A. Perfectly elastic demand:
B. Perfectly Inelastic Demand
C. Relatively elastic demand:
D. Relatively in-elastic demand.
E. Unit elasticity of demand:

Types of Elasticity of Demand

1. Price Elasticity of Demand:
2. Income Elasticity of Demand:

DEGREES OF PRICE ELASTICITY

Different commodities have different price elasticities. Some commodities have more elastic
demand while others have relative elastic demand. Basically, the price elasticity of demand
ranges from zero to infinity. It can be equal to zero, less than one, greater than one and equal to
unity.
According to Dr. Marshall : "The elasticity or responsiveness of demand in a market is great or
small according as the amount demanded increases much or little for a given fall in price and
diminishes much or little for a given rise in price."

However, some particular values of elasticity of demand have been explained as under ;

Types of Price Elasticity of Demand:-

1. Perfectly elastic demand.

2. Perfectly inelastic demand.
3. Relatively elastic demand.
4. Relatively inelastic demand.
5. Unitary inelastic demand.

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MEASUREMENT OF PRICE ELASTICITY OF DEMAND

There are five methods to measure the price elasticity of demand.

1. Total Expenditure Method.

2. Proportionate Method.
3. Point Elasticity of Demand.
4. Arc Elasticity of Demand.
5. Revenue Method.

Total Expenditure Method

Dr. Marshall has evolved the total expenditure method to measure the price elasticity of demand.
According to this method, elasticity of demand can be measured by considering the change in
price and the subsequent change in the total quantity of goods purchased and the total amount of
money spend on it.
Proportionate Method
This method is also associated with the name of Dr. Marshall. According to this method, "price
elasticity of demand is the ratio of percentage change in the amount demanded to the percentage
change in price of the commodity." It is also known as the Percentage Method, Flux Method,
Ratio Method, and Arithmetic Method.

Ed = Proportionate change in Quantity Demanded

proportionate change in price

Arc Elasticity of Demand

 According to Prof. Baumol: "Arc elasticity is a measure of the average responsiveness to

price change exhibited by a demand curve over some finite stretch of the curve".

 According to Leftwitch : "When elasticity is computed between two separate points on a

demand curve, the concept is called Are elasticity."

DEMAND FORECASTING–PURPOSE/ DETERMINANTS:

The information about the future is essential for both new firms and those planning to expand the
scale of their production. 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. Demand forecasting has an
important influence on production planning. It is essential for a firm to produce the required

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quantities at the right time. It is essential to distinguish between forecasts of demand and
forecasts of sales. Sales forecast is important for estimating revenue cash requirements and
expenses. Demand forecasts relate to production, inventory control, timing, reliability of forecast
etc. However, there is not much difference between these two terms.

Types of demand Forecasting: Based on the time span and planning requirements of business
firms, demand forecasting can be classified in to
1. Short-term demand forecasting and
2. Long – term demand forecasting.

1. Short-term demand forecasting: Short-term demand forecasting is limited to

short periods, usually for one year. It relates to policies regarding sales, purchase,
price and finances. It refers to existing production capacity of the firm. Short-term
forecasting is essential for formulating is essential for formulating a suitable price
policy. If the business people expect of rise in the prices of raw materials of
shortages, they may buy early. This price forecasting helps in sale policy
formulation. Production may be undertaken based on expected sales and not on
actual sales. Further, demand forecasting assists in financial forecasting also.
Prior information about production and sales is essential to provide additional
funds on reasonable terms.
2. Long – term forecasting: In long-term forecasting, the businessmen should now
about the long-term demand for the product. Planning of a new plant or expansion
of an existing unit depends on long-term demand.

The various factors that influence demand forecasting are explained as follows:

i. Types of Goods:
Affect the demand forecasting process to a larger extent. Goods can be producer s goods,
consumer goods, or services. Apart from this, goods can be established and new goods.
Established goods are those goods which already exist in the market, whereas new goods are
those which are yet to be introduced in the market.
Information regarding the demand, substitutes and level of competition of goods is known only
in case of established goods. On the other hand, it is difficult to forecast demand for the new
goods. Therefore, forecasting is different for different types of goods.

ii. Competition Level:

Influence the process of demand forecasting. In a highly competitive market, demand for
products also depends on the number of competitors existing in the market. Moreover, in a
highly competitive market, there is always a risk of new entrants. In such a case, demand
forecasting becomes difficult and challenging.

iii. Price of Goods:

Acts as a major factor that influences the demand forecasting process. The demand forecasts of
organizations are highly affected by change in their pricing policies. In such a scenario, it is
difficult to estimate the exact demand of products.

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iv. Level of Technology:

Constitutes an important factor in obtaining reliable demand forecasts. If there is a rapid change
in technology, the existing technology or products may become obsolete. For example, there is a
high decline in the demand of floppy disks with the introduction of compact disks (CDs) and pen
drives for saving data in computer. In such a case, it is difficult to forecast demand for existing
products in future.

v. Economic Viewpoint:
Play a crucial role in obtaining demand forecasts. For example, if there is a positive development
in an economy, such as globalization and high level of investment, the demand forecasts of
organizations would also be positive.

DEMAND FORECASTING–METHODS

Methods of Forecasting
Several methods are employed for forecasting demand. All these methods can be grouped under
survey method and statistical method. Survey methods and statistical methods are further
subdivided in to different categories.
1. Survey Method:
Under this method, information about the desires of the consumer and opinion of exports are
collected by interviewing them. Survey method can be divided into four type s viz., Option
survey method; expert opinion; Delphi method and consumers interview methods.

a. Opinion survey method:

This method is also known as sales-force composite method (or) collective opinion method.
Under this method, the company asks its salesman to submit estimate of future sales in their
respective territories. Since the forecasts of the salesmen are biased due to their optimistic or
pessimistic attitude ignorance about economic developments etc. these estimates are
consolidated, reviewed and adjusted by the top executives. In case of wide differences, an
average is struck to make the forecasts realistic.
This method is more useful and appropriate because the salesmen are more knowledge. They can
be important source of information. They are cooperative. The implementation within unbiased
or their basic can be corrected.

B. Expert opinion method: Apart from salesmen and consumers, distributors or outside experts
may also e used for forecasting. In the United States of America, the automobile companies get
sales estimates directly from their dealers. Firms in advanced countries make use of outside
experts for estimating future demand. Various public and private agencies all periodic forecasts
of short or long term business conditions.Apart from salesmen and consumers, distributors or
outside experts may also e used for forecasting. In the United States of America, the automobile
companies get sales estimates directly from their dealers. Firms in advanced countries make use
of outside experts for estimating future demand. Various public and private agencies all periodic
forecasts of short or long term business conditions.

C. Delphi Method:

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A variant of the survey method is Delphi method. It is a sophisticated method to arrive at a

consensus. Under this method, a panel is selected to give suggestions to solve the problems in
hand. Both internal and external experts can be the members of the panel. Panel members one
kept apart from each other and express their views in an anonymous manner. There is also a
coordinator who acts as an intermediary among the panelists. He prepares the questionnaire and
sends it to the panelist. 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. It has provided
more popular in forecasting non-economic rather than economic variables.

D. Consumers interview method:

In this method the consumers are contacted personally to know about their plans and preference
regarding the consumption of the product. A list of all potential buyers would be drawn and each
buyer will be approached and asked how much he plans to buy the listed product in future. He
would be asked the proportion in which he intends to buy. This method seems to be the most
ideal method for forecasting demand.

2. Statistical Methods:
Statistical method is used for long run forecasting. In this method, statistical and mathematical
techniques are used to forecast demand. This method relies on post data.

a. Time series analysis or trend projection methods:

A well-established firm would have accumulated data. These data are analyzed to determine the
nature of existing trend. Then, this trend is projected in to the future and the results are used as
the basis for forecast. This is called as time series analysis. This data can be presented either in a
tabular form or a graph. In the time series post data of sales are used to forecast future.
b. Barometric Technique:
Simple trend projections are not capable of forecasting turning paints. Under Barometric method,
present events are used to predict the directions of change in future. This is done with the help of
economics and statistical indicators. Those are (1) Construction Contracts awarded for building
materials (2) Personal income (3) Agricultural Income. (4) Employment (5) Gross national
income (6) Industrial Production (7) Bank Deposits etc.

c. Regression and correlation method:

Regression and correlation are used for forecasting demand. Based on post data the future data
trend is forecasted. If the functional relationship is analyzed with the independent variable it is
simple correction. When there are several independent variables it is multiple correlation. In
correlation we analyze the nature of relation between the variables while in regression; the extent
of relation between the variables is analyzed. The results are expressed in mathematical form.
Therefore, it is called as econometric model building. The main advantage of this method is that
it provides the values of the independent variables from within the model itself..

DEMAND FORECASTING

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The activity of estimating the quantity of a product or service that consumers will purchase.
Demand forecasting involves techniques including both informal methods, such as educated
guesses, and quantitative methods, such as the use of historical sales data or current data from
test markets. Demand forecasting may be used in making pricing decisions, in assessing future
capacity requirements, or in making decisions on whether to enter a new market.According

1 Cundiff and Still, "Demand Forecasting is an estimate of Demand during a specified

period. Which estimate is tied to a proposed marketing plan and which assumes a
particular set of uncontrollable and competitive forces."

2 Prof. Philip Kotler. The company (sales) forecast is the expected level of company
sales based on a chosen marketing plan and assumed marketing environment"

3 Evan J. Douglas, "Demand forecasting may be defined as the process of finding values
for demand in future time periods."

The cost should be controlled by producing correct level of goods in the firm and also
according to the demand for those goods in the market. For the estimation of demand, demand
forecasting is to be done by the firm.

 Forecasting = estimation of future situations.

 Forecasting reduces or minimizes the uncertainty.
 By forecasting effective decisions can be taken for tomorrow.
 Demand forecasting is based on the determinants of the demand.
 Demand for goods increases and gives sales.
 Sales are the primary source of the income for a firm.

STEPS INVOLVED IN DEMAND FORECASTING

1. Identification of business objectives:

In the first stage we should know what is the aim of forecasting? What we get or know from the
forecasting? Estimation of factors like quantity and composition of demand for goods, price to be
quoted, sales planning and inventory control etc., are done in the first stage.

2. Determining the nature of goods under consideration:

Different category of goods has their own distinctive demand. Example capital goods, consumer
durables and non-durables goods in which category our goods fall we should estimate.

3. Selecting a proper method of forecasting:

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There are different methods for demand forecasting. Which is best suited method that we should
select for doing demand forecasting?

4. Interpretation of results:

The forecasting which is done by the managerial economist should be interpreted in detailed
manner. That means it should be easy to understand by the top management.

Demand Forecasting Techniques

To invest money and others factors in business; we require a reasonable accurate forecast of
demand. Starting with qualitative methods like survey of collective opinions, buyers' intention,
Delphi approach and its variant, a number of quantitative methods are used for computing
demand forecasts as detailed below:

Opinion polling method

a) Collective opinion Survey:

Sales personnel are closest to the customers and have an intimate feel of the market. Thus
they are most suited to assess consumer’s reaction to company's products. Here each salesperson
makes an estimate of the expected sales in their area, territory, state and/or region, These
estimates are collated, reviewed and revised. Taking in to account product design, features and
price is decided and made. Thus, "collective opinion survey forms the basis of market Analysis
and demand forecasting.

Although this method is simple, direct, first hand and most acceptable, it suffers from following
weaknesses

1. demand estimates by individual salespersons to obtain total demand of the country may
be risky as each person has knowledge about a small portion of market only
2. Salesperson may not prepare the demand estimation with the seriousness and care
3. limited experience in their employment, salesperson may not have the required
knowledge and experience
b) Survey of Customers Intention

Another method of demand forecasting is to carry out a survey of what consumers prefer
and intend to buy. If the product is sold to a few large industrial buyers, survey would
involve interviewing them.If it is a consumer durable product, a sample survey is carried
out about what they are planning or intending to buy. It is not east to query all consumers
through direct contact or through printed questionnaire by mail. These surveys serve
useful purpose in establishing relationships between

a) Demand and price

b) Demand and income of consumers
c) Demand and expenditure on advertisement etc.

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This method is preferred when bulk of the sales made to institutions and industrial
buyers and only a few of them have to be contacted. Disadvantages are. Survey method is
not useful for households - interviewing them is not only difficult but also expensive.
They are not able to give precise idea about their intentions particularly when alternative
products are available in the market.

c) Delphi Method

The Delphi technique was developed at RAND Corporation in the 1950s. Delphi
method is a group (members) process and aims at achieving a `single opinion of the
members on the subject. Herein experts in the field of marketing research and demand
forecasting are engaged in

 analyzing economic conditions

 carrying out sample surveys of market
 conducting opinion polls

Based on the above, demand forecast is worked out in following steps:

1. Administrator sends out a set of questions in writing to all the experts on the
panel, who are requested to write back a brief predication.
2. Written predictions of experts are collected and combined, edited and
summarized together by the administrator.
3. Based on the summary, administrator designs a new set of questions and gives
them to the same experts who answer back again in writing.
4. Administrator repeats the process of collecting, combining, editing and
summarizing the responses.
5. Steps 3 and 4 are repeated by the administrator to experts with diverse
backgrounds until they come to one single opinion.

If there is divergence of opinions and hence conclusions, administrator has to sort it out through
mutual discussions. Administrator has to have the necessary experience and background as he
plays a key role in designing structured 'questionnaires and synthesizing the data.

Statistical methods

 Trend projection method

This technique assumes that whatever past years demand pattern will be continued in the
future also. Basing on the historical data that means previous year’s data is used to
predict the demand for the future. In this trend projection method, previous year’s data is
presented on the graph and future demand is estimated.

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 Regression Analysis

Past data is used to establish a functional relationship between two variables. For
Example, demand for consumer goods has a relationship with income of Individuals and
family; demand for tractors is linked to the agriculture income and demand for cement,
bricks etc. are dependent upon value of construction contracts at any time. Forecasters
collect data and build relationship through co-relation and regression analysis of
variables.

 Econometric Models

Econometric models are more complex and comprehensive as this model uses
mathematical and statistical tools to forecast demand. This model takes various factors
which affect the demand. For example, demand for passenger transport is not only
dependent upon the population of the city, geographical area, industrial units, their
location etc.It is not easy to locate one single economic indicator for determining the
demand forecast of a product. Invariably, a multi-factor situation applies Econometric
Models, although complex, are being increasingly used for market analysis and demand
forecasts.

 Simple Average Method

Among the quantitative techniques for demand analysis, simple Average Method is the
first one that comes to one's mind. Herein, we take simple average of all past periods -
simple monthly average of all consumption figures collected every month for the last
twelve months or simple quarterly average of consumption figures collected for several
quarters in the immediate past. Thus,

Sum of Demands of all periods =

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MEFA Unit – 2 Notes- 3RD Sem. JECRC Foundation

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DETERMINANTS OF SUPPLY
When price changes, quantity supplied will change. That is a movement along the same supply
curve. When factors other than price changes, supply curve will shift. Here are some
determinants of the supply curve.

1. Production cost:
Since most private companies’ goal is profit maximization. Higher production cost will lower
profit, thus hinder supply. Factors affecting production cost are: input prices, wage rate,
government regulation and taxes, etc.
Cost of production depends on the factors like

1 Price of raw materials

2 Rents and interest on capital
3 Cost of machinery
4 Payments to human resources (wages and salaries)
5 Transportation charges

If cost of production is high normally supply will be low

2. Technology:
Technological improvements help reduce production cost and increase profit, thus stimulate
higher supply. Use of latest technology decreases the cost of production and increases the
production capacity which increases supply of goods.

3. Number of sellers:

More sellers in the market increase the market supply. Supply depends upon the below
said factors. These factors should not arise if they arise; they affect the supply directly or
indirectly.

1 whether conditions
2 Floods
3 Wars
4 Epidemics (unexpected situations)

4. Expectation for future prices:

If producers expect future price to be higher, they will try to hold on to their inventories and
offer the products to the buyers in the future, thus they can capture the higher price.

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MEFA Unit – 2 Notes- 3RD Sem. JECRC Foundation

The relationship between price and quantity supplied is usually a positive

relationship. A rise in price is associated with a rise in quantity supplied.

LAW OF SUPPLY FUNCTION

1 Dooley. "The law of supply states that other things being equal the
higher the price, the greater the quantity supplied or the lower the
price, the smaller the quantity supplied."

2 to Lipsey, "The law of supply states that other things being equal, the
quantity of any commodity that firms will produce and offer for sale is
positively related to the commodity's own price, rising when price rises
and falling when price

As the price of good increases, suppliers will attempt to maximize profits by

increasing the quantity of the product sold.

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MEFA Unit – 2 Notes- 3RD Sem. JECRC Foundation

SUPPLY FUNCTION

The supply function is the mathematical expression of the relationship between supply and those
factors that affect the willingness and ability of a supplier to offer goods for sale
SX = f( PX ,PF ,O,…………………T , t, s)

SX = Supply of goods

PX = Price

PF = Factor input employed (used) for production.

Raw material
Human resources
Machinery

O = Factors outside economic sphere.

T = Technology.

t = Taxes.

S = Subsidies

There is a functional (direct) relationship between price and supply.

ELASTICITY OF SUPPLY

The Price Elasticity of Supply measures the rate of response of quantity demand due to a price
change. If you've already read Elasticity of Demand and understand it, you may want to just
skim this section, as the calculations are similar.

Definitions

1 to Lipsey, "Elasticity of supply is the ratio of percentage change in

quantity supplied over the percentage change in price."

Price elasticity of supply measures the relationship between change in quantity supplied and a
change in price. The formula for price elasticity of supply is:

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MEFA Unit – 2 Notes- 3RD Sem. JECRC Foundation

 ∆Q =change in the demand.(difference in demand)

 ∆P=change in the price.(difference in the price)
 P1=initial price. (first price/ old price)
 Q1=initial demand. (first demand/ old demand)

The value of elasticity of supply is positive, because an increase in price is likely to increase the
quantity supplied to the market and vice versa.

Five Types of Elasticities of Supply:

1. Unit Elastic Supply: When change in price of X brings about exactly proportionate
change in its quantity supplied then supply is unit elastic i.e. elasticity of supply is equal to one,
e.g. if price rises by 10% and supply expands by 10% then, change in the quantity supplied the
supply is relatively inelastic or elasticity of supply is less than one.

Es = % change in Quantity Supplied of X

% change in price of X

2. Relatively Elastic Supply: When change in price brings about more than proportionate
change in the quantity supplied, then supply is relatively elastic or elasticity of supply is greater
than one.

3. Perfectly Inelastic Supply: When a change in price has no effect on the quantity supplied
then supply is perfectly inelastic or the elasticity of supply is zero.

4. Perfectly Elastic Supply: When a negligible change in price brings about an infinite
change in the quantity supplied, then supply is said to be perfectly elastic or elasticity of supply
is infinity.

All the five types of Elasticities of supply can be shown by different slopes of the supply curve.
Fig. (1) Shows the supply is unit elastic because change in price from OP to OP1 brings about
exactly proportionate change in the quantity supplied of commodity X viz., from OM to OM1. In
this case Es = 1.

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MEFA Unit – 2 Notes- 3RD Sem. JECRC Foundation

Fig (2) shows that supply is relatively inelastic because change in price of from OP to OP1
brings about less than proportionate change in quantity supplied of X. in this case Es < 1.

Fig (3) shows that supply is relatively elastic because change in price of X from OP to OP1
brings about more than proportionate change in quantity supplied of X. in this case Es > 1.

Fig (4) shows that supply is perfectly inelastic because change in price of X from OP to OP1 has
absolutely no effect on quantity supplied of X. in this case Es = 0. Thus, if the supply curve is
vertical, i.e. parallel to Y-axis it represents perfectly inelastic supply.

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MEFA Unit – 2 Notes- 3RD Sem. JECRC Foundation

Fig shows that supply is perfectly elastic because a small change in price of X brings about
infinite change in supply. Thus, if the supply curve is horizontal or parallel to X- axis it
represents perfectly elastic supply.

Hence, the five different types of elasticity’s of supply can be shown by five different slopes of
supply curve.

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