Study of sales generated by a good or service to determine the reasons for its success or failure, and how its sales performance can be improved.
Law Of Demand – Demand Price Relationship
This law explains the functional relationship between price of a commodity and the quantity demanded of the same. It is observed that the price and the demand are inversely related which means that the two move in the opposite direction. An increase in the price leads to a fall in the demand and vice versa. This relationship can be stated as
“Other things being equal, the demand for a commodity varies inversely as the price”
“The demand for a commodity at a given price is more than what it would be at a higher price and less than what it would be at a lower price”
Demand Curve DD
It is a geometrical device to express the inverse price-demand relationship, i.e. the law of demand. A demand curve can be obtained by plotting a demand schedule on a graph and joining the points so obtained, like the demand schedule we can derive an individual demand curve as well as a market demand curve. The former shows the demand curve of an individual buyer while the latter shows the sum total of all the individual curves i.e. a market or a total demand curve. The following diagram shows the two types of demand curves.
In the above diagram, figure (A) shows an individual demand curve of any individual consumer while figure (B) indicates the total market demand. It can be noticed that both the curves are negatively sloping or downwards sloping from left to right. Such a curve shows the inverse relationship between the two variables. In this case the two variable are price on Y axis and the quantity demanded on X axis. It may be noted that at a higher price OP the quantity demanded is OM while at a lower price say OP1, the quantity demanded rises to OM1 thus a demand curve diagrammatically explains the law of demand.
Determinants (Factors Affecting) of Demand
The law of demand, while explaining the price-demand relationship assumes other factors to be constant. In reality however, these factors such as income, population, tastes, habits, preferences etc., do not remain constant and keep on affecting the demand. As a result the demand changes i.e. rises or falls, without any change in price.
1. Income: The relationship between income and the demand is a direct one. It means the demand changes in the same direction as the income. An increase in income leads to rise in demand and vice versa.
2. Population: The size of population also affects the demand. The relationship is a direct one. The higher the size of population, the higher is the demand and vice versa.
3. Tastes and Habits: The tastes, habits, likes, dislikes, prejudices and preference etc. of the consumer have a profound effect on the demand for a commodity. If a consumers dislikes a commodity, he will not buy it despite a fall in price. On the other hand a very high price also may not stop him from buying a good if he likes it very much.
4. Other Prices: This is another important determinant of demand for a commodity. The effects depends upon the relationship between the commodities in question. If the price of a complimentary commodity rises, the demand for the commodity in reference falls. E.g. the demand for petrol will decline due to rise in the price of cars and the consequent decline in their demand. Opposite effect will be experienced incase of substitutes.
5. Advertisement: This factor has gained tremendous importance in the modern days. When a product is aggressively advertised through all the possible media, the consumers buy the advertised commodity even at a high price and many times even if they don’t need it.
6. Fashions: Hardly anyone has the courage and the desire to go against the prevailing fashions as well as social customs and the traditions. This factor has a great impact on the demand.
7. Imitation: This tendency is commonly experienced everywhere. This is known as the demonstration effects, due to which the low income groups imitate the consumption patterns of the rich ones. This operates even at international levels when the poor countries try to copy the consumption patterns of rich countries.
Variation & Changes In Demand
The law of demand explains the effect of only-one factor viz., price, on the demand for a commodity, under the assumption of constancy of other determinants. In practice, other factors such as, income, population etc. cause the rise or fall in demand without any change in the price. These effects are different from the law of demand. They are termed as changes in demand in contrast to variations in demand which occur due to changes in the price of a commodity. In economic theory a distinction is made between (a) Variations i.e. extension and contraction in demand due to price and (b) Changes i.e. increase and decrease in demand due to other factors.
(a) Variations in demand refer to those which occur due to changes in the price of a commodity.
These are two types.
1. Extension of Demand: This refers to rise in demand due to a fall in price of the commodity. It is shown by a downwards movement on a given demand curve.
2. Contraction of Demand: This means fall in demand due to increase in price and can be shown by an upwards movement on a given demand curve.
(b) Changes in demand imply the rise and fall due to factors other than price.
It means they occur without any change in price. They are of two types.
1. Increase in Demand: This refers to higher demand at the same price and results from rise in income, population etc., this is shown on a new demand curve lying above the original one.
2. Decrease in demand: It means less quantity demanded at the same price. This is the result of factors like fall in income, population etc. this is shown on a new demand lying below the original one.
Fig (A) Extension/Contraction of Demand
Fig (B) Increase/Decrease in Demand
In figure A, the original price is OP and the Quantity demanded is OQ. With a rise in price from OP to OP1 the demand contracts from OQ to OQ1 and as a result of fall in price from OP to OP2, the demand extends from OQ to OQ2.
In figure, B an increase in demand is shown by a new demand curve, D1 while the decrease in demand is expressed by the new demand curve D2, lying above and below the original demand curve D respectively. On D1 more is demand (OQ1) at the same price while on D2 less is demanded (OQ2) at the same price OP.
Types of Price Elasticity
The concept of price elasticity reveals that the degree of responsiveness of demand to the change in price differs from commodity to commodity. Demand for some commodities is more elastic while that for certain others is less elastic. Using the formula of elasticity, it possible to mention following different types of price elasticity:
1. Perfectly inelastic demand (ep = 0)
2. Inelastic (less elastic) demand (e < 1)
3. Unitary elasticity (e = 1)
4. Elastic (more elastic) demand (e > 1)
5. Perfectly elastic demand (e = 8)
1. Perfectly inelastic demand (ep = 0)
This describes a situation in which demand shows no response to a change in price. In other words, whatever be the price the quantity demanded remains the same. It can be depicted by means of the alongside diagram.
The vertical straight line demand curve as shown alongside reveals that with a change in price (from OP to Op1) the demand remains same at OQ. Thus, demand does not at all respond to a change in price. Thus ep = O. Hence, perfectly inelastic demand. Fig a
2. Inelastic (less elastic) demand (e < 1)
In this case the proportionate change in demand is smaller than in price. The alongside figure shows this type.
In the alongside figure percentage change in demand is smaller than that in price. It means the demand is relatively c less responsive to the change in price. This is referred to as an inelastic demand. Fig e
3. Unitary elasticity demand (e = 1)
When the percentage change in price produces equivalent percentage change in demand, we have a case of unit elasticity. The rectangular hyperbola as shown in the figure demonstrates this type of elasticity. In this case percentage change in demand is equal to percentage change in price, hence e = 1. Fig c
4. Elastic (more elastic) demand (e > 1)
In case of certain commodities the demand is relatively more responsive to the change in price. It means a small change in price induces a significant change in, demand. This can be understood by means of the alongside figure.
It can be noticed that in the above example the percentage change in demand is greater than that in price. Hence, the elastic demand (e>1) Fig d
5. Perfectly elastic demand (e = 8)
This is experienced when the demand is extremely sensitive to the changes in price. In this case an insignificant change in price produces tremendous change in demand. The demand curve showing perfectly elastic demand is a horizontal straight line. Fig b
It can be noticed that at a given price an infinite quantity is demanded. A small change in price produces infinite change in demand. A perfectly competitive firm faces this type of demand.
From the above analysis it can be concluded that theoretically five different types of price elasticity can be mentioned. In practice, however two extreme cases i.e. perfectly elastic and perfectly inelastic demand, are rarely experienced. What we really have is more elastic (e > 1) or less elastic (e < 1 ) demand. The unitary elasticity is a dividing line between these two cases.
Types of demand
i) Direct and Derived Demands
Direct demand refers to demand for goods meant for final consumption; it is the demand for consumers’ goods like food items, readymade garments and houses. By contrast, derived demand refers to demand for goods which are needed for further production; it is the demand for producers’ goods like industrial raw materials, machine tools and equipments.
Thus the demand for an input or what is called a factor of production is a derived demand; its demand depends on the demand for output where the input enters. In fact, the quantity of demand for the final output as well as the degree of substituability/complementarty between inputs would determine the derived demand for a given input.
For example, the demand for gas in a fertilizer plant depends on the amount of fertilizer to be produced and substitutability between gas and coal as the basis for fertilizer production. However, the direct demand for a product is not contingent upon the demand for other products.
ii) Domestic and Industrial Demands
The example of the refrigerator can be restated to distinguish between the demand for domestic consumption and the demand for industrial use. In case of certain industrial raw materials which are also used for domestic purpose, this distinction is very meaningful.
For example, coal has both domestic and industrial demand, and the distinction is important from the standpoint of pricing and distribution of coal.
iii) Autonomous and Induced Demand
When the demand for a product is tied to the purchase of some parent product, its demand is called induced or derived.
For example, the demand for cement is induced by (derived from) the demand for housing. As stated above, the demand for all producers’ goods is derived or induced. In addition, even in the realm of consumers’ goods, we may think of induced demand. Consider the complementary items like tea and sugar, bread and butter etc. The demand for butter (sugar) may be induced by the purchase of bread (tea). Autonomous demand, on the other hand, is not derived or induced. Unless a product is totally independent of the use of other products, it is difficult to talk about autonomous demand. In the present world of dependence, there is hardly any autonomous demand. Nobody today consumers just a single commodity; everybody consumes a bundle of commodities. Even then, all direct demand may be loosely called autonomous.
iv) Perishable and Durable Goods’ Demands
Both consumers’ goods and producers’ goods are further classified into perishable/non-durable/single-use goods and durable/non-perishable/repeated-use goods. The former refers to final output like bread or raw material like cement which can be used only once. The latter refers to items like shirt, car or a machine which can be used repeatedly. In other words, we can classify goods into several categories: single-use consumer goods, single-use producer goods, durable-use consumer goods and durable-use producer’s goods. This distinction is useful because durable products present more complicated problems of demand analysis than perishable products. Non-durable items are meant for meeting immediate (current) demand, but durable items are designed to meet current as well as future demand as they are used over a period of time. So, when durable items are purchased, they are considered to be an addition to stock of assets or wealth. Because of continuous use, such assets like furniture or washing machine, suffer depreciation and thus call for replacement. Thus durable goods demand has two varieties – replacement of old products and expansion of total stock. Such demands fluctuate with business conditions, speculation and price expectations. Real wealth effect influences demand for consumer durables.
v) New and Replacement Demands
This distinction follows readily from the previous one. If the purchase or acquisition of an item is meant as an addition to stock, it is a new demand. If the purchase of an item is meant for maintaining the old stock of capital/asset, it is replacement demand. Such replacement expenditure is to overcome depreciation in the existing stock.
Producers’ goods like machines. The demand for spare parts of a machine is replacement demand, but the demand for the latest model of a particular machine (say, the latest generation computer) is anew demand. In course of preventive maintenance and breakdown maintenance, the engineer and his crew often express their replacement demand, but when a new process or a new technique or anew product is to be introduced, there is always a new demand.
You may now argue that replacement demand is induced by the quantity and quality of the existing stock, whereas the new demand is of an autonomous type. However, such a distinction is more of degree than of kind. For example, when demonstration effect operates, a new demand may also be an induced demand. You may buy a new VCR, because your neighbor has recently bought one. Yours is a new purchase, yet it is induced by your neighbor’s demonstration.
vi) Final and Intermediate Demands
This distinction is again based on the type of goods- final or intermediate. The demand for semi-finished products, industrial raw materials and similar intermediate goods are all derived demands, i.e., induced by the demand for final goods. In the context of input-output models, such distinction is often employed.
vii) Individual and Market Demands
This distinction is often employed by the economist to study the size of the buyers’ demand, individual as well as collective. A market is visited by different consumers, consumer differences depending on factors like income, age, sex etc. They all react differently to the prevailing market price of a commodity. For example, 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 market which is the aggregate of individuals. You may note that both individual and market demand schedules (and hence curves, when plotted) obey the law of demand. But the purchasing capacity varies between individuals. For example, A is a high income consumer, B is a middle-income consumer and C is in the low-income group. This information is useful for personalized service or target-group-planning as a part of sales strategy formulation.
viii) Total Market and Segmented Market Demands
This distinction is made mostly on the same lines as above. Different individual buyers together may represent a given market segment; and several market segments together may represent the total market. For example, the Hindustan Machine Tools may compute the demand for its watches in the home and foreign markets separately; and then aggregate them together to estimate the total market demand for its HMT watches. This distinction takes care of different patterns of buying behavior and consumers’ preferences in different segments of the market. Such market segments may be defined in terms of criteria like location, age, sex, income, nationality, and so on
x) Company and Industry Demands
An industry is the aggregate of firms (companies). Thus the Company’s demand is similar to an individual demand, whereas the industry’s demand is similar to aggregated total demand. You may examine this distinction from the standpoint of both output and input.
For example, you may think of the demand for cement produced by the Cement Corporation of India (i.e., a company’s demand), or the demand for cement produced by all cement manufacturing units including the CCI (i.e., an industry’s demand). Similarly, there may be demand for engineers by a single firm or demand for engineers by the industry as a whole, which is an example of demand for an input. You can appreciate that the determinants of a company’s demand may not always be the same as those of an industry’s. The inter-firm differences with regard to technology, product quality, financial position, market (demand) share, market leadership and competitiveness- all these are possible explanatory factors. In fact, a clear understanding of the relation between company and industry demands necessitates an understanding of different market structures.
Types of Elasticity of Demand:
The quantity of a commodity demanded per unit of time depends upon various factors such as the price of a commodity, the money income of the prices of related goods, the tastes of the people, etc., etc. Whenever there is a change in any of the variables stated above, it brings about a change in the quantity of the commodity purchased over a specified period of time. The elasticity of demand measures the responsiveness of quantity demanded to a change in any one of the above factors by keeping other factors constant. When the relative responsiveness or sensitiveness of the quantity demanded is measured to changes, in its price, the elasticity is said be price elasticity of demand. When the change in demand is the result of the given change in income, it is named as income elasticity of demand. Sometimes, a change in the price of one good causes a change in the demand for the other. The elasticity here is called cross electricity of demand. The three main types of elasticity are now discussed in brief.
(1) Price Elasticity of Demand:
The concept of price elasticity of demand is commonly used in economic literature. Price elasticity of demand is the degree of responsiveness of quantity demanded of a good to a change in its price. Precisely, it is defined as the ratio of proportionate change in the quantity demanded of a good caused by a given proportionate change in price. The formula for measuring price elasticity of demand is:
Price Elasticity = Percentage in quantity demand
Percentage change in price
?q x 100
Ep = q
?P x 100
= ?q / q ÷ ?P / P
Ep = ?q / ?P x P / q (For simple calculation)
Example. Let us suppose that price of a good falls from $10 per unit to $9 per unit in a day. The decline in price causes the quantity of the good demanded to increase from 125 units to 150 units per day, The price elasticity using the simplified formula will be:
Ep = ?q / ?P x P / q
?q = 150 – 125 = 25 ?P = 10 – 9 = 1
Original quantity = 125 Original price = 10
Ep = 25 / 1 x 10 / 125 = 2. The elasticity coefficient is greater than one.
Therefore the demand for the good is elastic.
The concept of price elasticity of demand can be used to divide the goods in to three groups.
(i) Elastic. When the percent change in quantity of a good is greater than the percent change in its price, the demand is said to be elastic. When elasticity of demand is greater than one, a fall in price increases the total revenue (expenditure) and a rise in price lowers the total revenue (expenditure).
(ii) Unitary elasticity. When the percentage change in the quantity of a good demanded equals percentage in its price, the price elasticity of demand is said to have unitary elasticity. When elasticity of demand is equal to one or unitary, a rise or fall in price leaves total revenue unchanged.
(iii) Inelastic. When the percent change in quantity of a good demanded is less than the percentage change in its price, the demand is called inelastic. When elasticity of demand is inelastic or less than one, a fall in price decreases total revenue and a rise in its price increases total revenue.
(2) Income Elasticity of Demand:
Income is an important variable affecting the demand for a good. When there is a change in the level of income of a consumer, there is a change in the quantity demanded of a good, other factors remaining the same. The degree of change or responsiveness of quantity demanded of a good to a change in the income of a consumer is called income elasticity of demand. Income elasticity of demand can be defined as the ratio of percentage change in the quantity of a good purchased, per unit of time to a percentage change in the income of a consumer. The formula for measuring the income elasticity of demand is the percentage change in demand for a good divided by the percentage change in income. Putting this in symbol gives.
Ey = Percentage change in demand
Percentage change in income
Ey = ?q / ?y x y / q
A simple example will show how income elasticity of demand can be calculated. Let us assume that the income of a person is $4000 per month and he purchases six CD’s per month. Let us assume that the monthly income of the consumer increase to $6000 and the quantity demanded of CD’s per month rises to eight The elasticity of demand for CD’s will be calculated as under:
?q = 8 – 6 = 2 ?y = $6000 – $4000 = $2000
Original quantity demanded = 6 Original income $4000
Ey = ?q / ?y x y / q = 2 / 200 x 4000 / 6 = 0.66
The income elasticity is .66 which is less than one.
Categories of income elasticity. When the income of a person increases, his demand for goods also changes depending upon whether the good is a normal good or an inferior good. For normal goods, the value of elasticity is greater than zero but less than one. Goods with an income elasticity of less than 1 are called inferior goods. For example, people buy more food as their income rises but the % increase in its demand is less than the % increase in income.
(3) Cross Elasticity of Demand:
The concept of cross elasticity of demand is used for measuring the responsiveness of quantity demanded of a good to changes in the price of related goods. Cross elasticity of demand is defined as the percentage change in the demand of one good as a result of the percentage change in the price of another good.. The .formula for measuring, cross, elasticity of demand is:
Exy = % change ^n quantity demanded of good X
% change in price of good Y
The numerical value of cross elasticity depends on whether the two goods in question are substitutes, complements or unrelated.
(i) Substitute goods. When two goods are substitute of each other, such as coke and Pepsi, an increase in the price of one good will lead to an increase in demand for the other good. The numerical value of goods is positive For example there are two goods. Coke and Pepsi which are close substitutes. If there is increase in the price of Pepsi called good y by 10% and it increases the demand for Coke called good X by 5%, the cross elasticity would be = %?qdx / %?py = 0.2 . Since Exy is positive (E > 0), therefore, Coke and Pepsi are close substitutes.
(ii) Complementary goods. However, in case of complementary goods such as car and petrol, cricket bat and ball, a rise in the price of one good say cricket bat by 7% will bring a fall in the demand for the balls (say by 6%). The cross elasticity of demand which are complementary to each other is, therefore, 6% / 7% = 0.85 (negative).
(iii) Unrelated goods. The two goods which a re unrelated to each other, say apples and pens, if the price of apple rises in the market, it is unlikely to result in a change in quantity demanded of pens. The elasticity is zero of unrelated goods.
Optimum population ( resources = population)
Over population ( resources < population)
Under population ( resources > population)
Optimum Firm- production at lowest point of LRAC
MC= MR= AC = AR