MODULE II

ANALYSIS OF DEMAND SUPPLY:

Demand function, Determinants of Demand, Law of Demand, Demand forecasting, Law of
supply.
ELASTICITY OF DEMAND AND SUPPLY:
Elasticity of Demand -Types & Measurement; Elasticity of supply-Types and Measurement.

Demand Analysis Overview

Demand analysis examines how consumer choices are impacted by price, income,
preferences, and market conditions. It helps us understand the relationship between price and
volume demanded in a market. It investigates the way consumer behaviour reacts to price
changes, making it easier to draw demand curves that showcase the quantity demanded at
varying prices.
Demand Analysis involves the management’s decision-making process concerning
production, cost distribution, advertising, inventory management, pricing, and related
matters. Although, how much a firm produces depends on its production capacity how much
of The production effort should be aligned with the potential demand for the product.
DEMAND ANALYSIS
Meaning of Demand Analysis:
Ordinarily, by demand is meant the desire or want for something. In economics, however
demand means much more than that, it is effective demand i.e. the amount buyers are willing
to purchase at a given price and over a given period of time.
From managerial economics point of view, thus, the demand may be looked upon as follows:
- Demand is the desire or want backed up by money. Demand means effective desire or want
for a commodity, which is backed up by the ability (i.e. money or purchasing power) and
willingness to pay for it.
The demand does not mean simply the desire or even need for a commodity obviously, a
buyer’s wish for the product without possessing money to buy it or unwillingness to pay a
given price for it will not constitute a demand for it for example a beggar’s wish for a Bike
will not constitute its potential demand, as he has no ability to pay for it.

In short
Demand = Desire + Ability to pay + Willingness to spend
Meaning of Demand
Demand means the desire backed by the willingness to buy a commodity and the purchasing
power to pay.
As stated by Stonier and Hague, in economics, “demand” signifies a request for goods that is
supported by sufficient funds to cover the requested items.
According to Prof. Bober, “Demand refers to the various quantities of a given commodity or
service which consumers would buy in one market in a given period of time at various prices
or at various incomes or at various prices of related goods.”
DEMAND FUNCTION
What Is Demand Function?
A demand function is a mathematical function describing the relationship between a
variable, like the demand of quantity, and various factors determining the demand. The
purpose of this function is to analyse the behaviour of consumers in a market and to help
firms make pricing decisions.

Economists rely heavily on this function in their economic theories. Generally, a

product’s demand acts as a variable affected by price. This function can assess the market
stability and market-clearing cost. Therefore, it specifies the quantities and prices an
individual or all customers are willing to buy and pay at any given time.
Demand Function Explained

The demand function, or the demand curve, describes the relationship between the quantity
demanded by customers and the product price. Thus, the price of goods becomes vital in
determining the number of goods consumers buy in a market. The most common form of this
function is the linear demand function. However, economists often use different functional
forms apart from the linear process, such as logarithmic and polynomial functions, to capture
different consumer behavior patterns.

Moreover, the process of demand describes the relationship between the need for a product
with that of other factors:

 Commodity demand: the demand for a commodity affects the item’s price either
positively or negatively.
 Commodity function: the quality of a commodity affects demand.
 Goods or service prices: if the costs increase, demand decreases.
 The expected price of the commodity in the future: if the customers expect any
change in their income or price change of a product, the demand changes.
 Related products and services price: if the substitute product’s price changes, then if
the demand for the original product changes, one can say the product is related to each
other as complement and substitute.
 Consumer’s pattern of taste: The company makes significant investments in
advertising to change the taste and preference of consumers to like the advertised
product.

We can refer to the above as the factors that affect demand. It occurs because various factors
influence the market for any commodity. Furthermore, income is not a determinant in the
Marshallian demand function. Economist Alfred Marshall gave his name to the Marshallian
process of purchasing power. Therefore, the market researcher can calculate the slope and
intercept of the economic demand function by forecasting how price or other economic
factors affect the requirement for a specific product.

Types of Demand Function

We can attribute the basis of these function types to either individual customers or the entire
set of consumers in the market. Below listed are the types of functions:

#1 – Individual Demand Function

The Individual function of demand means the functional relationship between a particular
need for a product and all the factors that affect it. Moreover, it also explains the relationship
between the market’s direction and its aspects. In addition, companies can calculate this
function by using data on consumer buying behaviour, such as surveys, market research, or
sales data. Therefore, this function is derived from individual consumers’ preferences,
income, and other characteristics of individual consumers. Consequently, it helps
understand consumer behaviour in response to changes in price.

#2 – Market Demand Function

The market function of demand means the existing functional relationship between the need
of the market and the factors affecting the market demand. Besides those factors affecting the
individual demand process, the magnitude, and structure of climatic conditions and income
distribution also affect the demand’s market function.
Subsequently, evaluating this function involves using data on the prices and quantities
demanded by all buyers in the market. Therefore, this data can be obtained from market
research, surveys of buyer behaviour, and sales records. Hence, this function evaluates the
market stability price and quantity, which is the point where demand meets supply.

Formula

This function can be calculated using two different formulas since it indicates the relation
between the demand level and other factors influencing the demand. One can differentiate
between the individual and market demand for goods or products.

#1 – Individual Demand Function

Algebraically, the individual function of demand is described as follows:

Dx = f (Px, I, Pr, E, T)

 The Demand of Commodity x (Dx)

 The function of product x (f)
 Price of good or service (Px)
 Incomes of buyers (I)
 Prices of related goods & services (Pr)
 The future expectation of the product (E)
 Taste patterns of buyers (T)

#2 – Market Demand Function

Algebraically, the market function of demand is described as follows:

Dx = f (Px, Y, Py, Ep, T, Pp, A, U)

 The demand of Commodity x (Dx)

 The function of commodity x (f)
 Price of good or service (Px)
 Incomes of buyers (Y)
 Prices of related goods & services (Py)
 The Expected future price of the product (Ep)
 Taste patterns of users (T)
 Number of buyers in the market (Pp)
 Distribution of Income (A)
 Government Policy (U)

Inverse Demand Function

Sometimes an independent variable like price defines the demand curve, so one calls it an
inverse function of demand. The inverse function of demand helps find that additional
income is created when one extra unit gets sold. The marginal revenue function creates the
first derivative for the inverse demand process. Moreover, price becomes the function of
direction in quantity here. Under this, price becomes the function of the commodity
demanded.

It is essential because:

 It aids in calculating the impact when the quantity demanded changes to the price.
 It helps assess the amount of product that will help maximize profit.

Demand Estimation and Demand Forecasting

In Demand estimating manager attempts to quantify the links or relationship between the
level of demand and the variables which are determinants to it and is generally used in
designing pricing strategy of the firm. In demand estimation manager analyse the impact of
future change in price on the quantity demanded. Firm can charge a price that the market will
ready to wear to sell its product. Over estimation of demand may lead to an excessive price
and lost sales whereas under estimates may lead to setting of low price resulting in reduced
profits. In demand estimation data is collected for short period usually a year or less and
analysed in relation to various variables to know the impact of each
variables mainly the price on the demand behaviour of the customers. It is for a short period.
In Demand forecasting mangers forecast the most likely future demand of a product so that
he can make necessary arrangement for the various factor of production i.e labor, raw
material, machines, money etc. Demand forecasting tells the expected level of demand at
some future date on the basis of past and present information. It helped in production
planning, new product development, capacity enhancement or new schemes etc. Demand
forecasting is generally used for short term estimation as well as long term forecasting.
Thus, demand estimation and forecasting means when, how, where, by whom and how much
will be the demand for a product or service in near future. The process of demand
estimation/forecasting can be broken into two parts i.e. analysis of the past conditions and
analysis of current conditions with reference to a probable future trend. It helps in estimating
the most likely demand of a good or service under given business conditions.

Features of Demand Forecasting

The main features of the demand forecasting are;
o Demand Forecasting is a process to investigate and measure the forces that determine sales
for existing and new products.
o It is an estimation of most likely future demand for a product under given business
conditions.
o It is basically an educated and well thought out guesswork in terms of specific quantities
o Demand Forecasting is done in an uncertain business environment.
o Demand Forecasting is done for a specific period of time (i.e. the sufficient time required to
take a decision and put it into action).
o It is based on historical and present information and data.
o It tells us only the approximate expected future demand for a product based on certain
assumptions and cannot be 100% precise.
LAW OF DEMAND
The law of demand describes the general tendency of consumers behaviour in demanding a
commodity in relation to the changes in its price. The Law of demand expresses the
relationship between price and quantity demanded of a commodity. According to the law of
demand the demand of a commodity extends with fall in its price and contracts with rise in
the price, other things being constant. 'Other things being constant' means that the other
determinates of demand except price remain unchanged. it explains the inverse relationship
between price and quantity demanded.
Statement of law of demand:-
“Ceteris paribus, the higher the price of a commodity, the smaller is the quantity
demanded and lower the price, larger the quantity demanded”.
Characteristics of the Law of Demand
The following are the chief characteristics of the Law of Demand.
1. Inverse Relationship. The relationship between price and the demand of a particular
commodity is inverse i.e., the demand of a commodity will fall with the increase in the price
of the commodity or it will increase with the fall in-the price.
2. Price an Independent Variable and Demand a Dependent Variable. In the Law of
Demand, price is regarded as an independent variable that affects the demand inversely. Thus,
it is the effect of price on demand that is to be examined and not the effect of demand on
price.
3. It is a Qualitative Statement. The Law of Demand simply explains the direction of
change in the demand with the increase or decrease in the price of a commodity. It does not
explain the quantum of change. The law is thus, a qualitative statement? and not a
quantitative statement.
4. Other thing remains the same. The Law of Demand applies only when other things
remain the same. In other words, there should be no change in factors influencing demand
except price.

The law of demand can be illustrated with the help of a demand schedule.
The demand schedules shows that with the fall in the price of the commodity its demand is
increasing.
A market demand schedule

Price of Commodity’ Quantity Demanded of ‘X’

(in kgs.)
 (in Rs.)

5 10
4 20
3 30
2 40
1 50

From the above example, we can say that with a fall in price at each stage demand tends to
rise. There is an inverse relationship between price and the quantity demanded.

DETERMINANTS OF DEMAND
The main determinants of demand are the following:
1. Price of the Product. The price of commodity or services directly affects its demand. The
fall in the price of a commodity leads to rise in its demand and rise in price leads to fall in its
demand. Price is the only determinant of demand in the short run.
2. Price of Related Goods. Two or more goods can be complementary or substitutes of each
other. The demand for a commodity is also affected by changes in price of its complementary
or substitute good. If two goods are substitute for each other then the increase in price of one
will result in increased demand for the other and vice-versa. E.g. Pepsi and Cocacola are
substitute of each other. The rise in the price of Cocacola increases demand for Pepsi and
vice-versa. Complementary goods are those which, are jointly demanded to satisfy a
particular demand.
There is opposite relationship between price of one complementary commodity and the
amount demand of the other complementary commodity. If price of one complimentary rises,
the demand for the other complementary falls. E.g. A fall in the price of Car will lead to
increase in the demand for petrol.
3. Level of Income. Income is an important determinant of demand for a
commodity,ordinarily, with an increase in income, demand for goods increase. There is a
direct relationship between income and quantity demanded. Rich consumers usually demand
more and more goods than the poor customers. Demand for luxury and expensive goods is
related to the income.
4. Taste, Habits and preferences of Consumer. The demand for many goods also depends
on consumer's taste, habit and preferences. Demand for goods changes with change in
fashion, habits, customs, traditions and general life-style of the society. Demand for several
products like ice-cream, chocolates etc. depends on taste and demand tea, cigarettes, tobacco
is a matter of habits.
5. Future trend of Prices. If it is expected that in future the price of a commodity will go up
the demand for the commodity in the present also will go up. If the prices are expected to fall
then the demand would fall.
6. Changes in Population. Generally the demand for a commodity increases with increase in
size of population, other things being equal, it is not merely the change in the size of
population but the changes in the composition of population also affect the demand forcertain
commodities. In a country of increasing population like India where hundreds of childrens are
born daily in big cities there will naturally be demand for toys, baby food and alike.
7. State of Business. If the country is passing through prosperity and boom conditions, there
will be a marked increase in demand. When the country is passing through recession and
depression then level of demand would go down.
8. Distribution of Income and Wealth. If the distribution of income is more equal then the
demand for all normal goods will be more. If the income is so unevenly distributed that
majority of population is poor then the demand for inferior and necessaries' will be larger.
9. Availability of Consumer Credit. If the credit facilities are available sufficiently to
consumers for the purchase of high priced durable goods such as car, colour TV, scooters and
alike, then their demand will increase.
10. Different Uses. When the price of a commodity is high, it will be used only in its more
important use. As the price of the commodity falls it will be used even in less important uses.
Thus, the demand increases will fall in price and vice-versa. Example of gram or electricity
can be citied.
11. Change in the number of Buyers. With the fall in the price of a commodity the number
of its purchasers increase and vice-versa. Therefore, demand increases with fall in price and
decreases with fall in price and decreases with rise in price.
12. Advertisement and Salesmanship. In the modern market, advertisement greatly
influence the demand for a commodity. Infact, the demand for many products like to
toothpaste, Cosmetics etc. is greatly affected by advertisement. The best salesmanship is the
one who does not merely sell what buyers want but who makes the buyers buy what he sells.
13. Inventions and Innovations. introduction of new goods or substitutes as a result of
inventions and innovations in a dynamic modern economy tends to adversely affect the
demand for the existing products.
14. Climate and weather conditions. demand for certain products is determined by climatic
and weather conditions for example, in summers there is a great demand for cold drinks,fans,
air conditioners etc.
15. Fashions. the demand for many products is affected by changing fashions. For example
demand for jeans is based on current fashions.
16. Customs. demand for certain goods is determined by social customs, festivals etc., for
example, during the Dipawali days there is a great demand for sweets & during Christmas
cake are more in demand.

ASSUMPTIONS OF THE LAW OF DEMAND:

The Law of Demand is based on the following assumptions:
(1) No change in taste, habits, preferences: It is assumed that there is no change in the taste,
habits, preferences of a rational consumer. Thus, consumers' choice of product must remain
the same.
(2) No change in the income level: If the consumer's income rises, he will demand more
though the prices of commodities rise. In such a situation, the law will not hold good
. (3) No change in population : The law is based on the assumption that there should be no
change in population, size, sex ratio, age composition, etc.
(4) No change in prices of related goods : The law assumes that the prices of close
substitutes and the complementary products should remain constant.
(5) No expectation of future change in the price: If the consumers expect high rise in the
price in future, they demand more though current price is high. In such condition, the Law of
Demand cannot be verified.
(6) No change in taxation : It is assumed that the structure of direct and indirect taxes
remain constant. Thus, the disposable income of a consumer should remain the same.
(7) No introduction of new product: It is assumed that there is no introduction of a new
product in the market. Thus, the consumer's taste, habits and preferences remain constant.
(8) No change in technology : The law assumes that the present technology of production
remains constant.
(9) No change in weather conditions : Climatic and weather conditions may bring sudden
change in demand, though there is no change in the price. Therefore, it is assumed that
weather conditions remain constant.

EXCEPTIONS TO THE LAW OF DEMAND

Followings are the exceptions of the law of demand:
1. Articles of Distinction/prestigious goods: The articles of distinction such as diamonds,
gems, costly carpets, etc. are in more demand when their prices are high. The reason is that
rich people measure the desirability of these articles in terms of their prices alone and
consider these goods as honour possession. Therefore, rich people demand more of articles of
distinction when their prices are high.
2. Giffen Goods. Price effect is the composite effect of 'income effect' and 'substitution
effect. Giffen goods (most inferior goods) are those inferior goods for which 'income effect'
of change in price is negative and is greater than the substitution effect. Therefore, the
demand of Giffen goods increases with rise in price and decreases with fall in their price.
3. Ignorance of buyers about Quality. Many a times, buyers’ due inertia or out of sheer
ignorance consider the price of the commodity as index of its quality. Due to this ignorance, a
lower-price commodity may be considered inferior. Therefore, purchasers buy lesser quantity
of the commodity at its lower price. But when the price of commodity is more, buyers
consider it to be superior and thus buy more of it than before.
 4. Future changes in Prices. Purchaser also act as speculators. When the price has increased
and is expected to rise further, buyers tend to purchase more quantities of the commodity out
of the apprehension of rise in price in future. Likewise, when prices are expected to fall
further, a reduced price may not induce the buyers to purchase more of the commodity.
5. Necessities of Life. We cannot reduce the consumption of necessaries of life and
conventional necessaries even if their prices have increased sharply.
6. Change in quality: people are to demand more even at a higher price provided quality is
good.
7. Fashionable goods. Goods that are in fashion are purchased by consumers regardless of
price even at a higher price. Consumers purchases the goods which are in fashion
Types of Demand
a) Direct and indirect demand: (or) Producers’ goods and consumers’ goods: demand for
goods that are directly used for consumption by the ultimate consumer is known as direct
demand (example: Demand for T shirts). On the other hand demand for goods that are used
by producers for producing goods and services. (example: Demand for cotton by a textile
mill)
b) Derived demand and autonomous demand: when a produce derives its usage from the
use of some primary product it is known as derived demand. (example: demand for tyres
derived from demand for car) Autonomous demand is the demand for a product that can be
independently used. (example: demand for a washing machine)
c) Durable and non durable goods demand: durable goods are those that can be used more
than once, over a period of time (example: Microwave oven) Non durable goods can be used
only once (example: Band-aid)
d) Firm and industry demand: firm demand is the demand for the product of a particular
firm. (example: Dove soap) The demand for the product of a particular industry is industry
demand (example: demand for steel in India )
e) Total market and market segment demand: a particular segment of the markets demand
is called as segment demand (example: demand for laptops by engineering students) the sum
total of the demand for laptops by various segments in India is the total market demand.
(example: demand for laptops in India)
f) short run and long run demand: short run demand refers to demand with its immediate
reaction to price changes and income fluctuations. Long run demand is that which will
ultimately exist as a result of the changes in pricing, promotion or product improvement
aftermarket adjustment with sufficient time.
g) Joint demand and Composite demand: when two goods are demanded in conjunction
with one another at the same time to satisfy a single want, it is called as joint or
complementary demand. (example: demand for petrol and two wheelers) A composite
demand is one in which a good is wanted for several different uses. (example: demand for
iron rods for various purposes)
h) Price demand, income demand and cross demand: demand for commodities by the
consumers at alternative prices are called as price demand. Quantity demanded by the
consumers at alternative levels of income is income demand. Cross demand refers to the
quantity demanded of commodity ‘X’ at a price of a related commodity ‘Y’ which may be a
substitute or complementary to X.
 Price Demand: The ability and willingness to buy specific quantities of a good at the
prevailing price in a given time period.
 Income Demand: The ability and willingness to buy a commodity at the available income
in a given period of time.
 Market Demand: The total quantity of a good or service that people are willing and able to
buy at prevailing prices in a given time period. It is the sum of individual demands.
 Cross Demand: The ability and willingness to buy a commodity or service at the prevailing
price of the related commodity i.e. substitutes or complementary products. For example,
people buy more of wheat when the price of rice increases.
Exceptional Demand Curve:
The demand curve slopes from left to right upward if despite the increase in price of the
commodity, people tend to buy more due to reasons like fear of shortages or it may be an
absolutely essential good. The law of demand does not apply in every case and situation. The
circumstances when the law of demand becomes ineffective are known as exceptions of the
law. Some of these important exceptions are as under.
1. Giffen Goods: Some special varieties of inferior goods are termed as Giffen goods.
Cheaper varieties millets like bajra, cheaper vegetables like potato etc come under this
category. Sir Robert Giffen of Ireland first observed that people used to spend more of their
income on inferior goods like potato and less of their income on meat. After purchasing
potato the staple food, they did not have staple food potato surplus to buy meat. So the rise in
price of potato compelled people to buy more potato and thus raised the demand for potato.
This is against the law of demand. This is also known as Giffen paradox.
2. Conspicuous Consumption / Veblen Effect: This exception to the law of demand is
associated with the doctrine propounded by Thorsten Veblen. A few goods like diamonds etc
are purchased by the rich and wealthy sections of society. The prices of these goods are so
high that they are beyond the reach of the common man. The higher the price of the diamond,
the higher its prestige value. So when price of these goods falls, the consumers think that the
prestige value of these goods comes down. So quantity demanded of these goods falls with
fall in their price. So the law of demand does not hold good here.
3. Conspicuous Necessities: Certain things become the necessities of modern life. So we
have to purchase them despite their high price. The demand for T.V. sets, automobiles and
refrigerators etc. has not gone down in spite of the increase in their price. These things have
become the symbol of status. So they are purchased despite their rising price.
4. Ignorance: A consumer’s ignorance is another factor that at times induces him to purchase
more of the commodity at a higher price. This is especially true, when the consumer believes
that a high priced and branded commodity is better in quality than a low-priced one.
5. Emergencies: During emergencies like war, famine etc, households behave in an abnormal
way. Households accentuate scarcities and induce further price rise by making increased
purchases even at higher prices because of the apprehension that they may not be available. .
On the other hand during depression, , fall in prices is not a sufficient condition for
consumers to demand more if they are needed.
6. Future Changes in Prices: Households also act as speculators. When the prices are rising
households tend to purchase large quantities of the commodity out of the apprehension that
prices may still go up. When prices are expected to fall further, they wait to buy goods in
future at still lower prices. So quantity demanded falls when prices are falling.
7. Change in Fashion: A change in fashion and tastes affects the market for a commodity.
When a digital camera replaces a normal manual camera, no amount of reduction in the price
of the latter is sufficient to clear the stocks. Digital cameras on the other hand, will have more
customers even though its price may be going up. The law of demand becomes ineffective.
8. Demonstration Effect: It refers to a tendency of low-income groups to imitate the
consumption pattern of high-income groups. They will buy a commodity to imitate the
consumption of their neighbours even if they do not have the purchasing power.
9. Snob Effect: Some buyers have a desire to own unusual or unique products to show that
they are different from others. In this situation even when the price rises the demand for the
commodity will be more.
10. Speculative Goods/ Outdated Goods/ Seasonal Goods: Speculative goods such as
shares do not follow the law of demand. Whenever the prices rise, the traders expect the
prices to rise further so they buy more. Goods that go out of use due to advancement in the
underlying technology are called outdated goods. The demand for such goods does not rise
even with fall in prices
11. Seasonal Goods: Goods which are not used during the off-season (seasonal goods) will
also be subject to similar demand behaviour.
12. Goods In Short Supply: Goods that are available in limited quantity or whose future
availability is uncertain also violate the law of demand.

The Law of Supply

The law of supply relates price changes for a product with the quantity supplied. In contrast
with the law of demand the law of supply relationship is direct, not inverse. The higher the
price, the higher the quantity supplied. Lower prices mean reduced supply, all else held
equal.
Higher prices give suppliers an incentive to supply more of the product or commodity,
assuming their costs aren't increasing as much. Lower prices result in a cost squeeze that
curbs supply. As a result, supply slopes are upwardly sloping from left to right.

As with demand, supply constraints may limit the price elasticity of supply for a product,
while supply shocks may cause a disproportionate price change for an essential commodity.

What is Law of Supply?

Economists have studied the behaviour of both buyers and sellers. They have discovered
the law of supply as a result of their findings. The law of supply describes the relationship
between price and amount supplied when all other variables remain constant (ceteris
paribus).
Price is a dominant factor in the determination of the supply of a commodity. As the price
of a commodity increases, the supply of that commodity in the market also increases and
vice-versa. This behaviour of the producers is studied through the law of supply.
The Law of Supply can be better understood with the help of the following table and graph,

The above table indicates that when the price of the commodity rises, an increasing
number of units are offered for sale.
In the above graph, the rising slope of the supply curve (SS) indicates a clear
relationship between price and quantity supplied.

Important points about Law of Supply:

 The law of supply states the positive relationship between price and quantity
supplied of a commodity after assuming that the other factors remain constant.
 As the law of supply indicates the direction of the changes in quantity supplied
of a commodity and not the magnitude of the change. it is considered as
a quantitative statement.
 The law of supply does not establish any proportional relationship between the
change in price and the respective change in quantity supplied of the
commodity.
 The law of supply is one sided. It is because the law explains only the effect of
change in price on the supply of the commodity and not the effect of change in
supply on the price of the commodity.

Assumptions of Law of Supply

The phrase “keeping other factors constant or ceteris paribus” is used when describing the
law of supply. This expression refers to the following presumptions that the law is based
on:
1. The price of other commodities is constant.
2. The state of technology has not changed.
3. The price of factors of production is constant.
 4. The taxation laws remain the same.
5. The producer’s objectives are constant.

Reason for Law of Supply

The main reasons behind the law of supply are as follows:
1. Profit Motive:
Maximising profits is the primary goal of producers when they supply a good or service.
Their profits grow when the price of a commodity rises without a change in costs.
Therefore, by increasing production, manufacturers increase the commodity’s supply. On
the other hand, as price fall, supply also declines since low price result in lower profit
margins.
2. Change in Number of Firms:
When the price of a specific commodity increases, potential producers are encouraged to
enter the market and produce the good to make money. The market supply rises as the
number of businesses increases. However, once the price begins to decline, some
businesses that do not anticipate making any money at a low price may stop production or
cut it back. As the number of businesses in the market declines, it decreases the supply of
the given commodity.
3. Change in Stock:
When the price of an item rises, sellers are eager to supply additional things from their
stocks. However, the producers do not release significant amounts from their stock at a
significantly cheaper price. They work on building up their inventory in anticipation of
potential price increases in the future.

Exceptions to the Law of Supply

Generally, the slope of the supply curve is upwards, showing that with the rise in the price
of a commodity, its quantity supplied also rises. However, there may be some cases when
there is no positive relationship between the supply and price of a commodity. These cases
are as follows:
1. Future Expectations:
The law of supply is not valid if sellers expect a fall in the price in the future. The sellers
will be willing to sell more in this situation, even at a cheaper price. However, if sellers
expect an increase in the future price, they will reduce supply to deliver the item later at a
higher price.
2. Agricultural Goods:
Agricultural products are exempted from the rule of supply as they are produced in
response to climatic circumstances. If the production of agricultural goods is low because
of unexpected weather changes, supply cannot be expanded, even at higher prices.
3. Perishable Goods:
Sellers are willing to offer more perishable commodities, such as fruits, vegetables, and
other foods, even if prices are dropping. This occurs because sellers cannot keep such
things for an extended period.
4. Rare Articles:
The law of supply does not apply to precious, rare, or artistic items. For example, even if
the price increases, the number of rare items like the Mona Lisa artwork cannot be
increased.
5. Backward Countries:
Due to the scarcity of resources, output and supply cannot be enhanced in economically
underdeveloped countries.

ELASTICITY OF DEMAND

Elasticity of demand is an important variation on the concept of demand. Demand can be

classified as elastic, inelastic or unitary.

An elastic demand is one in which the change in quantity demanded due to a change in price
is large. An inelastic demand is one in which the change in quantity demanded due to a
change in price is small.

The formula used here for computing elasticity of demand is:

(Q1 – Q2) / (Q1 + Q2) (P1 – P2) / (P1 + P2)

If the formula creates an absolute value greater than 1, the demand is elastic. In other words,
quantity changes faster than price.

If the value is less than 1, demand is inelastic. In other words, quantity changes slower than
price. If the number is equal to 1, elasticity of demand is unitary. In other words, quantity
changes at the same rate as price.

Types of Price Elasticity of Demand

 Perfectly elastic demand

 Perfectly inelastic demand

  Relatively elastic demand

 Relatively inelastic demand

 Unitary elastic demand

1. Perfectly elastic demand

Perfectly elastic demand is when the price is constant but there is a change in the demand i.e.
increase or decrease of a commodity. Thus, the demand curve is parallel to the X-axis.

Here, EP = ∞

2. Perfectly inelastic demand

Perfectly inelastic demand is when the demand is constant or there is no change in the demand
of a commodity even if the price changes i.e. increases or decreases.

Thus, the demand curve is parallel to the Y-axis. Demand for salt is an example of perfectly
inelastic demand.

Here, EP = 0

3. Relatively elastic demand

Relatively elastic demand is when the proportionate change in demand is more than the
proportionate change in the price.

In other words, this means that a little change in the price shall cause more change in demand.
Thus, the demand curve slopes downward from left to right. An example of this is luxury goods.

Here, EP ˃ 1

4. Relatively inelastic demand

Relatively inelastic demand is when the proportionate change in demand is less than the
proportionate change in the price.
In other words, this means that more change in price shall cause less change in demand. Thus,
the demand curve slopes downward from left to right but is steeper. An example of this is the
necessary goods.

Here, EP ˂ 1

5. Unitary elastic demand

Unitary elastic demand is when the proportionate change in demand is equal to the proportionate
change in price.

In other words, it means that the change in demand is the same as the change in price it may
increase or decrease.

Thus, the demand curve slopes downward from left to right but it is a rectangular hyperbola. An
example of this is comfort goods.

Here, EP = 1

Measurement of elasticity of Demand

1. Total Expenditure Method.

2. Proportionate Method.

3. Point Elasticity of Demand.

4. Are Elasticity of Demand.

5. Revenue Method.

1. 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 spent on it.

Total Outlay = Price X Quantity Demanded

There are three possibilities:

(i) If with a fall in price (demand increases) the total expenditure increases or with a rise
in price (demand falls), the total expenditure falls, in that case the elasticity of demand is
greater than one i.e. ED > 1.
(ii) If with a rise or fall in the price (demand falls or rises respectively), the total
expenditure remains the same, the demand will be unitary elastic or ED = 1.

(iii) If with a fall in price (Demand rises), the total expenditure also falls, and with a rise
in price (Demand falls) the total expenditure also rises, the demand is said to be less
classic or elasticity of demand is less than one (ED < 1).

This can be expressed with the help of a Chart.

formula to measure elasticity of demand:

In the Table we find three possibilities:

A. More Elastic Demand:

When price is Rs. 10 the quantity demanded is 1 unit and total expenditure is 10. Now
price falls from Rs. 10 to Rs. 6, the quantity demanded increases from 1 to 5 units and
correspondingly the total expenditure increases from Rs. 10 to Rs. 30. Thus it is clear
that with the fall in price, the total expenditure increases and vice-versa. So elasticity of
demand is greater than one or ED >1.

B. Unitary Elastic Demand:

If price is Rs. 6, demand is 5 units so the total outlay is Rs. 30. Now price falls to Rs. 5,
the demand increases to 6 units but the total expenditure remains the same i.e., Rs. 30.
Thus it is clear that with the rise or fall in price, the total expenditure remains the same.
The elasticity of demand in this case is equal to one or

ED = 1.

C. Less Elastic Demand:

If price is Rs. 5, demand is 6 and total outlay is Rs. 30. Now price falls from Rs. 5 to Re.
1. The demand increases from 6 units to 10 units and hence the total expenditure falls
from Rs. 30 to Rs. 10. Thus it is clear that with the fall in price, the total expenditure
also falls and vice-versa. In this case, the elasticity of demand is less than one or ED <1.

Diagrammatic Representation:

The total expenditure can be explained with the help of Fig. 7.

In the fig., there are three phases of the total expenditure curve.

Downward sloping (from A to D), (ii) Vertical (from D to G), (iii) Upward sloping (G to
J).

(i) Downward Sloping Curve

If the price- total expenditure curve slopes downward from left to right, it means the
elasticity of demand is greater than one. As we see in the diagram that when price falls
from Rs. 10 to Rs. 5 the total expenditure increases from Rs. 10 to Rs. 30. It means, there
is opposite relationship between price and total expenditure. The elasticity of demand in
this case is greater than one. Thus the curve from A to D represents the elasticity greater
than one or ED >1.
(ii) Vertical Curve.

If price-total expenditure curve is vertical or parallel to 7-axis, it means that with fall in
price from Rs. 6 to Rs. 5 the total expenditure remains the same. Thus, if total
expenditure does not change with the rise or fall in price, the elasticity of demand will be
equal to one. Thus, by joining points D and G we get vertical curve showing elasticity of
demand equal to one or Ed =1.

(iii) Upward Sloping Curve

If price-total expenditure curve rises upward from left to right, it means the elasticity of
demand is less than one. In the diagram, we find that when price falls from Rs. 5 to Re.
1the total expenditure also falls from Rs. 30 to Rs. 10. It means by joining G, H, I, J we
get an upward sloping curve showing elasticity of demand less than one or ED < 1. Thus,
it is clear that the changes in total expenditure due to changes in price also affect the
elasticity of demand.

2. 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. Its formula is as under:

Implications:
(a) This method should be used when there is a very small change in price and quantity
demanded.

(b) The coefficient of price elasticity of demand is always negative. It is because when
price changes, demand changes in the opposite direction. But by convention, we ignore
negative sign.

(c) The elasticity of demand is relative. It is not expressed in any unit rather expressed in
percentage or infractions.

3. Point Method:
This method was also suggested by Marshall and it takes into consideration a straight
line demand curve and measures elasticity at different points on the curve. This method
has now become very popular method of measuring elasticity. In this we take a straight
line demand curve, which connects the demand curve with both the axes OX and OY. In
the diagram OX axis represents the quantity demanded and OY axis represents the price.
4. Arc Elasticity of Demand:
“Arc elasticity is a measure of the average responsiveness to price change exhibited by a
demand curve over some finite stretch of the curve” Prof. Baumol

“Arc elasticity is the elasticity at the mid-point of an arc of a demanded curve” Watson

“When elasticity is computed between two separate points on a demand curve, the
concept is called Arc elasticity” Leftwitch

5. Revenue Method:
Mrs. Joan Robinson has given this method. She says that elasticity of demand can be
measured with the help of average revenue and marginal revenue. Therefore, sale
proceeds that a firm obtains by selling its products are called its revenue. However, when
total revenue is divided by the number of units sold, we get average revenue.

On the contrary, when addition is made to the total revenue by the sale of one more unit
of the commodity is called marginal revenue. Therefore, the formula to measure
elasticity of demand can be written as,

EA = A/ A-M
Where Ed represents elasticity of demand, A = average revenue and M = marginal
revenue. This method can be explained with the help of a diagram 12.

In this diagram 12, revenue has been shown on OY- axis while quantity of goods on OX-
axis. AB is the average revenue or demand curve and AN is the marginal revenue curve.
At point P on demand curve, elasticity of demand is calculated with the formula,

In this way, value of Ep is one which means that price elasticity of demand is unitary.
Similarly, if it is more than one, price elasticity of demand is greater than one and if it is
less than one, price elasticity of demand is less than unity.


ELASTICITY OF SUPPLY

Law of Supply states that, other factors being constant, quantity supplied increases with a
price increase and decreases with a decrease in the price of the commodity. The degree of
change in quantity supplied in response to changes in price is known as Price Elasticity of
Supply. Price Elasticity of supply undertakes how the supply of a particular product
responds to price fluctuations. There are five types of elasticity of supply; Perfectly Elastic
Supply, More than Unit Elastic Supply, Unit Elastic Supply, Less than Unit Elastic Supply,
and Perfectly Inelastic Supply.

Types of Elasticity of Supply

1. Perfectly Elastic Supply:

Price Elasticity of Supply is said to be perfect elastic supply when at a particular price,
there is infinite supply for a commodity, and with even a small change in its price, the
supply becomes zero. Perfectly Elastic Supply indicates that the suppliers are willing to sell
only when the prices of commodities are high. The price elasticity in this case is infinite;
i.e., ES = ∞, and the supply curve is a horizontal straight line parallel to the X-axis.
Quantity supplied can be OQ, OQ 1, or OQ2 at the same price as OP.
Price Supply
(in (in
₹) units)

20 150

20 250

20 350
The quantity supplied can be 150, 250, or 350 units at the same price of ₹20. However, it
must be kept in mind that perfectly inelastic supply is an imaginary situation.
.2 More than Unit Elastic Supply/Highly Elastic Supply:
Price Elasticity of Supply is said to be more than unit elastic when the percentage change in
supply is relatively greater than the percentage change in price. The price elasticity of
supply in such cases is greater than 1, i.e., ES > 1, and the supply curve intercepts on the Y-
axis.

The quantity supplied rises from OQ to OQ 1 with a rise in price from OP to OP 1. As QQ1 is
proportionately more than PP 1, the elasticity of supply is more than 1.
Price Supply
(in (in
₹) units)

20 200
Price Supply
(in (in
₹) units)

30 400

The quantity supplied increases by 100% due to a 50% increase in price.

3. Unitary Elastic Supply:

Price Elasticity of Supply is said to be unit elastic supply when a price change is precisely
equal to the change in quantity supplied. The price elasticity of supply is 1 in such cases;
i.e., ES = 1, and the supply curve is a straight line passing through the origin.

The quantity supplied rises from OQ to OQ 1 with a rise in price from OP to OP 1. As QQ1 is
proportionately equal to PP 1, the elasticity of supply is equal to 1.
Price Supply
(in (in
₹) units)

20 200

30 300

The quantity supplied rises by 50% due to a 50% increase in price.

4. Less than Unit Elastic Supply/Less Elastic Supply:
Price Elasticity of Supply is said to be less than unit elastic supply when the percentage
change in supply is relatively lower than the percentage change in price. Price Elasticity of
Supply is less than 1 in such cases; i.e., ES < 1, and the supply curve intercepts on the X-
axis.
The quantity supplied rises from OQ to OQ 1 with a rise in prices from OP to OP 1. As QQ1 is
proportionately less than PP 1, the elasticity of supply is less than 1.
Price Supply
(in (in
₹) units)

20 200

30 240

The quantity supplied rises by 20% due to a 50% increase in price.

5. Perfectly Inelastic Supply:

Price Elasticity of Supply is said to be perfect inelastic supply when the quantity supplied
does not change with the change in price. It shows that the supply would remain the same
irrespective of the price. The price elasticity in this case is zero; i.e., E S = 0, and the supply
curve is a vertical straight line parallel to the Y-axis.
Quantity supplied remains the same at OQ, with the change in price from OP to OP 1 to OP2.
Price (in
₹) Supply (in units)

10 30

20 30

30 30

The quantity supplied remains the same at 30 units, whether the price is ₹10, ₹20, or ₹30.
Measurement of Elasticity of Supply
The elasticity of supply is measured on the basis of slope in the nature of the supply curve.
There are three methods of measuring elasticity of supply, which are as follows:

1. Percentage Method:

According to this method elasticity of supply is calculated by dividing the percentage change
in quantity supplied divided by the percentage change in price.

Es = Percentage change in quantity supplied / Percentage change in price

Es = ( ΔQ/ ΔP ) x (p/q)

Where,
q = initial quantity supplied
p = initial Price
ΔQ = Change in quantity supplied
ΔP = Change in price
Es = Coefficient of elasticity of supply

2. Arc Method

The coefficient of elasticity of supply between two points on a supply curve is called arc
elasticity of supply. This method is used to measure the elasticity of supply when there is a
greater change in price and quantity supplied. According to this method, the elasticity of
supply is the coefficient of average between two points along a supply curve.

The figure below shows the measurement of elasticity of supply between two points A and B
along the supply curve SS.
3. Point method

The point method is used to measure the price elasticity of supply when there is a very small
change in price and quantity supplied. It is the measure of the percentage change in quantity
supplied in response to a very small percentage change in price. To calculate the elasticity of
supply at any point of a supply curve, the following formula is used:

Es = (ΔQ/ΔP) x (p/q)

Where,
ΔQ = Change in quantity supplied
ΔP = Change in price
p = Initial price
q = Initial quantity supplied
Es = Coefficient of elasticity of supply

The elasticity of supply depends upon the nature and slope of the supply curve, Therefore, the
measurement of elasticity of supply is varied as follows:

i. Point elasticity on a linear supply curve:

In the figure below, supply curve SS represents the linear supply curve and P is the point
where the elasticity of supply is to be measured. It shows that the initial quantity supplied is
OQ at the initial price OP. When the price increases to P1Q1, the quantity supplied increases
to OQ1. The supply curve SS meets at point A on the X-axis to the left from the origin.
Es at point B = (AQ/QB) X (QB/OQ)
Es at point B = AQ/OQ

The above equation shows that at point B, the price elasticity of supply is calculated by
dividing AQ by OQ. Hence, at point B, Es is greater than one or relatively elastic. Hence, it
can be concluded that:

a. If the supply curve meets the X-axis to the left of the origin, the price elasticity of supply
will be relatively elastic.

From the figure above;

Es at point B = AQ/OQ >1 (∵ AQ> OQ)

b. If the linear supply curve passes through the origin, the price elasticity of supply will be
unitary elastic or Es = 1.

In the above figure, the supply curve OS is passing through the origin. The supply elasticity
at point A is the ratio between OQ and OQ. Therefore, the supply elasticity at point A is
unitary elastic.

Es at point A = OQ/OQ =1 (∵ OQ = OQ)

c. If the supply curve does not meet Y-axis or if it meets X-axis rightward from the origin,
the price elasticity of supply will be relatively inelastic, ie. Es <1.

In the figure above, at point B, AQ is less than OQ. Therefore, the supply elasticity at point B
is inelastic or less than unity. The supply elasticity at point B is the ratio between AQ & OQ,
which is less than unity.

Es at point B = AQ/OQ < 1 (∵ AQ < OQ)

ii. Point elasticity on a non-linear supply curve

When the supply curve is a real curve, the supply elasticity is measured by drawing a line that
is tangent to the supply curve. When the tangent line cuts the X-axis, the supply elasticity will
be inelastic; when the tangent line cuts the Y-axis the supply elasticity will be elastic and
when the tangent line passes through the origin, the supply elasticity will be unitary elastic.
The measurement of supply elasticity on a non-linear supply curve can be shown in the figure
below:

In the above figure, SS is a non-linear supply curve. To measure elasticity at points E1,
E2,andE3, three tangents are drawn along the supply curve. i.e, BC, OD, and AF respectively.
The coefficient of price elasticity at various points are as follows:

a. Es at Point E1 = BQ3/OQ3 < 1 (∵ OQ3 > BQ3)

b. Es at Point E2 = OQ2/OQ2 = 1 (∵ OQ2 = OQ2)
c. Es at Point E3 = AQ1/OQ1 > 1 (∵ AQ1 > OQ1)

Factor influencing Elasticity of Supply

The following are the main factors, which influence the supply elasticity:

1. Nature of the commodity: The supply elasticity of durable goods is very high because
durable goods can be stored for a long time, The producers are not bound to sell them in the
market soon. The supply elasticity of perishable goods is low since perishable goods cannot
be stored for a long time.

2. Cost of production: If production is carried out under the condition of constant return to
scale, then supply can be expanded at the given price. In other words, this is a case of
relatively elastic supply. If production is carried out under the condition of diminishing
returns to scale (when the marginal cost rises as the production expands), then we have the
case of an inelastic supply.

3. Time element: In the long run, the supply elasticity will be relatively elastic because the
product can be increased in the long run. In the short run, the supply elasticity will be
relatively inelastic because the productive capacity is limited.

4. Producers' expectation: If producers expect a rise in the price of a commodity in the

future, they will cut down the supply in the present. As a result, the supply will be inelastic. If
they expect the price to fall, in the future, they will increase the present supply. Consequently,
the supply will become elastic.

5. Technical condition of production: Supply elasticity depends upon the technical

condition used in the industry. In all those industries, where large plants are set up and
production is carried out on a large scale, the elasticity of supply is very low because for
setting up huge plants, large capital and technical expertise is required which is not easily
available.

Thus, the supply of products in these industries cannot be increased easily. If the technology
is simple and capital equipment is less costly, the supply of the Product will be relatively
elastic.