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Demand and Supply Analysis

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    Deam DECCAN EDUCATION SOCIETY’S BRIHAN MAHARASHTRA COLLEGE OF COMMERCE DEMAND – SUPPLY ANALYSIS PROJECT REPORT Submitted for the partial fulfilment of requirement for BACHELOR OF BUSINESS MANAGEMENT IN INTERNATIONAL BUSINESS [BBM-IB] Degree Course under University of Pune GUIDANCE: Prof. Shiji Balan Madam A PROJECT BY: PRANAV S. BANSODE T. Y. B. B. M. (I. B. ) ROLL NO: 07 ACKNOWLEDGEMENT I Pranav Shrikant Bansode acknowledge that it was a pleasure to make the project and work it out.

    I have done this project report as per the syllabus and activities mentioned in the subject Project for third year of Bachelor of Business Management in International Business under the control of University of Pune. I hereby announce that I subjectively studied and took all the information required, by the literature of the economics like reference books and internet. I also assure that all the true and real data is provided in this report considering all the factors there of. And I abide to all the decisions taken by examiner. CERTIFICATE It is to certify that Pranav S.

    Bansode, a student of Third Year, Bachelor of Business Management in International Business, Brihan Maharashtra College of Commerce, Pune in the academic year 2010-11. Has done the project report as per mentioned by University of Pune. He has done all the activities under my guidance and supervision. Hence this project is held valid. MRS. BHARATI UPADHYE [Head of the Department BFT/ BBM-IB] Prof Shiji Balan Project Guide PREFACE I would like to mention that this project had given me real fun while doing. As well as it has taught me the actual on the basis of which the economies run and manage.

    Going in detail and analysing the theories really helped me to get the concepts clear and to get detail knowledge of the subject. It also gave me the practical implications and applications of the theories. I would like to thank all the instrumental part of this project. I would like to thank Prof Shiji Balan Madam and Mrs. Bharati Upadhye madam who guided me in many ways and gave their fruitful time whenever I needed it. They also gave me direction in which these projects should be done and how it can be implemented by us. I would like to thank all those authors of the books. This gave us detail knowledge of different aspect of the subject.

    I would like to thank them for their support. I would like to thank my parents for always supporting me to do well and motivating me in each and every step of my academic and personal life. I am confident that this project report will give us a lot to analyse and implement in the real life when we will be actually doing a job. At last, I would like to give humble thanks to all those who helped me directly or indirectly to build this project. Pranav S. Bansode INDEX * Main Page * Acknowledgement * Certificate * Preface * Index 1. Introduction 2. Utility a. Meaning b. Characteristics c. Measurement d.

    Neo-Classical Utility Theory e. Assumptions f. Total and Marginal Utility g. Law of Diminishing Marginal Utility h. Limitations i. Importance 3. Demand j. Meaning k. Factors Affecting Demand l. Individual and Market Demand m. Changes in Demand n. Law of Demand o. Assumptions p. Downward Slopping Demand Curve q. Exceptions to the Law r. Income Demand s. Cross Demand t. Demerit of Demand Theory 4. Elasticity of Demand u. Meaning v. Price Elasticity w. Classification x. Methods of Measurement y. Income Elasticity z. Classification {. Cross Elasticity |. Importance of Elasticity of Demand 5. Supply }. Meaning ~.

    Factors Influencing . The Law of Supply . Exceptions . The Elasticity of Supply . Factors Influencing Elasticity of Supply 6. Case Study of Gold . Gold’s Supply Demand Dynamics * Conclusion * References INTRODUCTION “Economics is a social science that analyses production, distribution, and consumption of goods and services. It deals with the allocation of scarce resources among alternative uses to satisfy human wants. ” Economics is a very broad term. Once Marshall wrote in his letters to Lord Keynes, the scope of the economics goes on increasing as we go as much as in detail but the basic idea in that remains the same.

    Most of the economists consider economics as material welfare or science of wealth. Economics can be considered as a science and an art too. Microeconomics and Macroeconomics are the two approaches to economic analysis. Ragnar Frisch was the first to use the terms “micro” and “macro. ” Microeconomics is the study of the economic action of individuals and small group of individuals. This includes the study of firms, households, prices, wages, incomes, industries, commodities. According to Maurice Dobb it is microscopic study of economy. In microeconomics we examine the tree not the forest.

    It the worm’s eye view of economic topic. Whereas macroeconomics is the study of aggregates or averages covering the entire economy. It includes topics such as employment, national income, national output, total investment, general price level etc. Let us come to our topic that is Demand Supply analysis. It is the analysis of the individual level. It comes under Micro economics. UTILITY As this project deals with demand and supply analysis on micro as well as on macro level it is imperative to study the term utility in detail. From this only the further studies can be explained and understood.

    A want satisfying power of the commodity is called as utility. It is a quality possessed by a commodity or service to satisfy human wants. It also can be specified as the value in use of a commodity because the satisfaction one gets out of that commodity is the value of the use of that commodity. TYPES OF UTILITY There are 7 types of utilities and the commodity can possess any of that. They are as follows: 1. Form Utility: When utility is created by changing the shape or form of the good it is known as form utility. Eg. A ply of wood is being shaped into chair. The raw sheet of wood is being developed to more useful chair. . Natural Utility: All the natural things or substances like water, air, sunrays, and minerals possess natural utility as we can use them to satisfy our need. 3. Place Utility: When commodities or services are transferred or transported from one place to other it gets place utility. Eg. Apples are grown in Kashmir very much though we can consume them in Pune. Hence in this case apples get place utility. 4. Knowledge Utility: When a commodity or any means leads to increase the knowledge of the user it derives knowledge utility. The best example of this newspaper, advertisement etc. 5.

    Time Utility: Many of the food grains are grown in only one season though we consume them the whole year. In these cases goods are stored at safe place and taken out when required. Eg: Raincoats may be produced the whole year but are sold only during rainy season. 6. Possession Utility: When commodities are changed from one person to other person, is known as possession utility. Eg: a blind person may own the study material which he can not read but if the same is given to a student he can use it. In this case the possession of the commodity increases utility to proper person and can satisfy a want. 7.

    Service Utility: When specialist renders service it may give service utility. Eg: Doctors, Lawyers etc CHARACTERISTICS OF UTILITY Every thing in this globe stands its own characteristics and scope, the salient features of Utility are as follows: 1. Utility and Usefulness: Anything which has utility does not mean that it is useful. If a commodity possess want satisfying power it has utility but consumption of that commodity may be useful or harmful. Two pegs of Vodka may give satisfaction to a drunkard. So it contains utility. But drinking alcoholic beverages harm to health hence they are not useful.

    Hence utility is different that usefulness. 2. Utility and Pleasure: Utility satisfies the want but it is totally different from pleasure. Utility of the commodity may derive pleasure or pain to the consumer. Vaccines or injections contain utility as they cure the illness of the consumer but they give pain, not the pleasure. Hence utility is different than pleasure and happiness. 3. Utility is Relative: Utility of the product changes as per the conditions. Hence it is the relative term for which it is being utilised. For Example, in olden days, Horses used to give utility but after the invention of scooter its utility has reduced.

    The umbrellas may give more utility in hilly region where there is more rainfall as compared to the plain area. 4. Utility and Satisfaction: Utility is want satisfying ability of the commodity. But still there is slight difference in both the terms. The clothes stored at the showroom possess utility. But we get satisfaction only when we purchase and wear them. Hence we can say that utility is the cause and satisfaction is the effect or result. 5. Utility is Abstract: Utility can only be experienced mentally. It can not be seen by eyes or touched by hands. Hence we call it as abstract.

    Eg: the syllabus taught by any professor can only be understood and inexpressible. Hence it is abstract. 6. Utility is Subjective: Utility is subjective and psychological concept. It changes from person to person. Eg: the sum of Rupees 1000 may be little for a person who owns Audi but it may be a lot to a beggar on the street. Utility of a glass of water may be high to a thirsty person as compared to a person who just drank water. MEASUREMENT OF UTILITY According to Marshall, the utility of a commodity can be measured in terms of money. If a consumer is willing to pay Rs 5 for an apple and Rs 2. for mango, then utility of an apple is Rs 5 and that of mango is Rs 2. 5 to him. It means the utility of an apple is equal to 2 mangoes. In other words, utility of an apple is twice as compared to mango. But this analysis does not hold when there are two different consumers offering two different prices for the same commodity. Suppose Amit offers Rs 5 for banana for which Aditya is prepared to pay Rs 3. The higher price paid by Amit does not mean that he gets more utility and Aditya gets less utility. Thus money does not measure him utility from a commodity. It simply measures the intensity of our desire for a commodity.

    Despite this weakness, money is used as a measure of utility. Cardinal and Ordinal Utility: These terms are basically of mathematics. The numbers 1, 2, 3, etc are cardinal numbers. According to the cardinal system utility of a commodity is measured in units and that utility can be added, subtracted and compared. For example if the utility of banana is 10, apple is 20 and mango is 40 then we can predict, that the utility of mango is twice of apple and 4 times of banana and so on. Ordinals are 1st, 2nd, 3rd, etc which may stand for 1, 2, 3 or 70, 65, 60 etc. they tell us that the consumer prefers the first to the second and the third and so on.

    But they can not tell by how much he prefers one to the other. Marshallian utility analysis is based on the cardinal measurement. Accordingly Hicks, utility cannot be measured cardinally because utility which a commodity possesses is subjective and psychological. THE NEO CLASSICAL UTILITY ANALYSIS The neo classical theory is given by Marshall, Pigou and others. It has cardinal measurement of utility. It is expressed as a quantity measured in hypothetical units which are called utils. If a consumer thinks that mango has 8 utils and apple has 4 utils, it implies that utility of a mango is twice as that of an apple.

    ASSUMPTIONS OF UTILITY ANALYSIS: The utility analysis is based on few of the assumptions and they are as follows: 1. The utility analysis is based on the cardinal concept which assumes that utility is measurable and additive like weights and lengths of goods. 2. There are no substitutes. 3. Utility is measurable in terms of money. 4. The marginal utility of money is assumed to be constant. 5. Consumers know the exact prices of various commodities and their utilities are not influenced by variations in their prices. 6.

    The consumer is rational who measures, calculates, choose and compares the utilities of different units of the various commodities and aims at the maximisation of utility. 7. The consumer must have the perfect knowledge of the choices of commodities open to him and his choices are certain. 8. Consumer has full information of the availability of commodities and their technical qualities. The whole Marshallian study comprising the Law of Diminishing Marginal Utility, the Law of Maximum Satisfaction, the concept of Consumer Surplus, and he Law of Demand is based on these assumptions. TOTAL UTILITY AND MARGINAL UTILITY

    Every commodity possesses utility for a consumer. When a person buys anything (Eg: Mangoes) he receives them in units 1, 2, 3, etc. to begin with 2 mangoes have more utility than 1, 3 mangoes have more utility than 2 and 4 mangoes have more utility than 3. The units of mangoes which the consumer chooses are in descending order of their utilities. In his estimation, the first mango is the best out of the lot available to him and hence that gives the customer the highest satisfaction, and accounts 20 utils. The second apple will naturally be the second preference and deliver lesser amount of utility that is 15 utils and so on.

    Total utility is the sum total of utility obtained by the consumer from different units of a commodity. In our example, the total utility of two mangoes is 35 utils, of the three mangoes 45 utils and of four mangoes 50 utils. Marginal utility is the addition made to total utility by having additional units of the commodity. The total utility of two mangoes is 35 utils, when the consumer consumes third mango the total utility becomes 45 utils. Thus marginal utility of the third mango is 10 utils. In other words, marginal utility of a commodity is loss in utility if one unit less is consumed.

    Algebraically, the marginal utility (MU) of a n units of a commodity is the total utility (TU) of n units minus the total utility of n-1. Hence, MU (n) = TU (n) – TU (n-1) All the above things can be easily explained and be understood in the following table and diagram. Units of Mangoes| Marginal Utility| Total Utils| 1| 20| 20| 2| 15| 35| 3| 10| 45| 4| 5| 50| 5| 0| 50| 6| -5| 45| 7| -10| 35| So as total utility is increasing, the marginal utility is decreasing upto the 4th unit. When total utility is maximum at the 5th unit, marginal utility is zero. It is the point of satiety for the consumer.

    When total utility is decreasing marginal utility is negative (unit 6th and 7th) these units give disutility or dissatisfaction, so it is no use having them. The same relationship is shown in figure. To draw the curves of total utility and marginal utility, we take the values from respective utility column and obtain pillars. By considering the tops of the bars we draw a smooth line we get TU curve. It increases from zero and at Q it reaches to the pick and then again slowly declines. To draw the MU curve we take the utils from MU column. The MU curve is represented by increment in total utility shown as the shaded part in the figure.

    When we join these heads we get the MU curve. So long as the TU curve is raising the MU curve is falling. When the former reaches the highest point Q the latter touches X axis at point C where MU is zero, when TU curve starts falling from Q onwards, the MU becomes negative from C onwards. Figure is drawn on graph given below. THE LAW OF DIMINISHING MARGINAL UTILITY Unlimited intensity is one of the most important characteristics of human nature. As we have more of any in succession, our intensity for its subsequent units diminishes or falls down. The generalisation of satiable wants is known as the Law of Diminishing Marginal Utility.

    Hermann Gossen was the first to formulate this law in 1854 but the name to this aspect was given by Marshall. Gossen stated it as, “the magnitude of one and the same satisfaction, when we continue to enjoy it without interruption, continually decreases until satiation is reached. ” Taking the example as given before, the rational human when consumes first mango derives the maximum satisfaction in terms of 20 utils. As he continues to consume the second and so on he derives less and less satisfaction. At the time of 5th mango when he consumes he reaches the satiety level when the satisfaction derived from that unit is zero.

    In the above mentioned graph, the MU curve explains this. It shows that marginal utility diminishes as more and more mangoes are consumed. Till the satiety point is reached, i. e. at C, after that the dissatisfaction starts when MU curve goes below X-axis. LIMITATIONS This is a universal law and holds true in the case of physiological, social or artificial wants. It is another thing that in the cases of certain commodities the limit of satiety is soon reached, while others take some time. The law will hold true only if following conditions. They are as follows: 1.

    Homogeneous Units: The units selected for the study should be homogeneous in the nature. It means the characteristics should be same in case of weight and quality. For Eg, if the first mango is sour and the second is sweet then the satisfaction derived from the second unit will be more. Hence it should be of the same taste and quality. 2. Continuity: There should be continuity of consumption of the product, there should not be a time lag between consumption of first unit and then second unit. Any thing consumed randomly may increase its utility. 3. Constant Prices: Prices of the commodity should be constant.

    Also the prices of the substitutes and competitors should be constant. 4. Rational Consumer: The consumer should be rational and wise person. He should not be mad or lunatic. He should not be under the influence of liquor or toxic material, due to this the mental condition of the consumer is not well and so the further consumption may give him more satisfaction than former. 5. MU Of Money Not Constant: Our intensity for money increases as we have more of it. The marginal utility of money never comes to zero. But definitely it falls when we have too much of it. But the marginal utility is less for rich person and more for poor person.

    Otherwise the rich would not have spent more on luxurious living. 6. No Change in Tastes: There should be change in taste, preferences, fashion, customs and income. Change in these things may increase the utility rather than decreasing it. 7. Suitable Size: The size of the commodity being consumed must be suitable. A thirsty person can not be feed with a spoon or bucket of water. This may give different result than decreasing the utility. 8. Indivisible Goods: The goods should not be indivisible. In case of consumer durable it is not possible to calculate its utility as it is spread over a long time.

    And moreover a consumer does not buy 6 cars or 10 air conditions as a time or one after one. 9. Ordinary Goods: The goods should be ordinary. The commodities like diamond, jewels, or hobby goods like coins, stamps the law does not hold true. The utility of additional jewel may be greater than the earlier pieces. But it may not be like this, if the collector gets the same stamp and coin for number of times then its utility diminishes. IMPORTANCE This law is important in many of the economic theories: 1. The law of diminishing marginal utility is the basic law of consumption.

    The Law of Demand, the Law of Equimarginal Utility, and the concept of Consumer Surplus are based on it. 2. The law helps to explain the phenomenon in Value Theory that the prices of a commodity falls when its supply increases. It is because with the increase in the stock of commodity, its marginal utility diminishes. 3. The principle of progression in taxation is also based on this law. As a persons income increases the rate of tax rises because the marginal utility of money to him falls with the rise in his income. 4. The changes in design, pattern and packing of commodities very often brought about by producer are in keeping with this law.

    We know that the use of the same good makes us feel bored; its utility diminishes in our estimation. We want variety in soaps, tooth pastes, pens, etc. hence this law helps in bringing variety in consumption and production. 5. The famous diamond-water paradox of Smith can be explained with the help of this law. Because of their relative scarcity, diamonds possess high marginal utility and so high prices. Since water is relatively abundant, it possesses low marginal utility and low prices even though its total utility is high. That is why water has low prices as compared to diamond though it is more useful than latter.

    DEMAND In the shortest way, demand is desire backed by ability to pay and willingness to pay, in given period of time. Demand is a function of price (p), income (y), prices of related goods (pr), and tastes (t). It is expressed as D= f(p, y, pr, t). When income, prices of other goods and tastes are given, the demand function is D= f(p). In the Marshallian studies the other determinants such as income, tastes, and substitute prices are given and considered constant. FACTORS INFLUENCING DEMAND The following mentioned are the factors which determine the level of its demand for the commodity by consumers. . Price: When price is low the more quantity is demanded and when the prices are high the lower quantity is demanded. And if the quantity is demanded more the prices are increased. 2. Income: If the income of the consumer is more the more is demanded by him and if his income is low then less is demanded by him. 3. Taste: When a consumer likes specific commodity, his demand for that is more. Eg: If the specific commodity is in fashion then the demand for that will be more though the prices are more. But the fashion has gone out then it will be demanded less at lower prices too. . Prices of Other Commodities: In this we have three kinds of distinction. A. Substitutes: When rise in price of one commodity leads to increase in demand for other commodity, those two commodities are called substitutes. Or we can say substitutes are those commodities which satisfy similar wants. Eg: Tea and coffee. When prices of coffee increase the demand for that decreases and at the same time the demand for tea rises. This is because the consumers of coffee shift their demand to tea and vice versa. B. Complementary Commodities: In this case the demand for two products is ependant on each other. They are linked to each other and known as complementary commodities. Eg Car and Petrol, Tea and Sugar. These are the commodities which can not be used without each other. Illustration: When the price of cars increases its demand decreases and with that the demand for petrol also decreases. But if the prices of cars decrease, it becomes cheaper and its demand rises and with that the petrol is also demanded more. C. Unrelated Goods: If two commodities are unrelated say television and butter, the change in price of one commodity does not affect the demand for other commodity.

    AN INDIVIDUAL DEMAND It is the consideration of the quantities demanded by a single consumer in the market. Individual demand refers to the quantity demanded by him at different level of prices, when other things are being considered constant, i. e. prices of other goods, income, tastes, etc. The individual demand is explained by demand schedule and curve. Demand Schedule is the list of prices and quantities demanded in numerical terms and the demand curve is the graphical representation of the same data. The below given is the individual demand schedule: Price (in Rs)| Quantity (Units)| | 10| 5| 20| 4| 30| 3| 40| 2| 60| 1| 80| The demand schedule speaks that when price is Rs 6 the quantity demanded is 10 units but when price falls to Rs 4 the same commodity is demanded 30 units and so on, the fall in price leads to increase in quantity demanded. The demand curve for the same is drawn on graph number two. The curve DD1 is the outcome of the above schedule of individual demand. Dotted points P, Q, R, S, T, and U show the various price-quantity combinations. It is called as demand points by Marshall. And the curve and points move towards right side. THE MARKET DEMAND

    In a real market, it consists not of a single consumer but many consumers. The market demand for a commodity is depicted with the sum total of various quantities demanded by all the individuals at various prices. Let us consider an example, suppose, A, B, C are three individuals who purchase the same commodity. Three people have their demand schedules for a commodity at given price levels. The above can be explained with the schedule given below: Priceper Kg (Rs)| A’s Demand| B’s Demand| C’s Demand| Total Demand| 6| 10| 20| 40| 70| 5| 20| 40| 60| 120| 4| 30| 60| 80| 170| 3| 40| 80| 100| 220| 2| 60| 100| 120| 280| | 80| 120| 160| 360| This is the summation of all individual demands together. The 1st column and the 5th column is the market demand. In this, when the price is Rs 6 per Kg the quantity demanded is 70 Kg, and when the price falls the quantity increases gradually. At the last level, when price further falls to Rs 2 the quantity demanded is 280 Kg. The figure for this is drawn on graph no. 3 enclosed herein. CHANGES IN DEMAND The individual’s demand curve is drawn considering that price of commodity, prices of substitutes or complementary goods, income and tastes of the consumer remains the constant.

    If any of the above factor changes the whole demand curve changes. When money income of the consumer rises, and other factors remain constant, his demand curve will shift upward to the right side. He will buy more quantity of the commodity at the same price. As shown in the figure below, before the rise in his income the consumer is buying OQ1 quantity at OP price. With the rise in income his demand curve D1D1 shifts to right at D2D2, now he buys more quantity i. e. OQ2 at the same price OP. when consumer buys more of the commodity at a given price, this is called increase in demand.

    On the other side, if the income of the consumer falls his demand will fall and the curve D1D1 will shift to left side D2D2, he will buy less of the commodity at the same price. Before the fall in income the consumer was demanding OQ1 quantity but after the fall in income he will now demand OQ2 quantity at the same price OP. When consumer buys less of the commodity at a given price, it is known as decrease in demand. The movement along the demand curve takes place when there is change in the quantity demanded due to a change in the commodity’s own price. The following figure explains this in details.

    When the price is OP1 the quantity demanded is OQ1. With the fall in price there is downward movement of the same demand curve DD from A to B. this is known as extension in demand. When price falls and the more quantity is demanded that is known as extension in demand. On the other hand, if we consider B as the original demand, as the prices increases from OP2 to OP1, as this leads to fall in quantity demanded, that is from OQ2 to OQ1. The same demand curve moves upward from B to A. This is contraction in demand. When price rises and the less quantity is demanded that is known as contraction in demand.

    Hence we can say that demand curves are not stationary. They shift to right or left due to number of causes. There are changes in tastes, income, habits, fashion, price of the substitutes and complementary goods, as well changes in the price of the commodity. Its also depends on the expectations of the future regarding the changes in prices or incomes, also the change in age and sex composition. THE LAW OF DEMAND The law of demand express a relationship between the quantity demanded and its price. Marshall defines it as, “the amount demanded increases with a fall in price, and diminishes with a rise in price. In simple words, “other things remaining the same, more quantity of a commodity is demanded at lower price and vice versa. ” Hence it expresses inverse relation between price and demand. The law refers to the direction in which quantity demanded changes with a change in price. In the diagram, this is expressed in the demand curve which has downward slope which is negative throughout its length. The inverse price and demand relationship occurs due to other factors remaining the same. ASSUMPTIONS Same as the Utility analysis, the assumptions for the law of demand are A.

    There should be no change in tastes and preferences. B. Income should be constant. C. No change in customs. D. Commodity should not confer the distinction on consumer. E. There should be no substitutes. F. No change in prices of other products. G. No change in the quality of the commodity. H. Habits should remain unchanged. If all the above conditions are there then only the law will hold good or operate, any change in anyone of this will lead not to operate this law good. To explain this law the same example of individual demand can be taken into consideration. DOWNWARD SLOPING DEMAND CURVE

    After studying all the characteristics, assumptions and the law of demand, first question which comes to mind is, “why does a demand curve slope downward from left to right? ” the reason for this also clarify the working of the law of demand. Following mentioned are the reasons for the same. 1. The law of demand is based on the law of marginal utility. According to this law, when consumer buys more unit of a commodity, the marginal utility of that commodity continues to decline. Therefore, the consumer will buy more units of that commodity only when its price falls.

    When fewer units are available, utility will be high and the consumer will be prepared to pay more for the commodity. This proves that demand will be more at lower price and it will be less at a higher price. Hence demand curve is downward slopping. 2. There are different uses of certain commodities and services that are responsible for the negative slope of the demand curve. With the increase in the price of such products, they will be used only for more important uses and their demand will fall. On the contrary, with the fall in price, they will be put to various uses and their demand will rise.

    For instance, with the increase in the electricity charges, power will be used primarily for domestic lighting, but if the charges are reduced, people will use power for cooking, fans, heaters, etc. 3. Every commodity has certain consumer but when its price falls, new consumers start consuming it, as a result demand increases. On the contrary, with the increase in the price of the product, many consumers will either reduce or stop its consumption and its demand will reduce. Thus due to the price effects when consumers consume more or less of the commodity, the demand curve slopes downward. 4.

    There are persons in different income groups in every society but the majority is in low income group. The downward slopping demand curve depends upon this group. Ordinary people buy more when price falls and less when price rises. The rich do not have any effect on the demand curve because they are capable of buying the same quantity even at higher price. 5. When price of a commodity falls, the real income of the consumer increases because he has to spend less in order to buy the same quantity. On the other hand, with the rise in the price of the commodity, the real income of the consumer falls.

    This is called the income effect. Under the influence of this, with the fall in the price of a commodity the consumer buys more of it and also spends a portion of the increased income in buying other commodities. For instance, with the fall in the price of milk, he will buy more of it but at the same time, he will increase the demand for other commodities. On the other hand, with the increase in the price of the milk he will reduce its demand. The income effect of the change in the price of an ordinary commodity being positive, the demand curve slopes downward. 6.

    The other effect of change in the price of the commodity is the substitution effect. With the fall in the price of a commodity, the prices of its substitutes remaining the same, consumers will buy more of this commodity rather than substitute. As a result, its demand will increase. On the contrary with the rise in the price of the commodity its demand will fall, given the prices of the substitutes. For instance, with the fall in the price of tea, the price of coffee being unchanged. The demand for tea will rise, and with the increase in tea prices its demand will fall. EXCEPTIONS TO THE LAW

    In certain cases the demand curve slopes up from left to right i. e. it has a positive slope. Under certain circumstances, consumers buy more when the price of a commodity rises, the less when price falls, as shown in the following graph, curve D. The causes for the upward movement of the demand curve are as follows: 1. War: If shortage is feared in anticipation of war, people may start buying for building stock or for hoarding even when the price rise. 2. Depression: During a depression period, the prices of commodities are very low and the demand for them is also less.

    This is because of the lack of purchasing power with consumers. 3. Giffen Paradox: If a commodity happens to be a necessity of life like wheat and its price goes up, consumers are forced to curtail the consumption of more expensive foods like fish and meat and wheat being the cheapest food they will consume more of it. The Marshallian example is applicable to developed economies. In the case of an underdeveloped economy, with the fall in the price of an inferior commodity like maize, consumers will start consuming more of the superior commodity like wheat. As a result, the demand for maize falls.

    This is what Marshall called the Giffen paradox which makes the demand curve to have a positive slope. 4. Demonstration effect: If consumers are affected by the principle of conspicuous consumption or demonstration effect, they will like to buy more of those commodities which confer distinction on the possessor, when their prices rise. On the contrary, the fall in their prices, their demand falls as in the case of gold and stock. 5. Ignorance Effect: Consumers buy more at a higher price under the influence of the ignorance effect, where a commodity may be mistaken for some other commodity, due to deceptive packing, label, etc. . Speculation: Marshall mentions speculation as one of the important exception to the downward sloping demand curve. According to him, the law of demand does not apply to the demand in a campaign between groups of speculators. When a group unloads a great quantity of a thing on to the market, the price falls and the other group begins buying it. When it has raised the price of the thing, it arranges to sell a great deal quietly. Thus when price rises, demand also increases. INCOME DEMAND There are three types of demand. Out of them we have seen price demand. Now we will see rest of them.

    In this we will consider other things remaining the constant, the relationship between incomes of the quantity demanded of the commodity by the consumer. It is regarding various quantities of the goods or services that will be brought by consumer at various levels of income in given period of time. The things which are considered constant are price of the product, prices of substitutes, tastes and preferences, etc. the income demand function of a commodity is written as D= f(y). There is direct relationship between income and demand. The demand for the commodity rises with the rise in the income and falls with the fall in income.

    Let us see this in detail with the figure presented on graph below. When income is OI the quantity demanded is OQ. When income rises to OI1 the quantity demanded rises to OQ1. The reverse can be shown likewise. Hence the income demand has positive slope. This is in case of normal goods. Let us take an example of a person who is habitual to consume inferior goods. So long his income remains below a particular level of his minimum subsistence; he will continue to buy more of this inferior good even when his income increases with small increments.

    But when his income starts rising above that level he reduces his demand for the inferior good. The other figure on the same graph explains this. OI is the minimum subsistence level of income where he buys IQ of the commodity. Upto this level, this commodity is normal good for him so that he increases its consumption when his income rises gradually form OI1 to OI2 and to OI. As his income raises above OI1 he starts buying less of the commodity, for instance at OI3 income level, he buys I3Q3 which is less than IQ. Thus in case of inferior goods, the income demand curve ID is backward slopping.

    CROSS DEMAND Let us now take the case of related goods and how he change in the price of one affects the demand of the other. This is know as cross demand and represented as D= f (pr). Related goods are of two types substitutes and complementary. In case of substitute or competitive goods, a rise in the price of one good say A raises the demand for the other good B, the price of B remaining the same. The opposite holds in case of a fall in the price of commodity A when demand for B falls. Same case is explained with figure drawn on the graph. Figure (A) denotes the demand for substitutes.

    When price of good A increases from OA to OA1 the quantity demanded for commodity B also increases from OB to OB1. The cross demand curve CD for substitute goods is positive slopping. For with the rise in price of A the consumer will shift their demand to B since the price of B will be unchanged. It also assumed that other factors remain unchanged. In case of other two goods which are complementary or jointly demanded, a rise in the price of one good A will bring a fall in the demand for good B and also the fall in price of A will lead to raise the demand for B. he same is explained in the same graph in figure (B). When price of A falls from OA1 to OA the demand for B increases from OB to OB1. The cross demand curve for complementary goods shifts negatively downward from left to right like normal demand curve. If however two goods are independent, a change in price of A will have no effect on the demand for B. We seldom study the relation between two unrelated goods like mangoes and computers. Consumers are more concerned with price-demand relationship of substitute and complementary goods. DEMERITS OF UTILITY ANALYSIS OR DEMAND THEORY 1.

    Indivisible Goods: This theory or analysis fails to explain the demand for indivisible goods. The utility analysis breaks down in the case of durable consumer goods like televisions and cars. The individual buys such commodities one at a time and keeps it with them for long term duration like at least 5 years. So it in neither possible to calculate the marginal utility of one unit nor the demand schedule or demand curve can be drawn for such products. Hence utility analysis is not applicable to indivisible goods. 2. Unrealistic Assumptions: The assumption that the consumer buys more units of commodity when its price falls is unrealistic.

    On this main consideration the whole demand theory and utility analysis is based. It may be true in food products like apples or mangoes etc but not in the case of durable goods. The fall in prices of TV does not lead consumer to buy three TVs. It may happen that three cars are purchased by a rich person but he does not purchase same three cars, he may purchase three different models. But rich person does not do this due to fall in price; he does it as he has enough money with him to do so. 3. Inferior Goods: Utility analysis fails to clarify the study of inferior and Giffen goods.

    Marshall’s utility analysis does not clarify the fact as to why a fall in prices of inferior and Giffen goods lead to a decline in their demands. Marshall failed to explain this paradox because the utility analysis does not discuss the income and substitution effect of the price effect. This makes the Marshallian law of demand incomplete. 4. Income Effect, Substitution Effect and Price: The utility analysis does not study these aspects. This is the greatest defect. The utility analysis does not explain the rise or fall in the income of the consumer on the demand for the commodities.

    It thus neglects the income effect. The change in price of one commodity makes the change in the prices of other goods; utility analysis has failed to explain this substitution effect as it is based on single commodity model. When price of one commodity changes, there is change in the price of other related good and this point is not considered in utility analysis. For example, the price of good X falls, the utility analysis only tells us that its demand will increase but it fails to analyse the income and substitution effect of a price fall via the increase in the real income of the consumer. 5.

    Man is Rational: The utility analysis is based on the assumption that the consumer is rational who prudently buys the commodity and has the capacity to calculate the disutility and utilities of different commodities and buys only those commodities which give him greater utility. The assumption is also unrealistic because no consumer compares the utility or disutility from each unit of the commodity he is buying. While he buys it under the influence of his desire, tastes or habits. Moreover consumers’ incomes and price of commodities also influence his purchases. Thus the consumer does not buy commodities rationally.

    This makes the utility analysis unrealistic and impracticable. 6. Money: Marginal utility of money is not constant. The utility assumes marginal utility of money to be constant. Marshall supported this on the plea that a consumer spends only a small portion of his income on a commodity at a time so that there is an insignificant reduction in the stock of the remaining amount of money. But the fact is that a consumer does not buy one commodities but number of commodities at a time. In this way when major part of his income is spent on buying commodities, the marginal utility of remaining money increases.

    For instance, every consumer spends a major portion of his income in the first week of the month to meet his domestic requirement. After this, he spends the remaining sum of money wisely. It implies that utility of remaining amount of money has increased. Thus the assumption that the marginal utility of money remains constant is away from reality and makes this analysis hypothetical. The utility of money to poor is very high as compared to the rich. 7. Imperfect Measurement: Marshall measured utility in terms of money but money is an incorrect and imperfect measure of utility because the value of money often changes.

    If there is fall in value of money, the consumer will not be getting the same amount of utility of a homogenous unit of commodity at different times. Fall in the value of money is natural cause to the rise in prices. If two consumers spend the same amount of money at a time, they will not be getting equal utilities because the amount of utility depends upon the intensity of desire of each consumer for the commodity. This hold money measurement inadequate. As spending depends upon the money power available with the person to spend. 8.

    Single Commodity: The utility analysis is a single commodity model in which the utility of one commodity is regarded independent of the other. Marshal considered substitutes and complementary as one commodity, but it makes the utility analysis unrealistic. For example, tea and coffee are substitute products. When there is change in the stock of any product, there is change in marginal utility of both the products. Suppose there is increase in the stock of tea. There will not only be fall in the marginal utility of tea but also of coffee and vice versa.

    The effect of one commodity on other and vice versa is called cross effect. The utility neglects the cross effect of substitutes, complementary and unrelated goods. This makes the utility model unrealistic. 9. Utility can not be measured cardinally: The entire Marshallian theory is based on the hypothesis that utility is cardinally measured in ‘utils’ or in units and that utility can be added and subtracted. For example when a consumer takes the first chapatti, he gets utility equivalent to 15 units; from the second and third chapatti 10 and 5 units respectively.

    And when he consumes the forth chapatti marginal utility becomes zero. If it is supposed that he has no desire after the fourth chapatti, the utility from the fifth will be negative 5 units if he takes this chapatti. In this way, the total utility in each case will be 15, 25, 30 and 30 and after consuming the fifth chapatti the total utility will be 25. Besides the utility analysis is based on this assumption that the consumer is aware of his preferences and is capable of comparing them. For example, if the utility of one apple is 10 units, and of a banana is 20 units, and of an orange is 40 units.

    It means that the consumer gives twice the preference to banana as against apple and four times to orange. It shows that utility is transitive. But critics say that the basis of the utility analysis, that it is measurable, is defective because utility is a subjective and psychological concept which can not be measured cardinally. In reality it can be measured ordinally. After this many economists developed their own theories like, Hicks came up with two commodities and indifference curve approach of the demand analysis of the consumers.

    Also, Professor Samuelson gave Revealed Preference Theory of Demand. THE ELASTICITY OF DEMAND The concept of elasticity of demand is generally associated with the name of Alfred Marshall. Earlier we had seen that the law of demand was as qualitative statement of relationship between price of commodity and its quantity demanded. The law of demand did not specify any quantitative relationship between the two magnitudes i. e. between price and quantity demanded. The reason behind is, there is no any quantitative uniformity in the behaviour of various goods Vis a Vis changes in their respective prices.

    For example the 10% fall in the price of a commodity does not lead to 10% increase in its demand. If prices of salt, radio and cars are drastically reduced by 10% there will not be 10% rise in quantity demanded of each product. It may happen that quantity demanded for salt may rise only 2% but for radio it may be 15%. The point here is that the quantity demanded for some commodities are more responsive to a given change in price. This is what we call the commodity is more elastic or less elastic in terms of price.

    Elasticity of demand may therefore be defined as, “extend to which the quantity demanded of a commodity changes in response to a given change in price. ” It simple words we may call it is a sensitiveness of demand to changes in price. It is capacity of demand to expand or contract in response to given changes in price. Earlier we had discussed that demand for a commodity depends on price of that commodity, prices of related goods, income, taste and fashion. As these factors are not constant in the real market, there seems a continuous change and hence the demand for each and every commodity is elastic.

    In case of elastic demand, the quantity demanded of the commodity is highly sensitive or responsive to even a slight change in its price. And in case of inelastic demand, even a drastic change in price may not affect the quantity demanded in any appreciable manner. 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. ” The elasticity of demand is segregated in following three types, they are Price, income and cross elasticities of demand.

    Out of all these the price elasticity of demand is more important in our study. PRICE ELASTICITY OF DEMAND It is the change in the quantity demanded due to change in the price of the commodity. Dr. Marshall has defined this as, “it is the ratio of proportionate changes in the quantity demanded of a commodity to a given proportionate change in its price. It is the ratio of a relative change in quantity to a relative change in price. ” Prof Lipsey says, “Elasticity of demand may be defined as the ratio of the percentage change in demand to the percentage change in price. ”

    Let us consider that E stands for elasticity of demand. Then we get E= relative change in quantity / relative change in price In other words, elasticity is the percentage change in quantity divided by the percentage change in price. Let us consider the numerical to explain this phenomenon; percentage 3 is for quantity and 1 for prices. let us see that price falls by 1% so we get E= 3% / -1% = -3 now let us see that price rises by 1% and so the quantity demanded falls by -3% so we get E= -3% / 1% = -3 Hence E is always negative, as it is negative; the minus sign can be omitted.

    E is also called as the coefficient of elasticity of demand. If coefficient is greater than 1, demand is said to be elastic. If E is 1 then demand has unit elasticity. If E is less that 1 but more than zero, demand is inelastic. If E is zero, the demand is said perfectly inelastic. A zero coefficient means that a change in price is accompanied by no change at all in the quantity brought. If a change in the price causes an infinitely large change in quantity, then the coefficient is infinity. When the coefficient is infinity demand is said to be infinitely or perfectly elastic.

    CLASSIFICATIONS OF PRICE ELASTICITY OF DEMAND 1. Perfectly Elastic Demand: It refers to that situation where the slightest rise in prices causes the quantity demanded of the commodity to fall to zero and slightest fall in price causes an infinite increase in quantity demanded of the commodity. The demand in such case is hyper sensitive and the elasticity of demand is infinite. Hence it should be remembered that the cases of perfectly elastic demand cases are very very rare in real life situation. And it is more used in theoretical manners.

    The diagrammatic representation of the same in given on the graph below. In this case the demand curve is horizontally parallel to X axis. 2. Perfectly Inelastic Demand: It refers to that situation where even substantial changes in price leave the demand unaffected. In simple, the price may rise or fall considerably, but the quantity demanded of the commodity remains unchanged. The demand in such cases are insensitive or non responsive and the elasticity of demand is zero. Also like perfectly elastic demand, the case of perfectly inelastic demand is rare in daily life.

    In the diagrammatic representation of this case the demand curve is vertically parallel to Y axis. 3. Relatively Elastic Demand: It refers to the situation where a small proportionate change in the price of a commodity is accompanied by a larger proportionate change in its quantity demanded. Means little fall in price leads to large increase the demand and vice versa. Elasticity of demand here is said to be greater than unity. The diagrammatic representation can be explained as the elasticity demand curve slopes downward but does not touch X axis. As well it starts on Y axis. 4.

    Relative Inelastic Demand: Refers to the situation wherein a big proportionate change in the price of commodity is accompanied by a smaller proportionate change in its quantity demanded. A given large proportionate fall in price is followed by a smaller proportionate increase in demand and vice versa. In the diagram the elasticity of demand curve starts on Y axis and touches X axis. 5. Unitary Elastic Demand: It refers to that situation where a given proportionate change in price is accompanied by equally proportionate change in the quantity demanded. The fall in the price is followed by same amount of increase in quantity demanded.

    The elasticity of demand here is called equal to unity. The curve in this case is referred to as rectangular hyperbola. It has constant elasticity at every point. In the diagram the curve has downward slop from left to right. This is also very less in real life practice. METHODS OF MEASUREMENT OF PRICE ELASTICITY There are four methods by which economists measure the elasticity of demand. Let us see them one by one. 1. Percentage method: The price elasticity of demand is measured by comparing the percentage change in price with the percentage change in demand.

    The elasticity of demand is the ratio of the percentage change in the quantity demanded to the percentage change in price charged. Thus, Ep = % change in q / % change in p = (? q / q) / (? p / p) = (? q/p) x (p/q) Where q refers to quantity demanded, p refers to price charged and ? refers to the change. If Ep > 1 demand is elastic. If Ep < 1 demand is inelastic. Ep = 1 demand is unitary elastic. Suppose the price of price of the certain commodity declines from Rs 500 to Rs 400 each that is by 20% whereas demand goes up from 400 to 600 that is by 50%.

    Hence elasticity of demand amounts 2. 5 percent, which is a case of elastic demand. It has been generally observed that the demand for luxuries is elastic and for necessaries like food grains it is inelastic. It may be zero for essential commodities like salt. It is noted that the elasticity of demand is always negative but it is always taken as positive for easy calculations. The reason behind it is negative is that the demand and price have inverse relationship, when price rises demand falls and vice versa. INCOME ELASTICITY OF DEMAND

    Elasticity is general concept; it can be used be used wherever there is a functional relationship between variables. Now we will see, what is Income Elasticity of Demand? It is demand for a commodity shows that commodity changes as a result of a change in his income. It shows the responsiveness of a consumer’s purchases of that commodity to a change in his income. It may be defined as, “ratio of proportionate change in the quantity demanded of the commodity to a given proportionate change in the income of the consumer. The formula for the same is Change in the quantity demanded / change in the income of the consumer It concludes from the above formula that income elasticity of demand for a commodity will be high, if a proportionate increase in consumer’s income of 1% is accompanied by proportionate much larger increase in the demand for that commodity 5%. Hence the income elasticity will be equal to 5. Likewise, income elasticity of demand for a commodity will be low if 1% decrease in consumer’s income if followed by 5% decrease in demand the income elasticity will be 0. . Here we have to assume that price of the commodity and all other factors remain the same and only income of the consumer changes. As we know that, income rise is always positive and hence the income elasticity of the demand is positive. In short, changes in the consumer’s money income and his expenditure on any particular commodity are generally in the same direction. CLASSIFICATION OF INCOME ELASTICITY OF DEMAND Income Elasticity of Demand has been segregated under five heads. Let is see them in detail: 1.

    Zero Income Elasticity of Demand: This refers to the situation where a given increase in consumer’s money income does not result in any increase of the quantity demanded of the commodity. The quantity brought of the commodity remains constant despite the increase in the income of the buyer. It is expressed as Ei = 0. Here E stands for elasticity and i stand for Income. 2. Negative Income Elasticity of Demand: This refers to that situation where a given increase in the consumer’s income is followed by an actual fall in the quantity demanded of a commodity. This happens in case of economically inferior goods.

    In mathematical terms, it is expressed as Ei < 0. 3. Unitary Income Elasticity of Demand: In this the proportion of the consumer’s income spent on the commodity in question is exactly the same both before and after the increase in the income. The income elasticity of demand here is equal to unity. Mathematically unitary income elasticity of demand is expressed as Ei = 1. 4. Income Elasticity of Demand Greater than Unity: This refers to the condition where the consumer spends a greater proportion of his income on the commodity in question when he becomes richer and more prosperous.

    The income elasticity of demand is greater than unity in the case of luxuries. Symbolically, it is expressed as Ei > 1. If Ei is greater than 1, income elasticity of demand is said to be high. 5. Income Elasticity of Demand Less than Unity: In this situation, consumer spends smaller proportion of his income on the commodity in question when he becomes richer and more prosperous. The income elasticity of demand for a commodity becomes less than unity in case of necessaries, the expenditure on which increases in a smaller proportion when the consumer’s income goes up.

    Mathematically it is expressed as Ei < 1. If value of Ei is less than 1, income elasticity of demand is said to be low. In the following graph all types of income elasticity of demand curve are drawn and explained. CROSS ELASTICITY OF DEMAND The cross elasticity of demand is the percentage change in the quantity demanded of a good to the percentage change in the price of a related good. The cross elasticity of demand between good A and B is Eba = percentage in the quantity of B / percentage change in price of A (? qb/? pa) X (pa/qb) Cross elasticity of substitutes

    In case of substitutes the cross elasticity is positive and large. The higher the coefficient Eba, the better substitute the good are. If the price of butter rises, it will lead to increase in the demand for jam. Similarly a fall in the price of butter will cause a decrease in the demand for jam. Cross elasticity of Complementary Goods If two goods are complementary, rise in the price of one leads to a fall in the demand for the other. Rise in the prices of cars will bring a fall in their demand together with the demand for petrol. Similarly fall in the price of cars will raise the demand for petrol.

    Since price and demand vary in the opposite direction, the cross elasticity of demand is negative. There are many factors which determine the elasticity of demand, they are as follows: Degree of necessity, proportion of income spent on the commodity, existence of substitutes, habits and preferences, uses of the commodity, postponement, time, range of prices, joint demand, effect of distribution of wealth, technological factors. IMPORTANCE OF ELASTICITY OF DEMAND The concept of elasticity of demand is of great importance in the sphere of government finance as well as trade and commerce.

    Let us see each of them in detail: 1. Declaration of Certain Industries as Public Utilities: The concept of elasticity of demand enables the government to decide as to what particular industries should be declared as public utilities to be taken over and operated by state organ. Thus, an industry which is controlled by a private monopolist and the demand for whose products is inelastic is a clear case for being declared as public utility and being consequently, owned and operated by State. 2. Determination of Monopoly Price: To a monopolist the elasticity of demand helps in determining the price.

    If he is a monopolist, he will have to consider the nature of demand while fixing the price of his product. In case the demand of his product is inelastic, he can charge high price and sell a smaller quantity. If on the other hand, the demand is elastic, he will have to fix lower price so as to stimulate demand and thus maximise his monopoly on new monopoly or revenue. 3. Effects on the economy: The working of economy is affected by the nature of consumer demand. It affects the total volume of goods and services produced in a particular country. 4.

    Determination of the Foreign Exchange Rate: The concept of elasticity of demand helps the government in fixing an appropriate foreign rate of exchange for its domestic currency in relation to the currencies of the other countries. For example, before devaluing or revaluing domestic currency in relation to foreign currency, the government has to study carefully the elasticities of demand for its imports and exports. It is only through such a study that the government can have an idea of the likely effects of devaluation or revaluation of its currency on its balance of payments. . Economic Policies: Economic policies of the modern governments are also guided by the elasticity of demand. They have also to control business cycles and inflationary pressures and also check deflationary trends. For these purpose again, the nature of consumer demand will have to be taken into consideration. 6. Increasing Returns: When a particular industry is subject to increasing returns, the manufacturer may reduce the price of his product to develop the market so that he may be able to produce more and take full advantage of the economic of large scale production. 7.

    Poverty in Plenty: The concept of elasticity of demand explains the paradox of poverty in the midst of plenty. For example, a burn per crop of food grain instead of being a cause of agricultural prosperity may spell disaster if the demand of the commodity is inelastic. 8. Price Fixation: The individual procedure under imperfect competition has to consider the elasticity of the demand for his product when he fixes its price or contemplates a change in the existing price. He has to take into account the reaction or response of his customers in formulating his price policy.

    Likewise, the monopolist too has to study the elasticity of demand of his commodity before he fixes its price. If his product happens to have inelastic demand, the monopolist is in a position other things remaining the same, to fix a high price for it. The concept of elasticity of demand also helps the monopolist to practice price discrimination it the market. he must carefully study the elasticity of demand for his product in different markets before he can practice price discrimination. He can resort to price discrimination only if the elasticity of demand for his product is different in different markets. . Factors of Payments: The concept of elasticity of demand also influences the determination of the rewards for factor of production in a private enterprise economy. For example, if the demand for labour in a particular industry is relatively inelastic it will be easier for the Trade Unions to get their wages raised. The same remarks apply to other factors of production whose demand is relatively inelastic. 10. Economic and Taxation Policies: The concept elasticity of demand proves helpful to the government of every nation to frame economic as well as the taxation policies.

    The government has to take into consideration the elasticity of product before imposing statutory price control on it. Likewise, the Finance Minister has to consider the nature of elasticity of demand for a commodity before levying an excise tax on it. 11. Terms of Trade: It is possible to calculate the terms of trade between two countries only by taking into account the mutual elasticities of demand for each other’s products. The term of trade implies the rate at which one unit of domestic commodity will exchange for units of a commodity of a foreign country.

    While calculating the terms of trade, we have to consider the mutual intensities of demand for the products of the two countries. SUPPLY The supply curve is analytical tool to study the determination of prices and output of goods and services. By supply is meant the quantities of a commodity or services which a seller is willing and able to offer for sale at various prices during a given period of time. The higher the price, greater will be the quantity supplied by the producer and vice versa. Therefore the relation between price and quantity supplied is direct and positive. FACTORS INFLUENCING SUPPLY

    The quantity supplied of a commodity is not dependent upon its price alone but on a number of factors such as the prices of other commodities, the price of factor of production, the technology and the goals of the producers. And it is mentioned mathematically as SQ = f (pq, pa, pb…….. F1,F2,…….. G,T) Where S is supply of the commodity Q which is function of Price of the commodity Q, prices of other goods a, b: factors of production F1, F2: the goals of producer G and the technological factor T. Determinants of Supply 1. Price of the Commodity: Higher the price of the commodity, the larger will be the quantity supplied and vice versa. 2.

    Prices of other Commodities: A change in the prices of other commodity also affects the supply of the commodity. For instance, if price of good X rises the producer of good Y will produce less of Y and will produce more of X in order to sell more. 3. Prices of Factor of Production: If the price of any one factor of production i. e. labour or capital used in the production of a commodity increases, its cost of production will increase. As a result, its output will fall and the supply will be reduced and vice versa. 4. Goals of Producers: If producer aims at maximising profit, he will produce less of the commodity which involves large risk.

    A producer who aims at maximising his sales will produce and sell more. 5. State of the Technology: If new and improved methods of production are used, they tend to increase the supply of commodities. THE LAW OF SUPPLY The law of supply states that, other things being equal, the quantity supplied varies directly with the price of the commodity. When price rises, the quantity supplied rises, and when price falls eh quantity supplied also falls. ‘Other things being equal’ means factors that influence the market supply of a commodity. The assumption of the law is that all the factors affecting supply must be constant.

    The law of supply is explained with the help of a schedule and a curve. A supply schedule is a statement of various quantities of a given commodity offered for sale at various prices per unit of time. Below given schedule gives a hypothetical supply schedule for apples. Price in Rs| Quantity Supplied| 50| 400| 40| 300| 30| 200| 20| 100| 10| 50| The diagram for the same is given on the graph below. It can be explained as follows: We have a supply curve SS. The supply curve has a positive slope. It moves upward to the right. EXCEPTIONS The exceptions to the law of supply are as follows: 1.

    When prices are expected to fall much, seller will sell more in order to clear their stocks. This is in short run. 2. Over the long run, the supply is influenced by changes in cost which are, in turn, affected by changes in technology. 3. Changes in habits, tastes, fashions, weather and national and international disturbances also affect the supplies of commodities. 4. The rise in the price of a good or service sometimes leads to a fall in its supply. This happens particularly in the case of labour service. When wages rise to a level where the workers feel satisfied, they will work less than before in order to have more leisure.

    They will also have a tendency to educate their children rather than to send them to work. The supply curve in such cases is backward slopping. Again when wages increase the supply of labour reduces. THE ELASTICITY OF SUPPLY The concept of elasticity is also applicable to supply. The elasticity of supply is the degree of responsiveness of a change in price on the part of sellers. The coefficient of elasticity of supply is E = (change in amount supplied / amount supplied) / (change in price / price) = ? q / ? p X p / q Where q is quantity supplied and p is price and ? is the change.

    The coefficient of elasticity of supply is always positive. There are five cases of elasticity of supply. 1. Supply is relatively elastic when a given change in price causes a more than proportionate change in the amount supplied. 2. The elasticity of supply is unity when the change in amount supplied is in exact proportion to the change in price. 3. Supply is relatively inelastic when a given change in price leads to a less than proportionate change in the amount supplied. 4. Supply is called perfectly inelastic when a change in price causes no change in supply whatsoever. 5.

    When an infinitely small change in price leads to an infinitely large change in the quantity supplied, supply is perfectly elastic. The elasticity of supply is measured in point method. FACTORS INFLUENCING SUPPLY ELASTICITY There are few of the factors which determine the elasticity of supply. They are as follows: 1. Producers’ Expectations: If producers expect the rise in the prices in the future, they will cut down the supply today. As a result, the supply will be inelastic. On the other hand, if they expect the price to fall in the future, they will increase the present supply.

    Consequently the supply will become elastic. 2. Time Element: The longer the time period, the more elastic will be the supply of commodity. The shorter the time period, the more inelastic the commodity will be supplied. The supply of the commodity can be increased or decreased in the long run than in the short run. 3. Cost of Production: If the per unit cost of production increases at a faster rate than the rise in price, the supply will be inelastic. On the other hand, if per unit cost of production of a commodity increases very slowly in response to a price rise, the supply will be elastic. 4.

    Nature of the commodity: If a commodity is perishable, its supply in inelastic. This is because its supply cannot be raised or cut by a rise or fall in its price. On the other hand, the supply of a durable commodity is elastic because its supply can be changed with the change in its price. GOLD’S SUPPLY / DEMAND DYNAMICS The annual western world gold supply reported by the American press usually indicates a growth rate of approximately two percent. This is confusing, because the two percent is referring to the total gold produced since time immemorial (i. e. the total existent gold above ground).

    Several sources accord this amount to be approximately 119,000 metric tons (3. 8 billion troy ounces). Therefore, many researchers still have no clear idea of the real supply/demand dynamics. Recently, i had the good fortune to receive the South Africa chamber of mines of statistical data publication. What i found was as illuminating as surprising. For the purpose of this study certain less significant supply/demand factors are not considered here. on the supply side: central bank sales, old gold scrap, gold loans, forward sales, option hedging and implied disinvestment were not considered.

    On the demand side: central bank purchases, bar hoarding, gold loans, option hedging and implied investment are also  not  taken  into  account. our  specific  purpose  is  to  only  match  yearly  gold  mine  production  to  commercial  demand  for  fabrication – i. e. real supply and demand factors. It is evident that western world gold production (including CIS sales) during the last 11 years has been erratic — ranging from an increase of 17. 4% (1986) to a decline of 5. 8% (1991). For the most part erratic production during the decade may be blamed upon the vagaries of Russian CIS mine mismanagement and political instability.

    Whereas the 11-year (1985-1995) annual western world gold supply compound growth rate was 3. 4%, production during the most recent five years has declined 1. 5% per annum – virtually flat. Furthermore, there is scant hope that the 1997 production will rebound. In view of the fact the world’s largest gold producer (South Africa) has suffered substantial production declines in the last two years, it is quite possible this year’s total western world’s mine production will again be flat to down. ANNUAL  WESTERN  WORLD  GOLD  SUPPLY  (A) + (C)| Y E A R| ANNUAL MINE PRODUCTION (B) Metric Tons)| ANNUAL PRODUCTION GROWTH RATE  (%)| 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996| 1382 1446 1698 1686 1814 1948 2145 2020 1947 2089 2069 1992 2064 (D)| 13. 8 4. 6 17. 4 (0. 7) 7. 6 7. 4 10. 1 (5. 8) (3. 6) 7. 3 (1. 0) (3. 7) 3. 6 (D)| Observation of the annual western world gold demand table (below) provides a picture of moderate consumption growth – albeit erratic. Nevertheless, the annual compound demand growth was 6. 3% for the 11-year period (1985-1995). However, demand grew at a slower 3. 9% compounded annually during the most recent five years.

    Although at first glance this seems rather modest, it is relevant to notice that demand is growing, while mine production is virtually flat to down. looking at the entire 11-year span demonstrates that gold demand is increasing 1. 9 times faster than the supply’s yearly compound growth rate (6. 3% versus 3. 4%). the third table depicts significant gold mine production shortfalls vis-a-vis mine supply. 1996’s production deficit is estimated at 1,119 metric tons, equal to 35% of total fabrication demand — and rising ANNUAL  WESTERN  WORLD  GOLD  DEMAND  (A) + (C)|

    Y E A R| ANNUAL CONSUMER DEMAND (B) (Metric Tons)| ANNUAL CONSUMER DEMAND GROWTH RATE  (%)| 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996| 1529 1571 1786 1688 1942 2340 2478 2590 2891 2763 2700 3007 3183 (D)| 1. 9 2. 7 13. 7 (5. 5) 15. 0 20. 5 5. 9 4. 5 11. 6 (4. 4) (2. 3) 11. 4 5. 9 (D)| Source: www. gold-eagle. com TODAY’S SITUATION As anticipated, 2010 was an outstanding year for gold; demand was strong in all sectors. Annual gold demand grew at the rate of 9% to 3,812. 2 tonnes, worth US$150bn.

    This performance was mainly attributable to higher jewellery demand, strong momentum in key Asian markets and a paradigm shift in the official sector, where central banks became net purchasers. CONCLUSION In today’s competitive world, for every businessman it is absolutely essential to study the individual demand and supply, to conduct his trade and achieve his goals of profit. The study of demand and supply also plays an important role in framing and regulating the pricing policy of the commodities. Hence this analysis of demand and supply is very important and helpful to the government.

    All the economic theories are based on demand and supply theories and hence it is the basis of the subject economics. It was a real pleasure to do this project and to get the understanding of the important factors of the subject economics. It has very wide scope and importance in many fields like, financial, academic and real life. REFERENCES * BOOKS * MICROECONOMIC THEORY M. L. Jhingan 5th Revised Edition Vrinda Publication, Delhi * MICRO ECONOMICS M. L. Seth Laxmi Narain Agarwal Publications, Agra * INTERNET * www. managementparadise. com * www. gold-eagle. com * www. indianexpress. com * www. wikipedia. org THANK YOU!

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